The importance of second-level (L2) solutions as one of the approaches to scaling and increasing the throughput of the Ethereum blockchain can hardly be overestimated. Most of the leading DeFi or NFT protocols in the ecosystem support L2 solutions, and project developers are working on integrating them. Some new services already at the start use second-layer solutions, skipping the development phase on the main Ethereum network, writes RBC Crypto.
Key projects
The reason for the popularity of second-tier solutions is simple: everything that users can do on Ethereum can be done using L2 solutions, spending hundreds of times less on network fees. The reason for trust in the technology lies in the initial unconditional support and advertising of solutions from the Ethereum Foundation and Vitalik Buterin personally. The latter quite often writes about the development of second-level solutions, which makes additional advertising for projects. Buterin is more likely than others to speak positively about one particular project – Polygon (MATIC).
The heyday of L2 protocols came in 2022, but this year the dynamics is likely to continue. The amount of transactions using second-layer solutions is approaching the indicators of the main Ethereum network. Optimism (OP), launched just six months ago, quickly became one of the leaders in terms of the number of transactions, demonstrating successful integration with iconic platforms – Uniswap decentralized exchange and the largest NFT marketplace OpenSea. The project was further popularized by a large distribution of tokens for the first liquidity providers, as well as a policy of distributing tokens through airdrops through ecosystem partners. For example, additional OP tokens can be obtained by using the Revert Finance credit service for existing positions on the Uniswap exchange.
The Arbitrum project also remains one of the leading L2 protocols and stands out for its approach. The protocol uses two types of networks for different tasks: Arbitrum One and Arbitrum Nova. The first one, as a rule, is used by those who care about a special level of reliability in DeFi protocols, and who are ready to lose the speed and cost of transaction processing for this. Arbitrum Nova is more suitable for gaming and social applications that need increased transaction confirmation speed with minimal commissions. The technology of the latter is recognized and integrated into the services of the leading players in the Web 2.0 space, such as Reddit.
From a technical point of view, the classification of solutions of the second level is complex and multifaceted. For a basic understanding, three groups can be distinguished, the first of which is usually classified as “Optimisitc Rollups”, among the most recognizable protocols of which are the previously listed Polygon, Optimism and Arbitrum. The second includes solutions of the zkRollups category with zero knowledge proof technology (Zero knowledge, ZK). The most popular projects are Loopring (LRC), zkSync and the Aztec anonymous transaction network.
The third category includes those projects that use network branches (sidechains) and various combinations of several technologies and networks. For example, the Parastate protocol works by communicating with the Polkadot blockchain and allows you to use the popular languages Rust, Golang and C++ for application development. Other examples include xDAI Chain to implement the DAI stablecoin at the second layer, or Cartesi (CTSI) to enable decentralized logic in a Linux environment, allowing developers to call the project the first operating system on the blockchain.
Advantages and disadvantages
The first thing users pay attention to is the size of commissions. Arbitrum is the most expensive to use, Optimism has lower commissions, and Polygon is the cheapest solution to work with. At the same time, in any of the three networks, commissions will not exceed a few dollars even at the moments of the highest network load. For comparison, at the peak of the crypto market and the hype around the release of NFTs on the Ethereum core network, commissions could reach $200 due to the extremely high load on the network.
The choice of network is often influenced by the availability of highly profitable and user-friendly liquidity pools. The pool of concentrated WBTC/USDC liquidity on the Uniswap exchange on the Polygon network tends to attract significant volumes – one of the main reasons for users. The profitability of the pool with the relative stability of assets in the pair also leaves alternatives behind. In January 2023, the yield was more than 105% per annum when the range was set to ± 6% percent of the market price of the MATIC token.
A separate important criterion for comparing solutions of the second level is the analysis of the composition of assets located in DeFi protocols (total value locked, TVL). The stability of the entire ecosystem of a particular solution for many projects is too much dependent on the price of its own asset, a sharp drop in which can provoke cataclysms for the entire DeFi market. The Arbitrum ecosystem is considered the most independent of the price of its own token, simply because the network does not yet have its own asset at all. A large share of TVL of other second-tier solutions, however, is represented by native tokens, the real value of which is often in question.
Thus, the share of the OP token in the TVL of the Optimism ecosystem at the time of writing is 33%, and the share of LRC in the TVL of the Loopring ecosystem exceeds 58%. However, many users are taking the risk of “linking” their assets to second-tier solution tokens in liquidity pools while their price is rising – since the beginning of the year, the OP token has risen in price by more than 180%, and LRC has gained in price by more than 85% , thus making profitable any DeFi initiatives paired with these tokens.
Risks and alternatives
The main advantage of using second-tier solutions, in addition to low commissions, is the convenience of work. There are quite a few platforms that help users keep statistics and manage all their accounts at the same time in different protocols. The process of exchanging assets between L2 solutions is also constantly being optimized and is gradually becoming more convenient, cheaper and safer.
The main disadvantage of working with second-tier solutions is the high dependence on the Ethereum network, the reliability of which, when discussing the future of L2 projects, is perceived as a kind of unconditional given. Nevertheless, Ethereum itself expects a large number of major updates in the near future, any failures in the implementation of which will negatively affect not only the price of ETH, but also the tokens of the second-level solution protocols.
An alternative for users who want to use all the advantages of L2 solutions, but at the same time be less dependent on the Ethereum network, can be projects that have their own first-level blockchains, for example, Fantom or Celo. The use of the latter is already possible in many classic DeFi and NFT services, and liquidity pools on Celo on Uniswap are well-deservedly popular.
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