Seize the L2 Gold Rush In-depth Analysis of L2 Token Economics

Layer 2 tokens are coming.

Arbitrum , Optimism , zkSync , Starkware – all these current hot layer 2 networks don’t have tokens yet!
But these Layer 2 networks are all growing fast, with billions of dollars in TVL locked up and attracting more on-chain activity every day. The future of Ethereum is in the hands of the Layer 2 network.

The question is, “When will the coins be issued¹”?

/zkSync/ has confirmed that it will be “community owned”.

/Arbitrum/ and /Starkware/ have not responded yet.

/Optimism/ said on the Bankless podcast that they have no plans to issue coins in the near future.

It doesn’t really matter whether they publicly confirm the issuance plan. They all have shareholding structure tables² full of investors and team members. They also all need to stimulate growth and improve liquidity.

In the words of Charlie Munger: “Whoever gives me bread, whoever I sing to.”

The bread is there now, and the results look straight to the point.

In order to preempt the L2 gold rush, the following questions need to be answered:

  • What does L2 tokenomics look like?
  • What incentives will there be when issuing coins?
  • What do they use to govern?
  • How will the tokens be distributed?
  • What are they waiting for?
  • Will the second-layer token of rollup be parasitic on ETH ?

We brought in the guy who helped launch Immutable’s IMX token, to share his thoughts on all of this.

Let’s get ready for the L2 gold rush.

—— RSA

Rollup tokens are coming

By John Wang, Independent Analyst and Buider

This article is based on a long Twitter post by John Wang

Seize the L2 Gold Rush In-depth Analysis of L2 Token Economics

Seize the L2 Gold Rush, In-depth Analysis of L2 Token Economics

Image attributed to Logan Craig

The layer 2 network (L2) token is coming soon, and will soon usher in a big explosion, but there is very little information about the L2 token economics, and more importantly, “when will the token be issued”?

This article intends to discuss in depth.

Here is some background information. I facilitated the issuance of IMX and GODS on the Immutable chain, and GOG on the StarkEx chain. With that in mind, I’m going to share my experience in the emerging field of cryptocurrencies .

Although I work with the Starkware team, I have no inside information on these L2 tokens. The following is largely based on my idea of ​​what good rollup token economics look like and how they will be distributed. All of this is just some educated guesses.

issue

  • Vampire attacks on other L1 networks via aggressive airdrops or incentivized strategies
  • Token pledge economic system and governance system
  • Rollup cost subsidy
  • Token distribution
  • Cross-chain bridge, fiat currency deposit entry and /Token/ cooperation
  • EVM compatible
  • MEV acquisition or prevention
  • Is the rollup token parasitic on ETH?

Seize the L2 Gold Rush, In-depth Analysis of L2 Token Economics

Seize the L2 Gold Rush In-depth Analysis of L2 Token Economics

Rollup overview

If you don’t know much about Rollup, check out this DCBuilder’s great article, which is very informative.

The Big Four of Rollup: Arbitrum, Optimism, zkSync, and StarkNet have already opened whitelisted dApp applications and/or have centralized sequencers and validators, but plan to build a decentralized sequencer in 2022, while Drive permissionless access. It is worth mentioning that recently Arbitrum was down for ten hours precisely because of the centralized sequencer problem³.

As the TVLs locked into these Layer 2 networks grow at any time, they especially need to be decentralised. A logical solution is to issue tokens.

Seize the L2 Gold Rush, In-depth Analysis of L2 Token Economics

Seize the L2 Gold Rush In-depth Analysis of L2 Token Economics

Image copyright attribution: L2Beat

When will the coins be issued?

I think rollup tokens will be launched in the following order in late 2022 and early 2023: zkSync (/confirmed/) → StarkNet (/no news/) → Arbitrum (/no news/) → Optimism (/publicly denied/) .

Seize the L2 Gold Rush In-depth Analysis of L2 Token Economics

Seize the L2 Gold Rush, In-depth Analysis of L2 Token Economics

Source: Bankless Interview with Optimism

That said, any project—including Layer 2 networks—should only issue coins when they reach a “product-market fit⁴”. I think rollups can reach product-market fit only if they address the following issues:

  • Decentralized Sequencer
  • Cross-chain bridge/deposit
  • EVM compatibility/equivalent

Incentive programs are marketing expenses and can be very expensive. You always need to prove that users like your product first, otherwise you are wasting your marketing budget.
— @QiaoWang

We’ll come back to these issues later.

aggressive incentives

Are you ready to witness the biggest vampire⁵ attack in history?
In comparison, SushiSwap ‘s vampire attack on Uniswap is only insignificant In order to compete with other L1 public chains⁶, rollups tokens should vigorously promote user migration to L2 through aggressive airdrops, staking, liquidity mining, and ecosystem funds. Cross-chain bridges between L2 networks will allow the rollups system to catch up with other centralized L1 public chains.

Rollups should be strategically airdropped to early rollups early adopters or ETH users, as well as other active users of the L1 public chain, and at the same time, it should be able to filter out the army of cross-chain robbers. Incentives for developers can also be proportionally quantified according to the active usage of their deployed contracts. Rollups can also work with DeFi 2.0 protocols like Olympus Pro for common liquidity incentive pools or L2 bond pools.

However, in order to attract more TVL, the industry needs a better cross-chain bridge infrastructure between L1 and L2. The Rollups team⁷ members also understand this, and it is likely that coins will not be issued until then.

But what would token economics⁸ look like?

Staking mechanism of L2 tokens

Incentives can be balanced against the need for the following slashable staking mechanisms:

  • Sequencer and prover for zkRollups (with hints)
  • Fraud proof originator and validator for Optimistic Rollups (with hints)
  • Member of the Data Availability Committee at Validiums/zkPorter
  • Data Availability Guardian for zkPorter (officially announced)
  • $METIS Mode: Incentives provided to Rangers (validators) to cheat-challenge the sequencer (winner keeps slashed $METIS)

For reference, Immutable’s IMX deposits a certain percentage of transaction fees into the staking reward pool, a model that can be borrowed from other rollup tokens.
Tokens lose liquidity once they participate in staking, so the staking mechanism itself can greatly improve the security of rollups. Matter Labs said, “To make the data in zkPorter unavailable, an attacker would need to raise 2/3 of the total market cap of all staked tokens”.

METIS is a forked token of the Optimism mechanism, with a dynamic Bond threshold pledge mechanism. For sequencers, if the value of their staked tokens is lower than the value of the block to be sequenced, they will not be able to participate in the sequence of the block. Transactions cannot be packaged until a qualified sequencer is found, thus limiting the size of the transaction value.

cost subsidy

The ZK Rollup system should pursue a user growth strategy that sells at a loss by subsidizing the cost of early users.

According to Polynya’s model prediction, with the increase of TPS, the transaction fee can be leveled at 3.33 TPS, and all the way down. Matter Labs agrees, “The current service operates infinitely close to break-even, and will remain so until decentralization.”

Seize the L2 Gold Rush In-depth Analysis of L2 Token Economics

Seize the L2 Gold Rush, In-depth Analysis of L2 Token Economics

This can be achieved through spending on marketing budgets, or through token inflation. The subsidy cost of several thousand dollars per day is not worth mentioning compared to the tens of millions of dollars spent every day to protect the security of SOL, DOT, AVAX , NEAR’s Aurora and other networks.

For reference, Solana spends $18 million per day in security costs, but only sells $225,000 of transaction-packed blocks. On Immutable, we directly subsidize the transaction gas fee in full, and hope that the transaction fee will be subsidized by one or two.

In contrast, Optimism Rollups…

ORs (Annotation: Optimism Rollups) follow another way to reduce transaction fees: compress calldata. Their packaging deal is low enough, although I know that some ORs still have some room for optimization.
— @polynya

governance design

All rollups currently have multi-signature smart contracts deployed on L1 .

Rollups are a new thing, so they need to be upgraded and bug fixed on the L1 side in the early days. What’s more important at the moment is that we have detailed transparency reports and emergency exit mechanisms like escape pods.

The current Rollup escape mechanism is not very useful. You need the ability to generate new blocks to get your funds out of a layer 2 smart contract, but for most users, they don’t have that ability.
— @JohnWang

As the DAO matures, Rollup’s smart contracts on L1 should be voted on by governance tokens and eventually become immutable. For now, multi-signature smart contracts on L1 definitely mean a trusted initial setup, but because of the timelock, you can withdraw your funds at any time, so it’s not a substantial security risk.

Other governance topics include MEV reduction mechanisms designed for sequencers, fee models, implementation of fraud proofs on Optimism, treasury spending such as ecosystem funds and DAO partnerships, data availability layers, and funding public goods through MEV auctions .

As you can see, there are tons of issues for the L2 DAO to vote on.

While there are many innovative solutions, the first step towards making a decentralized ordering mechanism feasible should be for the rollup team to designate a few high-reputation teams around the world and rotate among them. A better solution would be to have a governance token and decide through governance voting ( Lido ?)
– @polynya

Token distribution

I am amazed at zkSync’s public announcement that they are going to allocate 67% of their tokens to the community. This sets a competitive bottom line for others to follow. This sets a benchmark for others to follow.

The FDV ⁹ of some existing L2 dApps protocol tokens has reached an astonishing tens of billions of dollars, and the rollup tokens of L2 smart contracts are at least ten times that. In terms of market value, it is easy to rank among the TOP 30.

Taking it a step further, IMX and DYDX have $9 billion in FDV, and StarkNet and zkSync tokens will only go higher. At 8% inflation, it is enough to subsidize gas fees to $0.01 at 500 TPS. If inflation is as high as SOL, TPS greater than 5000 is also possible (Annotation: keep the gas price of $0.01)
– @polynya

Starkware recently raised funding at a valuation of $2 billion, and zkSync at $1.25 billion.

If we use Cooper’s data to deduce the industry average level of the token distribution plan, 35% of which is reserved for the team or insiders, and the ultra-low discount of early VCs is launched, then the initial market value of these tokens is the lowest. $7 billion.

Private investors
are allocated to those who buy equity early and convert to tokens later or buy tokens outright.
There will also be a lock-in period, generally consistent with team members.
Investor allocations have been on a downward trend — from about 25% in 2013 to 15% in 2021.
[image:9EBB32A3-9E1E-4659-9437-998B038AB397-60073-00000E5152EA628D/FISKPmAVcAQovOK.png]
– @Coopahtroopa.eth

Compared with L1, a major disadvantage of L2 tokens is the lack of token distribution. Even if the airdrop and incentive programs work well, other L1 public chain tokens have a certain time advantage due to their poor performance in recent years. If the L2 token is strong in the early stage, it may be further accumulated by giant whales.

We can solve this problem by subsidizing transaction fees with continuously inflating L2 token rewards (like Bitcoin), attracting users, and ensuring wider distribution to maintain long-term security.

Barriers to Issuing L2 Tokens

cross-chain bridge

Cross-chain bridges and coin-to-gold channels for L2 are crucial to attracting TVL and solving the problem of liquidity fragmentation.

At present, some cross-chain bridges have shortened the 7-day withdrawal period of Optimistic rollup, such as Hop Protocol, Connext Network, Argent, Celer Network, Maker, PolyNetwork , Layerswap, MultiChain, etc.

At present, the TVL of the L2 native cross-chain bridge only accounts for 17.7% of all cross-chain bridge TVLs in Ethereum. Compared to other L1 chains, ZKRs cross-chain bridges have unparalleled advantages because you can verify state transitions on the L1 target chain through trust-minimized cross-chain bridges. In the long run, rollups will have the best composability execution layer even when executed across multiple shards or external DA sources.

Seize the L2 Gold Rush, In-depth Analysis of L2 Token Economics

Seize the L2 Gold Rush In-depth Analysis of L2 Token Economics

Mustafa Al-Bassam, founder of Celestia, put it bluntly, “For trust-based cross-chain bridges, the operator of the cross-chain bridge can steal your funds. This is because these chains do not verify each other’s state transitions, but only rely on A committee of validators to sign transactions. Such as Eth- Polygon ‘s cross-chain bridge or Eth-Solana’s Wormhole cross-chain bridge”.

Starkware and Loopring have partnered to develop dAMM, a cross-ZKL2 AMM that allows asynchronous liquidity sharing with other L2 and L1 liquidity pools such as Uniswap.

Layer 2 network technologies require extensive manual integration from existing infrastructure. Centralized exchanges , oracles like CoinList, Chainlink, and data indexes like Graph Protocol all have to do custom integration. As far as I know, BitGo/institutional custodians don’t even have specific plans for this, limiting institutional access to L2.

Incentivizing liquidity through inflation or centralized market makers within the cross-chain bridge will make the L2 ecosystem vulnerable due to the highly volatile nature of hot money or its reliance on centralization. In order to incentivize liquidity within the capital pool, the Hop project and Polygon jointly launched a liquidity mining program to issue MATIC rewards to those liquidity providers. As expected, liquidity in those pools plummeted once the liquidity mining program ended.

It can be seen that there is still a lot of work to be done in the cross-chain bridge.

EVM compatibility/equivalence

Software composability and its importance.

In the coming months, EVM compatibility/equivalence will appear across all four major Layer 2 networks¹⁰.

For true composability it is EVM equivalence, not just EVM compatibility, that matters.

Metis DAO and Optimism have EVM equivalence. Optimism 2.0 integrates the EVM interpreter in its Geth client without having to reimplement the on-chain EVM. This provides the system with future security guarantees against future EVM upgrades.

Developer tools like DappTools (smart contract libraries, command line tools, format validation, symbolic execution, project management, etc.), Hardhat, Solidity, Vyper, and all others will work seamlessly on native OVM 2.0, while Developers of these tools also don’t have to worry about supporting fragmented codebases.

In contrast, Arbitrum One (formerly Nitro), zkSync 2.0, and StarkNet are all EVM-only compatible. Simple syntax differences between Cairo and Solidity hurt code interoperability. Given this, zkSync admits that they are not yet fully EVM compatible.

With only minimal changes to the code, the prepared Solidity contract ABI can be deployed on the chain. However, it is not yet possible to achieve cross-L2 message communication or seamless invocation of smart contracts.

zkEVMs are extremely complex, and developers are still struggling with issues such as denial-of-service attacks caused by validators not being able to handle rollback transactions.

Seize the L2 Gold Rush, In-depth Analysis of L2 Token Economics

Seize the L2 Gold Rush In-depth Analysis of L2 Token Economics

Are Rollup tokens parasitic on ETH?

How the second-layer rollups verify and execute contracts, while L1 is dedicated to storing immutable transaction data. In the current situation, the tokens of the L1 chain have captured little value. Take a look at Solana and Avalanche .

Seize the L2 Gold Rush, In-depth Analysis of L2 Token Economics

Seize the L2 Gold Rush In-depth Analysis of L2 Token Economics

Value capture mainly occurs at the protocol layer. This also means that the settlement layer, execution layer, and consensus layer are competing for MEV¹¹ and the currency’s store of value.

In fact, according to this Flashbots paper, in Eth 2.0, “MEV can increase validator rewards by 75.3%”!

As more liquidity floods into the Layer 2 network, L2 tokens are essentially parasitic on the MEV value capture of L1 tokens. L2 diverts the revenue of miners that provide security to L1, reducing the security budget and thus the cost of launching a 51% attack.

This is a serious issue that the ETH community has not yet taken seriously.

Why does L2 capture MEV?

Layer 2 networks may see more complex MEV and coordination mechanisms between sequencers and miners. The background of the people running PoS validators is closer to the background of those who really understand MEV than the current PoW miners.

Under the interaction between different ordering mechanisms, cross-rollups will contribute to the MEV combinatorial explosion effect. Flashbots has a great paper in which they recommend that orderers “accumulate votes on the chain with the most MEV value… thereby reducing their cross-domain MEV cost”, “Mechanisms like Flashbots or SGX-based DAOs can reduce The cost of cross-chain collusion”.

However, as Flashbots founder Stephane Gosselin put it, “settling rollups on mainnet, there really isn’t much MEV — the only thing miners can do is delay settlement for a few blocks, but that doesn’t really affect the rollups experience, and The cost is quite high.”

Ethereum’s net gain

Although the second-layer network may be parasitic on ETH in the short term, the long-term relationship between the two is a positive-sum game¹². Indeed, as more activity gradually migrates to the Layer 2 network, more MEVs will be captured than L1. At the same time, compared to a world where no rollup exists, this could create pressure for lower earnings in the short term.

Because rollups submit tens of thousands of transactions to the L1 chain in batches at one time, the transaction fees for rollups scale logarithmically. This is almost like the dilemma of “small profits but quick turnover” and “big profits but few sales” in the field of sales. From the scale of data availability provided, L1 transactions from rollups will pay higher transaction fees than normal transactions.

Another thorny issue is that miners may leave the network, reducing L1 security. To make matters worse, more L2 transactions will lead to more state bloat and higher storage requirements for full nodes, thereby reducing decentralization.

At the end of the day, what we should be asking is: Are there rollups yet that will make ETH’s price even higher?

Interactions that happen directly on Ethereum L1 will have a demand cap due to block size limitations and high gas fees driving most users away. In a world with rollups, recursion, hierarchical L3, the potential user scale¹³ would be in the billions.

In the same fixed L1 block space, rollups are packed into larger network effects.

Seize the L2 Gold Rush, In-depth Analysis of L2 Token Economics

Seize the L2 Gold Rush In-depth Analysis of L2 Token Economics

The expansion of Ethereum to global use means that the block space on L1 is always full. Rankers on L2 earn L2 transaction fees and at the same time pay their fees on L1, earning the price difference between the two, everyone is happy.

Also, I don’t think MEV and transaction fees are drivers of ETH’s value. Solana’s transaction fee income is extremely low, but it still has a market cap of $80 billion.

The value of ETH should be calculated using a fusion of commodity pricing and quantity theory of money (Ethereum is a country and ETH is its currency). The value capture of the security layer comes from the economic activity that takes place on it, as well as the “moneyness” of ETH. Although with higher TPS and lower transaction fees, L2 still significantly increases the speed of money flow.

Many skeptics say that L2 reduces the “moneyness” of ETH. @TaschaLabs claims:

You can buy it directly on a centralized exchange, such as /ZKTOKEN/, transfer it to your ZK wallet , and then spend your /ZKTOKEN/ on ZK’s L2 without ETH.

The reality is that ETH’s “moneyness” is far from being diminished. Compared to fluctuations in tx demand due to unstable demand for a specific dApps or use case on a specific L2, the sum of the tx demand for all rollups will be more stable. In a rollup world, ETH will become the universal currency.

People buy ETH not only to pay gas fees, but also because many things are priced in ETH. ETH will be the main utility token for paying gas fees (even on rollups). NFTs are denominated in ETH. The largest liquidity pools on Uniswap are all paired with ETH.

ETH is a reliable collateral and the first choice for payment.

ETH has a first-mover advantage in terms of widely distributed “moneyness” network effects.

Deflationary token economics contribute to the monetary narrative. As @epolynya said, “rollups have the big advantage that they spend very little on an inflationary budget, or a tiny fraction of other competing L1s.”

L2 tokens are coming

Rollups’ tokens are exciting. Still, there’s a lot of prep work to be done before they roll out. I don’t expect most rollups tokens to launch until the end of this year, or even 2023.

But I believe in unstoppable. Layer 2 networks need tokens to compete with other competing L1s. By launching a native token, and implementing a suite of incentive programs and airdrops, the technology will be propelled to fulfill its original prophecy: scaling Ethereum.

Once they issue coins, there will be an uproar.

Let’s wait and see.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/seize-the-l2-gold-rush-in-depth-analysis-of-l2-token-economics/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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