Let’s Talk About L2s

Well, it seems that the crypto market simply will not stop. BTC seems determined to regain its ATH quickly and we have institutional players market buying BTC to cover their incredibly popular ETF products. Retail does not appear to have entered the arena yet, though the recent surge in Memecoins would suggest they are waking up from their 2-year slumber. When Retail investors do arrive, it should make for some interesting fireworks. Come what may, we will proceed with our agenda. In week 1 we spoke about Layer 1 Blockchains (“L1s”). This leads to the question, well are there layer 2 Blockchains also (“L2s”)?? In short, yes, and this article will explain some of the larger ones for you that live on Ethereum.

Differences between L1s and L2s – the Trilemma

L2s build on top of L1s allowing them to scale. They typically inherit the security of the L1 (Ethereum for the purpose of this article) while concentrating resources on providing utility and optimized scalability (Built in – i.e. speed).

L2s are a secondary blockchain network, which reduces the load on the parent chain (Ethereum in our case) by handling part of its capabilities. Think of Ethereum as CFO who is inundated with invoices for various items. He needs to (i) understand the purpose behind the invoice, (ii) confirm its authenticity, (iii) allocate it to an approved budget and then, and only then, (iv) approve payment and (v) ensure money is sent to the relevant creditor. A L2 in this case would be an efficient assistant who takes the bulk of the workload to their desk(s) (the L2 network) to process.

Of course, the final approval still comes from the CFO. So, the assistant will send the result of their work back to the CFO, who will add it to the final ledger upon his approval. Once approved, the transactions processed on the L2 network are then added to the main Ethereum blockchain.

Examples of L2s on Ethereum are (in no order of our preference):

  1. Optimism;;
  2. Arbitrum;
  3. StarkNet;
  4. ZkSync; and
  5. Polygon

In terms of features, L1 solutions typically consist of the following components:

  1. A network of nodes and block-producing miners;
  2. Storage of all transaction data; and
  3. A consensus mechanism.

(reference – https://layer3.xyz – go have a look at Linea Park quests for an airdrop while you are there).

The Trilemma is the raison d’etre for the existence of L2s. You can only have two out of the three elements of security, scalability and decentralization in any blockchain. So L1s give the L2 its security and decentralization allowing it to deliver scalability (i.e. speeeed!).

With respect to Ethereum case, the explosive growth in its use since 2015 has brought key scalability issues into sharp relief. The main issue you will hear about or have perhaps experienced firsthand is high transaction fees (gas fees). However, there is also network congestion, and slow transaction times during periods of high network activity – generally when a large and extremely popular NFT mint is happening, i.e. the worst possible time for users to have issues. Their transactions will probably fail, they will pay the exorbitant fees and the mint will mint out (sell out) while they are furiously refreshing the mint site, adding max Gwei (making the transaction even more expensive) and trying and failing repeatedly to successfully mint the NFT. Not the best user experience we can attest! While there have been some attempts to make transactions faster, Ethereum still needs scaling solutions built to handle the masses. Of course the NFTs could always just mint on an L2…. But that would be too easy no?

L2s do the heavy lifting of transactions that Ethereum cannot as it was not designed to prioritize speed (scalability in consultantspeak!), Ethereum was focused on security and decentralization. For context, Ethereum’s transaction processing capability stands at a mere 15 to 30 Transactions Per Second (TPS). Large payment providers like Visa and Mastercard can do 1,700 TPS. So clearly Ethereum cannot be the internet computer if it is so slow.

L2 Solutions on Ethereum

L2s mainly differ in how they reduce Ethereum’s transaction load. The most common types are sidechains and blockchain rollups.

Sidechains (and bridging)

Sidechains are independent blockchains with native tokens and consensus mechanisms whose purpose is to help scale the parent network. They connect to the parent blockchain using a two-way bridge that enables users to move assets to and from Ethereum. This process is known as bridging and can take anything from a few seconds to a number of hours (looking at you Linea) to complete. Sometimes the bridge is automatic, and the assets will just show up in your wallet when the transaction is confirmed. In other occasions, you will need to claim your asset onto the sidechain / parent chain – ahem… Linea! So, when bridging always send yourself the transaction hash if you need to claim your assets on the other end so you do not forget where they are as your assets will be knocking about the internet until they are claimed by you and then reflected in your wallet.

However, there’s no real transfer of assets between the two chains. Sidechains use something called a two-way peg where a smart contract locks up assets on the main chain (Ethereum) and mints a mirror image of the tokens on the sidechain (the L2). The value of these new assets is pegged to the assets on the original chain.

Blockchain Rollups

Blockchain rollups are L2 scaling solutions that “rollup” or bundle a number of transactions and then send them to Ethereum as a single piece of data. This network then adds this to an Ethereum block and confirms it.

Using the earlier analogy, the assistant carries the invoices to their desk, processes them, and compresses a big pile of paperwork into a single file. The assistant then sends that file, instead of the whole pile, back to the CFO (Ethereum). This way, the CFO has to deal with a fraction of the paperwork, which occupies less space on his desk. Therefore, as a user, you pay less gas fees because your transaction is grouped with many others and occupies less data space on the Ethereum block.

Tell me more!

  1. Optimism; Optimism (OP) Mainnet is a fast, stable, and scalable L2 built by Ethereum developers, for Ethereum developers. Built as a minimal extension to existing Ethereum software, OP Mainnet’s Ethereum Virtual Machine (EVM)-equivalent architecture scales (i.e. speeds up) your Ethereum apps without surprises. If it works on Ethereum, it will work on OP Mainnet at a fraction of the cost. With the recent spike in gas costs, over $100 USD worth of ETH to do a simple swap, this will drive users to the L2s.

OP Mainnet helps scale the Ethereum ecosystem by using optimistic rollups. Optimistic rollups assume that all transactions bundled together are valid unless otherwise proven. That means transactions are trustlessly recorded on Optimism but ultimately secured on Ethereum.

Optimistic what?

An optimistic rollup is a type L2 scaling solution that relies on off-chain computation to trustlessly record transactions that happen in L2. Periodically the system publishes a Merkle root of the transactions that happen within the rollup in order to update the “state” of the rollup on the main underlying blockchain. A network of external validators checks the Merkle roots to make sure that they are correct before the state is updated sometime later. If an inconsistency arises, then the validator can publish a fraud proof during the dispute period, which can cause the state of the system to be rolled back to the previous valid state. 

Merkle me this…

A Merkle root is a hash of all the hashes of all the transactions that are part of a block in a blockchain network. It is a simple mathematical way to verify the data on a Merkel Tree (defined below, breadth!). A hash is a function that converts an input of letters and numbers into an encrypted output of a fixed length. This is a clever way of saying the key that unlocks a safe that is full of transactions on a particular blockchain. A Hash is a one-way function. Think humpty dumpty falling off that wall, once he hits the ground and breaks, he is a Hash. You cannot reverse engineer a hash (All the King’s horses and all the King’s men cannot put Humpty back together again). So, if you have a use a function (a Hash) on the same data, the resulting Hash will be the same, so you can validate that the data is the same (i.e. not amended in any way) if you already know it’s hash. In other words, the same data will always create the same hashed value. A hash is developed based on the information present in a block header.

Merkle Trees are data structures comprising of a host of Merkel Roots. Trees have roots right! A Merkle tree totals all transactions in a block (data packet which strung together forms a chain… hence blockchain) and generates a digital fingerprint of the entire set of operations, allowing the user to verify whether it includes a particular transaction in the block.

A Merkle Root is outlined in the above diagram. This shows you a 3 level, 7 transaction blocks. The lowest level, transaction Ha Hb etc. is called the leaf level. There are 4 transaction hashes at this level. The level above (level 1), transaction Hab etc. has 2 transaction hashes and so on. You can see that on each level, each transaction hash connects with 2 more on the lower level.

At the top (level two), there is the final last transaction hash called the root, and it will connect to the two hashes below it (Hab and Hcc), (at level one). See here for more details: https://www.investopedia.com/terms/m/merkle-root-cryptocurrency.asp#:~:text=A%20Merkle%20root%20is%20a,whole%2C%20undamaged%2C%20and%20unaltered.

OP did an airdrop of their native token to users last year.

  • Arbitrum; Arbitrum is another rollup chain designed to improve the scalability of Ethereum. It achieves this by bundling multiple transactions into a single transaction, which in turn reduces the load on the Ethereum network.

Arbitrum’s native token is called the Arbitrum token, or ARB for short. The token serves as a means of governance for the protocol. Holders of ARB can participate in decision-making processes, such as proposing and voting on protocol upgrades or changes.

Arbitrum did an airdrop of their native token to users last year. They had quite a detailed campaign encouraging users to engage with the protocol.

A number of Perpetual DEXs are on Arbitrum such as https://app.gmx.io/#/trade and  https://gains.trade/trading as the transaction costs for placing a leverage trade on various crypto assets are minimal.

  • StarkNet; StarkNet is a permissionless decentralized L2 validity rollup, built to allow Ethereum to scale via cryptographic protocols called STARKs. It started out in 2018 and has just completed a rather underwhelming airdrop.

The StarkNet Token is needed to operate within the ecosystem.

  • ZkSync; zkSync is another L2 protocol that scales Ethereum’s security and values through zero-knowledge cryptography (this is where ZK comes from). This is one of the most hyped airdrops at the moment. zkSync is fully open source allowing anyone to see the code and fork (copy) it if they like. This openness promotes a lot of innovation in the space. It is something that quite a few blockchains do.

Zk rollups such as zkSync, produce a single cryptographic proof called “validity proof,” which attests to the validity of the transactions bundled together

  • Polygon; Polygon is by far the biggest L2 out there. It was the first L2 and it is a sidechain. Its core component is the Polygon Software Development Kit (SDK) that supports the developers to develop DApps on Polygon. You can use Polygon to create optimistic rollup chains, zero knowledge rollups, stand alone chains or anything a developer may wish.

Polygon is backed by Binance and Coinbase so it did not bother with an airdrop! 😊

Why so many L2s?

Well, you never know which one will actually work! Quite a few teams have spent years building on the shoulders of giants (Vitalik Buterin &Ors) to scale up Ethereum – the internet computer and bring it into your daily lives. The main use case we see for L2s at the moment is perp Dexs, gaming (on Polygon anyway – see their tie up with Nakamoto Games) and reduced swapping fees if the token you are looking for is also (or only) available on an L2. There are omnichain tokens coming in the not-so-distant future but we will look at them in a later article.

Contract exploit risk always hangs over a project so it is best for the industry that there are a number of large L2s out there. There are others not featured here – have a look here https://coinmarketcap.com/view/layer-2/ for more.  

In the News

Real Yield is rewards based on the performance of the protocol you are staking on. Put simply, income generated by token X is shared

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