What’s Layer 2? How does it work?
Jul 1, 2025・5 min read
All blockchain networks, including Bitcoin (BTC) and Ethereum (ETH), share a feature known as Layer 1. This network layer secures transactions, maintains decentralization, and records data on a public ledger so that no single person or organization can control or alter it.
But as cryptocurrency became more mainstream, Layer 1 blockchains faced increasing demand. Every transaction requires verification from multiple computers (nodes), which slows processing and causes network congestion. When too many transactions happen at once, wait times and fees increase.
To address these challenges, developers created Layer 2 solutions – secondary networks that work alongside Layer 1 to speed up transactions and lower costs while maintaining security.
In this guide, we'll explain what Layer 2 is, how it compares to Layer 1, and why crypto relies on both.
What is Layer 2?
Layer 2 solutions (L2s) speed up transactions and lower costs by handling them off-chain before finalizing them on Layer 1.
Some L2 networks bundle transactions before submitting them to Layer 1, while others process them separately and update only the final results. This improves scalability while relying on Layer 1 for security.
Think of Layer 2 like an express lane at a toll booth – cars still have to pass through, but they move much faster.
How do Layer 2 networks operate?
Understanding how L2 networks operate starts with recognizing that they don’t replace Layer 1 blockchains. Instead, they work alongside them. Here’s how:
- Processing transactions off-chain: L2 networks handle multiple transactions separately from Layer 1, bundling them together before submitting a final record, which reduces congestion and lowers fees.
- Verifying transactions: Some L2s, like optimistic rollups, allow users to challenge suspicious transactions before they’re finalized on Layer 1. Others, like zero-knowledge rollups, use cryptography to prove transactions are valid instantly (more on rollups below).
- Final security on Layer 1: Once L2 submits a batch, Layer 1 confirms and secures the transactions, keeping everything decentralized and tamper-proof.
These improvements make Layer 2 an indispensable network layer for scaling blockchain transactions while preserving the integrity of the Layer 1 blockchain.
Let’s look at a simple example of how Layer 1 and Layer 2 collaborate when purchasing and using crypto:
- Buy crypto on an exchange: First, you sign up on a crypto exchange and deposit funds (either fiat currency like USD/EUR or another cryptocurrency) into your exchange account. Let’s say you buy 1 ETH. Once the purchase is complete, the exchange stores your ETH in a custodial wallet, meaning you don’t have direct control over it on the blockchain. Instead, the exchange holds the private keys, and your ETH is only accessible within the exchange's system.
- Transfer to a personal wallet: To take full control of your ETH, you transfer it to a non-custodial wallet, where you control the private keys. This is important because only you can access and move funds from a non-custodial wallet, unlike an exchange, which can freeze or restrict access. This transaction must be confirmed on Ethereum’s Layer 1 blockchain, which can take several minutes depending on network traffic. If the network is congested, transaction confirmations take longer, and fees increase.
- Use Layer 2 for faster transactions: If you want to send or trade your ETH instantly with lower fees, you can use a blockchain bridge to transfer it to a Layer 2 network. The bridge locks your ETH on Layer 1 and issues an equivalent amount on Layer 2, where transactions happen off-chain. Once on Layer 2, you can move funds almost instantly at a fraction of the cost. When you're ready to bring your ETH back to Layer 1, the bridge releases your locked ETH after verifying the Layer 2 transaction.
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What are Layer 2 frameworks?
L2 frameworks take different approaches to improving blockchain efficiency. While all L2s process transactions separately from Layer 1, they use different methods to validate and finalize them.
Side chains
Sidechains function as independent blockchains that run parallel to Layer 1. They have their own operators and validators, meaning they do not rely on L1 for security. This allows for more flexibility, but sidechains are generally less secure than other L2 solutions since their consensus mechanisms can be more vulnerable to attacks.
Rollups
Currently, rollups are the most widely adopted L2 solution due to their security and scalability. There are two types:
- Optimistic rollups assume all transactions are valid by default. However, they enter a challenge period, during which users can submit fraud proofs if they detect an invalid transaction. If a fraud proof is verified, the fraudulent transaction is reversed, and the dishonest party may be penalized.
- Zero-knowledge rollups (ZK rollups) generate cryptographic proofs (zk-SNARKs or zk-STARKs) that confirm the correctness of a batch of transactions. These proofs are submitted to Layer 1, eliminating the need for individual transaction verification.
Plasma
Plasma chains use smart contracts on Layer 1 to manage deposits, withdrawals, and dispute resolution while processing transactions off-chain. Instead of submitting every transaction to L1, plasma groups them into a single summary (a Merkle root) and submits that instead. This reduces congestion while keeping transactions verifiable.
However, because plasma relies on fraud challenges and exit periods for security, withdrawals can take longer than those of other Layer 2 solutions. While plasma is more secure than sidechains, it does not fully inherit Layer 1 security like rollups, which post cryptographic proofs directly to the main blockchain.
Payment channels
State channels allow two users to conduct unlimited off-chain transactions between them. Only two transactions are recorded on L1 – one to open the channel and another to close it, at which point the final balance is settled on L1. This makes state channels extremely fast and efficient, but they require participants to agree in advance and cannot be used for open-ended interactions like rollups.
Advantages of Layer 2 solutions
Let’s recap the benefits of Layer 2 crypto protocols, many of which we’ve already touched on throughout this guide. Here’s a summary of how L2 improves blockchain performance:
Higher transaction throughput and faster finality
Layer 1 blockchains have limited transaction speeds – Bitcoin takes about 10 minutes per block, while Ethereum takes 12–15 seconds. Layer 2 solutions process transactions off-chain, allowing near-instant execution and significantly increasing throughput.
Finality depends on the L2 mechanism – ZK-rollups validate transactions instantly using cryptographic proofs, while optimistic rollups assume validity by default but introduce a challenge period before settlement.
Lower transaction costs
Layer 2 lowers gas fees by bundling multiple transactions into a single batch before submitting them to Layer 1. Because L1 fees apply per batch rather than per transaction, users share the cost, making transactions significantly cheaper. L2 also reduces competition for L1 block space, further driving down costs.
Scalability and efficiency
Layer 2 solutions increase blockchain capacity, allowing more transactions per second without overwhelming Layer 1. Rollups maintain Layer 1 security by submitting proofs on-chain, while sidechains trade decentralization for speed and efficiency.
Improved privacy
Some Layer 2 frameworks, such as ZK-rollups, enhance privacy by encrypting transaction data before submitting it to Layer 1. Techniques like zk-SNARKs verify transactions without exposing user details. However, not all L2 solutions prioritize privacy.
Why both Layer 1 and Layer 2 scaling solutions matter
Layer 2 solutions don’t replace Layer 1 blockchains – they work alongside them to make transactions faster and cheaper. While Layer 1 blockchains keep everything secure and decentralized, they can be slow and expensive when traffic is high.
L2 solutions take some of the load off Layer 1 by bundling transactions together before sending them for final approval. This helps prevent congestion, speeds up processing times, and lowers fees, making crypto easier and cheaper to use.
Beyond just making transactions faster, L2 solutions open the door for more innovation. They make crypto trading smoother and give developers better tools to build apps that work seamlessly with Layer 1 blockchains.
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Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.