A blockchain behaves like an ecosystem that can be divided into so-called layers, comparable to the Internet protocols, which are classified into layers according to the TCP/IP reference model. In the crypto space, “Layer 0”, “Layer 1” or “Layer 2 projects” are often spoken of colloquially. But what does that mean and why does it exist?
The different layers
Layer 0
Layer 0 projects are often called the projects that offer developers frameworks for Layer 1 blockchains. They also offer an underlying infrastructure and security layer that enables data exchange from Layer 1 blockchains. This in turn improves the interoperability and scalability of Layer 1.
Layer 0 protocols work differently depending on their design and relationship to the Layer 1 blockchain. Cosmos, for example, consists of a multi-hub architecturewhereas Polkadot offers a central hub.
Layer 1
A layer 1 forms the heart of an ecosystem: Ethereum, for example, is a basic blockchain on which other projects such as Uniswap & Co. are based.
Layer 1 blockchains carry the consensus mechanism. Consensus determines how node operators in a decentralized network agree on the new valid transactions. Layer 1 would therefore be the crucial layer that should make a network as secure and decentralized as possible in relation to the Blockchain Trilemma.
Layer 2
Layer 2 projects are projects that are layered on Layer 1 blockchains. The aim of Layer 2 is primarily to compensate for the lack of scalability of Layer 1 blockchains.
Layer 2 allows Layer 1 to, among other things, outsource individual transactions and functions, thereby increasing network capacity while reducing transaction costs.
Each second layer offers a different technological strategy for a scaling solution.
Well-known examples of Ethereum-friendly second layer projects are Polygon, Arbitrum or Optimism. The Lightning Network, for example, is a Layer 2 network for Bitcoin.
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Layer 2 vs Layer 3
To be distinguished from Layer 2 are application layers, which are often referred to as Layer 3. Layer 3 acts as a user interface for the user and hosts all sorts of things dApps and protocols.
Decentralized exchange platforms or NFT marketplaces could fall into the category of Layer 3 projects.
The value of the different blockchain layers
There are now numerous approaches to improving the interoperability and scalability of Layer 1 blockchains.
Without all the use cases, however, a blockchain remains, to put it bluntly, just one Blockchain: One Chain with ones lined up next to each other blocksthat contain records.
Layer 3 projects play a crucial role in making the technology tangible for users and making the ecosystem economically attractive. However, Layer 3 projects are less likely to receive the value of an underlying base blockchain, which is essential for a decentralized infrastructure.
An investor could take the value of the individual “layer projects” into account in his financial decisions. He could ask himself how actively the competing scaling solutions are currently and will be used in the future, or how much Layer 1 projects will build on Layer 0 projects. A rather rigid niche product could one day bring the project to a standstill.
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