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What is Bitcoin Layer 1 and How Does the Blockchain Work?

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Conceptual image of Bitcoin layer 1 and the blockchain
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Bitcoin layers have been key to unlocking the true potential of the Bitcoin blockchain network. 

But to understand why Layer 2 networks are needed, we have to take a step back and really unpack Bitcoin's Layer-1 network. After all, defining what L1s, L2s and sidechains are is critical to understanding how a main chain interacts with its scaling solutions.

Our Learn Center will delve into what comprises Layer-1 blockchains, what makes Bitcoin's Layer-1 network unique, how the blockchain platform works, and why common Layer 2 scalability solutions are crucial to Layer 1 scaling efforts.

What is a Layer 1 in Blockchain?

To begin, we have to understand what an L1 is first. 

In blockchain technology, Layer 1 refers to the base layer of a crypto blockchain protocol. This layer serves as the foundation for blockchains and is responsible for the core functionality of the network, including transaction validation, consensus mechanism, and security.

The Layer 1 network is where the blockchain's protocol rules and governance are established. It is the layer that defines how transactions are processed, verified, and recorded on the blockchain. In a public blockchain network, such as Bitcoin or Ethereum, Layer 1 is where nodes and miners participate in the network to validate transactions and add new blocks to the blockchain

One of the key features of Layer 1 blockchains is their ability to provide a decentralized, trustless system for peer-to-peer transactions. By utilizing a distributed network of nodes and miners, the blockchain can achieve a high level of security and transparency. The consensus mechanism used in Layer 1 determines how transactions are validated and how new blocks are added to the blockchain.

Another important aspect of Layer 1 is its scalability. As the number of transactions on the blockchain network grows, it becomes increasingly important for the protocol to be able to handle increased traffic without sacrificing performance or security. Some blockchain projects have been working on improving Layer 1 scalability through various techniques, such as sharding or off-chain solutions.

Layer 2 blockchain protocols are also popular scaling solutions that allow developers to explore dApps built on top of blockchain layer 1s. Layer 2 protocols often provide strong scalability solutions as they often inherit the decentralization and security found on the main chain, as is the case with blockchains like Bitcoin and Ethereum. 

Overall, L1 networks are a critical component of a blockchain protocol, providing the foundational layer for the network's operation, security, and scalability. It establishes the rules and processes that govern the network and enables peer-to-peer transactions in a decentralized and secure manner.

What are the Key Components of Bitcoin L1?

Bitcoin L1 is the base layer of the Bitcoin blockchain. It is responsible for creating, validating, and securing new blocks of transactions. The miners who run the Bitcoin network work on L1, and they are responsible for verifying transactions and adding them to the blockchain.

The L1 is critical to the functioning of the main blockchain network. It ensures that transactions are verified, secure, and transparent. Because Bitcoin operates on a decentralized network, there is no central authority controlling the blockchain. Instead, all Bitcoin nodes on the network work together to maintain the integrity of the ledger.

One of the most important aspects of Bitcoin L1 is its consensus mechanism. The network uses a proof-of-work (PoW) consensus mechanism as opposed to a proof of stake (PoS) consensus mechanism. PoW requires miners to solve complex mathematical problems to validate transactions and add them to the blockchain. This ensures that no one can simply add fraudulent transactions to the network and that all transactions are verified by the network's participants.

To see how all those components fit together, we'll walk through the exact transaction process on Bitcoin Layer-1.

How do transactions on Bitcoin Layer 1 work?

First, users must create a transaction. Creating a transaction on Bitcoin's Layer 1 involves specifying the amount of cryptocurrency (the BTC native token, in this case) users want to send and their recipient's address. In order to create the transactions, users also need to have access to the private key associated with their Bitcoin address to sign the transaction. Once a user has created a transaction, they need to broadcast it to the network, which involves sending the transaction data to nodes on the network that act as validators. 

However, valid transactions aren't added directly to the blockchain. Instead, they are added to the mempool, which is a pool of unconfirmed transactions waiting to be included in the next block (a waiting room, of sorts). 

From there, miners select a set of transactions from the pool and solve complex mathematical problems as part of the PoW consensus protocol. The first miner to solve the problem gets to add the new block to the blockchain, which includes the validated transactions and a reward of newly minted BTC (a key part of the mining economy). These rewards are halved every few years during Bitcoin Halving events.

Once a transaction is confirmed and included in a block, it is considered final and cannot be reversed. The network ensures that no one can spend the same BTC twice by using a UTXO (unspent transaction output) model, where each transaction output can only be spent once. In other words, the network is preventing double spend to ensure the integrity of the blockchain.

Solving the Blockchain Trilemma

However, Bitcoin also faces a problem common to all Layer 1 blockchains, even newer ones like the Ethereum blockchain.

The Blockchain Trilemma is a term used to describe the challenge of balancing three critical factors in blockchain technology: security, scalability, and decentralization. It is often used to explain the limitations and trade-offs that exist in blockchain design.

Security refers to the ability of a blockchain to prevent unauthorized access, fraud, and other types of attacks. Blockchain networks must be secure to ensure that transactions are validated and recorded accurately and that the network remains immutable.

Scalability refers to the ability of a blockchain network to handle a large number of transactions. As we mentioned previously, when blockchain adoption grows, the network must be able to process an increasing number of transactions without slowing down or becoming congested.

Decentralization refers to the distribution of power and decision-making across the network. A decentralized blockchain network has no central authority, which reduces the risk of censorship, corruption, and other types of abuse.

The Blockchain Trilemma essentially suggests that it is challenging to optimize all three factors at one time. For example, improving scalability may come at the cost of decentralization, as more nodes are required to process more transactions, leading to centralization of the network. Similarly, enhancing security may also reduce scalability, as more complex security protocols may slow down the network.

Blockchain developers must make design decisions that balance these three factors and prioritize the most important ones for their specific use case. 

How Does the Blockchain Trilemma Apply to the Bitcoin Layer 1 Blockchain?

As the first and most prominent blockchain network, Bitcoin is key in discussions about the Blockchain Trilemma.

In terms of security, Bitcoin Layer 1 is designed to be highly secure through the use of cryptographic protocols and the proof-of-work consensus mechanism. The PoW mechanism ensures that transactions are validated by a decentralized network of nodes, making it difficult for attackers to compromise the network. In terms of decentralization, Bitcoin Layer 1 is designed to be highly decentralized, with no central authority controlling the network. This makes it resistant to censorship and other forms of attack.

However, in terms of scalability, the Layer-1 blockchain faces limitations. The network can process only a limited number of transactions per second, which can lead to congestion and higher transaction fees during periods of high demand. This limitation is due to the design of the PoW mechanism, which requires significant computational power to validate and process transactions. Not only that, because Bitcoin Layer 1 prioritizes a high level of security and decentralization, it faces challenges in scalability by design.

This scalability issue has previously discouraged developers from building on top of the Bitcoin blockchain. Many believe that while the blockchain provides a high level of security and decentralization, the blockchain's design makes it difficult to build dApps on top of the network.

Fortunately, Layer 2 scaling solutions, in particular, have emerged to help expand the Bitcoin blockchain ecosystem, allowing developers to build on top of the main chain.

A Brief Overview of Bitcoin Layer 2 Scaling Solutions

Layer 2 solutions in blockchain refer to protocols and technologies that operate on top of a blockchain's base layer to increase scalability and throughput while maintaining the underlying network's security and decentralization. Layer 2 solutions can provide faster, cheaper and more efficient transaction processing for blockchain networks.

Bitcoin Layer 2 scaling solutions are designed to address limitations of the Layer 1 protocol. Here are some examples of Layer 2 scaling solutions for Bitcoin:

Lightning Network: The Lightning Network is a Layer 2 solution that enables instant micropayments without the need for confirmation on the Bitcoin blockchain. It works by creating a network of payment channels between users, which allows for faster and cheaper transactions. The Lightning Network has already processed millions of dollars worth of transactions and has the potential to significantly increase Bitcoin's transaction throughput.

Liquid Network: The Liquid Network is designed to offer faster and more confidential transactions, as well as improved inter-exchange settlement. It has a one-minute block time and two-block finality, making it suitable for high-frequency trading and other time-sensitive applications, and also offers a confidential transaction feature that hides the transaction amount. The Liquid Network is operated by a group of trusted entities called the Liquid Federation. Of the 60 members, there are 15 functionaries that help to confirm new blocks and secure and manage the network's Bitcoin funds. It uses its native token, Liquid Bitcoin (L-BTC), which is backed 1-to-1 with BTC.

Stacks: Stacks is a Bitcoin layer that holds properties of Bitcoin Layer-1 and Layer-2 solutions (hence its overall classification as a Bitcoin layer). It is a Bitcoin layer that enables smart contracts and dApps to use BTC as an asset and settle transactions on the main Bitcoin chain. Stacks is the top Web3 project built on Bitcoin and boasts its own smart contract language, Clarity, and its own consensus mechanism.

These are just some of the scaling solutions and networks created to improve upon the blockchain architecture of Bitcoin L1. 

Addressing the Challenges of Bitcoin L1

Ultimately, Bitcoin L1 is the backbone of the Bitcoin blockchain. But despite being the oldest and, to date, biggest blockchain, it has been seen primarily as a store of value as its design doesn't inherently allow for many of the same use cases that newer blockchains like Ethereum do (most notably, the creation of dApps).

In recent years, the conversation around Bitcoin L1 has shifted thanks to a number of scaling solutions that have appeared to empower developers to build on the Bitcoin main chain. Most notably, the emergence of Bitcoin layers have unlocked a myriad of functionalities for Bitcoin, including NFTs, DeFi, DAOs, and more.

That’s why while Bitcoin has, historically, faced a scalability problem, it is still possible to explore the full potential of Bitcoin and, subsequently, the Bitcoin economy. 

In fact, trillions of dollars are still waiting to be unlocked on the blockchain, and scaling solutions that allow for settlement on Bitcoin L1 are the key to revealing the true value of the network.