Blockchain is in the moon race as it tries to develop scalability solutions that meet demand without sacrificing security and decentralization. This is the classic blockchain trilemma.
The rapid growth of decentralized finance, NFTs and gaming has led to adoption congestion in the Ethereum network. This is due to its limited processing speed, which can only process a handful of transactions per second. Many dApps are not usable at times.
Ethereum’s transition to a proof-of-stake sharded network may alleviate some of that pressure on layer 1, with sharding splitting the Ethereum network into new chains or shards to spread the load, reducing congestion, and increasing transactions per second.
However, full deployment is still many years away and participation isn’t slowing down anytime soon, so the urgent need for scalable solutions has accelerated adoption of layer 2, which runs on top Ethereum’s layer 1. This technology is not designed to improve performance at its base layer.
Layer 2 (and related technology) offer many different solutions to Ethereum scaling. Each solution has its own benefits and tradeoffs.
- State Channels, and Payment Channels
- Optimistic Rollups
Plasma chain are independent blockchains that anchor Ethereum. They are sometimes called child chains because they function as smaller copies the Ethereum mainnet. These child chains combine smart contracts with cryptographic verification to offload transactions from their parent chain.
Each Plasma chain has its own block validation mechanism. The Ethereum mainchain periodically reports back to it, using its security to settle disputes that are raised via fraud proofs.
Plasma chain enables high throughput and low transaction costs. Only basic transactions such as token transfers and swaps will be supported. There is also a requirement for liveliness and chain withdrawals may prove difficult.
Several projects offer implementations of Plasma to dApp integration. These include OMG Network and LeapDAO.
Layer2 sidechains are compatible Ethereum Virtual Machines (EVMs) that run parallel to the Ethereum mainchain. Sidechain nodes are responsible for verifying and processing transactions, adding block and maintaining the sidechain’s own consensus rules such as proof of authority or delegated proofof-stake to ensure more efficient transactions.
Compatibility can be achieved through a two-way bridge with Ethereum. However, its security is not directly inherited. It is the responsibility and responsibility of the sidechain.
Sidechains use established technology to support more complex transactions with EVM compatible. However, they are less decentralized and rely upon their own consensus mechanisms and security rather than layer 1. So technically they are not layer 2.
Projects that offer sidechain implementations include POA Network, xDai Chain and xDai.
State Channels and Payment Channels
One of the most widely discussed layer 2 scaling solutions is state channels. They use multi-signature agreements to allow participants to transact quickly off-chain and then return to layer 1 to finalize transactions as needed.
State channels can handle more complicated interactions, such as a game. Payment channels, on the other hand, are simpler state channels that deal only with payments between two parties. State channels are ideal for micropayments because they allow for high transaction throughput and low costs. The setup and settlement costs are prohibitive for micropayments. However, they can be used to make one-off payments. Liveliness is essential and funds must be kept in open channels.
The main projects leveraging state channels on Ethereum are Celer, Perun, and Raiden.
Optimistic rollsups are located in parallel to layer 2 of the Ethereum main chain. These rollups allow transactions to be executed quickly and cheaply in batches outside of layer 1. However, they still maintain the security of Ethereum base layer for submissions as one transaction.
As computation is the slow and expensive element of the Ethereum network, optimistic rollups offer up to 100 times scalability improvements as they don’t run any computation by default, a number that will increase further with the future introduction of Ethereum sharding.
Optimistic rollups assume that transactions are valid and can only run computation if challenged by fraud-proof. Optimistic rollups use an optimistic bonding system. Anyone found guilty of a fraudulent transaction will lose their bond and be incentivized to do so.
Optimistic rollsups are compatible with EVM and Solidity, so they can handle any Ethereum layer 1 transaction. Optimistic rollups are secure and decentralized because all transaction data is stored on layer 1. They also provide execution scaleability. Due to potential fraud issues, it is possible for transactions on-chain to take a long time.
As optimistic rollups support both simple payments and complex smart contracts, they are seen as more immediately suitable for DeFi applications, with Optimism, Arbitrum, and Cartesi among the multiple projects offering implementations.
In a sign of the future direction of the space, the leading DEX platform Uniswap recently also announced it would be taking the next step in adopting layer 2 tech by launching on Optimism to sharply reduce transaction costs for its users.
Zero-knowledge rollups, or ZK-rollups, bundle transactions off-chain and generate a cryptographic proof, known as a SNARK. ZK-rollups, in contrast to optimistic rollups perform computation off-chain and submit these valid proofs to layer 1.
ZKrollup smart contracts keep the state of all transactions at layer 2. This can only be changed with validation proof. Validating blocks is faster and cheaper because ZK-rollups do not need all transaction data but only the validity proof.
Additionally the ZK-rollup contract already verified the transactions so there is no delay in moving from layer 2 into layer 1.
ZK-proofs have faster finality times and are secure and decentralized. The data required to recover the state is stored at Ethereum layer 1. Some ZK-rollups don’t have EVM support and validity proofs can be very time-consuming to compute. This makes them ineligible for dApps that do not have a lot of on-chain activity.
Multiple ZK-rollup implementations are also available, including ZKSwap and zkSync. ZK-rollup technology is used to make scalable, low-cost Ethereum payments. ZkSync provides a trustless protocol that allows for secure, scalable and reliable transactions on Ethereum. This protocol can be used by crypto wallets as well as defi platforms to access PayPal-like scale. ZKSwap is a ZKrollups-based layer-2 DEX that offers zero gas fees and high transaction throughput. This transforms the future of AMM.
Harmony offers something unique. It combines the best of both ZK-rollup and optimistic worlds. Harmony offers full EVM compatibility unlike ZK-rollups. It also provides faster settlement and shorter withdrawal times than Optimistic rollsups. It also has gas-efficient interoperability thanks to its sharded Proof-of-Stake Blockchain that bridges to Ethereum through smart contracts.
By building on the benefits of both Optimistic rollups and ZK-rollups, generally seen to be the most promising of layer 2 scaling technologies, while addressing their shortcomings, Harmony can provide a more wholescale solution for projects to deploy. Harmony’s interoperability extends beyond Ethereum, with its Horizen bridge connecting to Binance Smart Chain. This opens up access to the wider defi ecosystem.
Validium uses validity proofs like ZK-rollups, but instead, data is not stored on Ethereum layer 1, allowing for scalability of up to 10,000 transactions per second per Validium chain, of which multiple can run in parallel.
Validium has no withdrawal delays, which improves capital efficiency and makes it less vulnerable to economic attacks by high-value, fraud-proof-based dApps. Validium chains offer limited smart contract support.
Projects providing implementations of Validium include Loopring and StarkWare. Immutable X, the first layer 2 scaling solution for NFTs on Ethereum, utilizes StarkWare’s Validium and ZK-rollup technology to enable transaction speeds of over 9,000 per second with zero gas fees while retaining Ethereum’s security for its ecosystem of marketplaces, apps, and games.
Polygon is something of an aggregator of these layer 2 solutions, offering multiple implementations of several layer 2 technologies. Polygon is the fastest growing layer 2 network. It offers multiple implementations of several layer 2 technologies and makes it accessible to everyone.
Polygon has been adopted by Defi blue chip companies. Platforms like Aave and SushiSwap already integrate with it.
CVI, the decentralized volatility index for the crypto space powered by the COTI network, has also followed that lead in integrating with Polygon. CVI users are able to open positions, provide liquidity, and stake while simultaneously processing transactions on the main ETH blockchain.
No single scaling solution is enough to realize the secure, decentralized and scalable vision for Ethereum 2.0. This avoids the problems of high fees or bottlenecks.
Sharding is sure to help on-chain scaling at layer 1. But off-chain layer 2, flexible solutions that can be tailored to the specific requirements and acceptable tradeoffs of the plethora dApp projects are crucial to the future development of blockchain.
The ecosystem as a whole can be greater than the sum its parts. Different layer 2 solutions are possible and can work in harmony to meet the growing demands of mainstream adoption. This will continue to reduce congestion and prevent single points or failures as we move to Web 3.0.
Arbitrum, Optimism and the Battle for Ethereum L2 Supremacy 2022
New data suggests that the ecosystem is experiencing record-breaking network activity. In the last two months, both layers – 1 and 2 – have collectively processed 152 million transactions. However, it is the layer two solutions such as Arbitrum, Optimism, and others that accounted for 58%.
On the other hand, Ethereum mainnet transactions were observed to be hovering at their lowest point in over two years, which isn’t the case for layer two rollups. This is responsible for processing the same number of transactions as the mainnet.
Arbitrum – Undisputed Layer 2 Leader
Arbitrum and Optimism are the most popular Layer 2s. However, the popularity of these rollups can be explained by the ease with which projects can port over to them. These two important layer-two solutions have been integrated into well-respected centralized crypto exchanges.
As the hype about alternative L1s faded, the commitment to scaling Ethereum’s ecosystem paid off. pic.twitter.com/xMTo0DfaOm
— Messari (@MessariCrypto) December 17, 2022
Looking at the total value of these protocols, Arbitrum is clearly in control with $1. 06 billion. Despite the bear markets, the market has grown steadily. This can partly be attributed to the Nitro upgrade which introduced lower fees and increased capacity.
Furthermore, its developer – Offchain Labs – raised around $147 million in funding from the likes of Lightspeed Ventures, Coinbase Ventures, Pantera Capital, as well as billionaire Mark Cuban, among others. According to Pitchbook, the firm’s post-money valuation is over $1.2 billion.
In a bid to expand the footprint of Arbitrum, Offchain Labs announced the acquisition of Prysmatic Labs, which happens to be one of the core engineering teams behind Ethereum’s transition to proof-of-stake.
Optimism Trailing Closely
The latest stats from DeFiLlama also showed that Optimism has grown significantly in terms of TVL share, which currently stood at $526. 15 million. Outside of DeFi, the layer 2 solution has witnessed positive growth in the NFT space. Over the past few months, there has been a steady upward trend in the number of buyers for Optimism NFTs. Several initiatives, such as introducing Optimism quests, among others, have managed to attract more users.
The scaling solution secured $150 million in Series B funding, co-led by Andreessen Horowitz and Paradigm, in March this year.
Layer 2’s main attraction is the declining transaction fees. Arbitrum and Optism have done well in this regard. Dune Analytics data suggested that the fees on both the layer 2 solutions have plunged substantially.
Ethereum’s History: From Whitepaper to Hardforks and the ETH Merge
Ethereum, the second largest cryptocurrency, is the home of smart contracts and decentralized applications (dApps), holding a major share of the total value locked in the sector. Ethereum’s dominance in the dApp market was up to 90% before other rival platforms were created.
Nonetheless, Ethereum is still the undisputed king of dApps. Despite its high fees, the platform is still the first choice for different applications, ranging from finance, exchanges, and storage to gaming, non-fungible tokens (NFTs), and governance. This shows how far it has come since its whitepaper was published in 2013.
This article highlights the timeline of major events that made Ethereum a favorite decentralized blockchain network for dApp developers and its journey to Proof-of-Stake.
2013: The Conception of Ethereum
Ethereum, like all things, began with an idea. And the idea, which the Russian-born Canadian computer programmer Vitalik Buterin conceived, was to leverage blockchain technology to develop decentralized applications, unlike Bitcoin, which was strictly created for financial use.
Ethereum’s introductory paper was published in late 2013 by Buterin, the co-founder of Bitcoin Magazine. The whitepaper explained the concept of the new technology, its fundamental principles, and its possible use cases. But the project wouldn’t launch until two years later.
On January 23, 2014, Buterin officially announced the start of the Ethereum ecosystem, calling on volunteers, developers, investors, and evangelists to join the project. The programmer revealed that he was working with Gavin Wood and Jeffrey Wilcke as primary core developers to build the platform. Other founding team members include Anthony Di Iorio, Joseph Lubin, and Charles Hoskinson.
Buterin also noted that his team’s goal was to provide a “platform for decentralized applications – an android of the cryptocurrency world, where all efforts can share a common set of APIs, trustless interactions and no compromises.”
Three months later, Wood published the project’s “Yellow Paper,” which provided a detailed definition and specification of the Ethereum ecosystem, including Ethereum Virtual Machine (EVM), fee rewards for miners, and smart contracts. He also played a crucial role in creating Ethereum’s prototype by helping to code the project’s first functional implementation into seven programming languages.
2014’s Crowdfunding: $18M Worth of BTC Funded Ethereum
Ethereum developers needed large funding to build the project. So the team decided to raise capital from public investors through an initial coin offering (ICO) that lasted for 42 days, from July 20 to September 2, 2014.
In June 2014, the project established the Ethereum Foundation, a Swiss-based non-profit organization, to manage the legal and marketing efforts of the ICO campaign. The Foundation created a total of 60 million ether (ETH), the native cryptocurrency of the Ethereum ecosystem, for public sale. The company sold 2,000 ether per bitcoin (BTC) for the first two weeks of the ICO and 1,399 ETH per BTC for the remainder of the token sale event.
Interestingly, the Foundation sold over 50 million tokens within the first 14 days of the crowdfunding, and by the end of the campaign, the project raised a total of 31,531 BTC, worth more than $18 million. This made Ethereum’s crowdfunding the fifth most successful ICO in crypto history (back then).
The non-profit also created another 12 million ETH, bringing the total amount of minted ether to 72 million. The company said the additional tokens would be used for marketing and other developmental activities.
2015: The Birth of Ethereum
About two months after the crowdfunding, ETH DEV organized Ethereum’s first event, dubbed DEVCON-0, which hosted Ethereum developers worldwide to discuss the protocol’s security and scalability.
In April 2015, the Foundation launched its first grant program, DEVgrant, to support the best projects on the Ethereum ecosystem ahead of the platform’s pre-launch, and the program is still running to date.
On May 2015, the Ethereum development team released Olympic, a test version of the network, which focused on four areas – transaction activity, virtual machine usage for smart contract execution, mining prowess, and stress testing. The Foundation rewarded testers with 2,500 ETH and other prizes in each category of the testing stage.
After the Olympic testing phase, Ethereum officially went live on July 30, 2015, nearly two years after Buterin published the project’s whitepaper. The project’s first public release, known as Frontier and aimed at developers and technical users, marked a significant milestone for the team. It was the birth of a new blockchain ecosystem for decentralized applications of all kinds, even though the protocol would later undergo a series of upgrades as it matured.
Like Bitcoin, the newly launched protocol adopted a proof-of-work (PoW) consensus mechanism. Ethereum created its first block (genesis block) through Frontier, and the block contained 8,893 ether transactions to different wallets, with a block reward of 5 ETH. Ether had no value during this period as there was no market for it yet. Investors who participated in ICO were still HODLing their tokens.
Ethereum’s Ice Age
The Ethereum development team introduced the Ice Age and, with it – the difficulty bomb on September 7, 2015, at block 200,000. It is a difficulty adjustment scheme designed to increase mining difficulty on the network after every 100,000 blocks, thus making it impossible for miners to keep up with the increasing difficulty level. This would make the network freeze over time, hence the name “Ice Age.”
The feature was implemented to ensure there would be consensus in the ecosystem on future upgrades that would transition Ethereum to a proof-of-stake (PoS) consensus network.
On March 14, 2016, at block 1150000, the team launched an upgrade dubbed “Homestead,” nearly a year after Frontier went live. The new release came with GUI, thus making the platform useful for non-technical users.
The fork also enhanced the platform with Ethereum Improvement Proposals (EIP), which ensured the platform could run future upgrades.
The DAO Attack of 2016: 3,600,000 ETH Stolen
On April 30, 2016, a Decentralized Anonymous Organization (DAO) was created on Ethereum at block 1428757. The DAO raised $150 million worth of ether from over 11,000 investors, but little did anyone know the success wouldn’t last.
A decentralized autonomous organization (DAO) is similar to a company’s board of directors, except that DAO members are anonymous, and their voting rights are determined by the number of tokens vested.
Barely three months after its launch, the DAO was hacked because its developer deployed the project without careful auditing. The attacker moved about 3.6M ETH, worth $60 million at that time, from the platform, which led to a controversial forking of the Ethereum network to recover the stolen assets.
The incident gave Ethereum its first real existential threat since DAO’s failure would have devastating consequences for the budding blockchain network in addition to financial losses for investors because the DAO had become one of the biggest projects on Ethereum.
The Ethereum community attempted a soft fork to avoid making permanent changes to the blockchain, but that didn’t work. A hard fork was then implemented, and the funds were restored and returned to investors.
A hard fork means permanently deviating from a blockchain’s latest version to upgrade or orphan the old chain. Hard forks are usually performed by people who wish to create a new token or chain that runs on different rules.
Ethereum’s hard fork after the DAO attack created a new blockchain. The original network was rebranded as Ethereum Classic, while the new chain retained the name – Ethereum.
It is worth noting that Ethereum would later undergo several hard forks. However, unlike the DAO event, none resulted in a controversial chain split except the 2022 Beacon Chain upgrade, which transitioned Ethereum to a PoS consensus mechanism. Other vital upgrades on the network include the Tangerine Whistle, Spurious Dragon, Byzantium, and Constantinople.
2020: The Ethereum Scalability Issues
After surviving the DAO incident, Ethereum’s next major challenge was its scalability issue. Like Bitcoin, the Ethereum blockchain faces the Blockchain Trilemma, a concept first used by Buterin while describing the core functions of a decentralized blockchain network.
The Ethereum co-founder stated that security, decentralization, and scalability are the three desirable elements of a blockchain network. However, it’s difficult for a blockchain to have efficient levels of all three features simultaneously. In other words, it must compromise one core feature to optimize for the other two.
By late 2017, Ethereum had become a favorite smart contract platform for dApp developers. The network also enjoyed euphoria from the bull market that year, with the blockchain game CryptoKitties pulling crowds into the Ethereum ecosystem. This resulted in network congestion, with transactions taking longer to confirm and gas fees shooting through the roof.
The scaling issues on Ethereum created a market for off-chain scaling products such as Polygon.
You can find out more about Layer2 scaling solutions in this in-depth article.
The DeFi boom of 2020 and 2021 did not make things easy for Ethereum. While the blockchain continued to record a significant adoption rate, average users were plagued with high gas fees, thus creating the need for users to sort out cheaper alternatives such as BNB Chain and Tron.
To resolve its scalability issues, Ethereum implemented an upgrade in December 2020, marking the start of the network’s transition from PoW to PoS. The upgrade required 16,384 deposits of 32 staked ETH in the contract address before it was implemented.
Proof-of-stake is a blockchain consensus mechanism that verifies crypto transactions and creates new blocks through randomly selected validators, unlike PoW, which requires miners to solve mathematical puzzles. In PoS, validators must stake their coins before they are allowed to verify transactions on the network.
PoS is a more secure and energy-efficient consensus mechanism than proof-of-work architecture. According to the Ethereum Foundation, proof-of-stake is also better for implementing new scaling solutions, which Ethereum needs more than ever.
The upgrade created a separate PoS chain called the Beacon Chain, which ran parallel to the Ethereum PoW Mainnet. Both chains would then merge to form a single network called Ethereum 2.0 or ETH 2.0. However, the Foundation rebranded the new name to “Consensus Layer,” noting that ETH2 sounded like a new operating system, which was not the case. The rebrand was also part of the Foundation’s effort to prevent users from being victims of scams such as swapping ETH for ETH2.
2022: The Ethereum Merge
The Ethereum development team released several updates after the launch of the Beacon Chain in preparation for the Merge. Some of these upgrades were Altair and Bellatrix.
The precise explanation, as provided by the Ethereum Foundation, is:
“The Merge represents the joining of the existing execution layer of Ethereum (the mainnet we use today) with its new proof-of-stake consensus layer – the Beacon Chain.”
The Ethereum Merge was implemented with an upgrade called “Paris” at block 15537393 on September 15, 2022. At the time of the upgrade, over 13.4 million ETH coins were staked on the deposit contract. The fork saw Ethereum’s transition to a PoS consensus nearly two years after the Beacon genesis.
So what happened to Ethereum’s PoW miners after the Merge? The Ethereum network was forked to create a separate chain (similar to Ethereum Classic). The blockchain is called proof-of-work Ethereum (ETHW), and it allows miners to continue verifying blocks by solving complex mathematical puzzles for ETH rewards.
You can take a look at our complete guide on the Merge here.
The Future: What’s Next After the Merge?
With the Merge successfully implemented, the next major upgrade on Ethereum is Sharding, a multi-phase upgrade designed to improve the protocol’s scalability and overall capacity. This is known as an on-chain scaling solution.
Sharding will work synergistically with layer2 rollups while splitting the entire Ethereum network into independent partitions called shards, thus improving the network’s throughput by up to 1000x. Aside from scalability, Sharding will introduce other benefits to Ethereum, such as more network participation and improved decentralization.
The upgrade is expected to be fully implemented around 2024 or beyond. This means that until then, Ethereum will likely continue to depend on off-chain scaling solutions such as layer 2 and sidechains.
Bitcoin, Technical Analysis: BTC Closes to $17,000 Before Christmas Day
Bitcoin rose closer to the $17,000 level on Saturday, despite crypto markets mostly consolidating to start the week. Global cryptocurrency market cap has fallen 0. 32% as of writing. Ethereum was also higher earlier in the day, with prices nearing the $1,230 level.
Bitcoin (BTC) remained under the $17,000 level to start the weekend, as prices continued to consolidate despite earlier gains.
BTC/USD hit a high of $16,905. 22 earlier in today’s session, which comes a day after price was at a bottom, at the $16,793. 53 mark.
The move saw the world’s largest cryptocurrency continue to trade above a key point of support at $16,800.
As can be seen from the chart, earlier gains have somewhat eased, as the 14-day relative strength index (RSI) failed to break above a ceiling at 48.00.
The index is currently trading at 46. 72, with bulls still attempting to push past the aforementioned point of resistance.
On the other hand, should price strength decline below a floor at 45. 00, bitcoin will likely move towards the $16,000 level.
Following a low of $1,216. 34 on Friday, ETH/USD raced to a peak of $1,227. 00 earlier in today’s session.
As a result of today’s move, ethereum once again attempted to break out of a key ceiling at the $1,230 level.
Looking at the chart, the breakout did not occur, mainly due to the RSI also remaining below a ceiling of its own at 47.50.
As of writing, the index is tracking at 47. 12, with momentum appearing to be bearish as a result of the direction of moving averages (MA).
The 10-day (red) MA extended its downward cross with its 25-day (blue) counterpart, which typically is a sign of price declines.
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Could market sentiment change ahead of Christmas Day? Please leave your comments below.
Eliman has a unique perspective on market analysis. He was previously a retail trading teacher and brokerage director. He is currently a commentator on various asset classes including Crypto, Stocks, and FX.
Image Credits: Shutterstock, Pixabay, Wiki Commons
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