Examining a point of view; Why are layer 2 protocols so important?

If you’re somewhat familiar with blockchain and cryptocurrency knowledge, you’ve probably heard about layer 1 protocols and their scalability issues. Bitcoin and Ethereum are first-layer protocols, both of which face scalability issues; For this reason, in recent years, solutions called layer 2 protocols have tried to solve this problem. Why are these protocols so important?

in this contentWe are going to answer this question by examining a point of view. Although Bitcoin and Ether are the most discussed in the space of digital currencies, the investment opportunities are far beyond these two digital currencies. If you plan to invest in the field of digital currencies, it is very important to be able to identify new and profitable opportunities in this field. So stay with us until the end of the article.

Layer 2 protocols and their purpose

As we said, the scaling problem of the first layer protocols makes their applications more limited than their real capabilities. Bitcoin can only enable peer-to-peer transactions. Even though Ethereum allows access to smart contracts and decentralized finance (DiFi) and many more applications, it faces the problem of network congestion and transaction disruption, which increases fees or gas amounts.

Second-layer solutions rely on Bitcoin and Ethereum blockchains to increase their capabilities, and their goal is to increase scalability, expand applications, speed up transaction execution, and reduce network congestion in first-layer protocols.

scarcity of block space; The main problem of layer 1 protocols

What determines the value of layer 1 protocols is the block space. Block space contains various information and smart contracts. Bitcoin, Ethereum and other first layer tokens are valued according to the amount of demand for this space; Just like a ticket to a very important speaking event, the more people buy it, the more expensive it gets. The reason is that the space of the hall is limited and the crowd increases in it; So anyone who pays more can enter the main hall.

Bitcoin allows people to make peer-to-peer transactions. The price of Bitcoin increases as the demand for it increases. In contrast, Ethereum, the largest first-tier blockchain based on smart contracts, allows users to access smart contracts and build decentralized applications and decentralized financial protocols, or DeFi. All this must be done in block space.

Block space is scarce in layer 1 protocols; For this reason, a blockchain like Ethereum cannot handle as many transactions as other financial systems. Ethereum can ultimately only process a few tens of transactions per second, which is not comparable to networks like Visa or the New York Stock Exchange. That being said, how is DeFi going to take over traditional finance functions?

second layer protocols; Increasing block space entries

Now let’s assume that the first layer protocols are the event hall that everyone rushes to enter. This will mean a long queue at the entrances and congestion in the network, resulting in a dramatic increase in gas. This is where the importance of second layer protocols becomes clear.

What if there were additional rooms surrounding the main hall, and people in the rooms watched the lecture at the same time as everyone else on built-in televisions? Certainly, the crowd in the main hall will be less.

After the speech is over, all these people have to go through the main hall again and exit. Each room has a separate entrance to the main hall; Therefore, the number of entrances is more and this prevents everyone from crowding in front of one entrance. This is what layer 2 protocols do.

Layer 2 protocols distribute transactions into additional block spaces and load and process a number of transactions in each much faster or cheaper than layer 1. After processing, all these transactions must be returned to the first layer. Now that the number of inputs is much higher, the problem of network congestion is reduced and thus, the first layer protocols have been able to process more transactions in a short period of time.

Popular second layer protocols for Bitcoin and Ethereum

Among the famous layer 2 protocols, we can mention Stacks for Bitcoin, Arbitrum, Polygon and Optimism for Ethereum. Layer 2 protocols, like their counterparts in the first layer, have a native token that acts as an incentive or incentive to use the network.

As an investor, the second layer is for you as an investment in the infrastructure that allows greater access to the first layer, while creating space for developers to design new and useful features. Let’s examine these protocols.

Polygon

Polygon is the first platform of the second layer; For this reason, it is better known. This platform, which is supposed to increase the scalability of Ethereum, allows developers to build their decentralized applications faster and more easily on Ethereum. The Polygon network can process about 7,000 transactions per second; While this number for Ethereum is only about 30 transactions per second.

Last year, JP Morgan did a DeFi deal using Polygon, and it made headlines. The main token of Polygon is called MATIC (MATIC), which currently has a market value of about 10.65 billion dollars and ranks ninth in the market.

Immutable X

ImmutableX acts as a scaling system for non-fungible tokens (NFTs) and aims to reduce gas costs and long transaction verification times. The market value of the main token of Immobile X network called IMX is estimated at 1.06 billion dollars. The mentioned token ranks 52nd in the market and is much lower than Metik. This gap shows how important Metic’s market share is.

Stacks

Over the past month, Stax has been making a lot of noise. While Polygon and ImageCable X help Ethereum scale, Stax is focused on Bitcoin. This protocol has expanded its use beyond peer-to-peer transactions by enabling the implementation of smart contracts and the creation of NFTs called Ordinals on Bitcoin.

Since Bitcoin is the most popular digital currency, the digital currency community pays special attention to the STAX project. The native token is called STX and with a market value of about 1.23 billion dollars, it is ranked 45th in the market.

The future of layer 2 protocols

Polygon, ImageCableX, and Stacks were just three examples of layer 2 protocols, and of course, their list does not end there. Optimism (OP) and Loopring (LRC) and a number of other protocols are also designed to increase usability in the cryptocurrency ecosystem. Arbitrum, as the second layer of Ethereum, has recently surpassed it in terms of the number of transactions.

The success or failure of these projects will be determined over time; But the impact and opportunity and access to what they provide should not be ignored. The scalability of digital currencies can help these currencies grow further and consolidate their foothold as an alternative to the traditional financial system.