• Fees on the Bitcoin blockchain decreased by 22% due to Runes and Ordinals transactions falling sharply

• Ethereum fees dropped to a 6-month low, as activity on Mainnet dwindles

Exchanges Netflows — The net amount of inflows minus outflows of a specific crypto-asset going in/out of centralized exchanges

ETH Fees Hit Lows Amid L2 Competition

Ethereum fees have been heading lower, and reached a 6-month low this week. While on the surface this may seem bearish for ETH, the reason behind it shows signs of promise.

For years Ethereum has been building towards activity moving to L2 networks built on top of Ethereum Mainnet (L1). Vitalik’s roll-up centric roadmap from 2020 has very much come into fruition, with more than 50 L2s currently live in production.

This has led transaction activity to shift into L2s, while reducing the total amount of fees accrued by Ethereum.

Source: IntoTheBlock Perspectives

Record Share for L2s — The share of transactions happening on L2s hit an all-time high of over 82% in April

• This figure is accounting only for the largest three L2s (Arbitrum, Optimism and Base), pointing to the actual share including L2s likely being above 90% of all Ethereum transactions

• The trend towards L2s has accelerated since the launch of EIP 4844, which reduced fees by over 10x

• Transactions of Mainnet have since decreased by 10%, resulting in less fees being burnt, and ETH becoming inflationary again

As activity on L2s increases, the main players have been finding ways to differentiate from the long-tail.

Source: IntoTheBlock’s Ethereum L2 Perspectives

Institutions Pick Arbitrum; Retail the OP Stack

• Arbitrum accounted for 73% of the ETH transaction volume among the top 3 L2s last week

• Conversely, Arbitrum made up only 39% of the number of transactions, while Base had 50% share

• This week, Blackrock and Securitize submitted an application to bring the BUIDL real-world assets fund to Arbitrum

• On the other hand, “SocialFi” applications have been driving activity on top of Optimism’s OP Stack:

• Coinbase’s Base L2 recorded a surge in transactions from the user-owned group chat application FriendTech distributing its airdrop

• A new social media-based card game Fantasy.top recorded $6M in fees this week alone, on top of the Blast L2

It is clear that Arbitrum has earned the crown for DeFi and institutional activity, while Optimism has been targeting retail through a distribution of multiple L2s with creative applications on top. The growth of both has led to a heated competition in terms of the market cap of the largest L2s.

Ethereum’s scalability woes Inherent shortcomings hinder Ethereum’s ability to support the demand for smart contracts. The veteran chain has long struggled with reconciling security, scalability, and decentralization.

According to this well-known trilemma, it is only possible to enhance two of the properties with a compromise on the third. For Ethereum, these two priorities are security and decentralization.

Layer-2 (L2) solutions address the remaining piece of the puzzle — scalability — by resolving transaction bottlenecks. Smart contracts on these networks are faster, more cost-effective, and more efficient overall.

These enhanced self-executing agreements support a myriad use cases, from payments to supply chain management to property ownership.

Ethereum L2 ecosystem. Source: thirdweb How Layer-2 solutions work L2 blockchains are based on secondary protocols running atop Ethereum’s primary chain (Layer 1). They process transactions independently before combining them into batches — single transactions recorded on the main chain.

Validators or relayers ensure the accuracy of the off-chain data. By offloading some processing tasks from the Ethereum mainnet, L2 blockchains advance the development and deployment of smart contracts.

Layer 2 vs. Layer 1: Overview of advantages Layer-2 smart contracts are superior to Ethereum’s primary layer. Their agile infrastructure and scalability focus are well-positioned to address emerging challenges and integrate tech advancements.

1. Supercharged throughput L2 solutions offload transactions from the main chain, reducing congestion and speeding up contract execution. Furthermore, Layer 1 maintains network integrity, which they inherit. As a result, dApps can handle more transactions without sacrificing efficiency or security.

2. Lower fees Following the Dencun upgrade in March 2024, L2 transaction costs dropped by 50–99%. As of June 20, the average Optimism, Polygon, and Arbitrum One fees are below $0.01, compared to around $0.74 for Ethereum gas fees.

Thus, transactions on L2 are not just cheaper, but dramatically so — a crucial benefit for users and businesses. Enhanced efficiency and convenience are key aspects that make L2 solutions so intriguing.

Layer-2 transaction fees as of June 20, 2024. Source: l2fees.info 3. Interoperability As L2 solutions are inherently interoperable with Layer 1, developers can utilize Ethereum’s infrastructure and reach a wider user base. Smart contracts may be programmed to interact with multiple blockchains, leveraging their unique features for a more versatile and seamless ecosystem.

1. Higher speeds With fewer on-chain interactions needed, L2 smart contracts have shorter transaction confirmation times, enhancing the usability and responsiveness of dApps.

Transactions occur almost instantaneously in comparison with Layer 1. This is particularly important for gaming dApps and those facilitating real-time payments.

1. Security and privacy L2 blockchains inherit Ethereum’s robust security, backed by approximately 1 million validators and over $100 billion in stakes. This provides a secure environment for dApps with enhanced privacy features, reassuring users about the safety of sensitive data.

Ethereum staking data as of June 14, 2024. Source: Dune 6. Improved user experience Designed with users in mind, L2 smart contracts eliminate delays and reduce gas fees, improving interactions with dApps.

The combination of scalability, lower costs, and increased speed changes how we interact with blockchain technology. It translates into better wallet integrations, simpler onboarding, and more intuitive interfaces, which are crucial for mainstream adoption.

Layer-2 solutions for smart contract development L2 solutions address smart contract scalability in various ways. Ethereum developers should consult Ethereum Improvement Proposals (EIPs) — standardized frameworks ensuring compatibility across platforms and projects. Bitcoin has its own range of L2 options.

State channels These solutions enable direct communication between participants off-chain — without needing a third party, like a miner, to confirm their transactions. Opening a channel is an on-chain transaction. Then, any number of transactions between the parties happen through the channel off-chain.

State channels accelerate processing, lower costs, and boost scalability by unburdening the main chain. Multi-signature technology temporarily locks a portion of the blockchain, adding the channel’s final state once the transaction is approved. Hence, the main chain only records the resulting state of interactions.

Zero-Knowledge Rollups (ZK-Rollups) ZK-Rollups offload transactions from the main blockchain but relay only a small amount of data with a cryptographic proof — validity proof. This technology ensures the validity of transactions and data privacy, as it does not require revealing specific information.

ZK-proofs also reduce gas fees, making settlements prompt. They save significant amounts of processing energy, eliminating the need for essential data about the digital agreements. The proof, known as a Succinct Non-Interactive Argument of Knowledge, ensures transaction integrity.

Optimistic Rollups Unlike ZK-Rollups, Optimistic Rollups are assumption-based and use fraud proofs. Aggregators publish minimal data on Layer 1, assuming it is correct unless proven otherwise — hence the name.

Verification is not immediate. Instead, if a transaction is disputed, the L2 blockchain validates it through a fraud-proof process, penalizing the sender if they are dishonest. Both processing times and gas fees decrease, while compatibility with existing contracts streamlines migration.

Basic principles of Optimistic Rollups. Source: Chainlink Plasma This framework creates child blockchains anchored to the “parent” mainnet. Each has its specific consensus mechanism and periodically commits a summary of the processed transactions to the main chain, removing congestion risk.

Plasma allows withdrawals from the child chains to the main one. It supports massive scalability and customization for various use cases, including decentralized exchanges (DEXs), gaming, and dApps with unique consensus needs.

Sidechains: Why they are different Unlike L2 blockchains, sidechains rely on their own security. These are autonomous networks running parallel to the main chain. A two-peg system enables asset exchange between the two. Some sidechains are dependent, which means they derive all assets from transfers from the primary chain.

Sidechains provide development flexibility and reduce congestion on the primary chain. They support unique governance mechanisms or consensus algorithms, serving diverse needs, from private enterprise applications to cross-chain asset transfers.

Smart contract development process on Layer-2 The development process for L2 solutions involves several technologies, such as Optimistic Rollups or ZK-Rollups. Solidity remains the preferred programming language.

1. Explore: Developers should assess each solution’s use cases and strengths, such as throughput, implementation difficulty, and available development libraries.

2. Code: Development should align with the standards of the chosen solution, ensuring contract compatibility with the Ethereum Virtual Machine (EVM). Simplifying contract logic can make auditing, maintaining, and upgrading easier.

3. Test: Dedicated testnet environments help identify and fix vulnerabilities, ensuring the contract meets all functional and behavioral requirements.

4. Deploy: Depending on the project stage, smart contracts may be deployed on the mainnet or testnet of the L2 solution. Role-based access controls are recommended to prevent single points of failure.

5. Integrate: Integrating smart contracts into applications ensures a seamless and cost-effective user experience. Reputable oracles should be used for fetching on-chain prices to provide accurate, tamper-resistant data.

Layer-2 smart contracts on Bitcoin While Ethereum is the leading platform for smart contracts, Bitcoin also supports its own Layer-2 solutions. Lightning Network leverages its smart contract scripting language to enable low-cost P2P transactions with acceleration to millions to billions of TPS.

Via Lightning payment channels, transactions between parties are made without broadcasting to the main blockchain. These channels may exist for prolonged periods, and only the final balance — once all transactions are finalized — is posted to Bitcoin.

Layer-2 networks on Bitcoin. Source: Crypto.com The Stacks blockchain enhances Bitcoin’s utility without altering its core protocol. Using Proof-of-Transfer (PoX) consensus, Stacks leverages Bitcoin’s Proof of Work to secure its network and enable smart contracts that interact directly with Bitcoin’s state and transactions.

Wrapping up Layer-2 smart contracts enhance dApp performance and make blockchain interactions more efficient. The underlying solutions, from State Channels to ZK-Rollups, improve Ethereum’s scalability, cost, speed, security, and user experience, paving the way for a new era of smart contract development.