Layer 2s are the newest solution to hit the cryptocurrency market and are poised to alleviate the mounting transaction processing load, thereby enhancing scalability.
In “The Limits of Crypto and The Rise of Layer 2s,” Joel Hugentobler, Cryptocurrency Analyst at Javelin Strategy & Research, delves into the obstacles that blockchain networks are contending with, what Layer 2s are, and the risks associated with adopting this solution within a traditional business model.
Barriers Facing Blockchain Networks
Hugentobler’s report acknowledges the growing demand for block space. As the number of blockchain users grows, the volume also increases, contributing to network congestion. This ultimately leads to a drop in processing speed and a surge in cost.
“Bitcoin being the first to the market, the number of base-layer blockchains has proliferated over the years, and they’re all trying to solve this scalability issue,” Hugentobler said.
“But when they’re trying to solve these issues of cost or congestion and they’re changing the core design of the blockchain, they face what’s called the blockchain trilemma—which is really finding the balance of tradeoffs between decentralization, security and, and scalability.”
Layer 2s Defined
Layer 2 refers to a solution that is “off-chain” yet is constructed on top of the original blockchain to enhance scalability as well as performance.
“A Layer 2 is a separate protocol,” Hugentobler said. “But it really refers to the level of implementation of scaling solutions.
“There are a number of ways that different companies go about it, but they can be directly implemented on top of the blockchain itself, or as a separate function of a base layer. However, they’re still dependent on that base layer to finalize transactions.”
The main role of Layer 2 is to free the base layer of bitcoin or ethereum and keep it from becoming congested with any additional tasks outside of the execution and settlement.
Risk Inherent to Layer 2s in Traditional Business Models
With the adoption of any new solution, there is always the potential for risk, especially when that solution is integrated into traditional business models. It is no different for Layer 2s. As the newest solution to enter the cryptocurrency ecosystem, they carry the risks of users being unable to withdraw their funds or outright lose them if the solution isn’t implemented properly.
Second, a lot is involved when it comes to integrating Layer 2s within a traditional business infrastructure, including front and back offices. Lastly are the unending calls for government regulation to further advocate consumer protection.
According to Hugentobler, all these issues should be seriously considered as potential barriers to adoption by companies and developers looking to add Layer 2s into their business.
In his research, Hugentobler discovered that the transaction volume on the Lightning Network, a Layer 2 protocol, has seen better than a 200% compound annual growth rate since 2018. This points out the direction in which Layer 2s are headed. It is in line with the growing number of businesses and merchants accepting bitcoin payments by using the Lightning Network.
Learn more about how Level 2s can address blockchain issues and the barriers tied to implementing this solution for businesses.