Layer 2 Blockchains Were All The Rage For Crypto Investors. But Layer 1 Blockchains Made Them Way More Money This Year

Remember when layer 2 (L2) blockchains were the new crypto investment theme, and if you were anyone with a Gemini account you probably forked over some investment capital and bought the layer 2 blockchain tokens.  Layer 2 was where it was at. Layer 1 was slow, costly, and old-school. Investors tried to get ahead of the new thing in the crypto market.

It’s been a mixed bag for them all year.

Loopring (LRC) is down around 12.5% ending August 20. Optimism (OP), which is the main Ethereum-based layer 2 network, has done well and is up 54.3%. But Arbitrum ARB/USD and Polygon (CRYPTO:MATIC) are down 22.3% and 18.5%, respectively. Meanwhile, Bitcoin BTC/USD and Ethereum ETH/USD – the original layer 1 behemoth – are both up over 32% year to date.

The original Layer 1 chains are plagued with bottlenecks, and that’s mostly by design. To address the challenges they faced, blockchain developers created a second layer that ran on the layer ones that had a multitude of purposes, including being able to transaction across different blockchains. For example, if a blockchain is slow to index data, a developer makes a Layer 2 that reads and indexes blockchain data. There is no shortage of Layer 2 solutions out there. But, despite the rapid evolution of the industry over the last several years, most L2s don’t offer anything new outside of faster and cheaper transactions. On the other hand, the novel Layer 1s now have the benefit of hindsight. Having studied what has worked and what hasn’t among the L2 competitors, they have improved their systems and don’t need to rely on additional Layer-2 infrastructure to give developers a full spectrum of tools needed to do whatever it is they are making on those platforms.

“We decided to build a Layer 1 blockchain because there is no existing network that meets the objectives we require,” said Alberto Fernandez, a representative for Qubic, a decentralized artificial intelligence-run blockchain. Fernandez is based in Andorra la Vella in the Pyrenees mountain nation of Andorra north of Spain.

“We needed extreme processing speed, instant finality, and a new consensus algorithm compatible with useful proof-of-work,” he said. The network’s database is stored in the RAM of the nodes, eliminating the main bottleneck present in most Layer 1 blockchains. Their smart contracts can executive over 50 million transactions per second, according to the company.

Old school Layer 1s like Chromia CHR/USD from Stockholm, Sweden, which started in 2019 and launched their main network in July, are taking different approaches.  So instead of building a new L2 on top of existing blockchains, they took those L2 solutions and brought them into a new standalone blockchain platform. (Their token is down 0.4% so far this year.)

“The idea behind Chromia was to combine the best aspects of relational databases with the best aspects of blockchain, with an economic model that more closely resembles cloud computing – where customers are leasing network resources -- compared to traditional blockchains – where you are paying per transaction,” said Henrik Hjelte, co-founder and CEO of Chromia. 

Chromia is designed to function independently as a base layer for decentralized applications. True Global Ventures (TGV) has about $ 5 million invested in its parent company, ChromaWay.  TGV also backs The Sandbox, a metaverse gaming company.

“Layer 2s have gained momentum, but since many of them are extensions of Ethereum, one could argue that their success is mainly a positive for Ethereum,” Hjelte said. “The new, alternative Layer 1s still have an important role to play. There will always be a market for well-designed technology that can offer something new. In the normal world, relational databases have a dominant position as the backbone of all kinds of applications, it is just new to the blockchain world.”

Some estimates suggest that there are over 130 Layer 1 blockchains out there besides Bitcoin and Ethereum. Other well-known Layer 1 chain include Solana SOL/USD, Cardano ADA/USD and the four-year-old Polkadot DOT/USD

Layer 2s are newcomers and designed to make life on the Layer 1 chains easier to work with. There are around 30 of those and each one uses a different technical approach – known in the blockchain developer world as optimistic rollups, zero-knowledge rollups (aka zkRollups), or state channels.

Retail investors sought these new plays out over the last three to four years, with excitement building in 2021 after Optimism’s launch.

But the L1s have held their own and have been less risky investments.

Developers who use these blockchains also seem happier with them today than they did when the L2s were coming out to solve a whole host of problems for app developers.

“I think Ethereum now offers significantly improved performance compared to previous years,” said Leona Hioki, co-founder at Intmax in Switzerland. Intmax is an L2 zkRollup solution using a so-called stateless architecture that runs over Ethereum. It is used for money transfers.

“The modern L2s often require substantial development from L1, and due to their architecture they face limitations in scalability and still lack privacy but you can use Ethereum alone and that gives you unmatched security, true decentralization, and trust.”

Hioki’s Intmax was recently mentioned by Vitalik Buterin, Ethereum’s founder, who called it one of the best scaling solutions available on that blockchain. Intmax does not have a token associated with it.

“That comment helps us build a strong following within the Ethereum community,” Hioki said. “We don’t have plans to expand to other chains, but even before Vitalik mentioned us, we attracted top-tier teams and companies from around the world, like Settle Network, the largest off-ramp/on-ramp solution in Latin America.”

The L2s were born because blockchain developers – all trying to build a better web, all trying to build the next hot video game and eliminate the middle man in financial transactions – wanted scalability and lower costs.

“Everyone just wanted to do transactions quickly and cheaply,” said Hjelte. “I think over time people have become more aware of problems,” he said, adding that companies have been able to solve those problems, as Chromia is trying to do with data in a “blockchain cloud”.

But for investors, it looks like there is no difference between an L1 and L2 in terms of where to invest.

Retail investors will be better off sticking with the well-known names that have been around for a while. Those not afraid to throw caution to the wind can try out the alternative Layer 1s and see if developers can make them popular enough so they are worth the risk.

The writer of this article is an investor in Bitcoin, Polkadot, and Cardano.

This article is from an unpaid external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.