Layer-2 Solutions, What Are They?

| November 17, 2023

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Layer-2 Solutions

The adoption and use of blockchain technology have increased dramatically in recent times, thanks to the myriad use cases and ease of value transfer it offers. Its ability to generate returns as a financial instrument has further contributed towards the rising popularity of crypto assets and underlying blockchain technology. The rising number of novel financial applications and increasing user base has led to a phenomenal increase in the number of transactions conducted over these blockchain networks, exceeding the parameters considered during their creation.

Increased transaction activity exceeding the throughput on blockchain networks like Bitcoin and Ethereum has, on many occasions, led to backlogs and long transaction confirmation times. With limited scalability in sight, slower transaction speeds and higher transaction/miner fees resulting from high demand have significantly affected the large-scale adoption of decentralized solutions by individuals and enterprises alike.

The scalability issues faced by most native blockchains are legacy problems that are deeply ingrained in their design, leaving little room for improvement without compromising on other crucial parameters like the degree of decentralization and security. As a workaround, Layer-2 solutions that work on top of the native blockchain protocol have emerged as a viable alternative. By offloading the majority of transaction processing activity to a secondary protocol, layer 2 solutions have made faster and cheaper transactions possible while ensuring that the records of such transactions are maintained and secured by the primary chain.

What is a Layer-2 Solution?

Layer-2 solutions are external blockchain protocols implemented over layer-1 blockchains like Bitcoin and Ethereum to offer increased throughput to these networks. Layer-2 blockchains work by handling the processing of transactions off-chain and help relieve network congestion from the layer-1 chains that are unable to scale and witness increased user activity.

Layer-2 protocols operate on independent consensus mechanisms as compared to the layer-1 mainnet but rely on the mainnet for transaction security. These scaling solutions process transactions rapidly using their consensus mechanisms and send them to the main chain as compressed data packets. On the main chain, the transaction bundles are processed and stored immutably at a fraction of the cost and time. Thus, layer-2 protocols improve the transaction rates of the blockchain network tremendously while relying on the robust transaction security of the layer-1 chain.

Why is Layer-2 Preferred Over Layer-1 Updates?

The immense popularity of off-chain or layer-2 scaling solutions lies in their easy implementation over existing blockchain networks. By using layer-2 solutions, the desired improvements can be attained without making any significant changes to the primary or the main protocol, thereby allowing users to enjoy the security and integrity offered by the main chain.

Improving existing layer-1 solutions by switching consensus mechanisms or implementing other changes is a painstaking process that often comes with its own drawbacks. Today, even though we have multiple layer-1 protocols that promise higher transaction throughput and seamless scalability, many prefer layer-2 solutions on legacy protocols over them, and for a good reason.

Newer blockchains are still in the process of gaining a strong user base, and for a decentralized system, its security and reliability depend on the extent of network participation. Meanwhile, using a widely adopted blockchain enhanced by an associated layer 2 scaling solution ensures that the record of all transactions is maintained in one form or another on a reliable, widely adopted protocol.

Hence, layer-2 solutions are looked at as an immediate means to scale for Proof-of-Work blockchains that look to preserve decentralization. Layer-2 solutions were in fact popularized by the Ethereum network much before it transitioned to PoS. Further, layer-2 solutions can exist in tandem with layer-1 solutions, providing exponential transaction throughput when combined.

Beyond offering scalability, layer-2 solutions have managed to provide various benefits to blockchain networks that witness high traffic. They have been able to reduce transaction fees drastically for users, which on networks like Bitcoin and Ethereum would sometimes amount to more than the funds being transacted. With faster speeds and lower fees also comes the opportunity for developers to offer new use cases to blockchain users, which are set to further drive-up adoption.

Types Of Layer-2 Solutions

The superior functioning of layer-2 solutions can be seen with some of the more popular off-chain scaling projects. For example, Lightning Network for Bitcoin and Optimism for Ethereum are making transacting on these networks convenient and allowing Ethereum developers to expand use cases on the programmable blockchain. These scaling projects incorporate various technical solutions like state channels and rollups to achieve their goals.

State Channels

State channels are multisig smart contracts on blockchain networks that allow transacting parties to create channels on which transactions occur off-chain without the need for the validation of all transactions. The first and the last transaction, however, are recorded on the main chain representing the initial and final states of the channel. By keeping the interaction with the layer-1 blockchain minimal, users spend a fraction of the transaction fees and experience fast transaction confirmations thanks to state channel protocols.

Multisig authentication on state channels prevents the wrong parties from entering transaction channels, keeping these protocols secure. The Lightning Network is the most popular state channel protocol allowing huge numbers of users to transact quickly and economically.

Rollups

Like state channels, rollups submit condensed amounts of data that aptly represents the entire bulk of transactions, limiting the resources needed by the mainchain to process and store transactions. They, thus, increase scalability and come in two different forms depending on how they function to scale layer-1 networks.

Optimistic Rollups

Optimistic rollups function by assuming that every transaction initiated on the layer-2 is valid. The transactions are bundled into data packets that consume lesser space and computation on the main blockchain than processing all the transactions conventionally on-chain. Reduced storage combined with the lack of individual transaction verifications reduces transaction fees drastically and improves on-chain confirmation times.

A distinct feature of optimistic rollups is their use of fraud proofs to determine the validity of transactions within batches. While all transactions are assumed to be valid, disputes surrounding suspected transactions can be raised within specific time windows. Fraud-proof computations are executed to check the validity of said transactions before submitting the rolled-up data on-chain.

Optimistic rollups possess EVM compatibility, unlike other rollup solutions, making it a highly popular layer-2 solution. Optimism and Boba Network are two of the most prominent optimistic rollups that work on top of the Ethereum blockchain.

Zero-Knowledge Rollups

While optimistic rollups use fault proofs to maintain transaction validity, ZK rollups utilize validity proofs to prove the authenticity of all transactions. Unlike their counterpart, each transaction is validated on the layer-2 protocol. Once validated, a summary of the transactions represented by their initial and final states is sent to the layer-1 chain for record-keeping purposes.

ZK rollups are the faster of the two rollups since they submit smaller amounts of data to the main chain and do not have to reserve waiting times for fraud disputes like optimistic rollups. Notable examples of ZK rollups are Loopring and zkSync, which operate as layer-2 solutions for Ethereum.

Layer-2 Solutions to Solve Blockchain Scalability and Drive Layer-1 Developments

Layer-2 solutions are considered the go-to for addressing scalability issues faced by many native blockchain networks. Some of the popular layer-2 solutions offer great security with respect to protocol practices and smart contract utilization — hence gaining user confidence. These solutions are, therefore, witnessing increased user adoption which is simultaneously taking the burden off layer-1 blockchains. Their easy implementation is a boon for blockchains, causing many networks to rely on them also. With the development of layer-1 scaling solutions, it will be interesting to watch how layer-2 protocols fare. Their implementation will likely synchronize with layer-1 developments, offering great scalability which will make blockchain networks more efficient than centralized systems.

Learn more about Liminal here.

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More on Crypto

As we continue constructing a fully regulated digital asset custody platform, ensuring secure storage for both crypto and fiat assets remains a critical priority. 

To facilitate the last checkpoint of enabling institutions to convert their digital asset treasury into fiat currency, we’re expanding beyond pure wallet infrastructure and integrating seamless fiat off-ramp capabilities for our partners.

We’re thrilled to announce our partnership with Encryptus, licensed and compliant off-ramp solutions tailored for institutional clients. This collaboration elevates Liminal’s service offerings by empowering our partners to convert their digital asset treasuries into fiat currencies efficiently.

Integrating A Seamless Off-Ramp Solution

The digital asset ecosystem historically faced friction points when transitioning between fiat and cryptocurrencies. Off-ramp solutions address this pain point by enabling efficient and streamlined conversion between asset classes, minimising value loss and simplifying compliance processes.

Here’s how off-ramp changes the game:

  • Reduced Friction: Frictionless conversion minimises delays and operational complexities associated with traditional fiat-crypto exchange methods.
  • Enhanced Efficiency: Streamlined workflows expedite asset conversion, increasing speed and cost-effectiveness for institutional and individual users.
  • Optimised Value Preservation: Advanced off-ramp solutions prioritise minimising price slippage and value loss during conversion, protecting user portfolios.
  • Simplified Compliance: Integrated compliance features navigate regulatory complexities, ensuring adherence to relevant financial regulations.

With our partnership with Encryptus, we have embedded their institutional-grade APIs, connecting their off-ramp solution within Liminal’s wallet and custody platform. 

This integration simplifies our clients’ liquidation requirements while keeping their assets secure and more:

  • Effortless Digital Asset to Fiat Conversion: Our partners will be able to access treasury management and facilitate business payments in 54 countries and individual payments in an extensive network of 80+ countries.
  • Streamlined Compliance and Regulation: Our partners will be able to leverage Encryptus’s rigorous licensing and compliance framework, ensuring adherence to stringent financial regulations.
  • Enhanced Platform Value: We will be able to expand the functionality of the Liminal custody solution, attracting institutional users seeking comprehensive digital asset management capabilities.

Moving Towards A Robust Off-Ramp Partnership With Encryptus

The partnership between Liminal and Encryptus earmarks a significant step forward in secure digital asset custody, representing a shared commitment to pushing compliant practices while supplying institutions with easy access to convert their digital assets to fiat. 

For Encryptus, the opportunity to integrate with Liminal’s established platform presents a chance to reach a wider audience and scale their innovative off-ramp solutions to new heights. By streamlining fiat conversion within Liminal’s secure custody infrastructure, Encryptus gains access to a trusted network of institutional users seeking seamless and compliant treasury management.

For Liminal, this collaboration reinforces our dedication to partnering with companies that demonstrably prioritise clear governance and robust policy frameworks. By aligning with Encryptus’s stringent compliance standards, we reaffirm our commitment to building a secure and sustainable future for digital assets, where trust and regulatory certainty go hand-in-hand.

January 22, 2024

Hello world, it’s that time of the month when we share the biggest security breaches in the world of Web3 through our Security and Regulatory Newsletter. 

Liminal believes in optimizing security and custody practices globally across the Web3 industry. Through our Newsletter, we highlight security, regulations, and compliance incidents that have happened in the past month and how one can follow better Security practices to safeguard their digital assets. 

We will also highlight regulatory changes that might have happened globally, which were significant to the overall ecosystem.

Dive in and get a detailed analysis of everything security and regulation in the domain of web3 with Liminal’s Monthly Security and Regulatory Newsletter.

Web3 Security Compromises in January

Abracadabra exploited for almost $6.5 million, Magic Internet Money stablecoin depegs

The Magic Internet Money ($MIM) stablecoin has lost its dollar peg again, dipping all the way below $0.77 in a flash crash before returning to around $0.95.

The depeg appears to be related to an exploit of the Abracadabra lending protocol, which allows people to borrow $MIM. An attacker exploited an apparent flaw in the platform’s smart contracts to drain around $6.5 million.

Goledo Finance hacked for $1.7 million

Goledo Finance, an Aave-based lending protocol, was exploited through a flash loan attack. The attacker stole assets estimated by CertiK to be around $1.7 million.

Goledo Finance contacted the attacker to offer a 10% “bounty” for the return of the remaining assets. In a message on January 29, the attacker wrote: “I hacked Goledo and want to negotiate.”

Socket service and its Bungee bridge suffer $3.3 million theft

The Socket cross-chain infrastructure protocol was hacked for around $3.3 million in an attack that exploited its Bungee bridge. The thieves were able to exploit a bug that allowed them to take assets from those who had approved a portion of the system called SocketGateway.

A little over 700 victims were affected, and the highest loss from a single wallet was around $657,000. 121 wallets lost assets priced at more than $10,000.

On January 23, the protocol announced they had recovered 1,032 ETH (~$2.23 million) of the stolen funds.

Web3 Regulatory Practices for January

The EU Imposes Stricter Due Diligence Rules for Crypto Firms

On Jan. 17, the European Council and the Parliament came to a provisional agreement on parts of the Anti-Money Laundering Regulation (AMLR) that now extends to the crypto sector.

Under the new rules, cryptocurrency firms will be required to run due diligence on their customers involving a transaction amounting to €1,000 ($1,090) or more. 

However, the agreement isn’t final yet as it has to be first officially adopted by the Council and Parliament before the rules can be applied.

So, after the EU passed its landmark MiCA regulation last year, which clarified rules about cryptocurrencies, regulators are now targeting the space with tighter controls. 

While these regulations bolster security and trust in the crypto market, potentially attracting more cautious investors and combating financial crimes, they also present challenges. 

The US State of Virginia Introduces Digital Assets Mining Rights

Recently, the Virginia State Senate introduced Bill No. 339, which outlines regulations for the transactions and mining of digital assets and their treatment under tax laws. 

The legislation exempts individuals and businesses engaged in crypto mining activities from obtaining money transmitter licenses. Additionally, it protects miners from any discrimination. 

Issuers and sellers of crypto are also exempted from securities registration requirements if certain conditions are met. Moreover, those offering mining or staking services are not to be classified as “financial investment” but must file a notice to qualify for the exemption.

The bill further incentivizes crypto’s use for everyday transactions by offering tax benefits. Under this, up to $200 per transaction can be excluded from an individual’s net capital gains or gains derived from using crypto to purchase goods or services, starting from Jan. 1, 2024.

Key Takeaways:

  • Hackers continue to exploit vulnerabilities in DeFi protocols and cross-chain bridges, highlighting the need for robust security measures.
  • Regulatory frameworks are evolving rapidly, with stricter AML rules and supportive legislation for emerging technologies like crypto mining.
  • Staying informed about these developments is crucial for navigating the digital assets market safely and responsibly.

Stay #LiminalSecure

These events highlight the constant evolution of Web3 security and regulation. You can confidently navigate this dynamic landscape by staying informed and prioritizing security best practices. 

At Liminal, we’re committed to empowering institutions to unlock the full potential of digital assets without compromising security or compliance norms with our robust custody and wallet infrastructure solutions. Join us on this journey towards a safer, more accessible future for digital assets.

January 15, 2024

Buckle up as we’re about to take a trip down memory lane. 

The year 2023 was a wild ride that showed signs of a plummeting market, groundbreaking innovation and regulatory hurdles. 

Contrastingly, in the same year, we saw no market-shattering crashes. Financial institutions extending an olive branch, key jurisdictions unlocking the doors to blockchain technology. 

Simultaneously, at Liminal, we experienced significant breakthroughs, re-engineering our positioning and becoming a pioneer in digital asset security with bank-grade custody. 

We took major strides this year, right from building comprehensive products to becoming a qualified custodian, from revamping our brand design to expanding our offices in newer locations, from partnering with hyper-local communities to onboarding a diverse set of clients,  we did it all. 

So, let us take you through everything we accomplished in 2023 and what the future holds.  

Liminal Became A Qualified Custodian

One of the prominent moves we made this year was to change our positioning as a regulated custodian from being a wallet infrastructure platform. 

We got two licenses in key jurisdictions to operate as a regulated custodian. 

The first one came from Hong Kong, where we acquired the TCSP license issued by the SFC, which oversees and regulates financial activities to ensure compliance with legal and regulatory obligations. 

Our next license came in the MENA region, where we got In-Principle Approval for the FSP license granted by the FSRA, a governing body in ADGM, to establish a progressive financial services environment. 

Both these licenses paved the way for Liminal to push its wallet infrastructure and offer bank-grade custody to institutions looking to operate in these particular regions. 

Liminal Introduced A Suite of Products & Features

Continuing our building spree, we launched new products and integrations to broaden the existing infrastructure and added more parameters of security, scalability and sustainability. 

Staking-as-a-Service

Liminal launched staking for institutions to eliminate the risks involved in running staking nodes and the vulnerabilities in hot wallet transfer. 

Hence, we introduced an industry-first mechanism of cold wallet staking to ease staking for institutions and secure assets explicitly.  

Whitelabel Solution

Accelerating the go-to-market time for organisations looking to build a secure and customisable application, Liminal launched its whitelabel solutions

Targeted to help organisations meet security standards, manage assets with maximum control, and add their custom branding to give it a personal touch. Our whitelabel solution is a first-in-class custodian-developed solution for institutional grade custody.

Smart Consolidation

We are building not just secure custody but also automation-based features to eliminate manual errors, increase the throughput of transactions and scale institutional wallets. 

Taking this ahead, we launched the Smart Consolidation feature to automatically calculate all the active addresses and consolidate them into a single address. With this level of automation, managing multiple addresses becomes uber easy for wallet teams. 

Travel Rule 

To limit the use of cryptocurrencies for activities like money laundering and terror financing by regulatory bodies, travel rule was mandated for institutions to follow. 

Continuing the latest compliance integration policy, Liminal partnered with Notabene to introduce Travel Rule, enabling institutions to manage counter-party risk and extend the process of due diligence right from the Vaults dashboard.   

Liminal Accured List Of Security Certifications

Following our ISO certification for data privacy and risk management, we added two new security certifications to fortify our systems and build trust for our clients. 

Liminal Achieves Crypto’s Highest Security Mark: CCSS Level-3 Certified

Cryptocurrency security lacked a gold standard, creating a vulnerable ecosystem. Enter the CryptoCurrency Security Standard (CCSS), setting the bar for auditing and certifying custodian infrastructure and establishing levels of trust and confidence for investors. 

Liminal became only the second wallet infra platform and the first regulated custodian to be accredited with Level-3 certification, deeming wallets, transfer environments, workflows and engines safe and secure. 

Liminal Reciueved SOC 2 Type II Certification

To tackle threats in institutional-grade security, organisations’ SOC has been identified as the primitive compliance standard for service organisations to handle customer data.

Liminal successfully attained SOC 2 Type II certification, validating its setup of security controls & compliance processes to be industry standard. 

Liminal Level Up

Liminal unveiled its most significant platform upgrade ever, revolutionising the future design standard of a qualified custodian. This level-up activity included revamping our website and product UI, giving a completely new look and feel to not “Liminal” but “Liminal Custody”. 

The Liminal level-up activity was a strategic step and the biggest one for us this year to create an intuitive, inviting and tailored experience for our clients. 

Liminal Reached New Borders

We spread out our operations this year, reaching new borders and onboarding a new wave of institutions across gaming, DeFi, HNI wealth, treasuries, and exchanges! From Indonesia and Africa to India, UAE, and Korea, we are setting up custody operations worldwide. 

This isn’t just a roster of clients; it’s a network ready to spark connections, collaborations, and shared success to further the definition of secure assets. 

Liminal Collaborated With Law Enforcement Agencies

The best and the proudest moment of Liminal for this year was when we collaborated with CBI & Himachal Prashesh police department to aid them in seizing digital assets. 

This partnership put us on the map, as we became the first point of contact for LEAs in India, and we standardised the process of secure seizure of digital assets. Leveraging our expertise, we enabled a safe space for officers to learn the basics of custody, contributing to a safer digital landscape.

Team Liminal Grew Bigger

Building such a massive infrastructure, prioritising security and compliance over everything else, we had to grow the team to build at pace and expand at an even higher level. Not only did we grow in team numbers, but we also elongated our footprint to new destinations. 

Team Liminal went from 32 to 70 with 5 new offices in Mumbai, Ahmedabad, Hong Kong, Singapore and ADGM, setting up our custody operations steadfastly. 

What’s To Look Out For In 2024

We are excited to announce that our commitment to integrating the most secure digital asset wallets with a cutting-edge custody platform is swiftly becoming a reality. 

The upcoming year, 2024, will serve as a testament to this transformative journey. Moving beyond self-custody, we are constructing a comprehensive infrastructure encompassing both custodial and non-custodial wallets. Exciting products are set to launch starting from the first week of January, some of which are: 

  • Official Custody Platform Launch
  • Liminal’s Off-Exchange Settlement Hub
  • Secure Custody of Real-World ‘Tokenised’ Asset

The Web3 space has evolved explicitly this year, pushing the narrative of secure digital asset custody and security, introducing new regulations and compliance standards, licensing VASP providers and standardising the use of custodians as a trusted third party. 

At Liminal, we took major strides this year, from building comprehensive products to becoming a regulated custodian, from revamping our brand design to building the full infrastructure of custodial and non-custodial wallets.

January 5, 2024

Find Out How You Can Benefit From A Fully Self-Custodial Wallet Architecture