What is layer 2 in crypto?

Layer 2 is a network built on top of a main blockchain, the layer 1, that processes transactions off chain and then settles them back on the main chain. It exists to make transactions faster and cheaper without giving up the security of the underlying blockchain: Arbitrum, Optimism and Base on Ethereum, and the Lightning Network on Bitcoin, are the best-known examples.

What is layer 2 in crypto?

Layer 2 in crypto is one of the main scaling solutions in blockchain technology: a network that sits on top of a layer 1 blockchain such as Ethereum or Bitcoin and handles transactions on its behalf. You transact on the second layer, and it regularly posts the results, or a proof of them, to the main chain.

Think of the layer 1 as a court and the layer 2 as a notary. The notary can process thousands of routine agreements quickly and cheaply and only files a summary with the court; if there is a dispute, the court has the final say. That is the key test: a true layer 2 relies on the base layer for its security guarantees instead of on its own set of validators. Layer 2 doesn’t replace layer 1. It needs it.

Why layer 2 scaling is needed

Layer 2 scaling is needed because popular layer 1 blockchains have scalability issues: they can only fit a limited number of blockchain transactions in each block. When demand rises, blockchain users bid against each other for space, network congestion builds up and gas fees climb.

This is the blockchain trilemma, also called the scalability trilemma: it is hard for one blockchain to be decentralised, secure and scalable at the same time. Ethereum and Bitcoin chose decentralisation and security, which keeps the chain verifiable by thousands of ordinary computers but limits transaction throughput. Making the base layer much bigger would raise the cost of running a node and sacrifice decentralisation instead. Layer 2 solutions take a different route to improving blockchain scalability: keep the main chain lean, move transaction processing off chain, and reach higher throughput without compromising security, while reducing congestion on layer 1. Cheaper fees are also a precondition for widespread adoption of crypto payments. Our scalability entry covers the wider picture.

Layer 1 vs layer 2 blockchains

Layer 1 is the base blockchain with its own consensus mechanism; layer 2 is an extra network that inherits its security from that base layer chain. Ethereum, Bitcoin, Solana and the XRP Ledger are all layer 1 blockchains.

Scaling solutions come in two flavours. Layer 1 scaling changes the base chain itself, and some blockchain networks, such as Solana, aim for higher transaction throughput on the base layer directly. Layer 2 scaling solutions leave the base chain alone and build on top. In the Ethereum layer model, Ethereum is the primary network for security and settlement, and rollups handle most day-to-day activity in the wider blockchain ecosystem.

How layer 2 solutions work

Layer 2 solutions work by moving execution away from the main blockchain and sending only compact results back. In practice there are three steps:

1. Deposit. You lock assets in a smart contract on layer 1, called a bridge, and the same amount appears on the layer 2.
2. Off chain execution. Your transactions run on the second layer, where a sequencer orders and executes them in seconds. This takes the computational load off the main chain.
3. Settlement. The rollup bundles many transactions into a single batch, compresses the transaction data and posts it to layer 1 with a proof or a commitment.

Batching is where the cost efficiency comes from. Posting one batch to Ethereum costs much the same whether it holds ten or ten thousand transactions, so the cost of a single transaction is shared across multiple users: the more transactions in a batch, the lower the costs per person. Since Ethereum’s Dencun upgrade in March 2024, rollups can post this data in cheaper “blobs”, which pushed fees down further. The data must stay available, so anyone can rebuild the rollup’s state and withdraw if the operator disappears.

The main types of layer 2 scaling solutions

The main layer 2 types are rollups, payment channels and, with caveats, sidechains and validiums. They differ in how they prove that off-chain activity was honest.

Rollups and fault proofs

Rollups are the leading way to scale Ethereum. Optimistic rollups such as Arbitrum, Optimism and Base assume transactions are valid and give anyone a challenge window, typically about a week, to submit fault proofs (also called fraud proofs) if something is wrong. Optimistic rollup fault proofs are also why withdrawing through the official bridge back to Ethereum takes around seven days. A ZK rollup such as zkSync or Starknet posts a validity proof instead: cryptographic evidence that every rollup transaction in the batch was executed correctly. Because a ZK rollup proves each batch up front, there is no long waiting period.

Payment channels

A payment channel lets two parties lock funds once, swap signed messages off chain as often as they like, and settle the final balance on the main chain. The Lightning Network on the Bitcoin blockchain is the best-known example and is used for small, fast bitcoin payments.

Sidechains, validiums and fewer validators

Sidechains are separate blockchains with fewer validators of their own, linked to a main chain by a bridge. They are cheap and fast but don’t inherit layer 1 security, so strictly speaking they aren’t layer 2 blockchains. Validiums use validity proofs but keep transaction data off chain in a separate data availability layer, which adds a trust assumption.

Lower fees and faster transactions

The main benefit of layer 2 for you is lower fees and faster confirmations. Rollups reduce costs and increase transaction speed: a swap or transfer that runs into high gas fees on Ethereum mainnet at a busy moment usually costs a small fraction of that on a rollup, and confirms in seconds. You still pay transaction fees there, usually in ETH, just far less.

Here is how it looks on an exchange. Say you want to move €200 of ETH from your exchange account to your own hot wallet to use a DeFi app. In the withdrawal screen you choose the network: Ethereum, or a rollup such as Arbitrum or Base if the exchange supports it. The exchange shows the fee for each option before you confirm, and the rollup route is usually much cheaper. The catch is that your wallet and the app you want to use must support that same network. Fees still change with demand, and bridging between networks can add its own costs.

Layer 2 risks for EU crypto users

Layer 2 networks add their own risks on top of normal crypto price risk. The main ones:

• Bridge and smart contract risk. A bridge is a smart contract that holds large amounts of locked crypto, which has made bridges a frequent target for hacks. A bug in a rollup’s smart contract code can affect everyone using it.
• Sequencer and upgrade risk. Many rollups still rely on a single sequencer run by the team, and their contracts can be upgraded by a small group of key holders. If the sequencer goes offline, transactions can pause. Independent trackers such as L2BEAT show how far each network has decentralised.
• Split liquidity. Your tokens on Arbitrum aren’t automatically usable on Base; moving them takes a bridge.

MiCA regulates the exchanges and custodians you use to buy crypto and withdraw it to a layer 2, not the layer 2 networks themselves. Once your coins sit in your own wallet on a rollup, there is no regulator to complain to and no investor compensation scheme. Crypto-assets can lose all their value, so only use money you can afford to lose.

Is layer 1 or layer 2 better?

Neither is better; they do different jobs. Layer 1 offers final settlement and the strongest security, which suits large amounts held for a long time, while layer 2 offers cheaper transactions and higher throughput for frequent, smaller activity.

Many users keep savings on the base layer and a smaller amount on a rollup for daily use. Whichever blockchain networks you pick, the same rule applies as everywhere in crypto: know which network you are on before you press send.

Related terms

• Ethereum
• Gas Fee
• Scalability
• Smart contract
• Throughput