Many stories in the media are about how the Bitcoin Blockchain is inefficient. There are currently two methodologies for achieving blockchain scalability using solutions in Layer-1 and Layer-2 (like the lightning network). This article will explain the problem, what Layer 1 and 2 solutions are, their forms, and how they solve blockchain speed and efficiency issues.
Speed and Scale are the Issues
In our last Blockchain Introduction article, we learned the tremendous benefits that Blockchain technology offers, trustless interactions, decentralization, high levels of security, and immutable records. Blockchain has enabled the booming cryptocurrency and DeFi ecosystem with its ongoing technological innovation.
However, many blockchains, including Bitcoin, suffer from a scalability issue; reaching the maximum quantity of data that a blockchain can process due to its capacity (called throughput). Ideally, the throughput would be infinite transactions per second or TPS. To compete on an industrial scale, Bitcoin can look at the Visa the processing system, which claims a 24,000 TPS maximum but averages 1,700. Bitcoin has between 3-7 TPS, mainly due to its decentralization and privacy requirements that require time and processing power for mining, distribution, and validation.
Image courtesy of coinmarketcap
Bitcoin wishes to transform finance, but to do this it must have good throughput for every transaction. If Bitcoin’s scalability issue can be solved, then the industrial, financial, and general public’s acceptance of the Blockchain is more likely to provide Bitcoin’s safe and efficient benefits. Most scaling solutions must solve problems without the need for increased block size nor by introducing additional measures that tamper with a Blockchain’s decentralization and security.
To this end, there have been two types of solutions to solve the scale limitation problems; Layer 1 and Layer 2 solutions. In simple terms, a Layer-1 network solution refers to the Blockchain itself, while a Layer-2 protocol is a third-party integration, working in conjunction with the Layer-1 Blockchain. Let’s dig a little deeper.
Image courtesy of Petro Wallace
Layer 1 solutions help improve a Blockchain’s throughput by changing the rules of the protocol itself. Layer 1 solutions can entail protocol changes that increase the amount of data within each block or accelerate a block confirmation rate expanding the network’s throughput. These changes would generally lead to more minor improvements to the throughput unless they are a full protocol overhaul.
Significantly increasing the Blockchain’s throughput requires changes to the Blockchain’s consensus mechanism and how it processes data. Bitcoin uses a Proof-of-Work (PoW) consensus mechanism while Ethereum has chosen to shift to a Proof of Stake (PoS) mechanism with its Eth 2.0 upgrade. The PoS model is proving to support increased transaction speeds and better energy efficiency.
The ETH2.0 upgrade is also taking advantage of an added Layer 1 solution called Sharding. Sharding is a rework of a distributed database process brought into Blockchain. Sharding breaks the entire Blockchain into datasets called shards which is more manageable than nodes maintaining the network as a whole. The shards process data in parallel, allowing for simultaneous multiple transaction processing. The shards will interact with the main chain and one another, sharing addresses, balances, and states. Zilliqa, Tezos, and Qtum are already using a shards system, and Bitcoin could potentially benefit from this Layer 1 change.
Bitcoin’s Taproot Upgrade
In early November, Bitcoin will undergo a significant upgrade known as ‘Taproot.’ Taproot will be updating Bitcoin’s back-end code, intended to increase privacy, transparency, and fungibility. At the same time, Taproot is improving Bitcoin’s smart contract functionality. With Taproot, the Bitcoin Network will support decentralized finance applications, simple executable scripts, and oracle input data, much-needed increases in Bitcoin’s functionality.
Layer 2 solutions create an additional 3rd party protocol built on top of the Layer 1 blockchain. Their goal is the increase the Blockchain’s throughput while leaving the original rules and characteristics of the Layer 1 protocol in place. Layer 2 solutions will handle most of the processing and supply Layer 1 with the information to finalize the results. By Layer 2 taking the heavy processing load, Layer 1 is less congested and more scalable. The Lightning Network is the most notable Layer 2 throughput solution built on top of Bitcoin’s Blockchain (Layer 1) and discussed below.
Layer 2 solutions are mainly zero-knowledge rollups and optimistic rollups:
ZK-Rollups are bundles of data collateralized by a smart contract on the main chain while transported off-chain for processing and computing. The “Zero-knowledge” means that the verifiers can know that they have the same information, but the actual data is not disclosed. ZK-Rollups can produce a block in about one minute and have the goal to process 2,000 TPS, and the ZKSwap had over 100TPS in a recent pressure test. A possible step forward for Bitcoin especially adding a Smart Contract Functionality.
ORs have generally run on the Ethereum Layer 1 and are designed to process a more significant number of smart contracts without straining the Layer 1 protocol while benefitting from the Ethereum network’s security. An OR’s data aggregator will compute merkle roots (a way to ensure that data passed on a peer-to-peer network is whole) instead of the entire smart contract. ORs increase transaction speeds but are not as fast at ZK rollups. Lacking speed these may not be great as a Bitcoin Layer 2 solution.
The Lightning Network
Bitcoin’s Lightning Network is the best-known Layer 2 solution for Bitcoin. Lightning takes transaction bundles from Layer 1, deals with them off-chain, and transfers the resulting information back to the main chain in a ZK rollup fashion. The most significant benefit the Lightning Network adds is smart contracts to Bitcoin’s functionality which on its own cannot otherwise do and is a considerable improvement.
Image courtesy of blockonomics
Additional Solutions for Bitcoin
Sidechains are a hybrid of Layer 1 and Layer 2 scaling solutions, with an adjacent transactional chain processing large batch transactions. Sidechains incorporate their own consensus mechanism, different from the Consensus Mechanism of Layer 1 but using Layer 1 for security, batch transaction confirmation, and dispute resolution. A sidechain’s transactions are not private between users and are publicly recorded. Any sidechain security breach would not impact the Layer 1 main chain or other sidechains. Sidechain development requires effort and infrastructure to build and maintain. Being another blockchain itself, linked via a two-way-peg(2WP), a protocol allowing for cryptocurrency transfer between the two chains requires additional users’ trust. The Liquid Network is a Bitcoin sidechain that takes the processing away from the bitcoin blockchain.
Courtesy of sciencedirect.com
Short for “Parallel chains,” Parachains run parallel to each other in an interconnected blockchain system but are created within a similar framework, with the same security attributes and connected to a central relay chain. The chains can work independently, addressing their specific applications. Because workloads are spread efficiently, Parachains have breakneck transaction speeds. The most famous Parachain is Polkadot, with a potential 166,666 TPS. Bitcoin would need a huge overhaul to become a Parachain un unlikely solution.
The Plasma Layer 2 protocol similar to a sidechain built on top of Ethereum using secondary “child” blockchains in a “nested” blockchain model, assisting the Ethereum main chain in its verification process. Plasma chains are like Parachains or smart contracts but have a different hierarchal structure taking transactions from Ethereum and improving its scalability. Moving in this pattern:
Root Chain → Infrastructure → Plasma
A plasma type of solution is not likely for bitcoin in its present form.
Hashgraphs are a unique distributed ledger technology different from Blockchain. The only Hashgraph is the Hedera Hashgraph, a patented technology that considers itself a third-generation public ledger. Hashgraphs use events rather than blocks with 10,000 TPS, low fees, decreased energy usage, and faster processing times.
Image courtesy of Eric Wall
While Hashgraphs are interesting and Hedra is trying to be the future of distributed ledgers, this is not an application that could be applied to Bitcoin.
While Bitcoin’s Blockchain throughput remains slower than legacy systems like the Visa network, and its energy use remains significant, Bitcoin’s adoption by the masses will be hampered. Once these issues are sufficiently solved, both industry and the general public will be able to see the additional benefits of trustless transactions and improved security with a lower transaction cost that make Bitcoin a superior product. It is hard to predict if a Layer 1, Layer 2, or a combination of both will be the ultimate winner. Something does need to be done to ensure that Bitcoin remains the prominent choice of crypto investors. Whichever is chosen, they may not care particularly care, but the end-user will be the ultimate beneficiary of this technology.
Disclaimer: The author of this text, Jean Chalopin, is a global business leader with a background encompassing banking, biotech, and entertainment. Mr. Chalopin is Chairman of Deltec International Group, www.deltecbank.com.
The co-author of this text, Robin Trehan, has a Bachelor’s degree in Economics, a Master’s in International Business and Finance, and an MBA in Electronic Business. Mr. Trehan is a Senior VP at Deltec International Group, www.deltecbank.com.
The views, thoughts, and opinions expressed in this text are solely the views of the authors, and do not necessarily reflect those of Deltec International Group, its subsidiaries, and/or its employees.
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