Bitcoin and its Different Layers

August 8, 2023

In continuation of Bitskwela’s Bitcoin (BTC) series, our topic of discussion for this piece will be BTC’s layers: what are layers, why are layers necessary, and what are BTC’s layers 1, 2, and 3. Let’s go! 

Way back in 2008, BTC was introduced to the world as a peer-to-peer digital currency that is outside the control of any one person, company, or any other entity. The technology was monumental at the time, as it eliminated the need for third-party involvement in transactions. Bitcoin has gone on to be the most popular and recognizable cryptocurrency. For a more in-depth look on BTC and its history, you can check out Bitskwela’s modules on it here

The course’s iteration of Bitcoin is what we call the Layer 1. This is the primary blockchain upon which other layers are developed, but more on that later. Layer 1, or the main chain, contains the chain’s distributed ledger as well as its Proof-of-Stake consensus mechanism.

As Bitcoin’s popularity exponentially increased, so did its number of users. For a particularly young piece of technology, this posed a myriad of problems in relation to scalability. The sheer number of users meant that transaction speeds slowed and slowed as users increased. In addition, with the system prioritizing higher-value transactions, it became more expensive to use the platform. If this was to be the currency of the future, innovations had to be made to adapt to the demand. One such innovation are layer 2 solutions, which are the Lightning network and the Liquid network.

The Lightning Network 

The Lightning Network is a Layer 2 solution that was created in 2016 by Joseph Poon and Thaddeus Dryja in order to counter Layer 1’s scalability issues. The layer accomplishes this with the use of smart contracts.  Through smart contracts, the Lightning Network allows users to have private, off-chain channels with remote ledgers where they can undergo numerous transactions, with the final outcome being settled on the main Bitcoin network. This severely alleviates the huge amount of transactions occurring on the BTC blockchain by taking on the smaller, recurring transactions. The blockchain, then, becomes exponentially scalable. 

This layer powers such services as Strike. Going off of their tagline “Accept and send bitcoin and dollars via the Lightning Network.”, Strike allows users to transact (pay, send, receive, and hold currency) on the Lightning Network at a rapid pace. 

Another interesting use of this Layer 2 solution is demonstrated by THNDR Games. This Bitcoin game developer utilizes the Lightning Network’s capacity for speedy microtransactions for in-game rewards and in-game purchases.

Scalability is one thing, but there’s also the matter of adding versatility to the blockchain to improve upon its functionality. This is where the Liquid Network comes in. 

The Liquid Network

The Liquid Network, also a Layer 2 solution, improves the scalability and functionality of the blockchain by way of asset issuance. It allows users to transact with or even create other tokens, like Non-Fungible Tokens (NFTs), and other digital assets. It allows for a rapid and private transfer of assets with a higher number of throughput (i.e. more items being transferred). The Liquid Network is used by arbitrage traders that are in need of the Liquid Network’s faster transaction times to take advantage of certain price movements in the market, since with Bitcoin’s slower transaction times, traders may not be able to take action on any advantageous price movements in a timely manner. It is also used by retail investors as a safe way to transact quickly without converting their BTC to other, riskier altcoins

These are just two of the most well-known Layer 2 solutions for Bitcoin. Others include Rootstock (RSK) and Drivechain, both of which promote interoperability between Bitcoin and other blockchains. We did not include so-called Layer 3 solutions (for now) since the concept of Layer 3 solutions is not yet well-defined in the industry. Another thing worth mentioning: Ethereum also has Layer 2 solutions as a Layer 1 blockchain, but that’s for another piece. Nevertheless, as needs increase and evolve, so too would this particular technology. We can be sure that there will be more and more innovations to go, thus leading to more and more layers.

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