The Definitive ZK Rollup Market Analysis 2023

TL;DR: This report identifies market leaders and other emerging companies in the ZK rollup space. Their key differentiators are presented in the table below. When estimating the Layer 2 market size, network fees and transaction volume are considered the most reliable metrics. These suggest that L2s could attain a market size of $0.2T — $1T in approximately 16 years, with a CAGR of 20%. ZK rollups are poised to accrue significant value, and this value will not only accrue to the leading L2 rollup but also to Ethereum and specific cross-rollup tools like the shared sequencer.

Introduction & Scope

As Ethereum continues to rise, its scalability issues have become increasingly prominent. Zero-Knowledge (ZK) rollups have emerged as a promising tool for Layer 2 solutions that mitigate scalability challenges. This market research report delves into an assessment of market leaders, offers concise insights into other notable companies, and highlights their unique attributes. I then outline the market size and put forth a thesis on value accrual.

Note: This report focuses on ZK rollups, acknowledging 1) ZK proofs can be also used for other purposes such as privacy enhancement, and 2) Layer-2 can be achieved by other technology such as Optimistic rollups. Nevertheless, the market size analysis in this report encompasses the entire L2 market, given that both ZK and Optimistic rollups vie for dominance in Ethereum’s scaling arena.

Photo by Nenad Novaković on Unsplash

Company Analysis

In this section, I’ll begin by providing a detailed comparison of the two market leaders, followed by a concise overview of the key differentiators for other notable companies in the ZK rollup space.

Market Leaders — StarkWare vs. zkSync

Two most prominent market leaders StarkWare and zkSync, as they aim to form a larger ecosystem, and, according to L2BEAT, they are the only general-purpose ZK rollups that have TVL over $100M.

zkSync, developed by Matter Labs, is an EVM-compatible ZK rollup that began as zkSync 1.0 (zkSync Lite) and later evolved into the full-scale zkEVM called zkSync Era. Despite some limitations, zkSync Era seeks to support smart contracts and achieve greater functionality and interoperability in the Ethereum ecosystem.

StarkWare, an Israeli firm founded by Eli Ben-Sasson, co-inventor of ZK STARK proofs and a founding scientist of Zcash, is developing StarkNet, a permissionless L2 rollup and EVM-compatible scaling solution for Ethereum.

These two leading projects are distinct from each other in the following aspects:

• Proofing Technologies: Many of the distinct features of StarkWare and zkSync arise from their chosen ZK technologies. StarkWare employs zk-STARKs, while zkSync opts for zk-SNARKs. StarkWare’s unique choice of zk-STARKs over zk-SNARKs brings StarkNet certain advantages/disadvantages:
• a. Proof Size: StarkWare’s zk-STARKs generate larger proofs, potentially problematic for bandwidth and storage-sensitive situations. In contrast, zkSync’s zk-SNARKs yield more compact proofs, ideal where minimalism matters.
• b. Complexity: zk-STARKs eliminate the need for a trusted setup, adding transparency but introducing technical complexity. zk-SNARKs require a one-time trusted setup; despite potential vulnerabilities, their longevity in the field means greater familiarity.
• c. Quantum Resistance: StarkWare’s zk-STARKs offer quantum resistance, ensuring long-term viability. Conversely, zkSync’s zk-SNARKs, rooted in elliptic curve cryptography, remain susceptible to quantum threats.
• EVM Compatibility: Compatibility matters because it will affect adoption rate. zkSync Era offers near-total EVM compatibility, enabling developers to utilize Solidity. StarkNet doesn’t provide this natively, but it offers conversion from Solidity to Cairo via the Warp transpiler. There is a tradeoff, however, Cairo equips StarkNet with potentially superior scalability and throughput.
• Ecosystem and Partnerships: Being relatively newer, StarkNet’s ecosystem is not as mature as zkSync’s. The latter’s advantage is further magnified by seamless migration from Ethereum, attributable to smart contract compatibility. As of August 2023, StarkNet is favored by game and NFT dApps, while zkSync is popular for DeFi and cross-chain dApps. This distinction is not a mere coincidence; early investments from AAVE and Curve have in part influenced the zkSync ecosystem’s direction.

To summarize the differentiators between StarkWare and zkSync:

• Relative to other companies discussed in the next section, they both hold leading positions (evidenced by their developer activities and TVL) and are building robust ecosystems with the ambition of becoming the default/predominant Ethereum L2 rollup.
• In direct comparison, zkSync adopts zk-SNARKs, which produce compact proofs with a requisite one-time trusted setup but are susceptible to quantum threats. Conversely, StarkWare utilizes zk-STARKs, generating larger proofs without a trusted setup, and boasts quantum resistance.
• zkSync’s ecosystem is more mature.

Other Significant Emerging Companies

Loopring

Loopring is a ZK-Rollup L2 protocol designed for decentralized exchanges and payment systems.

Key Differentiators:

• Among the earliest scaling protocols on Ethereum; This comes with a drawback — its throughput is considered low by current standards.
• DEX focus. Loopring directly competed with early offerings from StarkWare and zkSync (i.e., StarkEx and zkSync Lite, respectively). However, StarkWare and zkSync have since upgraded and diversified, targeting broader applications and leaving Loopring in a specialized market segment.

Scroll

Scroll X is a newer Ethereum ZK-Rollup-based Layer-2 solution optimized for Ethereum compatibility, facilitating the smooth migration of existing dApps. Developed in collaboration with the Ethereum Foundation, Scroll ensures 100% bytecode equivalence with Ethereum, permitting direct deployment of dApps without alteration. It is also pioneering a decentralized marketplace for generating zero-knowledge proofs for third-party developers.

Key Differentiators:

• Complete bytecode equivalence with Ethereum, ensuring smooth dApp migration (Surpasses competitors in EVM compatibility).
• Developed in collaboration with the Ethereum Foundation and received personal feedback from Vitalik Buterin.
• Features a decentralized marketplace for zero-knowledge proofs.

Polygon zkEVM

Polygon zkEVM is a product of Polygon, a prominent Ethereum scaling company. Previously, Polygon acquired zk-focused firms like Hermez and Mir. Consequently, Polygon zkEVM emerges as an enhanced variant of Polygon Hermez, enriched by the contributions from Polygon Zero.

Key Differentiators:

• Boasts direct EVM compatibility, superior to that of StarkNet and zkSync but comparable to Scroll.
• Spearheaded by Polygon, a seasoned and esteemed scaling company with a history of zk-centric initiatives, including projects like Zero and Nightfall.

Note: It’s imperative to differentiate between Polygon zkEVM and Polygon PoS, the latter being Polygon’s inaugural main network operating as a Proof of Stake sidechain for Ethereum. Moreover, Polygon is in the process of introducing Miden, a general-purpose, STARK-based rollup boasting EVM compatibility. Given the information at hand, Miden seems poised to be a potential rival to StarkNet.

Aztec

Aztec is a distinct ZK-Rollup L2 protocol emphasizing privacy in addition to scalability. To achieve this dual goal, it employs a two-tier zero-knowledge circuit system: one layer encrypts private user transactions, and another compresses them.

Key Differentiators:

• Uniquely marries scalability with privacy, a rarity among similar projects.
• Offers the privacy-focused bridge solution, Aztec Connect.
• Not EVM compatible. One can argue that privacy has some conflict with EVM compatibility.

Immutable X

Immutable X is an Ethereum L2 scaling solution optimized for NFT minting and trading, leveraging Validium ZK-proof. It provides gas-free minting and trading with its core infrastructure and a global marketplace. Additionally, its zkEVM is designed for the GameFi sector.

Key Differentiators:

• Specialized in NFT minting and trading with near-zero gas fees.
• Proprietary zkEVM tailored for GameFi applications.
• Provides a shared global NFT order book, amplifying liquidity across platforms.
• Furnishes both API and SDK for expedited NFT project development.

Espresso

Distinct from the others on this list, Espresso functions not as an L2 rollup but as a shared sequencer network. In essence, a shared sequencer comprises a decentralized node network that multiple rollups can use to replace their single centralized sequencer.

Key Differentiators:

• Pioneers in the realm of sequencer decentralization.
• Offers a toolset that many L2 rollups, even cross-domain ones, can utilize.
• Acts as a complement, rather than a competitor, to the other projects listed.

Market Size & Growth Rate

Estimating the market size for Ethereum’s Layer 2 solutions is more challenging than for many traditional industries. I’ve observed several misconceptions in market size estimations:

• Total Value Locked (TVL): Some rely on TVL as an indicator (an example here), but this metric is often skewed by staking pools and AMMs, which can significantly distort actual L2 usage.
• Market Capitalization: Others employ the market cap formula (price multiplied by the number of circulating tokens). While this approach may be applicable for Ethereum (L1), it’s unsuitable for L2 rollups. Many promising rollups, including zkSync and Base, do not have a token as of now.
• Number of Addresses/Users/Developers: These metrics indicate growth but do not directly correlate with market size.

In my perspective, the most reliable metrics for estimating market size are network fees and transaction volume. Data from Orbiter reveals that over the past two years (as of August 2023), the CAGR of L2 transaction volume has been 580%. In fact, by September 2022, L2s had surpassed Ethereum in transaction volume and are currently processing 3.8 times as many transactions.

If Ethereum’s vision of being the infrastructure for the future of the Internet (Web3) and the future of finance (DeFi) materializes, then the combined transaction volume of Ethereum and L2s should match that of the entire Internet. Given the current Ethereum market cap of $225B, it seems plausible for it to reach the $1.2T size of Global Internet Service Providers (data source: IBISWorld) within a couple of years. Drawing a parallel, a16z Crypto’s report, “State of Crypto 2023,” likened the progress of blockchain in 2022 to the state of the internet in 1996. Based on this analogy, it may take Ethereum and L2s approximately 16 years to reach a market size of $1.2T.

Comparing Internet users to unique active blockchain addresses (log scale) reveals that Blockchain in 2022 mirrors the Internet in 1996. (Source: State of Crypto 2023, a16z Crypto)

As for the market share that L2s might capture, we need to make some assumptions. If L2s enhance Ethereum’s scalability by 20 times and charge fees at 5% of Ethereum per transaction, L2s would comprise about 50% (= 20*5%/(20*5%+1)) of the combined ecosystem of Ethereum and L2s. Reasonably estimating, L2s could capture anywhere between 20% to 80% of this market. This means that in ~16 years, L2s might hold a market size between $0.24T and $0.96T, signifying a CAGR of roughly 20%. Although this is a broad estimate due to its inherent complexities and unpredictable trajectory, it’s better to be roughly right than precisely wrong by using wrong metrics such as TVL.

Thesis for Value Accrual

As a pivotal technology in the blockchain realm, ZK rollup is poised to accrue significant value. The preceding Market section highlights a sizable market with a high CAGR. ZK rollup tackles Ethereum’s scalability issue, reducing network congestion and increasing throughput, thus reinforcing Ethereum’s L1 dominance. Compared to Optimistic rollups, ZK rollups hold long-term advantages, primarily due to their transaction immediacy and reduced on-chain gas costs.

The question is, where does the value come from and where does it go? The value sources of ZK rollup are MEVs and transaction fees accrued to / charged by L2s. Regarding the future distribution of this value, I suggest it will flow towards leading rollup protocols, revert to Ethereum, and also be channeled to certain cross-rollup tools. I’ll elaborate below.

First, a considerable value will inevitably flow towards L2 rollup protocols given they directly collect MEVs and transaction fees. In the long run, it is likely only one or few, rather than many, general-purpose rollup plus potentially a few niche rollups in specific verticals will be able to accrue value. These survived rollups are anticipated to be those:

• Exhibit rapid adoption rates: General-purpose rollups thrive on network effects, necessitating the onboarding of developers and users. Achieving this often involves seamless transitions from Ethereum’s base layer to rollups (e.g., Scroll’s EVM equivalence), robust developer support, superior user experience, complemented by strategic business development and marketing initiatives.
• Possess advantages beyond mere technology: Moore’s Law is relevant to ZK-proof technologies, suggesting tech advance can be fleeting. Therefore, a lasting competitive advantage might not be anchored solely on technology.
• Gain backing from proactive, influential VCs: While I typically view Web2 startups or Web3 consumer-facing projects touting their VC backing with skepticism-over-reliance on VCs can be concerning-in the realm of blockchain infrastructure like ZK rollups, the portfolio networks these VCs offer can expedite the integration of other projects into the rollups, rapidly shaping an ecosystem.

Secondly, I anticipate a substantial portion of the value reverting to Ethereum. A bull case for Ethereum is that L2 rollups do not issue a token or have a bad tokenomics, leaving more value on the table for Ethereum to capture. Even in a bear case where L2 captures most of the value, Ethereum still gets paid by L2 for data and executions, and ETH passively appreciates as the ecosystem thrives.

Finally, some value will be accrued to rollup tools, such as a shared sequencer, which is currently underestimated. Although ZK rollups solve Ethereum’s scaling problem, they reintroduce centralization concerns. A shared sequencer can counteract this centralization, capitalizing on its own network effects. Consequently, as dominant shared sequencers materialize, they are poised to siphon off a fraction of the value from ZK rollups.

ZK rollups are a crucial innovation in the Ethereum ecosystem, addressing scalability challenges. Entrepreneurs in this sector should understand that their achievements rely not merely on technological advancement but also on an integrated strategy that embraces strategic alliances, business development, developer support, and community involvement. Investors should recognize that while the L2 market is expansive, only elite rollups are poised to garner substantial value. Nevertheless, investments in decentralized sequencers or merely holding Ethereum might also reap benefits from the L2 surge. As Ethereum continues to grow and evolve, it will be fascinating to see how ZK rollups and other L2 solutions shape its future trajectory.

About The Author

With recent experience in both investing (as an angel investor) and operating (as a product manager for a startup), Haydon Luo has developed well-rounded skills for both sides of the same coin of VC. Previously, Haydon began his career at AECOM, a Fortune 200 multinational infrastructure consulting firm.

As a dedicated fitness enthusiast, Haydon is also committed to the blockchain space through volatile cycles for many years. His expertise encompasses token investment, technical development, and in-depth long-form analysis.

Haydon holds an MBA from the Carlson School of Management at the University of Minnesota and a BEng from the Hong Kong Polytechnic University. He speaks English, Cantonese, and Mandarin Chinese.

Connect with Haydon on his website, LinkedIn, and Twitter.

DISCLAIMER

The analysis in this document is for general information purposes only. While I endeavor to keep the information up to date and correct, I make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability with respect to the document or the information, products, companies, or related graphics contained in this document for any purpose. Any reliance you place on such information is therefore strictly at your own risk.

Originally published at https://www.haydonluo.com on August 16, 2023.