What are layer 1, layer 2, and layer 3 protocols

Layer 1: The foundation

Layer 1 blockchains form the entire backbone of the decentralised digital ledger technology by establishing the core protocols upon which all subsequent layers and applications are built. These blockchains are critical as they define the basic rules of operation for the network, including how data is structured and validated.

Key features of layer 1 blockchain protocol 

• Immutability: The blockchain's immutability, achieved through cryptographic hashing, ensures that transactions recorded on the network are tamper-resistant and maintain their integrity over time.
• Security: Security is a top priority for Layer-1 blockchains since they are the base layer of all things web3. They leverage cryptographic algorithms and decentralised network structures to protect against malicious actors. 
• Consensus mechanisms: Layer-1 blockchains utilise these consensus algorithms to maintain the integrity of the network and prevent double-spending. Each mechanism has its own advantages and trade-offs, and the choice of consensus algorithm often depends on the specific requirements and goals of the blockchain project.
• Smart Contracts: Many Layer-1 blockchains support the execution of smart contracts, which are self-executing contracts with the terms of the agreement directly written into the code. Smart contracts enable the automation of contractual agreements, reducing the need for intermediaries and enhancing transparency. This feature opens up new possibilities for decentralised applications (dApps) and the automation of various business processes.
• Decentralisation: Decentralisation is of course, a hallmark of Layer 1 tech, aiming to eliminate any central authority. Instead, control is distributed among all participants in the network, each of whom maintains a copy of the entire ledger.

Examples of prominent layer 1 blockchain protocol

Source | Layer 1 Blockchain Protocol

• Bitcoin

The original blockchain is known for its robust security and PoW consensus. Do we need to say more?

• Ethereum

Highly versatile, supports smart contracts and is transitioning to a PoS consensus to improve scalability and energy efficiency.

• Solana

Famous for its high throughput and fast transaction speeds, utilising a unique PoS combined with Proof of History (PoH).

• Cardano

Uses a research-driven approach and a unique PoS algorithm called Ouroboros, focusing on sustainability and peer-reviewed security measures.

Limitations of layer 1 blockchain protocol

Despite their foundational importance, Layer 1 blockchains have challenges. The most significant limitation is scalability. As the number of users grows, these blockchains often need help to maintain high transaction speeds and low costs. 

The blockchain trilemma is a fundamental challenge that Layer 1 blockchains face. It's tough to achieve all three key goals of decentralisation, security, and scalability at the same time. In reality, you can only truly excel in two of these areas, making tough choices necessary. 

For instance, Bitcoin and Ethereum prioritise decentralisation and security, but this comes at the cost of scalability. When you try to improve one aspect, you often have to sacrifice another. 

However there are some ways L1s such as Ethereum, are trying to scale via Sharding - a clever way to break up a big database into smaller, manageable pieces called shards. Each shard is like its own little database that can be handled and expanded separately. 

This helps L1s scale up by allowing them to deal with tons of data and heavy traffic without getting bogged down. The load is distributed evenly across all the nodes by spreading the data across multiple shards. This makes it a breeze to manage and maintain the database while still keeping it running smoothly and reliably.

Layer 2: Scaling solutions

Source | Layer 2 Blockchain Protocol

Think of Layer 1 blockchains as the base of towering skies. They are sturdy but could be more flexible with space. Now, picture Layer 2 protocols as innovative architectural techniques that add more floors and features without putting pressure on the foundation. These protocols are built directly on top of Layer 1 blockchains and are designed to supercharge them, enhancing scalability and performance without altering the original structure. The primary role of Layer 2 protocols is to address the inherent scalability issues faced by Layer 1 blockchains.

A more familiar metaphor might be - think of Layer 1 as banks in your country, and Layer 2 as the “mobile wallet” platforms that let you transfer money without having to interact with your bank every time. When you do withdraw to your bank though, balances get settled with the Layer 1 platform (in this case: your bank).

Layer 2: Scaling techniques

• Lightning Network

This is like opening express lanes on a highway; it allows for rapid, off-chain transactions among participating nodes and settles back on the Bitcoin blockchain.

• Rollups

These act like compressing files before sending them through email. Rollups process transactions outside the main chain, and then send a summary back to the main chain, drastically reducing data load and costs.

StarkNet is a Layer 2 scaling solution that utilises zk-Rollups to scale Ethereum, enabling high throughput and low transaction costs while maintaining security and decentralisation. It leverages zero-knowledge proofs to validate the integrity of transactions without revealing transaction details, ensuring privacy and confidentiality. 

StarkNet's zkEVM (Ethereum Virtual Machine) is a key component that allows for the execution of smart contracts on the StarkNet network, ensuring compatibility with existing Ethereum-based applications. 

• Sidechains 

Sidechains are a clever way to boost the scalability of main blockchain networks. They work as their own (faster) blockchain layers, connecting to the main chain through a two-way bridge, allowing assets to be transferred between the two. This setup enables the sidechain to handle some of the data processing off-chain, which helps reduce congestion and increase efficiency. Sidechains are separate blockchains with rules, consensus mechanisms, and tokens. 

One prominent example of sidechains in blockchain is the Liquid Network. The Liquid Network allows faster and more private transactions than the main Bitcoin blockchain.

• State channels

Similar to opening a bar tab instead of paying per drink, state channels allow participants to transact multiple times off-chain and then settle the final state on-chain. The Lightning Network is a prime example of state channels in action. This Layer 2 solution sits on top of the Bitcoin blockchain and lets users make multiple transactions off-chain without having to broadcast each one to the entire network.

Benefits of layer 2 blockchain protocol

Source | Layer 2 Blockchain Protocol

• Faster transactions

By handling transactions off the main chain, these protocols ensure lightning-fast processing times.

• Lower fees

Less congestion on leading in the network means significantly lower transaction fees.

• Improved scalability 

With the ability to process many more transactions per second, Layer 2 solutions greatly enhance the scalability of blockchains, making them more practical for everyday use and large-scale applications.

Layer 3 : The application layer

If Layer 1 is the foundation of a building and Layer 2 is the infrastructure like plumbing and electrical systems. Now, meet Layer 3: the furnished rooms, the decor, and all the personal touches that turn the building into a functional, welcoming space.

Layer 3 protocols are the applications and services that sit atop the underlying blockchain layers, bringing them to life for everyday users. Layer 3 is where the block starts to interact with the end user. It's all about providing specialised functionality and enhancing the user experience.

Source | Layer 3 Blockchain Protocols

Critical features of Layer 3 protocols, such as:

• Interoperability: Layer 3 helps different blockchain networks to communicate and work together. It’s like having a universal remote that only controls your sound, system, and lights.
• Customisation: These protocols can be tweaked to serve specific use cases, whether it’s finance, gaming, or healthcare, and they are precisely what users need right out of the box.
• Improved Scalability and Performance: Layer 3 optimises user interaction with blockchains, ensuring that applications run smoothly, even as they scale to accommodate more users and complex operations.

Examples of Layer 3 protocols and applications

• Decentralised Exchanges (DEXs): Smart contracts enable platforms where users can trade cryptos directly with one another without needing a central authority.
• Gaming Platforms: If you were playing a game where you truly own the in-game assets and can trade or sell them on an open market, all powered by blockchain.
• Social Media: Operating on blockchain allows uncensorable content and gives users control over their data and interactions.

The Evolving Blockchain Ecosystem

This blockchain layer structure addresses the infamous blockchain trilemma by balancing decentralisation, scalability, and security. The blockchain landscape is evolving. Innovations like sharding in Layer 1 and advancements in rollup technologies in Layer 2 are pushing the boundaries of what blockchains can handle. Meanwhile, Layer 3s are seeing a surge in decentralised finance (DeFi) platforms, NFT marketplaces, and even blockchain-based gaming and social media platforms, which promise a more decentralised, secure, and user-driven internet.

The Bottomline:

So, as we watch this ecosystem grow and transform, it’s clear that the future of blockchain is not just about building higher but building smarter, with each layer supporting and enhancing the next. 

The journey of blockchain is far from over, and the layers we build today will pave the way for tomorrow’s innovations. Ready to discover more about this layered universe? Visit India Crypto Research today!