This article aims to provide an overview of the underlying architecture of blockchain and its scalability. It references scalability solutions such as consensus protocol changes, sharing, nested blockchains, and state channels. If you are unfamiliar with crypto, read our articles on blockchaincrypto, and DeFi before reading this article.

While blockchain technology has proved to be a force to be reckoned with, the underlying structure of these decentralized networks faces a challenge known as the Blockchain Trilemma. This trilemma refers to the need for a network’s balance between decentralization, scalability, and security. Decentralization in blockchain refers to transferring decision-making and control from a centralized entity to a distributed dispersed network. Scalability is essential to any network and refers to the network’s ability to support high transaction volume, enabling future development and growth. The security of a network is dependent on its level of vulnerability against hacks and attacks. 

To understand the layers of blockchain technology and its current standing against legacy systems (e.g., traditional payment processors), we need to understand the scalability issue in some detail. To become highly scalable, blockchain networks must be able to efficiently onboard a growing number of users, handle large amounts of transactions, and process data.

Centralized platforms, often referred to as legacy systems, are significantly ahead of Decentralized platforms due to their rapid processing and settlement times. To illustrate with an example, Visa processes about 1,700 transactions per second compared to Bitcoin’s 4-7 transactions per second. However, decentralized currencies are trying to compete with these traditional payment processors while maintaining their core properties, such as transparency and access, central to their mission. 

What Are Layer-1s?

A Layer-1 network acts as the base infrastructure on which other networks, protocols, and applications can be built on. These underlying architectures work on different consensus mechanisms, out of which proof-of-work (PoW) and proof-of-stake (PoS) are the most common. These consensus mechanisms have their unique security, speed, and decentralization levels. To illustrate, Ethereum is a Layer-1 network that currently uses PoW to arrive at a consensus regarding matters such as account balances and order of transactions, amongst others.

What Are Layer-1’s Scaling Solutions?

Layer-1 scaling solutions optimize the base protocol by accommodating more data and users and increasing transaction speed and capacity. The two most common methods to obtain layer-1 scaling include:

1. Fundamental Changes in Consensus Protocol

The two most popular Layer-1 decentralized networks, namely Bitcoin (BTC) and Ethereum (ETH), currently use the PoW consensus protocol. PoW is when miners are incentivized to use their computational power to solve complex cryptographic problems to reach a consensus securely. PoW uses a significant amount of energy, almost equivalent to a country like Austria (73.2 TWh). In comparison, PoS aims to carry out the same objective as PoW with better efficiency regarding scalability and energy consumption. PoS enables users to become validators by staking the required Ethereum (ETH). It also eliminates the need to compete for block creation previously done by miners by randomly assigning network validators.

2. Sharding

Another popular Layer-1 scalability method is known as sharding. In a typical Layer-1 network, independent nodes are responsible for maintaining and storing all transactions and critical data of the network. While this method ensures a certain level of security, it significantly slows the transaction processing speed of the network. Sharding allows for splitting the transactional workload of a blockchain network into separate shards. Splitting workload helps reduce network latency as shards can simultaneously process numerous transactions in parallel. However, sharding does come with security concerns. Due to shards individually processing their share of data, a possible attack from a malicious program or hacker on shard could result in loss of information or data. 

What Are Layer-2s?

A Layer-2 network functions by operating on and extending the functionality of a Layer-1 network. Layer-2 networks improve the scalability and efficiency of the underlying Layer-1 network by increasing performance and programmability and significantly reducing transaction costs. To illustrate, the Polygon (MATIC) network is a Layer-2 solution that is built on top of Ethereum (ETH) to reduce network fees and decrease network latency. 

What Are Layer-2 scaling solutions?

Layer-2 scaling solutions entail decongesting the base Layer-1 blockchain by shifting a part of its transactional volume to an adjacent system. This additional layer helps the base layer process a majority of transactions, making scalability possible. Some examples of Layer-2 solutions are:

1. State Channels

Definition

Off-chain interaction is made possible by state channels, which are two-way communication channels between participants. 

How it works

On-chain interaction between participants increases transaction processing time due to the dependency of miners. Smart contracts or multi-signatures help seal off specific portions of the blockchain, and participants can directly engage in interaction with each other without miner participation. When the entire transaction is completed, the final state of the channel is added back to the blockchain. 

Example

Ethereum’s Raiden Network and Bitcoin’s Lightning Network.

2. Sidechains

Definition

Sidechains are similar to state channels because they are also adjacent transactional chains that help the base blockchain achieve scalability. 

How it works

Sidechains use an independent consensus mechanism separate from the original chain. They are differentiated from state channels since participant interactions in Sidechains are shared and recorded to the public ledger. 

Example

RSK (RootStock) and Liquid.

3. Nested Blockchains

Definition

A Nested blockchain consists of multiple blockchains on top of a pre-existing base blockchain. 

How it works

These different levels will stay connected to each other through the parent-child connection. The base chain delegates work to a web of these secondary chains, which process and return after completion. This distribution model enables the base blockchain to reduce its processing burden, leading to exponential scalability. 

Example

A popular example of this is the OMG Foundation, which builds the Boba network as a Layer-2 nested blockchain scalability solution on top of the Layer-1 Ethereum protocol to improve transaction throughput and extend the capabilities of smart contracts. They also provide a higher level of security than state channels as a breach in the sidechain does not impact other Sidechains or the main chain.

Conclusion

Scalability is one of the most critical issues to be tackled to enable mainstream adoption of crypto and their use cases. Layer 1 and 2 scaling solutions are actively working on this issue while staying true to the tenets of blockchain technology, security, and decentralization. 

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Disclaimer

This publication is provided for informational and entertainment purposes only. Nothing contained in this publication constitutes financial advice, trading advice, or any other advice, nor does it constitute an offer to buy or sell securities or any other assets or participate in any particular trading strategy. This publication does not take into account your personal investment objectives, financial situation, or needs. Treehouse does not warrant that the information provided in this publication is up to date or accurate.