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A complement to Ethereum? How does L2 affect value capture over L1?

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So far, about 70% of the fees paid by users in Arbitrum and Optimism have been captured by Ethereum verifiers.

How does L2 affect value capture on L1?

原文作者： Michael Nadeau

原文编译： Foresight News

This crypto winter, the growth of Ethereum extension solutions is one of the few stories that the market continues to watch. Transaction fees are down, applications are migrating to L2, and TVL is growing; At the same time, the user experience is getting better.

L2 comes to the highlight moment, but how does it affect ETH on L1? Should ETH holders and verifiers view L2 as complementary to Ethereum? Will value accumulate in the technology stack? What does this mean for other L1 public chains?

This week we have a data-based update covering the economics of the Web3 technology stack as it relates to L2:

L2 Business Model and Recent Growth How L2 affects the mental model/framework of ETH Economics Investors Do we still need L1 competition chains?

L2 business model and recent growth

L2 attempts to address the scalability issues of Ethereum L1. They make money by compressing data and "reselling" Ethereum's block space. L1 is slow and expensive, with limited block space. Therefore, we should think of Ethereum as the final clearing and settlement layer of the technology stack. The base layer records the final state of everything that happens at the execution and application levels above it -- as the only source of facts.

The execution services that enhance the user experience (lower costs, faster transactions) for the application are handed over to Tier 2. These services are performed on another chain outside of Ethereum and then data is recorded into L1. Below is a simplified view of the technology stack.

Most computing resources (Gas) are currently consumed in Ethereum L1, where applications were originally built. Keep in mind that the Web3 stack has no centralized party coordinating development activities (nor does the Internet), everything is open source. Builders are scrambling to get in, but not everyone is working on the same schedule or with the same agenda. This is not the well-coordinated agile sprint you see in well-run tech companies.

The L1 infrastructure and applications are under construction before the extension solution is rolled out. With the L2 outbreak, we expect to see more application migration, and new projects may start directly on L2 in the future.

The data reveals this trend. Here's a quick look at total computing resource (Gas) usage on Ethereum and how top level L2 is consuming resources right now.

Data source: Arcana Analytics

Arbitrum and Optimism now take up more block space than Polygon. Collectively, these three L2s make up about 4.5 percent of the current Ethereum block space, up from about 3 percent at the end of 2022.

Let's look at the other data in L2:

Note: The average per-transaction fee for Ethereum L1 so far in 2023 is $4.84.

As mentioned earlier, L2 serves applications by providing users with a better and cheaper experience. They buy block space on Ethereum L1, then compress the data, package the transaction, and eventually record the data proof to Ethereum.

But are all L2 equal? Are they all complementary to Ethereum?

L2 and ETH economics

Prior to L2, transaction fees would skyrocket when Ethereum became congested. At one point in 2021, a transaction cost as much as $200. Using Ethereum during an adoption cycle is a bit like trying to hail an Uber after a late flight, with too much demand and not enough supply.

L2 is designed to solve this problem. But what exactly happens when users pay a 21-cent fee for Arbitrum today? How much does Arbitrum get in fees? How much money does the verifier get?

How much value does the baker get when you buy a sandwich at a coffee shop? How much should meat producers be paid? How much to the dealer? How much for toppings and condiments? What's so special about sandwiches? What brings the most value? Is everything else supplemental?

This is something we should be thinking about in terms of L2 and the economics of the Ethereum technology stack.

The answer is that through 2023, about 62% of what users pay at Arbitrum goes to Ethereum verifiers. Since its inception in 2021, 64% of all fees have been paid to Ethereum validators.

At the same time, 80 percent of the Optimism generated by optimism now goes to Ethereum verifiers. Since its inception in 2021, 74% of all fees have been paid to Ethereum L1. The following is the data provided by Token Terminal:

It's a win-win situation. Superior execution and lower costs for application users further drive more use cases, more developers, and ultimately more users. Ethereum verifiers will benefit in the form of transaction fees, and passive holders will benefit as increased transaction volume boosts demand for Ethereum. At the same time, Optimism and Arbitrum benefit from Ethereum's network effects and can essentially outsource their consensus and security costs to the base layer.

What about Polygon?

Polygon is a side chain of Ethereum, which makes it different from Optimism and Arbitrum. As a side chain, Polygon has its own set of verifiers. It therefore has its own consensus and security, unlike Optimism and Arbitrum, which are "aligned" with Ethereum.

As of 2023, Polygon has paid 44% of user fees to its suppliers/verifiers, and the remainder has been destroyed. Since Polygon's fees are paid with MATIC tokens, neither Ethereum verifiers nor ETH holders receive these values. That is, Polygon periodically submits its state to the Ethereum mainnet, which contains a summary of all transactions on the side chain since the last checkpoint.

The checkpoint is then stored on Ethereum as Merkle Root, a unique hash value that represents the state of the side chain at the time. So Polygon, although integrated with Ethereum, has minimal economic impact on L1 compared to Arbitrum and Optimism because checkpoints require the least amount of data. We can see this by looking at the primary source of Ethereum destruction. Arbitrum and Optimism topped the leaderboard, while Polygon came in third from bottom despite handling a high volume of transactions.

In short, not all L2 is created equal. Side chains such as Polygon operate more like their own LL1, while leveraging Ethereum for final security and settlement guarantees. Rollups like Optimism and Arbitrum really rely on Ethereum for consensus, security, and data availability.

When we analyze the economic impact on Ethereum verifiers and ETH holders, we see rollups such as Optimism and Arbitrum as complementary to Ethereum. They can create net new demand for block space by providing a superior user experience for application developers. At the same time, much of the value processed by their solution ultimately goes to the Ethereum verifier in the form of transaction fees and to the passive ETH holder in the form of fee destruction.

Polygon hardly seems to complement us. In fact, it looks like Polygon holders and verifiers have benefited more from its close ties to Ethereum.

Investment Perspective: How to understand complementarity?

Every product on the market has substitutes and complements. A substitute is another product you might buy when the first one is too expensive. Chicken, for example, is a substitute for beef. Complementary items are products that you normally buy with other products, think gasoline and cars, or bread and hot dogs. Other things being equal, when the price of a product's complementarity falls, demand for that product increases.

Now, if L2 is complementary and they keep reducing costs to achieve superior user experience, what does this mean for ETH?

We think ETH will continue to capture most of the value generated by L2.

An analogy might help highlight what we're thinking: Let's compare Ethereum, Google and the Internet. We think that owning Ethereum might be like owning a piece of the Internet, or the important protocols that run the Internet. Right now, Google sits on top of Internet Protocol. Google is great. It solves the search problem on the Internet. In doing so, Google has increased the utility of the Internet and brought more users. Now, let's assume that every time someone uses Google to search, 6 cents goes to Google and 14 cents goes to Internet Protocol. Which investor would you choose? What if Google was just one of thousands of applications running on the Internet (Ethereum)?

Likewise, Arbitrum and Optimism are addressing important questions. We think they will drive more users to Ethereum. But we cannot ignore the fact that today about 70% of value belongs to ETH verifiers and holders. The market seems to be valuing the security, decentralization, and settlement assurance of the execution services L2 provides.

Does this mean investors should avoid L2? There's definitely some nuance here. We think Ethereum could reach a trillion-dollar market cap in the next bull market. If L2 continues to charge 30% of user transaction fees, and all transactions (or the vast majority) go through L2 in the future, then one could argue that they could get 30% of Ethereum's valuation, which would be a $300 billion expected market cap.

On this line of thinking, L2 still has plenty of upside. Keep in mind that only about 4.5% of the Gas used on Ethereum today runs through L2. That being said, the top three L2's together generate 6% of Ethereum's transaction fees, but 14% of Ethereum's fully tradable market cap.

Investment mode

Our current thinking is that a few L2s may capture most of the value of the second layer of the technology stack. This is what we have observed so far, and is consistent with the power-law dynamics we have observed throughout the Web3 technology stack. We'll also be watching for Coinbase's release of L2, Base later this quarter.

Another way to think about it is to compare owning ETH to owning an index fund. Just like the rotation of new companies in the S&P 500. Apps will rotate in and out of the Ethereum ecosystem. Ethereum verifiers and ETH holders will benefit. Just as SPY holders benefit from a powerful new business being added to index funds.

We think investing in L2 and apps is more like picking stocks than picking ETFs or indexes. Of course, in this case, the (ETH) index still represents a call option on the future of Web3.

Do we still need L1 competition chains?

If L2 is solving Ethereum scaling problems, what is the value proposition of alternatives such as Solana, Avalanche and Cosmos?

First, let's take a quick look at some numbers to compare Solana's performance.

Solana is still more than 10 times more efficient than Polygon, the most scalable L2 (side chain) on Ethereum today. Solana is also dominant in terms of developers and has a strong user base of over 380,000 per day by 2023. That being said, TVL reveals how L2 benefits from being "aligned" with Ethereum. L2 doesn't have to channel its TVL the way Solana does. I guess that's why SOL verifiers get to keep 50% of the transaction fee (50% of which is destroyed), while Arbitrum and Optimism together only keep about 30%.

But how does Solana's monolithic scaling approach compare to the modular approach via L2 on Ethereum?

Solana bundles clearing and execution services into the same solution, which is unique compared to Ethereum and alternative L1s such as Cosmos and Avalanche.

The modular approach taken by Ethereum, Cosmos, and Avalanche creates a lot of additional complexity related to interoperability, security, centralization, data availability, and so on that Solana does not have to deal with.

We believe Solana is significantly different from Ethereum and other competitors due to its unique overall architecture. In fact, Ethereum's approach to scaling through L2 is starting to look very similar to the approach of Avalanche and Cosmos. So if developers can deploy on Ethereum Rollup and have instant access to Ethereum's mobility and network effects, why would they choose the Avalanche subnet or the Cosmos application chain?

To sum up, we see Solana as an alternative to Ethereum, not a complement to it. We think this makes Solana the most interesting alternative. L1 opportunity in the Web3 technology stack - This is why we took a position in the network during the market dislocation earlier this year. We reported on the project in early January. We also recommend using the network, wallet, app, pledge service, etc. We think Solana offers the best encrypted user experience right now.

All in all, as L2 gains traction, we think the value proposition of alternatives that are not very different from Ethereum will be called into question.

conclusion

Ethereum L2 is growing and becoming more efficient. It's early days, but the indications are that Rollup is very complementary to ETH, as validators and holders get 70% of their fees through them. This is not the case for side chains such as Polygon that run their own validators. The L2 margin of the Optimisim and Arbitrum must be monitored. We expect margins to fall significantly as more competitors enter the space, but we will continue to watch the numbers. Zero competition may eventually commoditize the executive layer of the technology stack.

As L2 complements Ethereum, we believe that as L2 costs fall, the demand for Ethereum-based applications will increase, resulting in more value for verifiers and ETH holders. Note that the volume of transactions flowing through L2 ultimately needs to grow at a faster rate than fees decline. As solutions such as Arbitrum and Optimism mature, it appears that the scaling approach to the Ethereum ecosystem is converging with that of Cosmos, Polkadot, and Avalanche. For example, Optimism "super chain" looks similar to Cosmos Hub or Avalanche C-Chain.

Investors have a range of options when configuring the Ethereum ecosystem (ETH, L2, Oracle, cross-link bridge, application/protocol) asset portfolio. That being said, ETH appears to have a more attractive return due to the complementarity of L2 Rollup. In addition, investors should consider that side chains like Polygon are less "consistent" with Ethereum and act more as alternative L1 while taking advantage of Ethereum's network effects and EVM standards. We believe Polygon has stronger value-add potential compared to Rollup. In some ways, Polygon should be compared to Solana more than to Optimism and Arbitrum.

We believe that the growth and scalability of Ethereum L2 will shake up the value proposition of competing L1 chains with similar scalability approaches -- such as Cosmos, Avalanche, and Polkadot. Solana is markedly different, however, because it takes a single extended approach (bundling billing and execution).