Ethereum’s Second- Layer Projects Duke It Out for Dominance

An update to Ethereum last month dubbed “The Merge” cut the second-largest blockchain’s energy costs by more than 99%, but it didn’t address its largest barriers to user adoption: high fees and slow speeds.

As more updates aimed at these problems lie around the corner, several projects and companies are duking it out with their own solutions for solving Etheruem’s user experience shortcomings. The winner (or winners) of this competition will play a major role in defining Ethereum – and assuring its survival – in the years to come. But the shift to this new future has been slow going.

This article originally appeared in Valid Points, CoinDesk’s weekly newsletter breaking down Ethereum’s evolution and its impact on crypto markets. Subscribe to get it in your inbox every Wednesday.

Ethereum’s UX woes

Anyone who has used Ethereum will be familiar with the bummer that is gas fees – a sort of tax that users pay on transactions to help keep the network up and running.

At the peak of crypto’s last hype cycle, network congestion sent Ethereum transaction fees through the roof. Simply sending tokens from one blockchain address to another could’ve cost as much as $5, and more complicated actions – like exchanging currencies via a decentralized exchange like Uniswap – were often so expensive as to become cost-prohibitive (think flat rates of $40 swap).

Ethereum’s ability to expand will not depend on upgrades to its core technology, but on “rollups” – third-party networks that provide a quicker, cheaper platform for transactions.

Rollups like Arbitrum and Optimism solve for Ethereum’s high fees by processing transactions quickly and cheaply on a separate “layer 2” network that runs alongside Ethereum. These layer 2 transactions get bundled up and passed back down to Ethereum’s main network with some kind of mechanism to “prove” they haven’t been tampered with. If everything checks out, the transactions are recorded in Ethereum’s ledger like any other.

Read more: What Are Layer 2s and Why Are They Important?

Rollup networks are generally considered the answer to Ethereum’s scaling woes – enabling the Ethereum ecosystem to welcome new users without making any updates to its core code.

Arbitrum and Optimism, the first rollups to launch, were welcomed with open arms by an Ethereum community desperate for a more usable blockchain network, and it was hoped that Ethereum app builders would move en masse to their cheaper shores rather than leave the ecosystem altogether in favor of newer blockchains (e.g., Solana) or less-secure sidechains (e.g., Polygon).

But it hasn’t been smooth scaling for Ethreum’s keystone rollups. Arbitrum and Optimism have thus far failed to gain the sort of traction their creators envisioned at the height of 2021’s crypto mania, and the emergence of more technically advanced competitors threaten to render them obsolete before they even leave a mark.

The Optimistic rollup race

Today, Arbitrum and Optimism house a combined $3 billion in assets – paltry in comparison to Ethereum’s total value locked (TVL) of $60 billion.

The teams behind Arbitrum and Optimism have vied to increase their market shares through a series of product launches, incentive programs and community outreach campaigns.

Arbitrum, for its part, recently launched Arbitrum Nitro – a splashy update to its platform with across-the-board user experience upgrades. The team built out a cheaper and faster (albeit slightly less secure) version of the network aimed at more demanding applications, such as gaming.

For a while, Arbitrum’s usage was an order of magnitude higher than Optimism’s, but Optimism eventually managed to make headway with the launch of its native OP token. The rollout of Optimism’s token and accompanying community governance system was initially bungled, but the token has, in recent months, succeeded in attracting users to the platform.

One piece of evidence that OP has aided network adoption is the growth of Optimism’s version of Aave, a stalwart of crypto lending and borrowing that initially launched on Ethereum. Aave expanded to Arbitrum and Optimism this year, but Optimism, unlike Arbitrum (which has no token) offered OP tokens as an incentive for people to use Aave on its network.

The OP incentive program caused Aave’s lending volume on Optimism to blow past that on Arbitrum, whose creators have shied away from providing the same kind of direct economic incentives for users to jump aboard.

Optimism’s TVL of $1.9 billion, a key – albeit imperfect – measure of network adoption, recently surpassed Arbitrum’s $1.5 billion TVL, with its success owing largely to the Aave/OP token incentive program (Aave alone accounts for more than 60% of Optimism’s TVL).

But Optimism cannot yet declare victory in Ethereum’s rollup race. Earlier this week, Aribitrum boasted double the number of active addresses compared to Optimism, according to blockchain analytics firm Nansen. It’s not a sure bet, moreover, that Optimism’s OP handouts will be a sustainable way for it to extend its TVL lead: Crypto’s addiction to subsidizing users in search of high yields has, in the past, come under fire for attracting disloyal, mercenary capital as opposed to building organic communities.

The rise of ZK rollups

The success of Arbitrum and Optimism may ultimately lie less in how they compete with each other and more in how they adapt to the emergence of new rollup technologies.

Arbitrum and Optimism are both “Optimistic” rollups. In these systems, after rollup transactions are bundled up and passed down to Ethereum, network operators have a period of time in which they can pore over transaction data and reject any activity that looks fishy. This mechanism – which “optimistically” assumes transactions are correct unless they are disputed – carries the potential for delays and security vulnerabilities.

But there’s a new kid on the rollup block. So-called zero-knowledge (ZK) rollups work similarly to Optimistic rollups by processing transactions on a layer 2 network, but they use fancy cryptography – so-called zero-knowledge proofs – to definitively prove that the transactions they pass down to Ethereum are trustworthy.

Read more: What Are Rollups? ZK Rollups and Optimistic Rollups Explained

As Arbitrum and Optimism are finally beginning to show some signs of growth, several competitors are already gearing up to launch “zkEVMs” – ZK-rollup networks that, like Arbitrum and Optimism, can support virtually any Ethereum-based application.

Ethereum scaling behemoth Polygon recently launched a test version of its zkEVM, and two other companies – Matter Labs (the creators of zkSync) and Scroll – are operating on a similar timeline.

In comparison with the optimistic, give-’em-the-benefit-of-the-doubt tech used by Aribtrum and Optimism, ZK tech is generally considered more advanced and secure.

But fully fleshed-out ZK rollups were thought to be years away when Optimistic rollups debuted last year, and there’s a chance that the hubbub around soon-to-arrive ZK rollups is partially marketing hype.

“I’m skeptical that the ZK technology is ready to operate at the scale that is needed to run a competitive layer 2,” Ed Felten, the Princeton Computer Science professor who co-founded Arbitrum builders Offchain Labs, told CoinDesk. “For general [Ethereum applications], I’m very skeptical that they will be ready to do that soon. … Maybe one of these systems will come out and be fully functional and have fully working ZK proofs soon, but I would bet against that occurring.”

The Arbitrum and Optimism teams recognize, however, the theoretical advantages of ZK technology and have expressed openness to integrating it into their platforms once it matures.

“We’ve said from the beginning, it has always been our strategy that we are not tied to Optimistic as opposed to ZK [rollups] in terms of what we provide, and if the moment comes when we think ZK is viable for what our user base needs we would switch,” said Felten.

Whatever the long-term ZK plans of Optimism and Arbitrum, it’s difficult to imagine that Ethereum’s rollup first-movers are undaunted by the trio of competitors nipping at their heels.

Proto-danksharding and danksharding

Whether or not Arbitrum, Optimism, or some new ZK contender ultimately takes Ethereum’s rollup throne, the Ethereum community is going all-in on a vision where rollups become the network’s main point of entry.

Read more: Scaling Ethereum Beyond the Merge: Danksharding

Key to Ethereum’s rollup-centric vision will be danksharding and proto-danksharding – a set of network upgrades that will make it easier for rollups to pass data back down to Ethereum’s base chain.

Sharding is a method of increasing network transaction capacity – thereby increasing fees and decreasing costs – by splitting up activity across multiple “shards,” almost like adding new lanes to a congested highway. Sharding was initially slated to accompany Ethereum’s shift to a proof-of-stake consensus mechanism, but it was deprioritized due to its technical complexity and the fact that rollups were already solving some of Etheruem’s most pressing scaling problems.

Now that Ethereum’s Merge and transition to proof-of-stake is out of the way and the rollup landscape is beginning to mature, developers have put sharding back on its roadmap – but with a rollup-focused twist.

Rather than making it easier for Etheruem to handle more transactions, proto-danksharding and danksharding will make it easier for the network to process abstract “blobs” of data. Ethereum’s network was initially optimized to handle transactions one by one, but rollups pass down lumps of data representing large groups of transactions. The more data the network can handle, the more layer 2 transactions it will be able to process.

“Both [danksharding and proto-danksharding] will significantly reduce the cost of data on Ethereum, which is the biggest source of cost in operating layer 2 systems like ours,” Felten said. “So those mean a substantial reduction in cost and therefore substantial reduction in fees that our users pay.”

Though Optimism and Arbitrum have thus far struggled to attract the lion’s share of Ethereum users, these upgrades all but guarantee that they (and their soon-to-arrive competitors) will have a key role to play whenever the next crypto craze arrives.

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