Will Harborne is the Founder and CEO of non-custodial exchange DeversiFi.
This is a pivotal year for Ethereum layer 2 (L2) solutions. What happens over the coming months will be critical in making decentralized finance (DeFi) work better, faster, and more reliably for a far greater number of users.
Last year saw L2 solutions roll out with great promise, increasing the number of decentralized apps across verticals such as exchanges, marketplaces, wallets, bridges, and more. Yet the growing user base and total value locked on Ethereum L2 were eclipsed by alternative layer 1 blockchains emerging to fill the market gaps that persisted such as Ethereum’s scalability issues. With multiple apps deployed across chains, we are now seeing increasing fragmentation that adds complexity for end-users and detracts from the ultimate goal of making DeFi accessible for all.
This year, L2 solutions will not only fulfil the promise of DeFi without compromise but take DeFi usage to even greater heights. The pieces of the puzzle – hitting critical development milestones, and L2’s increasing relevance in a multi-chain environment – are set to come together this year to make this a reality.
[Layer 1 (L1) is the base protocol (the Ethereum blockchain), while layer 2 (L2) is any protocol built on top of Ethereum.]
Fulfilling the promise of DeFi without compromise
Ethereum creator Vitalik Buterin has claimed that (L2s or) “rollups are in the short and medium-term, and possibly in the long term, the only trustless scaling solution for Ethereum”. We have seen this start to play out, with the total value locked (TVL) in layer 2 protocols such as StarkNet, Arbitrum, and Boba Network growing from USD 50 million to a high of USD 7 billion.
However, many alternative L1s such as Solana, Avalanche, and Terra have completely outpaced the Ethereum ecosystem and have achieved higher individual TVLs than all L2s combined.
It’s clear there is a huge demand for blockspace, and alternative layer 1 chains have provided solutions for many of Ethereum’s downsides thus far, including fees and speed of transactions, which have significantly risen as more dapps were created and transactions congested the Ethereum network.
That said, we are in danger of losing the elements of decentralisation that are the foundation of this emerging industry.
While alt-L1s can presently optimize for higher throughput and lower transaction fees, development in the Ethereum ecosystem aims to achieve that while strengthening its building blocks of security and decentralization.
Zero-knowledge technology upgrades, a catalyst for growth
The future of decentralization is L2, and Zero-Knowledge (ZK)-based solutions are widely regarded as the optimal scaling technology due to their robust process of verification. ZK uses cryptographic proofs to validate the legitimacy of all transactions, compared to Optimistic rollups where users can submit “fraud proofs” in suspected fraudulent cases. The former requires validation to be accepted onto Ethereum, whereas the latter assumes legitimacy unless disputed. ZK also processes transactions faster as they do not have waiting periods for potential disputes.
ZK-led developments were an early catalyst for L2 growth, early to this was Starkware whose existing solution, StarkEx, is already used by top 10 L2 dapps including dydx, Immutable X, and DeversiFi. This shift matters because the current solution, StarkEx is a permissioned and customized scaling engine secured by Starkware and only available to clients. The new StarkNet that is already ready for the deployment of dapps, is a permissionless and decentralized ZK-rollup that allows anyone to deploy smart contracts and secure transactions.
This moves the wider Ethereum ecosystem forward in achieving its decentralisation ideals.
Initiatives key to generating traction this year
This year, we will see a greater number of apps launching natively on L2 rather than on Ethereum L1 or other side-chains and L2 will become the dominant way of using Ethereum. Instead of porting over existing Solidity code from Ethereum, developers will increasingly write L2-native protocols. Without the need to pass through a congested layer 1 Ethereum, coupled with L2’s high capacity and low cost, we will witness major bandwidth expansion this coming year.
We predict there to be a higher TVL locked in Ethereum L2 DeFi than L1, as well as higher trading volumes. Ethereum L1 will gain almost no new users, and rather be used by bots, and as a liquidity store for big pools like Uniswap and Aave. But almost all end user interactions will take place solely on Ethereum L2 by the end of the year.
However, there is a lot more left to be done to address low levels of user activity on L2. Where L2 apps have fallen short of expectation and where we see great opportunity to level up this year is in community engagement. For instance, the lack of native tokens on L2 solutions may be a reason why growth has not been as rapid as on alt-L1s. Launching a native token can help spur growth and liquidity.
To compete with alt-L1s, rollup tokens could be an effective incentive to drive migration to L2 through initiatives such as airdrops to community members, and liquidity mining programmes to incentivize token holders. L2s should also enable cross-L2 token bridges to drive more seamless user engagement within the ecosystem, while setting up developer incentives to reward them for development work and encourage more innovation and efficiency.
Emergence of multi-chain ecosystems stimulates L2 growth
The emergence of a multichain world is providing a fresh stimulus for DeFi and for L2 as multiple blockchains work together and have an increasing dependence on L2s for their specific superior features.
It should not take highly technical DeFi know-how, dozens of failed transactions, hours of worry over ‘lost’ funds in bridges, and stuck transactions to give people the confidence to seek out and access the best of DeFi opportunities.
Anyone should be able to connect their non-custodial wallet and access the best of DeFi, with confidence that their funds are always safe and that they are always in control.
As the multi-chain reality expands everyday, we will see a more pressing need for users to be able to access the best of the multi-chain world, directly from the ease, convenience, and privacy of their own L2 control center. As this need grows, we will see more and more use cases, support, and integrations across Ethereum. There will be more L2s connected by bridges, and users currently stuck on different chains will instead find it easier to fulfill all their needs through interactions within the Ethereum ecosystem.
L2 2022 is here
To be sure, pushing DeFi projects to work better, faster, and more reliably is no easy feat. L1 blockchains will continue to gain momentum and be popular alternative choices, growing on last year’s momentum.
However, it’s no longer the case that ‘winner takes all’, and it is likely the case that rather than competing for existing market share, the DeFi pie will simply grow.
The pivotal building blocks of L2 are being put in place this year to increase decentralization, and therefore access, improve community engagement, and therefore traction, all within a multi-chain environment that increasingly relies on L2 as a control centre.
With L2 ecosystem projects playing their part, L2s and the wider Ethereum ecosystem will rise to greater heights, fulfilling the ideals of DeFi while delivering greater outcomes for users.