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Layer 2 Development: Market Data Analysis

Authored by Mengchu Jiang, Siyu Chen, Researcher at Huobi Research Institute

Abstract

Major exchanges announced numerous OP tokens recently, and zkSync has claimed official tokens that will be issued. It seems Layer 2 is gaining attention again. However, some pointed out that the TVL of Layer 2 has decreased by over 40%, which is far from expectations. In this article, the status quo of Layer 2 will be introduced, and its rationale will be analyzed and presented.

Summary

1. TVL of Layer 2 (in ETH) has increased over 20% after holding stable for 3 months. Layer 2 is comparatively independent; its capability to receiving funds from Ethereum is rather weak, so any impact from competition of Layer 1 chain is negligible.

2. The increase in the number of projects deployed on OP Rollup is clear: 50% on Arbitrum and double that on Optimism, Metis and Boba. Deployments on OP Rollup has also seen some disparity : over 10% increase in top 2 and no increase for the last two. Optimism has an evident increase in terms of TVL and addresses, but a comparatively slower absolute increase than Arbitrum; the positions of the top 2 will remain unchanged in the short run. The increase in OP Rollup is motivated by demand, as its potential as an infrastructure gains recognition.

3. Diversity of the ZK Rollup ecosystem needs to be developed in the long run. An uptrend, signaling huge potential has been seen in the growth of TVL for zkSync and StartNet, with over 100 projects. Those EVM-incompatible projects have reached a bottleneck. Projects that fall under the trading category are more susceptible to market fluctuation.

1 Rising Layer 2 surrounded by Layer 1 competition

Cryptocurrency prices are volatile; it would be inaccurate to measure the degree of market prosperity merely by TVL in the unit of USD as the overall market has influence on the price to some extent. Instead, original token in certain Layer 1 chains (i.e., ETH in Ethereum, AVAX in Avalanche, etc.) could be a fairer scale for evaluation of Layer 1 chains.

Layer 1 chain competition has always been a heated topic in the crypto world. Since 2022, although the market has experienced some upheaval, fundraising never stopped for Layer 1 chains. The following chart lays out the change in TVL for various Layer 1 chains. This year, TVL of Ethereum and BSC decreased gradually, while TVL of Avalanche, Fantom, Solana, and Polygon has increased by different amplitude, and Tron remained constant.

Layer 2 is an off-chain scaling solution, the fundamental design philosophy is to transfer the storage and calculation that would have been completed on-chain to off-chain with certain security settings to ensure legitimacy and security; the final state is submitted back to Layer 1 and synced to the whole network. The major Layer 2 battlefield surrounds Ethereum — that no major changes will be done to undermine the underlying logic of Ethereum network, which is more feasible than ETH 2.0, yet improves performance by 30–100 times. Layer 2 chains primarily serve to provide higher performance at lower costs than the more mature Layer 1 chains, eating into the latter’s market share and revenue.

What can we expect from Layer 2 in this war? Did it function as well as expected? An ideal performance would be that the decreased TVL from Ethereum is equal to the TVL increase in Layer 2. The following chart illustrates the change in f TVL on Ethereum and Layer 2. Two conclusions can be made from the chart: change of TVL on Ethereum is huge, whereas change in Layer 2 is small. First of all, in terms of absolute quantity,, Layer 2 is as yet not capable of taking over revenue from Ethereum. Second, change in TVL for the two did not always move in opposite directions, which indicates a weak relationship between the fund flows. As primitive as it is, Layer 2 is too young to overtake Ethereum.

From the end of January to the end of April, TVL of Layer 2 remained constant, as if it had no impact Layer 1 competition. An increase in TVL for Layer 2 was spotted at the beginning of May thanks to the official announcement by Team Optimism at the end of April: that original token, OP, would be issued. Optimism tokens were airdropped to early supporters more airdrops are to be expected in the future. An increase of over 20% in TVL of Layer 2 was in response to the expectation that OP and other top-tier Layer 2 players would continue with airdrops.

Conclusion 1: Layer 2 has seen continuous increase after a stable period of 3 months. Layer 2 is comparatively independent; the capability of receiving funds from Ethereum is rather weak, so the competition of Layer 1 chain has had hardly any influence on its TVL.

2 Ecosystem of OP Rollup

Current Layer 2 ecosystem is dominated by Rollup tech tracks — OP Rollup and ZK Rollup, to be more specific. Some are in Validium. The following table introduces current mainstream projects in Layer 2.

Four projects are major players in Optimistic Rollup: Arbitrum, Optimism, Metis and Boba. Arbitrum is the champion in this category that it accounts for over 50% of the TVL for long. In the second half of April, after the news of possible Optimism token issuance announced, a rapid growth was seen in a short time period (for more information, refer to Could OP Make Optimism the Next Rollup King). Metis and Boba have been through speedy growth, and are just behind Optimism. The Number of projects deployed on these 4 major networks are detailed in the following table. Compared to the March, the number of projects on Arbitrum has increased over 50%, and the rest doubled in number. It is apparent that OP Rollup on the whole has achieved a higher adoption rate.

Change in TVL of the four networks is demonstrated in the following chart (price unit as ETH). Different from the growth in terms of project number, the last two have been nearly stagnant while the top 2 continues to grow.. This indicates market concentration. . The leading project in Layer 2, Arbitrum, has a greater absolute growth than Optimism, which just announced the issuance of tokens. For the time being, we do not expect the competitive landscape between the top 2 players to shift.

The following table compares the number of addresses on the top 2 networks. Setting April 27 as the middle point when Optimism officially announced its issuance plan and calculating daily incremental number of addresses in the ranges of March to April 26 and April 28 to May 30, we can see that announcement has had remarkable impact on growth; Arbitrum also benefited from the announcement. The announcement is overall beneficial to the whole Layer 2 segment as more users entered; it is a milestone for Layer 2.

The more users, the more active network? Let’s see the data for an answer. The chart below portrays number of daily transactions of Arbitrum and Optimism. From this year, the two maintain slow growth while the trend hardly changes. The issuance of tokens seems unavailing in terms of activeness. It may be deemed as the comparatively independent environment is cultivating natural growth.

From the data above, we found that the TVL of the top 2 in OP Rollup is growing, and the number of users/addresses is growing even more quickly, while the number of transactions has maintained constant growth. It is possible that a large number of users flocked to Layer 2 to participate in the airdrop, but very few material transactions were observed. It also indicates that growth is mainly driven by rudimentary demands, such as trade, borrow, and profit, etc., that is why the growth in number of transactions remained constant. . As the market tends to be bearish as a whole, projects in various Layer 1 chains have entered a downturn and even the absolute advantage in cost reduction cannot lift Layer 2 against the overall bear market and negative sentiment.

The good news is that more funds are flowing into Layer 2 despite the bear market due to its potential for becoming mainstream infrastructure in the future.

Conclusion 2: Clear growth was spotted on the number of projects deployed on OP Rollup, and a trend of concentrated distribution appeared. Optimism emerged victorious over Arbitrum for TVL growth and number of addresses, but fell a little behind on absolute growth rate; the relative positions of the two in the overall market have not been affected. The overall growth of OP Rollup is demand-driven, reflecting the recognition of its huge potential to becoming crucial infrastructure.

3 Ecosystem of ZK Rollup

Mainstream projects in ZK Rollup are zkSync, dYdX, StarkNet, Loopring and ZKSpace, etc.

ZkSync, as a Layer 2 solution from Matter Labs, is the leading tech track project in ZK Rollup. TVL of zkSync has totaled over US$75 million (or 41K ETH). Consider that zkSync 2.0 is still in the middle of its test phase, with the mainnet not yet launched, this unprecedented progressive technology, zkEVM, which aims to break the EVM incompatibility bottleneck, the potential for zkSync is beyond imagination.

Being the first project in ZK Rollup to be compatible with EVM, zkSync 2.0 has been expanding — more than 100 protocols have been deployed on the testnet so far. At the beginning of May, zkSync confirmed that it will issue a token in the future. Although specific time of token release has not been disclosed, functions of zkSync will be honed until the full compatibility with EVM is achieved and modularity for smart contracts is ensured. Its market share is expected skyrocket at the time of unveiling.

StarkWare is the superstar team in ZK Rollup. Its first gen product is StarkEX, on which the largest decentralized derivative exchange, dYdX, is constructed. TVL of dYdX has been just below US$1 billion since last October, and dropped slightly to around $0.95 billion after May 10. As the market went bearish, contracts volume has fallen from the peak of US$1.23 billion in April to US$0.57 billion dollars at its lowest, a maximum rally of 54.7%. Daily transactions shrank from US$2 billion to around US$1 billion.

The latest product from StarkWare is StarkNet, a solution to ZK Rollup. Developers could utilize smart contract (Cairo) to deploy all kinds of dApps, and not merely limited to payment processing and trading. The bridge opened on May 9, and TVL of StarkNet increased correspondingly. However, the volume remains rather small, merely less than 300 ETH.

StarkNet possess abundant project source and partners, but the ecosystem is still heading towards a brighter future.

Loopring and ZKSpace (former ZKSwap) are early players in ZK Rollup. So far, total transaction volume of Loopring has exceeded 5 billion dollars with more than 100K users and 30K wallet addresses. Loopring NFT Market and Loopring Wallet are also available. In Loopring NFT Market, mining function was added in February.

The number of accounts add up to around 10,00 on ZKSpace with the number of daily transactions standing at around 1,000. Current business includes 3 protocols in the ecosystem: DEX on Ethereum Layer 2, payment processing and NFT Market, ZKSwap, ZKSquare, and ZKSea, respectively. In April, ZKSpace started to support all DEX function such as deposit/withdraw, transfer and liquidity accretion; minting and trading venue are also opened on ZKSea.

Being pioneers in ZK Rollup, Loopring and ZKSpace launched ahead of others by initial planning of exchanges on Ethereum Layer 2. With early advantage, considerable funding was received in the early phase. However, they face the same obstacles as other DEXs with independent development paths: when perks from early mining disappear, compatibility with EVM becomes a prerequisite; no further development can take place happen. From the figure above, TVL of both projects went down after reaching the peak. To tackle the problem, Loopring and ZKSpace developed their own remedial plans: the DEXs each developed their own NFT trading protocols and continuously carried out the functions of NFT market, adding playability to acquire incremental market share. ZKSpace further attempted to increase rewards for mining and buy back of itse token, ZKS, to encourage users to perform more transactions. These attempts have worked, but the root problem remains unsolved. Future innovations must emerge from either Matter Labs or StarkWare.

Conclusion 3: The depth of the ZK Rollup ecosystem needs to be improved for the sake of development in the long run. Uptrend has been observed in the TVL of zkSync and StarkNet that host countless projects, and its future looks promising.;. Projects that are incompatible with EVM are facing a bottleneck, while projects that involve trading are most susceptible to market changes.

About Huobi Research Institute

Huobi Blockchain Application Research Institute (referred to as “Huobi Research Institute”) was established in April 2016. Since March 2018, it has been committed to comprehensively expanding the research and exploration of various fields of blockchain. As the research object, the research goal is to accelerate the research and development of blockchain technology, promote the application of blockchain industry, and promote the ecological optimization of the blockchain industry. The main research content includes industry trends, technology paths, application innovations in the blockchain field, Model exploration, etc. Based on the principles of public welfare, rigor and innovation, Huobi Research Institute will carry out extensive and in-depth cooperation with governments, enterprises, universities and other institutions through various forms to build a research platform covering the complete industrial chain of the blockchain. Industry professionals provide a solid theoretical basis and trend judgments to promote the healthy and sustainable development of the entire blockchain industry.

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