What are Layer-2 Blockchains and Why Does Ethereum Need Them?

Introduction

Ethereum still reigns supreme in 2024 as crypto’s leading smart contract platform. There is growing competition from other layer-1 chains like Solana, Cardano, Avalanche, BNB Chain and the surging Tonchain, but no one’s quite ready to come for the king.

Ethereum was the first chain to enable decentralized applications (dApps), decentralized finance (DeFi), NFTs, and more, and it rightly deserves its reputation of excellence – a reputation that earned it spot ETF approval in 2024.

Ethereum always prioritized decentralization over scalability, never compromising. This led to major network congestion at times over the years, especially when its popularity surged. At periods of high demand, ETH transactions become slow and gas fees skyrocket. This remained true after the move from proof-of-work consensus to proof-of-stake in 2021 during ‘the Merge’. Ethereum’s failure to evolve in its early years saw co-founders like Charles Hoskinson and Gavin Wood leave the project (to found rival projects Cardano and Polkadot respectively).

Evolve it did. Finally. The early 2020s saw a slew of so-called Layer-2 (L2) scaling solutions come in, battling for crypto dollars and the ETH of DeFi investors in an ultra-competitive frontier. At present, the total Ethereum layer-2 ecosystem has captured a total value locked of over $40 billion in crypto, according to L2Beat.

With new entrants like ZkSync recently joining the fray, it’s the perfect time to take stock of the Ethereum layer-2 landscape to figure out what’s nice to know and what you actually NEED to know.

What are Layer-2 Chains?

Layer-2 blockchains are secondary networks built on top of Ethereum to offload transaction processing from the main Ethereum chain (Layer-1). By handling transactions on a separate chain, Layer-2s provide a faster and cheaper way to use Ethereum without compromising on the security of the base layer. You can think of Layer-2 chains as an efficient assistant that processes the bulk of Ethereum’s transactions separately, then sends the processed data back to Ethereum for final approval and addition to the Ethereum ledger.

The need for Layer-2 solutions stems from the blockchain trilemma: the tradeoff between decentralization, security, and scalability faced by all blockchains. By design, Ethereum prioritizes decentralization and security at the expense of scalability. With Ethereum currently processing only 15-30 transactions per second on its main network (compare traditional payment networks like Visa which handle 1700 TPS), L2 chains are crucial for Ethereum to scale and support mainstream adoption.

EIP-4844 drops Layer-2 transaction fees

A huge boost for layer-2s came in March 2024 when the network implemented EIP4884 during its Dencun upgrade.
EIP-4844, also known as ‘proto-danksharding’, is an Ethereum improvement proposal that aims to help Layer-2 solutions by introducing a new transaction format called ‘shard blob transactions’. These transactions allow Layer-2s to store large amounts of data on Ethereum at a dramatically lower cost, helping them to offer cheaper transactions and onboard more users to compete with ultra-cheap chains like Solana, thereby further improving Ethereum’s scalability and accessibility, as we can see in this Dune chart below.

Types of Layer-2 Solutions: Sidechains vs. Rollups

The two main categories of Ethereum L2 scaling are sidechains and rollups.

Sidechains

Sidechains are independent blockchains with their own consensus mechanisms and native tokens. They connect to Ethereum through a two-way bridge, allowing users to move assets between the chains.

Sidechains don’t actually transfer assets to Ethereum – instead they ‘lock’ the original tokens in an Ethereum smart contract and ‘mint’ pegged versions of those assets on the sidechain. Polygon is a prominent example of an Ethereum sidechain focused on scalability. Sidechains are no longer very popular, and the top ten layer-2 chains are all rollups.

Rollups

Rollups, on the other hand, keep transaction data on Ethereum. Rollups “roll up” or bundle hundreds of transactions together off-chain, then post a cryptographic proof of those transactions to ETH. By compressing transaction data in this way, rollups reduce the data footprint on Ethereum, resulting in lower fees.

There are two types of rollups:

Optimistic rollups assume transactions are valid by default, only running a fraud proof if a transaction is challenged.
Zero-knowledge (zk) rollups generate a validity proof for each rollup block, verifying the accuracy of the off-chain transactions.

Leading optimistic rollups include Arbitrum and Optimism, while examples of ZK rollups are Immutable X and zkSync. An advantage of optimistic rollups is EVM-compatibility: compatibility with the Ethereum virtual Machine that makes it easier for Ethereum developers to port their dApps to the rollup. However, ZK rollups can offer faster transaction finality and higher throughput.

Benefits and Use Cases of Layer-2 Networks

The core benefit of Ethereum L2s is massively improved scalability. Rollups like Arbitrum have achieved 40,000 TPS compared to Ethereum’s 15-30 TPS. This allows for near-instant transactions at a fraction of the cost of Ethereum base layer.

Major brands are turning to Ethereum L2s to make their Web3 initiatives viable. Starbucks chose Polygon for its Odyssey loyalty program to provide a seamless, low-cost user experience. Blockchain gaming, which requires high volume, low-latency transactions, is another growing use-case. ImmutableX is a ZK rollup purpose-built for NFT gaming with features like gas-free minting.

DeFi protocols are also expanding to L2s to offer users lower fees and faster settlement. Uniswap v3, Aave, and other top Ethereum dApps are now deployed on optimistic rollups. Even blockchain-powered social media platforms like Reddit’s Community Points and decentralized Eternal platform have launched on Arbitrum for cheaper costs and better scale.

And as layer-2 chains continue to blossom, we see task-specific layer-3 chains built on top of them in turn.

Top Ethereum Layer-2 chains in 2024

Tools like L2Beat and CoinMarketCap provide a wealth of excellent on-chain data about all the best layer-2s, which are worth mastering before you make any investments. Core metrics to grasp include total value locked (TVL), which means how much funds are contained within the project ecosystem, total active users and wallet addresses, and of course fully diluted value (FDV), which is total market cap of the layer-2 asset if all the coins to be issued were already in circulation.

Here’s a quick rundown of some of the best layer-2s right now. We’ll do a deeper dive in a follow-up article:

Dominant Ethereum’s L2 (*Credit: L2BEAT*)

Arbitrum One: Is a leading Layer-2 rollup that processes transactions off-chain. It achieves 40,000 TPS, reduces transaction costs, and has $17 billion TVL and 40% market share.
Optimism: Uses optimistic rollups (ones that assume valid transactions), creating faster processing and lower costs. It is compatible with Ethereum tools and contracts.
Base: Incubated by Coinbase, Base uses Optimism’s tech. Their stated aim is to create a ‘super-chain’. They have achieved an impressive $7.4 billion TVL since Nov 2023.
Polygon: Migrated from sidechain to zkEVM. Currently clocks 7,200 transactions per second at $0.01 average cost. Its accessibility for everyday use-cases is shown by the fact that Starbucks chose it to host their loyalty program.
Linea: EVM-compatible ZK rollup by Consensys, with higher throughput, and lower fees. Uses an innovative lattice-powered prover, zkSNARK tech, and no trusted setup.
Immutable: Designed for NFTs and gaming, Immutable uses zero-knowledge proofs, for fast, gas-free, carbon-neutral minting and trading, and offers a streamlined experience.
Ronin: Created by Axie Infinity team, Ronin achieves near-instant and low-cost transactions for gaming and NFTs, using proof-of-authority consensus.
zkSync Era: Uses zero-knowledge proofs for scalable, low-cost payments and smart contracts. It is accessible and user-friendly for various applications.
Starknet: Starknet is a ZK rollup that supports general-purpose smart contracts. It uses the Cairo language, is efficient and easy to use, and attractive for complex dApps.
Mantle: Built on BitDAO, BitDAO improves user experience for dApps, DeFi, and decentralized governance. It enables faster transactions and lower fees to drive adoption.

Is The Future Still Ethereum and Layer-2?

Ethereum L2s are not a replacement for the Ethereum base chain, but rather a complement to make Ethereum more accessible for users and developers. In return, they benefit from Ethereum’s battle-tested technology. Even with future Ethereum upgrades like sharding, L2 chains provide a powerful scaling solution that preserve’s Ethereum’s decentralization and security.

With benefits like sub-second settlement times, negligible fees, and improved capacity, layer-2 chains are key to bringing Ethereum to the masses and to drive the next wave of Web3 adoption.

However, layer-2s are not always that easy to use, and it can be burdensome moving funds across Ethereum layers and chains in order to transact and invest.

Disruptive and ultra-cheap chains like Solana, TON and SUI continue to offer growing competition for the Ethereum ecosystem in blossoming new fields such as memecoins, DePin, Real World Assets (RWA) and artificial intelligence. Therefore these developments – in particular, the arrival of the Base Network and Linea – should really help Ethereum retain its lead, thanks to the influence of Coinbase and the ease of use of its Base Wallet.

Add to that the innovation brought by ZK rollups like ZkSync, and it’s safe to say that Ethereum’s bull case and its stable of layer-2 chains remain intact. Read this year’s Van Eck report to see their crazy price predictions for 2030.

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What are Layer-2 Blockchains and Why Does Ethereum Need Them?

Introduction