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Bitcoin Layer 2 solutions like the Lightning Network, rely on the main blockchain for security and allow for faster transactions. In contrast, sidechains operate independently and require user permission to access funds, which sets them apart from genuine Layer 2 solutions.
Venture capital investing in Bitcoin Layer 2s is at an all-time high. At least that’s the narrative Bitcoin-related media is trying to sell. However, what’s considered a Layer 2? Are all these projects VCs are pouring money into actual Layer 2s? Or are they trying to fool us? The devil’s in the details, and that’s exactly where the controversy lies.
The Bitcoin network’s main chain is Layer 1, and the community’s role is to protect that blockchain at all costs. The integrity of the Bitcoin project relies on it. By definition, a Layer 2 would be a secondary network that inherits the security guarantees and works on top of the first layer. The role of the Layer 2 would be to help scale the main network, even though some people think that it could also increase utility.
This debate is interesting, but not crucial. Why? Because Bitcoin’s modular approach means that different developers can test their theories on other layers and not affect the main network. Experimenting on the main chain is too risky and not justifiable. The market will decide which L2 solutions survive, while the base Bitcoin network keeps producing blocks and being the best money humanity has invented.
However, if billions of people want to use Bitcoin, the main chain is not enough. The L1 is perfect for store of value, but not ideal for medium of exchange. To unpack that, we need to establish a crucial concept.
Also known as the scalability trilemma, the theory says that a blockchain can only optimize for two out of these three factors: security, decentralization, and speed. The Bitcoin network is the most secure and decentralized, but it only processes one block every ten minutes. That’s by design and the limit is crucial for decentralization, but it does present a scalability problem.
Layer 2s fix this.
Technically, the Lightning Network is built on State Channels. To participate, two users lock BTC on the main chain and create a “channel” between them. That unleashes their BTC on the Lightning Network and there, users can make all the transactions they want without touching the main chain.
Also, all the channels are interconnected with other Lightning Network participants, so, in practice, any user can transact with most other users. The only other time the Lightning Network interacts with the main chain is when a channel closes.
The Lightning Network is a true Layer 2 solution because it inherits the security the main chain’s Proof-Of-Work network provides. The estimation is that it can handle up to a million Transactions Per Second, so it’s a scalability solution of the highest order and activates micro-payments on Bitcoin. Plus, the Lightning Network doesn’t create a new, unnecessary token. It respects that sats are the standard.
It’s also important to take into account what “Mikko Ohtamaa, co-founder of algorithmic investment protocol Trading Strategy” told Magazine:
“The true test of a genuine L2 is: “Can you get your money back without someone else’s permission?”
In the Lightning Network’s case, the answer is a resounding yes.
Technically, a sidechain is a completely different blockchain that runs parallel to the main chain. Those have their own features and consensus mechanisms, they don’t inherit the security of the main network because sidechains rely on their own security models. To participate, users usually have to lock up BTC and they receive a wrapped version of it, that’s effectively a whole other coin.
Not only that, as the previously linked “Bitcoin layer 2s’ aren’t really L2s at all: Here’s why that matters” article puts it:
“Sidechains often use oracles or cross-chain communication tools to maintain consistency with the assets on the main blockchain.
Oracles are systems used to feed data from outside sources into a blockchain. These tools add a layer of complexity and bring their own risks.”
The main difference, nevertheless, is that someone controls the sidechain. You need their permission to get your money back. This is what Venture Capital prefers, so that’s where the money goes. In any case, sidechains are not Layer 2s. They are sidechains, and there’s nothing wrong with that.
A quick search around the Internet will show that disinformation around Layer 2s runs rampant. Surprise, surprise, the reason might be money. Back to the Magazine article:
“Alex Thorn, head of research at Galaxy Digital, tells Magazine that the company tracked 13 fundraising rounds by Bitcoin layer-2 projects. Of those, eight did not disclose funding amounts, while the remaining five raised at least $34.7 million together. While that is just a small portion of the total reported by Galaxy Digital, Thorn notes that Galaxy’s reported value solely relies on publicly available data and that the actual amount could be much higher.”
People who are looking for that venture capital will tell you that the public doesn’t understand what a Layer 2 is and that distinction is meaningless, but the truth is the truth. If someone controls the network, if users need permission to access their money, that’s not a Layer 2.
Take note, angel investors.
