Layer 2

Layer 2 networks, or L2s, increase transaction capacity and lower costs by executing transactions off the main chain, known as layer 1, and periodically settling to it. Rollups are the dominant design: optimistic rollups assume transactions are valid unless challenged within a dispute window, while zero-knowledge rollups post cryptographic validity proofs. Other designs include payment channels such as Bitcoin’s Lightning Network.

L2s let base chains such as Ethereum scale without sacrificing decentralization at the base layer, and many consumer, trading and payments applications now run on them. Trade-offs include reliance on sequencers that order transactions, upgradeable contracts controlled by small groups, withdrawal delays, and fragmented liquidity across networks. The value captured by L2 tokens versus the base layer asset is an active debate.

For allocators, L2 activity affects fee revenue on the base chain and the competitive position of individual networks. Example: a payments company settles stablecoin transfers on an Ethereum rollup, paying a fraction of mainnet fees while relying on Ethereum for final settlement.