Layer-1 vs. Layer-2: What's the Difference

Layer 1 (L1) are decentralised networks where cryptocurrency transactions are carried out and transactional data is processed and stored – whether it’s transactions carried out by users of the layer 1 network itself or another crypto application built on top of it. These are usually blockchains, but can be other distributed database structures, such as directed acyclic graphs (DAGs).

In this article, we delve into the intricacies of Layer-1, how they work and the differences between Layer-1 and Layer-2 (L2). 

What is Layer 1?

Layer 1, also known as the protocol layer or blockchain layer, represents the foundational layer of cryptocurrency. This is because they provide the infrastructure for other crypto applications and protocols by processing all the transactions and events that are carried out within decentralised apps, acting almost as an operating system similar to iOS does for the apps on your phone. Ethereum is one example of a Layer 1 that acts primarily as an operating system for other decentralised apps to build on top of. 

Layer 1s may also in some cases be not only the foundational layer, but the only layer. For example, in a Layer 1 cryptocurrency like Bitcoin that is designed purely to be transacted as a currency and only process transactions made using their own network. 

At the core of a Layer 1 network is a consensus mechanism protocol that’s responsible for validating and recording transactions. This process ensures the record of transactions are secured and can’t be changed so they can be trusted by everyone participating in the network. The most well-known consensus mechanisms are Proof of Work (PoW) and Proof of Stake (PoS). 

Just as a sturdy foundation of a house supports the structure above it, Layer-1 networks provide the basic framework without which nothing else could be built. 

Layer-1 vs Layer-2: Understanding the Fundamental Difference

Layer 1 and Layer 2 represent distinct layers of cryptocurrency networks, each serving a unique purpose. 

Layer 1 serves as the foundational layer of crypto, where consensus protocols process and store transactions. These support their own cryptocurrencies, as well as decentralised applications (dApps) and smart contracts.

Layer 2 protocols, on the other hand, are there to support Layer 1 networks in their day-to-day operations and enable them to scale. They are built to increase the efficiency and security of the underlying Layer 1 network.

In some cases, Layer 1 networks face scalability hurdles that render them unsuitable for specific use-cases. For instance, a global supply chain management system might struggle to operate efficiently on the Bitcoin network due to its lengthy transaction times, or on the Ethereum network due to unfavourable fees. Nonetheless, these systems can still leverage the security and decentralisation offered by these networks. In such scenarios, the optimal approach is to build atop these networks with Layer 2 solutions, improving scalability while leveraging Layer 1 infrastructure.

For example, the Lightning Network, a prominent Layer 2 solution for Bitcoin, expedites transactions and reduces costs by processing them outside the main Bitcoin network before bringing them back into it. This approach not only addresses scalability issues but also harnesses the security and decentralisation inherent in Layer-1 blockchains, providing a comprehensive solution for diverse crypto applications.

Fundamental Elements of Layer-1 Blockchains

Block Production

In Layer 1 blockchains, miners or validators are responsible for validating and approving transactions. In a blockchain, for example, miners typically compete to solve complex mathematical puzzles to validate transactions and add them in batches to the blockchain. Validators, on the other hand, verify the validity of transactions and propose new blocks to be added to the chain based on predetermined consensus rules.  

Imagine each block as a page in a ledger of transactions and miners as rubber stamping each page and laminating it so it can no longer be edited. These blocks contain information about new transactions and refer back to previous blocks, creating a secure and unchangeable record of transactions.

Transaction Finality

Transaction finality ensures that once a transaction is recorded on the blockchain, it cannot be changed or reversed. The time it takes for finality or confirmation may vary, but transactions are only considered fully settled when confirmed on the Layer 1 blockchain.

Native Currency

Layer 1 blockchains have their own native cryptocurrencies, used for paying transaction fees and rewarding miners/validators and are referred to as coins. Examples include BTC, ETH, SOL and ADA. In contrast, cryptocurrencies that power decentralised networks and are built on top of Layer 1 blockchains are called tokens (UNI, LINK, GRT). 

Security

Layer 1 blockchains set the rules and mechanisms for ensuring the security of the network. This includes deciding on consensus mechanisms such as Proof of Work or Proof of Stake, as well as establishing rules for validator interactions. While other layers may provide some security features, Layer 1 blockchains are ultimately responsible for maintaining ecosystem security.

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*This information is not intended to be nor does it constitute financial, tax, legal, investment or other advice; nor is it a call to trade. The information is intended as general market commentary for information purposes only. Before making any decision or taking any action regarding your finances, you should consult a qualified Financial Advisor.