Ethereum has scaled using Layer 2s (L2s) - customizable blockchains built on Ethereum that inherit Ethereum's security. L2 architecture allows for a secure, decentralized, neutral Ethereum Layer 1 that provides limitless scaling capacity in customized environments. This is how Ethereum can become the backbone of the new digital economy.
Why did Ethereum choose to scale via a network of Layer 2 (L2) blockchains instead of aggregating all users, apps, and liquidity onto Layer 1? To explore this, we need to revisit the first principles of why blockchains exist, starting with the following question:
What Differentiates a Blockchain from a Database?
A database stores historical information - transactions, data, etc. - in one central place and is typically controlled by one entity.
A blockchain also stores historical information, but is not controlled by one entity. Instead, a blockchain consists of a globally distributed set of computers (called nodes) working independently to verify all transactions and data stored on the chain.
As a result, although a database will almost always be faster and cheaper than a blockchain, a blockchain’s distributed set of nodes provides additional security and resilience (also called “decentralization”). No individual or central entity can control a globally decentralized blockchain, which makes it an ideal ledger of record for valuable assets.
A common follow-up question since the birth of Bitcoin has been: why not pursue the benefits of “blockchain technology” without “crypto”? The reason is that both technologies are intrinsically interconnected.
Blockchains, like all economic systems, rely on incentives. All of a blockchain’s nodes (miners/validators) must be incentivized to independently and honestly verify the blockchain’s history and transactions. Therefore, every blockchain network requires a native, decentralized crypto asset with its own monetary policy. This native crypto asset is issued programmatically by the blockchain to pay its miners/validators.
Without a native asset within a blockchain ecosystem to pay a distributed set of miners/validators, there is no incentive for miners/validators to validate a blockchain and the blockchain system would not be secure. In other words, if a blockchain does not have a strong underlying crypto asset, then a database will always be better, faster, and cheaper to use
The greater the value of a blockchain’s native crypto asset, the more incentive there is for miners/validators to perform work and receive the underlying tokens. Most blockchain ecosystems have weak monetary policies - they use high inflation of their crypto assets to pay validators, which depresses the underlying value of the token. Or, other blockchain ecosystems do not have enough decentralization (their nodes are few and have a high barrier to entry), meaning they effectively function as databases.
There are two main blockchain ecosystems with native crypto assets that have strong monetary policies and strong underlying decentralization of validators/miners: Bitcoin and Ethereum.
The Layer 2 Model to Scale Ethereum
To summarize - global blockchains have only one advantage over databases: their distributed set of individual nodes, validators, and/or miners can provide greater security, reliability, and resilience than a centralized database. But this advantage comes at a (literal) cost: blockchains are more expensive and slower than databases.
And in fact, the more “decentralized” (globally accessible for a diverse set of participants to run nodes/validators) and secure a blockchain is, the slower and more expensive the blockchain will be for everyday transactions. This phenomenon is described as the “blockchain scalability trilemma,” diagrammed below:
This trilemma exists due to the architecture of blockchains, which need a globally distributed set of computers (nodes) working to validate and verify the blockchain’s transactions and history. As a result, when choosing a blockchain design, we can only pick one side of the triangle above:
However, banks, companies, and other regulated entities cannot use a slow, expensive blockchain as core infrastructure for their billions of users, which is one reason that blockchain adoption has not yet reached an inflection point in adoption.
But, as of Summer 2024, there is now a solution to the blockchain trilemma!
One key conclusion we made in ETH: A Store of Value with Cash Flow is that the entire point of a blockchain is security. And security is achieved in two ways: (1) having a prohibitively high economic cost to attack the chain, and (2) having a robust, geographically distributed set of lightweight nodes securing the chain, which makes it decentralized and therefore not controllable by one entity or oligopoly. Only Ethereum and Bitcoin achieve both criteria, and they do so by keeping their base layer – or Layer 1 (L1) – very simple, resulting in slower speeds and higher fees.
So how do we solve the blockchain trilemma and introduce scalability to a stable, secure, but slow L1 if we can’t increase throughput at L1 itself?
We can build additional smart contract layers on top of the base layer. The Ethereum blockchain, unlike the Bitcoin blockchain, was designed for programmable smart contracts from the start - meaning that smart contract layers built on top of Ethereum can inherit the full security of Ethereum while being optimized for speed and scale. These smart contract layers are called Layer 2s (L2s, also known as “rollups”).
The technical potential and architecture of the L2 ecosystem is vast and will be explored in several upcoming pieces. However, it is important to understand why Ethereum has a rollup-centric, or L2-centric roadmap: while Ethereum L1 has been optimized for security and decentralization, L2s can be fully customizable while inheriting Ethereum’s security.
This means that the design space for L2s is virtually infinite! There is no such thing as a “one size fits all” blockchain. Companies, countries, and other users will want to customize their blockchain ecosystems, and as different regulatory frameworks emerge, blockchains will likely need to integrate regulatory changes to be compliant. Some examples of what is possible:
All iterations of L2s can have cheaper, faster, and potentially private transactions while inheriting the security of Ethereum. And because all L2s “settle” transactions on Ethereum, they will be able to interoperate with each other, effectively building an “Ethereum Trade Network” - which represents the full potential of the Ethereum economy.
Conclusion
L2s are the answer to the scalability trilemma, and are how Ethereum will scale to billions of users without relying on a centralized database like today’s web2 architecture.
And to create a beautiful flywheel of economic security, L2s themselves pay fees to Ethereum L1 to settle transactions on the blockchain. These fees accrue value to ETH, which strengthens the economic security of Ethereum while cementing ETH as the canonical store of value and monetary asset across the whole L2 ecosystem.
Ethereum is the only blockchain with a secure, decentralized Layer 1 and a fully customizable Layer 2 ecosystem. Demand for ETH transactions will come from Ethereum Layer 1 and the aggregate users and transactions across all of its Layer 2 blockchains. Institutions can have their cake and eat it too; they can have their own customized institutional L2 which plugs into the liquidity and network effects of the Ethereum economy!
Ethereum’s Layer 2 scaling roadmap is the only way to scale institutionally and allow customized blockchains, regulatory compliance, privacy, speed, low fees - all while keeping Ethereum Layer 1 as strong, secure, and decentralized as possible.
Published 1/21/2025
This article is for informational purposes only and should not be considered as financial, investment, or trading advice. Etherealize does not guarantee the accuracy or completeness of the information provided. Investing in commodities carries risks, and readers should seek the advice of a qualified financial advisor before making investment decisions. Etherealize may have financial interests in the commodities discussed in this article.
