Crypto has undeniable benefits. It’s completely independent from central banks and governments, lets you hedge against economic upheaval, is fast becoming a store of value (like gold!), and can be a fantastic long-term investment.
One thing is for sure, though. Once you go down the rabbit hole, crypto gets complicated. Unless you’re already a certified techie, you’ll have lots to learn — all the time. Blockchain scaling solutions, which come in three layers, are among those things. They’re not just “behind-the-scenes” aspects of crypto transactions that you can simply ignore, either. Scaling solutions have practical implications, too, and understanding them can potentially save you money.
If you’ve heard talk about layer 1, 2, and 3 solutions, and all you have in response are raised eyebrows and question marks, it’s time to change that.
What Is ‘The Blockchain,’ Anyway?
Everyone even vaguely interested in cryptocurrencies has heard of the blockchain — and you can probably rattle off a definition, too. The blockchain is a “decentralized digital ledger that stores crypto transaction records in a tamper-proof way.” What does that mean, though?
It stores transaction data, and it does so securely and through a consensus mechanism. Everyone can see the transaction history, but nobody can change it and no central body is in charge. There’s a layer of proof built in to make sure the record is accurate.
That’s the foundation of what makes crypto work.
People talk about “the blockchain” like they talk about “the internet,” but that’s not really correct. Each cryptocurrency — like Bitcoin, Ethereum, Dogecoin, Solana, and so on — has its own blockchain. It’s more accurate to talk about blockchains, plural, than about the blockchain.
This is also precisely what layer 1 is, but more about that later.
These layer 1 blockchains place security — which includes tamper-proofing — above all else. That’s not all there is to blockchain design, though. There are two other important aspects.
The Blockchain Trilemma
Layer 1 blockchains (like Bitcoin and Ethereum) are great for security. The two other crucial elements for a successful blockchain are true decentralization (not only isn’t the blockchain controlled by one entity, but by design, it never can be) and scalability — being able to handle a large transaction volume quickly and affordably.
Start tinkering with one of these three core design goals, and one area often falls behind just as another improves. They’re all necessary, but in practice, two (decentralization and security) shine at the expense of the other (scalability). That’s called the blockchain trilemma. The “pick two of these three areas to focus on” approach isn’t satisfactory, and yet level 1 blockchains can’t overcome it. That’s where layers 2 and 3 enter the picture.
That’s still quite complex, so now is probably a good time to introduce the obligatory silly analogy. If you want your house renovated, you probably want that done quickly, properly, and affordably. A person can dream, but you’ll have to settle for just two. You know you don’t want to sacrifice the “properly” pillar, so that leaves you with two choices. Do it yourself and spend (lots of) time, or hire a contractor and spend (lots of) money.
Want all three? Then you’ll need a new element — like a favorite uncle who’s a top-notch contractor willing to offer labor for free. That’s the function layers 2 and 3 have in blockchain technology.
What Is Layer 2, Then?
Layers 2 and 3 are built on top of layer 1. They don’t replace it, but they add extra functionality off-chain (that is, away from layer 1), in order to decongest the network. Layer 2 is for scalability, and it handles transactions. While layer 1 stores data and thereby keeps a permanent, unchangeable record, layer 2 relies on the security layer 1 provides while moving to a different space to process a large volume of transactions very quickly — while also introducing its own security protocols.
Like “the blockchain,” layer 2 isn’t a single entity. Many different layer 2 solutions exist, each with their own set of pros and cons. Not all are still popular, but it’s good to know a little about the main ones.
State Channels
State channels make it possible for two people to complete smart contracts and transactions offchain, without clogging the primary network (layer 1). They’re used for frequent (recurrent) transactions between two parties or micropayments. Transactions have to be signed by both parties to be valid, and the channel keeps track of balances as well as contract storage. Layer 1 then only has to be used to open and close transactions.
Sidechains
Sidechains are another layer 2 solution. They’re essentially separate blockchains that run alongside the main chain. They’re fast, but less secure than layer 1 — and also less secure than some other layer 2 solutions. Sidechains are used in cases where scalability is more important than security, like trading in-game virtual items.
Rollups
Rollups merge multiple transactions into one, so they can be submitted to the layer 1 chain as a single transaction. This saves time and frees layer 1 up for faster transaction speeds, but is less workable for real-time transactions. Instead, rollups are meant for batch processing. Two main types exist. Optimistic rollups are approved unless they’re challenged. Zero-knowledge rollups use complex cryptographic proof to process transactions without revealing their details.
Plasma
Plasma is an older, layer 2-like scaling solution that uses a master contract. There’s a challenge period to prevent fraud, during which withdrawals can be prevented. Plasma is no longer as popular as the other layer 2 solutions. It’s still being researched for potential new future use cases, though.
Where Does Layer 3 Come In?
Layer 3 is for dApps, and it’s what you interact with when you complete cryptocurrency transactions. These blockchain protocols are called layer 3 solutions because they’re built on top of layer 2 the way layer 2 solutions are built on layer 1. However, they’re not strictly a layer on their own — more of a tool kit to make layer 2 more usable.
Layer 3 solutions can handle more complex smart contract designs, app support, and large transaction volumes. They come into play for crypto gaming apps, NFTs, crypto borrowing and lending, and even blockchain-based social media platforms.
| Layer | Function | Core features | Examples |
| Layer 1 | The core blockchain layer — responsible for decentralization, consensus mechanisms, and security. | – Consensus mechanisms (PoW, PoS) – Opens and closes transactions – May execute smart contracts – Provides security – Stores data | Bitcoin, Ethereum, Solana |
| Layer 2 | Built on layer 1 to make transactions faster and cheaper. | – Uses state channels, sidechains, rollups, or plasma – Decongests the primary network – Makes crypto scalable | Lightning Network (for Bitcoin), Optimism (for Ethereum) |
| Layer 3 | Provides a user-friendly interface. | – Connects users to layers 1 and 2 – Abstracts layer 1 and 2 processes. – Enables cross-chain processes. | Uniswap, Aave |
How Do You Interact with Layers 1, 2, and 3?
With a look at what layer 1, layer 2, and layer 3 solutions are in crypto out of the way, you might be wondering how that works out in practice. Which layers do you interact with when you complete cryptocurrency transactions? Can you choose? This is where the layers get interesting in practical terms.
What Does Layer 1 Do?
Layer 1 is, as we’ve seen, the foundation — the main blockchain, which focuses on security. Bitcoin, Ethereum, Solana, Dogecoin, Avalanche, and Polkadot are a few examples. Layer 1 solutions work in different ways for different cryptocurrencies, but they all have the same basic characteristics:
- A consensus mechanism that establishes whether a transaction is valid. Bitcoin uses “proof of work” (complex math puzzles), while Ethereum uses “proof of stake” (tokens), for example.
- Data storage. Layer 1 keeps a permanent record of all transactions.
- Security, which depends on the nature of the consensus mechanism as well as the extent to which the blockchain is decentralized.
Some blockchains execute smart contracts on layer 1 — Ethereum, for example — but others do that on layer 2. Some examples of things that take place mostly within layer 1 include wallet transfers and minting native tokens (like mining new Bitcoins).
Everything layer 2 does is also rooted in layer 1, especially at the beginning and end of a transaction, keeping the whole process secure. The processes in layer 1 take time, though, limiting the transaction volume. That’s where layer 2 solutions come in.
Where Do You Encounter Layer 2?
Whether you’ll encounter layer 2 solutions depends on how you interact with cryptocurrencies. This look at examples should make that clearer:
- Decentralized crypto exchanges — like Loopring — use layer 2 solutions to make large-volume trading faster and much cheaper.
- Decentralized finance protocols that facilitate lending and borrowing — like Aave or Uniswap — are adopting layer 2 options like Optimism and Arbitrum to slash costs and create a better experience for their users.
- Blockchain games can’t afford to rely purely on layer 1 solutions, and use layer 2 to make their models financially feasible.
- Micropayment platforms like the Lightning Network use layer 2 for cheaper and faster transactions.
Layer 2 solutions are also used to mint NFTs and for much larger operations, which might impact you indirectly, but these examples show how you may have already interacted with layer 2, without even knowing it. Some crypto exchanges, like Coinbase and Kraken, have also adopted layer 2 protocols to reduce transaction fees — but that’s not yet universal.
What About Layer 3?
Layer 3 is less well-defined than the other two layers, but it’s essentially the front end built on layer 2. If this discussion has left you with a spinning head, and you still don’t understand what any of this really means, that’s actually precisely where layer 3 comes in. It hides all this complex blockchain stuff from view, so that you can simply buy, sell, and trade cryptocurrencies through decentralized apps.
Layer 3 is where you can start to relax, knowing that layer 1 and 2 functionality is unfolding in the background — keeping you safe and speeding up your transactions without bothering you. Layer 3 can even combine several layer 2 processes quietly and beautifully.
Hiding the internal layers under a shiny and intuitive user interface isn’t all layer 3 does, though. It also introduces its own functionality — including bits that would be hard to work out in layers 1 and 2. They include identity confirmation, privacy features, and protocols to access information on the primary blockchain.
When you buy an NFT, the marketplace is layer 3. When you use Mastodon, the social media platform itself is the third layer. When you use Uniswap, the app is layer 3 — and we could continue with more examples, but you get the picture. Layer 3 is more complex than a typical user interface solely because it’s built to connect to a decentralized blockchain rather than a centralized server.
Why Understanding the Layers of Blockchain Technology Matters
If you’ve made it to this point, you now have a clearer understanding of how modern blockchain technologies work.
You know that layer 1 is the foundation on which everything else is built. It’s what makes crypto decentralized and secure — but on its own, it’s both slow and (often unreasonably) expensive. You know that layer 2 takes the load off that primary network, so that it can be faster and cheaper while retaining its security and decentralized nature. Layer 2 makes cryptocurrencies scalable.
You also know that layer 3 works to give you the same kind of user-friendliness you’d expect from a fiat ebanking app (where you might also remain blissfully unaware of all the SWIFT stuff going on in the background).
A little look under the hood helps you understand how different layers work together, and build on each other, to give you access to secure, decentralized, fast, and affordable crypto transactions — while making sure you don’t have to have expert levels of knowledge about how all this works.
There’s a practical side, too. Working with coin exchanges and payment platforms that rely on level 2 solutions makes transactions significantly more affordable — so look out for platforms that use them, like Polyogon, Lightning Exchange, and Optimism.
