Pantera Capital Chief of Staff: How does Layer 2 unlock the next wave of killer apps?

In the trend of true decentralization, the problem of expansion is and will continue to be handled by various complementary solutions.

Original title: “Pantera Capital Chief of Staff: How does Layer 2 unlock the next wave of killer apps? 》

After the summer frenzy of DeFi in 2020, due to the skyrocketing demand for the ethereum custody protocol, gas costs have risen to sky-high prices, which has also caused serious network congestion. Fortunately, with the popular release of expansion solutions such as Optimism and Offchain Labs’ Arbitrum , the “Layer 2 Summer” in 2021 indicates that it will be a solution.

Next, we discussed why Layer 2 technology is so important. We start with the basics of expansion, and then detail how the new off-chain tools can help solve the two problems of transaction speed and cost. Finally, we discussed what this means for the broader ecosystem and why Layer 2 will unlock the next wave of killer applications based on blockchain technology.


If the promise of blockchain technology is to democratize financing channels—reducing costs by removing rent-seeking intermediaries—the biggest irony is that users are still very sensitive to transactions on Ethereum, which hosts most DeFi protocols. expensive. In a distributed network like Ethereum, each transaction requires storage and processing by each node: this means that as the user base grows, the network will inevitably encounter capacity limitations. This is the reason for the well-known high gas fee. Because network congestion promotes the increase in gas cost and processing time, small transactions cannot operate normally. This makes it almost impossible for DApps with high requirements on computing to run directly on the increasingly crowded blockchain.

Simply put, Ethereum has become a victim of its own success. In the past year, as millions of people scrambled to accept and use DeFi protocols, NFT markets, and other DApps hosted on Ethereum, the demand for processing transactions has surged. In this case, due to the limited computing power of each node and the size of a single block, its processing power has been disappointing.

When more transactions appear to compete for a certain limited block space and computing power, gas fees will rise, and transaction volume and speed will slow down. In 2021, Ethereum fees have increased by 845% compared to 2020; the average block capacity was approximately 70% in January 2020, and has now risen to a sustained level of 98%.

Problems in the expansion

Increasing the capacity of a network like Ethereum is particularly challenging. There are three main characteristics that define a blockchain: decentralization, security, and scalability. You can choose two of these three characteristics, but if you insist on using the most direct method, you won’t have any of these three. This means that if the scalability of the blockchain is improved-in this way it can process more transactions, it will be faster, and it will be cheaper-usually it will weaken its security or decentralization characteristics.

This big problem is often referred to as the “scalability ternary paradox”. Since the early development of the ecosystem, it has been plagued by the supporters of blockchain technology. In 2014, Vitalik Buterin made an unforgettable promise: The Ethereum community will either solve the scalability problem or “or it will perish here.” Fortunately, with the recent scalability upgrades and the launch of the breakthrough Layer 2 extension tool, the success of this project is just around the corner.

Broadly speaking, there are two ways to overcome the scalability trilemma. The focus of Layer 1 or on-chain expansion is to improve the blockchain itself; the focus of Layer 2 or off-chain expansion is to improve the way the blockchain is used.

Layer 1

In the Ethereum ecosystem, the leading Layer 1 extension proposal refers to “sharding”, which will split the transaction database horizontally by creating a new chain or “sharding” to reduce the data that each validator needs to process quantity. This will allow the total amount of transactions processed by the distributed network to exceed the computing power of a single node. Ultimately, this will lower the threshold for new validators to join the distributed network, increase its throughput, and reduce the cost of transactions on it.

However, the expansion method of Layer 1 has serious limitations. This expansion approach involves extremely challenging computer science and game theory challenges, many of which have never been solved before. Hard-forking the protocol is also an important basis for implementing them; as a practical issue, this requires a strong consensus around every Layer 1 upgrade among all stakeholders. As in any complex and decentralized system, this is a difficult and time-consuming proposal.

The long-term delay in the hard fork upgrade plan of Ethereum, which has been troubled by ” ETH -2″, shows that it is very difficult to implement major Layer 1 changes in terms of technology and community coordination.

Layer 2

The Layer 1 solution focuses on improving the performance of the core blockchain, while the Layer 2 approach focuses on improving how the blockchain is used. Its proponents believe that because distributed ledgers are inherently limited by capacity, they should only carry the most valuable transaction data. Layer 2 migrates low-critical operations to off-chain, but leaves assets and cryptocurrencies in Layer 2. It allows users to return to Layer 2 at any time to resolve disputes or recover their encrypted assets. This fixes the operation of Layer 2 in the security of the local Layer 2 and releases valuable block space on the core blockchain. Ultimately, this allows Layer 2 to process more transaction volumes at a faster speed and lower cost.

Layer 2 solutions mainly have the following three types: state channels, side chains, and Rollups. Although all three can provide compound benefits for blockchain capacity, the Ethereum community has adopted Rollups as the most promising way to expand the network. Although other Layer 2 solutions can achieve scalability after accepting major trade-offs in terms of security or decentralization, Rollups accepts some centralization without sacrificing trustlessness (this is a key priority of decentralization).

Rollups transfers most of the calculations off-chain, and then regularly pushes batch transaction data and the resulting state roots to the Layer 1 blockchain. By performing operations outside the mainnet, but recording transaction data and/or certification in Layer 1, Rollups can benefit from the security of the core blockchain, while achieving greater throughput and significantly reducing costs. Broadly speaking , there are two types of Rollups: ZK-Rollups and Optimistic Rollups.

ZK Rollups transfers calculations to Layer 2, and periodically batches and compresses transaction data outside the main chain to generate a valid proof of its integrity and publish it to the Ethereum mainnet. By issuing the proof of the correctness of each state transition, ZK-Rollups guarantees the validity of the state on the chain and allows users to withdraw money immediately. But the calculation of these proofs is complicated and time-consuming. Even if developers can finally use Solidity with ZK Rollup technology, they currently need to rewrite smart contracts in a custom programming language. For now, ZK-Rollups is the most suitable project for realizing direct payments, such as decentralized exchanges or payment platforms.

StarkWare, which we invested in before, is now the leading pioneer of ZK-Rollups technology. In mid-2020, Starkware used StarkEx to set up 1.3 million accounts on Ethereum and set an initial balance for each account within 12 hours, showing StarkEx (its ZK-Rollups that supports decentralized transactions can be expanded Sex engine). If this behavior is run directly on the mainnet, this process will consume the entire capacity of the Ethereum network for 4.5 days. StarkEx operated the entire process in just 12 hours with an astonishing average cost of $0.003 per transaction and 2.5% of Ethereum’s capacity.

Unlike ZK-Rollups, Optimistic Rollups assumes that the transaction is valid and only runs fraud proofs in case of challenges. Optimistic Rollups relies on all parties to verify the data submitted by Layer 2-and challenge the incorrect state-to maintain the integrity of the conversion. Although computationally efficient, this forces users to wait for a challenge period before they can access their funds. Nevertheless, the scalability advantage brought by Optimistic Rollups is huge, it can reduce the gas cost of Ethereum by 10,000+% and increase the throughput by up to 200 times.

Projects such as Arbitrum use Optimistic Rollup technology to easily integrate existing DApps and support the execution of arbitrary EVM code at the off-chain level, while making minimal changes to the underlying smart contracts. Since its launch in August 2021, more than 250 development teams have begun to develop on top of Arbitrum. The project was selected by Reddit to launch its own Layer 2 Rollup. Aave, Balancer, Band Protocol, Coinbase Wallet, Chainlink, Curve, DAI stablecoin, Etherscan, DODO, MetaMask, Shapeshift, Sushiswap and Uniswap are all online or coming soon Integrate with Arbitrum’s technology.

The ability and promise of Optimistic and ZK-Rollups is that by anchoring transactions in the local Layer 1 security, users can choose to revert to Layer 1 to recover their assets or resolve disputes. They created game-theoretic incentives for users and operators to act honestly. This makes them an important catalyst for the creation of a secure and scalable network where users can conduct transactions without having to trust a centralized intermediary or its counterparty. In short, the promise of blockchain and cryptocurrency is obvious. After the recent launch of the much-anticipated Layer 2 extension project, this promise is now easier to fulfill than ever.

What does it mean to solve scalability

In order for blockchain-based protocols to replicate and eventually replace the pillars of traditional finance, they need to match or exceed the performance of their infrastructure. Without the help of Layer 2, the Ethereum mainnet can only process 15-20 transactions per second (TPS). The Bitcoin main chain can only handle 7 transactions. In contrast, the VisaNet payment network processes approximately 1,700 TPS on average, and Nasdaq processes approximately 500-1,000 TPS. With the introduction of Layer 2, this gap will narrow or disappear. It is expected that just using Rollups will increase the TPS on Ethereum to between 1,000 and 4,000 TPS.

Other Layer 2 solutions such as state channels and side chains will increase the capacity of the ecosystem, and highly scalable Ethereum alternatives like Polkadot will also increase. Taken together, these tools will make it possible to create a point-of-sale payment system based on blockchain that provides instant transfers to achieve fast checkout and guarantee settlement, with a throughput comparable to the Visa network.

In the short term, the benefits of higher transaction speed and lower costs will be most strongly felt in the DeFi field. Applications that migrate to Layer 2 will provide lower transaction fees and lower minimum transaction sizes, and pass on their significant cost-saving status to users. This will drive DeFi’s overall transaction volume, attracting retail users who left the centralized exchange who were previously unwilling to trade directly on Ethereum or users who use less secure alternatives like Binance Smart Chain.

For example, allowing dYdX’s Starkware integration to provide users with a higher maximum leverage threshold, lower liquidation penalties, and cross-profit trading functions.

The DeFi protocol itself will also be improved. Applications like Perpetual Protocol and dYdX allow users to use margin and leverage to go long or short cryptocurrency assets; when the value of the issued collateral falls below a specified threshold, the collateral will be automatically liquidated. When the transaction takes a few minutes to process, the function of the clearing mechanism is sub-optimal, but in a large-scale ecosystem close to instantaneous transactions, it plays a more effective and precise role. This significantly improves the capital efficiency of DeFi agreements. For example, allowing dYdX’s Starkware integration to provide users with higher maximum leverage thresholds, lower clearing penalties and cross margin trading functions.

More broadly, the emergence of high-throughput, almost free and instant transactions will enable blockchain-based protocols to rival or surpass the user experience on traditional web browsers. Historically, one reason that attempts to build decentralized Facebook, World of Warcraft, Visa, or SecondLife have basically stalled during the establishment process is that public blockchains lack the processing of hundreds or thousands of calculations per second. Application capabilities.

With scaling tools that increase throughput by 50-1,000 times, applications that used to be too slow or computationally intensive to run on the core blockchain will become feasible. This will mark an unprecedented expansion in the size and scope of the addressable market for blockchain-based projects, opening up the next generation of decentralized social media, virtual worlds, micropayment platforms, gaming ecosystems, etc.

in conclusion

In order for a blockchain-based system to realize its vision of a transparent, secure, censorship-resistant, and privacy-protected financial infrastructure, the ability to expand the ecosystem will need to be an iterative and long-lasting project. Right now, Layer 2 solutions can provide powerful, flexible, and composite tools. Over time, the best way to extend Layer 1 is likely to increase its efficiency as a data availability engine to optimize the capabilities of Layer 1 and allow Layer 2 to run on it. In the trend of true decentralization, the problem of expansion is and will continue to be handled by various complementary solutions.

For now, Layer 2 is leading the development of a scalable and stackable blockchain ecosystem, and we can’t wait to see the waves of innovation they release.


Posted by:CoinYuppie,Reprinted with attribution to:
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