The vision of building a secure, user-friendly decentralized web relies on the development of critical infrastructure. This vision is supported by a shared economic framework and embraced by hundreds of millions of people. Layer 2 scaling solutions play a vital role in building this foundation and enhancing the capabilities of Ethereum. These projects collaborate to form a strong ecosystem that drives Ethereum to its full potential.
This article will dive into Layer 2 innovations, narratives, challenges, and their transformative impact on Ethereum mass adoption. Our analysis will be based on data from Footprint Analytics’ Layer 2 research page, providing valuable insights into this evolving ecosystem.
Why do we need Layer 2?
Blockchain technology has long been appreciated for its advantages such as decentralization, security, and scalability. However, the "blockchain trilemma" shows that it is extremely challenging to achieve all three within a simple architecture. Ethereum currently processes more than 1 million transactions per day, but due to increasing demand, it often faces network congestion and high transaction fees. To solve this problem, Layer 2 networks have emerged as an innovative solution.
The main goal of Layer 2 is to increase transaction throughput by achieving higher transactions per second (TPS) while maintaining decentralization and security. These Layer 2s achieve this goal by combining multiple off-chain transactions into a single Layer 1 transaction. As a result, transaction fees are significantly reduced, making Ethereum more accessible and inclusive to a wider range of users.
Types of Layer 2
Currently there are three main types of Layer 2: Rollups, State channels and Plasma.
Rollups
As a Layer 2 solution, Rollups aggregate multiple transactions into a single transaction on Layer 1, saving user costs by distributing transaction fees among participants within the Rollup. There are two main types of Rollups: Optimistic Rollups and Zero-knowledge Rollups (ZK-Rollups). Optimistic Rollups use fraud proofs to ensure the validity of off-chain transactions, while ZK-Rollups use zero-knowledge proofs to enhance privacy and security.
Examples of Optimistic Rollups include Arbitrum (Arbitrum One), Optimism (OP Mainnet), and Base.
Arbitrum was launched by the Offchain Labs team in August 2021 and has become a leader in the industry, accounting for more than 50% of the market share. With the Nitro upgrade, Arbitrum achieves full EVM equivalence, allowing developers to seamlessly migrate smart contracts from Ethereum to Layer 2 with little or no modification.
Optimism is the second largest Ethereum Layer 2 solution, which was soft-launched in January 2021 and fully open to everyone in December of the same year. Optimism adopts an EVM-equivalent architecture to provide a seamless scaling solution for Ethereum applications.
Base was built on the OP Stack in partnership with Optimism and launched on the mainnet in July 2023. In just a few months, it has achieved great success, gaining the third largest share in the Layer 2 market. Base was incubated by Coinbase, leveraging Coinbase's expertise in building crypto products.
On the other hand, ZK-rollup applications include zkSync Era, Starknet, Linea, and Polygon zkEVM.
zkSync Era, the world’s first zkEVM blockchain, was launched on mainnet for all users in March 2023 and has quickly captured the fourth largest market share in the Layer 2 market. zkSync Era has become the dominant Rollup solution in terms of user activity, including TPS and number of transactions.
Starknet went live on the mainnet in November 2021. It uses the STARK cryptographic proof system to achieve security, low cost, and high performance. Starknet uses Cairo as a development language and is not compatible with EVM. Efforts are currently underway to achieve compatibility between Solidity and Cairo through a transpiler called Warp.
Linea, a Layer 2 solution from ConsenSys, will be launched on the mainnet in July 2023. It provides EVM compatibility, allowing developers to easily migrate and build applications on its network.
Polygon zkEVM public beta was launched in March 2023 and aims to be equivalent to EVM. Polygon (formerly Matic) is a blockchain platform that provides diversified blockchain solutions. Polygon zkEVM is one of Polygon's products.
State channels
State channels are a mechanism that allows participants to conduct fast and unlimited off-chain transactions and settle the final results on Ethereum. This approach can reduce network congestion, fees, and transaction delays.
Raiden Network is an off-chain scaling solution that focuses on researching State channels technology, defining protocols, and developing reference applications. It enables near-real-time, low-fee, and scalable payment capabilities that are compatible with ERC20 tokens on Ethereum. The network aims to improve scalability and usability while maintaining compatibility with the Ethereum ecosystem.
Plasma
The Plasma chain is an independent blockchain connected to the Ethereum mainchain through an anchor, which uses fraud proofs (similar to Optimistic Rollups) to resolve disputes.
OMG Network uses the Layer 2 Plasma architecture to provide strong security guarantees and high throughput. It provides a scalable solution for third-party developers who intend to build decentralized payment applications on Ethereum.
Data Insights
The consensus is forming: it’s only a matter of time before Ethereum achieves mass adoption. So, how is it progressing?
Similar to the spread of other technologies, Ethereum's adoption trajectory can be described by a classic bell curve. It starts with a small group of innovators quickly accepting the technology, which then attracts the participation of early adopters. As Ethereum continues to develop and mature, it gradually expands its coverage, attracting the majority of early and late adopters, and then enters the mass adoption stage. Finally, in the final stage of adoption, the technology will benefit the remaining part of the population, the so-called "laggards."
Let’s explore the impact of Layer 2 on Ethereum’s mass adoption from the following perspectives:
TVL (Total Value Locked)
Total value locked (TVL) is considered a leading indicator of adoption.
As of the end of October 2023, Arbitrum is far ahead with a TVL of $6.004 billion and a market share of 61.03%, consolidating its position as the market leader. Optimism follows closely with a TVL of $2.598 billion and a market share of 26.41%, demonstrating its wide adoption and user engagement.
Other chains make up the second tier, but their market share lags far behind, at less than 5%. Newly added Base, which went live on the mainnet on July 13, 2023, holds the third spot with a TVL of $463 million. zkSync Era ranks fourth with a locked value of $451 million, while Starknet ranks fifth with a TVL of $135 million.
Data source: Layer 2 Overview
Number of users and transaction volume
User activity, such as the number of unique users (bridgers) interacting with Ethereum and transaction volume, are key metrics for measuring adoption.
Among the various Layer 2 solutions, zkSync Era is far ahead, accumulating 2.67 million unique users, accounting for 37.10% of all Rollups, and facilitating 2.23 million transactions, accounting for 50.84% of Rollup activity. zkSync Era's initial airdrop event attracted a large number of users and has maintained its leading position since then. In terms of transaction volume, Starknet follows closely with 1.7 million transactions, accounting for 23.70% of Rollups.
Base and Linea were launched on the mainnet in July 2023 and have been very popular in the market. They have surpassed Optimism and Polygon zkEVM in terms of independent user participation and transaction volume.
Transaction throughput
Transaction throughput is one of the main scaling challenges often discussed in the blockchain community.
Currently, the Ethereum mainnet has a processing capacity of about 15 transactions per second (TPS). In comparison, Visa has the capacity to process about 24,000 TPS, while Mastercard can process 5,000 TPS.
Layer 2 is closing the gap. In October, well-known Rollup solutions such as Arbitrum and zkSync Era had an average TPS of about 9.5 to 10, which is the closest to Ethereum among existing Rollups. Rollups have made a significant contribution to scalability, with total transaction throughput exceeding Ethereum mainnet by 321% in October and a scalability factor of 4.21.
Although Rollup technology helps improve scalability, no Rollup can currently surpass Ethereum in terms of throughput. In a bear market, attracting and retaining users is challenging for both Layer 1 and Layer 2 networks. Building a thriving Layer 2 ecosystem requires not only powerful solutions but also high-traffic applications. In addition, due to the lack of seamless interaction between multiple Layer 2s and between Layer 1 and Layer 2, the user experience is affected, such as the need to switch wallets and incur liquidity costs.
cost
Layer 2 plays a vital role in reducing Ethereum network fees. By combining multiple off-chain transactions into a single Layer 1 transaction, Ethereum transaction fees have dropped significantly.
According to Footprint Analytics, the average Rollup transaction fee was 3% to 10% of Ethereum in October 2023.
Data source: Average Gas Fee
These numbers indicate that Layer 2 is growing in popularity and adoption, highlighting their potential to ease Ethereum congestion and improve scalability.
Layer 2 Innovation
In the ever-changing blockchain technology landscape, leading Layer 2 solutions such as Optimism, zkSync, and Arbitrum actively pursue innovative approaches to solve persistent challenges and maintain a focus on interoperability. These well-known players maintain a rapid pace of innovation in terms of technology and applications, constantly striving to stay ahead and maintain a competitive advantage in the market.
Superchain, proposed by the Optimism ecosystem, is a network of multiple networks that share a common code base called OP Stack. The framework aims to establish an interoperable environment where various Layer 2 networks can communicate and transact with each other, similar to how the Internet enables communication between devices. By providing horizontal scalability, Superchain solves the challenges associated with traditional multi-chain architectures. These challenges include different security architectures between parallel chains, which may increase system risks as more chains are added, and the cost of establishing new nodes for each newly added chain.
Source: Superchain - OP Stack Docs
In June 2023, zkSync launched Hyperchains, a new type of network that runs as a fractal instance of the zkEVM. These Hyperchains run in parallel with Layer 1 shared settlement, with the flexibility to run as a Layer 2 network with zkSync Era, or as a Layer 3 Validium. Hyperchains in the zkSync ecosystem can be developed and deployed by anyone, without permission. To ensure trust and seamless interoperability, each Hyperchain must be driven by the same zkEVM engine on the ZK Stack. GRVT is the first Hyperchain in the zkSync ecosystem, a hybrid cryptocurrency exchange that combines the advantages of centralized and decentralized exchanges. Its closed beta Alpha version is expected to be launched in November 2023, followed by the mainnet version in the first quarter of 2024.
Source: Architecture - GRVT
Arbitrum Stylus was launched by Arbitrum in August 2023, allowing smart contracts to be developed in multiple programming languages such as Rust, C, and C++ on its Layer 2 network. In addition to Solidity, developers can now write smart contracts in languages compatible with WebAssembly (WASM). WASM can run code in languages such as Rust and C++ on the network, and with Arbitrum Stylus, it can also run these codes on the blockchain. Stylus introduces a second equivalent virtual machine that is fully interoperable with the EVM, providing a new way to write smart contracts.
Layer 2 Narrative
Layer 2 itself has become an important narrative in the cryptocurrency space since 2022. In the Layer 2 space, narratives play an important role in shaping public perception and influencing market movements. These narratives provide insights into the future of Layer 2 and Ethereum as a whole.
Full-chain games. These games use blockchain to replace centralized game servers and put all aspects of the game on-chain, including assets, logic, state, and storage. Starknet and COMBO (currently running on testnet) have positioned themselves as important supporters of full-chain games in the public blockchain space.
Modular blockchain. Initially, blockchains were designed as monolithic blocks, with a single blockchain handling all tasks. However, the concept of modular blockchains emerged, which focus on specific functions rather than trying to cover everything. Celestia is the first modular blockchain network. It is ready and has announced plans for an airdrop and launch in October 2023.
Zero Gas Fees. Gas fees have always been a major obstacle to the mass adoption of Ethereum. To solve this pain point, GasZero (currently running on the testnet) was born as a Layer 2 network that provides a unique solution: no Gas fees are charged for trusted end users. On GasZero, users can interact with decentralized networks and smart contracts without pre-depositing any tokens in their wallets.
Layer 3. There is currently no widely accepted definition of the Layer 3 concept in the blockchain industry. Ethereum co-founder Vitalik Buterin believes that it is too early to define it because the architecture of the multi-Rollups ecosystem is still evolving and most discussions remain at the theoretical level. However, Vitalik shared three possibilities for Layer 3 in the future:
Layer 2 is used for extensions, and Layer 3 is used for customized features such as privacy protection.
Layer 2 is for general extensions and Layer 3 is for custom extensions.
Layer 2 is used for trustless extensions (Rollups), and Layer 3 is used for weak trust extensions (Validiums).
Challenges facing Layer 2
Cost-effective Layer 2 networks are gaining traction as an alternative to the congested Ethereum network. Maintaining a robust base layer while cautiously scaling certain capabilities is critical. The Ethereum community encourages the development of technology and applications, but it is critical to maintain a delicate balance between user-friendliness and the benefits of decentralization, as Vitalik Buterin emphasized at the Ethereum Hong Kong Hackathon in October 2023.
According to Vitalik, Layer 2 faces four key challenges:
Prove the security and decentralization of the system. Validity (zero-knowledge) proofs and fraud proofs are used to prove the legitimacy of transactions without having to be processed on the Ethereum chain. However, validity proofs face the problem of centralization because they rely on specific hardware.
Decentralization of sorters. These sorters validate, sort, and compress transactions before transmitting them to Layer 1. However, this centralized setup has been criticized for its potential to become a single point of failure, censorship-prone, or easily shut down by authorities.
Cross-Layer 2 Wallets. They make it possible to seamlessly interact between multiple Layer 2 solutions without having to switch wallets.
Data availability. It refers to on-chain data availability, which is the challenge of storing a complete copy of blockchain data to verify transactions. It is worth noting that solutions such as Validiums and Optimiums are not usually classified as Layer 2 because they do not publish data on Layer 1. Instead, they introduce additional trust assumptions on top of Layer 1.
In addition, as we mentioned before, there is currently no Layer 2 network that can surpass Ethereum in terms of throughput. The top priority is to develop the Layer 2 ecosystem.
Ecosystem and applications. Currently, most of the applications in the ecosystem of Layer 2 networks are DeFi applications. They need to introduce more types of phenomenal dApps so that Layer 2 can expand its ecosystem, attract more users, and encourage them to stay.
Conclusion
In summary, Layer 2 networks are driving Ethereum towards mass adoption by effectively solving the scalability and cost challenges that have hindered the development of Ethereum. These networks provide innovative solutions that increase transaction throughput, reduce fees, and make Ethereum more accessible and inclusive to a wider audience.
In addition, in addition to Ethereum's Layer 2 network, opBNB has emerged as the BNB chain's response to the scalability challenge. In September 2023, opBNB successfully completed the mainnet launch. In fact, in the face of these challenges, the response measures and future development directions of other public chains are equally exciting. Everyone's focus remains on the development of the ecosystem and attracting users. Infinite possibilities are unfolding before us, and each public chain will embark on its own unique path to scalability and mass adoption.
