Ethereum is among the most widely adopted blockchain networks. While the chain has always enjoyed fundamental success since its launch in July 30, 2015, its technical limitations have been unearthed as on-chain activity increased over time. Primarily, the chain’s inability to scale tests its capacity limits at times of heightened traffic. This has driven transaction costs into the tens of dollars, which is not conducive to mass adoption.
The issue with high fees, and the architecture that enables, them is twofold:
1) High fees bar some user demographics from consolidating on the network;
2) They show the network is inefficient in handling outsized amounts of activity.
The foundational victories of Ethereum (underscored by a total value locked greater than $25 billion, the presence of more than 850 decentralized applications, and an average daily active address count in excess of 350,000 in 2023) have disincentivized users from vacating the network in spite of these setbacks. Instead, they paved the way for the development of scalable, inclusive off-chain solutions in an effort to sidestep on-chain constraints.
Layer 2 (L2) platforms are leading the charge in the race to solve Ethereum’s sustainability shortfalls. Consequently, they have become an integral component of Ethereum utility and the advancement of the greater Ethereum ecosystem.
In this piece we’ll cover what L2s are, how they work, and quantify how they are bringing scalability and inclusivity to the Ethereum landscape.
What are L2s?
Layer 2s are solutions intended to scale Ethereum, by handling transactions off the Ethereum mainnet (Layer 1 or L1). These platforms hold individual systems, each containing their own validators to which L2 transactions are directly submitted. This allows them to set their own rules and practices for managing activity, and avoid submitting data directly to costly L1 block producers – in turn, making them more optimized for cost efficiency and scalability. On occasion, L2 validators cement the chain’s activity on L1. Posting the data produced by L2s to mainnet grants them the dual benefit of scalability, and the decentralized security model of Ethereum mainnet. It also differentiates them from alternative Ethereum scaling solutions.
Arbitrum and Optimism are currently the leading Ethereum L2 platforms. Others include ZkSync, Starknet, and Polygon’s recently launched ZkEVM.
Layer 2 functionality and how it differs from other scaling solutions
There are a number of ways to solve Ethereum’s scalability problem; L2s are just one option. Making a distinction between the spectrum of alternatives is important, however. The biggest difference is the diverging relationships with Ethereum mainnet, and ensuing tradeoffs.
The most prominent L2s are rollups, which include the likes of Optimism and Arbitrum. Popular alternative scaling solutions include sidechains, like Polygon. At a high level, the difference between rollups and sidechains seems nuanced. Afterall, they both accomplish the same goal of scaling Ethereum. However, key distinctions between their functionality and their relationships with Ethereum mainnet set them apart.
The following examines how sidechains and rollups work, and emphasizes why L2s are different from other Ethereum scaling solutions.
Sidechains
Sidechains are independent, Ethereum-compatible blockchains that function in tandem with Ethereum mainnet. Instead of holding a direct link to mainnet, they are joined with it through two-way bridges as indicated by the graphic above. This allows them to function individually under their own assortment of rules (e.g. consensus algorithms and block parameters), and native currencies in which fees are paid; all while harnessing Ethereum native assets. Unlike L2 scaling solutions, sidechains do not post transactional data to Ethereum mainnet. In consequence, sidechains come with security and decentralization tradeoffs, as they do not hold an explicit relationship with Ethereum mainnet.
Layer 2 rollups
Rollups, on the other hand, benefit from Ethereum’s security and decentralization despite their activity being executed off of mainnet. This is due to their unique functionality. Rollups work by:
1) Executing transactions through their own validators;
2) Posting the data to mainnet block producers, where consensus and finality are reached.
Visualized in the graphic above, many transactions on a rollup equate to a single transaction on Ethereum mainnet. This cost-saving process is referred to as batching, where many L2 transactions are bundled into a single package before being posted to Ethereum mainnet. It allows many transactions to split a single mainnet fee, dividing the cost to transact across a multitude of actions.
Rollups’ consistent communication with Ethereum distinguishes them from other scalability solutions, and directly links them to Ethereum mainnet. The relationship between rollups and Ethereum mainnet also means that transaction fees on rollups are paid in ETH, further differentiating them from sidechains.
Improved scalability and lowered costs
The outcomes of L2 off-chain models foster an environment of scalability and inclusivity by lowering costs, and improving the capacity to process transactions. Don’t just take our word for it. The numbers speak for themselves. The following on-chain data provides an overview of the efficiencies of Ethereum’s chief L2 solutions. It uses Optimism and Arbitrum as examples, due to the availability and robustness of their on-chain data.
Transactions Per Second
Transactions per second (TPS) is a headline measure of a network’s throughput, or capacity to process activity. A higher TPS suggests that a network has the capability to effectively handle large amounts of transactions in a timely manner. This is a quality that is expected of all impactful scalability solutions.
The chart below contrasts the combined TPS of Optimism and Arbitrum, against that of Ethereum mainnet. As you can see, Optimism and Arbitrum combine for a daily TPS count in excess of Ethereum mainnet. 2023 year-to-date (YTD), the L2s have combined for a TPS nearly 50% higher than that of Ethereum mainnet. So far this year, Optimism and Arbitrum boast a combined daily TPS of 17, compared to Ethereum mainnet’s 12 TPS.
The delta between the TPS counts suggests L2s may be better suited for scalability, and are aiding in solving the capacity headwinds faced by Ethereum mainnet.
Source: Flipside Crypto
To offer a better idea of how the individual solutions stack up, the following chart individually shows Optimism’s, Arbitrum’s, and Ethereum mainnet’s daily TPS. Arbitrum has maintained an average daily TPS that outstrips Ethereum mainnet’s, since late February. In opposition, Optimism has lagged behind both Arbitrum and Ethereum mainnet.
Average transaction fees
The TPS metric only tells the scalability half of the Ethereum L2 story, however. It’s great that these solutions can process a larger amount of transactions than that of Ethereum mainnet. But, can they do it in a cost effective way that simultaneously cultivates inclusivity?
The chart below compares the combined daily average transaction cost of Optimism and Arbitrum, to that of Ethereum mainnet. It is clear through the visualization that L2s offer a significantly cheaper alternative to the costly mainnet. Over the last year, Optimism and Arbitrum have combined for an average cost per transaction of $0.19, compared to Ethereum mainnet’s $4.17.
Source: Dune
Alternatively, we can look at the cost ratio between L2s and Ethereum mainnet to emphasize the economic efficiency of these solutions. On average, Optimism and Arbitrum have combined for a cost savings of 27 times over Ethereum mainnet; meaning Ethereum mainnet has been more than 25 times more expensive to use over L2s, on average. This represents significant savings on L2 over Ethereum mainnet. The end result is lower barriers to entry, empowering a greater variety of users the ability to use Ethereum.
Painting the full picture
Combining the economic efficiency, and improved activity handling of these L2s paints the fullest picture of how they embody sustainability. From this vantage point, we detect that Optimism and Arbitrum have combined for 98% of Ethereum mainnet’s TPS, at 3.99% of the cost on average, using the last year’s worth of data. Through this measure it becomes clear that L2s offer a lower limitation, and a highly efficient opportunity to live on Ethereum and tap into its strengths.
The Layer 2 growth story
The high capacity and low fee characteristics of L2s have opened the floodgates for growth. This has attracted a large swath of active addresses, and pool of value.
Daily Active Addresses
Both Optimism and Arbitrum have experienced an influx of Daily Active Addresses (DAA) over the past year. Active addresses are those that have executed at least one action on-chain (e.g. send a transaction or use a smart contract). Addresses that are on the receiving end of an action, but don’t execute themselves, are omitted from the count. For example, an address that receives 100 USDT, but then doesn’t do anything with it, is not included in the active address count.
Since July 2022, Optimism and Arbitrum have seen an increase of 1,154% and 543% ,respectively, in the seven-day simple moving average (SMA) of their DAA counts. This represents growth of 137,000 Arbitrum addresses, and 92,000 Optimism addresses.
Source: Dune
Total Value Locked
In addition to the growth in active addresses, Optimism and Arbitrum have seen an economic boom in the amounts of total value locked (TVL). Combining for roughly $3.5 billion in value locked across their ecosystems today, the two networks held less than $1 billion in July 2022. Arbitrum added $1.8 billion to its TVL, equating to 255% in growth; Optimism supplemented $718 million in TVL, representing 263% growth.
Over this same period, Ethereum mainnet hemorrhaged $3.4 billion in value, losing ~11.5% of the value locked in its ecosystem. The juxtaposition of TVL growth in L2s, against a contracting Ethereum mainnet TVL, exposes the true impact of L2enablements and the demand for the qualities they carry.
Source: DeFiLlama
Capping off Ethereum’s Layer 2 revolution
It is evident that Ethereum faces uphill battles in capacity and cost efficiency. Sequentially, this has amounted to formidable entry restrictions that pose limitations to mass adoption and accessibility. Nonetheless, its resiliency has forced the creation of alternative means of using the network through L2s. These solutions have proven to be economically and functionally efficient platforms that reduce the burden of Ethereum mainnet’s headwinds. In doing so, L2s have begun offering the base for an efficient and inclusive future of the Ethereum ecosystem.
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