L3 Economic Dilemma: Profitability is unattainable unless the monthly transaction volume exceeds 50 million

Original Title: The Economics of L3s

Author: Syndicate

Compiled by: Deep Tide TechFlow

As discussed earlier, L3s face real challenges regarding economic sustainability.

While Base generated over $30 million in revenue through sequencers in Q1 2024 alone, the effective methods for a few L2s (like Base, Arbitrum, OP Mainnet, and Polygon) do not apply to L3. Why is that?

Currently, L3 is becoming increasingly popular due to its ability to significantly reduce costs for users and developers—opening up possibilities for building new fully on-chain applications, games, and experiences. Similar to how cloud computing has reduced the cost and time of building web applications by thousands of times, L3 could achieve the same effect for Web3, enabling new global networks to be built at a fraction of the speed and cost. At least, that is the theoretical expectation.

However, reducing costs by thousands of times also presents significant economic challenges for L3: a drastic reduction in fees means they cannot rely on sequencer fees as a primary source of revenue unless they achieve transaction volumes similar to L2s, which is unfeasible for almost all L3s. Additionally, to achieve such drastic cost reductions, the operational costs of L3 still need to be reduced by 10 to 100 times from today's levels. This would require a complete transformation of the infrastructure underlying L3, rather than incremental improvements.

This creates a serious economic dilemma for L3. How do L3s hope to address this issue?

L3 Breakeven Analysis

Through our collaboration with emerging L3 ecosystems, the Syndicate team has observed that L3s are attempting to address this challenge by increasing network fees to generate profits from their sequencers (or at least attempt to break even). So far, these efforts have not resulted in profitability.

A few months ago, we conducted an economic scenario simulation for L3—an analysis relative to L2 under various on-chain activities and fee levels—to understand their breakeven and profitability pathways. The results were alarming.

If L3 fees are 10 times (or more) cheaper than today's L2, L3 will never be profitable unless its monthly transaction volume exceeds 50 million. This is equivalent to over 50% of Base's activity or 75% of Arbitrum's activity.

Base and Arbitrum—the two most active L2s on Ethereum—typically see 50 million to 100 million transactions per month. But these are the largest players. In the past 30 days, Zora saw 3.8 million transactions, Mode saw 3.8 million transactions, and Redstone saw 1.1 million transactions.

To achieve breakeven, an L3 with 5 million monthly transactions needs to set its fees within 3 times that of L2. This is a significant challenge, especially if L3 primarily competes on lower fees. Simply being 3 times cheaper than L2 is far from sufficient to attract users and developers to adopt the new network. Therefore, L3 must differentiate itself from L2 in other areas, such as scalability, customizability, and community ownership.

In the past 30 days, only two L3s have exceeded 5 million transactions, both focusing on gaming: Xai (275 million transactions) and Proof of Play Apex (69 million transactions). Xai's network fees are nearly 200 times lower than L2, which means it may be operating at a loss. On the other hand, Proof of Play Apex's network fees are 15 times higher than L2, which means it may be profitable, depending on who is paying the fees.

Given all this, what are the pathways for L3 (and L2) to achieve sustainability and long-term value?

Current Arguments Supporting L3s

Today, L3 can be viewed as an "operational cost" or "cost center," aimed at initiating the development of a new network that becomes valuable over time. Additionally, by running sequencers, setting network fees, and using custom gas tokens, L3 provides operators with new economic tools to dynamically manage their ecosystems—including users, developers, applications, and partners—through targeted gas subsidies and incentives.

For example, consider a fully on-chain game on L2 that pays transaction fees for each on-chain operation. To improve user experience, game developers may want to sponsor many (or all) transactions on behalf of users, which can become very expensive as the game progresses. Even with today's low gas fees on popular L2s, if a game has 50,000 daily active users (DAU) and players perform an average of 100 on-chain operations daily, the total gas fees sponsored daily exceed $10,000 (or nearly $5 million annually). For many L2s, this number could grow to $25 million to $50 million annually! Therefore, building games on their own L3 reduces these variable costs to nearly zero, making many new mainstream social, gaming, and consumer applications—i.e., on-chain applications—economically viable.

The Future of On-Chain Gaming

"Fully on-chain" is also a major selling point for some games and applications. For example, Skyoneer is a fully on-chain game existing on its L3 Gold focused on strategy games. Pirates Nation is another fully on-chain game existing on Proof of Play Apex L3, stating: "When a game is on-chain, it means we are not running any servers. We cannot shut down the game; it will exist forever… On-chain games… guarantee permanence, interoperability, and composability." Here, lower costs are not the direct selling point, but they are a necessary condition that enables the other benefits of being fully on-chain.

Ultra-low fees also unlock new use cases that users might not participate in otherwise. Consider how Ham Chain recently enabled new tipping and microtransaction experiences on its L3 by significantly reducing the cost per transaction.

Thus, the primary economic benefit of L3 lies not in revenue generation but in the value they provide for applications built on them. By drastically lowering transaction costs, L3 enables new applications and business models that may be economically unfeasible on more expensive L1 or L2 networks, and they allow applications to retain more value at lower costs.

Future Economic Opportunities for L3

While today L3 may be viewed as a cost center or negligible revenue source, our team has a clearer vision of how L3 can become increasingly sustainable and valuable in the future. Some new models are emerging that will profoundly reshape the economics of L3, both for developers and users.

The most obvious example is priority fees. As more applications, users, and transactions gradually migrate to L3, we may see the emergence of a priority fee market in popular L3s within gaming, social, and financial sectors. Of course, the priority fee market will only open when activity on L3 grows to the point where block space is no longer as abundant as it is today on Ethereum L1 and popular L2s like Base.

However, one more innovative model we are already beginning to see is using native gas or staking tokens for L3. For example, Degen Chain uses $DEGEN as its native gas token, creating additional utility for $DEGEN. New L3s being developed not only plan to use their custom gas tokens but also plan to implement custom staking mechanisms to help secure or co-operate the network, thereby giving their tokens more utility. By using native tokens—rather than merely focusing on the value created through sequencer profits—many L3s are exploring ways to create value through their native tokens. In some cases, like Degen, this is a greater value driver and opportunity than sequencer profits.

There are even greater economic breakthroughs ahead. Our team has delved into the development and issues of L3 to strive for growth and long-term sustainability, and through this work, we have identified significant problems (and opportunities) related to the design and operation of L3 that ultimately limit their economic autonomy and potential today. However, if you can fundamentally change the design and operation of L3—you can unlock new revenues, new markets, and major structural advantages. This means that in the near future, L3 will not only be 1000 times cheaper but will also be able to access new revenue and value generation opportunities that are currently impossible. We look forward to sharing our research and work in this area in the coming weeks.

Future Outlook

As L3 continues to evolve, we will see many new experiments in the realm of value creation and capture, both from the perspective of chain operators and from developers and users.