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At this year's TOKEN2049, Konstantin Richter, Blockdaemon Founder & CEO, delivered a keynote exploring what Layer 2s (L2s) are, their role, and their growing relevance to institutions.

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A link to the full recorded presentation can be found below, with a full recap touching on key points outlined in this blog.

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Why are L2s Important?

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A Layer 2 (L2) is a collective term to describe a specific set of Ethereum Scaling Solutions. It is a separate blockchain that extends Ethereum and inherits its security guarantees. 

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Ethereum, and other Layer 1 networks, face throughput limits that increase fees and delay transactions. 

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Ethereum's scaling strategy relies on Layer 2 networks, which enhance scalability by using the security of Ethereum's Proof of Stake.

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Optimism, for example, uses Optimistic Rollups, a L2 scaling solution that bundles many transactions into one transaction and posts it to Ethereum, with computation and state storage off-chain. It verifies transactions using fault proofs. This assumes transactions are valid, and if invalid, triggers a challenge period and re-run the problematic transaction on the main chain. It derives its security from Ethereum but is itself a blockchain. 

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Optimism’s OP Stack shows how Layer 2s can enable multiple chains to operate under a unified framework. Binance's OPBNB and Coinbase's Base, both built on Optimism’s technology, are prime examples where firms create proprietary Layer 2 networks that mesh with their main services, optimizing scalability while minimizing costs.

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These examples highlight the growing institutional acknowledgment of the advantages provided by L2s.

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Institutional L2s as the New Private Blockchains?

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Institutions prefer private blockchains for control and compliance, but increasingly seek interoperability with the wider industry. 

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This drives interest in custom, public permissioned L2 solutions on the Ethereum Virtual Machine (EVM) for institutional applications. Ethereum has had a L2 rollup-centric roadmap since 2020.

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This also offers smaller entities a chance to compete with traditional finance giants by using L2 technologies to provide efficient, cost-effective services.

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L2 solutions, including optimistic and zero-knowledge executions, are advancing quickly, with significant enhancements in data throughput projected—an 81x increase within three years. These improvements make scalable, low-cost operations comparable to what Cosmos appchains and Polkadot parachains initially introduced.

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Below is a framework to understand where institutional L2s fit in a wider context. 

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Use Cases for Institutional L2s

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There are a number of use cases for institutional L2s. 

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1. Payment Systems with Stablecoins: Stablecoins are a core pillar of crypto market liquidity. Despite market fluctuations, their market cap remains strong, attracting both institutional and retail users alike, drawn to the digital fiat model. While regulations can increase adoption, the success of USDC and USDT shows they are not essential for retail acceptance.

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2. Onchain Finance: Exchanges like Binance and Coinbase have their blockchains, with Kraken developing its own L2. This highlights the benefits of onchain finance, such as faster settlements and better cross-platform integration.

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3. Tokenization of Real World Assets: Though still emerging, tokenization is poised for growth, backed by expert forecasts. It leverages blockchain's key features - token-based value transfers - to potentially transform asset markets, including capital markets.

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Why Would Institutional Companies Start Their Own L2s?

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1. Full Control: Banks and financial institutions prioritize control when launching Layer 2 (L2) solutions to meet their security and operational standards. This control spans across the following: 
   • Transaction Sequencing.
   • Clients/Provers.
   • Compliance.
   • Bridge to public liquidity.
   • Smart contract code on source chain.
   • dApps.
   • Optimize Performance/Trade-offs.

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2. Compliance: 
   • A fully managed L2 ensures all infrastructure is in one jurisdiction.
   • Transaction privacy from competitors.
   • Full transparency guarantee for regulators (regulators could even participate/mediate).

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3. Platform Revenue: 
   • New markets/methods to dominate a category (e.g. web3 settlement, interoperability, etc.).
   • Many revenue models are possible, both traditional access fees as well as tx-based fees (own token models unlikely for institutions). 
   • Companies can also receive gas via sequencer (e.g. in USDC).
   • On-/off-ramp fees via bridge.

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The Future of Interoperability

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Many networks result in fragmented liquidity. Isolated networks that operate privately, therefore, lack value. An L2's strength lies in its interconnectedness, being interoperable with other networks. Effective L2s must allow transactions across both banking and public networks to achieve true adoption.

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Conclusion 

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Blockdaemon supports both institutional and open source L2s. For companies launching an L2, Blockdaemon is the ideal decentralization partner, as well as providing institutional grade wallet infrastructure. 

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In addition, Blockdaemon’s fully compliant offering, and existing market-access to other regulated customers, offers the potential for partnerships. 

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Blockdaemon successful and ongoing commitment as a node operator of the Base, zkSync, and Stacks ecosystems, for example, are prime examples of our commitment to supporting the L2 ecosystem. 

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Our strength-of-service across our Wallet, APIs, Nodes and Staking services underpin this support. Blockdaemon’s full ‘node stack’ powers key infrastructure across tokenization, payments, financial industry interoperability, and analytics companies, capitalizing on the key trends such as Account Abstraction (AA), Layer-2/3 Rollups (L2), and Maximum Extractable Value (MEV). 

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For companies considering their L2 strategy, book a call with Blockdaemon today. 

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