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Coinbase: five minutes to read Layer1, Layer2, and side chain solutions
Scaling Ethereum & AMP; Crypto for a Billion Users
By Justin Mart & Amp; Connor Dempsey
Decentralized financial communities
By the end of 2021, Ethereum had grown to support thousands of applications from decentralized finance, NFT, gaming and more. The entire network processes trillions of dollars in transactions each year, with more than $170 billion locked up on the platform.
But as the saying goes, more money, more problems. Ethereum's decentralized design eventually limits the number of transactions it can process to 15 per second. As Ethereum's popularity goes well beyond 15 transactions per second, the result is long waits, with fees of up to $200 per transaction. Ultimately, this will cost many users and limit the types of applications ethereum can currently handle.
Scalable solutions are needed if blockchains based on smart contracts are to grow into financial and Web 3 applications that support billions of users. Thankfully, the cavalry has started to arrive, with a number of solutions coming online recently.
Is it competition or complementarity?
The goal is to increase the number of transactions that can be processed by publicly accessible smart contract platforms while remaining sufficiently decentralized. Expanding the smart contract platform with a centralized solution managed by a single entity is trivial (Visa can process 45,000 transactions per second), but then we're back to where we started: a world owned by a few strong centralized players.
There are two ways to solve this problem :(1) build entirely new networks that compete with ethereum and can handle more activity, or (2) build complementary networks that can handle ethereum's excess capacity.
Broadly speaking, they can be divided into the following categories:
While they differ in architecture and approach, the goal is the same: to allow users to actually use the network (for example, interact with DeFi, NFT, etc.) without paying high fees or experiencing long waits.
The first & have spent 1 layer
Ethereum is considered layer 1 blockchain -- a separate network that protects user funds and executes transactions in one place. Want to switch from 100 USDC to DAI using a DeFi application like Uniswap? Ethereum is where all this is happening.
Competing tier 1 can do everything Ethereum does. The difference is that the new system design can achieve higher throughput and thus lower transaction costs, but usually at the expense of increased centralization.
Over the past 10 months, new Tier 1 networks have come online, and their total value has soared from $0 to about $75 billion over the same period. The field is currently led by Solana, Avalanche, Terra and Binance Smart Chain, each with a growing ecosystem worth more than $10 billion.
Non-ethereum tier 1 TVL
All layers 1 compete to attract developers and users. This is difficult without any of Ethereum's tools and infrastructure that make it easy to build and use applications. To bridge this gap, many layers 1 employ a strategy called EVM compatibility.
EVM stands for Ethereum virtual machine, which is essentially the brain that performs the calculations needed to make transactions happen. By making their network EVM compatible, Ethereum developers can easily deploy existing Ethereum applications to the new Layer 1 by copying and pasting their code. Users can also easily access EVM compatible Layer 1 through their existing wallets, simplifying migration.
Take binance Smart Chain (BSC) as an example. By releasing an EVM-compatible network and tweaked the consensus design to achieve higher throughput and cheaper transactions, BSC saw a surge in usage of DeFi apps last summer, which are similar to popular Ethereum apps like Uniswap and Curve. Avalanche, Fantom, Tron and Celo have taken the same approach.
In contrast, Terra and Solana do not currently support EVM compatibility.
EVM compatible vs non-EVM compatible with layer 1 TVL
Interoperable chains
In a slightly different tier 1 store are blockchain ecosystems such as Cosmos and Polkadot. Rather than building new standalone blockchains, these projects build standards that let developers create blockchains for specific applications that can communicate with each other. This could, for example, allow tokens from a gaming blockchain to be used in applications built on a separate blockchain from a social network.
More than $100 billion of chains built using the Cosmos standard are now interoperable. Polkadot, meanwhile, recently reached a milestone that will also unify its blockchain ecosystem.
In short, Ethereum's direct competitors are diverse, and there will be more to come.
Side chain
The difference between the side chain and the new layer 1 is undoubtedly a fuzzy one. Side chains are very similar to EVM compliant Layer 1, except that they are specifically designed to deal with ethereum's excess capacity, rather than competing with the entire Ethereum. These ecosystems are closely integrated with the Ethereum community to host Ethereum applications in complementary ways.
Axie Infinity's Ronin side chain is a prime example. Axie Infinity is an Ethereum-based NFT game. Since ethereum fees make playing games very expensive, building Ronin side chains allows users to move their NFT and tokens from Ethereum to a low-cost environment. This made the game affordable to a wider audience and led to its popularity.
As of this writing, users have transferred over $7.5 billion from Ethereum to Ronin to play Axie Infinity.
Polygon POS
Side chains like Ronin are application-specific, while others are suitable for more general applications. Currently, Polygon POS side chain is the industry leader with a value of nearly $5 billion, deployed in over 100 DeFi and gaming applications, including the familiar Aave and Sushiswap, as well as Quickswap, Uniswap's clone.
Also, Polygon POS doesn't look any different from EVM compliant Layer 1. However, it was built as part of the framework to extend Ethereum, not compete with it. The Polygon team believes that in the future, Ethereum will remain the dominant blockchain for high-value transactions and store of value, while daily transactions will move to Polygon's low-cost blockchain. Polygon POS also maintains a special relationship with Ethereum through a process called checkpoints.
With low transaction costs, Polygon's vision for the future seems feasible. With the help of the incentive program, users flocked to Polygon POS, and its average daily transaction volume surpassed ethereum's (though spam trading inflated the number).
Layer 2 (Rollup)
Both layer 1 and side chains have an obvious challenge: securing their blockchains. To do so, they must pay a fee to a new crop of miners or proto-verifiers to validate and secure the transaction, usually in the form of inflation of base tokens (Polygon's $MATIC, Avalanche's $AVAX).
However, this also brings significant disadvantages:
Wouldn't it be great if we could borrow ethereum's security to create scalable ecosystems? Access layer 2 networks, especially "Rollup". In short, Layer 2 is a separate ecosystem that sits on top of Ethereum and its security depends on Ethereum.
Crucially, this means layer 2 doesn't need to have native tokens -- so not only are they more complementary to Ethereum, they're essentially part of Ethereum. Ethereum's roadmap even pays homage to the idea by saying that Ethereum 2.0 will be "rollup-centric."
How Rollup works
Layer 2 is often referred to as Rollup because they "Rollup" or bundle transactions together and execute them in the new environment before sending updated transaction data back to Ethereum. Rather than having the Ethereum network handle 1000 Uniswap transactions alone (expensive!) Better to unload the calculation on layer 2 summary (cheap!) before committing the result back to Ethereum. .
However, when the results are sent back to Ethereum, how does Ethereum know that the data is correct and valid? How does Ethereum prevent anyone from Posting incorrect information? These key questions distinguish two types of Rollup: Optimistic Rollup and ZK-rollup.
Optimistic Rollup
"Optimistic" in Optimistic Rollup assumes that it is valid when a result is submitted to Ethereum. In other words, they let the Rollup operators publish whatever data they want (including potentially incorrect/deceptive data) and assume it's correct -- a very Optimistic prospect, no doubt! But there are ways to combat fraud. As a check and balance, there is a window of time after any withdrawal where anyone can look for fraud (remember, blockchain is transparent and anyone can see what's going on).
One of the observers can prove mathematically that fraud has occurred (by submitting a fraud certificate), and Rollup will restore any fraudulent transactions, punish bad participants and reward the observer (a clever incentive system!). .
The downside is that there is a short delay when a user moves money between Rollup and Ethereum, waiting to see if any observers have detected any fraud. In some cases, this can be as long as a week, but we expect these delays to decrease over time.
The key is that Optimistic Rollup is intrinsically connected to Ethereum and ready to help make Ethereum the scale it is today. As a result, we have seen strong initial growth as many of the leading DeFi projects have switched to leading Optimistic rollups - Arbitrum and Optimistic Ethereum.
Arbitrum and Optimistic Ethereum
Arbitrum and Optimistic Ethereum are the two main projects currently implementing Optimistic Rollup. It's important to note that both companies are still in the early stages, and both maintain a level of centralized control, but both plan to decentralize over time.
It is estimated that Optimistic Rollup can increase scalability by 10-100 times once mature. Even in its early days, DeFi applications on Arbitrum and Optimism have accumulated billions of network values.
Optimistic has deployed over $300 million of TVL across seven DeFi apps, most notably Uniswap, Synthetix and 1Inch.
Arbitrum goes a step further, investing about $2.5 billion in TVL among more than 60 applications, including familiar DeFi protocols such as Curve, Sushiswap and Balancer.
Arbitrum was also selected as Reddit's extension solution for their long-awaited effort to flag community points for the social media platform's 500 million active users.
ZK-Rollup
Optimistic Rollup assumes that transactions are valid and provides room for others to prove fraud, whereas ZK-Rollup actually proves to the Ethereum network that transactions are valid.
As a result of the bundling, they submit so-called proof of validity to ethereum smart contracts. As the name suggests, validation lets the Ethereum network verify that transactions are valid, making it impossible for Repeaters to trick the system. This eliminates the need for proof of fraud, so transferring funds between Ethereum and ZK-rollup is an efficient just-in-time operation.
While instant settlement and no withdrawal times sound great, ZK-Rollup isn't without trade-offs. First, generating validity proofs requires a lot of computation, so high-performance machines are needed to make them work. Second, the complexity surrounding proof of validity makes it more difficult to support EVM compatibility, limiting the types of smart contracts that can be deployed to ZK-ROLLup.
So Optimistic Rollup entered the market first and is more capable of addressing ethereum's current scale issues, but zK-Rollup could be a better technical solution in the long run.
The adoption of the ZK - a Rollup
The case for ZK-rollup goes deep, with multiple teams implementing it both in work and in production. Some notable companies include Starkware, Matter Labs, Hermez, and Aztec. Today, ZK-Rollup mainly supports relatively simple applications such as payments or exchanges. For example, derivatives exchange dYdX uses Starkware's (StarkEx) ZKRollup solution to support nearly 5 million trades per week and over $1 billion in TVL.
However, the real credit is given to the ZK-Rollup solution, which is fully EVM compliant and therefore able to support popular general-purpose applications (such as the complete suite of DeFi applications) without the withdrawal delay of Optimistic Rollup. The major players in this space are MatterLab's zkSync 2.0, Starkware's Starknet, Polygon Hermez's zkEVM and Polygon Miden, all of which are currently working on mainnet releases. (Aztec, meanwhile, is focused on applying ZK proofs to privacy).
Many in the industry (including Vitalik) are considering zK-rollup in combination with Ethereum 2.0 as a long-term solution to extend Ethereum, primarily because of their ability to fundamentally process hundreds of thousands of transactions per second without compromising security or decentralization. The upcoming FULLY EVM-compatible ZK-Rollup will be one of the key issues to watch as Ethereum evolves.
A broken world
In the long term, these scalable solutions are necessary if smart contract platforms are to scale to billions of users. In the short term, however, these solutions may pose significant challenges for users and encryption operators. Navigating from Ethereum to these networks requires the use of cross-chain Bridges, which are complex and potentially risky for users. For example, some cross-chain Bridges have been targeted.
More importantly, a multi-chain world breaks down composability and mobility. Consider Sushiswap is currently implemented on Ethereum, Binance Smart Chain, Avalanche, Polygon, and Arbitrum. Sushiswap's liquidity was once concentrated on one network (Ethereum); now it is spread across five different networks.
Ethereum applications have always benefited from composability -- for example, Sushiswap on Ethereum can plug and play with other Ethereum applications like Aave or Compound. As applications scale to new networks, applications implemented at layer 1 / side chain/Layer 2 can no longer be combined with applications implemented at another layer, limiting availability and posing challenges for users and developers.
An uncertain future
Will a new tier like Avalanche or Solana continue to grow and compete with Ethereum? Will blockchain ecosystems like Cosmos or Polkadot proliferate? Will the side chain continue to work in harmony with Ethereum, shouldering its excess capacity? Or will Rollup, combined with Ethereum 2.0, win? No one can say for sure.
While the future is uncertain, we should take comfort in the fact that so many smart teams are working on some of the most challenging issues facing open, permission-free networks. Just as broadband ultimately helped the Internet support many revolutionary applications, we believe we will eventually see these successful scale solutions in the same light.
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