Layer 1 (L1) blockchains, such as Solana and BNB Chain, have been competing with Ethereum, and delivered exceptional returns to investors during the previous bull market. This historical return has made infrastructure investment nearly indisputable for crypto venture capital (VC) firms in this bear cycle.
Despite the enthusiasm, further elevated by the launch of new L1s—Sei, Sui, and Aptos—within a short time span of 2023 with billion-dollar market capitalisations amidst the depth of the “crypto 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 the “winter” persists.
In this article, we will take a step back from the hype of the alternative blockchain platforms, and revisit the original one, Ethereum. We will take a short detour on the development of Ethereum, its objectives, and how it arrived at today’s rollup-centric narrative. We will then discuss the viability of the current rollup landscape and Ethereum’s position in a multichain world.
Genesis of Ethereum and Its Continuous Product-Market Fit
To understand Ethereum’s resilience and significance, it is crucial to reflect on its history. Back in 2014, blockchain tech alternatives were just starting to emerge. With Bitcoin, people primarily used it for transferring value. However, there were other ideas, such as 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 inspired him while working with the Mastercoin team. The main premise was to improve Bitcoin by creating a Turing-complete blockchain, enabling generalised on-chain computations. This allowed developers to introduce a wide array of decentralised functionalities, including finances, tokenisation, domain naming services (DNS), and decentralised organisational structures.
The excitement about improving blockchain technology brought together dedicated developers for Ethereum, led by Gavin Wood, who published the Ethereum “yellow paper”, specifying the Ethereum Virtual Machine (EVM). Unlike Bitcoin, which relied on its C++ implementation, Ethereum aimed to create implementations based on a specification. This Ethereum developer guide and the right timing attracted a strong community, solidifying Ethereum as the primary Bitcoin alternative, with its pre-sale netting 31,591 bitcoins (BTC), worth almost $18.5 million at that time, in exchange for about 60.1 million of Ethereum’s native cryptocurrency (ETH).
ICO Boom and the DeFi Revolution
On 30 July 2015, Ethereum launched its mainnet with its first Genesis block. Ethereum’s technology offered trust, security, pseudonymity, and decentralisation, supported by robust cryptography. This allowed swift, global cryptocurrency transfers without intermediaries. The technology and ability to tokenise anything using the ERC-20 standard made Ethereum the perfect blockchain for conducting initial coin offerings (ICOs). The blockchain community quickly realised this, and in 2017’s ICO boom, more than 1,000 ICOs were launched with ERC-20 tokens.
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 during the same period, such as Solana, Algorand, Cosmos, and Polkadot. Before any of these alternatives could gain sufficient traction, a “crypto winter” of 2018 struck, and user activity plummeted.
Yet, some ICO projects, such as Bancor, Aave, Kyber, and Synthetix, continued to develop on Ethereum, laying the foundation for DeFi. Fast forward to 2019, the launch of Compound (COMP) started the liquidity mining craze. Subsequently, a flurry of protocols began sprouting. Against a backdrop of zero interest rates in traditional financial services (TradFi), “yield farmers” flooded into the space, hunting for high returns.
Scalability Challenges and the Rise of “Ethereum Killers”
As the COVID-19 pandemic created economic uncertainty, mainstream media coverage of crypto prices attracted a new wave of users. However, this inflow proved too much to handle, as in June 2020, Ethereum gas fees soared to an all-time high of 508,034,850 Gwei, or 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” such as Solana, Tezos, and Luna.
Despite the competition, Ethereum managed to maintain its dominance. 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 flopping. 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
Vitalik Buterin is no stranger to the challenges that Ethereum faces. In 2021, he introduced the concept of the scalability trilemma. It highlights the issues and trade-offs faced while scaling a decentralised network.
With a focus on these three challenges, the Ethereum Foundation and community have been making efforts to encourage discussions, collaborations, and coordination to improve the blockchain. Since its inception in 2015 from the first mainnet Frontier launch, Ethereum has completed about 20 major upgrades to the mainnet. One of the most notable updates was the move from Proof-of-Work (PoW) to Proof-of-Stake (PoS) during the so-called “The Merge” upgrade.
However, “The Merge” was just the beginning. Ethereum laid out an expansive roadmap to execute its vision of becoming the world’s biggest decentralised supercomputer. In a 2020 tweet, Buterin shared a simple summary of the vision where the Ethereum ecosystem evolves, if it overcomes the scalability obstacle.
The overall roadmap set 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 Ethereum roadmap, leading to an “end game” and the subsequent upgrade to “Eth 2.0”.
Dencun Upgrade and Proto-Danksharding (EIP-4844) Explained
A new roadmap brings us to the latest upgrade slated for the end of 2023, the Dencun Upgrade. The term Dencun comes from the terms “Deneb” and “Cancun”, referring to the upgrades to Ethereum’s consensus mechanism and execution layer respectively.
There will be numerous Ethereum Improvement Proposals (EIPs) included in the Dencun updgrade. DWF Ventures summarised the crucial ones in the table below:
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 “blob”. This novelty aims to optimise rollup data by encapsulating it within blobs, eliminating the need for extensive Ethereum block space. Although inaccessible in the Ethereum Virtual Machine (EVM), blobs are referenced using versioned hashes of 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 network fees market for regular transactions on the base layer, which tends to be expensive due to high block space demand. Historical data from Layer 2 (L2) 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 $30.6 million and $19.6 million have been paid by Arbitrum and Optimism respectively to publish call data to L1 from January to August 2023.
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, the danksharding upgrade will take some time as concepts like Proposer-Builder Separation (PBS) and Data Availability Sampling (DAS) are still in the works.
Danksharding will require PBS to be implemented first, given that generating commitments for 32 MB of blob data will be too expensive for most validators, and might impact decentralisation. DAS will also be implemented to allow validators to efficiently verify blob data (by only downloading a small portion of each blob) even as block size continues to increase.
Other Planned Improvements
The significance of the Dencun Upgrade extends beyond proto-danksharding. 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 the Layer 1 blockchain, ideally saving costs for users. This is in line with Ethereum’s sharding roadmap, and contributes to the overall roadmap for the protocol.
Scenarios For Ethereum’s L2 Blockchains and Rollups
Currently, the Ethereum community aims to make Ethereum rollup-centric, with sharding as the main form of scalability on L1 down the road. Some might argue that, as sharding on L1 improves, Layer 2 (L2) solutions, rollups in particular, might lose appeal, and the current strive for rollups would be inconsequential since the L1 would be able to match L2’s transaction cost and throughput without any security compromise or compatibility issues.
However, it is important to acknowledge that Ethereum is a multifaceted project where short-term usability carries equal importance alongside overarching architectural goals. Rollups, such as Base or Blast, 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 (rollups) 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 rollups, it’s important to dive into their current feasibility. The Dencun upgrade appears to enhance the feasibility of rollups by reducing transaction costs and increasing throughput. Evidently, the launch of these rollups has already helped to ease transaction costs and congestion on Ethereum. Currently, rollup-based blockchains provide a 5.82x scaling factor for Ethereum transactions, as per L2Beat.
The widespread popularity of rollups led to mounting competition in the Ethereum ecosystem. Currently, there are 17 rollup networks operating on Ethereum, and there are more L2 launches planned 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 rollups increases, the fragmentation on Ethereum worsens. This could lead to a situation where, due to a prolonged decrease in user activity, liquidity follows Pareto's principle. At this point, crypto liquidity would concentrate within the top 20% of L2s, 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 Buterin 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 rollups could be abstracted away, simplifying the onboarding process for future users. This could allow L2 to turn into a true seamless scaling technology for Ethereum.
Conclusion: Towards Eth 2.0 and Maintaining Market Dominance
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 help 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.
Related Articles
With the approval of the Ethereum exchange-traded fund (ETF), market sentiment surrounding Ethereum
As Layer 2 (L2) solutions for Ethereum continue to grow, the blockchain space has faced a new issue
Ethereum Layer 2 protocol Blast is gearing up for its highly anticipated airdrop scheduled for June