Crypto 102 - The blockchain trilemma 📐 & Layer 1/2 protocols

==========================================================

Interested to invest in Bitcoin, but don't know where to start? Consider signing up for the AMEX credit card (exclusive Seedly & Singsaver deal) to claim up to SGD $365 worth of Bitcoin!

I'm currently partnering with Seedly & Singsaver to help accelerate local adoption of cryptocurrency. It's a movement I feel strongly about. This is perfect for investors who are apprehensive of buying their own crypto themselves, but wish to get some exposure to a strong asset that has proven itself to be a store of value.

Do note that this promotion IS THE SAME as the current #ownthefuture crypto campaign happening right now. Come join the Hodl movement 😃

Sign up using this link, and follow the steps below.

1. You will be directed to a Seedly x SingSaver landing page. Enter your email address and click “confirm” (reminder: use the same email address throughout the application process)
2. Complete your application and take a screenshot of the Application Reference Number (important)

3. Fill in the SingSaver rewards form that will be sent to your email

Note: Terms and conditions apply.

SingSaver or Seedly will never ask you for your wallet address nor conduct airdrops. Do reach out to [email protected] for any questions on the campaign.

==========================================================

Prerequisite knowledge

Understanding of blockchains and how they work (see opinion article below):

Crypto 101 - Blockchains 🧊⛓

OK we know blockchains are a thing but nobody said anything about layers...

====================================

Retail: K so blockchains = crypto?

Crypto: Not all blockchains are equal

Retail: Yes that I kno-

Crypto: L1 L2

Retail: WTF 😭

Crypto: Have Fun Staying Poor.

====================================

A SIMPLE guide below to get you started (Don't worry, only 2 layers!)

The Blockchain Trilemma

To first understand why crypto wears many clothes__ (but only 2!), we need to look into the state of things surrounding crypto today.

The blockchain trilemma is a term coined by Vitalik Buterin (founder of Ethereum), which is a belief that public blockchains must sacrifice one of these components in their infrastructure:

• Security
• Decentralization
• Scalability

A brief primer on each of them.

Decentralization

This is the key selling point of crypto, isn't it? The idea that consensus is achieved not by a centralized party, but a global and distributed network of participants from the everyday user to the crypto OGs that can validate blockchains & transactions on top of it. Users can transact with network users freely without even a need for a centralized entity, as groups of nodes can validate the transaction and broadcast to the network. This presents a direct trade-off to speed, since for a transaction, a group of nodes need to confirm and validate the transaction as opposed to 1 node which is faster.

Scalability

This is important for mass adoption. How can it be that the network is so slow that only 3 people are using the network at any given time. For a popular protocol (like Ethereum), it must have the ability to scale & to support both high transactional throughput and high users. We've already seen a negative example with (ETH) with the NFT mania causing serious network congestions.

This is how much I spent on ETH gas fees. 😪 From my experience, each transaction costs about $40+ USD, and even more if you're neck deep in yield farming and NFTs.

In contrast with legacy networks like Visa & Mastercard which can support huge levels of throughput (70,000 Transactions Per Second) & is already much more scalable, blockchain networks need to seriously improve to properly compete with solutions they so claim to disrupt.

Security

There's a reason why Visa/Mastercard can scale transaction throughput to become one of the largest payment networks in the world. They control the entire network and with their confirmation, they can verify that the transaction is honest and true. This is also why your credit/debit card transaction is approved within < 5 seconds.

In the crypto context, having just 1 confirmation for each transaction = centralization, and is the anti-thesis of crypto itself, since any node (participant) can simply come out and validate the transaction (which may be fraudulent). It's quite important so I'll explain with an example.

Alice owns 100 Bitcoin (BTC). She has 3 payments that require a transfer of 50 BTC each. transfers 50 BTC to Bob. Being fraudulent, she colludes with a node to double-spend her transaction (recall that nodes are responsible for validating transactions). With each transaction, the node makes it so that the remaining balance magically tops up to 100BTC, and then validates the transaction. This means that Alice, even after spending 150 BTC in payments, still has 100 BTC, which is a double-spend (spending money (or tokens) that she does not have). Read that again.

This can be easily mitigated if there were a network of nodes who constantly screen the network for any fraudulent transactions coming in and simply reject those transactions.

Blockchain security is a critical component that can never be compromised. In fact, security is the top priority of any popular blockchain ecosystem.

Layer 1 & Layer 2

The king and queen of crypto has shown that they've done poorly in the area of scalability. BTC's max transaction throughput is 7 TPS, whlist ETH's is 15 - 45 TPS. From above, both Visa & Mastercard can probably do at least a few thousand times more.

mUh gLoBaL pAyMeNtS sYsTeM 🤡

The Ethereum network is _forever _congested with wannabe collectors of NFTs (read: JPEGs) like punks, kitties, doges and even rocks 👀. Ethereum developers are working hard to make the transition to ETH 2.0.

Here, ETH 2.0 is a layer 1 solution.

Siri, explain.

Ok so what is a blockchain? It's simply the base protocol of any cryptocurrency network. Any network/ecosystem with its own base protocol is a layer 1 blockchain (or L1s). BTC is a L1 protocol since its transactions are settled on the Bitcoin blockchain.

Many more can be found in this link here (pic shows some; NOT an exhaustive list).

Layer 2 (L2) protocols are networks whose transactions are settled on another blockchain. For example, the lightning network (LN ⚡; more on that in my next piece) enables BTC micropayments between users, but their final balances (or states) are broadcasted & validated on the main BTC L1 blockchain.

The LN itself is NOT a blockchain.

L2 solutions improve the features of the base protocol, most often scalability (as it's the most desired upgrade of any blockchain regarding the trilemma). Because the LN facilitates tons of transactions between users, thus addressing the scalability problem on the BTC network, it's a L2 solution/protocol.

Editor's note: The terms protocol and solution are interchangeable because each L2 protocol would likely be designed to alleviate the solutions faced by many L1 protocols (hence protocol is partly equal to solution).

So, we know that L1 protocols are really blockchains themselves. Hence, here Etheruem (ETH) 2.0 is referred to as a L1 solution, since it's an improvement over the core blockchain (ETH 1.0) that potentially solves at least 1 of the components laid out in the blockchain trilemma (usually scalability).

Value accrual

In the prior section we've established the differences between L1 and L2 networks. It's now clearer why value often acrrues to L1 protocols / chains more so than L2. It's not a surprise that the top 10 cryptocurrency are mostly L1s.

Note that USDC/USDT are ERC-20 tokens (i.e. created on the Ethereum network), and hence are L2 protocols. We can also think of L2 protocols as decentralized (as they operate on some kind of blockchain) apps (dApps) running within a particular ecosystem & serving users of that ecosystem.

Ecosystem dApps

This does not mean that L2s are not investible though, but by definition value creation of L2s depend on the L1 protocol it is on. You as a L2 protocol cannot expect to have 10 million users if the underlying L1 protocol only has 5 million active users.

On the flip side, popular L2 protocols can theoretically set up shop (expand) on other L1 chains as well, thus amplifying the value creation which generally flows back to the token holders. Here's an example of one of the biggest lending platform on Ethereum (Aave) setting up a L2 protocol on the Avalanche ecosystem (L1).

All said, investing in cryptocurrencies already require a more stringent due diligence process + domain knowledge, let alone L2 protocols. As I've mentioned on Twitter, the hyperspeed of crypto market cycles can mint _many _wealthy people, but can also financially ruin them.

Do your own research!

Conclusion

This was a simple overview on the blockchain trilemma and the difference between L1s and L2s. My next opinion article will shed some light (ha) into Bitcoin's Lightning Network ⚡ & how it's unlocking BTC's use case as a global medium of exchange.

Cheers,

Joey

==========================================================

Interested to invest in Bitcoin, but don't know where to start? Consider signing up for the AMEX credit card (exclusive Seedly & Singsaver deal) to claim up to SGD $365 worth of Bitcoin!

I'm currently partnering with Seedly & Singsaver to help accelerate local adoption of cryptocurrency. It's a movement I feel strongly about. This is perfect for investors who are apprehensive of buying their own crypto themselves, but wish to get some exposure to a strong asset that has proven itself to be a store of value.

Do note that this promotion IS THE SAME as the current #ownthefuture crypto campaign happening right now. Come join the HODL movement 😃

Sign up using the link here, and follow the steps below.

1. You will be directed to a Seedly x SingSaver landing page. Enter your email address and click “confirm” (reminder: use the same email address throughout the application process)
2. Complete your application and take a screenshot of the Application Reference Number (important)
3. Fill in the SingSaver rewards form that will be sent to your email

Note: Terms and conditions apply.

SingSaver or Seedly will never ask you for your wallet address nor conduct airdrops. Do reach out to [email protected] for any questions on the campaign.

==========================================================

This is a long form of my original thread on Twitter

https://twitter.com/JoeyKoh_/status/1428730179304624138

I post a lot more on crypto as well as growth stocks investing on Twitter. Do toss me a follow if the content you see here is up your alley.

For advanced crypto hobbyists:

Meta-thread on resources relating to crypto, NFTs & the Solana ecosystem.

All info available on my website here.

===============