Scaling Solutions

The next piece of the blockchain puzzle

Identifying strong narratives in Crypto has always been important when it comes to potential investment opportunities. Not over-investing 6 months after you heard about it, but identifying trends early enough to capitalise on them as they begin to form.

2017 - ICOs 2020 - DeFi 2021 - NFTs, Memecoins, Layer 1 etc

Given how Layer 1 projects (Solana, Avalanche, Fantom) performed in 2021 based on their ability to scale with faster and cheaper transactions, in comparison to Ethereum - Layer 2 scaling feels like a logical progression. Ethereum is still by far the dominant Layer 1 blockchain in terms of activity, value, decentralisation and security. Solutions which ultimately scale the protocol have tremendous value in my eyes and will be here to stay. Feels like the next potential big narrative

Many key projects for both Optimistic and ZK-Rollups are still without tokens, although they are heavily hinted towards having one in the near future.

Here is a Layer 2 write-up, which discusses our thoughts on scaling solutions. Includes:

🔹 Need for scaling

🔹 Scalability Trilemma

🔹 Ethereum 2.0

🔹 Types of Layer 2s

🔹 Layer 2 projects

🔹 Final Thoughts

Scaling Ethereum with Layer 2s

Need For Scaling

As Ethereum has grown in both in popularity and usage over time, the main chain itself has reached capacity limitations. Congestion on the network has led to slower and more expensive transactions and the cost of using the network has risen significantly. Ethereum by design prioritises decentralisation and security over scalability, which has resulted in higher transaction costs. This has become even more evident in recent years as transactions have risen from $1-2 on average to $30+ per transaction - making the network unviable to use for many users. This stems simply from the popularity of Ethereum as users are forced to compete for block space in order to have their transactions verified. Ethereum can currently process around 15-25 Tx/s but demand far outstrips this. DeFi on Ethereum has over $125bn in value locked, and NFT sales volume has risen from $30m in 2020 to over $20bn in 2021. This level of growth in activity are some key drivers causing the unviable transaction costs we see today.

(Source: bitinfocharts.com)

Scalability Trilemma

The ‘Scalability Trilemma’ refers to 3 components to every blockchain: Decentralisation, Security and Scalability. The trilemma is that current blockchains are only able to achieve two of these traits at the expense of the third. Ethereum is highly decentralised and secure, but as we mentioned has limited scalability in its current state. Competing Layer 1 blockchains such as Solana or BSC are highly scalable (cheap and fast transactions) but have high barriers to entry to run nodes. This ultimately makes them less secure by nature (fewer validators), leading them to be more centralised and ultimately easier to corrupt or disrupt. Layer 2 scaling solutions are seeking to help solve the scalability issues on the Ethereum network. This is an exciting and important topic as these are real steps towards solving the ‘scalability trilemma’ and could move us closer to a more complete blockchain infrastructure.

(Image credit: dealroom.co)

Ethereum 2.0 - Scaling Layer 1

Ethereum is looking to improve scaling directly on its Layer 1 chain and is looking to do so with the development of Ethereum 2.0. ETH 2.0 will introduce sharding, which will effectively break down the main blockchain into smaller shards making information more manageable and boost efficiency. Even with a significant improvement in Ethereum's scalability from ETH 2.0, it will likely still fall very short of medium-long term network demand. If ETH 2.0 were to realise its full potential (which in itself may take several years), over time it may be able to manage 80,000-100,000 transactions per second but even then with global adoption this will likely remain insufficient. With finance, gaming, governance and hundreds of other use cases potentially being able to utilise the blockchain in the future, and with our lives becoming more and more integrated online - we could see demand of well over 1,000,000 transactions per second in the not so distant future. Layer 2 scaling solutions are here to stay.

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Types of Layer 2s

PlasmaEffectively, plasma chains are separate blockchains which are tethered to and operate alongside Ethereum - so by offloading transactions from the main chain onto the plasma chain, faster and cheaper transactions are made possible. Plasma chains utilise ‘Fraud Proofs’ just like Optimistic Rollups, however the data is stored off-chain which is unlike Optimistic rollups. This means plasma solutions cannot leverage the security of the Ethereum network and it takes a long time to withdraw funds back to ETH mainnet Examples include: OMG Network

Side Chains ‘Side Chains’ are Ethereum compatible but independent blockchains, with their own consensus models meaning they can have a token and method to secure their blockchain. Side-chains work in the same way as the Ethereum main chain because it’s based on the same Ethereum Virtual Machine. This makes them easily interoperable with Ethereum and funds are easily bridged between the two, however they also are not secured by Ethereum's network.Examples include: POLYGON & SKALE RollupsRollups are scaling solutions which remove transactions from the main chain and perform these on a separate Layer 2 blockchain. Rollups batch together these transactions and then post them back onto the Ethereum network - allowing for much more efficient transactions but still leveraging the security of the main chain. There are two key types of rollup: Optimistic and ZK-RollupsOptimistic Rollups - Optimistic Rollups are one type of layer 2 that do not run on Ethereum's base layer but on top of it. This enables running smart contracts at scale while still being secured by Ethereum. As the name suggests, ‘Optimistic’ rollups optimistically assume that all transaction posts are valid - however anyone can challenge these transactions if they believe they are incorrect or fraudulent by submitting a ‘fraud proof’ and the transactions are reversed. Can process around 2000 Tx/s and is over 10x cheaper than ETH mainnet but has a very long withdrawal time back to Layer 1 of around 7 days to account for fraud disputes. Examples include: Optimism, Arbitrum, METISZk Rollups - ZK-Rollups (Zero Knowledge Rollups) work by batching together groups of transactions off chain, before posting the results back onto the Ethereum network with significantly less information and at a much lower cost. Instead of posting the full set of transactions like Optimistic Rollups, zk-rollups simply post a ‘proof’ which ensures the transactions are correct and are secured by mathematics and cryptography. One drawback is that zk-rollups are a new and complex technology; it will take time for them to mature before becoming as easily integrated as other layer-2 scaling solutions. However, given their mathematical certainty and efficiency they are deemed to be much more scalable.Examples include: StarkWare, ZK-Sync

(Image Credit: ethereum.org)

Final Thoughts

The need for high performing blockchains is forever growing, with more use cases every week and adoption increasing by the day - we are witnessing a transition into a more blockchain embracive world. A future which potentially handles global financing, multi-billion dollar entertainment industries, governance and countless other unrealised use cases needs to be handled with care and assurance. Ethereum has ensured decentralisation and security within its network to act as a strong foundation for this potential transition - resolving the ‘scalability trilemma’ could potentially be a breakthrough of unknown proportions. From our research at the Crypto Rand Group, it feels clear that Layer 2 scaling solutions are a step towards achieving this, and although not perfect and far from fully implemented, it is a big step in the right direction. ‘Rollups’ seem like the strongest Layer 2 solution - as the most efficient, secure and scalable of the solutions discussed. Vitalik Buterin himself has published work titled ‘A rollup-centric ethereum roadmap’. The future is as exciting as it is unknown, but blockchains are on their way to changing it.

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