Comprehensive Interpretation: How Arbitrum Became the Leader of Layer 2?

*Author: Xiaojing, * Bixin Ventures

In this article, we will focus on the current development status of Arbitrum, analyze its technical advantages and ecological progress, and explore the deep reasons behind Arbitrum's advantageous position in the Layer 2 competitive landscape. We believe that with a large number of ecosystem builders and innovations, Arbitrum will continue to grow rapidly in the Layer 2 race for some time and maintain its leading edge.

Overview

Arbitrum is a Layer 2 scaling solution based on Ethereum, aiming to enable developers to easily run EVM contracts and complete Ethereum protocols on Layer 2. Currently, the platform does not issue tokens as it can trade Ethereum-based tokens.

According to DefiLlama data, after January 31, Arbitrum's TVL surpassed Polygon, ranking fourth, and it has continued to widen the gap, solidifying this position. Recently popular projects in the Treasure DAO ecosystem (such as magic and the beacon) and GMX, which at one point had fees exceeding those of Ethereum, are all projects on this chain. As a representative of Layer 2, Arbitrum has attracted many star projects to migrate here due to its technical and ecological advantages, also entering the sight of many investors.

Team Background

The development team Offchain Labs was co-founded by former White House technology officer and Princeton University computer science professor Ed Felten, along with Princeton PhD students Steven Goldfeder and Harry Kalodner.

Offchain Labs Financing Information

Development Timeline

• January 2021: DeFi Demo product launched on the testnet
• May 2021: Testnet deployed
• September 2021: Official launch of the mainnet Arbitrum One, completing $120 million Series B financing
• August 2022: Launch of the upgraded version Nitro
• February 2023: The development team announced that a new programming language, Stylus, will be launched for Arbitrum One and Arbitrum Nova this year

Currently the Highest TVL Layer 2 Protocol, Active Trading

(Arbitrum's DEX trading volume ranks third across all chains)

(Arbitrum's daily total transaction count once exceeded that of the mainnet)

(Arbitrum's TVL shows significant advantages among competing Rollup solutions)

(Arbitrum's active address count continues to rise, reaching four times that of Optimism)

(The transaction processing volume of 2.21 arb has surpassed the mainnet, source: dune)

In summary, the current data for Arbitrum is very positive.

Transaction Volume, Liquidity, and Traffic Have Increased Significantly Year-on-Year

After Optimism launched its token, it quickly completed a rapid rise in TVL; prior to this, Arbitrum occupied over 53% of TVL in the Layer 2 space. Looking back at recent historical data, it is not difficult to draw conclusions from the overall trend.

First, Arbitrum One's daily transaction volume has increased by 600% year-on-year; since early February, Arbitrum One has handled 40-50% of the mainnet's transactions, with average costs reduced by nearly 97% compared to L1.

(Source: Arbiscan)

Additionally, Arbitrum's liquidity continues to increase. Currently, 87,000 ETH has been bridged to Arbitrum, which is more than the total of all other major scaling solutions combined. DeFi TVL has also grown by 39% in the past month, and DEX trading volume has increased by 46% compared to last week.

(Source: l2Beats)

Meanwhile, in the last quarter, Arbitrum's verified contracts have increased by over 50% quarter-on-quarter.

(Source: Arbiscan)

Technical Analysis

Nitro Version Upgrade Brings Rapid Growth in Liquidity and Users, New Programming Language Supports Trends

The Arbitrum ecosystem consists of two public chains: One and Nova. The former is the narrow definition of Arbitrum, while the latter is based on AnyTrust technology and was launched on August 10, 2022, suitable for high-frequency interactions and cost-sensitive scenarios (such as chain games GameFi and social SocialFi). The main difference between the two lies in the storage location of processed data; Nova achieves significant cost reductions through a Data Availability Committee (DAC). We will primarily discuss Arbitrum One.

Currently, Arbitrum has released 28 versions on GitHub, having gone through the testnet phase (including Alpha and Beta) to the current Arbitrum V1.4, with Nitro launched in August being the latest version.

In September 2022, after completing the Nitro upgrade, Arbitrum led OP in daily active users and transaction volume, widening the gap.

Additionally, the development team recently announced that the new programming language Stylus will be launched this year, allowing developers to use Rust, C, and C++ for development; C and C++ have long been among the top three programming languages. This narrative is more appealing than Near's approach to attract JavaScript developers.

(Source: GitHub)

Bifurcation Method Reduces Proof Node Scale to Cut Costs and Improve Efficiency

Currently, blockchain scaling can be viewed from two angles:

1. Improving the performance of the chain itself, corresponding to horizontal scaling, which involves increasing block size, parallelism, sharding, etc., such as monolithic chains, sidechains, and application-specific chains.
2. Modular blockchain, corresponding to vertical scaling, which involves moving execution or more content off-chain and then validating results on L1.

Ethereum's vertical scaling is primarily based on Rollup, which is currently the mainstream solution for Layer 2. ZkSync, StarkNet, Optimism, and Arbitrum all adopt the Rollup path, but the ZK Rollup approach used by zkSync and StarkNet for deployable contracts is still immature; Optimism's use of fraud proofs in the Optimistic Rollup method leads to slow withdrawals.

(Source: MoleDAO)

Compared to Optimism, Arbitrum has made some minor improvements by processing only part of the transactions involved rather than all, thus only needing to prove the results of specific nodes. Additionally, Arbitrum's Nova employs a more efficient AnyTrust technology, which assumes at least two DCA members are honest, greatly reducing transaction costs.

Moreover, the EVM's synchronous execution environment supports non-EVM contracts and allows for custom precompiles to reduce costs. Nitro's WASM-based design creates significant structural advantages for EVM+ innovation; before the complete implementation of ZKEVM, both Rust and Solidity contracts can be developed on Arbitrum.

Layer 2 Competitive Analysis

(Source: l2beats)

In the Layer 2 space, the main technical paths are the Optimistic series (hereinafter referred to as Op series) and Zero Knowledge (hereinafter referred to as ZK series). Arbitrum has significant advantages compared to its competitors.

First, in terms of user experience, the Optimistic series Arbitrum and Optimism are consistent with Ethereum and can be used directly on MetaMask, which is superior to the ZK series zkSync and StarkNet. Secondly, the former two have a first-mover advantage, attracting many star projects with built-in user bases, such as Sushi, which may form ecological barriers.

In contrast, the ZK series faces challenges such as high technical development difficulty, lack of EVM equivalence, and long construction cycles for supporting ecosystems, making it difficult to achieve a narrative similar to public chains in the current environment. The progress of ZK infrastructure is worth noting; fundamentally, in terms of technology and efficiency, the ZK path will eventually demonstrate its advantages, but this does not prevent the OP series from being a more excellent investment direction at this moment.

Within the OP series, due to EVM equivalence, low development thresholds, and rapid maturation of numerous applications, effective ecological barriers have formed. Specifically, let's compare Arbitrum and Optimism.

From the data, Arbitrum's transaction count and active address count have surpassed Optimism this year, forming a trend with TVL on the rise. Optimism has already issued tokens (currently OP serves only as a governance token), making Arbitrum, which is lively and has expectations for token issuance, more interesting for profit-seeking Web3 players.

(Source: dune)

Why is there an expectation for token issuance? If no tokens are issued, relying solely on gas extraction from different Layers (if any) is difficult to sustain. The actions of competitors also lead to the same conclusion; currently, Op has issued tokens, and StarkNet has also launched a token plan, so expectations for Arbitrum's token issuance are high.

Overview of Quality Projects in the Ecosystem

The prosperity of the on-chain ecosystem is the fundamental measure of a chain's value, with project parties, developers, and users being important elements within the ecosystem. This section introduces the leading projects and operational strategies in various sub-sectors of the Arbitrum chain, illustrating the vibrancy and completeness of the on-chain ecosystem.

(Arbitrum chain's revenue in the past week ranks fourth, only behind ETH, Polygon, and BNB Chain; tokenterminal)

From a technical perspective, it has been mentioned that the Arbitrum ecosystem consists of two chains, where Nova is suitable for gaming and social applications, while One is suitable for DeFi and NFTs. Let's start with DeFi.

GMX

Noticing Arbitrum's outstanding performance during the bear market, many leading DeFi projects have covered or migrated to this chain, including Uniswap, SushiSwap, AAVE, Curve, gTrade, etc. The DeFi ecosystem of Arbitrum largely revolves around GMX, the DeFi application with the highest TVL across the chain.

GMX is a decentralized derivatives trading platform on Arbitrum and Avalanche, supporting 30x leverage and allowing trading without KYC. Its tokenomics design is quite ingenious, as shown in the following diagram:

Staking** GMX can earn unlocked GMX, multiplier points, and ETH/AVAX rewards**, specific reward information can be found here.

From the fees generated by flash swaps and leveraged trading, 30% will be converted into ETH/AVAX and distributed to staked GMX, with the distributed fees based on the amount after deducting referral rewards and the network costs of keepers (approximately 1% of total fees).

GMX has a floor price fund, existing in the form of ETH and GLP. The GMX/ETH liquidity pool belongs to the protocol and is provided by the protocol, with the fees generated from this trading pair converted into GLP and deposited into the floor price fund. 50% of the funds received through Olympus bonds will also be sent to the floor price fund, while the other 50% will be used for marketing.

The floor price fund is used to ensure the liquidity of GLP and provide stable ETH rewards for staked GMX. When the floor price fund increases, if the floor price fund divided by the total supply of GMX is less than the market price, it will also be used to buy back and burn GMX, thus linking GMX's minimum price to ETH and GLP. (If necessary, it will also be used to pay bug bounties)

The GMX liquidity on Uniswap will gradually increase as GMX prices rise. It is stored in the same multi-signature wallet as XVIX and Gambit migrations.

The predicted maximum supply is about 13 million. Minting beyond the maximum supply has a 28-day time lock. This situation will only occur during new product launches or liquidity mining. Any changes will be subject to governance voting.

As the ecosystem continues to grow, GMX's products have also attracted some developers to innovate and expand around GLP, including Rage Trade, GMD, Jones DAO, PlutusDAO, and others.

Rage Trade

Rage Trade is a perpetual contract based on the Arbitrum ecosystem and has confirmed plans for token issuance; the product integrates DeFi liquidity from other chains through the Omnichain recycled liquidity mechanism and conducts 80-20 Vaults. The 80-20 Vaults are strategies for ETH-PERP, with 80% of funds earning interest in the protocol while 20% provides liquidity. Another business line is a stablecoin product, where Rage Trade has layered Risk-On (Aave + Uniswap) executing GLP hedging strategies, while Risk-Off lends to Risk-On to scale.

(Source: Rage Trade)

Currently, Rage Trade's total locked value (TVL) is $16.06 million, with an average APY of 7.48%, and the protocol has not yet released a token.

(Source: Defilama)

GMD

GMD is a yield optimization and aggregation platform, with products centered around the GMX token GLP; it allows users to deposit tokens into the Delta neutral vault and purchase GLP, distributing the earned yield to stakers. GMD's design mechanism is simple, providing single-asset staking vaults for USDC, BTC, and ETH, and the Delta neutral strategy maintains the asset ratios in the three vaults in line with the GLP asset ratio. The average APR for the vaults is 20%, and they are nearly fully subscribed. In the face of some uncompensated risks, GMD will use its native governance token for compensation.

(Source: GMD Official)

Currently, GMD's TVL is approximately $7 million.

On February 27, GMD announced the launch of a new Launchpad and guaranteed strict due diligence for projects applying to join.

(Source: Defilama)

Jones DAO

JonesDAO is a yield-generating protocol on Arbitrum that allows participants to earn returns using options protocols. The jGLP and jUSDC pools are important components of the yield strategy protocol JonesDAO, which also occupies a major share in the GLP market.

In these two pools, USDC investors place USDC into the jUSDC pool, while the jUSDC treasury lends USDC to the jGLP treasury (the jGLP treasury will mint GLP using borrowed USDC to generate fees); simultaneously, investors in GLP and the basket of GLP assets will also place assets into the jGLP treasury to mint GLP and generate fees. The fees and GLP liquidity mining can enhance the value of jGLP, benefiting GLP investors. The fees also help increase the value of jUSDC, benefiting USDC holders.

(Source: Jones DAO)

(Source: TokenInsight)

PlutusDAO

PlutusDAO is a governance aggregator for Dopex and JonesDAO (the so-called "governance black hole of Layer 2"). It accumulates governance tokens from projects like Dopex and JonesDAO as much as possible, then provides users with the pls series of credentials, creating yields for users through bribery/staking/reinvestment methods. PlutusDAO will become a target for bribery from other projects due to its substantial ownership of governance tokens. Additionally, PlutusDAO has opened a GLP treasury for GMX, where the APR for converting to plvGLP will be 20% with PLS subsidies.

Treasure DAO

DAO is a community of developers, investors, and users, forming the most vibrant part of the ecosystem. The most influential DAO on Arbitrum is undoubtedly TreasureDAO, supported by Offchain Labs.

A popular narrative views Treasure DAO as the Nintendo of Web3. This Loot project, which migrated from the mainnet in October 2021, has undergone over a year of expansion and reshaping, attracting many NFT OG players and now coming into the public eye. The Trove market, BridgeWorld, and MagicSwap are key infrastructures within the Treasure DAO ecosystem. TreasureDAO has also incubated the phenomenal game The Beacon, fully activating the vitality of developers under the organization of TreasureDAO. They all have close ties to the Magic token.

(In the past two months, Magic has risen from a low of $0.5 to $2.0)

Arbitrum Ecosystem Development: Emphasizing Community and Good User Incentives

At the current stage of development, most Web3 users are attracted by airdrops or expectations of airdrops. The Odyssey event is one of the means by which Arbitrum attracts users and invigorates the ecosystem.

The Odyssey event has gone through two phases and is currently paused, with plans to restart at an appropriate time this year. The first phase of the Odyssey began in April, where users voted for 14 different groups of projects to advance as interaction targets for subsequent tasks; the second phase officially started in mid-May, originally planned to last seven weeks, with two projects' tasks launched each week, each corresponding to an NFT. If users collect 12 out of 15, they will receive a commemorative NFT designed by Ratwell & Sugoi, the founders of tubby cat. Unfortunately, due to the event's overwhelming popularity, on-chain gas fees soared (at one point even exceeding the swap fees on the mainnet), affecting the participation of ordinary users, leading Arbitrum to choose to pause this event.

From the strategy and implementation of the event, the Arbitrum operations team fully listened to community feedback and considered the overall situation. Although the event did not go smoothly, it still garnered significant attention and popularity. Considering Arbitrum's impressive performance, when the Odyssey restarts, there will certainly be more users participating, providing a huge opportunity while also testing the chain's performance and security.

(Source: dune)

Arbitrum 2023 Outlook

Offchain Labs mentioned in a speech at SmartCon 2022 that Arbitrum will continue to expand decentralization in the future, including validators, sequencers, governance, and authorization of software upgrades; it will also continue to reduce costs and improve TPS; the Odyssey should restart this year; the Nova ecosystem (social, gaming) will continue to incubate; and emphasize the decentralization of validators, governance, authorization of software upgrades, and sequencing.