In today’s multichain world, more than 30 Layer 1s (L1s) are listed on Coinmarketcap. These Alternative L1s, such as Solana and Luna, delivered exceptional returns to investors during the previous bull market. The historical return has made infra-investment nearly indisputable for VCs in this winter cycle.
Despite the enthusiasm surrounding these L1s, with Sei, Sui, and Aptos launching with valuations of billions during the depths of winter, there is yet to be a clear signal or catalyst indicating Ethereum’s defeat. In contrast, crypto liquidity in DeFi has primarily flowed back to Ethereum as winter persists.
In this article, we will take a step back from the alternative infrastructure hype, and revisit the origin of all — Ethereum. The article will take a short historical detour on the development of Ethereum, its objectives, and how it arrived at today’s roll-up-centric narrative. We will then discuss the viability of the current roll-up landscape and Ethereum’s position in a multichain world.
The Genesis of Ethereum and Its Continuous Product-Market-Fit
To understand Ethereum’s resilience and significance, it’s crucial to revisit its origin. Back in 2014, blockchain tech alternatives were just starting out. With Bitcoin, people use it mainly for the transfer of value. But there were other ideas, like Namecoin for decentralised names and BitMessage for secret messaging. It was a time ripe for blockchain infrastructure innovations.
In that same year, Vitalik Buterin released Ethereum’s white paper. Its core idea was inspired when he was working with the Mastercoin team. The main premise was to improve on Bitcoin by creating a Turing-complete blockchain, enabling generalised on-chain computations. This introduces a wide array of decentralised functionalities including finance, tokenization, domain naming services (DNS), and organisational structures.
The excitement about improving blockchain technology brought together dedicated developers for Ethereum. Led by Dr. Gavin Wood, he published the Ethereum Yellow Paper, defining the Ethereum Virtual Machine (EVM). Unlike Bitcoin, which relied on its C++ implementation, Ethereum aimed to create implementations based on a specification. Ethereum’s developer guide and timing attracted a strong community. This solidified Ethereum as a Bitcoin alternative with its pre-sales netting 31,591 bitcoins, worth $18,439,086 at that time, in exchange for about 60,102,216 ether.
Ethereum’s Role in the ICO Boom and DeFi Revolution
On 30 July 2015, Ethereum launched on mainnet with its first Genesis block. Ethereum’s technology offers trust, security, pseudonymity, and decentralisation, supported by robust cryptography. This allowed swift, global cryptocurrency transfers without intermediaries. The technology and ability to tokenise anything into ERC-20 made it the ideal platform for ICOs. The blockchain community quickly realised it and in 2017’s ICO boom, more than 1,000 ICOs were launched using ERC-20.
The ICO frenzy revealed the limitations of Ethereum in terms of transaction speed and cost, which became bottlenecks as the community grew. This frustration led liquidity to Ethereum “alternatives” budding through the same period such as Solana, Algorand, Cosmos, Polkadot, and more. before any of these alternatives could get enough traction, crypto winter struck and user transactions evaporated.
Yet, some projects that ICO-ed on Ethereum, such as Bancor, Aave, Kyber, and Synthetix, continued to develop on the platform laying the foundation for DeFi. Fast forward to 2019, the initial launch of Compound (COMP) started the liquidity mining craze. Subsequently, a flurry of protocols started sprouting. Against a backdrop of zero interest rates in the tradfi space, “yield farmers” flooded into a space, hunting for high yields.
Challenges with Ethereum’s Scalability and the Rise of “Ethereum Killers”
As the COVID-19 pandemic created economic uncertainty, mainstream media coverage of crypto pricing attracted a new wave of users. However, this influx of users proved too much to handle as Ethereum gas fees soared to one of an all-time high of 508,034,850 Gwei which is about 0.5 eth.
The issue of high transaction costs and low throughput was once again brought to centre stage. This led to the emergence of “Ethereum killers” like Solana, Tezos, and Luna.
Despite the competition, Ethereum managed to maintain its dominance in the previous summer. This could be attributed to its status as an incumbent in the smart contract blockchain space and the fact that its closest competitors ended up in a flop. However, the latest cycle has brought to light a formidable challenge — competition from alternative Layer 1 solutions, coupled with Ethereum’s struggle to address high transaction costs and throughput limitations.
The future success of Ethereum will heavily depend on its ability to adapt and effectively tackle these urgent scalability issues.
Ethereum’s Response: Road to Overcoming the Scalability Trilemma
Ethereum’s Founder, Vitalik, is no stranger to the challenges Ethereum faces. In 2021, he introduced the concept of the scalability trilemma. The trilemma highlights the challenges and trade-offs faced in scaling a decentralised blockchain.
With a focus on these three issues, the Ethereum Foundation and community have been making efforts to encourage discussions, collaborations, and coordination in order to improve Ethereum. Since its inception in 2015 from the first mainnet Frontier launch, Ethereum has completed about 20 upgrades to the mainnet. One of the most notable upgrades on the Ethereum network was the move from Proof of Work (PoW) to Proof of Stake (PoS) with “The Merge”.
However, “The Merge” is just the beginning. Ethereum has laid out an expansive roadmap to realise its vision of becoming the world’s decentralised supercomputer. In an old tweet back in 2020, Vitalik shared a simple summary of the vision of where the Ethereum ecosystem can evolve if it overcomes the scalability obstacle.
The overall roadmap sets ambitious goals, envisioning roll-ups scaling to over 100,000 transactions per second (TPS) without a substantial increase in costs.
Then in 2022, Vitalik Buterin unveiled a comprehensive roadmap leading to Ethereum’s “end game” and the subsequent upgrade to Eth 2.0.
Dencun Upgrade: Preparing for The Surge with Proto-Danksharding (EIP 4844)
With that, it brings us to the latest upgrade slated for the end of 2023, Dencun Upgrade. The term Dencun comes from Deneb + Cancun, which refers to the upgrades to the consensus and execution layer respectively.
The heart of the Dencun Upgrade lies in EIP-4844, also known as proto-danksharding. This pivotal enhancement introduces a new transaction type that includes an additional component called the “blob.” This innovation aims to optimise rollup data by encapsulating it within blobs, eliminating the need for extensive Ethereum block space. These blobs, while inaccessible in the Ethereum Virtual Machine (EVM), are referenced using versioned hashes on blocks, with actual blob data stored as commitments on the Beacon chain.
Furthermore, the proposal introduces an additional fee market dedicated to the supply and demand for blobs. This market operates independently of the fee market for regular transactions on Layer 1, which tends to be expensive due to high block space demand. Historical data from Layer 2 solutions, such as Arbitrum and Optimism, indicates that the potential demand for blobs is roughly 10x lower than the target level. This means that fees paid to L1s will likely be negligible till blob demand reaches the target level.
Besides the technical intricacies, the Dencun Upgrade presents a valuable opportunity for rollups. Over $30.6m and $19.6m have been paid by Arbitrum and Optimism respectively to publish call data to L1 from January to August this year.
With EIP-4844(Proto-Danksharding), rollups are able to achieve a higher margin of profit and still pass on some cost savings to users. These additional revenues will not directly lead to value accrual for Arbitrium and Optimism but will go to governance. These funds can then be used to fund additional grants or public goods for the chain, which could bring in greater liquidity for the ecosystem.
The upgrade will introduce an average of 3 blobs (~0.375 MB per block) up to a maximum of 6 blobs to be attached to each block. This lays the foundation for danksharding, which will allow up to 128 blobs (~32 MB per block) to be attached to blocks. However, danksharding upgrade will take some time as concepts like Proposer-Builder Separation (PBS) and Data Availability (DA) Sampling are still in the works. Danksharding will require PBS to be implemented first given that generating commitments for 32MB of blob data will be too expensive for most validators and might impact decentralisation. DA Sampling will also be implemented to allow validators to efficiently verify blob data (by only downloading a small portion of each blob) even as block sise continues to increase.
That said, the significance of the Dencun Upgrade extends beyond proto-danksharding alone. The latest update consists of other Ethereum Improvement Proposals (EIPs) which collectively aimed at bolstering scalability and security:
- EIP-1153: introduces transient storage opcodes, whereby values stored will be discarded at the end of every transaction. Key use cases for this will be enabling gas savings by allowing single transaction ERC-20 approvals and preventing the possibility of reentrancy attacks.
- EIP-4788: stores the root of each beacon chain block in the EVM, making consensus layer data available in the execution layer. Thus, this minimises trust on third party oracles to pull data, improving the security of liquid staking protocols, bridges etc.
- EIP-5656: introduces a memory copying function which would help with computationally heavy operations (such as EVM384), without increasing overhead for the EVM.
- EIP-6780: modifies the behaviour of SELFDESTRUCT opcode (if it is not called in the same transaction as creation) — whereby calling it transfers the ether balance from the contract to the target account without deleting the account.
- EIP-7044: ensures that signed validator exits will be valid forever by locking the signature domain on the Capella fork. This ensures that there will be no friction in managing user’s funds after every upgrade.
- EIP-7045: increases the maximum attestation inclusion slot from one to two epochs. This ensures that there is sufficient time for validators to determine the validity of attestations in the event that there are sufficient malicious attestors in the first epoch.
- EIP-7514: includes changes to the ETH staking rewards curve due to the fact that current growth levels will project 50% of ETH supply staked by May 2024 — which puts a strain on the consensus layer from additional economic weight.
- EIP-7516: introduces the BLOBBASEFEE opcode to support EIP-4844, which allows smart contracts to calculate the usage costs and facilitate implementation of blob gas futures to smooth out data costs.
Overall, the key result for the Dencun Upgrade is a reduction in fees paid to Layer 1, ideally passing on cost savings to users. This is in line with Ethereum’s sharding roadmap and contributes to the overall roadmap for Ethereum as well.
Navigating the L2s World and Finding A Viable Path For Roll-ups
Currently, the Ethereum community aims to make Ethereum roll-up-centric, with sharding as the main form of scalability on L1 down the road. Some might argue that as sharding on L1 improves, roll-ups might lose appeal and the current strive for roll-ups would be inconsequential since the L1 would be able to match Layer 2 (L2) transaction cost and throughput without any security compromise or compatibility issues.
However, it’s important to recognise that Ethereum is a multifaceted project where short-term usability carries equal importance alongside overarching architectural goals. Roll-ups currently stand as the most practical solution for scaling Ethereum, considering that sharding might require several more years to reach technical completion. In the face of these constraints, we have the opportunity to combine various short(roll-ups) and long-term (sharding) solutions. This approach can help fulfill the immediate need to alleviate network congestion while preventing the creation of a single weak point.
While we temporarily set aside the long-term concerns related to roll-ups, it’s important to delve into their current feasibility. The Decun upgrade appears to enhance the feasibility of roll-ups by reducing transaction costs and increasing throughput. Evidently, the launch of these roll-ups has already helped to ease transaction costs and congestion on Ethereum. Currently, roll-ups provide a 5.82x scaling factor for Ethereum transactions.
Roll-ups gaining widespread popularity has led to mounting competition in the Ethereum ecosystem. Currently, there are 17 roll-ups operating on L2 Beats, and there are more L2 launches on the horizon. The increasing number of L2 solutions could potentially introduce liquidity fragmentation within the Ethereum network.
This challenge becomes even more pronounced when we consider the declining number of active wallet addresses since 2022. This trend makes it increasingly difficult for L2 solutions to gain the necessary traction and ensure profitability.
The current state of L2 competition presents two potential scenarios. In the worst-case scenario, as the number of roll-ups increases, fragmentation on Ethereum worsens. This could lead to a situation where, due to a prolonged decrease in user activity, liquidity follows Pareto’s law. At this point, liquidity would concentrate within the top 20% of roll-ups, causing other chains to gradually fade away.
On the brighter side, the Ethereum community has the potential to address this issue by enhancing interoperability and improving the user experience when bridging between different roll-ups. Fortunately, this challenge has captured the attention of Ethereum builders. In a recent article, Vitalik discussed the possibility of enshrining ERC-4337, known as account abstraction (AA), into the core Ethereum protocol. With improved wallet mechanisms and user-friendliness, the complexities of roll-ups could be abstracted away, simplifying the onboarding process for future users. This could allow roll-ups to turn into a true seamless scaling technology for Ethereum.
Conclusion: Towards Eth 2.0 & Maintaining Market Dominance
In conclusion, Ethereum has a solid position as the pioneering force in smart contract blockchain technology and widespread adoption. While acknowledging the significance of its ideological and technical foundations, the imperative lies in making the blockchain truly practical.
To uphold Ethereum’s enduring dominance, maintaining an unwavering commitment to continuous upgrades is important. These upgrades helps to address the ever-evolving demands of its users. In this context, the forthcoming Dencun Upgrade, despite its inherent challenges and limitations, symbolises a significant step toward practical implementation while meeting user demands.
As the blockchain space continues to evolve, the future remains uncertain. The growth of blockchains is contingent upon their adoption. Ethereum’s commitment to adaptability and user-centric enhancements are important for its continued success in this dynamic landscape.