Battle of the Layer1s: The Fierce Decade
[ — by MolochNess]
The Layer1 wars rage on. Ethereum is the largest fish in crypto’s tiny pond, but it remains to be seen how these fish compete on the global stage. Ethereum, Polygon, Arbitrum, and Optimism combined have fewer than 2 million daily active addresses, which should illustrate how early we still are.
However, the stakes are clearly high! Layer1 platforms (L1s) remain the single-biggest category in crypto, with >30% dominance (60% if you include BTC), with the remainder split between stablecoins, DeFi, NFTs, middleware, etc. There is an enormous potential market for L1s, with billions of users left to capture.
Several burning questions remain:
• Can Ethereum scale crypto to the masses, or will something stronger take its place?
• Which competing Layer1s are best-positioned to carve out their own chunk of the market?
• Should the competition compete on technology or community?
• How much value can Layer1s even capture in an L2/L3-centric world?
The ecosystems I’ll be comparing are Ethereum, Cardano, and IOTA (2.0)
Others are worth discussing: Solana, Cosmos, Avalanche, Algorand, Polkadot, etc, but time is finite!
To cover this subject in a fraction of the depth it deserves, this article is split into two.
For this first part, the points of comparison are:
• Scalability
• Decentralization
• Security
Scalability
We want more users, but what does “scale” mean in the context of decentralized platforms? For some, it refers only to TPS. The higher the better! For others, it means supporting more users without eroding the qualities that make DLTs special in the first place.
Given the purpose of our industry, the latter is the one we ought to care most about.
Imagine a classy restaurant: ‘La Chaina’, that serves 100 people a day. If La Chaina wants to serve 1,000 people a day from one location, some combination of: food quality/presentation, order speed/accuracy, service, atmosphere, etc, will necessarily suffer. If you degrade the quality from fine dining down to fast food to meet demand, have you actually scaled La Chaina?
The same principles apply to DLTs. Increased traffic = more expensive hardware/internet requirements, which excludes many people from participating in consensus or node operation, defeating the purpose of a supposably decentralized and inclusively-accountable network.
Ethereum intends to scale entirely with Layer2s: Optimistic and ZK Rollups, Validiums, and others.
The original plan was to scale Ethereum via Execution Sharding, which meant multiple copies (shards) of the blockchain would run in parallel. Shards would be coordinated by the central Beacon Chain, and each additional shard would increase Ethereum’s total capacity, without making any individual shard too ‘heavy’ for average node operators to process. Eventually it was decided that Execution Sharding was overly complex, and Rollups with Data Sharding would serve as a good alternative.
Rollups move computation off-chain, posting compressed data back to L1 as often as desired.
• Optimistic Rollups assume all transactions are valid, leaving a 1 week challenge period to prove otherwise via fraud proofs. They are simpler to build with and more cost-effective for complex smart contract interactions.
• ZK Rollups prove correctness with validity proofs posted to L1. Simple transfers and swaps are cheap, but generalized computation tends to be gas inefficient.
• Validiums operate similarly to ZK Rollups, but with data held off-chain by a 3rd party, such as a Data Availability Committee (cheaper, but with weaker trust assumptions).
There are also Volitions, which allow users to pick between on-chain (ZK Rollup) and off-chain (Validium) data, depending on their cost/security priorities.
ZK technology has made staggering progress in the years since Ethereum’s pivot away from Execution Sharding, so I expect to see exploration of ZK Execution Sharding to scale L1 economies without surrendering users to 3rd party L2s.
Cardano plans to scale with an array of technologies, each catering to different use-cases.
• Ouroboros Leios (Input Endorsers) aims to supercharge base-layer throughput by utilizing untapped network resources (dead-time) for parallel transaction processing.
• Ouroboros Hydra. Isomorphic state channels (mini-blockchains) that allow activity to move off-chain and settle final results to Cardano L1 as needed, while inheriting much of its security.
• Sidechains. While not directly secured by L1, they can be economically aligned and/or share a subset of Cardano’s stake-pools. These allow new users to enter into Cardano’s ecosystem, and facilitate rapid feature experimentation that can be integrated into the core network if desired.
• Rollups/Validiums. Much the same as on Ethereum, although theoretically more efficient due to Cardano’s EUTXO model. It’s not currently possible to deploy these on Cardano, due to the lack of validity proofs/proper Data Availability, though these are likely to be remedied in future upgrades.
IOTA shares a lot in common with Ethereum, Cardano, and Cosmos’s scaling strategies: the shared security model with L2 chains, UTXOs and parallel processing on L1, and the App-Chain thesis, respectively. Mana stands to be an attractive model for L2 chain operators. Instead of being forced to pay non-refundable fees to settle to L1, there’s an added option of buying a share of network throughput, which can be sold whenever desired. Leaderless consensus should enable extreme performance advantages compared to traditional blockchains, and there is also a long-term vision to scale L1 further via ZK-Sharding. However, with so many pieces of the roadmap left to build, these will have to be revisited at a later date.
Decentralization
The crux of our industry, but how do we measure it?
Node count/requirements, core/ecosystem developers, and client diversity all matter. However, stake distribution, also known as the Nakamoto Coefficient (NC) or Minimum Attack Vector (MAV), is arguably the single-most important factor for decentralization.
Put simply: a smaller number (eg: 5) means a network is more vulnerable to attack, as fewer entities need to collude, or be pressured by governments, to harm an ecosystem. If a cartel reaches >50% of stake, they can potentially reverse transactions, censor people based on their identity or the dapps they use, and generally undermine a network. On the flip-side, a large NC/MAV gives users/developers the confidence to explore and build without worry. Also, if stake was verifiably spread evenly across 100,000 unique, globally distributed entities (NC/MAV of 50,001) , the need for non-stakers to run nodes would be greatly diminished. Developer and client diversity remain important for security reasons (redundancy in case one client faces a severe bug), but even if they were all malicious, they cannot force validators to install harmful or censorious software.
Each platform uses a variant of Proof of Stake, but their implementations have different tradeoffs and count ‘validators’ differently. At time of writing:
Ethereum has 497,000 “validators”. Each validator is a virtual entity with 32 ETH at stake. Since the protocol explicitly forces people to split their stake into arbitrary chunks, large ETH-holders must operate multiple “validators” each. This can mislead people who expect a similar ratio of “validators” to unique entities validating the network, implying a much greater level of decentralization than actually exists. Ethereum has an NC/MAV of 4, with 50.4% of ETH stake controlled by Lido, Coinbase, Kraken, and Binance. While Ethereum can still turn this around, it’s not a good look that ETH stake is concentrated in the hands of a few centralized, regulated entities.
Cardano has 3,210 ‘stake-pools’, most of which accept stake delegation from passive holders.
While stake-pool operators (SPOs) can/do run multiple pools, doing so is disincentivized by the protocol unless they reach a much higher stake threshold ($22mil vs ~$42k). Thus, while Cardano has fewer pools than Ethereum has validators, the number gives a much better representation of decentralization. Cardano has an NC/MAV of 23, Binance and EToro with 10.8% and 2.1% respectively, and the remaining 37% controlled by community members and large holders.
This is a large gain over Ethereum: 5x larger NC/MAV, and reduced dominance of centralized entities, but there’s still a lot of room for improvement.
IOTA has yet to remove its infamous ‘Coordinator’, so for now it scores a zero in decentralization.
However, if ‘Coordicide’ did ever launch, when you take IOTA’s many strengths into consideration:
• Large and passionate community, going strong from 2015
• Learnings from others’ mistakes (eg: lack of native stake delegation)
• Perhaps the fairest L1 token distribution ever
(100% of $MIOTA sold, vs ~80% of $ETH/$ADA, ~25% of $DOT, ~20% of $AVAX, and ~2% of $SOL)
There’s a good chance IOTA could quickly reach the top 5 in terms of decentralization.
Security
If NC/MAV is the focal point of Decentralization, it stands to reason that Economic Security — the cost to buy a controlling share of a network’s stake — should be the focal point of Security.
Platforms that accrue more value to the core token ($ETH, $ADA, $MIOTA) will have higher market caps over the long term, directly increasing the cost of an economic attack on the network.
Value accrual can happen in a few ways. Revenue can be paid to token-holders, the supply can shrink via burning mechanisms (eg: EIP-1559), or simply from demand to buy/hold the tokens for the benefits they offer (eg: access). Each one drives demand for the token, boosting price, market cap, and network security.
‘Staking Ratio’ is another point to consider: the percentage of tokens currently staked.
Market cap is important, but even if a network was valued at $1 trillion, if just 1% of tokens are staked ($10 billion), it will only cost ~$5.1 billion to acquire a majority stake.
Ethereum
After removing Execution Sharding from their roadmap, Ethereum’s long-term economic security is questionable. If L1 doesn’t scale to support more users, and L2s pay orders of magnitude less in fees to settle onto Ethereum, where will the money to provide security come from?
If we assume an L2 → L1 settlement fee of $0.0001 per transaction, then Ethereum would need 35 billion L2 transactions/day to generate the same revenue L1 earns today (~$3.5 million revenue and ~1 million transactions per day).
Staking Ratio is 13.8% (15.9 million $ETH)
Why so low? Three big reasons are:
• ETH in DeFi. With such a strong on-chain economy, ETH-holders have more choice of where to deploy their capital to earn yield.
• Lack of native stake delegation. Without this, holders are forced to jump through extra hoops initially, and when switching providers, and potentially accept worse trust assumptions (eg: custody via CEX or smart contract), disincentivizing more people from staking.
• Slashing. Even though risk of being slashed is low, a perception of risk is enough to deter people. The Shanghai fork enabling staking withdrawals in Q2 2023 should derisk ETH staking further, increase the Staking Ratio over the following months.
Cardano
If L1 and L2 scale together, that creates a harmonious environment, where a variety of L2s exist and thrive, but the L1 has a robust economy to fund economic security, and gives it greater leverage against L2s that wish to undermine it.
Staking Ratio is 71.9% (25.4 billion $ADA).
The main explanation for this figure, is how ingrained staking is in Cardano’s culture.
YouTubers, Twitter personalities, even dapps run their own stake-pools and solicit $ADA delegations. It’s a stark contrast compared to Ethereum, where stakers keep most things lowkey, and have no reason to discuss their staking habits. Also, there are presently fewer opportunities to generate $ADA yield on Cardano, so staking is the go-to choice for most holders.
IOTA
Similar to Cardano, if IOTA successfully scales L1s and L2s, that bodes much better for long-term economic security. L2 transactions are simply lower profit-margin for L1, so shouldn’t be relied upon to keep an ecosystem alive.
Staking Ratio won’t be known until Coordicide, but if we speculate: it seems likely $MIOTA will support native stake delegation like Cardano, Avalanche, etc, making a Staking Ratio of 60–90% likely. Especially after the Mana market picks up, many holders will want to sell access on the open market.
Thus concludes part one! The next post/s will cover the following points:
• User/Developer experience
• Notable PoCs and Deployments
• Obstacles/risks to be aware of
• Road to mass adoption
Stay tuned for more!