Layer-2 Ethereum competition

Comparison and competition between Layer-2 solutions on Ethereum

Ethereum has reached its scalability limit. Ethereum processes approximately 500,000 transactions per day, equivalent to 30 transactions per second. For comparison, the Visa payment system can handle up to 150 million transactions per day and 65,000 transactions per second, greatly surpassing Ethereum’s capabilities. In practice, reaching the limits of the blockchain leads to network congestion (where transaction processing can take several hours) and extremely high gas fees.

Currently, Ethereum is one of the most advanced blockchains in terms of network security and stability. Most individuals and companies prefer to use this blockchain for transactions or project development. However, as the number of transactions increases, the network becomes more overloaded. To address this issue, validators prioritize confirming transactions with higher gas prices. But these higher costs are passed onto users, raising the minimum gas fee, which at times can exceed the cost of the transaction itself.

There’s no need to process such large volumes of data using Layer-2 solutions, as it sends this data through various processing channels (third parties), recording only the final result on the Layer-1 blockchain.

Advantages of Layer-2 solutions:

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• Increasing transactions per second (TPS) improves user experience and reduces network congestion.
• Transactions are consolidated into a single batch before being recorded on the main network, reducing gas fees.
• Any updates to the Layer-2 solution don’t alter the underlying blockchain, as Layer-2 is built on top of the blockchain, which helps maintain network security.
• It enables the creation of Layer-2 networks for specific applications that are designed to optimize certain functions.

What is a Rollup?

Rollups are a scaling solution that operates as follows: it aggregates or “rolls up” a multitude of transactions into a single “batch,” which is then sent back to the consensus layer (L1) for verification. This enhances efficiency by verifying multiple transactions simultaneously and increases the number of transactions that can be validated and confirmed. Currently, there are two types of rollups:

• Optimistic Rollups
• ZK Rollups

ZK Rollups

ZK Rollups bundle transaction data into one entity, and then each “rollup” of transactions is sent for verification off-chain, generating a cryptographic proof (known as SNARK, in the case of zkSync) that the transactions are valid. Finally, the SNARK is submitted as proof of validity to the main network (Ethereum).

It’s worth mentioning that ZK Rollups leverage the economies of scale, where a larger number of users conducting transactions makes the network more cost-effective to use. This is in contrast to a typical blockchain where usage costs increase as the network’s usage grows.

Optimistic Rollups

Optimistic Rollups take a different approach to transaction verification. Instead of proving the validity of each batch, this technology optimistically assumes that each computation is valid unless proven otherwise.

The summer of 2023 has been marked by the emergence of a variety of Layer-2 blockchains on the Ethereum Mainnet. Projects that have been actively developing since Ethereum’s transition to PoS are now entering a new phase and beginning to compete for users among themselves.

Possible risks associated with Layer-2 Solutions

Vitalik Buterin, Ethereum сo-founder, published an article titled ‘Don’t overload Ethereum’s consensus.’ Within this piece, Vitalik highlighted certain challenges that could conceivably pose a threat to the foundational Layer-1 Ethereum network:

“Hermione creates a successful layer 2, and argues that because her layer 2 is the largest, it is inherently the most secure, because if there is a bug that causes funds to be stolen, the losses will be so large that the community will have no choice but to fork to recover the users’ funds. High-risk.”

The well-known blockchain trilemma, which involves decentralization, scalability, and security. In one way or another, any blockchain encounters at least 1 issue from the components of the trilemma. At the moment, the Ethereum blockchain is attempting to address the scalability issue through Layer-2 solutions. However, uncontrolled scalability may lead to problems with the decentralization and security of the Ethereum blockchain itself. Is it truly necessary for Ethereum to have so many Layer-2 solutions?

Competition between Layer-2 on Ethereum

The cryptocurrency market is currently in a bear cycle. Bitcoin and many altcoins have corrected by 50–90% from their all-time highs (ATH). But does this mean that the cryptocurrency market isn’t evolving? Not quite so, State of Crypto report by a16z tells the opposite:

• The number of active developers is still higher than during the bull market of 2021;
• The number of verified smart contracts is already twice as much as in 2021;
• The number of unique blockchain users has almost doubled compared to 2021;
• The transaction volume remains at peak levels seen in 2021.

However, does this mean that Layer-2 solutions on Ethereum could attract users from web2, or will they have to compete for existing users? Primarily, the initial challenge lies in outcompeting other Layer-2 solutions for the current user base. By achieving success in this regard, projects will be better positioned to attract new users. If your product does not capture the interest of the current blockchain community, why would it be appealing to newcomers?

Optimism and Arbitrum case

At present, the Ethereum ecosystem is seeing the flourishing of two prominent Layer-2 solutions: Optimism and Arbitrum. Both projects are achieving significant progress across key metrics and are effectively addressing Ethereum’s scalability challenge.

It is important to recognize that a project’s success is not solely dependent on technology; it also relies on community engagement, marketing efforts, and the ability to attract new users to the ecosystem. These two projects have set a new trend for Layer-2 solutions: they rewarded their early users with a token airdrop (ARB and OP), a strategy that wasn’t initially planned.

Optimism distributed its airdrop to over 150,000 users, rewarding them with $OP tokens valued at an average of around $2,000. On the other hand, Arbitrum set a new record by distributing its airdrop to over 500,000 users in their network, rewarding them with $ARB tokens valued at an average of around $3,000.

These actions were received extremely positively by the community. Users of the systems received rewards for utilizing the networks, and the project teams gained significant hype within the entire crypto community. As a result, the core metrics of the projects continued to grow even after the airdrop event.

It’s worth noting that both projects are built on the concept of Optimistic Rollup, while a significant portion of projects currently in the Alpha stage are utilizing Zk Rollup technology (such as zkSync, zkEVM, Linea, Starknet). Zk Rollup technology is more advanced and superior in technical characteristics compared to Optimistic Rollups. However, relying solely on technology isn’t sufficient. No matter how innovative and user-friendly your product is, if team don’t focus on building and strengthening their community, the whole project might not achieve their goals and meet the expectations of investors.

Community importance

Arbitrum and Optimism have set a high standard for all other projects planning to scale the Ethereum network in the future. These projects have captured an audience not only with their technology and user-friendliness but also with their consistent community engagement.

If any of the new projects solely focus on their technology, they risk falling behind and losing the competition to other Layer-2 solutions. The average Ethereum blockchain user won’t adopt every Layer-2 solution available; they’ll require one or a few solutions that cater to their everyday needs.

If a project fails to support its early users and meet their expectations, its continued development could be at risk.

Conclusion

Certainly, the period spanning from the end of 2023 through 2024 is anticipated to showcase the comprehensive launches of several fresh Layer-2 solutions within the Ethereum ecosystem. These solutions will primarily compete among each other not only based on technology but also through their community engagement efforts.

Disregarding either of these two crucial factors could be a point of no return for such projects. It’s abundantly clear that Ethereum requires scalability, but it must be controlled and timely. Currently, Ethereum doesn’t need dozens of Layer-2 solutions. It can be assumed that projects are going to thrive are those that not only build a modern and necessary product but also manage to attract users through effective community engagement.

In this case, the success stories of Arbitrum and Optimism should serve as benchmarks for new projects. Technology without users is of no use to anyone.