Scaling Blockchain: All You Need to Know About Layer 1 and Layer 2
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Explore why the crypto industry is talking so much about scalability, what Layer 1 and Layer 2 are, how they work, and why they are useful solutions but still not perfect.
Why Do We Need Scaling Solutions?
Back in June 2010, the number of transactions occurring on the Bitcoin network didn’t surpass 100 per day. Now, in 2024, that number is nearly 500,000 transactions every day. Most blockchains have a limit on how many transactions can be processed at one time, which means users often have to wait and pay higher fees.
This situation is often compared with busy city roads that are always congested because they can’t accommodate the increasing number of cars. Similarly, when too many transactions happen simultaneously, the blockchain—just like our city streets—can become congested, slowing everything down.
The concept of scaling for blockchains began to gain attention after 2015 when experts proposed and implemented some of the first solutions. Nowadays, crypto projects keep exploring ways to make blockchain transactions faster and cheaper, and they have already made significant progress. Yet, many blockchains still have a long way to go. Traditional payment systems can process more transactions much faster.
Scaling solutions such as Layer 1 and Layer 2 help make the blockchain more efficient by managing the flow and speed of transactions.
What are Layer 1 Scaling Solutions?
Layer 1 scaling solutions are changes made directly to the blockchain’s protocol. These can include increasing block sizes, changing how transactions are verified through consensus mechanisms, or splitting the database into multiple parts (a method called sharding) to process transactions faster.
Here’s a look at some of the main types:
Increasing block size
How it works: By increasing the size of each block on the blockchain, more transactions can be included in a single block. This is like adding more lanes to a highway, allowing more cars to travel at once.Example: Bitcoin Cash (BCH), a fork of Bitcoin, was created to increase the block size to accommodate more transactions per block.First, a bit of history. Initially, Bitcoin’s anonymous creator, known as Satoshi Nakamoto, implemented a 1 MB limit on block sizes to protect the network against spam transactions. As Bitcoin became more popular, this size limit led to slower transaction times and higher fees, which caused a major debate among community members.Some believed Nakamoto saw this limit as temporary and advocated for larger blocks to handle more transactions, speeding up processing times and reducing costs.The disagreement led to a significant event in Bitcoin’s history: the creation of Bitcoin Cash via a hard fork in 2017. Bitcoin Cash initially increased its block size to 8 MB and later to 32 MB. Another variant, Bitcoin SV, expanded its block size even more to 128 MB.
Pros and cons of increasing block size:
Pros
- Faster processing: more transactions per block.
- Bigger blocks allow miners to process more transactions and earn more fees.
Cons
- Requires more advanced computing power, possibly pushing out smaller miners and centralizing the network.
- Bigger blocks can slow down the system during busy times.
Sharding
How it works: Sharding splits the blockchain’s data into smaller pieces, called shards, that can be processed in parallel. This means different nodes handle different transactions simultaneously. It’s almost like checkouts at a supermarket into multiple lines to speed up processing.Examples: NEAR is one of the projects that uses real-time sharding. Ethereum had plans to use sharding but switched to Danksharding, a Layer 2 solution.
Pros and cons of sharding:
Pros
- Increased transactions per second (TPS)
- Faster transaction speeds
Cons
- Sharding reduces the number of nodes in each shard, which can lead to centralization.
- Independent operation of shards can cause inconsistencies in data recording.
Consensus Algorithm Enhancements
How it works: A consensus algorithm in cryptocurrency is a set of rules that allows all the computers in a network to agree on the same data. This system ensures that every transaction is verified and added to the blockchain securely. Proof-of-work (PoW) and proof-of-stake (PoS) are two popular types of consensus algorithms.For instance, transitioning from PoW to PoS reduces the energy and time required for transaction processing.Example:Ethereum switched on its proof-of-stake mechanism in 2022 to improve scalability and reduce energy consumption. According to the Crypto Carbon Rating Institution data, Ethereum’s energy usage dropped significantly right after the update.
Pros and cons of changing consensus mechanism:
Pros
- Increased efficiency and speed
- Reduced energy consumption
- Enhanced scalability
Cons
- Complex transition process
- More vulnerable to certain types of attacks
- Centralization risks: validators are chosen based on their holdings
Segregated Witness (SegWit)
How it works: SegWit is a protocol upgrade that changes the way data is stored, allowing more transactions to fit within a block. It separates (segregates) transaction signatures (witnesses) from the rest of the transaction data.Examples:Litecoin adopted SegWit in May 2017. Bitcoin implemented SegWit in August 2017 to improve its scalability and adjust the size limit of blocks.
Pros and cons of SegWit
Pros
- Increased block capacity and reduced fees.
- Faster transaction verification.
- SegWit fixes transaction malleability, making it easier to implement Layer 2 solutions like the Lightning Network.
Cons
- Complex implementation.
- Not all parts of the network may adopt SegWit. It may lead to inconsistencies.
- SegWit’s introduction can cause a split in the community.
What are Layer 2 Scaling Solutions?
Layer 2 solutions are additional layers built on top of the main blockchain. It is much like adding express lanes or new roads that divert and manage traffic more efficiently without altering the main roads. They handle transactions outside the blockchain and then record the final outcomes back to the main chain. This way, they significantly reduce the burden on the network, allowing it to process transactions faster and cheaper.
After the March 2024 Dencun upgrade, which aimed to enhance the scalability of Ethereum, the second-largest blockchain, Ethereum’s transaction fees significantly dropped. One reason for the decrease was that more activities shifted from Ethereum’s main blockchain (Layer 1) to Layer 2 solutions and other blockchains.
Types of Layer 2 Solutions
Rollups
How they work: They bundle many transactions together on a Layer 2 chain and consolidate them into one transaction that gets sent back to the main Ethereum blockchain. This method splits the cost of the single, more expensive transaction among many users, making it more affordable and efficient than processing each transaction separately on the slower, primary blockchain.Examples: Optimistic rollups are called optimistic because they assume all transactions are valid unless proven otherwise. They’re ideal for applications that don’t require every transaction to be processed instantly because there may be a delay while waiting for possible fraud proofs.Zero-knowledge rollups (zk-Rollups) bundle many transactions into a single one and validate them using cryptographic proofs.
Pros and cons of rollups
Pros
- Increased scalability
- Reduced costs
- Transactions can be completed faster
Cons
- Zk-Rollups are complex and can be expensive due to the advanced technology required.
- Security and centralization risks.
- Some zk-Rollups may not support all types of Ethereum smart contracts.
Sidechains
Side chains operate parallel to the main blockchain, allowing transactions and smart contracts to be processed independently. Essentially, a side chain is a separate blockchain that is attached to the parent blockchain via a two-way peg, which allows assets to be securely moved between the main blockchain and the side chain.How it works:
Assets are locked on the main blockchain, and a corresponding amount is then released on the side chain. This allows the side chain to operate with its own independent consensus algorithm, which can be tailored to specific needs, such as faster transaction speeds or enhanced privacy. Transactions are processed on the side chain, and then the results or final state can be reconciled with the main chain.Examples: Liquid Network is a Bitcoin side chain, and Polygon is an example of a scaling solution for Ethereum.
Pros and cons of sidechains
Pros
- Transactions are finalized quickly, independent of the main chain’s processing times.
- It is possible to use advanced privacy measures. Users can make transactions anonymously.
- Security risks of sidechains don’t impact the main chain.
Cons
- Side chains don’t inherit the security of their main chains.
- It is difficult to transfer data between sidechains as they may not be compatible with each other.
- Risks of centralization.
State Channels
Side chains in blockchain technology allow users to make rapid, cost-effective transactions without overloading the main blockchain.How it works:
- Opening the channel: Users start by depositing funds into a smart contract on the main blockchain, like Ethereum. This acts as both a starting balance and a security deposit to ensure everyone acts honestly.
- Using the channel: Once the channel is open, participants can make numerous transactions among themselves. These transactions are not recorded on the main blockchain, which speeds things up and reduces costs. Instead, they sign and exchange these transactions privately, only updating the main channel state.
- Closing the channel: To close the channel, the last agreed state of transactions is submitted to the blockchain. The smart contract then checks this state, approves it, and returns the funds to the users based on the final transactions.
After numerous transactions, only the final state is submitted to the blockchain. This means instead of hundreds or thousands of transactions, only two transactions (one to open the channel, one to close it) touch the main blockchain, drastically reducing fees and congestion.
Pros and cons of state channels
Pros
- Reduced costs
- High throughput
- Privacy: Transactions within a state channel do not need to be broadcast to the public blockchain.
Cons
- All participants in the state channel must be continuously online to respond to state updates and disputes.
- Complex setup
- Adding or removing participants requires closing the current channel and opening a new one.
Nested Blockchains
A nested blockchain is a special kind of blockchain setup where smaller, individual blockchains operate under the umbrella of a main blockchain. This structure allows for more specific and localized processing, helping to manage tasks efficiently and keep the main blockchain less cluttered.How it works: In a nested blockchain system, the main blockchain oversees and connects several smaller chains, each responsible for specific tasks or operations. These smaller chains handle their own transactions and data but report back to the main blockchain, which ensures everything runs smoothly and securely.Example:The OMG Plasma project is an example of Layer 2 nested blockchain infrastructure.
Pros and cons of nested blockchains
Pros
- Enhanced scalability
- Efficient transaction handling
- Reduced main chain load
Cons
- Increased complexity
- Possible security vulnerabilities
- Dependency on the main blockchain
Conclusion: Layer 1 or Layer 2?
Both Layer 1 and Layer 2 scaling solutions can speed up transaction times and increase capacity. However, they also come with their trade-offs, often described by the scalability trilemma—balancing scalability, security, and decentralization.Layer 1 modifications directly enhance the blockchain’s core, but they can lead to security vulnerabilities and potentially centralize the network. Layer 2 solutions operate on top of the existing blockchain infrastructure. While they make daily blockchain use more efficient, they add complexity and can also centralize control because Layer-2 solutions are often operated by centralized entities.The crypto industry actively seeks ways to address these concerns and mitigate risks associated with centralization and security.
Eric Huffman 
Ihssan El Medkouri 
Connor Brooke 