Welcome to the Etherverse. There are quite a few destinations on our trip, but first, we should take a moment to discuss the need for such blockchains to exist, and get acquainted with some terms and concepts. Layer 2s are a critical piece of infrastructure needed to prepare for the expanding use of blockchain technology. Whether that is a public layer 2 for people to buy and sell stuff, or a private layer 2 meant to handle in-game transactions, layer 2s are a logical response to the blockchain trilemma.
You might have heard the term blockchain trilemma before. It’s not as scary as it sounds, it’s simply a mental model for understanding the three big challenges facing any blockchain. Those challenges are scalability, decentralization, and security. The perfect balance of these three things can mean the difference between world domination and historical obscurity. The scalability challenge is where layer 2s unlock massive potential for Ethereum. Currently, Ethereum can process around 12-16 transactions per second (TPS). This might seem all right until you compare it to something like Visa. In 2021, the Visa payment network processed an average of 7,372 transactions per second. So yeah, 16 TPS isn’t going to cut it if Ethereum wants to onboard the world. So we need layer 2s, but how does it work?
There are two types of layer 2 solutions, rollups, and plasma. For our purposes, we won’t be getting into plasma (it’s slightly older tech and not currently being used by the popular layer 2s).
A rollup gathers up loads of transactions on layer 2 into a single transaction that gets settled to the layer 1 chain. There are two types of rollups right now, optimistic and zero knowledge (hereinafter referred to as zk). They each have pros and cons, but for our purposes, let’s just outline a few key differences.
Optimistic rollups are exactly that, optimistic. They presume that all transactions sent to layer 1 are valid without any proof. There is a waiting period of about a week for proofs to be rejected by network participants. If a network participant can prove that a transaction is fraudulent, it is rejected. Optimistic rollups can also execute smart contracts directly on layer 1, kind of cool.
Zk rollups process transactions off-chain and create a batch before posting to layer 1. They generate a cryptographic proof, called a SNARK (succinct non-interactive argument of knowledge), that can verify the transactions without needing every single detail about each transaction. Since the proof is submitted with every batch, there is no waiting period for proofs to be rejected. This makes the on-chain processing speed of zk rollups significantly faster than optimistic rollups. Unlike optimistic rollups, zk rollups are not capable of using smart contracts directly on layer 1. All right, now that we got all the nerd talk out of the way, let’s talk about some specific layer 2 ecosystems.
Up first is the home of GMX and TreasureDAO, sporting a cozy $800m in total locked value (TVL), it’s Arbitrum! Arbitrum is an optimistic rollup that went live on September 1st, 2021, and saw a TVL of $2.7b by November of 2021 (this has since plummeted, obviously). Most popular layer 1 DeFi products, such as Aave, Uniswap, Sushiswap, and Yearn are available on Arbitrum, but the real star of the Arbitrum DeFi scene is the decentralized perpetuals market GMX. Thanks to high speeds and low-cost transactions, GMX can offer low fees, zero price impact perpetuals trading on-chain. This is something that would not be feasible on the Ethereum mainnet due to lower transaction speeds and higher transaction costs. GMX is definitely the popular kid on Arbitrum as it accounts for nearly 25% of TVL across the entire chain.
The NFT scene on Arbitrum is centered around TreasureDAO. Their marketplaces have done roughly $264m in volume since last November across 35.9K unique wallets. They claim to be building a decentralized Nintendo with a variety of NFT games all using the same currency called $MAGIC. The previous iteration of their marketplace was exploited on March 3rd, 2021 with several NFTs being bought and sold without permission from the owners. Nearly all of the stolen NFTs were returned to the original owners, and the exploit was fixed. The $MAGIC token has lost a lot of value similar to other small market cap tokens, but people continue to keep building with it. The NFT scene on Arbitrum will be very interesting to watch as Arbitrum Nitro (protocol upgrade for faster speeds and cheaper transactions) comes online in the near future.
Next up is Optimism! With a TVL of $556m, things are looking up for this optimistic layer 2. It went live in early July of 2021 but has seen an explosion in usage following the release of the $OP token this summer. Their native token is used as a bootstrapping mechanism for new projects and projects they deem to be “public goods.” Public goods funding is a new angle, and time will tell how much this will contribute to the success of Optimism. The most dominant protocol on Optimism is currently Synthetix, taking up a whopping 34% of all TVL. They host a variety of financial derivatives using synthetic assets (get it? Synthetix. lol). You can trade real-world assets without having to log into your Robin Hood account! The really interesting thing is that other protocols on Optimism are able to use Synthetix to make some interesting products without worrying about all those low speeds and high fees on layer 1.
Let’s highlight a couple of fun and interesting protocols currently running on Optimism. Thales Protocol is a platform for peer-to-peer parimutuel markets. Nice, what is that? Parimutuel markets take all of the collateral from participants and place it in a single pool for payouts. Once the market-settling event happens, then all the winners are paid from the shared pool (with a fee going to the house of course). This is basically what you do on holidays when your cousin Terry gets hammered and you all take bets on whether they will make it to work on time at Old Navy the next day. On Thales, you can buy and sell positions based on token prices at some date in the future (think options trading). The really fun thing about Thales is the exotic market.
You can take positions on anything from sporting events to crypto events. My personal favorite is “Will Avatar 2 break the record for the largest domestic opening weekend in terms of box office results (domestic gross USD), per the-numbers.com?”. Yes, it will, even if I have to go see it 50x at the downtown AMC where parking is terrible.
Speaking of betting, who doesn’t like the lottery? At the time of writing this, Mega Millions has a prize of $1.28b. That’s a lot of Wendy's Bourbon-Bacon Cheeseburgers, but if you don’t win, all that cash is dust in the wind. What if you could enter a lottery and not lose your ticket prices? Well, you are in luck! Pool Together is live on Optimism. Pool Together is a “crypto-powered savings account based on premium bonds” per their website. Basically, it’s a no-loss lottery. You can park some stablecoins in the protocol and get a chance to win some cash without losing your money (unless they get hacked/exploited of course). The protocol is live on several blockchains, but Optimism boasts the largest TVL for Pool Together thanks to the incentive rewards with $OP tokens.
All right, it’s time to talk about the elephant in the room, Polygon. Is it layer 2? Is it a side chain? Is it something else? The answer is yes. Polygon is an absolute behemoth. With $1.92b in TVL and a dump truck load of partnerships, Polygon is poised for continued success in 2022. Polygon offers a variety of Ethereum scaling solutions. The Polygon PoS chain is the most familiar solution. Transactions are settled directly on the PoS chain, and staking nodes and checkpoints are used on Ethereum to leverage Ethereum’s security. If you are building something and don’t want to use the PoS chain, you could decide to spin up a separate blockchain using Polygon technology to create optimistic or zk rollups. Polygon has just recently announced their zk rollup that is EVM (Ethereum Virtual Machine) compatible. This is big news for developers who want to use the EVM without deploying on mainnet Ethereum.
The business development arm of Polygon has been humming all year. They have recently announced a flurry of partnerships. Instagram will be using Polygon to bring NFTs to their platform. Stripe is using Polygon to support crypto payments. Adobe is integrating Polygon into their Behance platform for NFT creation. Draftkings uses Polygon for its NFT marketplace. Speedchain (business to business payment platform) is partnering with Polygon for a custom Ethereum layer 2. The list goes on and on. If you are looking for something blockchain related, chances are Polygon has something to offer you.
Immutable X is another layer 2 that has had several big partnership announcements this year. Their zk rollup is lightning fast and they pay for all the gas fees (yay!). The IMX layer 2 was created out of necessity. Their God’s Unchained digital collectible card game needed a solution to fix slow transaction speeds and high gas fees. So they created IMX. They are positioning their layer 2 to be the premier place for gaming blockchain integrations.
The highly anticipated game Illuvium is using IMX as its blockchain of choice. The game's recent land sale saw $72m in profits. In June of this year, Immutable announced a $500m venture fund to build blockchain enhanced games. The popular collectibles platform Veve, who partners with Disney and Marvel, migrated to IMX last December. If you are into gaming and affordable name brand NFTs, IMX is your spot.
There is so much happening in the Etherverse right now. We have only scratched the surface of the bustling economies being secured by Ethereum. In the next few months, new zk rollups with EVM compatibility are coming online from Polygon, zkSync, and Scroll. New financial tools, new games, new scams, and new friends are all ripe for the picking in this environment. It’s an exciting time to be part of the Ethereum community as the world is being onboarded to the blockchain through layer 2s.
Unless everything goes to zero first.