Published Feb 27, 2020
By Anthony Foy, CEO Qredo
By promising to scale Bitcoin until thousands of people can simultaneously buy cups of coffee without strain, the Lightning Network has made Layer 2 a household name. But second layer solutions are more than just a mechanism for scaling, and can do more than just enable coffee-sized micropayments.
Layer 2 protocols can boost liquidity, fortify security, add interoperability, and develop the cryptocurrency ecosystem enough for a long-awaited category of investors to enter the space: Institutional Investors.
Paving the way forward
The success of the first regulated cryptocurrency investment platforms—CME, Bakkt, and Grayscale—indicates strong institutional appetite for this new asset class. But outside of these select venues, there are still key barriers preventing institutional investors from entering the market.
Poor custodian/exchange security and a terrible track record of hacks and thefts
Slow settlement times preventing traders from taking advantage of immediate opportunities
Low liquidity making it tricky for big players to get in and out of the market
High fees and complex custodial processes reduce capital efficiency and make it more difficult for investors to climb the j-curve
Lack of transparency making regulatory interaction difficult
What institutional investors need is full transparency, capital efficiency, ample liquidity, and assurance of the safe and proper execution of their orders—all ambitions that can be realized with L2.
Why Layer 2 is the key
The pinch-points preventing institutions entering the cryptocurrency market are symptoms of poor scalability.
In their present state, blockchains struggle to provide sufficient quantity and speed of transactions while retaining decentralization. Layer 2 solutions resolve this trade-off by shifting computational activity from the blockchain to an additional layer that is still anchored to the underlying blockchain for settlement.
This multi-layer architecture is modelled on the World Wide Web, which relies on similar layers of cryptographic code and networking beneath the surface 'application layer.’
Not only can this layered system help individual blockchains to scale—as with Bitcoin's Lightning and Ethereum's Plasma—but it can also connect different blockchains, as with the blockchain-agnostic Layer 2 network Cosmos. This protocol aims to add interoperability to blockchains; opening up the 'walled gardens' of distinct cryptocurrencies into an open landscape where assets can be directly transferred directly between chains.
Qredo as a Layer 2 solution
Qredo is a Layer 2 network that tracks and transfers the right to ownership of digital assets, leaving settlement to the cryptoasset’s underlying blockchain. This is built using the same consensus engine as Cosmos—Tendermint—as the asset tracking and authorization layer.
Because Tendermint is blockchain-agnostic, Qredo can act as a Layer 2 solution for almost any blockchain, allowing cryptocurrency businesses to easily transact with multiple assets using a single protocol.
Ownership of the digital asset—which could be a security token, a utility token, or almost any cryptocurrency—is recorded on the Qredo blockchain via a corresponding set of secure secrets held by Multi-Party Computation (MPC) Nodes. These MPC nodes sign transactions in a secure distributed way, without the need for a private key.
By combining the Qredo blockchain as a Layer 2 protocol with MPC transaction signing, the network effectively becomes a network for safekeeping, asset tracking, clearing and transaction throughput. This unlocks numerous benefits for institutional digital asset managers:
The Qredo blockchain acts as a bridge between different blockchains, allowing different crypto assets to be tracked and atomically swapped without a third party.
Multiple digital asset safe storage
The Qredo blockchain supports multiple digital assets. This eliminates the need for pre-funding of multiple exchanges and wallets, and allows assets to be kept under your control even when an exchange is hacked or malicious.
Faster and cheaper transactions
As a layer-2 solution Qredo can clear transactions with near instant transfer on any digital asset pair at a dramatically lower cost with a lower operational burden.
Without a third party, custodial risks are minimized. Holders can swap assets without relinquishing control over their private key, and coins remain protected in on-chain escrow accounts.
All transactions are recorded cryptographically on the blockchain ledger, creating an immutable record that can be shared with regulators on request.
Unlike ordinary cryptocurrency transactions that can be viewed by anyone, transactions made off-chain on the Qredo Layer 2 network are removed from the public eye.
Ultimately, Layer 2 technology is essential for easing the bottlenecks of the cryptocurrency market whilst preserving the principles of decentralization.
It opens the door to new market participants and sets the stage for new financial instruments that have thus far been impossible to replicate in the digital asset world.