Layer 2 Review
Market Recap
Crypto Meets Resistance at All Time Highs
Layer 2 Review
We have recently published two articles that focus on smart contract platforms, or layer 1's as they are otherwise known. In them, we explored how to compare and evaluate layer 1's and touched on the tradeoffs their developers had to make when designing them. When a blockchain has made the decision to prioritise security and decentralisation, they suffer from the problem of scalability.
In order to rectify this, projects like Ethereum have had to rely on layer 2 solutions to help them alleviate on-chain pressure and reduce fees for the users of the platform. We have previously detailed the different approaches to layer 2 design, and we suggest you read this before jumping into this article.
In this piece, we will review some of the significant layer 2 projects, the design approaches they have taken and how they are currently doing when compared with one another.
Polygon
Polygon is currently one of the most popular Ethereum Layer 2 solutions. It was launched in 2017 under the name Matic but recently had a rebrand to Polygon.
The Polygon team were trying to implement the Plasma approach as a scaling solution, which was a relatively new technology at the time. This, however, proved more difficult than first thought, and while they still leverage Plasma as their "bridge" or entry ramp for Ethereum to Polygon transactions, they have pivoted to the sidechain approach on their mainchain. Polygon has also recently conducted one of the biggest public chain mergers with a project called Hermez. Hermez employs a zkRollup solution that will be further integrated into the Polygon network over time.
Polygon has found traction with many of the largest Ethereum projects and currently sits arguably as the leader of layer 2 solutions for Ethereum specifically.
Arbitrum
Arbitrum was developed by the company Offchain Labs and launched its mainnet, Arbitrum One, on 31 August 2021. They have since managed to find decent traction and have several notable projects, both crypto and traditional, already leveraging their infrastructure, including Reddit, the social media site.
Arbitrum uses the optimistic rollup approach, which means that it passes messages between smart contracts on the Arbitrum layer 2 chain and the Ethereum mainchain. There is also the added benefit of inheriting the security of Ethereum through rollups. Future implementations of Arbitrum also plans to introduce two other approaches, AnyTrust Channels and AnyTrust Sidechains. AnyTrust Sidechains and Channels intend to guarantee correctness as long as one validator of a dApp is acting honestly, even if all others are colluding.
Optimism
Optimism was developed by the team formerly known as Plasma Group. They are still in the process of launching their mainnet to the public, but they have allowed certain projects to start leveraging their infrastructure, such as Synthetix and Uniswap, in their community launch.
Optimism also uses the optimistic rollup approach. They also plan on introducing one-click deployment. This is exciting because, as one can imagine, the process of moving the code of a project from one blockchain to another can be rather tedious, and developers often have to modify their code. In contrast, Optimism will allow projects to deploy their code with only one click. This may very well encourage projects to use their infrastructure.
xDai
xDai is a project that has been developed through a partnership between the POA Network and MakerDAO. The project has been live since 2018 and has employed a dual token model, a stablecoin xDai (a 1:1 representation of MakerDAO's Dai) which is used for payments on the network and a governance token STAKE. The project has used the sidechain approach and has its own consensus and validators.
Loopring
Loopring is one of the layer 2 projects that have been around for the longest. They conducted their ICO in 2017 and raised around $45 million; however, due to a tightening of regulation in China, they had to return about 80% of the funds they raised and continue development with the rest. Loopring also initially started out with a specific use case to target, exchanges. They implemented zkRollups which allow people to exchange assets off the Ethereum mainchain with the added benefit of zero-knowledge proofs. At a high level, zero-knowledge proofs will enable a computer program or software to make a claim or "share" data without ever actually revealing the data itself. It is rather impressive cryptography.
ImmutableX
Immutable, an Australian based startup, created Immutable X. The first phase of the Immutable X platform launched in April of this year with a specific focus on non-fungible tokens (NFT's). They have adopted two approaches when it comes to scaling, Validium zkProof or zkRollups and the exciting thing is that they let the user decide which to use. The key difference being where the data itself is stored. With zkRollups, the data is stored on-chain, and Validium, the data is stored off-chain. This allows Validium to achieve higher throughput, but it comes at a price as it currently centralises data. While this problem isn't completely solvable, the company behind Validium, StarkEx has tried to mitigate it by establishing the Data Availability Committee (DAC).
SKALE
The SKALE project was founded in 2018 and launched the final phase of its mainnet in December of 2020. The scaling approach they have taken is using Plasma. They have also adopted a multichain approach and made it possible to create unique, customisable blockchains that can be configured for a specific application. Each SKALE chain is therefore independent but can also benefit from all the other chains within the SKALE network itself. Each node in the SKALE network acts similarly to fisherman in the Polkadot network, watching other SKALE chains to ensure that the validators are acting honestly.
Approach/ Technology Summary
These projects have all taken different approaches to Ethereum scaling, and all present their own benefits and tradeoffs. Below we will analyse the different projects on three basic metrics.
Total Value Locked/Bridged
There are two different metrics that are similar but represent different types of demand. Total Value Locked (TVL) and Total Value Bridged (TVB). TVL is the total value of all tokens on top of the network that the chain is securing. Not all tokens and projects originate from Ethereum and can actually be built directly on top of the layer 2 itself. Therefore it can be somewhat inaccurate to use it as a proxy for its use as a layer two scaling solution. We say somewhat because we have seen newer projects such as Float Capital building directly on a layer 2 such as Polygon instead of the Ethereum mainchain, simply because of the limitations Ethereum is currently experiencing. TVL shows total use of the layer 2 as a smart contract platform. TVB is how much has been locked up in smart contracts on Ethereum and "transferred" or bridged over to the layer 2 chain (they are locked up in a smart contract to stop them from being represented or used on both networks). This can be considered direct demand for the project as a layer 2 scaling solution.
Average Transaction Cost
One of the core reasons people have been leveraging layer 2 solutions is to reduce the cost of gas associated with their transactions. Currently, Ethereum gas fees are very high, averaging $12.70 for the most basic of transactions. The more complex the smart contract or code you need to execute, the more gas you will have to use to complete the transaction and, therefore, the higher the cost. The lowest cost approach per transaction is plasma and state channels; the rest compete on similar fee levels. However, they are significantly lower than using the Ethereum mainchain.
Currently, Polygon sits as the leader when it comes to both TVL and TVB, and it has one of the lowest average transactions fees. From a layer 2 perspective, it has found decent traction. However, as Optimism and Abritrium mature and start gaining traction when it comes to dApps, we may see them flipping Polygon. However, many factors go into this, so we look forward to seeing how the market will develop over time.
Notable Articles and News Stories This Week:
Facebook's New Name Will Be Meta
Facebook will officially change its corporate name to Meta, CEO Mark Zuckerberg said on Thursday.
According to Zuckerberg, the company decided to rebrand because the name Facebook doesn't fully align with its future vision, adding that moving forward, the tech giant will be "metaverse-first, not Facebook-first."
"Today we are seen as a social media company, but in our DNA, we are a company that builds technology to connect people, and the metaverse is the next frontier just like social networking was when we got started," Zuckerberg added at the Facebook Connect virtual reality conference.
During a quarterly earnings call on Monday, Zuckerberg announced that the company will be pouring over $10 billion into its metaverse division. They will report a separate set of financials for Facebook Reality Labs, which will oversee the company's virtual and augmented reality efforts.
"This is not an investment that is going to be profitable for us anytime in the near future," he said, adding that the company expects to see the $10 billion investment grow even larger in the years to come. "[However, the metaverse will be] the holy grail of social experiences."
Read more about the change here
Mastercard is Preparing its Network for CBDC
Mastercard is focused on facilitating crypto investments as well as readying its network for a central bank digital currency, CEO Michael Miebach said during the company’s third quarter earnings call on Thursday.
“We could not have an earnings call without talking about crypto,” Miebach said when asked about the space. “We see significant volumes in terms of people actually investing in crypto and selling crypto, so as an asset class there’s a lot going on, and I think we have a role to play to facilitate consumers wanting to do that.”
Mastercard most recently partnered with digital asset platform Bakkt to make it easier for merchants, banks and fintechs in the US to embrace and offer cryptocurrency solutions and services.
Read the full story here
'We Need to Allow Banks' to Hold Bitcoin: FDIC Chair
Federal Deposit Insurance Corporation (FDIC) Chair Jelena McWilliams, one of the country's top financial regulators, believes it's time to allow banks to hold cryptocurrency, such as Bitcoin, for themselves and their clients.
"I think that we need to allow banks in this space, while appropriately managing and mitigating risk," she said in an interview with Reuters at the Money20/20 conference in Las Vegas.
McWilliams' comments come as an interagency team comprised of staff at the FDIC, the Federal Reserve, and the Office of the Comptroller of the Currency (OCC) look to wrap up their work on coordinating crypto policies for U.S. banks.
Read more here
Whilst we all have the option to look, to seek to understand, it’s often easier not to. Bitcoin, Ethereum and distributed ledger technology are complex systems that require significant due diligence. At Etherbridge, we aim to lower the barriers to understanding this fast-growing digital economy.
If you are interested in staying up to date, please subscribe to our newsletter at etherbridge.co
This is not financial advice. All opinions expressed here are our own. We encourage investors to do their own research before making any investments.
