Bitcoin Layer 2s 101

What are Bitcoin L2s?

Bitcoin Layer 2s (L2s) refers to protocols built on top of the Bitcoin blockchain to enhance the network’s transaction efficiency and solve its limitations.

A blockchain network is typically made up of two interconnected layers:

• Execution layer: This layer is responsible for receiving, processing, and computing the effects of transaction requests from users. It transmits transaction details to the consensus layer for verification
• Consensus layer: This layer runs the consensus algorithm and coordinates the network's miners or validators to verify and approve transactions before they are finalized and added to the blockchain

Bitcoin L2 solutions create a separate execution layer to handle transactions away from the main Bitcoin chain, which helps to reduce congestion.

Purpose of Bitcoin L2s and How They Work

Bitcoin L2 solutions tackle the scalability and programmability limitations of the Bitcoin network, which can generally handle only around 7 transactions per second¹. By enabling processing off of the main chain, L2 networks allow users to conduct multiple transactions without recording each one on the main chain except the confirmed final settlement. This increases transaction speed and reduces costs, making microtransactions more viable.

Key mechanisms used in Bitcoin L2 solutions include:

1. State channels (e.g., Lightning Network): These allow users to make multiple payments quickly without recording each one on the main blockchain. Only the final amounts are saved, which significantly reduces congestion and enhances efficiency
2. Sidechains (e.g., Rootstock, Liquid Network): These are separate blockchains, linked to the Bitcoin main chain, that can process transactions faster. They let developers test new features without affecting the main network while periodically finalizing transactions on the Bitcoin main chain
3. Rollups (e.g., Merlin Network): Consolidate multiple transactions into one before logging onto the main blockchain, enhancing scalability and transactions per second

Overall, Bitcoin L2s aim to improve transaction efficiency while maintaining security and decentralization through utilizing the Bitcoin main chain.

What Can You Do with Bitcoin L2s?

Bitcoin L2 networks enable a wide range of use cases that were previously difficult or impractical on the main Bitcoin chain, such as:

• Enhanced Programmability: L2 solutions introduce smart contract functionality to the Bitcoin ecosystem, enabling the development of decentralized applications (dApps), non-fungible tokens (NFTs), and decentralized finance (DeFi) services
• Bitcoin DeFi: L2 protocols like the Lightning Network and Stacks facilitate the growth of decentralized finance in the Bitcoin ecosystem, allowing users to engage in activities such as asset management, atomic swaps, borrowing, lending, and trading

In summary, Bitcoin L2 solutions aim to make using Bitcoin easier and more efficient while keeping its security intact. This is a rapidly developing space and more novel use cases and solutions are sure to emerge.

_{1 Blockchain.com as of 7 Oct 2024}