9 min readThe Web3 landscape has evolved as blockchains have come up against limitations that prevent them from meeting real-world demands. The tech stack now consists of several ‘layers’: protocols built on top of each other, which are designed to address these limitations. Layer 2s typically boost scalability for layer 1s like Ethereum, while layer 3s and 0s offer greater customisation and facilitate communication between chains.
This article explores the key components of each layer to help cryptocurrency investors understand how they work.
Layer 1
Layer 1s (L1s) are foundational protocols that serve as the base layer in the blockchain ecosystem and execute fundamental operations. They use consensus mechanisms to validate and keep a record of transactions and ensure a protocol’s security by safeguarding against 51% attacks, which would allow a malicious party to take control of a network and reverse transactions. The widest-adopted mechanisms are ‘proof of work’ (PoW), which involves participants known as miners competing to process transactions by solving complex mathematical problems, and ‘proof of stake’ (PoS), where validators ‘stake’ or lock up crypto for the right to process transactions.
Learn about the differences between PoW and PoS.
L1s face limitations, a challenge Ethereum founder Vitalik Buterin dubbed the ‘blockchain trilemma’ in reference to the technology’s key features: decentralisation, security and scalability. Incorporating all three is practically impossible, forcing developers into a tradeoff, which typically means prioritising decentralisation and security at the cost of scalability. As a result, L1s can experience congestion at times of high demand, leading to inflated transaction fees. For instance, when decentralised finance apps started to gain traction in the summer of 2020, Ethereum’s gas fees hit more than $50 per transaction.
The infrastructure underpinning the two biggest cryptos by market cap, bitcoin ($2.11 trillion as of the January 20th 2025) and Ethereum ($405 billion), were L1s before the term entered the crypto lexicon. Other well-known examples include Solana ($125 billion) and Cardano ($37 billion).
Layer 2
Layer 2s (L2s) are one of the first solutions designed to address the blockchain trilemma. They’re built on top of L1s, so they inherit the security provided by the underlying protocol, which continues to determine the finality of transactions. Ethereum hosts the majority of L2s to date.
The most common type of L2s are rollups, which improve scalability and reduce fees by processing transactions on behalf of a base layer off-chain. They then batch the transactions together and submit them to the L1. Rollups come in two forms:
Optimistic rollups assume transactions are valid unless warned otherwise by an L2 validator
ZK rollups verify transactions using a cryptographic technique called zero-knowledge proofs, which protects sensitive data.
The biggest L2s by market cap are Mantle ($3.2 billion) which uses optimistic rollups and Polygon ($3.83 billion) which uses the ZK version. Other L2s that have attracted attention include Arbitrum ($3.13 billion) and Optimism ($2.38 billion).
Bloomberg recently reported that Deutsche Bank, one of the world’s largest investment banks, is building an L2 to accelerate transactions and mitigate regulatory risks, such as dealing with sanctioned entities, by improving transparency. Part of the Monetary Authority of Singapore’s Project Guardian, a group of financial institutions exploring blockchain solutions, the L2 will be built on Ethereum and use ZK rollups.
Layer 3
Layer 3s (L3s) are an application layer built on L2s which allow developers to build decentralised apps on dedicated blockchains. They’re highly customisable, so they can boost scalability or provide users with a higher degree of privacy while leveraging the security provided by the base layer. Given Ethereum hosts the majority of L2s, the same applies to L3s.
L3s can also serve as a bridge or communication protocol, allowing applications features to be shared by multiple blockchains. Known as interoperability, this is a key feature driving blockchain adoption because it breaks down the siloes between the plethora of L1s.
Degen Chain, launched in spring 2024, is the biggest L3 by market cap ($110.85 million as of January 20th 2025). Built on Base, it provides flexible infrastructure to meet the needs of the users of Warpcast, a decentralised social network. Examples of decentralised apps (dapps) running on the protocol include decentralised exchange Degenswap and NFTdegen, a platform for launching non-fungible tokens. Degen Chain’s native token is DEGEN, a meme coin inspired by ‘degeneratives’, a term used by the crypto community to describe speculative traders.
Layer 0
Layer 0s (L0s) provide the infrastructure for developers to build and deploy customisable L1 blockchains that host individual applications or specific use cases. They consist of three components: a mainchain to facilitate the transfer of data, sidechains to support the application or use case, and a protocol allowing the L1s to communicate. Each sidechain uses its own consensus mechanism and can leverage the security provided by the L0.
In addition to facilitating interoperability, L0s can help to address the blockchain trilemma as the L1s can be designed to improve scalability.
Polkadot is the biggest L0 by market cap ($10.02 billion as of January 20th 2025). It currently hosts 215 sidechains (as of January 20th 2025), called parachains, with Bittensor the most prominent (market cap $3.53 billion). Bittensor connects suppliers with excess computing power and developers of artificial intelligence applications who need to train and run their models.
Learn more about decentralised physical infrastructure networks (DePINS) and Bittensor.
Other notable L0s by market cap include Avalanche ($15.39 billion as of January 20th 2025), which refers to its mainnet as the primary network and sidechains as subnets, and Cosmos ($2.4 billion), which consists of a hub and zones.
Conclusion
There are four layers of blockchain technology, with the first three building on each other.
L1s like bitcoin and Ethereum are the foundational layer. They process transactions and secure the network using a consensus mechanism such as PoW or PoS. L1s currently capture the most value in the Web3 ecosystem, but they face limitations caused by the ‘blockchain trilemma’.
L2s overcome these limitations, usually by processing transactions on behalf of an L1 and then sending them in batches to the base layer.
L3s allow developers to build customisable blockchains to host individual dapps. They also facilitate interoperability between chains.
Finally, L0s provide the infrastructure to develop customisable L1s, which address the blockchain trilemma and enhance interoperability.
