DeFi is known to facilitate open on-chain financial activities through its combinability and lack of licensing, rapidly forming a more efficient money market through individual DeFi protocols. However, as of now, the DeFi world, which upholds an open and inclusive low barrier due to expensive Gas fees, is turning into a game that seems to belong only to giant whale users. Transaction fees in different DeFi protocols can easily range from $50 to $200, discouraging many retail investors and seriously hindering DeFi from achieving its goal of the next 10 million users.
To address this issue, some of the head DeFi protocols are trying to find a change of scenery by deploying and moving to Layer2. For example, Synthetix has pledged 5.3 million SNXs on Optimism, representing 5% of its total SNX pledges in L1. Aave currently has $2 billion in TVL on Polygon after turning on liquidity mining, but it still has $11.5 billion on Layer1. The upcoming launch of Arbitrum and Optimism this summer is also very exciting to see if some DeFi protocols will be “factory pre-installed”. But at the same time, the community has serious concerns and doubts about the future of the DeFi protocol mobility and combination of multiple chains and layer2 architecture, migration costs, migration process, whether the corresponding supporting services and infrastructure to keep up with the problems and technical trade-offs.
As a new idea to solve this problem, Celer Network has released Layer2.finance, which differs from the first idea in that the expansion method of Layer2.finance is not through the migration of DeFi protocols, but through the migration of users and mobility to layer2 to achieve the “in-place expansion” of the existing DeFi ecosystem. “In situ scaling”. Users transfer liquidity to the rollup chain of layer2.finance by putting their funds into a layer2 rollup contract. From layer1’s perspective, this corresponds to the formation of an aggregated pool of liquidity for multiple users. On top of layer2’s rollup chain, users can make operations on the funds they have deposited in layer2.finance, such as putting them into lending agreements or participating in various types of liquidity mining to gain revenue. It is important to note here that the layer2 operations performed by users on layer2.finance do not immediately issue a transfer of funds from layer1, but only express a user’s “willingness to allocate funds”. When there are more users on layer2.finance, the same willingness to allocate funds over a period of time can be aggregated without trust into a single layer1 fund transfer transaction via layer2.finance, and the total amount of funds transferred is the sum of all the same willingness to allocate funds. By using a method similar to that of “Pound for Pound”, layer2.finance allows retail investors to share and significantly reduce costs when interacting with the DeFi protocol. The main innovation of layer2.finance from a technical point of view is the cost reduction based on layer2, and from a product point of view it has the potential to become the main portal of DeFi in the future.
Layer2 technical solutions and trade-offs
In the first version, layer2.finance used the Optimistic Rollup architecture developed by Celer itself, where the presence of a challenge period (fraud prevention window) caused delays. Users may have to wait several hours before their transaction requests are packaged and sent to L1’s DeFi protocol. Similarly withdrawing funds from the strategy pool requires a similar wait time.
However, Layer2.finance has reduced the long challenge period from days to hours by simplifying the state and calculations. Together with the fact that the Celer State Guardian Network (SGN) acts as a distributed watchtower to monitor the Layer2 state, this also adds a certain level of security to Layer2.finance. Thus, although the length of the challenge period was reduced, no one took risks as a result.
In addition to this, StarkWare has abandoned the idea of developing a separate “DeFi Pooling” similar to layer2.finance and has announced a partnership with layer2.finance to work on and launch a layer-2 version, which will be available at the end of the second quarter. StarkWare is the leading zk-rollup solution company, and its ZK-STARK algorithm provides great scalability and product diversity to projects such as DeversiFi, dYdX and Immutable X. The addition of layer2.finance to the StarkWare ecosystem will greatly enhance its competitiveness.
We think it is reasonable for layer2.finance to use Optimistic Rollup in the first version to develop itself, because Optimistic Rollup is faster to launch and more flexible to upgrade in later iterations. Although ZK Rollup has a shorter challenge period than Optimistic Rollup, the few extra hours of waiting time do not seriously impair the user experience since the application scenario of layer2.finance itself requires users to wait for common aggregation, and the Optimistic Rollup is less costly to spread out when the user base is not very large. Rollup has a lower levelized cost. By adding a version of ZK Rollup with StarkWare in the future, the pooled funds distribution time and withdrawal time will be greatly reduced, thus further enriching Layer2.finance’s application scenarios for highly concurrent users, including, for example, aggregated transactions.
Network effect of enriched users
Currently, layer2.finance v0.1 (similar to the beta public test version) has been online on the Ethereum mainnet for a week and supports three protocols, AAVE, Compound and Curve 3Pool, with Compound and Curve coming with liquidity mining. The current total locked position is $1.5M with 270+ users. According to Celer Network Twitter, in the first week, layer2.finance saved a total of $34,000 in Gas fees for 900 DeFi transactions, with an average savings of $40 per transaction. Although relatively small compared to the massive DeFi protocols that lock up billions, it is already bringing tangible benefits to the users involved, demonstrating the performance benefits of layer2.finance.
Unlike many other DeFi protocols, which simply pursue the volume of lock-in as a measure of network effect, another important measure of layer2.finance is the number of participating users, as the cost reduction of layer2.finance comes from the increase in the number of users.
At this stage, layer2.finance has not yet developed an initial network effect for two main reasons. Firstly, layer2.finance has not yet turned on liquidity mining, but after the planned v1.0 goes live, layer2.finance will probably turn on liquidity mining to do the initial user acquisition; secondly, the current online trading strategy is more conservative, and users in other protocols (e.g. harvest) can get higher returns with the same strategy by additional liquidity mining. Higher returns for more aggressive and medium-risk bulk strategies have not yet been accessed.
If both of the above issues are solved in the official v1.0 release, layer2.finance will have a good chance to attract users and gain a high user retention rate through strong network effects and rich and constantly increasing DeFi strategies with the market. For liquidity mining, it is expected that Celer will improve the existing liquidity mining mechanism by not simply emphasizing the lock-in amount, but also emphasizing the network effect of the number of users. The speed of new strategy access is crucial for user retention in layer2.finance. The Celer team also mentions on the official website that they are working on the integration with YFI, Uniswap, Sushiswap, 1inch, Alpha Finance, DODO and Liquity, as well as with the yet to be launched DeFi protocol. They are also working with DeFi protocols that are not yet online to access layer2.finance’s strategy interface at the beginning of the launch in order to expand the pool of different strategies as much as possible.
Potential to become a DeFi portal
The strategy interface of layer2.finance is flexible and not limited to interaction with a single DeFi protocol. For example, a strategy can include multi-protocol strategies such as pledging a portion of ETH to a Maker, lending DAI to generate interest on Curve, etc. This also gives layer2.finance the ability to compete with aggregation protocols such as Rari Capital and Harvest Finance. However, from a different perspective, layer2.finance can also integrate directly with these aggregators, using the aggregator itself as part of the strategy, reducing the cost of becoming available to users and providing the aggregator with long-tail liquidity that it would otherwise not receive, achieving a win-win situation with the strategic aggregation protocol.
Layer2.finance stands for DeFi portal entrance market, although DeFi portal platforms like instadapp that focus on user-friendly operations can attract some new users to use, but because providing such a solution in layer1 actually increases the cost of gas consumption additionally, in new users are likely to be lost from the platform. For layer2.finance, however, users not only have no additional costs, but also continue to enjoy the benefits of low fees and easy “one-click operation” for different protocols and strategies. If the DeFi protocol on layer2.finance can be rapidly iterated as the community grows, it has the potential to serve as a high-retention portal to the DeFi world and to build up further network effects and positive feedback.
IOSG is optimistic that the Layer2 track will continue to iterate in the future with innovative solutions like Layer2.finance, which does not create liquidity fragmentation, does not require redevelopment or redeployment on Layer2, and can be additionally adapted to scenarios such as extremely concurrent aggregated transactions in the future through ZK-Rollup integration. However, its current limitations also remain and are expected to be addressed in the near future (perhaps in the next release), such as
Users need to suffer some waiting time
The number of existing policies is limited and needs to be increased
The APY of the current strategy is still relatively low compared to other protocols
Comparison of Layer2.finance and DeFi L2 migration approaches
Overall, layer2.finance introduces a brilliant idea to solve Ethereum’s Gas cost problem and bring more users into the DeFi world. Although the first version still has limitations, we still see a clear and viable roadmap and we will keep an eye on layer2.finance’s development.
We are also optimistic about StarkWare’s performance and development in the layer2 track. StarkWare’s self-developed ZK-STARK zero-knowledge proof protocol is an upgrade to SNARK, which aims to provide “zero-knowledge, simple, transparent, obvious and secure” cryptographic proofs. Technically, zk-STARK does not require an initial trusted setup, as they rely on a conflict-resistant hash function. This approach also eliminates the assumption that zk-SNAR itself is computationally expensive and vulnerable to attacks by quantum computers. In addition, StarkWare also has the Validium mode, in which the data is stored under the chain, thus improving efficiency and making it more suitable for high-frequency scenarios.
In conclusion, whether it is layer2.finance or StarkWare, privacy and scaling protocols have great potential in the cryptocurrency world and could be a groundbreaking path to mainstream adoption, a track we will keep an eye on and be enthusiastic about.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/layer2finance-the-future-of-the-scaled-exterior-defi-portal/
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