- There's a major problem with Ethereum.
But there's a solution.
The problem is that it gets complicated fast.
It's hard to determine which layer 2
might take the cake,
benefiting from Ethereum's massive market share.
So I decided to do a deep dive and build an actual
research report on the topic, comparing the top layer 2s.
And by the way, this entire research report
and much more, including access to live coaching
and trade signals every single day, will be
available through our exclusive membership Finova,
linked in the description below.
The site is my baby, and members seem to love it as
much as I do, so make sure to check that out.
In order to explain why layer 2s matter,
you need to understand the problem
with Ethereum in the first place.
Ethereum will undergo a major upgrade, and
this does a lot of exciting things.
It will be 99% more energy efficient
thanks to the proof-of-stake consensus,
meaning it won't require miners anymore.
Then eventually it will
utilize something called Sharding.
Not to be confused with ???.
Yeah, this is what my content has fallen to.
by essentially taking Ethereum
from a single lane county road and expanding
that to a 64 lane mega highway.
But there's one thing it won't do
Easily the most hated thing about Ethereum will stay.
The reason for this is the upgrade will
have an impact on the consensus layer.
And unfortunately, gas fees are
paid on the execution layer.
So the fees that you pay right now will simply go
to people staking, not the miners that it currently goes to.
So of course, this is a major issue.
The average person just can't
afford a $20 transaction cost.
And in order for this technology to really
benefit humanity, it needs to be affordable.
Enter layer 2s, this is the
long term solution to Ethereum.
Projects like Arbitrum, Optimism, Polygon and others are built
on top of Ethereum in order to improve efficiency
and lower costs to transact on the network.
Ethereum by itself will not be cheap anytime soon.
So these layer 2s will produce a
ton of value and will continue to
see them control multibillion dollar market caps.
A big issue in crypto is definable use cases.
What problem does this project actually solve?
Well, with Ethereum layer 2s, that
question has an extremely simple answer.
It saves the end user a ton on transaction costs.
But how does it actually do that?
The most popular solution is what's called a Roll up.
There are two major types of roll ups
Optimistic and zero knowledge, or ZK for short.
We won't go too in depth on the differences between
the two, but all you need to know is
ZK roll ups are slightly less secure and more efficient, where
optimistic roll ups aren't quite as efficient, but they do
have the same level of security as the Ethereum main net,
which is super, super secure.
That's the important thing.
So imagine that your job is to add up
numbers on a calculator all day, dream job, I know.
All day they're just being thrown at you.
37+12+57
You're just punching away at your Ti-86
all day long trying to keep up.
And this is expensive because you have to
charge the customer every single time you hit
that equal sign, you are Ethereum.
Now imagine someone comes along and says, hey, what
if I do some of that math for you?
People can just send me the numbers, I'll add them
up and then I'll just send you the total.
Then you just pay me once for a whole bunch of people.
That's a roll up.
So instead of punching in the three numbers 37+12+57=106
the Roll up can just send you the single total of 106.
You're doing far less work and the customers
get to split that fee three ways.
This is how rollups save money.
They take a bunch of transactions, do the hard
computational work off-chain for hundreds of individual transactions
before finally sending Ethereum one single transaction to go
ahead and post to the blockchain.
The results are good security with insane efficiency.
In fact, using a roll up can reduce
gas fees by up to 100 times.
Now this brings up something else important.
Blockchains classically run into a
problem called the Trilemma.
There are three major issues, but life isn't fair, so
it's really only feasible to solve two of those three.
It's kind of like a video game where you only get
so many stat points and you're left like, well, I guess
I'm going to be the unluckiest person on the planet so
I can be as charismatic as the Rock..
Anyways, the blockchain trilema is
decentralization, security and scalability.
Ethereum put all of its
stats on security and decentralization.
A blockchain like Solana went
with scalability and security.
However, because of that, it's not as decentralized.
Pretty much no one decides to skimp out
on security, which makes sense because they literally
deal with currencies and it's super important.
But the point here is that a layer 2
is essentially the intersection of this Trilemma, helping to
bridge the gap on these three major focus areas.
Layer 2s are able to specialize
specifically on scalability because they get to
rely on Ethereum's robust security back end.
Currently transacting on Ethereum doesn't really
make sense unless you're dealing with thousands of
dollars because the fees will just eat away
at any potential profits of a trade.
A layer 2 will open up use cases
like microtransactions and make the blockchain more accessible
to people all around the world.
Now, it's not quite all sunshine and roses, though.
Layer 2s do have a few downsides.
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Now, the downsides of layer 2s.
First, you can remove the
liquidity from the primary blockchain.
If a layer 2 were to get insanely
popular, like more so than Ethereum itself, this
would draw money out of Ethereum, which is
needed for that system to work properly.
That's not great.
Second, it might not play so nicely.
Ethereum is built to work well with others.
When you have layer 2s communicating with
other layer 2s or other programs, things
can easily start to have problems.
And third, there are just
more opportunities for security risks.
By the nature of money flowing through
another system, there are just additional things
that can and will eventually go wrong.
- Hold on to your butt.
So, now that we understand what they do, let's go
through a few of the most promising layer 2s.
Here are the top five Ethereum layer 2s by
total value in currency locked on their platforms.
And you might notice that Polygon isn't on here,
and I'll explain why in a few minutes.
Arbitrum is extremely dominant, commanding more
than 50% of the total value.
However, you can see that Optimism actually
has slightly more average daily transactions.
Transaction fees even vary between these layer 2s from
as low as a penny to as much as
50 cents plus in terms of unique addresses.
Optimism also takes the cake here.
But what's crazy is, in terms of
both value locked and transactions, Arbitrum
and Optimism rival even some
of the largest blockchains.
They're currently ranked 10th and
17th in all of crypto. That's crazy.
And what you might be wondering is
Now, this can vary from platform to platform, but
let's say you wanted to make a swap on
Uniswap and get the low transaction fees of Arbitrum.
You just need to visit Uniswap, connect your
wallet, click the drop down to Arbitrum,
accept the pop up, and you're connected.
Now you just need to go to the Arbitrum
token bridge, send some tokens over from Ethereum to
Arbitrum, and you're good to go.
Now, in terms of market cap of these
layer 2s, there's quite a bit of variety,
and this is, of course, ever changing.
Loopring has the largest market cap, with Optimism in second,
and Arbitrum has no market cap.
And the reason for this is they actually don't
have a token, despite being the largest in terms
of total value locked, which is kind of weird.
And there have been rumors in the past
that they'll do an airdrop in the future,
but there's just no confirmations on this yet.
Now, breaking this down further, we can see some
of the individual risks of these layer 2s, and
I need to thank L2BEAT.com for making this
information accessible. It would be much more difficult without them.
We won't go too crazy in depth here, but
For example, take the risk of funds being stolen, which
is obviously bad, a risk to every one of these
five projects is there's no delay on code upgrades.
This means it's not impossible for an upgrade to
happen that could be detrimental to the ecosystem and
you would have no notice ahead of time.
Is this likely? No.
But is it possible?
Yeah, theoretically.
Arbitrum also carries a risk of funds being frozen.
This would happen if the
centralized validator goes down.
And if this were to happen, there would be
no way to produce a new block of transactions
to go ahead and get your funds out.
On the plus side, Arbitrum's daily transactions and addresses
have had a steady increase over the last year.
Now, dYdX has the same code upgrade issue, as well
as some small issues like the risk of being censored.
This would happen if an operator
refused to include transactions of your
specific wallet when creating a block.
Again, unlikely, but it's possible.
So it's good to bring this up.
I wasn't able to get all of
dYdX's transaction and address metrics.
However, the TVL has been relatively steady,
but their market cap has seen a
large decrease for many, many months.
Optimism has the same risk as Arbitrum,
where user funds could theoretically be frozen.
Optimism's TVL is quite healthy, and so is
the increase in their unique addresses and transactions.
Loopring has the same risk
of funds being stolen and users potentially being censored.
However, it seems to be on the
healthier side in terms of risk.
Their market cap and TVL have
seen a very sharp decrease.
And by the way, if you appreciate this content,
just go ahead and hit that subscribe button.
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Now, there isn't a ton of
available transaction data for loop ring.
However, their unique addresses have consistently increased over the
last year, especially the last six months. Metis Andromeda
has the same risk of those funds being stolen
as well as some additional risks that include the
potential for a large dishonest validator to win a
dispute versus an honest validator hurting the system, which
of course would be terrible.
Their TVL and market cap have been hit quite hard.
Now despite the risks here and because again life isn't
fair, Metis actually has the lowest fees when compared to
the other options that we've chatted about today.
And if you'd like an even more in depth look
at the risks, there are additional pages on this research
report again available on Finova.finance linked down below.
Now for the project you've all been waiting for -
The reason I separated Polygon from the rest is at current
Polygon is more like a proof-of-stake side chain.
The other projects that we talk about
derive their security directly from Ethereum.
Polygon is a bit different but it is massive
with daily transactions, unique addresses and total TVL quite
a bit larger than the rest on this list.
In fact, if we go back to that TVL comparison,
Polygon is the 6th largest compared to all blockchains.
Again, insane.
Polygon has seen growth in users and transactions
are healthy despite the current market conditions.
Polygon is one of the most exciting projects
right now in terms of helping to solve
that Trilemma problem that we chatted about earlier.
So which of these is the most likely to succeed?
I wish I knew exactly.
But I think an investment in layer 2s could use a
bit of diversification just to be sure.
Arbitrum isn't investable, so that
one's out of the question.
But I think diversifying into both Polygon and
Optimism would yield the highest of success given
usability, utility, ecosystem growth and developer strength.
However, of course this is my
personal opinion and not financial advice.
I don't claim to be a fortune teller.
What I am sure of is Ethereum is here to stay.
These projects are still under development though, so
they're not the most user-friendly right now.
But anything that can take the success
of Ethereum and make it widely available
around the world will see massive growth.