The new technology that promises to solve Ethereum’s growth woes is gaining traction, raising the stakes that one day most of the network’s transactions may not take place on its own blockchain.
For years, slow speeds and high transaction fees have plagued the network that underpins the $550 billion Ether cryptocurrency, home to the most popular blockchain applications. Its weaknesses have allowed new competitors like Solana and Avalanche to gain ground. However, the help of so-called Layer 2 technologies, or rollups, could be a solution.
Digital ledgers like Ethereum are designed to slow down and become more expensive as their popularity increases. But these Layer 2 projects, many of which have only recently debuted, can effectively take transaction data from Ethereum, compress it, and publish it back to the original chain for a fraction of the time and cost. So far, the user base is relatively small.
But the rapid growth is raising expectations that not only will Ethereum be able to stave off competition, but that other blockchains could adopt similar scaling solutions.
If the technology takes off, networks like Ethereum may only be used directly for very large transactions in the future, with most activity on Layer 2 networks.
Read more: What Is Layer 1 in Blockchain?
“That’s where we’re headed with Ethereum,” Jeff said. Dorman, chief investment officer at Arca, a digital asset investment manager. “It’s a good problem to have. It’s that old Yogi Berra who says ‘nobody goes to that restaurant anymore because it’s too crowded — of course it’s too crowded because everyone goes there! It will take some time to scale properly, but it will absolutely work itself out because there is demand for it.”
Layer 2 solutions, including Arbitrum, Loopring, Optimism, and StarkWare, are leading the charge, thanks in part to their acceptance by cryptocurrency exchanges. Rollups can provide a huge competitive advantage by making it significantly cheaper to trade Ether and other Ethereum-based currencies. A transaction that could cost merchants $50 and take 14 seconds to confirm directly on Ethereum could cost less than a penny and happen instantly, according to the program.
Decentralized exchange dYdX moved to Layer 2 in April and its daily trading volume matched that of Coinbase Global Inc. for one day this fall, as traders, in part, liked its lower fees. Additionally, Binance, the world’s largest crypto exchange, integrated with Arbitrum in November, and Coinbase are also working on Layer 2 integrations.
“They are at the center of the future of Ethereum,” said Tim Beiko, a computer scientist who coordinates with Ethereum developers, about Layer 2.
About $7 billion of value is locked in Layer 2 chains, up from just $48 million at the beginning of the year. , according to tracker L2Beat. However, there have been barriers to adoption. It can take a week to move funds from the Arbitrum network to Ethereum without additional technology called bridges. Transaction fees can still be too high for many apps. And there are still not enough popular Ethereum apps that use rollups.
Read more: What Are Decentralized Applications (DApps)?
“If I can use Layer 2, I prefer to use it because I don’t want to pay all the fees,” said David Mihal, who runs a few sites that aggregate Layer 2 stats. “But of course, the problem with any new chain is getting these network effects. I still use Ethereum Layer 1 more than I use Layer 2 because a lot of the fun apps are still there.”
However, further, development could encourage further adoption. Ethereum is currently considering a proposal from its co-founder Vitalik Buterin that could reduce Layer 2 transaction costs by five times. More hoards are issuing tokens, offering followers additional incentives. Funding is being wasted. And existing companies are doubling down. Polygon, whose token has a market cap of $14 billion, is working to expand its capabilities, and StarkWare is implementing a way to further scale and reduce costs in the coming months.
“Today, Ethereum could look like Manhattan in the mid-17th century,” StarkWare CEO Uri Kolodny said. “Farms and manufacturers are all producing there. What we’re doing is we’re the skyscraper technology that uses the same footprint and now serves many, many more people. We believe this can be built to whatever height is needed.”
