Cryptocurrencies are digital assets that use cryptography to secure transactions and control the creation of new units. They are decentralized, meaning they operate without the need for a central authority or intermediary. Cryptocurrencies can be classified into different layers based on how they interact with the underlying blockchain network.

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Layer 1 cryptocurrencies are the native coins of their own blockchain. They are the base layer protocols that provide the foundation for other applications and services to run on top of them. Layer 1 cryptocurrencies are responsible for validating transactions, maintaining consensus, and ensuring security and scalability of the network. Some examples of layer 1 cryptocurrencies are Bitcoin, Ethereum, BNB Chain, Cardano, and Avalanche.

Layer 2 cryptocurrencies are not coins, but rather solutions that aim to improve the performance and functionality of layer 1 cryptocurrencies. They are built on top of layer 1 blockchains and use various techniques to increase transaction speed, lower fees, enhance privacy, or enable new features. Layer 2 solutions do not require changes to the Layer 1 protocol, but rather rely on smart contracts, sidechains, channels, or rollups to process off-chain transactions and then settle them on-chain.

One of the most popular and widely used layer 2 solutions is the Lightning Network (LN), which is based on the Bitcoin blockchain. LN is a network of payment channels that allow users to send and receive instant and low-cost transactions in BTC. LN transactions are not recorded on the Bitcoin blockchain until the channel is closed, which reduces congestion and fees on the main network. LN also enables interoperability between different blockchains that support it, such as Litecoin and Decred. LN usage exploded in 2021, with channels more than doubling and capacity more than tripling in just one year. LN can be considered as the cryptocurrency giant of the second layer, as it has the most users, nodes, and liquidity among all layer 2 solutions.

Layer 2 solution for Bitcoin & Ethereum networks

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Bitcoin and Ethereum are two of the most popular cryptocurrencies in the world, but they both face scalability challenges as their networks grow. Layer 2 solutions are designed to address these challenges by providing faster, cheaper, and more secure transactions on top of the existing Layer 1 blockchains. Layer 2 solutions are also known as "scaling solutions" or "off-chain solutions" because they move some of the computation and data storage away from the main chain, while still relying on it for security and end-chain.

One of the main reasons for scaling Layer 2 is for the future because it allows for more innovation and experimentation without compromising on decentralization or security. Layer 2 solutions can support different types of transactions, such as token transfers, swaps, smart contracts, NFTs, games, etc., which may not be feasible or efficient at Layer 1. Layer 2 solutions can also cater to different use cases and preferences, such as privacy and accessibility. Interoperability, user experience, etc., which layer 1 may not satisfy.

Some of the most prominent examples of Layer 2 solutions are rolls, channels, plasmas, and side chains. Aggregations are a technology that aggregates multiple transactions into a single transaction on Layer 1, which reduces gas costs and increases throughput. Channels are a means of establishing direct connections between users or nodes, enabling instant, low-cost off-chain transactions. Plasma is a framework that creates sub-chains that inherit Layer 1 security, but offer faster and cheaper transactions for specific purposes. Sidechains are independent blockchains connected to Layer 1 via bridges, allowing for more flexibility and customization.

Tier 2 scale is not a one-size-fits-all solution, but rather a diverse and evolving ecosystem that offers many trade-offs and benefits. By leveraging Layer 2 solutions, Bitcoin and Ethereum can overcome scalability limitations and enable more users and applications to join the decentralized revolution.