With the unsettling crypto narratives of 2022 hopefully behind us, 2023 has started on a largely positive note for the industry, with favorable CPI inflation numbers leading to a resurgence in the price of Bitcoin, Ethereum and leading altcoins. With the next Bitcoin Halving scheduled for sometime in April or May 2024, there is a strong interest now in identifying the biggest narratives and next bull run winners early in 2023.
One already well-documented trend we covered in our 2023 preview is the continued rise of layer-2 (L2) scaling solutions, most notably for Ethereum. With the relative dominance and established network effect of Ethereum, and its–at times–astronomically high gas fees and slow wait times, creating a dynamic layer-2 environment surrounding the chain has risen to among the highest priorities in crypto.
Progress has until now come in fits and starts, but it’s shaping up that Ethereum layer 2s might transform the crypto ecosystem fairly soon. The successful Ethereum Merge was probably the brightest crypto story of 2022, reducing the chain’s energy usage by 99.95% and laying the foundation for future milestones like sharding.
With many layer-1 competitors all but dissipating in 2022, it seems like Ethereum will remain the top smart contract chain for a long time, and possibly even flip the market cap of Bitcoin one day. Therefore, it’s no surprise that the Ethereum layer-2 narrative is now so strong, with the scaling capabilities they bring hugely important to the future success of Ethereum.
In this article, we’ll look at Ethereum’s various layer-2 scaling solutions and where they may take us in 2023.
What are layer-2 scaling solutions?
A Layer-2 scaling solution is an additional network layer built on top of a blockchain’s base layer. These networks allow for a higher volume of transactions to be processed without overloading the layer-1 chain, improving overall efficiency and user experience.
While layer-1 networks prioritize decentralization and security, they often struggle with scalability due to the resources required to maintain a functional ecosystem. Layer-2 networks aim to address this issue and maintain a balance between the three core tenets of blockchain technology: decentralization, security, and scalability, also known as the “blockchain trilemma.”
Examples of layer-2s include Ethereum’s rollups, the Polygon Network, Solana’s Nitro, and the Lightning Network on Bitcoin.
What are the key Layer-2s on Ethereum (so far)?
Layer-2 scaling solutions on Ethereum can take a fairly wide variety of forms, but the most relevant are rollups and the Polygon Network.
Rollups process transactions on a layer-2 network and then send compressed data back to the layer-1. There are two primary kinds of rollups: Optimistic rollups and Zero-Knowledge (ZK) rollups.
Zero-knowledge and Optimistic rollups square off
Optimistic rollups, such as Arbitrum and Optimism, rely on a 1-week dispute period to guarantee the validity of transactions before they are processed on the layer-1 network. They assume that transaction batches are legitimate and require at least one honest node to submit fraud proofs to challenge invalid state transitions.
The “zero-knowledge” in ZK rollup refers to the cryptographic proof used by this technology, which enables users to prove that a statement is true without revealing any additional information about it. ZK rollups employ demanding cryptographic proofs called zk-SNARKs to verify transactions without requiring a dispute period or need to publish it on Ethereum.
Essentially, rollups allow for data validity to be checked without sharing data. Although ZK rollups are the superior technology, the intense computational demands and higher overheads have meant their implementation has been slow, with limited use for complex smart contracts. However, that may change with the advent of zkEVM, a kind of rollup ZK rollup that has arrived sooner than expected and is capable of much more than simple transactions.
Currently, optimistic rollups still dominate the rollup market at the time of writing, with Arbitrum One and Optimism holding $2.26B and $1.21B in total value locked (TVL), respectively. Meanwhile, ZK-rollup competitors such as dYdX and Loopring trail at $389M and $83M. New entrants such as ZKSync and Starknet are predicted to have massive launches later in 2023.
The Polygon Network is a popular layer-2 scaling solution on Ethereum, but it operates as a separate blockchain rather than as a layer on top of Ethereum. While Polygon offers faster and cheaper transactions than Ethereum, it is also not as decentralized.
Polygon calls itself “an EVM enabled sidechain”, yet its separate consensus mechanism with many additional features rely on the proven security of Ethereum.
The team behind Polygon is now working to improve the chain’s decentralization by leveraging Ethereum as its main security layer and launching a so-called “True Layer-2,” which will rely on zkEVM technology.
Currently, Polygon has a TVL of just over $1B, down from all-time highs of nearly a factor of ten higher during the last bull run.
Other notable layer 2s on Ethereum
In addition to more ZK-rollup providers like zkSync and StarkNet, Ethereum is host to a budding ecosystem of smaller layer-2s catering to various niches. One of these is Metis, a layer 2 seeking to improve upon the concept of decentralized autonomous organizations (DAOs) with a hybrid solution called decentralized autonomous companies (DACs).
Another rising Ethereum layer 2 is Immutable X, which runs on a parallel framework called Validium and caters to gaming and NFTs.
A Layer-2 future?
One indicator of the growth of layer-2 scaling solutions on Ethereum is simply the amount of ETH being spent on gas fees for layer-2 transactions. This is a trend that steadily increased throughout 2021 and hit new highs last year. Furthermore, while the TVL on Ethereum dropped from $69B in August 2022 to around $24B in early January 2023, the TVL drop in Ethereum layer-2s was relatively smaller.
While the next major development on Ethereum, the Shanghai Upgrade, will be solely focused on enabling the withdrawal of staked ETH, it’s likely to be followed by what’s been called “The Surge.” This will enable something called “protodank-sharding,” otherwise known as EEP-4844, which is a step along the way to full sharding.
EEP-4844 is set to increase the transaction speeds on Ethereum layer 2s by 100x. The dramatically-improved capacity would put layer-2 throughput somewhere well ahead of Visa and even the Solana Network, much touted for its transaction speeds. Such quick processing time could make widespread crypto payments with Ethereum layer-2s begin to look like a reality.
Polygon (MATIC) has been on a deal-making spree, inking agreements with a handful of the biggest brands in the world to use the L2 for various projects. Polygon Studios CEO Ryan Watt has even described Polygon as a “funnel” for collaborations with leading brands.
Notable Polygon partners now include Starbucks, Nike, Reddit, Adidas, Disney, the NFL, Stripe, Adobe, and even Meta. It’s not hard to see how a combination of EEP-4844, with its skyrocketing transaction speeds, and Polygon’s network effect as it accumulates users through partners, could make it an extraordinary force to contend with a bit down the road.
The pairing of Ethereum Virtual Machine (EVM), the most popular smart-contract execution environment, with ZK-rollup technology is expected to have a tremendous impact on the viability of Ethereum layer 2s. The new zkEVMs have the ability to port any Ethereum smart contract onto a ZK rollup without code alterations. Work is underway on them at Matter Labs, Polygon, and Scroll.
Ethereum co-founder Vitalik Buterin has said that ZK rollups will primarily be used for payments in the short term due to the underlying computational demands. While they will dominate in the medium- and long-term, the less flashy Optimistic-rollup technology will still prevail for now.
However, the rapid progress in zkEVMs has apparently come as a bit of shock to Vitalik. His new advice to the likes of Optimism and Arbitrum “is that they should start ZK-ifying themselves fairly soon.”
While it’s still early in 2023, layer-2s are showing no signs of slowing down as they continue to innovate and drive Ethereum’s growth across new avenues such as gaming and Web2 integrations. The end of year should deliver a few clear winners that will continue to thrive for years to come.