Ethereum (ETH) is the 2nd largest cryptocurrency by market capitalization at $ 297 billion. It performed exceptionally well in 2021, surpassing $ 4,000 at its peak in May after starting the year around $ 800. One of the main drivers of Ethereum’s success is the diverse ecosystem of Decentralized Finance (DeFi) platforms built on its network.
DeFi platforms have attracted tons of users looking to lend, borrow, earn interest and more. A consequence of the widespread adoption has been that the number of transactions on Ethereum has skyrocketed, slowing the network and increasing transaction costs. While there are simple solutions to this problem, the simpler ones can sacrifice security and decentralization to speed up transaction costs. Layer 2 projects can be a vital interim solution for the future of Ethereum.
What is Ethereum?
Ethereum is a decentralized, open-source blockchain network that uses its native Ether token to pay transaction fees. Ethereum was first visualized in 2013 in a white paper written by Vitalik Buterin. It was launched on July 30, 2015 and has become the second most successful cryptocurrency, behind Bitcoin.
The network is distinguished by 2 main functions. The first is that it functions as a platform that hundreds of thousands of other cryptocurrencies can build on. The most common type of these are ERC-20 tokens, which are a big part of the best cryptos in the world.
The second and possibly the most important function of Ethereum is that it can compute code within the network called “smart contracts”. These are self-fulfilling contracts that only require trust in the code and not with the other parties to the contract. DeFi platforms use smart contracts to provide users with enhanced financial tools for loans, borrowings, interest, insurance and more.
Smart contracts can be much more complex than simple transfers or transactions, which increases congestion and transaction costs. The massive adoption of smart contracts has recently skyrocketed Ethereum transaction fees and led many users to low-cost, more centralized competing blockchains. However, due to the recent crash in the cryptocurrency market and the success of the Polygon side chain, Ethereum fees have returned to much lower levels – for now.
Layer 1 vs Layer 2 on Ethereum
Layer 1 is the term used for the underlying blockchain architecture and changes to it are called Layer 1 solutions. For example, Ethereum could be easily scaled by increasing the block size and therefore the number of transactions verified per block. However, this would make mining prohibitively expensive – centralizing the network to only the richest miners with the best equipment. This could leave the power to verify the channel in the hands of a few, putting the network at risk of malicious attacks. The Ethereum community does not wish to make this Layer 1 change because it would sacrifice decentralization and therefore network security.
Layer 2 solutions are network-backed and require no Layer 1 modifications. Layer 2 solutions still exploit the security of the Layer 1 network consensus mechanism, but they can significantly speed up transactions. Ethereum Layer 1 can handle around 15 transactions per second, while some Layer 2 projects can scale up to 4,000 transactions per second. Layer 1 Ethereum network scalability upgrades are planned for the coming years, and Layer 2 will prevent dApps from leaving Ethereum in the short term.
Optimism is a for-profit public benefit company working to launch Optimistic Mainnet Rollups. It was born out of a nonprofit called Plasma Group, founded by Ethereum creator Vitalik Buterin and a co-creator of Bitcoin’s layer 2 solution, the Lightning Network. Plasma Group switched to for-profit Optimism in January 2020 and has been a leading optimistic stack-up project.
A rollup is a Layer 2 solution in which a large batch of transactions are aggregated and processed out of the main network (Layer 1), and then the condensed transaction data is published on Layer 1. This can dramatically increase network throughput, reduce congestion and transaction costs.
A new type of key player in this solution is called an aggregator, which publishes a batch of transactions to a smart contract on layer 1. Invalid transactions are deleted via challenges from other network participants. They have about 1 week to post proof that the transaction was miscalculated.
An important feature of Optimistic Stacks (ORUs) is that they will be compatible with most smart contracts, unlike Plasma and many other Layer 2 solutions. This is essential to keep DeFi user transaction fees low and reduce network congestion. ORUs could increase transaction speed on platforms that integrate it by a factor of 100. This is fast enough for Ethereum’s current transaction throughput and should help DeFi and other platforms attract more. users, even before Eth 2.0 was finished.
ZkRollups (ZKR) are a powerful scalability solution using zero-knowledge evidence (ZK). ZK proof simply proves that you know something without revealing what it is. A ZKR introduces the relay, which adds a ZK-SNARK (a special ZK proof that does not require interaction between the relay and the verifier), which proves that the transaction batch is valid. This dramatically reduces the amount of information published on Layer 1, increasing transaction throughput by up to 10 times more than ORUs.
While ORUs rely on challenges to remove invalid blocks, ZKRs make it impossible to post an invalid block. Therefore, users don’t need to trust aggregators like they do with ORUs – they need to trust the back-end’s ability to calculate and verify the ZK-SNARK signature.
The main drawbacks of ZKR are that they are computationally intensive and have to create specific evidence for each type of transaction to work properly. Only limited evidence is available to date for direct transfers and other straightforward transactions. Therefore, ZKRs will not be compatible with many smart contracts and DeFi platforms until the right evidence is built. While ZKRs appear to be a vastly superior method and may eventually overtake ORUs, they are not as useful at this time.
Where to buy Ethereum
Since Ethereum is the second largest cryptocurrency, it is available on many different trading platforms. Brokers like WeBull and Robinhood support ETH as well as almost all cryptocurrency exchanges. Some of the best exchanges are Coinbase, Gemini, Crypto.com, eToro, and Voyager.
Investors in the United States will need to comply with Know Your Customer regulations by verifying their identity on the platform before purchasing cryptocurrencies. This requires your address, driver’s license (or other valid ID and social security number.
Where to Buy Layer 2 Cryptocurrencies
Some of the more exciting Layer 2 cryptocurrencies include Polygon (formerly Matic) and LoopRing. Polygon primarily works as a side chain of Ethereum, delivering tiny fees and blazing speed. It has already been integrated with dozens of large decentralized applications (dApps) like Curve Finance and has exciting plans to extend Ethereum’s scalability.
LoopRing uses zkRollups to scale and facilitate swap and swap transactions, improving decentralized exchanges that use it enough to start competing with centralized exchanges. Both of these cryptos can be purchased on Coinbase, Binance, Crypto.com, Gemini, and a few other exchanges.
Cryptocurrency Price Movements
The cryptocurrency market has mostly moved sideways over the past few weeks after partially recovering from the recent crash. This crash was caused by the ban on cryptocurrency services in China and Tesla’s decision to no longer accept Bitcoin as a payment method.
A new recovery saw the light of day last week after a few major world events. El Salvador added Bitcoin as legal tender in the country and Tesla announced that it would resume Bitcoin payments after fossil fuel consumption decreases. Bitcoin is back above $ 40,000 and Ethereum is around $ 2,550, although they are both well below their all-time highs.
What effect will layer 2 have on Ethereum?
Layer 2 projects are likely to be the most important as an interim solution for the scalability of Ethereum (and other cryptos). Ethereum 2.0, which is slated to join Ethereum 1.0 between 2021 and 2022, will hopefully reduce congestion and transaction speed issues slow enough that Layer 2 projects aren’t as necessary. However, Layer 2 solutions will not go away after the full release of version 2.0 and will further maximize transaction speed and minimize fees.
Benzinga has developed a specific methodology for classifying cryptocurrency exchanges and tools. We prioritized platforms based on offers, prices and promotions, customer service, mobile app, user experience and benefits, and security. To see a full breakdown of our methodology, please visit our Cryptocurrency Methodology page.
Gemini creates crypto products to help you buy, sell, and store your bitcoin and cryptocurrency. You can buy bitcoin and crypto instantly and access all the tools you need to understand the crypto market and start investing, all through a clean and attractive interface. Gemini Crypto Platform offers great account management options. You can manage your account at a glance, view 24 hour changes and percentage changes to your account balance. Start now with Gemini.