Last updated on May 3rd, 2024 at 08:17 pm
Interest in Ethereum’s scalability solutions has gone way up this year. On March 16, Layer 2 networks saw a significant spike, with transactions surpassing Ethereum’s mainnet by 48%. On that day, Orbiter Finance reported over 1.54 million transactions on Layer 2 platforms, more than Ethereum’s 1.04 million transactions. On February 22, Layer 2 transactions peaked at 1.52 million.
However, this rising interest has caused some issues for Ethereum. As transactions grew, platforms like Arbitrium had problems coping with the massive transaction volume, facing interruptions while handling as many as 11 million inscriptions within a specific period. Ethereum, in contrast, registered a relatively modest 2 million inscriptions.
Inscriptions are a type of data, usually metadata of tokens or NFTs, recorded on blockchains. They are a more cost-effective alternative to smart contracts, requiring less gas. The surge in inscription use is primarily driven by speculative trading of low-value assets.
Data points show that more and more Ethereum users are leaning towards Layer 2 scaling solutions because they offer faster and cheaper transactions compared to the Ethereum mainnet, raising critical questions about how useful Ethereum will be in the future.
The Layer 2 Landscape in 2023
This year was quite competitive in the Layer 2 space, with several new projects launched. One standout performer was Arbitrum, which saw a 47% increase in daily transactions and a 100% growth in market capitalization. This allowed Arbitrum to surpass Polygon in the total value locked (TVL) on-chain, a key metric reflecting the on-chain value and user preference.
While Polygon held down the top spot for daily transactions, Arbitrum showed strength with a significantly higher TVL compared to Polygon and Optimism. Arbitrum’s current $2.35 billion TVL outpaces Polygon and Optimism’s $844 million and $810 million, respectively.
Arbitrum’s dominance is evident in the DeFi protocols and applications it hosts, including popular DEXes like Uniswap, AAVE, and GMX.
Not only Arbitrum and Polygon stole the show in 2023; Optimism also scored record-high demand in 2023, driven by initiatives like Coinbase’s sandbox, launched on July 21 to provide developers with a test environment for new applications. The blockchain-based universal identity project, Worldcoin, also contributed to Optimism’s success by deploying most of its Safe wallets on the chain. Worldcoin’s token airdrop on July 26 further increased activity on Optimism.
Coinbase’s Layer 2 solution, Base, also stood out among the new entrants. Launched in August, it set a new daily transaction record of 1.88 million on September 14, surpassing Optimism and Arbitrum. However, it still trailed behind the established leader, Polygon, which recorded 2.1 million transactions on the same day. Despite its transaction milestone, Base’s daily active users on September 14 numbered around 86,000, lower than its previous high.
Base gained attention for features like token bridging, swapping, liquidity provision, and NFT issuance. Within weeks of its launch, it attracted over $242 million in assets and boasted 130,000 daily unique wallets. Although Base operates on the Optimism-Ethereum stack, its unique features, such as sequencers for Mainnet transaction processing, quickly gained traction.
The Impact on Ethereum’s Utility
While Ethereum paved the way for innovative decentralized applications and DeFi protocols, its success came at a price. Before Ethereum’s transition from Proof of Work (PoW) to Proof of Stake (PoS), the network grappled with well-documented limitations in transaction throughput and scalability. These challenges led to network congestion and high transaction fees, particularly during periods of high demand.
To tackle these problems, the Ethereum community explored solutions, leading to the development of Layer 2 scaling solutions. These are built on the main Layer 1 blockchain and use various technologies to enhance network efficiency, enabling faster and more cost-effective transactions while maintaining principles like security and decentralization.
In the past eight months, Ethereum’s transaction fees have remained relatively low, averaging $2 to $6 per transaction, according to BitInfoCharts. This decrease is attributed to the increased adoption of Ethereum’s Layer 2 scaling solutions.
David Lawant, head of research at FalconX, noted,
“Ethereum L1 fees since friends.tech launched on August 10 are 25% lower than the average for the year until then.”
On August 27, the total daily fees paid by users for executing transactions on Ethereum reached a record low of 1,719 ETH ($2.8 million), down 89% from the year-to-date high observed on May 5, according to data from CryptoQuant.
While this is seen as a positive development for the chain, some experts think there could be more to this increased adoption of Ethereum Layer 2 scaling solutions.
A report by RxR Research in 2023 contended that the network is trading below its fair value by 27% when certain vital factors are holistically considered. According to the report, Ethereum’s network valuation is just north of $375 billion.
Unlike traditional models focusing on mainnet users, RxR’s models incorporate data from Ethereum’s Layer 2 networks, providing more reliable long-term forecasts.
The report employed a modified Metcalfe-centric model to reach its conclusion, noting that existing models do not take scaling dynamics into account. Traditional models place a premium on the number of active users on the network’s mainnet, but RxR’s models incorporate data from Ethereum’s Layer 2 networks.
The report highlights that including L2 activity provides more reliable data for long-term forecasts. The analysts emphasized that ignoring off-chain and L2 activities may present an overly pessimistic view that the Ethereum network is overvalued because it is not known if the adoption of L2s has taken some of Ethereum’s value in terms of market cap.
Final Thoughts
With experts tipping Ethereum to rise due to market and on-chain activity, the impact of significant numbers on Layer 2 solutions becomes crucial in assessing the robustness of the Ethereum chain and its value. The decline in total fees paid is a key indicator of low network usage, closely linked to the level of activity and pending transactions. The eight-month low in fees is attributed to the increasing popularity of Ethereum’s Layer 2 scaling solutions, reflecting a positive, long-term development for the Ethereum network.
The rise of Layer 2 solutions contributes to a more efficient and cost-effective transaction environment, enhancing the overall functionality of the Ethereum ecosystem. As Ethereum continues to evolve and adapt to address scalability challenges, the positive trajectory driven by Layer 2 scaling solutions is expected to further bolster its position in the market.
Disclaimer: This piece is intended solely for informational purposes and should not be considered trading or investment advice. Nothing herein should be construed as financial, legal, or tax advice. Trading or investing in cryptocurrencies carries a considerable risk of financial loss. Always conduct due diligence.
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