Learn about Blockchain Layer 1 vs. Layer 2 Scaling Solutions

| November 17, 2023

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Blockchain Layer1 vs Layer2

Experts and crypto enthusiasts in the world of Web 3.0 talk a lot about “layer 1” and “layer 2.” These are important ideas about blockchains, but they might make you scratch your head a bit. To simplify it, The base blockchain protocols such as Bitcoin or Ethereum are referred to as L1 layers. The third-party protocols built on top of the base blockchain protocols are called L2 layers. 

Key Takeaways 

  • Layer 1 and layer 2 scaling solutions offer ways to make blockchain infrastructure work faster and handle more operations. 
  • Layer 1 scaling solution essentially changes the fundamental rules of a blockchain to let it process more transactions. 
  • Layer 2 scaling solution introduces an extra layer of code on top of the L1 base layer. The L2 layer helps the core blockchain network to scale and work faster without changing the core L1 layer. 

What is blockchain scalability? 

Web3 blockchain technology is a new strong pillar in the world’s economy. It’s built on decentralized networks, not controlled by one person, company, or government. But there’s a big challenge these networks face. It’s called the “Blockchain Trilemma” This challenge is about finding the right balance between three critical components: Decentralization, Security, and Scalability. 

Decentralization 

The first component is a decentralized network. The computing and consensus mechanisms are distributed across the network in a decentralized infrastructure.  

Network Security 

The second component is security. The network has to be protected from malicious actors and cyber-attacks, which is why stringent security using cryptography is critical. These components are vital for the blockchain infrastructure to work well. 

Blockchain Scalability 

The third component is scalability. This component is critical for making the network able to handle multiple cryptocurrency transactions at once and grow in the future. This is important because it lets the blockchain compete with other systems, such as centralized systems that can do transactions fast.  

Example 

Right now, some big credit card companies can do thousands of transactions per second, while Bitcoin, a famous blockchain, can only do 4-6 transactions per second. On the other hand, the polygon blockchain can process 65,000 transactions per second.  

To be as good as centralized systems, blockchain, such as Bitcoin, Ethereum, and polygon services, needs to find a way to process, verify, and execute a lot of transactions quickly. Thankfully, new blockchains and solutions are being made that can help with this problem. They are making progress by using two different methods: one is called “Layer-1 scaling solution”, and the other is called “Layer-2 scaling solution”. These methods are helping blockchain cryptocurrency handle more transactions and become even more helpful. 

What is a blockchain Layer 1 v/s Layer 2? 

Layer 1 scaling solution 

Think of the base blockchain as the main network, called layer 1. This is like the heart of the whole decentralized ledger system. Talking about layer-1 scaling solutions means transforming this main network, the base blockchain, better, faster, and more scalable. Such solutions are sometimes referred to as on-chain networking. 

Simply put, some cryptocurrencies work on layer one because they can execute transactions directly on their blockchains. They have their native tokens for paying transaction fees. 

Example of Layer 1 blockchain Solution: Ethereum (ETH) and Bitcoin (BTC) are prominent examples of Layer 1 in the blockchain industry. 

How do L1 scaling solutions work?

The base layer developer teams usually bring changes in the layer-1 networks. Sometimes, the community must introduce significant changes in certain portions of the base layer (also known as a hard fork) or make minor compatible changes (also known as a soft fork).  

For instance, Bitcoin’s SegWit update is a small change. But if we want to make big changes, like making Bitcoin’s block size larger to 8MB, we need a big change called a hard fork. This kind of change can lead to two different versions of the blockchain. 

Another way to expand network size is by sharding. It’s like breaking the network operations into smaller parts and then processing it all together simultaneously. 

Layer 2 scaling solution 

Layer 2 is like a helper protocol that works above the main blockchain to make it function efficiently and scalable. When you use layer-2 scaling solutions, the L2 protocol moves a significant portion of the processing workload from the blockchain mainnet. It effectively manages the processing load and reports the final block to the blockchain mainnet.   

With this helper chain, the core blockchain mainnet doesn’t get too congested and executes a large number of transactions without getting too slow. This makes everything work better and more efficiently. 

Example of Layer 2 blockchain Solution: Polygon blockchain and Immutable X are prominent examples of layer 2 used on the Ethereum blockchain network. Plus, you need a polygon staking wallet or a multisig wallet to leverage the thriving crypto blockchain ecosystem.  

How do L2 scaling solutions work? 

Three prominent methods have been utilized in the layer-2 scaling solutions: roll-up, sidechain, and state channel. 

Roll-up 

Zero-knowledge roll-ups take multiple off-chain transactions from layer two and send them together as one block on the main chain. It is one of the most common types of scaling solutions employed by numerous blockchain cryptocurrencies. It uses Proof of Validity to ensure the transactions are appropriate, signed, and verified.  

The main chain holds your assets, such as Ethereum or polygon assets, and smart contracts help connect everything. These smart contracts make sure the roll-up is happening right. This method makes the original network safer. 

Sidechain 

Sidechains are separate blockchain networks with special validators that ensure nodes are okay. Smart contracts are like bridges that connect the main blockchain and the sidechain. They also check if the sidechain is doing things right. It’s important to keep an eye on the sidechain because it can control the assets on the main blockchain. Most wallets, such as polygon matic wallets, are compatible with sidechains. 

State Channel 

State channels help make a special connection between the real blockchain and an off-chain transactional channel. Usually, the parties seal off part of the main chain and then connect to an off-chain. This connection is set up using a special contract, such as a multi-signature smart contract they agreed on before. Then, they do their trade without putting everything on the main blockchain right away. When they finish all their trades, the channel’s end status is broadcast to the main blockchain for validation. This helps transactions happen faster and makes the network better at handling lots of trades – improving network capacity. 

Benefits of Layer 1 and Layer 2 Scaling Solution 

Layer 1 and Layer 2 blockchains are two different ways to make Web 3.0 blockchains scalable and work better when lots of users use them.  

Layer 1 blockchains, like the base, are the main part of a blockchain system. Examples are Bitcoin and Ethereum. They’re good at being safe and decentralized, but they can become slow and costly when many people use them. 

Layer 2 blockchains are built on top of others, like adding an extra layer to a building. They try to fix the slowness and scalability issues of Layer 1 blockchain infrastructures. They use external parallel networks to perform transactions without slowing the main network. 

Layer 2 ways include things like roll-ups, sidechains, and state channels. They’re faster and cheaper but not as safe as Layer 1 because they’re not as decentralized. 

Another difference is how they’re made. The design and implementation of both scaling solutions are quite complex. Changing Layer 1 is hard and needs everyone to attain consensus. But Layer 2 changes are easier because they’re built on top and don’t need everyone to attain consensus. However, they can bring their problems, like trusting the operators who run the layer two networks. 

What’s next after Layer 1 and Layer 2? 

A big question is if we’ll still need Layer 2 solutions when Layer 1 blockchains get better at handling lots of things. Some blockchains and cryptocurrencies are getting better, and new ones are being made to handle lots of operations. But it might take a while for the big ones to become scalable.  

The most likely thing is that Layer 1 will focus on being safe, while Layer 2 will support scalable Web3 blockchain infrastructure for special use cases. 

In the future, big blockchains like Ethereum and Polygon services might still be the most popular because they have many users and developers. They’re strong and trusted. This makes them a good base for Layer 2 solutions. 

Conclusion 

Layer-1 and layer-2 are two critical components of the plan to make the blockchain scalable, efficient and reliable. Both solutions are being designed to support a rapidly growing user base. 

Both the scaling solutions are not better than each other. Instead, many web3 blockchains, such as Ethereum and polygon blockchains, are trying both layer-1 and layer-2 solutions together. This way, scaling solutions can make the blockchain infrastructure handle more operations without losing safety or decentralization. 

 

FAQ 

What are the key features of Layer 1 blockchains in terms of consensus mechanisms? 

Layer-1 blockchains use numerous consensus mechanisms to process and validate transactions. Additionally, the consensus mechanisms help achieve agreement among network participants. Plus, they prioritize security by utilizing cryptographic algorithms and DLT infrastructure. 

How do Layer 1 blockchains ensure decentralization and censorship resistance? 

Blockchain cryptocurrency can stand up to censorship because of how they’re built. But when blockchains try to deliver really fast and cheap transactions, they might not resist censorship as well. So, the faster and cheaper L1 mainnet layers are, the less they can fight against censorship. 

How does the Lightning Network work as a Layer 2 scaling solution for Bitcoin? 

The Lightning Network uses micropayment channels to help scale Bitcoin. Micropayment channels make Bitcoin work better and handle transactions faster and at a lower cost. 

Which solution is more suitable for handling a high volume of small transactions quickly? 

L2 solution is considered to be ideal for handling a high volume of small transactions quickly. Layer 2 blockchains, such as polygon blockchain, make transactions quicker and cheaper by executing them off the main blockchain (L1). You can use L2 solutions using most crypto wallets, such as polygon staking wallets or polygon multisig wallets. 

What role do payment channels play in layer two scaling solutions? 

Think of channels as a way to do transactions promptly without paying high fees. But they only work for certain types of transactions because they’re made for specific tasks. They can’t do everything since they are not built on smart contracts. An example is the Bitcoin Lightning Network, which can handle lots of transactions without fees and is mainly used for payments. 

What is the difference between L1 and L2 scaling? 

Blockchain’s Mainnet (L1 layer) are really safe and decentralized, but they can’t handle lots of transactions and process requests at once. On the other hand, L2 layer solutions such as crypto polygon blockchain can handle more transactions and cost less, but they might not be as safe or decentralized as the blockchain’s mainnet (L1 layer). 

What are layer two scalability solutions? 

Layer 2 is a way to make your dapps work better and faster by dealing with transactions off the blockchain’s mainnet (Layer 1). The strong security of the layer 2 scalability solution is derived from the blockchain’s mainnet.  

What are Layer 1 scaling solutions? 

Making the bottom (core) layer of the blockchain cryptocurrency better and more scalable is called Layer 1 scaling. This means changing how the blockchain works so that it can be faster and handle more transactions at once. 

What is Layer 1 and Layer 2 scaling? 

Layer 1 scaling means making the main part of the blockchain better. This includes changing the rules of how it works so that it can be faster and handle more transactions. On the other hand, Layer 2 scaling is about creating something new on the blockchain that helps it work even better. 

Is Bitcoin a layer two solution? 

No. Consider blockchains such as Bitcoin and Ethereum as the main layer, called “Layer 1.” They handle all the transactions. On top of this layer, there’s another framework called “Layer 2.” This Layer 2 helps make things even better, especially when it comes to handling lots of transactions. It’s like adding an extra layer to improve how the blockchain works.

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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