Layer 1 refers to base blockchain protocols like Bitcoin, Ethereum, and Solana that process and finalize transactions directly on their main chain with native security. Layer 2 solutions are secondary protocols built on top of Layer 1 blockchains that handle transactions off the main chain to improve speed and reduce costs, then settle final state back to Layer 1 for security. L2s inherit security from their parent chain while offering 10-100x faster transactions and lower fees, though they add complexity and additional trust assumptions.
Example:
Ethereum (Layer 1) processes transactions directly on its blockchain with maximum security but handles only 15-30 transactions per second with gas fees of $2-$50 during congestion. Arbitrum and Optimism (Layer 2) process thousands of transactions per second with $0.10-$1 fees by batching transactions off-chain, then periodically settling the final state back to Ethereum's Layer 1 for security. When swapping $1,000 USDC for ETH, using Arbitrum costs $0.50 in fees versus $15 on Ethereum mainnet. Layer 2 provides the speed and cost savings while Ethereum Layer 1 provides the security foundation.