In the first quarter of 2021, there are two big stories in the world of Layer 1.
The first story is about Ethereum. It broke a record high and confirmed what may be the launch date of its most important upgrade to date (EIP-1559). The TVL in the DeFi field has increased by nearly 200% to approximately 48 billion. US dollars. It has become the most commonly used blockchain and has accumulated enough potential energy to enter the next round of upgrades.
The second story is about the challenger of Ethereum. With the rise of the cryptocurrency market, the subsequent retail gold rush has once again pushed Ethereum to the limit, and the average transaction fee (in U.S. dollars) has reached a new height. Users who couldn’t bear the rising costs turned their attention beyond Ethereum and found that the ecology that was once a wasteland was gradually becoming alive. The application ecosystem on the new Layer 1 such as Binance Smart Chain (BSC) and Solana, as well as inter-chain solutions such as Cosmos and Polkadot, accelerated growth in the first quarter, and the trend showed no signs of slowing down.
Although Ethereum has benefited from the growth of the entire Layer 1 field, it continues to lose market dominance. In the first quarter, its market dominance dropped to 51%, and may decline further, because newer and faster chains have found their footing, and their token prices have “randomly increased” (compared to Ethereum) . Next year will be a decisive year for Ethereum, as developers will explore solutions like flash bots and rollups to expand the network. What is certain in the first quarter is that the long-awaited expansion war has officially arrived.
1. Ethereum challenger
Judging from the current situation, this year is a year of revival of the “Ethereum Killer”. Most of the new Layer 1 raised a lot of money between 2017 and 2019, but made little progress, while Ethereum is all eyeballs.
In the past six months, the relationship between Ethereum and its so-called challengers has undergone subtle changes, as the high fees of Ethereum have forced users to explore new platforms. Users flow from Ethereum, making developers realize that they can make a living elsewhere. Developers launch new applications with token incentives, and users flock to find profits, which triggers a flywheel of speculation and development: a larger number of users brings more revenue or better currency prices to the development team, which triggers More developers joined and developed high-yield applications.
The flywheel effect of token incentives is significant (either in the process of rising or in the process of falling), which is why the new low-cost, high-performance Layer 1 has emerged rapidly. The success of Ethereum challengers depends on their ability to distinguish their products from Ethereum and stand out.
There are two types of challengers: vertical vertical integration (single-stack) and horizontal modular (interchain) networks.
A vertically integrated network is a fully functional and comprehensive technology stack. Ethereum (in its current form) is a single-stack network that superimposes different network touchpoints on each other, but they all share the same state. These chains achieve synchronous interoperability (also known as composability) because they can handle transactions that call multiple contracts within a block.
Binance Smart Chain (BSC) and Solana are two chains that use a single-stack model, and both performed better than the other top ten Layer 1 in the past quarter.
The rise of BSC is mainly due to its close connection with Binance and EVM compatibility. It uses BNB as the native token to pay for gas. BNB itself has a wide user base and can be used in various Binance product suites. When Binance launched BSC in September 2020, it also launched a $100 million support fund to guide its development. These funds directly or indirectly contributed to the birth of BSC as the most successful application to date-PancakeSwap (DEX) and Venus (lending platform). PancakeSwap competes with Uniswap in terms of daily trading volume, and Venus has accumulated more than $5 billion in TVL (or about 2/3 of Compound’s total TVL).
BSC is also compatible with Ethereum tools, which reduces the learning curve for most smart contract developers and helps accelerate application development. The key feature of BSC is to increase the support for MetaMask. Users familiar with MetaMask can switch between Ethereum and BSC almost seamlessly.
When Ethereum’s on-chain activity exceeded its maximum capacity in early January 2021, these building blocks of BSC were already in place. When the user experience of Ethereum deteriorates, BSC can provide a small but usable DeFi ecosystem at a cost of 4% and a block time of 3 seconds. The result is clear: users flocked to BSC, and its on-chain activity doubled in February. BNB is an integral part of the platform and DeFi liquidity pool. The excitement of BSC has led users to buy, deploy and hold more BNB.
BSC’s existing tokens worth more than 22 billion U.S. dollars are locked in more than 50 DeFi applications, and its TVL is second only to Ethereum (60.1 billion U.S. dollars).
Solana’s story is quite similar. The turning point was the arrival of Sam Bankman-Fried and the launch of Serum in August 2020. Unlike the popular AMM model on Ethereum, Serum uses an order book model characterized by an on-chain matching engine. Because of Solana’s fast processing time (more than 50,000 transactions per second) and low fees ($0.001 per 100 transactions), this on-chain order book is considered a more effective capital model. In contrast, Ethereum’s 15-second block time and unstable fees make the order book DEX appear inflexible and inefficient.
Almost all Solana applications are based on Serum, and its order book has become an important part of lending agreements such as AMM such as Bonfida and Raydium or Oxygen. Non-financial applications such as Audius and Solible also plan to use Serum’s matching engine in the backend to facilitate the transaction and distribution of NFT or social tokens.
It wasn’t until the Ethereum fee surged in January that Solana’s development began to accelerate. Since then, Solana’s DeFi has grown from Serum and a handful of projects to nearly 40 applications. These applications now have TVL over 750 million U.S. dollars. Although it is far from Ethereum, it has grown by more than 4000% since the beginning of February. .
BSC and Solana each benefit from its monolithic design. Synchronous composability can be said to be the decisive feature of Ethereum. Integrate existing building blocks to enable developers to innovate and create applications quickly. Through correct integration or differentiation methods, some core components can nurture a new DeFi ecosystem.
The problem is that vertically integrated networks have historically struggled with scalability. The amount of data in a single chain is large, and each application must comply with the same transaction rules. As a result, node storage costs and network fees increase with the increase in traffic on the chain. Ethereum has reached its upper limit and must find a way to remove the burden. This reduces storage costs and expenses, but breaks the connection of synchronization and combination.
BSC and Solana solve this problem by reducing the number of validators and increasing the cost of validators, respectively. BSC sets its validator set to 21 to minimize the time required to reach consensus. Its consensus layer also relies on Binance Chain (another earlier independent blockchain from Binance), which has only 11 validators (as shown in the figure below) to minimize on-chain complexity. Solana’s validator requirements are an order of magnitude higher than Ethereum’s node cost. Since the storage cost of validators will only increase over time, the most suitable facility for running Solana nodes is a high-end data center. These methods make it difficult to decentralize the power dynamics of the network (how many entities control the network).
Finally, will users care about centralization? Most people have sacrificed privacy for convenience. This may also be the case for decentralization, where users tend to be centralized products because of profit-driven products. But political decentralization has become the cornerstone of Ethereum’s DeFi, because almost every application is working hard to establish a DAO-based governance system. Transferring power to the community is a good protection strategy. When the cryptocurrency market adjusts, the rate of return will gradually approach zero, and in the long run, the user experience between networks will tend to be consistent. But those communities that are empowered and embrace decentralization will be more likely to ignore market fluctuations and insist on actively contributing to project construction.
If the control entity of the project does not cross the boundary, decentralization is actually not important. To protect the development of the community, the centralized approach is not sustainable. When decentralization is compromised, people will realize its importance.
Unlike an all-in-one network, a modular system divides processing, consensus, or storage responsibilities into different independent chains. These chains usually use their respective ecological software frameworks or shared modular toolkits to build infrastructure. The independent chain either provides a main function for a certain application, or provides a more general platform for application development like Ethereum.
The modular system is usually similar to the hub and branch topology, with independent chains inserted into the central hub or chain to facilitate cross-chain communication or assist in network security. Since these systems allocate computing resources, no single chain can undertake the operation of the entire ecosystem. This is to achieve scalability through parallelization.
Polkadot and Cosmos are two of the oldest and well-known modular networks, but Fantom and Avalanche have outstanding price performance in the first quarter.
Fantom has an independent consensus layer and application execution layer. The consensus layer is called Lachesis and provides validator resources to support and protect multiple external execution layers. Fantom’s first execution layer is an EVM-compatible platform, called Opera FTM, which was launched in December 2019, but did not receive widespread attention until January 2021. Its recent resurgence is due to Andre Cronje, an all-star DeFi developer and long-term consultant of Fantom, who helped build and market Fantom’s cross-chain solutions and technical capabilities.
Fantom launched the bridge to Ethereum in early March, which prompted Yearn Ecosystem’s DeFi applications-Curve, SushiSwap and Cream Finance to deploy versions of their contracts on Opera FTM. Alameda Research and BlockTower Capital purchased large amounts of FTM tokens at the end of February and early March, respectively, making headlines.
Avalanche is similar to Fantom in that it has multiple layers that perform core network functions (consensus, application execution, and token creation). Developers can also create custom execution layers called subnets that have use case-specific network parameters, but can ensure transaction security by using a subset of Avalanche’s validator group. Subnets can have overlapping validator groups, but they are all modular in other respects.
When Avalanche’s first DeFi application, Pangolin, was launched on February 9, 2021, on-chain activity accelerated. The network’s native gas and staking token AVAX increased from around $15 to nearly $60 in the subsequent frenzy. A large amount of user activity also caused a bug in the Avalanche code base, which made its main execution layer (C chain) unavailable for a whole day. This series of events shows that the demand for a low-cost DeFi environment is very real. Pangolin now has more than US$200 million in liquidity, with a daily trading volume of approximately US$15 million. Avalanche’s DeFi ecosystem continues to evolve, and there are already complementary financial products such as YetiSwap (Exchange), Snowball (Proceeds Aggregator), Penguin Finance (Asset Management) and SushiSwap.
The non-essential layer and its tokens in the modular system will also benefit from the improvement of the developer’s experience, and in some cases, better defensibility (the tokens bound to the security model on the chain are very Hard to fork). The Cosmos ecosystem is a perfect example of these advantages, because each region (independent chain) can be optimized for specific use cases, find product and market fits, and innovate quickly (add new modules) to take advantage of specific trends.
For example, Terra initially established its stablecoin creation system and generated organic user needs through the Chai application. As demand for Terra’s UST stablecoin grows, it added a smart contract module to its infrastructure in December 2020, which allowed Terra to launch a synthetic asset trading platform (Mirror Protocol) in the next few months. ) And the money market agreement (Anchor). UST is the core asset in each agreement, and the emergence of the agreement promotes the casting of UST. It can be seen from the price performance of LUNA in the first quarter that Terra’s DeFi ecosystem is developing rapidly and UST is being widely used. When Terra issued stablecoins, LUNA was burned, which is beneficial to price movements.
Modular networks still face some recent challenges. Although these systems do not limit intra-chain composability, inter-chain communication will be asynchronous by default. As mentioned earlier, seamless composability is usually a prerequisite for rapid innovation. But as Paradigm pointed out, “Synchronous interaction with all other applications is ultimately impossible to continue on a large scale.” Most chains, even Ethereum, are solving scalability problems through sharding. The future system will consist of a hybrid communication path of synchronous and asynchronous.
Another disadvantage of modular networks is that their architecture is relatively new. Therefore, their ecosystems are either incomplete or underdeveloped. But several modular systems are on the verge of major development milestones.
Experienced networks like Cosmos and Polkadot have a lot of developer activity, and they are about to release their defined functions. Cosmos Hub launched support for IBC connections in February and transferred in March to achieve cross-chain communication. This is the first in a series of planned upgrades aimed at improving the fundamentals of ATOM and the role of the Cosmos Hub in the ecosystem.
Similarly, Kusama and Polkadot plan to launch support for parachain (an individual chain connected to Kusama or Polkadot) at some point in 2021. Once online, holders of KSM and DOT can lend their tokens to the project to help them obtain parachain slots in exchange for token rewards. Stakers in the two networks will also charge the fees generated by the network in proportion to facilitate cross-chain communication.
So far, KSM and DOT have been advocating the right of coinage and have advocated granting voting rights to holders in their isolated networks. Parachains convert these tokens into more powerful capital assets (for a fee), while giving them currency-like characteristics (issued as collateral for parachain auction rewards). Users may bid on KSM to prepare for the parachain auction, which may take place in the next few months (or even earlier).
The success of the modular system will depend on the quality and scale of its sub-chain ecosystem.
Cosmos and Polkadot created a precedent, and now there are more than 200 and 130 projects waiting to be connected to each other. Greener modular networks like Fantom and Avalanche have only one main execution environment. In each case, the chain is EVM compatible, which is a great growth hack, but they must ultimately compete with other EVM-compatible Layer 1 (such as BSC) and Layer 2 solutions. The diversity of ecosystems in product suites or marketing strategies will determine whether they are successful or mediocre.
2.Layer 2 extension solution
The Layer2 scaling solution is definitely part of Ethereum’s development roadmap. They not only help bridge the gap between now and the launch of Eth2, but also serve as an accelerator for Eth2’s scalability, increasing its processing power to a theoretical maximum of about 100,000 transactions per second.
Generally speaking, these Layer 2 solutions accelerate transactions through off-chain means, and then package them as a single transaction and submit it to the base layer. Through batch transactions, Layer1 can significantly increase the number of transactions they process in each block, while theoretically providing similar security guarantees during settlement. Off-chain transactions are basically free, and the underlying network will not be dragged down by redundant data and calculation requests.
The Layer 2 solution is good news for a network whose average transaction fee at the beginning of the year has increased by more than 600%. Ethereum users have gradually become suddenly attracted to these solutions.
After the start of the 2020 downturn, the total value locked in Layer 2 increased by 606%, reaching $273.4 million by the end of the first quarter. This rate of return does not include the value of Ethereum plasma solutions, such as Polygon (it is more like a side chain rather than a real Layer 2 network), Validium-based applications such as Deversifi, or the newly added ZKSwap. At the end of the quarter, Ethereum users had deposited $745.5 million worth of assets in Layer 2, which was less than $100 million four months ago.
Layer 2 decentralized exchanges have also seen a surge in user activity. The total daily trading volume of all Layer 2 DEXs increased by nearly 3000% in the first quarter, which was driven by Loopring’s liquid mining plan launched in January and Polygon’s QuickSwap launch in February.
Although these numbers are far from Layer1 DEX, the trend is clear: the project is developing, and users are following up.
Venture capital companies have also recognized that users’ demand for and adoption of Layer 2 solutions is increasing. As pointed out by a16z, “There is no doubt that in order to support the rapid growth of the network, it is necessary to expand Ethereum.” This demand is the reason why venture capital companies invested more than US$100 million in Layer 2 solutions in the first quarter. The most notable of these are Optimism’s US$25 million Series A investment and StarkWare’s astonishing US$75 million Series B. investment.
The only development obstacle that Layer2 encountered in the first quarter was Optimism’s postponement of its release from April to July (or later). This delay should be just a small obstacle, because this year will be a big year for scaling solutions. The public release of Optimism and the integration of Uniswap are two of several major Layer 2 milestones expected in 2021. Other developments include Arbitrum’s optimistic rollup mainnet release, Matter Labs’ zkSync 2.0 supports Solidity smart contract development, and StarkWare’s STARK-driven ZK Rollup application support.
Although Layer 2 scaling solutions are indispensable for the next stage of Ethereum’s development, there are still some lingering problems related to their impact on the network and user experience.
- Layer 2 parasitic problem: Will Layer-2 be detrimental to the security of Ethereum and the value capture of ETH? Because they will transfer activities and miner/verifier fees from the base layer.
- Destruction of composability: In the foreseeable future, Layer 2 will be the isolated center of composable activities, and cross-Layer 2 activities can only occur on an asynchronous basis. When their underlying connection points (and liquidity) shift to different solutions, how will protocols that rely on Ethereum’s current composability standards respond?
- Cross-Layer2 communication: Currently, cross-L2 communication requires multiple expensive transactions because they must be routed through Ethereum. When users want to withdraw their assets to the base layer, they may face a long waiting period. If Ethereum’s DeFi is divided into different Layer 2, how should these transactions be processed to make it more convenient for users? Connext’s Spacefold trading track and the use of L1 liquidity for L2 applications are potential solutions, but the field of L1-L2 and L2-L2 transactions is still very broad.
- Repeated congestion problems: What happens if almost all protocols are transferred to the same Layer 2 and cause the same congestion problems that Ethereum experienced during peak periods?
Not every question will have a complete answer. Most solutions may end up being compromise solutions to difficult problems. But the need for scalability is real. Where there is a demand, there are opportunities. So far, cryptocurrency developers have been creative in their ability to solve problems within the scope of cryptography and blockchain, and crypto developers are quite creative in their ability to solve problems within the scope of encryption and blockchain.
3. The future of multi-chain
The agreement to generate revenue and the endless thirst for assets make it clear that the crypto industry is actually large enough to accommodate multiple blockchains. Layer 2s and Eth2 will alleviate Ethereum’s scale dilemma, but current scalability issues will also include bridged Layer-1s.
People who classify themselves as “X-Chain Sect” are because they refuse to accept the use of data to speak. Ethereum may become the center of the crypto economy, and Bitcoin is the leader in the role of cryptocurrency reserve assets. But now Layer 1 can provide better or even complementary services in specific areas. For example, Flow positions itself as a safe haven for NFTs, and THORChain can connect to traditional blockchains. As the cryptocurrency industry develops, more problems (which may be opportunities for optimists) will emerge, and the technical components needed to solve these problems may appear in the newer Layer 1.
Bitcoin started the wheel of history. Ethereum expands the possibilities by adding features. Their latecomers will expand the user base from the crypto native niche market to the mainstream. Although over time, some online communities fail to realize and the number of feasible chains will decrease, but the short-term future will be a multi-chain future.