Why Do We Need Layer 2s?
Ethereum currently processes over 1 million transactions per day, leading to high transaction fees due to high demand. Layer 2 networks address this issue by scaling Ethereum without compromising decentralization or security.

How Do Layer 2s Work?

Layer 2s operate by executing transactions off the main Ethereum chain (off-chain) and then submitting essential transaction data to Ethereum (on-chain). This approach increases transaction throughput while maintaining Ethereum's security.

Types of Layer 2s

1. Optimistic Rollups:

   • Assume transactions are valid but allow for challenges if fraud is suspected.

   • If a challenge occurs, a fault-proof is run to verify validity.

2. Zero-Knowledge Rollups:

   • Use validity proofs to prove transaction validity without revealing underlying data.

   • Transactions are computed off-chain, and compressed proof is submitted to Ethereum.

Current State of Layer 2s

Scalability:

• Layer 2 transaction fees are approximately 10 times lower than Ethereum's.

• However, fees on layer 2s can still spike during periods of high Ethereum use.

• Fees of $0.5 per transaction, remain high for users in developing countries.

Centralization Challenges:

• Sequencer Centralization: In popular rollups like Arbitrum and Optimism, sequencers (which order and batch transactions before submitting them to Ethereum) are currently operated by centralized entities, often the rollup development teams themselves.

• Governance Centralization: Foundational teams behind Layer 2s often hold significant influence over governance decisions, leading to concerns about centralization.

• Single Proof Scheme and Client Software: Reliance on a single proof scheme and client software introduces the risk of bugs or vulnerabilities affecting the entire chain.

So, in the current state layer2s are not as cheap as desired and not decentralized with many single points of failures.

Where we want to go:

Gas Fees: Achieve transaction fees as low as possible, ideally below $0.001 for basic operations such as swaps, lending, and other essential DeFi transactions.

Decentralization: Maximize decentralization of Layer 2 networks to ensure that transactions on Layer 2 are as secure as those on Ethereum's mainnet.

How can we get there?

Gas Fees: Roadmap for Reduction

Current Cost Breakdown: Approximately 90% of Layer 2 transaction fees are attributed to storing calldata on Ethereum's mainnet.

Proto-Danksharding (2024):

• Introduces data blobs (temporary storage spaces) that can be attached to Ethereum blocks. Blobs are automatically deleted after a set period and are cheaper to use since data is not stored forever.

• Enables Layer 2s to store data more cheaply, reducing transaction fees by 10x or more.

Full Danksharding (Several Years Away):

• Full realization of rollup scaling.

• Expands data blobs from 1 in Proto-Danksharding to 64.

• Utilizes data sampling techniques to reduce rollup costs further by avoiding full downloads of blob data for verification.

• Requires updates to consensus clients to manage large blobs effectively.

Decentralization: We need Multiple permissionless sequences, Multiple fault-proof schemes, and Multiple client software.

What are the current roadmaps for the projects?

• Except for Arbitrum, all other general optimistic and ZK rollups are currently in stage 0. We anticipate that the most optimistic rollups will also progress to stage 1 in 2024, accompanied by a 10x reduction in gas fees due to blob upgrades.

• All layer 2s are actively working to address security and scalability challenges.

Layer 2s are moving in the right direction.

Which layer 2 will win? What are the key metrics to track?

While tracking revenue, treasury, and profitability is beneficial, it's not paramount at this stage, as leading layer 2s can still raise substantial funds if necessary.

TVL & Stablecoins

• Arbitrum leads the pack, followed by Optimism (OP), Base, and zkSync. While TVL is an important metric, it can be easily manipulated. Therefore, let's compare stablecoin market capitalization, which is more difficult to influence.

• Arbitrum leads the pack, followed by Optimism (OP), Base, and zkSync.

• Even when combined, the stablecoin market capitalization of all layer 2s reaches just 3 billion. In contrast, the stablecoin market capitalization on Ethereum stands at 71 billion. This indicates that the current stablecoin presence on layer 2s lags significantly behind Ethereum's.

• A better perspective lies in considering which layer 2, Ethereum users will trust to move their funds. Most Ethereum Users prioritize security first and then gas fees.

• Of the current layer 2s, Arbitrum is the only one at stage 1 (stages), with all other general-purpose optimistic and ZK rollups remaining at stage 0. This places Arbitrum in a clear lead, significantly ahead of other layer 2s.

Daily Active Addresses: A Useful, Yet Imperfect Metric
DAUs are susceptible to manipulation through Sybil attacks, where fake identities inflate the active address count.

As shown below, zkSync Era leads with 51% of DAUs, followed by Arbitrum (ARB), Linea, Optimism (OP), Base, and Scroll.

Comparing TPS or DAUs is like counting the number of bills in your wallet but ignoring that some are singles, some are twenties, and some are hundreds.

Notably, the zkSync Era has dominated since August 2023, which is impressive and could be attributed to the anticipated airdrop.

Total Fee Paid by the Users:

The fees paid by users are very important metrics, as they help differentiate legitimate users from spam activity. In terms of fee amounts, Arbitrum clearly takes the lead, followed by zkSync, Era, StarkNet, Optimism, and Base.

Developers Experience: Developers using Arbitrum, Optimism, Polygon zkevm, Scroll, zkSync, or Linea chains benefit from different levels of Ethereum Virtual Machine (EVM) compatibility. On some chains, smart contracts can be deployed directly without modification, while others require minor adjustments. This compatibility with existing tools and wallets allows developers to focus on improving their code rather than rewriting everything from scratch, giving these EVM-compatible layer 2 solutions a significant advantage over non-EVM alternatives.

Collectives: Layer 2s part of Collectives like OP Stack, and StarkEx have an unfair advantage over independent L2s. Benefits

• Regular scalability and security updates

• Compatibility with developer tools

• Simplified bridging

A powerful example is Base's core devs collaborating with the OP Stack team to turbocharge the Superchain's development.

Final thoughts:

In the Layer 2 race, prioritizing trust over gas fees could be key. While lower fees attract users, the Ethereum community values security more. Degens, not mainstream users, drive TVL and stablecoin adoption for now. Optimizing for their needs can attract capital and developers. However, most Layer 2s will likely lower fees soon, making lower gas fees less of a differentiator. Arbitrum's early focus on security puts it in a strong position.

While ZK rollups offer a more efficient scaling solution than optimistic rollups (OP rollups), they are currently less mature. Furthermore, OP rollups are accruing strong network effects from users, developers, and dApps.

ZK rollups may face difficulties overcoming these well-established network effects, but their potential for greater scalability should not be underestimated.

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