What is a layer 2 blockchain and what is it used for?

In simplest terms, a layer 2 blockchain is a blockchain that is built on top of an existing blockchain. For example, Bitcoin and Ethereum are layer 1 blockchains and people build other chains on top of them. In this post I’ll explain why people created layer 2 blockchains and why you might want to invest or use some of them.

What is a layer 1 blockchain used for?

One of the main problems that the big layer 1 cryptocurrencies (Bitcoin & Ethereum) face is that everytime someone wants to add to the blockchain a bunch of computers have to do a bunch of math to make changes. (see “what are consensus mechanisms” to learn about why). 

You can think of a blockchain like a permanent notebook that people record information into. To make sure the notebook is secure and isn’t manipulated, thousands of people copy the notebook, word for word, into their own notebooks.

Now, imagine that you want to add a transaction to the notebook that says, “I am sending $10 to my friend Lily.” To record that you have sent that $10 to your friend, all these people have to confirm that the transaction took place and write it down in their notebooks to confirm it.

This makes layer 1 blockchains super secure and virtually unhackable, but it also comes at a cost.

Layer 1 blockchains work fine when there are a few transactions that people want to record, but when thousands of people want to all record transactions at the same time, the network gets clogged.

Say there are 100 people who want to record transactions, but only 5 people who can record those transactions. How do they decide whose transaction to record first?

This is when the transaction recorders (known as validators) auction their services to the highest bidder.

Now, in order to send that $10 to your friend Lily, you might have to pay a validator $80 to make the transaction happen. These are called “gas fees” which you can learn more about here. 

What are layer 2 blockchains used for?

To solve the problem of overcrowded blockchains like in the example above, people created “layer 2” blockchains. 

Layer 2 blockchains work by batching together transactions so that you don’t have to record every transaction individually. 

Let’s expand on the example above. Imagine you still want to send $10 to your friend Lily. If you did that transaction on a Layer 1 blockchain like Ethereum or Bitcoin, you might get charged $80 as a service fee because the network is super busy at the moment.

To avoid that steep fee, you can instead choose to make your transaction on a Layer 2 blockchain like Polygon.

Polygon will take your transaction and batch it with other people’s transactions. It might look something like this:

Sam sends $30 to Jason.

You send $10 to Lily.

Achint sends $32 to Max.

Esteban sends $7 to Victoria.

Sarah sends $87 to Alon.

Kelsey sends $13 to Brittany.

All these transactions will take place on the Polygon blockchain along with hundreds of others. Once Polygon has enough transactions, it will take that entire set of transactions and send it to Ethereum as just one transaction.

Ethereum will still charge the $80 transaction fee for recording this information, but that fee will now be split amongst hundreds of people. So, instead of being charged $80, you’ll now only be charged $0.30 for example.

Layer 2 Blockchain Examples

As the problem with Layer 1 blockchains becomes more apparent, more and more people are racing to create Layer 2 blockchains. A few more popular layer 2 blockchains are Polygon, Arbitrum, Immutable-X, X-Dai, and Optimism. 

Each of these cryptocurrencies is trying to solve the problems of Layer 1 blockchains. But, it should be noted that Ethereum is also looking to solve this problem by upgrading its own blockchain to what’s known as Ethereum 2.0.

Once Ethereum 2.0 comes out, it will make a lot of its limitations less of a problem. Layer 2 chains will still be needed of course, but maybe not to such an extent as they are now.