Overlay networks create virtual Layer networks on a Layer underlay. You get routing benefits with VLAN flexibility.
Why overlays exist:
- VLANs max out at IDs
- Large Layer domains cause broadcast storms
- VMs need to migrate without IP changes
- Multi-tenant environments need isolation
How overlays work:
Original Ethernet frame enters overlay
Tunnel endpoint encapsulates with new headers
Underlay routes encapsulated packet as IP
Receiving endpoint decapsulates
The physical network sees only IP packets.