Blockchain technology has evolved a great deal since Bitcoin’s debut in 2009. Today, the digital asset ecosystem is not short of choices when it comes to alternative blockchain networks. While Layer 1 chains such as Bitcoin and Ethereum are still the most dominant networks, Layer 2 scaling solutions are emerging as potential challengers, especially in the Decentralized Finance (DeFi) market.
What is the Difference Between Layer 1 and Layer 2 Blockchains?
For context, Layer 1 refers to the core infrastructure of a blockchain network, also known as the ‘mainnet’. In this type of chain, the base layer (Layer 1) acts as the primary network, finalizing transactions and any other on-chain processes in the case of a smart contract blockchain like Ethereum.
Although secure, Layer 1 chains have their own shortcomings, most notably the issue of scalability – which is what Layer 2 solutions are designed to solve.
Layer 2 infrastructures build upon the foundation of Layer 1 blockchains by introducing an additional layer to enhance transaction throughput. One can think of Layer 2 solutions as secondary frameworks; this is because they assume the transaction execution function, thereby reducing network congestion on the base layer.
That said, Layer 2 scaling solutions also have their downside: they are not as secure as Layer 1 blockchains.
The Current State of Layer 1 Blockchains
According to Coingecko, the total market capitalization of Layer 1 blockchains currently stands at $811 billion, with Bitcoin claiming the lion’s share at $524 billion, while Ethereum follows at $202 billion. Other Layer 1 blockchains that also feature among the top 10 digital assets in market cap include Binance’s BNB chain, Cardano, and Avalanche.
To further compare the performance of these Layer 1 ecosystems, we have classified them into three: Bitcoin, Ethereum, and the Ethereum Challengers (BNB, Cardano, Solana, Avalanche, and newer Layer 1 generations such as Aptos and Sui).
Bitcoin: The Ultimate Layer 1 Blockchain
Bitcoin, also nicknamed the ‘digital gold’, has consistently ranked as the top Layer 1 blockchain ecosystem in terms of market capitalization. This can be attributed to several factors, including Bitcoin’s value proposition as the ‘hardest asset in the world’. It has outperformed both the Nasdaq and Gold over the past decade, with BTC’s returns between 2011 and 2021 standing at 230.6%, while Nasdaq and Gold recorded 20% and 1.5%, respectively.
However, despite being a darling in the larger investment space, Bitcoin’s blockchain lags behind in terms of ecosystem development. Unlike Layer 1 smart contract blockchain networks, the majority of Bitcoin’s on-chain activity revolves around transactions. To provide a clearer perspective, Bitcoin’s blockchain currently supports only 7 protocols, whereas Ethereum boasts an impressive count of over 1800 protocols, as per DeFi Llama metrics.
Bitcoin Ordinals – A Passing Fad or Big Leap?
During the first half of 2023, Bitcoin’s blockchain network activity surged significantly, courtesy of Bitcoin Ordinals. This is a newly added protocol to the Bitcoin blockchain that allows users to mint NFTs. The latest data from Dune Analytics reveals that there are currently over 27 million Bitcoin Ordinal Inscriptions, all of which were minted in 2023.
The caveat, however, is that while Ordinals may have breathed new life into the Bitcoin blockchain, critics argue that they are causing an increase in network fees as they occupy too much block space. On the other hand, proponents are more focused on how Bitcoin Ordinals can expand the value of Bitcoin’s blockchain beyond supporting transactions.
But looking at the most recent statistics, it is questionable whether Bitcoin Ordinals are a passing fad or here to stay. Trading volumes and sales have plummeted by over 95%, according to DApp Radar.
Source: DApp Radar
Ethereum: The Leading Layer 1 Blockchain in DApp Development
The Ethereum blockchain has made significant progress over the past year. Most notably, this Layer 1 blockchain successfully migrated from a Proof-of-Work (PoW) to a Proof-of-Stake (PoS) consensus in the merge that took place in September 2022. Furthermore, staking withdrawals were eventually enabled in April 2023 through the Shanghai upgrade.
Since then, the amount of staked ETH has risen to over 26 million, up from 18 million around the time of the upgrade, according to data from Nansen.
But more importantly, Ethereum has maintained its position as the leading DeFi blockchain, while other Layer 1 and Layer 2 chains have witnessed a decline in the number of active users.
Source: Messari
It is also worth noting that Ethereum’s block time (average time between blocks) is currently a mere 12 seconds, while Bitcoin’s averages at 10 minutes. Consequently, there is also a significant difference in the average transactions per hour, with Ethereum averaging 42,000 transactions compared to Bitcoin’s 17,900 transactions.
Ethereum Layer 1 Blockchain Challengers
As for Layer 1 chains offering alternative smart contract environments, none have yet lived up to the hype despite booming when the Decentralized Finance (DeFi) market was hot. However, there are some noteworthy trends in this niche:
- The BNB Chain is the third largest Layer 1 blockchain with a market cap of $34 billion, currently hosting over 600 protocols.
- Tron is fast emerging as the go-to Layer 1 blockchain for stablecoin transactions, with over 1.2 million daily active users.
- Solana and Avalanche have continued to see a decline in number of users, although the former is making fundamental strides, with Shopify recently integrating Solana Pay.
- Newer generation Layer 1 blockchains Aptos and Sui dominated the first half of 2023. Aptos native APT outperformed other smart contract tokens.
Source: The Block Research
Layer 2 Scaling Solutions: Current Market Insights
As mentioned in the introduction, Layer 2 scaling solutions are designed to address the infamous blockchain trilemma coined by Vitalik Buterin. To put it simply, it is challenging for a blockchain network to simultaneously possess these three core functionalities: scalability, decentralization, and security.
Layer 1 blockchain networks are decentralized and secure, but they are not highly scalable. On the contrary, Layer 2 blockchains are scalable but rely on Layer 1 chains for advanced security features. That said, let’s delve into some of the developments in the Layer 2 scaling ecosystem.
Still a Drop in the Ocean
According to Coingecko, the total value locked (TVL) in Layer 2 blockchain networks is $3.78 billion. This figure is relatively small compared to the overall TVL in all DeFi protocols, which stands at $38 billion. Notably, Ethereum accounts for the larger share with 57%.
However, on the brighter side, Layer 2 scaling solutions have experienced consistent growth in the number of unique addresses over the past year, with nearly 2.5 million unique addresses recorded thus far. Moreover, the monthly gas usage for Layer 2 blockchains has remained high despite the macro and industry-specific headwinds.
Source: Coinbase Research
EVM Compatible – Optimistic and Zero Knowledge Rollups
These two types of Layer 2 scaling solutions are EVM compatible, meaning that they can seamlessly leverage the Ethereum blockchain for security while handling transaction execution. While they have been operational for barely a year, both Optimistic and Zero Knowledge Rollups are gradually disrupting the DeFi market. For an in-depth introduction, you can refer to this article we published earlier.
Shifting to the numbers, a recent report by Alchemy revealed that the number of developers in the Optimism ecosystem grew by 205% over the past year. Additionally, with the recent Worldcoin hype, which is built on Optimism, the TVL in optimistic rollups increased by over $692 million within a month.
Source: The Block Research
zKSync Era
Also noteworthy is the zK Sync Era, which went live earlier this year. Initially, when zK Sync launched, it did not support smart contract functionality. However, with the zK Sync era upgrade, this Layer 2 scaling solution now supports all Ethereum functionalities at a faster speed and lower cost.
Since its launch, the zK Sync Era has recorded an average of $5.9 million in monthly transaction fees, retaining an average of 41% of its net costs.
Source: Galaxy Research
Base: The New Kid on the Block
The latest addition to the Layer 2 blockchain ecosystem is Base, an L2 built by Coinbase on the OP stack. As of writing, Base is the 4th largest Layer 2 blockchain ecosystem with a TVL of $348 million, and it currently hosts 97 protocols according to DeFi Llama.
But perhaps the most notable achievement is becoming the fastest L2 to reach the 100K user mark; Base accomplished this milestone within 56 days of its launch.
Source: Token Terminal
The hype was fueled by several factors, including Coinbase’s involvement in the project, a DApp dubbed Friend.tech, which recently created a frenzy within the crypto community, and the interest shown by established crypto institutions like Circle, which is set to launch its native USDC stablecoin on Base.
Closing Thoughts
The Layer 1 and Layer 2 blockchain landscape has clearly expanded into a robust ecosystem that supports Decentralized Finance (DeFi) and Non-fungible tokens (NFTs). However, as emphasized in this article, a lot of innovation is ongoing, and distinguishing between valuable advancements and less impactful ones can be challenging. Nonetheless, this dynamic landscape serves as a testament to the boundless potential of blockchain technology.
