One of the hardest challenges of building a business is achieving scalability. Scalability by definition is the ability of something, especially a computer system, to adapt to increased demands. For a system to reach scale the operational mechanics must be structured such that most all repeatable tasks can be automated. Companies or systems that successfully implement scalable systems generally have a higher probability of succeeding in the long term.
The concept of reaching scalability also applies to digital applications, especially as it relates to blockchain technology. In fact, scalability has become the topic de jour for the Ethereum blockchain. Ethereum is a marketplace of financial services, games, social networks, and other apps that are built using programmable blockchain technology. The Ethereum Virtual Machine (EVM) executes smart contracts that enable digital applications to run in a decentralized manner. The EVM operates like an enormous super computer that is distributed among thousands of individual computers (i.e., nodes) in a peer-to-peer (P2P) to network where each participant is seeking to validate transactions.
As Ethereum has grown in popularity, more and more decentralized applications have been built resulting in more transactions on the Ethereum blockchain. While the increased activity is a positive for Ethereum and the web3 movement overall, but it’s created a new problem with respect to the system’s ability to scale. The level of transaction activity on the Ethereum blockchain has increased so much that the compute power necessary to reach consensus within the P2P network has become very expensive and it’s taking longer for transactions to settle/finalize.
The current version of the Ethereum blockchain (Layer 1 or L1) can only process ~15 transactions per second (TPS). This is not enough. For Ethereum to appeal to the masses it must figure out a way to reach scalability or risk falling by the wayside as a technology suitable only for a small, niche group of savants and developers who understand and can afford to use it.
Fortunately, there are several solutions in development to help solve L1 scaling challenges. One of the more popular solutions is creating secondary blockchains that operate using Ethereum’s base code, but process transactions outside of the main Ethereum blockchain. More formally, this secondary blockchain is called a Layer 2 blockchain or L2.
According to L2Beat, L2 is a chain that fully or partially derives its security from L1 Ethereum. By executing transactions in L2, the number of transactions per second increases exponentially. As previously stated, L1 Ethereum can perform 15 TPS. On L2, that number increases to 2000 to 5000 TPS (and maybe even a lot higher). There are several Layer 2 blockchains gaining ground that allow users to have all the functionality of the Ethereum blockchain and significantly less expensive to use. For example, Arbitrum One is a Layer 2 blockchain that charges $0.05/transaction to send ETH and $0.14/transaction to swap tokens. These same transactions on the L1 Ethereum blockchain cost $0.72/transaction and $3.61/transaction, respectively (as of September 9, 2022, 5:35pm CT) (Note: Transaction costs/gas fees vary according to the level of activity on the chain. The values stated above were the transactions costs on this specific date and time).
L2 Blockchains are still early in the early stages of development so there are still kinks to work out. As such, blockchain experts advise to be conservative with the amount of capital committed to these platforms. According to L2Beat, funds can be stolen, lost, or frozen if the validator fails to check the published state of a transaction; a contract receives malicious code; or if there are mistakes in the code layer that bridges L2 to L1 (1).
Despite these initial challenges, blockchain technology is steadily moving closer to achieving scalability through a variety of scaling solutions including zkRollups, Optimistic Rollups, Validium, and Plasma. If you’re interested in learning more about the details of how these systems work, please see the resources below.