If you have tried DeFi recently, you have probably experienced the frustrations of high transaction fees. As the demand for DeFi services on Ethereum have increased, it has become “normal” to pay higher fees such as $20 per transaction or even several hundred dollars on occasion. If this blockchain scalability problem isn’t resolved, these transaction fees will act as a roadblock to the mission of banking the unbanked with permissionless finance, and in that case DeFi becomes more of a playground for the rich.
Thankfully research teams have been working for years on upgrades to Layer 1 with Ethereum as well as a series of Layer 2 solutions, which act as an overlaying network that lies on top of the Layer 1 chain.
Consider Ethereum first. It is the underlying blockchain architecture, Layer 1. If you’re reading this in 2021, Ethereum only recently launched Phase 0 of its long-awaited transition to Ethereum 2.0 and Proof of Stake, which will mean Ethereum no longer uses a Proof of Work consensus mechanism it currently shares with Bitcoin, enabling faster transactions, less electricity burned (reducing the carbon footprint of the network), reduced centralization risks, and a Layer 1 design that aims to be World War III resistant.
So what’s Layer 2 then?
Layer 2 is a collective term for solutions designed to help scale your application by handling transactions off the main Ethereum chain (layer 1). Transaction speeds slow when the network is busy hampering the user experience for certain types of dapps, especially in DeFi and those related to gaming. And as the Ethereum network gets busier, gas prices increase as transaction senders aim to outbid each other. This can make using Ethereum very expensive.
So to summarize, we need Layer 2 because:
- Some use-cases, like blockchain games, make no sense with current transaction times
- It can be unnecessarily expensive to use blockchain applications
- Any updates to scalability should not be at the expense of decentralization of security – layer 2 builds on top of Ethereum.
Without going into the weeds, some of the most common Layer 2 solutions that have been worked on for years are:
With all the brilliant minds working on these solutions, all you need to know is that you can expect many of your favorite DeFi apps to begin building on Layer 2 solutions, enabling near instant transaction settlement times for fractions of a penny in gas costs.
Synthetix is building with optimistic rollups on Optimism and has already begun testing with Synthetix users.
Loopring, a popular DEX built with zkRollups, has been live for over a year with over $35M in total value locked trading for fractions of a penny in gas costs.
Curve Finance, the largest stablecoin and like-assets AMM with just under $1B TVL, recently unveiled their first live demo on the zkSync L2 smart contracts testnet.
The key takeaway is that 2020 was about DeFi stretching Layer 1 to its limits, which led many in the community to finally understand firsthand just how badly we need Layer 2 solutions. The good news is that many teams with greater foresight have been working on this for years and it feels like DeFi is the final kick in the rear end we needed to get building Web3 applications on Layer 2.