author: collaborator date: April 16, 2022
- Layer 1 blockchain refers to the underlying blockchain architecture.
- Layer 2 blockchain refers to various protocols that are built on top of Layer 1 to enhance the functionality of the original blockchain.
- Layer 3 is represented by blockchain-based applications, such as decentralized finance (defi) applications, games, or distributed storage applications.
Reading: Bitcoin layer 2
bitcoin (btc) was originally conceptualized as a blockchain that would handle all the transactional requirements of its users using the underlying architecture of the network. however, it soon became clear that the underlying network is too slow and inefficient for modern digital solutions.
This is when the blockchain added another layer to support more efficient operations. As other blockchains like ethereum (eth) introduced the functionality of decentralized applications (dapps), the need for more layers in the platform was also perceived.
what are the layers of the blockchain?
Modern blockchains and solutions based on them are typically represented by three main layers.
layer 1 block chain
Layer 1 refers to the architecture of the underlying blockchain, i.e. the blockchain itself. in the case of bitcoin, it is the btc network launched in 2009.
layer 2 blockchain
Layer 2 refers to various protocols that are built on top of Layer 1 to enhance the functionality of the original blockchain. layer 2 protocols often use off-chain processing elements to solve the speed and cost inefficiencies of the layer 1 network. examples of layer 2 platforms for bitcoin include lightning network and network liquid.
layer 3 blockchain
Layer 3 is represented by blockchain-based applications, such as decentralized finance (defi) applications, games or distributed storage applications. many of these apps also have cross-chain functionality, helping users access multiple blockchain platforms through a single app.
what is bitcoin layer 1?
bitcoin layer 1 is the underlying btc blockchain with its key components and feature set. Layer 1 in Bitcoin includes the actual BTC transaction ledger, network nodes, and the block verification mechanism known as proof of work (POW). In short, Layer 1 Bitcoin is the real BTC network with its full functionality as it was introduced in 2009.
what are the disadvantages of layer 1?
Unfortunately, despite being a revolutionary technology, bitcoin has suffered from slowness and, in recent years, high transaction costs. For example, five years ago, in November 2016,the average transaction fee in bitcoinwas just $0.25. in November 2021, the fee is already around $5. furthermore, bitcoin’s proof-of-work (pow) block verification procedure consumes power and is slow. these factors mean that bitcoin has not been a particularly efficient network since its inception.
These technical inefficiencies gave rise to Layer 2 protocols.
What Is Bitcoin Layer 2?
Bitcoin Layer 2 refers to protocols with additional features built on top of Layer 1. This additional feature typically includes faster processing and lower transaction costs. Most Layer 2 solutions achieve technical efficiencies by processing most transactions off-chain and then transferring completed transactions to the underlying Layer 1 ledger in a batch mode.
Layer 2 protocols can be thought of as separate networks built on top of the main Layer 1 network. The second largest blockchain platform, Ethereum, has a wide variety of Layer 2 solutions. By comparison, the number of Layer 2 solutions actively held layer 2 for bitcoin is much more limited.
Notable layer 2 projects in bitcoin include the lightning network, the liquid network and the omnidirectional layer.
lightning network (ln) is a layer 2 bitcoin protocol that offers users a fast micropayment platform. while crypto payments made through layer 1, the btc chain itself, are slow and expensive, payments made through ln are executed very quickly and involve very transaction fees. low.
the average transaction on ln is confirmed in seconds and virtually all transactions are confirmed in less than a minute. By contrast, btc layer 1 transactions take several minutes to confirm on average, and some transactions can remain in an unconfirmed state for days.
average bitcoin transaction confirmation times have hovered around the 10 minute level for the past 3 years (source: blockchain.com)
fares are also much cheaper on ln. the average transaction fee on the platform is fractions of a cent.
ln supports micropayments down to minuscule amounts: the smallest transaction allowed is just 0.00000001 btc ($0.00068). this could be useful for businesses that reimburse or reward their customer base with small amounts of frequent micropayments. By comparison, the smallest amount you can transfer using btc layer 1 is 0.00000546 btc ($0.37), which is almost 550 times that figure.
ln effectively solves the btc layer 1 scalability problem, specifically in the area of high volume micropayments. Many digital businesses require the high-volume payment option, something that the underlying BTC network would not be able to execute efficiently. on the contrary, ln handles these types of large-volume payments with ease.
liquid network is another bitcoin layer 2 project. is a sidechain designed for merchants and cryptocurrency exchanges for fast processing and settlement of bitcoin transactions. in addition to btc, it also supports usdt transactions.
the platform uses the l-btc coin for network operations. liquid network is governed by a federation of 57 crypto platforms, many of them crypto exchanges.
some of the governing members of liquid network (source: liquid.net)
Typical transaction confirmation speed on the liquid network is around a minute, somewhat faster than btc layer 1, though not as fast as on the lightning network. transaction fees are also only a fraction of a cent on the dollar on average.
The liquid network is primarily used by merchants, crypto exchanges, trading desks, and issuers of crypto assets. asset issuers can launch stablecoins, security tokens and other crypto assets using the platform.
Not all layer 2 projects focus on the issue of speed and costs of the underlying btc layer 1 network. some other projects try to solve other limitations of btc. for example, omni layer is a layer 2 project that helps users create and trade custom crypto currencies and assets.
one of the oldest layer 2 projects, omni layer, was also the first widely known crypto platform to have a substantial ico, way back in 2013. omni layer, called mastercoin at the time, managed to secure half a million dollars in the ico.
omni currently hosts over 800 custom coins and tokens. Issuers of these assets can trade with each other using omnilayer exchanges. they can also freely exchange their coins with btc and usdt.
what is bitcoin layer 3?
Layer 3 is often referred to as the application layer. it is a layer that houses dapps and the protocols that enable the applications. while some blockchains like ethereum or solana (sol) have a wide variety of layer 3 applications, bitcoin is not optimized to host such applications.
As such, layer 2 solutions are the furthest deviations from the core network that bitcoin currently has. some projects are trying to bring dapp functionality to the btc ecosystem through forks of the original btc network.
layer 3 applications
for example, cakedefi is a defi application that offers services such as staking, loans and liquidity extraction to holders of btc coins. cakedefi is based on a fork of bitcoin called defichain. defichain maintains “an anchor” on the core btc chain for some of its operations, but technically speaking, it remains a separate blockchain on its own.
Some industry watchers believe the lack of dapp functionality is one of btc’s biggest limitations. Since the advent of Ethereum in 2015, Layer 3 platforms have grown strongly in popularity and value. ethereum currently has close to 3000 layer 3 applications. blockchain based defi applications are worth a total of $185 billion right now.
another leading blockchain,solana, hosts more than 500 layer 3 dapps, and the total value locked in the network’s defi applications is approaching $15 billion.
In comparison, btc does not have a working application that can be clearly defined as a layer 3 application. there is an ongoing debate as to whether projects designed to “force” dapp functionality into btc are worth it. some in the industry argue that btc will always remain a network designed for crypto fund transfers, not dapps.
these folks point out that the tier 1 btc chain enjoys an industry leading market cap ($1.3 trillion at the moment) which dwarfs all tvl market cap figures and of all existing Layer 3 projects combined. as such, bitcoin may not be in dire need of layer 3 functionality, at least judging by financial figures.
Blockchain platforms can have three different layers. layer 1 refers to the actual underlying blockchain, with its core architecture and functionality. examples of layer 1 networks are the bitcoin, ethereum, and solana blockchains.
Layer 2 are protocols built on top of Layer 1 networks and extend some functionality of the underlying blockchain. for example, they can offer faster speeds and lower transaction costs than Layer 1.
Layer 2 protocols often use a combination of on-chain and off-chain operations to deliver their extended functional capabilities. examples of layer 2 projects in bitcoin include the lightning network and liquid network platforms.
Layer 3 refers to the protocols that enable dapps on the blockchain. while other blockchains have a large collection of layer 3 applications, the btc blockchain does not have any of them. some projects try to bring layer 3 functionality to the btc ecosystem by using apps designed on forks of btc.
However, these apps are still based on their own blockchains, not the main btc blockchain. There is debate as to whether BTC even needs to move to enable Layer 3 functionality. Some industry analysts argue that BTC is worth several times more than all of these Layer 3 applications combined, and therefore has no pressing need for Layer 3. 3 at all.