What exactly is a Real L2?

In the context of blockchain scalability solutions, an L2 typically refers to a scaling solution that inherits the security properties of the underlying Layer 1 (L1) blockchain, such as Bitcoin or Ethereum, while offering improved scalability and lower transaction costs.

For an L2 to be considered "real," it must have a robust mechanism for inheriting the security properties of the underlying L1 blockchain, either through fraud proofs (optimistic rollups) or validity proofs (ZK-rollups). This ensures that the L2's transactions are ultimately secured by the L1 network's consensus and security model, while still benefiting from the scalability advantages of executing transactions off-chain.

L2s that do not have a mechanism for inheriting the L1 chain's security or that rely on their separate consensus mechanism may be considered "side chains" or "parallel chains" rather than true L2s.

It's important to note that the debate around the "realness" of L2s often stems from concerns about centralization risks, security trade-offs, and the extent to which they adhere to the principles of decentralization and trustlessness associated with the base L1 blockchain.

The "FOR" argument

Bitcoin Layer 2 (L2) solutions, also known as second-layer protocols, are architectures built on top of the Bitcoin blockchain. They are designed to facilitate faster and cheaper transactions by moving a portion of the transaction processing off the main Bitcoin blockchain, while still inheriting the security and decentralization properties of the underlying network. Bitcoin L2s are real and viable solutions for scaling Bitcoin's transaction throughput and reducing fees. These second-layer protocols have been implemented and adopted, demonstrating their potential to address the scalability challenges faced by the base Bitcoin layer.

II. Evidence of Existing and Successful L2 Implementations

A. Lightning Network

The Lightning Network is a decentralized network of payment channels built on top of the Bitcoin blockchain. It enables near-instant and low-cost transactions by conducting them off-chain and only settling the final balances on the main Bitcoin blockchain. This is achieved through a network of bidirectional payment channels between participants, allowing for an unlimited number of transactions within the channels before final settlement.

As of 23/05/24, the Lightning Network has over 15,000 nodes and 53,000 active payment channels, facilitating thousands of transactions daily. Major companies and services, such as CashApp, Bitfinex, Kraken, etc., have integrated Lightning Network payments, demonstrating its growing adoption.

A graph of a curveDescription automatically generated with medium confidence

Lighting Payment Channels

B. Liquid Network

The Liquid Network is a federated Bitcoin sidechain designed to facilitate efficient and confidential transfers of Bitcoin between exchanges and financial institutions. It operates as a separate blockchain pegged to the Bitcoin blockchain, allowing for faster and cheaper transactions while still benefiting from the security of the Bitcoin network.

Prominent cryptocurrency exchanges, including Bitfinex, BitMEX, etc, have integrated the Liquid Network to enable seamless and low-cost transfers of Bitcoin between their platforms. Additionally, financial institutions like Blockstream, etc, are actively involved in the development and usage of the Liquid Network.

III. Benefits of L2 Scaling Solutions

A. Increased transaction throughput

One of the primary advantages of Bitcoin L2 solutions is their ability to significantly increase the transaction throughput compared to the base Bitcoin layer. By moving a portion of the transaction processing off-chain, L2 protocols like the Lightning Network and Liquid Network can handle a vastly higher number of transactions per second, alleviating the bottleneck and congestion issues faced by the main Bitcoin blockchain.

B. Lower transaction fees

Transaction fees on the Bitcoin network are determined by supply and demand, with higher network congestion leading to higher fees. By offloading transactions to L2 solutions, users can enjoy substantially lower transaction fees. Since L2 transactions are processed off-chain and only the final settlement is recorded on the Bitcoin blockchain, the fees associated with these transactions are drastically reduced.

C. Improved privacy and security

Certain L2 solutions, such as the Liquid Network, offer enhanced privacy features through confidential transactions and asset blinding. This helps protect the privacy of users and institutions conducting large Bitcoin transfers. Additionally, the Lightning Network's payment channel architecture provides improved security by reducing the surface area for potential attacks, as transactions are conducted off-chain and only the final balances are settled on the main blockchain.

The "AGAINST" argument

Proponents of Bitcoin Layer 2 (L2) solutions argue that they offer scalability and lower transaction fees while retaining the security and decentralization properties of the Bitcoin network. However, these claims are heavily contested. Bitcoin L2s are not truly decentralized or scalable solutions, and they undermine the core principles of Bitcoin. These second-layer protocols introduce centralization risks, face scalability limitations, and compromise the trustless nature of the Bitcoin network.

II. Centralization Concerns

A. Lightning Network hubs and routing challenges

The Lightning Network's design relies on payment channels and routing nodes, which can lead to the formation of large hubs or centralized entities. These hubs could gain significant control over the flow of transactions, undermining the decentralized nature of the network. Additionally, routing payments through multiple hops can be complex and inefficient, potentially leading to censorship or disruption of transactions.

B. Liquid Network's federated peg model and trusted participants

The Liquid Network operates as a federated sidechain, where a group of trusted participants (exchanges and institutions) are responsible for validating transactions and maintaining the peg to the Bitcoin blockchain. This centralized trust model goes against the core principles of Bitcoin, introducing a single point of failure and the potential for collusion or censorship.

III. Scalability Limitations

A. Transaction throughput is still bottlenecked by the base layer.

While L2 solutions aim to increase transaction throughput, they are ultimately limited by the capacity of the base Bitcoin layer. All L2 transactions must eventually settle on the main Bitcoin blockchain, which has a fixed block size and transaction processing rate. This inherent bottleneck limits the overall scalability potential of L2 solutions.

B. Liquidity constraints and channel capacity issues

The Lightning Network's payment channels require locked capital and face liquidity constraints, as channels need to have sufficient funds to facilitate transactions. Additionally, there are limitations on the maximum channel capacity, which can restrict the ability to conduct larger transactions efficiently. These factors can hinder the widespread adoption and scalability of the Lightning Network. Currently, it has a capacity of 5,000 BTC, the equivalent of ~$350 million in TVL, which is relatively small compared to its counterparts on Ethereum or Bitcoin’s Market Cap.

Lighting Network Capacity

IV. Security and Privacy Risks

A. Potential for censorship and disruption of payment channels

In the Lightning Network, payment channels can be unilaterally closed by either party, potentially leading to censorship or disruption of transactions. Additionally, routing nodes may choose to censor or block certain transactions based on their criteria, undermining the censorship-resistant nature of Bitcoin.

B. Privacy trade-offs and data leakage risks

While L2 solutions like the Lightning Network claim to offer improved privacy, they also introduce new privacy risks. Payment channels on the Lightning Network can leak information about transaction amounts and frequencies, potentially compromising the privacy of users. Additionally, the need to maintain channel liquidity may require users to disclose more information about their transactions and balances.

V. Misalignment with Bitcoin's Principles

A. Departing from the decentralized, trustless vision

Bitcoin's core principles revolve around decentralization and trustless operation, enabling a peer-to-peer electronic cash system without the need for intermediaries or trusted third parties. However, L2 solutions like the Liquid Network introduce centralized trust models and rely on federated participants, deviating from this fundamental vision.

B. Introducing complexities and dependencies.

Bitcoin's simplicity and elegance are part of its strength and appeal. L2 solutions, while aiming to address scalability, introduce significant complexities and dependencies on additional layers and protocols. This increased complexity can lead to potential vulnerabilities, interoperability issues, and a departure from the streamlined and self-contained nature of the Bitcoin protocol.

VI. Counterarguments and Rebuttals

While proponents of L2 solutions may point to their growing adoption and usage statistics, it's important to note that this adoption is still limited and concentrated among a relatively small subset of users and businesses. The vast majority of Bitcoin transactions and economic activity still occur on the base layer. Additionally, the adoption of L2 solutions may be driven more by the need to circumvent the scalability limitations of the base layer rather than a genuine preference for these second-layer protocols.

While L2 solutions can offer lower transaction fees compared to the base Bitcoin layer, this advantage comes at the cost of compromising other core principles of Bitcoin, such as decentralization and trustlessness. Additionally, the long-term sustainability of low fees on L2 solutions is questionable, as they are still ultimately dependent on the base layer's capacity and fees.

Conclusion

No, the Lightning Network and Liquid Network are not considered "real" L2s in the strict sense of the term.

The Lightning Network is a second-layer payment protocol built on top of Bitcoin, but it does not qualify as a real L2. Rather, it operates as a network of payment channels that enable off-chain transactions between participants. While the Lightning Network aims to improve Bitcoin's scalability and reduce transaction fees, it does not inherit the security properties of the Bitcoin blockchain directly. Instead, the Lightning Network relies on the underlying Bitcoin blockchain for opening and closing payment channels, as well as resolving disputes. However, the transactions within the payment channels themselves are not recorded on the Bitcoin blockchain until the channels are closed and the final balances are settled.

The Liquid Network, on the other hand, is a federated sidechain pegged to the Bitcoin blockchain. It operates as a separate blockchain managed by a consortium of trusted parties (exchanges and institutions). While the Liquid Network is designed to facilitate faster and more confidential Bitcoin transfers, it does not inherit the security properties of the Bitcoin blockchain. Instead, the Liquid Network relies on a federated peg model, where the trusted participants validate and secure the sidechain. This centralized trust model deviates from the trustless and decentralized nature of the Bitcoin blockchain, and as such, the Liquid Network is not considered a "real" L2 in the context of inheriting Bitcoin's security properties.

Both the Lightning Network and Liquid Network offer scalability solutions for Bitcoin, but they do not meet the criteria for being considered "real" L2. True Ls, whether optimistic or ZK-rollups, are designed to execute transactions off-chain while inheriting the security properties of the underlying Layer 1 blockchain through mechanisms like fraud proofs or validity proofs.

The debate around the "realness" of these solutions often centers on their ability to maintain the decentralization and trustlessness principles of Bitcoin while achieving scalability improvements.