The explosive growth of Layer 1 is one of the most important developments in the crypto industry in 2021. Several emerging Layer 2 networks have challenged Ethereum, and many Layer 2 projects have also been launched to join the competition.
In the annual report recently released by The Block, the competition pattern of Layer1 and Layer2 is analyzed in detail, and the technical and ecological progress of 10 mainstream Layer1 platforms is elaborated.
1. Overview of the competition in 2021
One of the main trends in 2021 is the growth of Layer 1 (L1) blockchains and their ecosystems, especially in relation to the growth of Ethereum, the current leading smart contract platform. As mentioned in our Market State section, Layer 1 protocols are one of the breakout winners of the cryptocurrency market in 2021.
Amplifying the price returns of layer 1 platform cryptocurrencies relative to ETH, they have significantly outperformed the price returns of ETH, such as Fantom (FTM), Solana (SOL), and Terra (LUNA).
Price and performance aside, quantifiable user activity for L1s in 2021 will increase substantially, mainly driven by the emergence of DeFi ecosystems on various L1 platforms. With the growing selection of DeFi protocols, users are depositing record amounts of funds into decentralized applications such as decentralized exchanges (DEXs), lending protocols, yield aggregators and derivatives exchanges.
On Ethereum alone, the total value locked (TVL) of DeFi protocols rose from about $16.1 billion in early 2021 to $101.4 billion on November 30, an increase of about 530% over the course of the year. The DeFi project TVL of the L1 ecosystem has grown faster overall, adding more than $166 billion since the beginning of the year, an increase of about 974%.
While Ethereum still had nearly all of the capital locked in DeFi at the start of 2021, its share of DeFi TVL had dropped to 63% as of Nov. 30.
The emergence of L1 alternative ecosystems occurs during a period of continued growth in the crypto market, including Ethereum. As Ethereum transaction volumes continued to hit record highs between January and May, users of the largest smart contract platform began to experience network scalability issues in early 2021 amid a surge in the broader crypto market. major issues.
Average transaction fees on Ethereum rose to an all-time high in the first half of 2021, with exorbitant gas fees and long confirmation times sometimes paralyzing users during periods of extreme network demand. Priority gas auction (PGA) bots and an increase in MEV activity since January also contributed to the long-term high gas prices at the start of the year.
In this environment of high network demand and rapidly growing costs, the relatively low-fee non-Ethereum L1 is starting to take center stage as users look for alternatives to activities they typically perform on Ethereum. EVM-compatible chains like Binance Smart Chain (BSC) are particularly well-suited for absorbing large numbers of new and existing users, providing an opportunity to experiment in a new but familiar ecosystem without the high capital cost barriers to entry.
Starting in February, the BSC ecosystem has grown dramatically, peaking at $34.8 billion in TVL on May 9, and then representing about 26% of DeFi TVL. In addition to TVL, the number of daily users of BSC has also increased significantly, and the average daily transaction volume in May also hit a new high of 8 million transactions.
As the crypto market generally declined from mid-May, these metrics of BSC adoption and usage declined sharply, and it was not until Nov. 14 that TVL regained its previous all-time high. Notably, the ecosystem also experienced a long series of attacks throughout the second quarter, highlighting the vulnerabilities and risks of a large number of protocols on the network that originated from unaudited forks of the Ethereum DeFi protocol.
Nonetheless, BSC’s explosive growth in 2021 provides a blueprint for other emerging L1s to build primitive DeFi protocols such as DEXs and lending platforms in the new L1 ecosystem, which may be attractive to active users and developers The essential.
Having said that, one of the biggest challenges the protocol continues to face right now is the issue of fragmented liquidity. Even with EVM compatibility in place, new L1 ecosystems that want to attract liquidity face an uphill battle, as users often need a compelling reason to transfer money that may already be earning on another platform Asset transfer. It turns out that one of the best ways to attract liquidity providers is to simply incentivize them.
2. Incentives and Funding
In the second half of 2021, users and activity on EVM-compatible chains increased dramatically, in part due to the massive increase in rewards offered by the L1 team and their funding.
Of these projects, perhaps the most notable is the Avalanche Foundation’s “Avalanche Rush” project, which launched on August 18 by distributing 10 million AVAX tokens (worth around 1.8 million at the time) to the Avalanche Protocol’s liquidity providers billion) to expand its DeFi ecosystem.
Since then, L1’s other funds have announced at least eight incentive programs of $100 million or more, including the Fantom Foundation, Terraform Labs, and the Algorand Foundation. Most projects are focused on promoting the development of DeFi in their respective ecosystems, although the exact goals and scope of each project and the method of token distribution vary.
The Avalanche Rush project primarily serves as a liquidity mining reward for ecosystem participants, while other projects, such as Fantom’s 370 million FTM reward project, are more specifically aimed at financing developers. In the Fantom project, if developers meet certain performance standards over a period of time, then they can use rewards as they wish, including liquidity rewards.
Both the Avalanche and Fantom projects distribute funds in the form of their native tokens, and others include Hedera, Algorand, and Terra. Therefore, the amount of these reward programs can vary depending on the market, especially as tokens are redistributed to a wider group of holders. These rewards typically come from funding from individual teams, provided by early investors through seed rounds or token sales.
In 2021, investment firms have increased their investments in specific L1 ecosystems, whether through investments in specific projects or through native token sales.
For example, as we highlighted in our funding and M&A section, Solana Labs raised $314.15 million in June through a private token sale led by a16z and Polychain Capital. Avalanche also announced a $230 million funding round in September, led by Polychain Capital and Three Arrows Capital.
Regardless of the reward token distribution or funding method, what matters most to each L1 team is the degree to which users and developers choose to invest their time and money in their particular ecosystem. One way to measure this is to look at changes in ecosystem TVL over time, which provides a general sense of DeFi protocol growth.
However, as we have pointed out in our previous reports, DeFi protocols in a particular ecosystem often hold large amounts of native network tokens (e.g., SOL on Solana), which increases the impact of token price changes on the entire ecosystem TVL Impact.
By normalizing the TVL growth of the ecosystem by the price of the corresponding native token, we can get a relatively more accurate picture of how much new capital has entered the ecosystem, rather than dollar gains primarily determined by token price performance. Since Q3, just before the wave of L1 incentive programs began, the percentage growth of TVL in the Avalanche ecosystem after price normalization has outpaced other major L1 ecosystems.
Interestingly, Avalanche’s TVL took its first big leap immediately after announcing Project Rush, and it has been able to retain a significant portion of its TVL over the past few months.
As of this writing in November 2021, Avalanche’s TVL has grown by $13.5 billion from the third quarter. Avalanche’s success in attracting capital is partly due to the EVM compatibility of the Avalanche C chain, upon which all DeFi protocols currently on Avalanche are built.
Since users and developers are able to interact with Avalanche using familiar Web3 tools such as Metamask and Solidity, the barriers to entry into this ecosystem are relatively low, especially for existing Ethereum users. Avalanche’s growth in the second half also benefited from the Avalanche bridge, which has significantly reduced cross-chain bridge costs since the upgrade in late August.
At the time of writing, Avalanche Bridge has continued to offer AVAX airdrops to bridge users over $75, ensuring that Avalanche cross-chain bridge users can immediately start using the network without first purchasing AVAX separately as gas.
3. Competition in a growing Tier 1 ecosystem
Combined with Avalanche’s EVM compatibility, the relative ease of transferring value from Ethereum to Avalanche has fostered particularly strong competition in the growing ecosystem. For example, in Avalanche, Pangolin DEX was by far the largest TVL protocol, but Trader Joe’s mid-August release shook the ecosystem with its clean interface and liquidity mining rewards, and surpassed Pangolin’s TVL in September .
For just over a month, Trader Joe and lending protocol Benqi held steady at the top of the Avalanche ecosystem’s TVL rankings, with both protocols holding over $1 billion in assets by early October.
However, in early October, the arrival of existing DeFi protocols from Ethereum, Aave, and Curve marked the beginning of a new phase of competition in the Avalanche ecosystem. Incentivized by the new liquidity provided by Avalanche Rush, Aave’s TVL ballooned on Avalanche, surpassing Benqi and Trader Joe for the first time in just a few days of launch.
A similar situation was seen in Fantom’s ecosystem, with TVL peaking at $6.2 billion on November 9. Like the Avalanche ecosystem, DeFi incumbents that have gained massive adoption on Ethereum are now starting to enter the Fantom ecosystem. As of November 30, Curve has become TVL’s fourth largest protocol in the Fantom ecosystem, initially launching on Fantom in June and offering CRV liquidity rewards.
On September 1st, FTM rewards on Curve also went live, further promoting the use of stablecoin trading protocols through Fantom’s rewards program. Interestingly, incumbent DeFi teams like Curve and Aave have been able to earn rewards directly from the Avalanche and Fantom reward programs, underscoring the desire of these L1 teams to attract established, well-known DeFi protocols to their ecosystem, Maybe even at the expense of native protocols.
In fact, a proposal to deploy Aave on the Fantom network has been passed on October 18, and through such a strategy, Aave can earn FTM rewards and establish a deployment protocol in the near future.
In 2021, the battle for DeFi protocol dominance in the Fantom ecosystem remains fierce, and during the year, Fantom’s native DEXs, SpiritSwap and spookswap, were Fantom’s top DEXs, both in TVL and volume. In these rapidly growing DeFi ecosystems, a clear trend in 2021 is the growing competition among protocols, leaving room for protocols to build significant network effects and communities.
With the well-known Ethereum-native DeFi protocols now starting to be released across many L1 ecosystems, these L1-native protocols are facing one of their biggest challenges to date, retaining and growing their user base. In a newer, smaller L1 ecosystem like Harmony, there are naturally more opportunities for DeFi protocols to quickly capture significant market share without a clear leader.
Harmony has a relatively small user and capital base compared to the more popular EVM-compatible L1s, and its ~$542 million ecosystem in TVL as of Nov. 30 was primed as it continues to grow. Environments like Harmony’s are also conducive to innovation, giving builders the opportunity to experiment with ideas in a less competitive environment.
A notable example of this innovation is the DeFi Kingdoms (DFK) protocol, which has become the largest protocol on Harmony as of November 30, with $280 million invested in TVL, or about 51% of Harmony ecosystem TVL .
As a DeFi protocol that includes an Automated Market Maker (AMM) based DEX and a non-functional marketplace that includes a gaming UI, DFK is a unique combination of gaming and DeFi in the crypto space today. In fact, DFK’s top position on the TVL Harmony leaderboard means that DFK provides the highest source of liquidity for many trading portfolios in the ecosystem.
Although users have to go through a role-playing game (RPG)-style interface to access its DEX and liquidity pools, DFK has amassed more TVL than SushiSwap and Curve’s Harmony deployments combined. DFK and SushiSwap are more comparable in terms of trading volume of DEXs, suggesting that some Harmony users looking to trade tokens may still prefer standard, simple DEXs.
Nonetheless, DFK has regularly outpaced SushiSwap in daily traffic on Harmony over the past few months, a clear indication that new DeFi protocols have the potential to capture a large number of investors in the relatively small but still growing L1 ecosystem. Meaningful share of user activity. The big question is whether DFK can ultimately maintain its dominance over more mature protocols like Sushi in the face of future growth.
For now, DFK continues to expand its lead over DeFi competitors in the Harmony ecosystem, and even with Harmony’s decision in September to offer Curve users a $2 million token reward, DFK doesn’t appear to be affected.
Ultimately, while it is difficult to predict which scenarios will have the greatest success over time in the L1 ecosystem, one thing is clear: the composition of these young ecosystems is short-lived with ample room for growth and destruction. Big changes can happen in just a few weeks.
4. Beyond EVM – Optimizing Performance and Growth
In 2021, with ethereum’s network demands and gas fees generally increasing, EVM-compatible chains are well positioned to move from ethereum to other L1 ecosystems as users and developers seek low-fee alternatives with familiar UI and concepts. liquidity.
At the same time, the focus on L1 alternatives has also brought renewed attention to non-EVM compliant blockchains and their differences in performance, security, and design. Compared to previous years, usage began to rise as various blockchains reached key milestones, and the unique characteristics of different network architectures, Sybil resistance, and consensus mechanisms were tested in production environments.
After the explosive growth of DeFi and the entire crypto market in early 2021, many L1 chains started to develop their own DeFi ecosystems without regard for EVM compatibility or easy access to on-chain capital.
A slew of product launches throughout 2021 also underscores that protocols tailored to specific blockchains can enable experiences that may not be possible elsewhere. One of the clearest examples of the synergy between applications and blockchain is Serum, an orderbook-based DEX built on Solana.
Typically, DEXs like Uniswap and SushiSwap have adopted the AMM design prevalent throughout DeFi, where passive liquidity pools allow traders to trade tokens based on the current ratio of the two tokens in the pool. In the AMM category, variants of the standard constant product design have emerged over time, but they all still rely on self-rebalancing liquidity pools that lack some of the core functionality of traditional central limit order books .
For example, users of AMMs essentially ask for market buys when making trades, unlike traditional order books where the matching engine executes trades when buy and sell orders overlap at user-specified prices.
Solana’s exceptionally high throughput (estimated at 50,000 transactions per second) and low transaction fees compared to other blockchains allow Serum’s on-chain ordering to be possible and costly on other blockchains function in the circumstances. By comparison, the throughput estimates for Ethereum and Avalanche are around 20 TPS and 4500 TPS, respectively.
This ability to take advantage of its technical specs to enable applications to benefit from deployments in its ecosystem may be one of the reasons why Solana will be able to see tremendous growth in 2021.
Even though Solana is non-EVM compliant, it has amassed $14.4 billion in TVL as of this writing, up from $153 million just 6 months ago, second only to Ethereum and BSC. Solana’s TVL growth is significant, and even normalizing it, SOL’s price increased from $1.84 at the beginning of the year to $208.71 on November 30 relative to the massive price appreciation in 2021.
Solana’s DeFi ecosystem is dominated by its DEXs, which make up most of TVL’s top protocols. The No. 1 exchange is Raydium Exchange, which leverages Serum’s order book to provide a trading experience similar to traditional centralized exchanges, while also offering liquidity pools that allow users to conduct Serum-based transactions.
As one of the first DEXs to launch on Solana, Raydium has been at the top of the Solana ecosystem TVL for most of 2021 and currently handles most of the transaction volume in the ecosystem.
A protocol that has grown considerably in recent months, Marinade Finance is a liquid staking solution for Solana that allows users to earn protocol fees by staking SOL in exchange for mSOL, which can then be used on the Solana ecosystem mSOL is used throughout DeFi applications.
The mechanics of Marinade are similar to LidoFinance, a liquid staking solution that has seen considerable growth in the Ethereum and Terra ecosystems in the form of stETH and bLUNA.
Interestingly, Marinade’s growth has continued despite Lido’s deployment of its own stSOL liquid staking solution in Solana in early September. At the time of writing, Marinade staked SOL’s TVL worth around $1.5 billion, much higher than Lido’s $208 million.
Much of the value of liquidity products like mSOL and stSOL comes from how well they integrate with other DeFi protocols in the ecosystem. If these products don’t have enough liquidity or use cases, their value proposition will drop dramatically compared to native SOL that can be used across the Solana ecosystem.
While Solana has seen immediate benefits from the technological advantages of its DeFi ecosystem, it has also seen significant growth in the NFT ecosystem in 2021, where factors such as network throughput are not necessarily critical. Taking Solana’s frequently fluctuating NFT floor price as its current market price, as of November 30, the total market value of Solana NFT has exceeded $820 million.
The growth of the Solana NFT ecosystem in 2021 will benefit from a number of key infrastructure developments, one of which is the June launch of the Metaplex NFT platform, which allows users to create NFTs on Solana and create their own stores or marketplaces.
The timely arrival of Metaplex’s contract ecosystem has underpinned the launch of Solana’s main non-functional trading markets, such as Solanart and Digital Eyes, which have been critical to the growth of Solana’s overall non-functional trading activity.
A notable aspect of rising NFT activity on Solana in 2021 is the interaction between Solana and Arweave, a decentralized storage solution that continuously backs up Solana’s ledger data to its own blockchain via the SONAR cross-chain bridge.
Regarding NFTs, Arweave also plays an important role as it is the default storage solution for all NFTs created through Metaplex. In fact, one way to visualize non-functional financial activity on Solana in 2021 is to look at the transaction history on Arweave.
As the number of daily active users in the Solanart and Digital Eyes non-functional gaming marketplaces began to rise in late August, so did the number of transactions on the Arweave network. Daily trading volume also peaked on October 7, which is in line with the decline in active users on Solana’s non-functional trading market since mid-October.
As a whole, the unique symbiotic relationship between Arweave and the Solana network deserves attention in the future, as the L1 network is expected to become increasingly interconnected over time.
The significant growth of the Solana ecosystem in 2021 can be attributed to the confluence of several key factors, including overall growth in the crypto market, timely product and infrastructure launches, and funding. However, its meteoric rise throughout 2021 has not been without its challenges.
One of the biggest challenges for the Solana network in 2021 came in mid-September, with the mainnet experiencing a prolonged period of unexpected downtime that didn’t begin to be fully resolved until about 17 hours after it started. Preliminary analysis of the event showed that during the initial IDO of the Grape protocol, a sudden increase in bot transactions caused the network transaction processing queue to become overloaded, followed by excessive memory consumption, causing multiple nodes to be disabled.
Ultimately, node validators vote to restart the network, but not until then, Solana’s DeFi protocol faces a significant risk of failure that could result in a significant loss of user funds. Solana’s 2021 network outage highlights the unique challenges of creating a new blockchain ecosystem, especially when it’s growing at such a rapid rate.
One of the issues is centralization, and Solana effectively trades throughput for decentralization because its validators are much more computationally intensive compared to other L1s. During an outage event, validators were able to quickly reach consensus to resolve key issues, but it has also been argued that this centralization creates a centralised risk point for the network.
While the ultimate goal of L1s like Solana is to achieve greater decentralization over time, blockchains are run by people, teams and governance bodies that are constantly innovating and allowing the system to improve. For relatively new L1 chains, this means that occasional centralized actions may be required early on to ensure continued success.
The fact that today’s blockchains are ultimately evolving the network is most evident in the case of network upgrades, where the decisions of developers can have a huge impact on the future of the network. These upgrades can help optimize many aspects, including performance, growth, and security. For example, with the implementation of EIP-1559, Ethereum’s London hard fork in August 2021 brought sweeping changes to the network’s transaction fee structure and monetary policy.
Avalanche’s September upgrade also introduced new block-based fees to the c-chain, as well as new congestion control mechanisms designed to combat malicious MEV activity on the network.
Sometimes upgrades are done to optimize growth, as we saw in the example of Tezos’ Granada mainnet upgrade in August 2021. Unlike most other L1 platforms, the Tezos blockchain can be upgraded through an in-protocol modification process that does not require a hard fork.
In the Granada upgrade, the Tezos consensus algorithm was replaced, the block time was reduced from 60 seconds to 30 seconds, and the concept of “liquidity baking” was introduced into the network. With this feature, Tezos governance effectively implements a native protocol mechanism to incentivize and attract liquidity to the network.
To achieve liquidity baking, Tezos created a Fixed Product Market Maker (CPMM) contract that acts like a liquidity pool for AMMs like Uniswap. This contract encourages tzBTC to join the tzBTC-XTZ pool, which continuously generates XTZ rewards, just like XTZ rewards to Tezos bakers (stakers).
Since XTZ joins the CPMM pool, the price of tzBTC in the pool is artificially inflated, thereby incentivizing arbitrageurs to add more tzBTC to the contract in exchange for relatively “cheap” XTZ.
As of Nov. 30, the contract has garnered about $20.2 million in total liquidity since its introduction, although growth has been relatively stagnant over the past few months.
As we mentioned recently, one problem with the specific support of tzBTC by liquidity bake contracts is that tzBTC is relatively more difficult to obtain for users who want to enter the Tezos ecosystem while remaining entirely on-chain. To do this, the asset must be bridged through the wrapper protocol and then exchanged for tzBTC.
Instead, users may choose to simply link the commonly used WBTC with wWBTC. As of November 30, WBTC was about twice as liquid on Plenty as tzBTC. In fact, users may have little reason to remove their liquidity from CPMM contracts, limiting the effectiveness of liquidity incentives.
Even so, Tezos’ unique approach to directly incentivizing liquidity through mainnet upgrades is a testament to how fluid today’s blockchain architecture can be as it adapts to changing market demands.
In this fast-paced crypto industry, protocol designs that were well-suited for a particular L1 ecosystem a year ago tend to become outdated after reaching new levels of growth or adoption. Therefore, for a newly launched or growing blockchain, the ability to implement the necessary changes relatively quickly can be an important factor in remaining competitive and achieving continued growth.
L1, which has undergone a major upgrade over the past year, and Terra, whose mainnet was upgraded to Columbus-5 on September 30th. Terra’s last mainnet upgrade to Columbus-4 was in October 2020, and this upgrade brings CosmWasm smart contracts to Terra, which for the first time enables developers to develop Rust applications for the Terra ecosystem. Less than a year later, the latest update brings a number of changes that reflect the needs of Terra’s now more mature ecosystem.
In the early Columbus-4 Terra protocol, a portion of all LUNA burned to issue UST was redirected to LUNA stakers, as well as a community pool to fund general ecosystem initiatives. While this mechanism was initially beneficial to bootstrap the growth of Terra’s young ecosystem, the emergence of supporting initiatives over the past year, such as Terraform Capital and the $150 million Ecosystem Fund, has ultimately reduced the need for community pools.
Therefore, Columbus-5 developed a new mechanism for LUNA issuance tax, 100% of the issuance tax is destroyed when UST is issued, which creates a simpler and more direct relationship between LUNA and UST demand.
This change is expected to put more deflationary pressure on LUNA in the long run as demand for Terra’s UST stablecoin grows. Much like Ethereum’s EIP-1559 upgrade, Terra’s 2021 Columbus-5 upgrade represents the way L1s is actively adapting to growth in a rapidly changing market environment.
5. Adapt to increasing connectivity in a multi-chain world
One of the main goals of the Terra platform is to expand the distribution of its UST stablecoin across the crypto ecosystem, regardless of the specific blockchain or protocol it uses. In the Terra model, UST is issued during periods of growing demand, where anyone can choose to burn LUNA in exchange for an equivalent of UST at current market prices, effectively increasing the supply of UST.
During 2021, the supply of UST has increased significantly, from about 182 million at the beginning of the year to about 2.7 billion on November 10, reflecting steady growth in demand for the stablecoin throughout the year.
As of November 22, the supply of UST has soared to 7.2 billion, an increase of about 4.5 billion in just 12 days. The latest increase in demand is not the result of a natural surge, but rather the result of the passage of Terra Proposals 133 and 134 on November 9, which designated the Terra community pool established prior to Columbus-5 to burn 88.675 million LUNA (about 4.5 billion at the time) in two weeks. Dollar).
UST minted from scheduled LUNA burns is expected to be used for a number of initiatives, including funding Terra’s native insurance protocol (known as Ozone), purchasing collateral reserves for UST, and funding UST’s multi-chain expansion.
Interestingly, another new feature implemented through the Columbus-5 upgrade is the transfer of LUNA/UST transaction fees to LUNA stakers instead of being destroyed as in previous mainnet releases. In fact, the impact of recent LUNA burns on staking rewards can already be seen.
The annualized yield on staking on LUNA has more than doubled since November 10, and as of this writing, the expected annual yield is around 10.4%. This increase in earnings is also expected to benefit Terra’s two largest TVL DeFi protocols — Anchor and Lido — which collectively hold $12.7 billion worth of TVL in the Terra ecosystem as of Nov. 30 of $9.9 billion.
Anchor’s TVL consists primarily of bLUNA collateral issued by Lido, meaning that the recent increase in yields from staking LUNA on Terra will benefit users of both protocols and translate directly into further growth. In addition to growth and protocol monetary policy, Terra’s Columbus-5 upgrade kicks off a significant new level of network interconnection, activating IBC transfers on October 21st.
As a blockchain built using the Cosmos SDK, Terra can theoretically communicate on-chain with any chain in the Cosmos ecosystem via the Inter-Blockchain Communication Protocol (IBC).
With the ability to transfer assets now, Terra goes one step further in expanding the presence of UST, which is already available in other L1 ecosystems such as Ethereum and Solana. For the Cosmos ecosystem, activating Terra’s IBC transfer brings it closer to the vision of an interconnected system of IBC-enabled networks.
As of this writing, there are currently 25 IBC-enabled blockchains in the Cosmos ecosystem. As can be seen from the number of IBC transfers, Osmosis currently leads the active area of the Cosmos network, followed by the Cosmos Hub and Crypto.org. Since the launch of IBC in late October, Terra rose to fifth on the list of Cosmos’ most active blockchains in November.
Perhaps the clearest sign of Terra’s expansion into the Cosmos ecosystem is the rise in liquidity of Terra’s native assets on Osmosis. As the most traded and liquid DEX in the IBC network, Osmosis can be considered a touchstone for general activity in the Cosmos ecosystem.
As of November 30, UST and LUNA have amassed about $89 million in liquidity on Osmosis, second only to OSMO and ATOM, the native tokens of Osmosis and Cosmos Hub, respectively.
With increased liquidity, UST and LUNA are now among the most traded tokens on Osmosis, highlighting Terra’s new presence in the Cosmos ecosystem.
For now, that’s largely confined to Osmosis, which has seen massive growth since its June release. Since then, TVL on Osmosis has grown to approximately $615 million as of Nov. 28, largely thanks to an initial airdrop to ATOM holders and OSMO’s ongoing rewards for liquidity providers.
Osmosis’s liquidity incentives are representative of some key differences between Osmosis and the Cosmos Hub, and the AMM DEX was originally conceived as a module.
Eventually, Osmosis was launched as a standalone DEX on its IBC-enabled blockchain, citing the need for rapid iteration on its features, which would be limited by the relatively slow governance of Osmosis Hub stakers. In fact, signs of these limitations can be seen in the Hub’s own DEX implementation, the Gravity DEX.
Launched on July 13, the DEX has received much less liquidity than Osmosis, with a TVL of around $34 million as of this writing. While the DEX itself technically went live in July, access to the exchange’s front-end interface via the Emeris hub didn’t launch until more than a month later, underscoring the need for Cosmos when constrained by the hub’s proposal and voting process. The apparent difficulty of the ecosystem building applications.
At the time of writing, there is still no additional incentive to provide Gravity DEX liquidity, a common feature in DeFi and Osmosis DEXs. It was only as recently as November 9th that the Cosmos Hub passed a proposal to increase the budget and farming modules, which would allow ATOM to be allocated for specific purposes, and do so through a standard farming mechanism. However, the actual implementation of these modules is not expected until early 2022.
As one would expect, with the OSMO token, Osmosis’s liquidity incentives give it an advantage over Gravity in attracting liquidity, again demonstrating the effectiveness of rewards in promoting specific user behavior in DeFi. In the future, the role of the Cosmos Hub in the wider Cosmos ecosystem will be more clearly defined as the central gateway for interacting with IBC-connected chains.
For example, the Hub will oversee the creation of the Gravity Bridge, a cross-chain bridge that will allow users to connect ERC20 assets from Ethereum to Cosmos. Like other ecosystems, this cross-chain bridge is critical to the general adoption of the Cosmos ecosystem, providing a straightforward way to transfer value from the most mature L1 ecosystems.
In an upcoming Vega upgrade, the Cosmos hub will also add IBC router functionality, which will allow it to provide routing services for IBC-enabled chains for a fee.
One of the biggest developments in the Cosmos ecosystem is the introduction of the Cosmos Hub’s interchain security system.
Essentially, this would allow a parent chain like the Cosmos Hub to produce blocks for a child chain (such as an IBC-enabled chain like Osmosis). While not expected to be released until the second quarter of 2022, the network connected to the Cosmos Hub can inherit its security guarantees, reducing the overall security cost of an IBC-enabled chain.
In implementing this shared security model, the Cosmos ecosystem will begin to look similar to the Polkadot network, which uses a primary relay chain to determine blocks for connected parachains. In 2021, the Polkadot ecosystem is like a field experiment, seeking to build an interconnected network secured by a relay chain.
Most of this activity takes place on the Kusama network, which serves as a testnet for the Polkadot version, allowing rapid iteration of theoretical concepts in production before Polkadot is deployed. One of the most important developments for the Polkadot ecosystem in 2021 is the first parachain auction in Kusama in June.
Through a unique parachain slot auction process, resulting in parachains like Karura and Moonriver, users are able to see, for the first time, in real-time what a network ecosystem built on Substrate can look like. Throughout the second half of the year, Kusama’s parachain auctions brought valuable attention and capital to the winners, effectively allowing the market to choose the most coveted financial primitives and products.
Crowdlending participants locked up hundreds of millions of dollars in KSM to support their favorite parachain projects, demonstrating the overall publicity of projects in the ecosystem, as well as fluctuating interest over time during the auction process.
So far, Polkadot’s trend for parachain slots looks similar to Kusama’s story, with Acala and Moonbeam winning the first two slots, sister networks to Acala and Moonriver respectively.
In fact, the use of EVMs in the construction of L1 networks in 2021 is so widespread that even emerging DeFi ecosystems like Algorand seem to be looking to learn from Ethereum, albeit from a slightly different angle. The launch of Tinyman DEX in October 2021 is the ecosystem’s biggest shock to DeFi. Perhaps more importantly, though, it introduces algorithms and virtual machines (AVMs).
By developing an AVM enhancement to the protocol on Algorand, the network clearly hopes to replicate the success of the Ethereum EVM in launching its smart contract platform.
As is often seen in other L1 ecosystems, the ability for developers to build DeFi primitives on the Kusama-connected network, backed by familiar Ethereum tools, facilitates rapid product launches and user acquisition. The most testament to user activity is Moonriver, which has surpassed $350 million in TVL in the five months since its June launch.
Nearly one-third of Moonriver’s TVL is currently locked in Solarbeam DEX, the platform that provides liquidity and rewards SOLAR, the native token. A key aspect of the Solarbeam protocol is that it integrates a cross-chain bridge between Ethereum and Moonriver, powered by the Anyswap protocol.
As of this writing, the Anyswap: Moonriver bridge has a TVL value of approximately $284 million and is currently the largest source of capital transfers between the Ethereum and kusama ecosystems. This important interconnectivity was exemplified by Bifrost’s partnership with Karura on October 19th, with BNC offering rewards for providing liquidity on the KaruraSwap DEX. Users can build BNC cross-chain bridges between Bifrost and Karura chains by using XCMP’s simple interface in both applications.
In a sense, the collaboration between Bifrost and Karura is reminiscent of the core of today’s mainstream DeFi protocols — composability, and the complexity of backing tokens between different chains. At the same time, the introduction of new cross-chain technologies, such as the XCM format adopted by Polkadot and Kusama, also comes with unforeseen risks that are often difficult to predict.
For example, the Karura and Kusama ecosystems faced a major issue on October 12, when an attacker stole 10,000 KSM worth about $3.2 million from Kusama’s parachain account. This vulnerability may be due to the Kusama network upgrading to v2 of the XCM messaging standard, while its parachains still use XCM v1.
In response, the administration quickly banned XCM transfers and passed a proposal that would allow them to force the transfer of stolen funds back to Kusama’s parachain account. Such incidents, along with the draconian measures taken by Karura and Kusama governance, underscore the level of risk that remains in a largely unaudited environment that has gone through major iterations.
6. The main development of the cross-chain bridge
The emergence of cross-chain bridges in 2021 is one of the most important developments to facilitate the rise of various L1 ecosystems and the current multi-chain landscape. As the primary means of transferring assets between different chains in a permissionless manner, these cross-chain bridges have become an important gateway for enabling the seamless flow of capital throughout the crypto ecosystem. Likewise, tracking activity around cross-chain bridges is now an effective way to assess usage and interest in certain ecosystems, both short- and long-term.
Perhaps the biggest example of the central role of cross-chain bridges in today’s crypto space is the dramatic rise in wrapped Bitcoin assets on Ethereum. Since the beginning of 2021, the number of BTC wrapped on Ethereum has increased from around 140,000 to 3,166,000 today. At current BTC market prices, this means an increase of around $10 billion in BTC assets on Ethereum, likely used as a production asset in DeFi protocols.
Most Bitcoin on Ethereum exists in the form of WBTC, which can only be issued by centralized custodians such as CoinList and Alameda Research. Other wrapped BTC assets, like renBTC, are backed by a decentralized network of nodes, but they are still backed 1:1 with actual BTC.
The best way to assess movement between L1 ecosystems is not just the growth of packaged assets, but the total value locked in the cross-chain bridges connecting the various ecosystems. In 2021 in particular, there will be significant capital transfers from Ethereum to other L1 chains, as DeFi players seek to invest in early-stage protocols emerging on other chains, as well as take advantage of attractive yields that may be found in the broader DeFi space.
According to smart contract statistics on Ethereum, the TVL of the cross-chain bridge has grown significantly in 2021, from $667 million at the beginning of the year to $32 billion on November 30. Among the various cross-chain bridges from Ethereum to other L1s, Binance Bridge has become the largest cross-chain bridge, with a TVL of about $10.4 billion as of Nov. 30, reflecting BSC’s rise to become the second largest smart contract platform rise. Cross-chain bridges will take many forms in 2021, with different implementations and degrees of decentralization.
For example, Binance Bridge is one of the most centralized cross-chain bridges because it is entirely managed by Binance. When users send assets via Binance Bridge, the assets are actually sent directly to the Binance exchange, where they are still issued as BSC-compatible wrapped assets.
While there is already a central point of failure when it comes to asset custody, Binance Bridge isn’t entirely permissionless either, banning users with U.S. IP addresses, highlighting some of the main problems that centralized bridges have for DeFi. Other cross-chain bridges, such as the Avalanche bridge, have implemented additional security measures in an attempt to better protect these now billion-dollar assets.
In 2021, the analysis of capital flows in and out of cross-chain bridges has become a particularly meaningful indicator of capital flows to specific ecosystems. For example, another cross-chain bridge that reflects its 2021 target chain growth is the Ronin Bridge, which players of the popular game Axis Infinity must pass to enter the Ronin sidechain and interact with the game.
In DeFi protocols throughout 2021, leading P2E game Axie Infinity has seen some of the most explosive growth, jumping from an average of 581 daily users in January to 121,000 in November. This growth can also be seen in the TVL growth of the Ronin sidechain, from around $31 million at the beginning of the year to $7.9 billion on November 30.
The specifications of most bridges currently deployed are similar to ChainSafe’s ChainBridge protocol, which uses a “lock and issue, destroy and release” mechanism. In this model, the tokens transferred through the bridge are locked in the bridge contract and the equivalent tokens are generated on the target chain.
When the wrapped tokens are sent back through the bridge, they are minted on the target chain and released from the bridge contract on the source chain. This approach works well for the most part because it provides an easy way to issue assets during transfers without changing the circulating token supply.
However, the main drawback of this mechanism is that it requires bridging escrow for the transferred assets, which can create a vulnerable single point of failure. If the cross-chain bridge contract is broken, it could lead to the theft of funds and render the wrapped tokens worthless from the bridge. One of the cross-chain bridges that use a non-custodial mechanism for cross-chain bridge transfers is the Anyswap protocol, which became popular in 2021 as the main cross-chain bridge between Ethereum and Fantom.
Anyswap combines liquidity trading with a common issue/burn mechanism, where an intermediate token like anyUSDC is used to eliminate the need for bridging custody. In the example of an exchange, a user connecting USDC would deposit it into any exchange, which would issue any USDC 1:1 on Ethereum and then immediately burn it, triggering any USDC issuance on Fantom.
It then uses the anyUSDC:USDC liquidity pool on Fantom to exchange wrapped USDC on Fantom. Under this mechanism, the transfer of assets does not require bridge custody, but only requires sufficient liquidity.
A notable example is the launch of Geist Finance on Fantom on October 6th, accompanied by unusually high liquidity incentives, resulting in a flood of capital into the Fantom ecosystem via the Anyswap: Fantom bridge. In just four days, the bridge secured more than $3 billion in deposit liquidity, most of which went into the Geist Finance protocol.
As returns on new lending protocols plummeted and capital was quickly pushed out of the Fantom ecosystem, the bridge lost around $1.8 billion in TVL just two weeks after TVL peaked. As cross-chain bridges become an increasingly important source of value and activity in an increasingly multi-chain world, users may start looking for cross-chain bridges that offer the ideal combination of speed, security, and decentralization.
These may look similar to the protocols of AnySwap, which also recently announced support for non-functional bridging. Another cross-chain bridge also provides non-functional bridging and is starting to gain traction in many chains. For example, the Wormhole V2 bridge, which uses a unique universal cross-chain messaging protocol, could theoretically allow any asset transfer between chains.
In the future, this common messaging format will technically allow assets residing on one chain to be used in DeFi protocols on another chain without leaving the source chain. In a way, cross-chain bridges essentially represent a subset of the oracle problem, where providers are always looking for the ideal compromise between speed, accuracy, and security.
So it’s no surprise that oracle provider Chainlink announced in August that it would be getting into the cross-chain game with its new Cross-Chain Interoperability Protocol (CCIP). With the growing need for permissionless asset transfers between more and more L1 ecosystems, cross-chain bridges are in the middle of the future of cross-chain DeFi.
In the future, it is unclear whether a bridge will eventually serve most cross-chain transfers. One thing is for sure: the road to eventual cross-chain interoperability will be filled with potential solutions in all their forms. In the end, the only way to come up with the best cross-chain solution is to let the market decide for itself.
7. Development of Ethereum Layer 2 scaling solutions
As layer 1 chains continue to threaten Ethereum’s dominance as a smart contract platform, Ethereum has advanced its infrastructure by leveraging layer 2 technology rollups. There are currently two types of rollups in the market, namely Zero-Knowledge and Optimistic, both of which currently exist on the Ethereum mainnet.
Even without a token launch, Layer 2 has seen a significant increase in TVL, which is likely to continue into 2022. With the launch of the Ethereum 2.0 shard chain planned for 2022, coupled with the possibility of token distribution, rollups will see greater adoption in 2022.
Optimisticrollups (ORUs) will see significant growth in 2021. Since the release of the Arbitrum and 0ptimistic mainnets on May 28 and June 22, ORUs have grown in both TVL and user metrics. At the time of writing, the locked value of Arbitrum and Optimism is $2.6 billion and $400 million, respectively.
User metrics for both Arbitrum and Optimistic are on the rise. While Optimistic did launch Synthetix earlier, its mainnet came after Arbitrum. That said, Optimistic and Arbitrum have roughly the same growth in terms of unique addresses, but Arbitrum has significantly higher peak transaction throughput than Optimistic.
However, both Arbitrum and Optimistic are basically able to have similar transaction throughput, suggesting that Optimistic will be ready to grow once it starts allowing decentralized applications (DApps) to be deployed permissionlessly.
Arbitrum and Optimistic have very different stances on DApp deployment: Arbitrum actively seeks as many DApps as possible, while Optimistic strictly follows whitelisting requirements for DApp deployments. This brings a larger ecosystem to Arbitrum compared to Optimistic. Since Arbitrum has significantly more DApps than Optimistic (58 instead of 6), the DApp Dominance graph below lists only Arbitrum’s notable protocols.
Arbitrum has seen significant growth through Curve, Balancer and SushiSwap. More notably, Abracadabra has also seen rapid growth in TVL, in part due to the rapid price increase of its native token SPELL. These DApps have been dominating Arbitrum’s TVL and will likely continue to do so in 2022.
Optimistic, on the other hand, is dominated by Synthetix. This is partly because at the time of writing, Optimistic only has 6 DApps. As more DApps are deployed on Optimistic, there is a good chance that Synthetix’s dominance will eventually decline.
In addition to this, there are two notable ORUs that gained significant traction in the last quarter of 2021, namely Boba and Metis.
At the time of writing, Metis only has a testnet DEX, while Boba already has a well-functioning bridge and a native DEX called OolongSwap that can be used for actual trading. The Boba Network airdropped their native Boba tokens to OMG token holders on November 12th.
This led to a lot of speculation on the price of the OMG token before the airdrop. More notably, the funding rate of OMG perpetual contracts on Binance reached -2.4% every two hours, and the price of OMG plummeted after the airdrop snapshot. It is unlikely that there will be another airdrop with this model.
That said, after the BOBA token airdrop, it saw a sharp increase in TVL, mainly due to the increase in TVL of BOBA’s native DEX, OolongSwap. OolongSwap has a liquidity mining incentive mechanism, which quickly attracts a large amount of funds to provide liquidity. That said, a significant portion of OolongSwap’s funding is likely to be mercenaries who may leave the ecosystem once the benefits are no longer attractive.
Another competitor worth mentioning is the Metis DAO, whose native token, Metis, rose in price after the BOBA airdrop. Going forward, it is unlikely that any L2s will repeat the airdrop of tokens in the way that BOBA did, considering that it distorts market prices to some extent. That said, the two largest ORUs will likely end up having to issue some form of token.
Zero-Knowledgerollups (ZKRs) have seen a phenomenal increase in 2021, from a TVL of $43.5 million on January 1, 2021, to the current $1.9 billion locked in ZKR solutions. Validium, a scalable solution that utilizes Proof of Validity but stores data off-chain, has also seen TVL grow throughout the year, albeit not as dramatically as ZKR.
In the ZKR space, one of the most notable highlights was the release of dYdX using StarkEx to scale transaction throughput. The exchange also launched governance tokens, which led to TVL rising from $96.5 million on Sept. 8 to $930 million at the end of November, becoming the main driver of ZKRs TVL growth.
ZKR’s other projects include Loopring, ZKSwap V2, zkSync, Aztec, and Polygon Hermez, all of which have grown in value since the beginning of the year, with TVL’s cumulative value increasing from $40 million at the beginning of the year to $943 million at the end of November.
While the value locked in Validium has not grown as much as the ZKR version, notable non-functional projects Sorare and ImmutableX both use StarkEx. Similar to dYdX, ImmutableX announced their utility token on July 22, which can be used for governance or for rewards.
This led to Immutable X becoming the Validium project with the highest TVL at the end of the year, at almost $350 million. During the year, ZKSwap V1 actually had the highest TVL, but is now defunct due to the release and success of V2.
In addition to the growing TVLs of ZKR and Validium, we can also see their usage increasing on a given day through deposit notifications to smart contracts for proof-of-validity-based scaling projects. Although the development of different projects varies and the number of days with high deposits varies, most projects can benefit from the need for a deposit function on an ongoing basis.
Both StarkWare and Matter Labs are pioneers in the field of proofs of validity. In 2021, StarkWare has launched StarkNet Alpha to mainnet on November 29th with the aim of building a full layer 2 for users and developers to connect back to mainnet via ZK-STARKs.
Matter Labs announced that their development of zkSync 2.0 will use zkEVM, an EVM-compatible compiler. Likewise, both companies are looking into creating a hybrid data availability where users can choose whether data is stored on-chain or off-chain, developing Volition and zkPorter as their solutions to merge the two forms of data storage.
8. Competitive outlook for Tier 1 platforms and scaling solutions in 2022
Much of the discussion around L1 and L2 platforms in 2021 will focus on scalability, especially with Ethereum transaction fees and usage reaching record highs at a time when crypto and NFTs are the new mainstream focus. In theory, L1 and L2s have different technical limitations and security guarantees.
In fact, from a user experience standpoint, they currently function similarly. In order to take advantage of the speed and cost improvements of L1 chains and L2 chains, users must first connect funds from an L1 chain such as Ethereum.
Therefore, like cross-chain bridges from L1 to L1, cross-chain bridges to L2s can also serve as a valuable indicator of the amount of money flowing from L1 to a particular L2. For example, TVL on the Optimistic Bridge has grown from about $47 million starting the third quarter to about $517 million as of November 30.
While experiencing more than 10x TVL growth over the past few months, the TVL of the Optimistic bridge is still dwarfed by other major L1 cross-chain bridges, such as BSC, whose TVL was around $31 billion as of November 30.
Currently, L1s has the advantage of serving as a host for a larger overall protocol ecosystem, as well as key infrastructure features such as oracles, cross-chain bridges, centralized exchange support, application support, and more. This fact is evident when comparing the TVL in L1 and L2 protocols, suggesting that DeFi activity currently dominates L1 over L2s.
At the same time, the growth of L2s also shows increasing traction. Often, this growth can be partially explained by the introduction of liquidity incentives that start to appear on L2s. For example, when ArbiNyan on Arbitrum launched in early September, token inflation and APYs were very high, which led to a lot of mercenary capital entering the Arbitrum ecosystem for quick gains, but quickly leaving.
That said, the TVL of Arbitrum and Optimistic is still growing significantly. Arbitrum’s TVL has continued to grow since early September, despite ArbiNyan’s rapid inflow and subsequent outflow of funds from Arbitrum. Only a few applications currently exist on Optimistic, but it is very likely that in 2022 many more DApps will be running on this L2, which will put Optimistic on the same growth trajectory as Arbitrum.
Another factor to consider is the possibility of a native token for L2s. Fundamentally, L2s are not ready to compete with L1s, but we have good reason to believe that they will compete with L1s in 2022. The combined effect of entry-level DApps, greater revenue generation opportunities, low fees, fast transactions, Ethereum-level security, and the possibility of native tokens is enough to jump over L1s to L2s.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/the-highlight-of-2022-annual-review-of-mainstream-l1-and-l2/
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