IOSG Ventures
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IOSG Ventures

Layer2.finance: Brings Mass Adoption and Onboard Small-fish Users to DeFi

Defi aims to improve financial activity with its composability and permissionless nature. Ideally it should get mass adoption but in fact it is turning into a whales’ game due to the high gas fee on Ethereum. A transaction interacting with the DeFi protocol usually costs $50 -$200, which keeps small-fish users away and becomes a roadblock for Defi to reach its next 10M users.

To address this problem, leading Defi protocols are looking for their way out by deploying and moving to Layer2s. Synthetix is running on Optimism with 5.3M SNX staked, which is only 5% of the SNX staked in L1. Aave has a $ 2B market size on Polygon, while still having $ 11.5B on L1. We can see that this approach is making slow progress and results in liquidity fragmentation.

Celer Network launched Layer2.finance to solve this in a completely different way. Layer2.finance enables quadratic scaling of the existing layer-1 DeFi ecosystem “in-place” with no protocol migration needed and therefore, does not cause liquidity fragmentation or break composability. In this way, instead of moving Defi protocols to L2, Layer2.finance is bringing users to L1.

The interaction with Layer2.finance is simple. Firstly, users have to deposit asset (currently only supports stable coins) from L1 to L2 wallet. And then they can start their investment journey by depositing into the pre-set investment strategies. Funds can be withdrawn from strategies or withdrawn from the L2 wallet with one click.

The Choice of Layer2 Solution

Using Optimistic Rollup in this first version, a delay is introduced into Layer2.finance due to challenge period. User might wait for several hours of aggregated fund allocation time before his investment proposal is batched and sent to L1 Defi protocols. Withdrawing from strategies also requires a similar waiting time.

But to clarify, the great effort had been made to reduce the challenge period from days to hours by simplifying the states and uncomplicating EVM computing. Celer State Guardian Network (SGN)’s monitoring L2 states as a decentralized watchtower also adds security to Layer2.finance. Celer team believes that nobody is taking risks because of the reduction in the challenge period.

What’s more, StarkWare has given up working on a similar idea of ‘Defi Pooling’ and announced a partnership with Layer2.finance. Hence, Celer and StarkWare team will collaborate to introduce a ZK-Rollup version of layer2.finance by leveraging StarkWare’s StarkEX infrastructure and the Cairo programming language, which will come out in late Q2.

We think it is reasonable that Layer2.finance used Optimistic Rollup to bootstrap the project for its nature of EVM-compatible and fast integration. It was a tradeoff, and the downside of the tradeoff (long challenge period) will be fixed by the upgrade of the ZK-Rollup version with StarkWare. We can foresee a huge reduction of aggregated fund allocation time and withdrawal time in the ZK-Rollup version, which will greatly expand Layer2.finance’s use cases.

Investment Strategies

There are currently 3 strategies in Layer2.finance supporting 3 Defi protocols: AAVE, Compound, and Curve. Users can deposit funds to AAVE for lending, to Compound for combined lending and automatic $COMP yield farming, and to Curve 3Pool for combined liquidity providing an automatic $CRV yield farming.

As we can see from current strategies, the use case is still limited because of hours of aggregated fund allocation time. Providing DEX liquidity can be another use case if slippage control can be applied to the strategies. And when comes to the ZK-Rollup version, DEX swap on some trading pairs with stable prices can also be possible with slippage control.

Celer team is exploring a partnership with YFI, Uniswap, Sushiswap, 1inch, Alpha Finance and Liquity to onboard as many strategies as they can. Moreover, the Layer2.finance strategy ecosystem is very open, strategies can also be added via DAO governance.

Although strategies are limited for now but seeing the Celer team’s actively reaching out to many leading Defi protocols and their proposal of supporting customized strategies via DAO voting, we think Layer2.finance will finally build a one-stop marketplace for Defi protocols, on which users can access many Defi protocols on L1 easily with very low cost, enjoy Defi investment with any capital size.

Possible Future Plans

One possible up-gradation is proposal settlement on L2, which is mentioned in StarkWare’s design of Defi Pooling. The rough idea is some contrary proposals to a Defi protocol by different users can be settled on L2, without sending all the proposals to L1. For example, if Alice wants to supply $500 to YFI and Bob wants to withdraw $200 from YFI, these 2 proposals can be settled on L2 and Bob get his $200 instantly from Alice’s deposit. Swapping on L2 is also possible if acceptable prices have been set by both parties and the orders match.

Liquidity mining for new strategies is mentioned by the Celer team. We don’t have many details about this, but one thing for certain is this liquidity mining won’t turn into a whale’s game due to the nature of Layer2.finance. The purpose of liquidity mining is to attract more small-fish users into the game, the design of which will be different from those whale-friendly liquidity mining that we have seen before. $CELR token will be involved in liquidity mining. Staking $CELR to SGN can help with L2F block producing and share profits.

Conclusion

If compare Layer2.finance with the approach of moving Defi to L2s:

We think Layer2.finance can become a better solution than moving Defi to L2s. There are apparent advantages, a) it won’t cause liquidity fragmentation; b) it doesn’t need any development or deployment of Defi protocols on L2; c)it can become a one-stop marketplace to provide users with access to all Defi protocols. The disadvantage we can see now is user has to wait for batching time, but this can be greatly improved by ZK-Rollup integration, and the growth of the user base can also shorten this waiting period.

Layer2.finance introduces a brilliant idea to get around the Ethereum gas fee problem and onboard small-fish users to Defi. Although there are still limitations for the first version, we can see a clear and feasible roadmap with the prospect of bringing more adoption to DeFi. From the week one report, there are $34k total gas fee saved from 900 Defi transactions, saving $40 on average per transaction. It’s a nice start and we look forward to the future prosperity of Layer2.finance.

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