Blockchains (L2) – Weekly fundamentals #68

A walkthrough of the most interesting charts and trends in crypto, with a focus on key business drivers and protocol fundamentals.

This week’s newsletter focuses on the blockchains (L2) market sector, which has a designated dashboard on Token Terminal. Let’s dig in!

Blockchains (L2s) are scaling solutions that increase the transaction throughput and speed of a blockchain (L1). Transactions executed on L2s are submitted to L1s for settlement in batches, which also results in lower gas fees.

Introduction

• Blockchains (L2) enhance the scalability of decentralized applications (dApps). They provide a platform for popular blockchain (L1) applications, such as Uniswap, Aave, and OpenSea, to transfer their transaction activity from the L1 to a separate chain. The L2s then aggregate these transactions into groups and send them back to the L1 for settlement. At present, over 30% of Uniswap's trading volume is generated on L2s.
• L2s offer a more optimized user experience. Through the mechanism of transaction batching, L2s can deliver higher transaction speeds and lower gas fees. This enables users to better utilize e.g. DeFi and NFT protocols, which might be too expensive on L1s like Ethereum. During periods of high network congestion, a transaction on Ethereum could cost hundreds of dollars, making L2s an attractive alternative.
• Dapps with greater throughput needs can operate on L2s, leading to the emergence of new market sectors. Derivatives exchanges and onchain gaming are notable examples of projects that have gained popularity on L2s due to their need for high transaction speeds and low gas fees. Consequently, L2s foster innovation and growth within the crypto industry, while simultaneously driving value back to the L1 during the transaction settlement process.

Overview

The daily fees and monthly active users over the past 180 days for the top 4 projects in the blockchains (L2) market sector are visualized below.

Scope of analysis

Chart analysis

• Blockchain (L2) fees have been in a general uptrend over the past 180 days. Notably, on the day of the ARB token launch (March 23rd, 2023), the sector saw its highest daily fees and active user counts, peaking at over $2m and 1m users, respectively.
• The surge in L2 fees can be largely credited to growth on Arbitrum and Starknet. Arbitrum has seen a significant rise in fees since the launch of the ARB token, with total fees reaching over $9.9m in May 2023. Starknet too has seen substantial revenue growth, generating over $4.5m in fees during the same month, a fourfold increase from the $1.1m recorded in January 2023.
• We expect the growth of L2s to continue. As a result of lower gas fees and higher transaction throughput, an increasing number of both users and protocols have been migrating to L2s. Numerous high-profile DeFi protocols have been deployed on various L2 platforms, and we're also seeing the emergence of new protocols native to L2s, with GMX, Gains Network, and Radiant Capital being notable examples.

• Since the ARB token launch in March 2023, the number of monthly active users on Arbitrum has nearly doubled, increasing from 1.4m to 2.7m. On the token launch day, nearly $1.8m was spent on fees on Arbitrum. $300k of these fees were then paid to Ethereum validators.
• Several DAOs on Arbitrum have been leveraging their ARB grants from the Arbitrum Foundation to incentivize user activity. For instance, Cap, a derivatives protocol native to Arbitrum, has been disbursing 100k ARB tokens as rewards to its users monthly. Likewise, the lending protocol Radiant Capital recently approved a governance proposal to distribute over 1.3m ARB tokens to current users and commit an additional 1m ARB tokens as rewards for future users over the coming year.
• The number of monthly active users on Starknet has seen an over 800% increase, likely driven by STRK airdrop farming. StarkGate, the canonical bridge for Starknet, has consumed over $5m in gas fees during the past 90 days, with more than 900k active users interacting with its contracts. Other popular projects on Starknet include DEXs like 10K Swap, MySwap, and JediSwap, as well as non-custodial wallet applications like Argent and Braavos.

Momentum

Some of the most interesting trends for projects in the blockchains (L2) market sector are visualized below.

• Following a recent significant protocol upgrade, fees on Optimism are decreasing even amidst a surge in user activity. Optimism’s Bedrock Upgrade, which was completed on June 6th, 2023, is a chain update designed to optimize gas usage, deposit times, and node performance, among other enhancements. Notably, the daily fees paid per active user were 70% lower on June 20th, just two weeks after the upgrade, compared to those on June 5th, a day before the upgrade was implemented.
• The Bedrock Upgrade introduced advanced data compression, which lowers the fees incurred when submitting transactions to Ethereum. Fees on Optimism are influenced by two elements: the fees on L2 (Optimism) and the transaction submission fees on L1 (Ethereum), the latter of which is referred to as the "L1 security fee." Ethereum's gas costs are determined by the size of the submitted data, meaning the costs are lower when the submitted data is compressed.
• The upgrade also brought about a new method for posting transactions on Ethereum. Instead of using smart contracts, the state is now submitted to an Externally Owned Account (EOA). This eliminates all gas fees associated with smart contract execution. According to the Optimism Foundation, this change further reduces fees by an additional 10% compared to the previous version of Optimism.
• Optimism is striving to build an ecosystem similar to Ethereum but with an enhanced user experience (UX). It's essential for Optimism, as well as other L2s, to deliver the best possible UX. A key objective for Optimism is to continuously enhance its "Ethereum equivalence", which means making it easy for existing dApps and users on Ethereum to migrate to Optimism. This transition is primarily driven by the prospects of faster transactions and lower fees that Optimism offers.

Gas fees by chain (USDT transactions)

• Average gas fees for USDT stablecoin transactions are 380x smaller on Polygon compared to Ethereum. Over the past 30 days, the average USDT transaction fee on Polygon amounted to just $0.0077, while the equivalent fee on Ethereum was $2.9136. Other L2s also exhibited substantially lower USDT transaction fees when compared to Ethereum.
• Small transactions are more cost-effective on L2s as they are processed off the Ethereum mainnet, thereby avoiding network congestion. Polygon's fees are particularly lower compared to other L2s, due to its design of submitting data to Ethereum only once every 30 minutes. In contrast, Optimism submits data to Ethereum approximately every minute, resulting in considerably higher costs. It's also worth noting that Polygon's Proof of Stake model differs from Optimism, Arbitrum, and Starknet in that it is a Plasma chain, while the other three are rollups.
• Stablecoin usage is likely to transition from Ethereum to L2s or alternative L1s like Tron, given their lower transaction fees. As stablecoins are becoming more prevalent in commerce, with smaller transactions happening more frequently, their usage for payments is likely to increase on L2s due to the reduced associated costs. However, we foresee that Ethereum will continue to hold large quantities of inactive stablecoin funds, as it remains a trustworthy and highly secure platform for storing large amounts of capital.

Other key highlights from the blockchains (L2) market sector

• BNB Chain announced opBNB, a layer 2 scaling solution based on Optimism OP Stack. The new chain launched its Testnet on June 19th.
• zkSync Era recently reached over $500M in TVL.
• The Graph is migrating from Ethereum to Arbitrum.

Changelog

Interview of the week

In this week's episode of the Fundamentals podcast, we're joined by Arno Bauer, a Senior Solution Architect at BNB Chain.

In this episode with Arno, we discuss what the BNB Chain’s core value proposition is, what optimizations they have focused on, and how they are positioned within the market. Also, we cover how blockchains can be valued, how economic sustainability should be addressed, the most exciting things happening on the BNB Chain right now, who the core contributors behind the blockchain are, and more!

Listen to the episode

Timestamps:
00:00 Introduction
02:28 BNB Chain’s core value proposition
02:59 The optimizations that BNB Chain has focused on
04:03 The problems that the BNB Chain solves for builders and users
05:30 An ecosystem of blockchains: Beacon Chain, BSC, ZkBNB, Greenfield
08:52 Internal product focus areas: scalability and decentralization
09:53 User activity, composition, and development
13:58 The blockchain market and BNB Chain’s position within it
15:38 Long-term vision for the BNB Chain
17:28 Core contributors behind the BNB Chain
18:43 Economic model
20:27 Economic sustainability
22:13 Value accrual to blockchain networks
23:59 What are the best metrics to measure/value a blockchain?
25:04 Are L1 blockchains economies, businesses, or something else?
28:17 Utility of the BNB token
29:17 Most exciting thing happening in the BNB Chain ecosystem
31:27 Growth drivers and challenges
35:18 Enhancing security in web3

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