If Layer 2 is successful, what impact will it have on Ethereum and the public chain structure?

In the past period of time, DeFi has shown us the congestion of Ethereum, and the gas fee is unbelievably high. This is just a superficial display from the level of user experience. Its deep meaning is that different DeFi protocols are competing for the block space of Ethereum, which is a zero-sum game.

When the block is full, the transaction of any protocol increases, which means that the transaction of other protocols decreases. With the increase of newcomers, the competition becomes more and more fierce, and finally the transaction fee of some mining is as high as hundreds of dollars. In the first few months of DeFi's popularity, Ethereum's transaction fees have surpassed Bitcoin to rank first in the encryption circle. Even if DeFi cools down today, its annualized transaction fee is not far behind Bitcoin.

Encrypted project annualized fee income ranking, SOURCE: tokenterminal

In the case of a hot market, the entire DeFi market will be fiercely fought. Since the transaction throughput is fixed, the value of the DeFi market as a whole cannot continue to rise. Because it will limit the transaction volume of the overall DeFi project, thereby affecting its sustainability.

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This naturally leads to issues of throughput and speed. People have proposed solutions such as Layer 2, sharding, and cross-chain, among which Layer 2 is one of the most frequently mentioned directions. Make a hypothesis, if Ethereum is a giant in the future, then Layer 2 based on Ethereum will be an important development trend.

In Layer2, what kind of evolution trend will it present? Will a hundred flowers bloom in Layer2? Still thriving? If Layer 2 is successful, what impact will it have on Ethereum and the public chain structure?

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First, let's take a look at the road to scalability of Ethereum in Vitalik's eyes:

In this development roadmap, Layer 2 is an important direction. From the records of Blue Fox Notes, there are many directions for Layer 2 practice, such as state channels, side chains, Plasma, Optimistic rollups, validium, ZKRollup, etc. You can refer to Blue Fox Notes’ previous article "Layer 2 Track of Ethereum" , "Ethereum Layer 2 Breakthrough: What It Means", "V God: Breaking the Conventional Thinking of the Relationship between Blockchain Layer 1 and Layer 2".

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It all looks very good. But there is a big problem here: Layer 2 itself is an island. If different projects adopt different Layer 2 solutions, how can they communicate with each other? This will break the composability on Layer 1. If DeFi's Maker, Uniswap, Compound, Curve, Synthetix, etc. cannot be combined, how can aggregation protocols, etc. help people obtain higher returns? How to promote the innovation of DeFi?

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Without composability, DeFi loses its original meaning. Even if it achieves extremely high transaction throughput and extremely low fees, if it loses interoperability, its value will be greatly reduced.

This situation means that, in the end, only a small number of Layer 2s are meaningful, which is similar to the network effect of the winner-take-all public chain. Because projects using the same Layer 2 technology are easier to achieve interoperability. This means that most of today's Layer 2 technologies will only be short-lived in the end. Therefore, when investing in this track, how to place a bet and when to exit needs to be considered.

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If mainstream DeFi projects all adopt a certain layer 2 technology, this layer 2 technology may become the de facto layer 2 technology, while other layer 2 may gradually withdraw from the stage of history (with the possible exception of layer 2 for games). This is similar to the principle of public chains. Composability and liquidity itself force other projects to make choices. If projects such as Maker, Uniswap, Curve, Synthetix, Aave, Compound, etc. all adopt some kind of Layer 2 technology, then other projects will have to stand in line. Even though initially, these projects will not adopt the same layer 2 approach, over time, they will end up on the same path. In terms of the adoption of Layer 2 technology, the decision of Lego, the foundation of DeFi with liquidity, is decisive.

Although there are a variety of Layer 2 technologies, each of which has different trade-offs, the core point is still security. If there is too much trade-off in this aspect, it can only become a transitional Layer 2 technology in the end, and may not even have a transitional opportunity.

Because no mainstream DeFi project will rashly adopt a certain Layer 2 technology and lock itself into an isolated island. For the project, it only gains theoretical scalability, but it may lose liquidity and composability , and then let yourself lose the advantage, which will outweigh the gain.

From the current point of view, the ZkRollup series technology has a higher probability of success, and it has achieved a better balance in terms of security and performance. Of course, ZKRollup technology itself is currently only a basic technical facility, and it also has its shortcomings. At the same time, it is not clear how to capture value. As such, it remains to be seen how much investment opportunity there is.

But it is indeed good for the DeFi industry. Its advantage is that as more DeFi projects adopt the same layer 2 technology, they can gradually realize interoperability on Layer 2 without worrying too much about the island effect of layer 2.

If DeFi on Layer 2 still achieves the composability and security of Layer 1, because its transaction throughput is hundreds of times that of today, and its transaction fees are also greatly reduced, then the possibility of large-scale adoption of the protocol will greatly increase. With the increase of the transaction volume of the agreement, the increase of income and the increase of users, both the actual value and the premium will increase greatly. This will lead to a breakthrough in the DeFi industry to a deeper and broader level. If you make a simple and crude analogy, with the current throughput and speed, the current market value of DeFi can reach about 10-15 billion US dollars, and the future layer 2 can increase the scalability by 100 times. Even if it is increased by 10 times, it can carry a DeFi market value of more than 100 billion US dollars, which has laid a solid foundation for the overall market value of DeFi in the future.

This is the direction that open finance should develop in the future.

Assuming that Layer 2 of Ethereum can break through the island effect, then DeFi projects will migrate to Layer 2 one after another, thereby greatly alleviating the current congestion and cost dilemma, and there can be hundreds of times the space for improvement.

When this point comes, there will be certain pressure on other public chains. When Ethereum's congestion cannot be resolved, other public chains can act as Ethereum's side chains to help Ethereum relieve congestion pressure, thereby gaining a position in the entire DeFi development process.

But if Layer 2 can successfully solve the problem, then the value of other public chains to Ethereum itself will decrease, although it will still have great value.

In addition, if Layer 2 is successfully implemented, this will lead to Ethereum being able to siphon a larger amount of Bitcoin assets, further becoming a place to carry more assets.

With the increase of protocols based on Ethereum, ETH can capture greater value, which will lead to an increase in the overall market value of Ethereum, and the increase in the overall market value will make Ethereum more secure. The more secure Ethereum can make it a public chain that carries a larger amount of assets. If Layer 2 and sharding have sufficient scalability, the bitcoin circulating on Ethereum may reach 10%, 20%, or even more than 30% in the future .

Once this situation is formed, a super public chain pattern may emerge. Although other public chains are still valuable and will still exist, the super public chain will siphon the largest amount of assets and become the most concentrated place for DeFi activities. The king of public chains.

Of course, there is a premise here: the Layer 2 and sharding solutions can be smoothly advanced. In addition, other public chains still have the opportunity to become public chains of tens of billions of dollars, but there will not be too many public chains above the trillion-dollar level, and there may be only one or two at most.

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