A detailed analysis of the characteristics and challenges of major Layer 2 solutions

This article is from OKEx Intelligence Bureau, with the original title "Layer 2 Observation: Staking Volume Soars, Fees Plummet, and Technical Development Flourishes."

It must be said that developers and users have long been fed up with the high fees of Ethereum. The latest data shows that the average fee on Ethereum has reached as high as $20, which is 8-10 times that of the peak in 2018.

In such a congested trading environment, almost all participants in the Ethereum ecosystem—developers, investors, users, etc.—are complaining, except for the Ethereum miners who are making a fortune.

Some compare Ethereum to the mid-1990s internet, believing that although Ethereum is currently cumbersome, expensive, and not very scalable, its strong user ecosystem remains robust, and its future vision may be realized faster than expected. However, I believe that if the current congestion situation of Ethereum does not improve, it is likely to be caught up by many rapidly developing public chain ecosystems, such as Polkadot and Cardano.

However, as Ethereum Layer 2 gradually gains attention, the congestion situation of Ethereum may be resolved.

So, what is the latest development of Layer 2? What solutions are available? After Layer 2 is applied, what impact will it have on Ethereum itself?

1. Layer 2 Observation: Deposits Soar, Fees Plummet, and Technical Development Flourishes

Currently, the most promising technologies for Ethereum Layer 2 are Optimistic Rollup and ZK Rollup. Although both are in the testing phase, the scale of deposits and application development cannot be ignored.

Take the asset synthesis protocol Synthetix as an example.

On January 15, the Optimistic Rollup scaling solution team, Optimism, launched the trial operation network of Optimistic Ethereum mainnet. In the following month, the number of tokens staked in the Optimistic Ethereum network by Synthetix exceeded 6.62 million, worth over $150 million.

Another example is the recently popular ZKSwap.

According to official news from ZKSwap, the total Gas cost for sending 9,000 transactions on Layer 2 was $1,500 (the on-chain cost from Layer 2 to Layer 1). In comparison, completing 9,000 transactions on the Ethereum mainnet would cost $180,000, making the transfer cost on ZKSwap's Layer 2 only about 1% of Ethereum's.

Regarding the recent progress of Ethereum Layer 2, Pan Zhixiong, the research director at ChainNews, believes that how to build the Layer 2 ecosystem is worth paying attention to, especially in combination with finance. This will not only bring performance improvements but also new experiences and innovative product experiments that were previously unimaginable on Layer 1.

In addition, many applications can completely solve the experience and compatibility issues caused by outdated protocol standards (such as needing to authorize ERC-20 token transactions beforehand) when integrating with Layer 1. For instance, the Layer 2 scaling technology ZK Rollup has transformed the paradigm of the Ethereum protocol itself, re-engineering the relationship between "computation" and "storage." By leveraging off-chain large-scale computing power combined with reasonable data compression techniques, it is expected to provide a nearly lossless security scaling solution for the Ethereum network, and this solution may continue to play a role in other blockchain networks in the future.

Pan Zhixiong believes that a possible trigger point is when applications with a large user base on Layer 1 genuinely migrate to Layer 2, which will attract more users rapidly, such as Uniswap and Synthetix, which are working in this direction.

The COO of Loopring tweeted in January that all ERC20 should consider using Layer 2.

So, what other advancements have been made in Layer 2 technology recently?

2. Layer 2 Technology Flourishes

Optimistic Rollup and ZK Rollup are two technologies managed by different teams, and each technology has different branches, each managed by different teams.

There are two teams responsible for developing the ZK Rollup solution: the Matter Labs team and the StarkWare team. The Matter Labs team is responsible for zkSync technology development, while the StarkWare team is responsible for StarkNet technology development. The core difference between the two technologies lies in the adoption of zero-knowledge proof technology; the former uses zk-SNARK technology, while the latter uses zk-STARK technology.

There are also two teams responsible for the Optimistic Rollup solution: the Optimism team and the Offchain Labs team. The Optimism team is responsible for OVM technology development, while the Offchain Labs team is responsible for Arbitrum Rollup technology development. The core difference between the two lies in the fraud proof mechanism, which can be divided into single-round interaction and multi-round interaction.

Although these technologies are currently in very early stages, the speed of progress is worth noting.

Taking the previously mentioned Optimistic Rollup as an example, it has already launched on the Ethereum mainnet. Although its functionality is very limited and it has only launched a few features in collaboration with Synthetix, a significant amount of funds is gradually migrating to this Layer 2 network, with a migration amount reaching $150 million in just one month.

In addition to pure Layer 2 scaling technology, a new concept of "Layer 2 aggregators" has emerged in the Layer 2 ecosystem.

Polygon is defined as the first structured and user-friendly Ethereum scaling and infrastructure development platform. In addition to the completed Plasma chains, Polygon will also support other Layer 2 scaling solutions in the future, such as Optimistic Rollups, zkRollups, Validium, etc., making Polygon the first "Layer 2 aggregator" on the Ethereum chain.

The core component of Polygon is the Polygon SDK, a modular and flexible development framework that supports building and connecting two mainstream scaling paths:

Secured chains (i.e., Layer 2 chains): These paths can rely on the security of the Ethereum network without establishing their own verification mechanisms. In addition to the completed Plasma chains, Polygon will also support other Layer 2 scaling solutions like Optimistic Rollups, zkRollups, Validium, etc., making Polygon the first Layer 2 aggregator on the Ethereum chain. From a use case perspective, this direction is more suitable for applications that require the highest level of security and emerging projects that are difficult to build their own verification mechanisms.

Stand-alone chains (i.e., sidechains): These paths can build sidechains independent of Ethereum, where the sidechain network has its own verification mechanism and is fully responsible for its own network security, but can also provide better independence and flexibility. From a use case perspective, this direction is more suitable for projects that do not require the highest level of security (such as gaming) and projects with strong community power (able to establish a sufficiently decentralized and secure verification mechanism).

The above outlines the current development direction of Layer 2 technology, and the following discusses some potential issues with Layer 2.

3. Potential Issues After Layer 2

Does this mean that Ethereum Layer 2 is flawless and omnipotent?

Not necessarily.

First, there is the adaptability issue between different projects.

For example, in December 2020, Axie Infinity co-founder Aleksander L. Larsen expressed his views on the relationship between Ethereum Layer 2 and blockchain game development, believing that a startup based on another startup's product carries significant risks.

Aleksander L. Larsen stated that they had been paying attention to the impact of Ethereum scalability on applications for a long time and had previously tested on the Loom network. However, the entire industry is still in a very early stage, and a startup based on another startup's product carries significant risks because everyone may adjust their product positioning and direction at any time. They will use their own solutions to address their own problems and gradually enhance decentralization.

Secondly, there is the interaction issue between different Layer 2s.

The so-called interaction issue refers to the composability between different DeFi applications based on Rollup. Simply put, if different Rollup chains have different DeFi applications, the information exchange between different Rollup chains will be more difficult than the information exchange on the Ethereum main chain.

Finally, in my view, Layer 2 itself may also have negative impacts on Layer 1 (Ethereum itself), which is directly related to the operating mechanism of Layer 2.

Simply put, the operating logic of Layer 2 is to transfer "transactions" (ETH transfers, ERC-20 transfers, DeFi interactions) that should be processed on Layer 1 (Ethereum itself) to Layer 2. Since the operational efficiency of Layer 2 is hundreds of times that of Layer 1, as soon as Layer 2 officially goes live, Layer 1 will be "relieved" from its current congestion. Both Optimistic Rollup and ZK Rollup can achieve this effect.

Layer 2 seems promising, but everything has its duality. It is well-known that the approach of Layer 2 to solve problems is not based on enhancing its own (Ethereum, or what we call Layer 1) performance, but rather on offloading a large amount of business. The consequence of this approach is a significant decrease in the usage frequency of Layer 1.

A significant decrease in the usage frequency of Layer 1 means that future ETH1.x may become a role similar to that of the "People's Bank of China" or the "Federal Reserve," and can only issue currency according to certain monetary policies. Although the future issuance of ETH will decrease, we know that ETH belongs to application-oriented smart contract projects. Once its usage value declines, regardless of monetary policy, the price will no longer receive effective application support. This is because the price increase logic of ETH is different from that of BTC; the former relies on applications, while the latter relies on consensus. When applications are no longer present, a price collapse is just a matter of time.

Moreover, we will see many strange phenomena on Ethereum that will become history, such as high miner fees.

Around February 10, Ethereum miners earned $4 million in just one hour, breaking the record again (the previous record was $3.5 million/hour). This year, with significant advancements in Rollup technology, a considerable portion of Ethereum DeFi projects will migrate to Layer 2, and the situation of high fees will be greatly alleviated, making high miner fees a thing of the past.

Perhaps with the development of Layer 2 technology, the following situation will arise: the price increase of ETH will be significantly limited, primarily because the usage frequency of ETH has decreased, while the tokens of projects based on Optimistic Rollup and ZK Rollup will soar, and the number of such project tokens is also experiencing explosive growth.