Will Layer 2 Continue to Boom?

Layer 2 (L2) solutions are on the rise — often hard to resist as the solutions boast of more transactions performed at a lower cost and at a faster rate. At their peak, Layer 2 solutions process 40,000 more transactions than the Bitcoin network in a single day — showing strong demand for the solution over Layer 1. But with the rollout of Ethereum 2.0 on the horizon, will Layer 2 continue to roll in hot — or roll by like a fad?

Source: Arbiscan

Layer 2 Takes Flight

What are Layer 2 solutions? A Layer 2 solution is best described as a scaling solution on top of mainstream Layer 1 solutions i.e., Bitcoin and Ethereum. To put it simply, L2 is similar to payment gateways such as VisaNet and Mastercard, but with added security. Its integration could be a boon to users seeking a new vista from L1’s occasional network congestion and high processing fees. 

With more users and protocols from the NFT frenzy, the Ethereum network is processing more transactions than before, leading to higher transaction fees and slower transaction time. Indeed, Ethereum’s average transaction fee at the time of writing is rising to $19.32 while processing only 15 transactions per second (TPS).

Source: Glassnode

Layer 2 is primed to level up Layer 1 solutions with the ability to process up to 4,000 TPS for a small fee. Arbitrum is one epitome of optimistic rollups. The Optimistic rollup processes less data on-chain, slashing Ethereum’s current transaction cost by 90%. 

Illustration of Arbitrum infrastructure by Offchain Labs.

Driven by increased congestion on the Ethereum network, investors have flocked to Layer 2 projects, driving the total value locked (TVL) in L2 projects to $3 billion at the time of writing — and 70.9% of the aggregate TVL can be attributed to Arbitrum. 

Source: L2Beat

However, will investors still see the incentives of using Layer 2 after Ethereum 2.0 ships? Perhaps the blockchain trilemma — decentralization, security and scalability — can help to explain the nuts and bolts. In absence of Layer 2 integrations, Ethereum will focus on scaling through specialized nodes, downplaying decentralization and security of the network.

Phase 1 of Ethereum 2.0 will focus on sharding, which stretches out the network’s load over 64 new chains. As a result, Ethereum 2.0 will see an increase in network efficiency and Layer 2 rollups will be scaled. 

With Arbitrum’s native token, ArbiNYAN, flatlining at around $0.30 for the past week, can the much-anticipated Layer 2 project sustain its growth?

Layer 2 Bridges Multichain 

To find the utility value of a network layer, we can apply Metcalfe’s Law. The theory suggests that a network’s value should be proportional to the square of connected users (a.k.a. the network effect). Currently, the unique active addresses of Arbitrum stand at 160,172, and the square of it represents 10x of its current TVL — indicating much room for growth. 

The network effect is also evident in the eight Ethereum cross-chain bridges, with TVL of the bridges rising to $10 billion. With Polygon and Arbitrum bridges constituting 70% of the pie, Layer 2 is becoming the go-to integration for interoperability between the different chains.

Source: Dune Analytics

Putting the numbers into context, the newly launched Arbitrum is leveling up big names in DeFi. For example, Arbitrum One is enabling smart contract users direct access to Chainlink’s decentralized services. In another major partnership, Polygon is teaming up with NFT and DEX platforms to create a new frontier — a multichain-verse.  

Layer 2 Enables Layer 1 Projects to Reach Greater Heights

The launch of the World Wide Web is never a one-click success; a second layer integration was added to proliferate the Internet we are using today. Similarly, Layer 1 projects will mature and reach greater adoption rates with the enhanced user experience that Layer 2 provides.