When investing in various crypto tokens, it’s easy to get lost in the volatility and trends of the market. However, what many people forget (particularly those new to the space) is that investing in a coin is really investing in the project behind it. And, as with traditional investing, you should know exactly where you are putting your money.
Aside from the high-level messaging a project may put out, it’s essential to understand how each project fits into the broader ecosystem.
One of the easiest ways to begin categorizing different coins (and, in turn, different projects) is via the layering concept. You might have heard of layer 1 and layer 2 solutions, but what do “layer 1” and “layer 2” even mean in the first place — or “layer 0” and “layer 3” for that matter?
Let me break down the functional differences between each layer and why many players will talk about “layer1” and “layer2” solutions
Coincu uses a house analogy, that I found quite useful, so I’ll use it too.
Layer 0 is the concrete base of a house. Layer 0 technology provides the framework, through both software and hardware, for blockchains to be built upon. Think nodes and everything else it takes to connect them to transfer data, including protocols and other mining hardware. This layer is often dubbed the “Internet of Blockchains,” because multiple blockchains can be built on a single layer 0 network.
- Allows for interoperability (i.e., different blockchains built on the same layer 1 foundation can speak to each other)
- Dapps can be “cross-chain” if two chains are built on the same layer. (Huge plus for developers!)
- Integrates blockchain with a traditional network.
Examples: Polkadot, Avalanche, Cardano, and Cosmos
Layer 1 is the first floor of the house. L1s are the world’s Bitcoins and Ethereums, representing the blockchain as you probably know it. L1s use the L0 infrastructure to actually transfer the data. Each L1 has its own structure, including consensus mechanisms, ledger systems, coding language, and often has its own token. Essentially, L1 is where all the work happens to run the core functions of a blockchain, which takes the most energy to run.
- Layer1 is where the three main characteristics of a blockchain really start to come in: decentralization, open-source, and immutability.
- Each blockchain can run independently of any other chain.
- It has its own structure that defines how the chain is run and how data is transferred and recorded.
- Define protocols/standards to support decentralized applications (Dapps).
Examples: Bitcoin, Ethereum, Solona, Cardano, Tezos, Algorand
Layer 2 is the second floor (Nice to have, but not necessary for a blockchain to run). They are third-party integrations that are built on top of L1 chains to add efficiency (system throughput) or scalability. Layer 2 transactions are considered “off-chain.”
- Not to be confused with apps, layer 2 solutions are primarily built to solve L1 congestion by taking some of the transactions off-chain
- More flexibility for L2 nodes (i.e., they can be any number of servers owned by a company or an individual, rather than decentralized.)
- Rely on Layer 1 chains for security
Lastly, layer 3 is the rooftop and outer landscape. L3 adds the visual UI component, creating apps and utilizing blockchain technology to create applicable use cases for everyday users. They are often referred to as Dapps.
- Add ease of use to blockchain technology.
- Provide clear use cases for an everyday end user
- Key for mass adoption
Examples: Uniswap, curve, Opensea
You’ll most likely hear about these different layers regarding the solutions it provides.
Because layer-1’s have so much to process, speed and scalability are difficult to maintain. This is particularly true because improving scalability requires a sacrifice in security or decentralization (coined as the “blockchain trilemma by Vitalik Buterin). As more and more people join the blockchain community, it is becoming harder and harder for L1s to keep up with transactions. Users either end up paying astronomical fees or waiting hours, even days, for their transactions to be confirmed.
In turn, several solutions have popped up:
Types of layer 1 solutions: consensus protocol changes (like forks), sharding, changes in block size
Types of layer 2 solutions: State channels, nester blockchains, sidechain, Optimistic rollups, Zero-knowledge rollups, Plasma, Validium
There will be more on this later, but for now, you understand what each layer means and the different solutions they could provide.
There are many ways to slice and dice the different sectors of blockchain technology and its budding industry. As you continue to explore and learn, pay attention to the projects behind the tokens and be skeptical of projects just looking to sell tokens. Taking the time to understand the high-level tech behind each project and defining the utility the project stands to offer is the first step in making sense of all the noise in the blockchain industry.
(By Madison Mariani)