To what extent do Layer 2 on Ethereum meet market demand, and are they overvalued?
Arbitrum and Optimism’s diluted capital currently stands at $13 billion and $8 billion respectively. StarkNet’s last funding round valued it at $8 billion. These layer 2 transaction speeds and network fees are still not truly optimal over the original Ethereum network. There are not many benefits for investors to hold tokens. So what makes Layer 2 so popular, and is Layer 2 overrated?
The current context of layer2
Layer 2 (also known as L2) is a necessary solution to the scalability issues of layer 1 to meet the needs of larger-scale users.
Currently, Ethereum is leading the way in developing layer 2 solutions and its current valuation is very high. To what extent does layer 2 on Ethereum meet market demand? .
Technology is in its early stages
Looking at the current performance of Ethereum Layer 2, the average number of transactions per second (TPS) across all networks is over 30 transactions per second. That’s just twice Ethereum’s transaction processing capacity of 15 transactions per second.
Such low performance is partly due to the fact that actual demand in the market is not high at the moment. The number of transactions per package remains low. For example, with Polygon zkEVM, there are only 3 to 10 transactions. This results in high volatility and expensive transaction fees, as the fees are evenly distributed across the number of transactions in the package.
On the other hand, layer2's processing power is still limited. Even adding the maximum number of transactions per second recorded for layer2 is just over 130 transactions/second.
Layer 2 has more complex architectures, such as Starknet, which take tens of minutes to execute transactions. This is certainly not an ideal time for user experiences, especially since they involve transferring large amounts of value over the network.
It can be seen from the technical perspective that layer 2 requires a lot of improvements to meet larger-scale needs. This takes time and resources to accomplish.
Evolving ecosystem
The current value of key Layer 2 assets exceeds $9.2 billion, almost one-third of Ethereum’s. Among them, the top two tiers are Arbitrum with $6.13 billion and Optimism with nearly $2 billion.
Both projects have been around for some time and have attracted many developments. Additionally, the issuance of tokens also contributes significantly to the total value of assets on the network. Taking Optimism as an example, the on-chain value of OP tokens is $631 million.
Given the open source nature of blockchain, EVM-compatible Layer 2 can leverage resources and quickly launch products similar to its predecessors. Optimism and Arbitrum have spent over a year developing the current ecosystem. As the community gathers and technology advances, we can expect the ecosystem to further reduce development time.
However, for new projects, blindly copying old projects is not a good thing. Project teams on Ethereum and layer 2 are currently very similar. This does not bring much actual value to users, and may even cause liquidity sources to be fragmented when funds flow to different networks.
Therefore, in order to attract users, zkEVM-compatible layer 2 needs a truly breakthrough project. Special-purpose Layer 2 of arrays such as Immutable X dedicated to games are also different directions to attract users. The project itself will also lower the level of competition as more and more new layer2 solutions are developed and soon to be launched.
Layer 2 takes more time to develop and capture value. At the current pace of infrastructure development, it will be many years before Ethereum and layer 2 networks can significantly meet user demand. If the ecosystem wants to attract value in the above-mentioned competitive environment without being eliminated, it also needs to have its own breakthroughs and highlight applications.
Layer 2’s future potential and role
While layer 2 has a lot of room for improvement, their potential is huge. The updated EIP-4488 reduces transaction costs for Layer 2 rollup solutions and garners community support, confirming Layer 2’s integral role in Ethereum’s development vision.
Both technology and support tools have improved significantly compared to just a few years ago. Updates like Op Stack make it easier for projects to develop layer 2, such as Coinbase’s layer 2 solution Base.
There are a lot of new layer 2s in development and that have raised significant funding. Although it will be a problem to get ahead, as long as 1 or 2 of our 10 projects are successful, it will also be a great contribution to the encryption market.
Finally, layer 2 does not need to wait until the infrastructure is powerful enough to handle thousands or tens of thousands of transactions before starting a development project. There may be different suitable items for each stage. Similar to how Ethereum developed solutions like AMMs, lending pools help solve the problem of limited liquidity and scalability. Layer 2 solutions also enable the development of projects that best fit the market environment.
So is layer 2 currently overvalued? The answer is yes. These projects are booming, but the price of these tokens is nowhere near the value created. Investors should consider carefully before making investment decisions.
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