Bitcoin layers (we’ll refer to them as L2s more broadly) are protocols and networks that act as a second layer built on top of the base Bitcoin blockchain. L2s generally leverage the underlying blockchain’s security while enabling faster transactions, lower fees, and more advanced functionality on their networks.
Bitcoin Layer 2 Explained
L2 solutions essentially move BTC and BTC-based transactions off-chain for processing before settling the transaction data back to the Bitcoin layer 1 (which we use to refer to the main blockchain network). This increases scalability by handling more transactions per second off the L1.
There are various types of layered solutions for Bitcoin including sidechains like Stacks, state channels like Lightning, and emerging rollup approaches. Together, these layers on top of the Bitcoin blockchain unlock more programmability and expressiveness as they process digital asset activity.
Each one of these layers offers their own solutions for building on top of Bitcoin and how transactions are processed. Sidechains, for example, are separate blockchains that peg to and settle on Bitcoin while state channels operate between two users to facilitate rapid payments back and forth. Emerging technologies like rollups also allow for faster transaction validation while ensuring that transfer information remains hidden.
By leveraging Bitcoin’s security while optimizing throughput off-chain, L2 solutions aim to bring greater speed, scalability, functionality and financial privacy to Bitcoin applications.
Bitcoin Layer 2 to Scale
Concerns around Bitcoin’s limited scalability and throughput has, over the years, led developers to build innovative scaling solutions that expand the Bitcoin main chain’s capabilities while retaining its core ethos. Layer 2 solutions (L2s), in particular, have become key. These solutions for Bitcoin have been rapidly gaining steam, offering everything from greater anonymity to application versatility and accessibility while benefiting from Bitcoin’s solid security model.
If you’ve heard of Bitcoin and blockchain technology, you’ve probably heard of what is called the “Blockchain Trilemma.” It’s a term that illustrates how the biggest challenge for developers is finding out how to balance security, decentralization and scalability on a blockchain in the cryptocurrency world. This is the case even for all blockchains like Bitcoin and Ethereum.
Bitcoin was designed as a decentralized crypto payment network, trustlessly powered by its users without central intermediaries. As a result, the Bitcoin network was built to prioritize security and decentralization, but that came at the expense of its scalability.
How Does Bitcoin Layer 2 Work?
You’ll also often hear people use the term “L2” when they’re referring to a number of scaling solutions for blockchains. Ultimately, the Bitcoin L2 ecosystem is diversifying, and each L2 makes use of different innovations, including the following:
Sidechains: These are separate blockchain networks that operate alongside the main L1, but they’re often connected to the L1 through a two-way peg. Users can transfer assets to the sidechain and put them to use before moving them back to the main chain.
State channels: These are Layer 2 scaling solutions that facilitate off-chain transactions between users. Since state channels handle transactions off-chain, they lessen network congestion while improving transaction speeds and lowering fees for users.
Rollups: In recent years, developers have made significant progress in bringing rollups to Bitcoin. Like state channels, rollups process transactions off-chain, but then they “roll up” multiple transactions into a smaller data package to settle back on the L1. The two main types of rollups are ZK-rollups and optimistic rollups, both of which offer their own advantages.
Despite their differences, all Bitcoin L2s accomplish the following:
Offload transactions from the Bitcoin L1: Layer 2 protocols process transactions off the main Bitcoin chain (hence the term, “off chain”), but ultimately settle them back on the Bitcoin L1. That’s also how L2s reduce network congestion, which results in faster transaction speeds and lower fees for users.
Maintain network security: Many people still consider Bitcoin to be the most secure and decentralized blockchain. This means that transactions that happen on Bitcoin L2s still inherit the security properties of the main chain.
In short, Bitcoin L2s improve the scalability, efficiency, and speed of the Bitcoin network. By processing transactions off the main chain while still relying on Bitcoin-backed security, L2s help grow the entire Bitcoin network.
Bitcoin Layers and Bitcoin Wallets
Understanding L2 blockchains and the different ways they work will be crucial for wallet users. The Bitcoin ecosystem has developed in large part thanks to Bitcoin L2 protocol technology and will remain a vital part of the blockchain's evolution – and the evolution of wallets – for years to come.
As Bitcoin’s layer 2 ecosystem expands, efforts have been made to integrate L2 protocols to enhance the user experience. The combination of Bitcoin wallets and layered solutions greatly unlocks the utility that users want for managing and putting their Bitcoin-secured assets to work.
For wallets, supporting layer 2s like Lightning could lead to faster transaction speeds and lower network transaction fees. This would, in turn, allow for Bitcoin users to more efficiently conduct transactions in their wallet applications. Furthermore, these solutions can also enable wallets to offer increased privacy protections for users as they conduct transactions.
These are all important developments for Bitcoin wallets as more users engage with Web3 applications. The programmability offered by these emerging technologies has helped unlock DeFi, NFT marketplaces, tokenized assets and additional peer-to-peer use cases built on top of Bitcoin. Today’s wallet users, in fact, have a much wider range of platforms and protocols at their fingertips than they did years before.
The need for users to access the growing decentralized application space is why Bitcoin wallets have made it a priority to integrate L2 technology. As Bitcoin matures into its role as the secure base layer for the internet of tomorrow, seamless wallet integrations with layered protocols like Lightning are critical to unlocking Bitcoin’s full potential across the DeFi space and beyond.
Examples of Bitcoin Layer Protocols
A number of layers already exist that have demonstrated great promise in addressing the Bitcoin network’s scalability issues. Examples include the Lightning Network and Stacks.
Lightning Network
The Lightning Network is a well-known Bitcoin layer 2 solution. It focuses on payments by operating as a network of payment channels. These payment channels with Lightning nodes at their core give users the ability to tap into instant, high-volume peer-to-peer micropayments.
By handling transactions off-chain and settling net balances on Bitcoin’s L1, Lightning allows for exceptionally fast and cheap payments that aren’t feasible directly on the main chain. The speed and ease with which Lightning handles transactions has actually led to a big push among the crypto community for its widespread adoption.
Stacks
The Stacks blockchain is a platform dedicated to unlocking smart contract functionality on Bitcoin. It has played a big role in the evolution of Bitcoin DeFi over the years, as it allows for dApps to be built on top of the Bitcoin main chain while leveraging its high level of security and decentralization. The Bitcoin layer has also been a pioneer of NFTs on Bitcoin and was a driving force behind the popularization of Ordinal inscriptions following the Ordinals protocol launch.
Stacks also has its own smart contract language, Clarity, along with its own Proof of transfer (PoX) consensus mechanism model. Users can also participate in the Stacking process to contribute to the network.
Rootstock
Rootstock is a Bitcoin L2 that improves smart contract functionality to Bitcoin. By using a process called merge-mining, the L2 helps Bitcoin miners mine Bitcoin and Rootstock without consuming extra resources. The L2 also supports a two-way peg between Bitcoin and RBTC, its native token. This gives users an easy way to transfer Bitcoin into the Rootstack chain and vice versa.
Liquid
Liquid is an L2 that operates as a federated sidechain. This means that it relies on a consortium of trusted entities (which are called functionaries) to validate transactions in Bitcoin miners’ stead. Liquid gives users the opportunities to lock their Bitcoin on the main chain and receive L-BTC, which is a tokenized version of BTC on the Liquid network.
New Bitcoin Layer 2 Protocols
Thanks to the emergence of new protocols on Bitcoin (including Ordinals, the BRC-20 token standard, Runes, and more), the number of Bitcoin L2s has grown significantly. Though Stacks, Lightning, Rootstock, and Liquid were known as the most prominently Bitcoin L2s, a number of new L2 projects have emerged as of this writing.
Today’s Bitcoin users may find themselves engaging with these new Bitcoin L2s, including:
Ark
Botanix
Babylon
Bitcoin Virtual Machine
BOB
B2 Network
Mezo
Of course, all of these L2 protocols are currently in their infancy. Users looking to engage with these newer Bitcoin L2s should make sure to do their research and understand the benefits – and potential risks – associated with each.
Advantages and Disadvantages of Bitcoin Protocol Layers
Advantages
Expanded use cases: Bitcoin layers enable new applications for users, including decentralized finance (DeFi).
Increased transaction speed: These layers can process transactions off-chain, resulting in faster speeds compared to the base layer.
Enhanced features: Additional functionalities such as improved privacy, asset issuance, and more robust smart contract capabilities are available.
Disadvantages
Potential for centralization: Limited network participants can lead to centralization. For example, the Liquid network relies on just 15 functionaries to manage transactions and secure BTC on the base layer.
Scaling challenges: Layer 2 networks might encounter scaling issues, particularly if they depend heavily on the base layer. For instance, the Lightning Network requires opening and closing channels on the base layer, which can involve costly on-chain transactions to achieve scalability.