Does Layer 2 undermine Ethereum's fundamentals? Data reveals the effectiveness of L2 strategies

Author: Nancy, PANews

Once a popular narrative, Layer 2 now seems to have become a target of criticism. With the continued slump in Ethereum prices, the market's disputes regarding L2 have intensified, and even Solana is considered to be following a similar path if it adopts a network expansion route akin to Ethereum. What is the progress of L2? Where are the points of contention in the market, and is the development path of L2 still worth looking forward to?

L2 "sucks" liquidity from Ethereum, ETH turns inflationary

As is well known, the Ethereum network has previously faced high transaction fees. With the completion of the Cancun upgrade, L2 fees have significantly decreased, leading to a better user experience and the emergence of more application scenarios.

According to data from Growthepie, in the past six months, the average monthly transaction costs of L2s such as OP Mainnet, Base, Arbitrum One, Starknet, Mantle, and Metis have decreased by over 97%.

Moreover, data from Tokenterminal shows that the daily transaction volume and monthly active user count of L2s have shown significant growth. Since the Cancun upgrade (as of September 4), the daily transaction volume of L2 has increased from $3.5 million to $8.3 million, nearly a 2.4-fold increase; the monthly active user count has risen from 10.9 million to 19.6 million, an increase of 79.8%.

L2 will only make ETH deflationary when both blob and regular fee markets are saturated. Therefore, after the Cancun upgrade, Ethereum L1 revenue has plummeted. Tokenterminal data shows that during the same period, Ethereum L1's daily revenue fell from $28.45 million to about $1.1 million, a decline of 96.1%. Meanwhile, Ethereum's network activity has decreased, and Gas fees have also dropped significantly. Etherscan data shows that as of September 4, Ethereum's Gas fees have fallen to 1.1 Gwei, a multi-year low; daily transaction volume has also decreased by 8.1% to 1.129 million transactions, and the number of daily addresses has similarly struggled to grow, dropping by 10.4% during this period.

This also poses a challenge to Ethereum's deflation narrative. According to Ultrasound.money, in the past 30 days, Ethereum has only burned 72,000 ETH, far below the 947,000 ETH issued, resulting in an inflation rate of 0.73%. Shortly after the Cancun upgrade (in April), the supply of ETH increased by 256,000.

Proponents' View: Initiating Ethereum's Counterattack Narrative, Yet Facing Long-term Challenges

L2 plays an important role in Ethereum's expansion route. "L2 is an extension of Ethereum's culture because Ethereum is an L2-centric ecosystem where you can freely build a sub-ecosystem with unique functions while being part of the larger Ethereum ecosystem. This sub-ecosystem is equivalent to a subcultural branch of Ethereum," said Ethereum co-founder Vitalik Buterin.

In this debate over Ethereum's expansion route, many community members support the development path of L2, believing that in the short term, L2 performs well in reducing costs and network congestion, but they also admit that it still faces long-term challenges, such as blob space utilization and fee issues.

"Currently, the infrastructure of Ethereum layer 2 is quite mature, even surpassing the application market in development. The recent criticism of underutilized blob space illustrates this point. However, the dismal price of cryptocurrencies cannot support this expectation, leading to a backlash in sentiment, with strong pessimism prevailing. Setting aside emotional influences, L2 is relatively successful; its success is evident in that L2 has diverted some mainnet traffic, relieving the mainnet from high Gas congestion pressure, which aligns with L2's initial vision. Essentially, L2's greatest success is eliminating the narrative of Ethereum Killers and Alt-layer 1. At least for now, Ethereum remains the only choice in the blockchain world beyond Bitcoin, with other high-performance layer 1s, parallel EVMs, modularity, and chain abstraction all supplementing Ethereum's 'central' position," said Web3 independent researcher Haotian.

At the same time, Haotian pointed out that although Ethereum has successfully reduced fees after the Cancun upgrade, it still faces issues such as underutilization of blob space and the lack of activation of the dynamic market for blob fees. This indicates that the current user and transaction volume of Ethereum L2 cannot deliver value to L1, let alone optimistic "deflation expectations." However, being able to position L2 ahead of Ethereum as the preferred choice for low fees, good experience, and high TPS is precisely the first goal of Ethereum's Rollup strategy. Therefore, in the short term, Ethereum's layer 2 strategy is undoubtedly successful.

Ethereum community member Ryan Berckmans cited data on blobs, stating that in recent months, blob utilization has stabilized at 80%, with each block purchasing about 2.4 blobs (up to 3). Although there has not been a significant increase in blob demand, this real growth may be masked by L2's optimization of blob usage efficiency. The continued strong growth of L2 indicates that demand for blob space may still be rising, which will tighten blob space and drive up fees, making DA (data availability) fees potentially exceed transaction execution fees, becoming an important source of revenue for Ethereum L1. Of course, this trend will also intensify competition among L2 protocols.

In the view of crypto researcher 0xTodd, L2 plans to bring those Ethereum killers back into the ETH ecosystem. Ethereum has at least realized: rather than letting talent and funds slip away, it is better to bring talent (at least on a verbal and revenue level) back in. Moreover, L2 is at least secured by the ETH mainnet. Additionally, L2 creates real revenue for ETH; whether ETH is used as GAS is not the key; what matters is that L2 will consume ETH, generating revenue for Ethereum.

"The more competitive the ecosystem is, the more valuable it becomes. The answer is clear: the Ethereum ecosystem (including various EVM chains)…" said SlowMist founder Yu Xian, providing an alternative indicator.

Opponents' View: Multiple Challenges Prevent Value from Flowing Back

Poor interoperability, severe homogenization, centralization risks, and value capture loss are widely regarded as the main issues currently facing Ethereum L2.

For instance, Multicoin Capital partner Kyle Samani pointed out that Ethereum faces two core issues: poor interoperability among Layer 2s leading to a subpar user experience, and outsourcing the execution layer to Layer 2s resulting in value capture loss. He believes that Ethereum's excessive pursuit of decentralization and the number of validators has overlooked user needs and financial functions. He argues that it is difficult to achieve a unified standard among various Layer 2s. Although Ethereum has advantages in regulatory status and talent reserves, its system design limits the realization of these advantages.

"Ethereum L2 aims to enhance the scalability of the Ethereum network, but it is marked as dangerous because they have the ability to transfer users' funds without restrictions. However, most major Ethereum L2 solutions are centralized, with a single server typically responsible for running the platform's operations. This design contradicts the decentralization and security principles of Cypherpunk, failing to provide the same level of security and stability as the Ethereum main network, which is harmful to investors, as these chains could collapse at any time due to a single event and could even be manipulated to steal users' funds," said Justin Bons, founder and chief investment officer of European cryptocurrency fund Cyber Capital. He also believes that expanding Ethereum will destroy all the capital and fees earned by Layer 2 networks because venture capital cannot take a cut from the expansion of Layer 1 networks. These "parasites" distort public goods, turning them into rent-seeking platforms in the venture capital chain.

Moreover, with the lowering of the threshold for launching chains, the number of L2s has surged dramatically. Data from L2BEAT shows that as of September 4, there are currently over 150 L2s launched or about to be launched. "Beware of junk L2 projects; some are merely imitating those who are genuinely doing the work," warned Emin Gün Sirer, founder of Ava Labs, while listing several characteristics of junk L2 projects, including project narratives that do not align with technical realities, projects selling tokens to raise funds without clear future technology, founders dumping personal tokens before launch, and very limited circulating tokens. Whether a project can solve the current biggest problems in cryptocurrency is key to judging its value.

At the same time, the technical homogenization issue of Ethereum L2 has also been criticized, exacerbating market concerns about liquidity fragmentation. "As L2s gradually increase, fragmentation is the next major challenge that needs to be addressed in the blockchain space. The real question is, do we have significant L2s? I believe we don't need too many generic L2s, but we do need some application-specific L2s or community-specific L2s," said Alex Gluchowski, CEO of Matter Labs, the main developer of ZKsync.

Gemini's head of sales Patrick Liou pointed out that a new Ethereum L2 emerges every 19 days. Although the emergence of multiple L2 blockchains aims to solve scalability issues, it inadvertently undermines the operation and adoption of blockchain and its applications, further exacerbating the problem of liquidity fragmentation.

Crypto researcher Jason also expressed concerns about the current state of L2 development, stating, "The main issues facing L2 currently include fragmented user experience, each issuing L2 diluting Ethereum's market value, various Layer 2s harboring ulterior motives causing Ethereum to lose unity, and reducing the willingness to innovate." He believes that if Layer 2 issues are not handled well, Ethereum may find itself in a situation similar to Cosmos; however, if it can successfully navigate these challenges, Ethereum will be reborn from the ashes.

How Did Vitalik Respond to the L2 Dilemma?

In response to these market concerns and doubts, Vitalik candidly stated that the current user experience of Ethereum L2 is too fragmented and that an open decentralized protocol is needed to transfer assets between various L2s. "We need an open decentralized (no operators, no management) protocol for quickly transferring assets from one L2 to another and integrating it into the default sending interface of wallets. But before getting too attached to any fancy toys, we need to do the foundational work first."

At the same time, he also addressed some of the development issues facing L2. For instance, regarding interoperability, Vitalik stated that this issue will soon be resolved. "We are achieving a smooth user experience across the entire Ethereum ecosystem (including L1, rollups, validiums, and even sidechains). The robustness of Ethereum L1 is improving, and there is a strong willingness for cooperation among L2 projects to enhance the overall interoperability of the ecosystem." Regarding security issues, Vitalik pointed out an important detail: the rules of Phase 1 require that code can only be overturned when the security council reaches a 75% voting threshold, and members preventing a quorum (i.e., ≥26%) must come from outside the company. Both Optimism and Arbitrum meet this requirement. Therefore, these organizations cannot unilaterally steal funds.

"A L2-centric ecosystem technically realizes sharding very well, but it is a sharding that can create its own rules. This is very powerful, capable of inspiring a lot of creativity and independent innovation, but it also has key challenges, especially in coordination," Vitalik noted. He emphasized that for a L2-centric ecosystem like Ethereum to succeed, it needs to understand these challenges and address them head-on to gain as many advantages as possible from the L1-centric ecosystem while getting as close as possible to possessing the best characteristics of both.

This year, Vitalik also shared his vision for the development of Ethereum L2 over the next decade during the Ethereum Developer Community Conference EDCON 2024, stating that by 2034, using Ethereum L2 will be as smooth and seamless as using the Ethereum mainnet directly. However, builders should not merely replicate Web2 but should take the initiative to explore boldly.