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Layer 2s are having a moment.
We’ve been talking about the potential of L2s for multiple years now and finally, their time has come.
In just the last 7 days, L2s have enabled Ethereum to scale to a factor of 5x and we’re only just getting started!
Moreover, L2s on Ethereum are securing more assets onchain than Solana, Avalanche, Cardano and even Binance Smart Chain… combined!
But why are they winning by so much?
It’s simple.
L2s on Ethereum provide fast and cheap transactions, just like Solana and Avalanche, however L2s do it with the settlement guarantees and the decentralization of Ethereum (PSA: L2s are not yet fully decentralized, but they are moving towards it).
This is something that Alt L1s just can’t compete with.
Not only that, but Ethereum L2s benefit from the network effects that Ethereum has created over its last 8 years of growth.
Developers, users, applications and liquidity from Ethereum will flow to its L2s, and amongst L2s, much easier than with other L1s.
It’s safe to say that Ethereum and its scalability roadmap via L2s has already won the smart contract blockchain wars. That’s not to say other L1s won’t survive, but the king remains in the Ethereum ecosystem.
The question we should be asking now is not what L1 is going to win, but instead, which L2 is going to win?
In the Ethereum ecosystem, there’s already 50+ Layer 2s live on mainnet executing transactions to Ethereum.
With many many more on the way (upcoming projects via L2beats.com)…
Of course, the most notable as of late being Base, an L2 launched by the publicly traded company, Coinbase.
In less than 1 week since going live to the public, Base has managed to accumulate more than $200 Million in total value locked. Putting it 5th for the most value locked amongst all L2s.
And already more than Cardano who has been around since 2017! 🤯
While 50+ L2s may seem like a lot, I believe there will be 1000s of L2s within the next couple years and millions over the coming decade.
L2s are a very exciting space for blockchain development and the overall web3 space.
They provide a much needed product (inexpensive & decentralized blockspace) with a profitable business model to go with it (more on this later).
In today’s report, we are going to take a snapshot of the current L2 ecosystem and breakdown who’s currently winning, what types of onchain activity are happening and where, as well as dive into the economics of L2s.
By understanding these numbers, we can get a better idea of where to put our attention in terms of building on and/or investing in L2s.
In next week's report, we will combine this data with a deep dive on the tokenomics of popular L2s and look into the value accrual components of L2 tokens.
Ok, let's dive into it!
The Top L2s In The Ethereum Ecosystem Currently
Much of the L2 ecosystem is still in Beta or only recently launched.
That said, there are a few ‘OGs’ which we are going to focus most of this report on. The 4 we will focus on today are:
Arbitrum
Optimism
Polygon POS (currently an L1, but planning to merge into an L2 within the next 6 months)
Immutable
Why are we choosing these 4?
With more than 86% market share of the total value locked on L2s, Arbitrum and Optimism are the clear leaders currently in the L2 ecosystem. They're also the 2 general purpose L2s that have been around the longest, launching back in September of 2021.
While Polygon POS is not yet an L2, if it were it would be 3rd on this list in terms of TVL. It’s also already near the top across L1s and L2s for almost every other metric, including users, transactions and onboarding the biggest brands into the space.
And finally, Immutable, one of the first Zero Knowledge Proof (ZK) rollups to go live on Ethereum. While Immutable sits only 7th in terms of TVL, their focus is not on accruing locked value from things like DeFi, instead they are focused on being the premier blockchain for gaming and NFTs.
This is important to keep in mind throughout this report. Finally, because Immutable uses ZK, the onchain data we have is limited and separate from the others.
In case you’re wondering, below is a list of other notable L2s in the Ethereum Ecosystem broken down by the 2 main types of L2s - zk proofs and optimistic rollups.
Zero Knowledge proofs are the next big innovation in blockchain. We are still waiting for general-purpose blockchains using ZK tech to go fully live and become scalable, but the leaders in this space so far are:
ZkSync Era
Starknet
Polygon ZkEVM
In terms of competitors to Optimism and Arbitrum, which both use optimistic rollups, there are only a couple that might have legs to compete at the current moment:
Base - Launched on August 9 by Coinbase
Mantle - Launched on July 17 by a massive community with a treasury in the Billions
There are many others, but these are the leaders of the pack so far. I’m sure there will be plenty of competition and innovation in this space, so this may change very quickly!
In the meantime, let’s dive into the activity across the top 4 L2s.
Onchain Activity Across Top L2s
While TVL is a nice metric to show off, it’s actually more of a vanity metric than anything.
Blockchains rely on fees to generate revenue and become profitable, not value locked. Value that’s locked technically has no value to a blockchain, instead, it’s the value being moved that truly matters.
So instead of looking at TVL (which is what most chains and people flaunt on Twitter) we need to be looking at transactions, contracts deployed, users, and then ultimately, fees generated.
Understanding the real (non-wash trading/airdrop farming), sustainable activity is what truly matters when understanding what L2 is going to win.
So let’s start with transactions, as this is what generates fees onchain (we’ll get to fees and economics later).
Polygon leads the way in transactions with more than 75 million/month. Arbitrum is fluctuating between 30-40 million/month, and Optimism is seeing consistent growth month over month reaching 18 million in July.
Immutable has less activity than the 3 above with about 6 million transactions/month, however considering its focus on NFTs (bear market) and gaming (slow to get started), its transaction consistency through the bear is pretty impressive.
In terms of users, most chains are seeing a decrease in active users throughout the 2022-23 bear market, however ETH L2s across the board are seeing sustained growth.
Smart contract deployment is a great place to look for potential future growth, as the more use cases and things onchain, the more potential users and transactions.
Polygon once again leads the way (by a long shot), but we’re seeing some very strong growth on Optimism too.
While we can’t track smart contracts deployed on Immutable, we do have this chart from the Immutable team showing the growth in developers building games on top of Immutable.
We can also see the trend of partnerships and expected sales volume from these games, which continues to grow significantly month over month.
While these are not perfect data points, they are a pretty decent proxy for expected future growth in transactions on the Immutable chain.
We will take a look at specific applications and use cases on each chain below, but from a high level we can quickly look at what tokens are being minted on each chain.
Here are NFTs minted on each chain per month… (what NFT bear market? 😉)
And here are the fungible tokens (ERC-20) launched per month…
Interesting to see that Polygon has long had a massive lead with NFTs launched, whereas Optimism and Arbitrum have now surpassed Polygon in terms of fungible tokens launched.
Optimism's growth in NFTs launched over the last few months is pretty incredible though.
Generally, Polygon has been the place for big brands to launch NFTs and the L2s have been more focused around Defi and tokens, it seems that maybe Optimism is changing that trend. It’s still too early at this point to tell however.
Immutable doesn’t differentiate between the token types in their data, but we can track total minted tokens. The numbers are on a downtrend, but remaining consistent nonetheless.
In terms of picking winners with onchain activity, I’d say it's still too early to tell.
Polygon had the benefit of being live during the previous bull market, so it’s numbers have been higher for longer, however it appears its growth is stagnant across users, NFTs minted, tokens minted and even transactions.
This may just be a symptom of the bear market and compared to inflated numbers from 2021.
Whereas, Optimism and Arbitrum launched at the tail end of the bull market and thus don’t have inflated numbers from the “good ol’ days”. Instead, they have been grinding through the bear and showing sustained growth on a monthly basis.
While Arbitrum had the early lead, it appears that Optimism has recently found its stride and will soon be ahead of Arbitrum in most metrics in the coming months.
The final thing we can look at onchain for activity are which apps and brands are currently building on each chain. After all, it's the use cases and applications that are going to drive growth across these chains.
Apps and Brands Building on Top L2s
Let’s break down each chain and highlight some of its top brands and use cases.
Arbitrum
The main use cases on Arbitrum currently are DeFi and Stablecoins.
On the DeFi side, Uniswap, Vertex, and GMX are the main applications used outside of bridging. And Circle’s USDC and Tether are the main stablecoins.
Outside DeFi and stablecoins, the only big partnership with Arbitrum (that we are aware of) is Reddit Community Points, which is currently small but has the potential to be massive. That’s not to be confused with the NFT Avatars Reddit has launched on Polygon that has generated more than 17 Million wallets.
Optimism
Optimism is similar to Arbitrum in terms of DeFi and stablecoin dominance, however as you can see from the chart below, its big winner as of late is Worldcoin, with more than 2 million wallets created to date.
While it doesn’t have huge traffic just yet, Optimism is also the home to more web3-like applications like Sound (music NFT platform) and Paragraph (onchain newsletter platform).
Polygon
Polygon is home to the largest brands in web3, with no real comparison in terms of partnerships.
Polygon is currently the home for:
Reddit NFT avatars = 17 million+ wallets and more than 20 million NFTs minted
Nike’s .Swoosh = 375,000 .swoosh IDs minted (still in Beta)
Starbucks Odyssey Rewards Program (still in Beta)
Draftkings Reignmakers Fantasy Sports Program (Millions of $’s in daily trading volume)
Countless other brands and games
In terms of partnerships, there is no comparison to what Polygon has done in the last few years. The only caveat is that most of these are paid partnerships with one off launches of collections and it’s unknown what the future plans are with those brands.
That said, the brands listed above have created something that appears to be real and long-term with massive potential. The question is, do these brands remain on Polygon or move elsewhere, like Worldcoin did.
Immutable
Immutable is the other team that has formed numerous partnerships, however this time with games rather than big brands. It’s estimated that Immutable has more than 250+ games being built on Immutable via partnerships, which is pretty incredible.
Some of the names consist of:
Unity
Iluvium
Gods Unchained (Immutable's own game with 200k+ users already)
Gamestop
Marvel
Immutable appears to be THE blockchain for web3 gaming. Almost all the big games and teams in this space are currently building here and Immutable has also built out the best tech stack to support these teams.
The reason that Immutable is lagging in terms of transactions and growth vs. the other chains is that games take a lot longer to build than DeFi applications. DeFi applications just need to work onchain, whereas games need to work onchain but the teams also need to build a real game that people want to play, so it’s a whole different timeline.
Immutable's stats are lagging behind the others, but if web3 gaming works out like we think it will, Immutable will be the biggest beneficiary of that.
There’s a lot happening across the L2 ecosystem as you can see from the image below, something tells me that we’re going to see many more popular apps and brands fill out this image in the near future.
Economics, Tokenomics, and Value Accrual of L2s
Now that we have an understanding of each chain's activity and use cases, what’s really exciting is we can also look onchain to understand the economics of L2s in terms of its revenues, expenses, profits and more.
We’re going to save the economics of L2 business models for next week's PRO report, where we will also breakdown the tokenomics and decipher if the value actually accrues to the token holders.
First, let's take a look at the revenues of these chains.
Here are the weekly revenues of L2s…
And here is the cumulative revenue all time for each…
These things are money-printing machines!
L2s earn revenue the same way that L1s do, requiring fees to transact on chain. Business is good for L2s as of late, with Arbitrum and Optimism generating about $740,000 in the last week.
Base has stolen the show lately though bringing in more than $1Million in revenue last week. My assumption is this isn’t sustainable, but it's too early to tell.
And lastly, Polygon, brought in just under $400,000 last week. It’s important to remember that Polygon is still its own L1 that is not very decentralized (180 or so validators) so its fees are much less currently.
Where these numbers really get interesting is when we dive into profit. L2s like Arbitrum and Optimism have a very different business model and expense structure vs L1s like Polygon currently have.
Next week we will dive into expenses and profits and show you just how much better the business model is of an L2 than an L1.
Then we’ll break down the tokens of each of these L2s and decide which may be the best long-term investment.
Thanks for reading, and see you in the next one!
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Disclaimer: This article is for informational purposes only and not financial advice. Conduct your own research and consult a financial advisor before making investment decisions or taking any action based on the content.
