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The first comment on the Bitcoin whitepaper, mentioned scalability as a potential problem for this type of decentralized solutions. Fast forward to a decade ago and we can all see that the problems of scaling are relevant to Bitcoin, and other cryptocurrency that want to be relatively decentralized and secure. We also specified this phenomenon in the article that explained The Blockchain Trilemma. While Bitcoin is using mostly Lightning Network or Liquid Network to solve this problem, Ethereum deals with it differently.
What are Layer 2 solutions?
Just like Bitcoin’s Lightning Network, Ethereum is also trying to develop Layer 2 solutions to lower the transaction costs and increase the transactions speed, while keeping the same level of decentralization and security. With transaction fees as high as 70 dollars (around May of this year), transactions on Ethereum were not only slow, but also extremely expensive.
This happened for several reasons. First of all, most of the DeFi projects are still built on Ethereum, which is also one of its main use cases. However, with the rapid growth of these DeFi solutions, Ethereum network slowly became clogged and transaction costs started to increase. And with the unprecedented growth of NFTs, which are just like DeFi, mostly built on Ethereum network, the whole network got into serious problems. According to some, that is also why so many “Ethereum killers” like Solana, Cardano or Polkadot were doing so well in the past few months. You can check ETH price and ADA coin price here.
The second biggest cryptocurrency is well established in this sector and is also supported by the increasing usage of its Layer 2 solutions. These solutions should specifically help with the scalability of the whole network, by bringing part of the transactions off chain (or on top of the original chain, since the Layer 2 solutions should be built as a network on the original network). Yet they stay on the Ethereum network via smart contracts, which simply means they are not migrating to other blockchains. The benefits of these solutions are higher transaction throughput, increase in speed of transaction and decrease in the costs of transactions.
Why are they important?
The reasons why Layer 2 solutions are important have already been aforementioned. However, there are many more benefits. For instance, in the case of Bitcoin, the Lightning Network offers fast transactions with low fees, and also enhances the security and privacy of transactions.
For Ethereum, the Layer 2 solutions are crucial to not only drastically decrease the high transaction costs, but to also increase its usability. Due to the high transaction costs, many use cases of Ethereum were not feasible during the time of expensive transactions. It made no sense having Microtransactions, in-game purchases or small rewards on Ethereum blockchain, if the transaction cost was drastically higher than the transaction itself.
Thus the Layer 2 solutions offer a great deal of benefits to Ethereum as well as the whole ecosystem, which encompasses a mixture of dapps, decentralized finance, NFTs and many others. Even Vitalik himself stated that the NFTs can be moved to Layer 2 solutions.
Testing phases and huge untapped potential
While the need for such solutions is more than obvious, its implementation and real life usage might not be so straightforward. Most of the Layer 2 solutions on Ethereum are only in testing phases or beta phases, which makes it increasingly difficult for “average Joe” to use them. Yet, the future seems really bright.
According to L2Beat, there are now at least 17 different Layer 2 solutions based on Ethereum. What is more important is its recent rise. L2Beat pointed out that the overall Total Value Locked (TVL) of these solutions rose by almost 300 % to about 3.5 billion dollars in the past 7 days.
This sharp rise in the total value locked is mostly associated with the project Arbitrum. Arbitrum is a Ethereum Layer 2 rollup network that has only seen a surge in TVL by almost 2,300 % in the past few days. At present, the project holds more than 2.5 billion dollars, more than two-thirds of the overall value of all the Ethereum Layer 2 solutions.
However, there are other projects that have been around for quite some time and are considered Layer 2 solutions with a bright future. These are for instance dYdX(check DYDX price here), Loopring or OMG Network. All of these serve a different purpose and their valuations are in the hundreds of millions (in case of OMG Network only in millions), which means that they have lots of room to grow. And as the fees of Ethereum network are around 5 dollars, (was priced at 20 dollars only a week ago), the need for Layer 2 solutions is still present.