Arbitrum – chad or…?

December 1st, 2022

The goal of this article is:

To explain how Arbitrum as a L2 chain functions;
To review a bunch of promising projects being built on Arbitrum.

PART 1 – Introduction
PART 2 – Optimistic roll-up determination
PART 3 – How does Arbitrum work, anyway?
PART 4 – Block production
PART 5 – Ecosystem highlights
5.1 – GMD Protocol
5.2 – Camelot
5.3 – 3xcalibur
5.4 – Radiant Capital
5.5 – Buffer Finance
5.6 – Rage Trade
PART 6 – Afterwords

PART 1 – Introduction

Let’s start with the basics, diving deeper and deeper.

Arbitrum is an optimistic rollup.

Quick reminder – there are 2 most popular types of Ethereum rollups: Optimistic (Optimism, Arbitrum, Boba) & Zk-rollup (zkSync, SkarkWare, Loopring). Both of them have the same goal – to scale Ethereum layer 1 network.

If you’re at the very beginning of learning “what the hell these blockchains and rollups are,” jump here, and you’ll probably get the answers in easy to understand format.

According to TVL of each L2 chain, Arbitrum is the most trusted and popular protocol. Even without its own token and corresponding incentives, Arbitrum has managed to maintain impressive amount of TVL for more than a year. What’s the secret? Let’s find the answer.

PART 2 – Optimistic roll-up determination

The explanation lies in its name. Each node (read validator) optimistically approves the state of the chain once a batch of transactions is submitted. Then, the other nodes have roughly a 7-day window to challenge the submission by issuing a fraud proof. It includes:

“Pre-state” proof;
“Post-state” proof;
A proof of transactions during a state transition.

Once submitted, the smart contract of the rollup verifies and compares the states. If the initial submission finds to be false, the state reverts, and the dishonest validator gets slashed.

Slashing – a penalty mechanism used in proof-of-stake blockchains. If a validator caught to be malicious, his staked tokens are confiscated. In the opposite, honest validators are rewarded.

PART 3 – How does Arbitrum work, anyway?

Let’s start with the basics:

People and contracts put messages (transactions) into the inbox. The chain reads the messages one at a time, and processes each one. This updates the state of the chain and produces some outputs.

Now, let’s have a closer look.

Everything starts with transactions. In general, all transactions on Arbitrum are directed to Sequencer.

Sequencer – a special full-node designed to take transactions, execute and put them in direct order. Currently, Sequencer is operated by Offchain Labs.

Sequencer publishes transactions in two ways: a real-time feed (soft finality), and batches posted on L1 Ethereum (hard finality).

Soft finality generally means that you have to trust that Sequencer will keep its promise and record transactions in a particular order (until a batch is posted on L1, i.e. hard finality). There can be 2 scenarios:

Sequencer acts honestly and/or without malfunctions – transactions will be recorded accordingly;
Sequencer acts malicious and/or faces issues – transactions will de delayed until they are published through delayed inbox.

The Arbitrum chain has two inboxes: core inbox & delayed inbox.

Once transactions are included in the core inbox, their ordering is fixed, execution is fully deterministic, and we can treat the resultant state as having L1-level finality. It happens once Sequencer publishes a batch of transactions to L1 (hard finality; read below).

In contrast, if Sequencer never includes a transaction in a batch, the user can include it in the L2 by posting in the delayed inbox and the "force including" it after some delay period (currently ~24 hours on Arbitrum One). Thus, even being malicious Sequencer can only, at worst, reorder or temporarily delay transactions; it cannot, f.e., forge a user’s transaction or propose an invalid state update.

Once ordered by Sequencer, these transactions proceed through the state transition function. The state transition function takes as input the current state of the chain (State, State1), along with the next transaction (Tx1, Tx2). It updates the state and sometimes emits a new L2 block on the Arbitrum Nitro chain (the latest update of the Arbitrum chain called Nitro).

Hard finality means that Sequencer periodically publishes its sequences to the L1 network (every few minutes). Sequencer concatenates the group of transactions in the feed, compresses them for efficiency, and posts the result as calldata (special message) on Ethereum. This is the final and official record of the transaction sequence. As a result, transactions are collected in core inbox.

Let’s sum-up a little bit.

The Arbitrum chain maintains almost prompt execution of transactions (2-3 seconds) thanks to soft finality by Sequencer. At this stage, it implies you have to trust Sequencer as a centralized source of information (it’s gonna be more decentralized in the future). However, you have an option to wait for Sequencer to publish a batch of transactions to L1 network (every few minutes). The amount of data posted by Sequencer is sufficient for any Arbitrum node to reconstruct and validate the state of the L2 chain. Since the state can be computed once a batch is published, only one honest validator is required to maintain the valid L2 chain. Thus, in terms of finality, we can treat L2 transactions as close to L1 transactions as possible.

PART 4 – Block production

We’ve learnt how transactions are sequenced by Sequencer. Now, let’s talk about how rollup blocks or RBlocks are created. Don’t confuse them with L2 blocks we were talking about earlier. L2 blocks are batches of transactions sequenced by Sequencer, while RBlocks are the ones updating the state of the network.

Arbitrum as a proof-of-stake blockchain has its own validators. They can act passively – by verifying the state without staking, or be active validators who stake tokens, propose & vote on RBlocks.

Please note, currently, validators have to pass through the whitelist process. At the moment of the latest update (Nov 2022), there are 9 whitelisted validators.

Each active validator can propose an RBlock, providing he has a minimum stake required. During the proposal, validators vote on the RBlock they believe is correct by staking on this block. Thus, if a validator stakes on the wrong block, he will be slashed.

As was said, only 1 honest validator is required. It means, most of them don’t even have to stake until they notice a malicious block is proposed. If this happens, they can propose an RBlock seems to be correct. This strategy is called defensive validator.

The last option is to verify RBlocks and never stake – called watchtower. This type of validator gives signals though any available means once a discrepancy is noticed.

It’s worth mentioning that active validators are incentivized to take part in the voting process – in case a malicious validator is caught, some amount of slashed tokens are distributed to them.

I’ve covered the simplified version of how the Arbitrum chain operates. This probably is quite enough for an average user. However, if you want to dig deeper, you are welcomed to familiarize with the official docs here. Now, let’s explore the evolving Arbitrum ecosystem and some interesting projects being built right now.

PART 5 – Ecosystem highlights

I’m not gonna cover the well-known protocols like GMX, Stargate, Balancer, etc, operating on Arbitrum for quite a long time. Instead, my goal is to familiarize you with some young, evolving & promising projects.

Please note, the following list doesn’t act as a financial advice or a “call” to buy anything. The best way to get a broad picture is to go through the official docs. As always, DYOR.

5.1 – GMD Protocol

Website: https://gmdprotocol.com/

Twitter: https://twitter.com/GMDprotocol

A yield aggregator built on top of GMX. The protocol allows users:

To stake their assets: USDC, ETH & WBTC in single-stake vaults generating an average 7-16% APY;
To stake $GMD native tokens to generate a complex “real yield” from $GLP.

You can find a deeper explanation in this thread.

5.2 – Camelot

Website: https://camelot.exchange/

Twitter: https://twitter.com/CamelotDEX

One of the firsts native DEX on Arbitrum aiming to become the main one. Camelot has several features:

Сustomizable liquidity & fees;
Possibility to manage your LPs through special NFTs called spNFT: send, harvest, merge, split, lock, etc. your LP positions.

BTW, if you are reading this as soon as it’s published, you still have time to participate in Genesis pools & public sale. FYI, Camelot is a community driven project, i.e. there was no pre-sale or investments from VCs. But before making any decision, I encourage you to go through this thread.

Deadlines: December 2 for genesis pools; December 6 for public sale.

5.3 – 3xcalibur

Website: https://www.3xcalibur.com/

Twitter: https://twitter.com/3xcalibur69

A liquidity marketplace, powered by Tri-AMM architecture to facilitate stableswaps, variable swaps and borrowing/lending.

As an average user, you can think of it as a combination of DEX + lending protocol. Kinda a competitor to Camelot.

What’s so special?

Tri-AMM architecture;
Non-Liquidatable Loans, Oracleless Money Markets and other features that are a bit complicated and should be covered in a separate article.

More info in the thread.

5.4 – Radiant Capital

Website: https://app.radiant.capital/#/markets

Twitter: https://twitter.com/RDNTCapital

An omnichain money market, where users can deposit any major asset on any major chain and borrow a variety of supported assets across multiple chains. The protocol is built atop of LayerZero, and Arbitrum is the first supported chain. BSC chain is supposed to be the next.

5.5 – Buffer Finance

Website: https://buffer.finance/

Twitter: https://twitter.com/Buffer_Finance

Exotic options on Arbitrum. There aren’t a lot of details, since the official docs are not published yet. The protocol migrated from BSC chain some time ago. Options as well as futures are quite popular derivatives, so I guess it’s worth mentioning.

5.6 – Rage Trade

Website: https://www.rage.trade/

Twitter: https://twitter.com/rage_trade

ETH Perp + Delta-neutral vaults. The protocol allows you trading ETH/USDC with up to 10x leverage along with providing liquidity in 80-20 tricrypto vault. Delta neutral vault in that case means that the supplied liquidity is used across many protocols to reduce the IL through hedging.

Moreover, they implement omnichain liquidity using LayerZero to collect the deepest liquidity from various chains.

A deep thread on Rage Trade.

PART 6 – Afterwords

I know, you’ve probably familiarized with some protocols already if you are an active DeFi user. I wasn’t trying to review hidden gems or extremely fresh projects – just the ones having a good potential in my modest opinion. Also, I haven’t mentioned Arbitrum Nova since the activity there is pretty low. Will think about the 2nd part if notice positive feedback.

If you enjoyed the reading, here is always a good way to please me by sharing the content. Moreover, since this is my biggest article at the moment of publishing, I’d like to test the collecting function on Mirror. Just setting a 1$ cost without expecting someone is gonna mint.

If you want to stay in touch, feel free to subscribe my Twitter. And thanks for your attention ;)