Ethereum Layer 2 is Rising to the Challenge

In the wake of Ethereum’s network congestion and sky-rocketing transaction fees, technologies around layer 2 solutions have matured dramatically in the past year.

Today, we’re seeing a meteoric rise in Ethereum layer 2 activity, as many leading DeFi protocols are now choosing to build on or port contracts to several thriving Layer 2 ecosystems.

What is Layer 2?

The term “layer 2” or “L2” collectively describes a number of solutions (rollups, validium, plasma, state channels, etc.) that help decentralized applications scale by taking transactions off-chain. They are conceptually built on top of Ethereum, hence the name.

Despite the congestion on the Ethereum network, layer 2 solutions allow users of any Ethereum application to enjoy near-instant and affordable transactions for a tiny fraction of the gas cost while still leveraging the robust security and decentralization of the Ethereum mainnet.

Top DeFi Protocols Are Leading the Way

DeFi 1.0 has shown its potential to transform global finance. However, Ethereum network congestion and high gas fees are still pricing many out of usage. Now that DeFi has established a firm foothold, we’re seeing some of the most well-known protocols rushing to implement layer 2 solutions to ease the burden and barrier to entry for users.

Aave

Aave, a non-custodial liquidity protocol for earning interest on deposits and borrowing assets. It launched on Polygon last month as part of a wider plan to make DeFi products more accessible to all and rapidly grew to over $1 billion worth of liquidity in just 10 days.

1inch

1inch, a platform that aims to find the best deals across multiple decentralized exchanges (DEXs), just announced its expansion to Polygon. It joins Aave as arguably the most notable DeFi dapps to integrate with layer 2. The move provides 1inch users access to several Polygon-based liquidity sources that already include Curve, SushiSwap, QuickSwap, Aave. 

dYdX

dYdX is a leading DeFi platform for margin and perpetual trading. To significantly scale trading, dYdX and StarkWare have built a Layer 2 protocol for cross-margined Perpetuals, based on StarkWare’s StarkEx scalability engine (Layer 2) and dYdX’s Perpetual smart contracts. dYdX users can now trade with zero gas costs, lower trading fees, and reduced minimum trade sizes.

The List Goes On

Additional projects include Chainlink, Sushiswap, Open Sea, Curve Finance, Graph, Polywhale, Decentraland, SuperFarm, Pooltogether, with many more on their way.

L2 Network Effect is Heating Up

As the technology continues to mature and the need to take Ethereum transactions off-chain grows, the growth of layer 2 ecosystems is getting interesting. Due to the recent surge in L2 activity, there is a significant network effect that provides even more incentive for DeFi protocols to integrate. 

Currently, it’s Polygon that boasts the most established and fastest-growing network. Since October 2020, the total value locked on Polygon has risen from under $5 million to $5.8 billion at the time of this writing. In comparison, xDAI’s TVL is currently around $71 million.

L2 DEXs Also on the Rise

Decentralized exchanges are the very heart of a layer 2 ecosystem.

While some protocols have made integrations with layer 2 — native DEXs solely focus on increasing available liquidity for layer 2 ecosystems, giving users a “Uniswap experience” with extremely low gas fees.

L2 DEX trading volume in the last 24 hours:

• Quickswap (Polygon): $668,286,390 
• Loopring Exchange: $22,181,254
• ZK Swap: $18,449,198
• Deversifi (Starkware): $6,053,032
• Leverj (Gluon): $3,011,540

By comparison, Uniswap's volume in the last 24 hours (at the time of writing this article) was 1.65 billion.

Hottest Upcoming Projects Are Building on L2

While many projects on Ethereum are migrating to layer 2 after initially building on layer 1, some of the most anticipated projects of 2021 are choosing to build there from the start.

One example is Scaleswap, an upcoming IDO launchpad that is in partnership with Polygon. Scaleswap is leveraging layer 2 scaling and a state-of-the-art UX to improve the IDO experience, making it accessible and fair to all.

IDO launchpads have fully revolutionized crypto investing and fundraising ever since the rise of Polkastarter in late 2020. However, as with many early DeFi protocols, the current platforms haven’t been able to provide truly open access due to high gas costs and less than ideal selection criteria for deciding participation in launch pools. Layer 2 scaling and a community-centric approach are helping Scaleswap tackle both of these pain points head-on.

Ethereum 2.0 on the Horizon

The big question on everyone’s minds is whether the layer 2 space will still be relevant once Ethereum 2.0 arrives. Ethereum 2.0 has multiple layers, and not all are being immediately deployed. One aspect, the PoS merge, is scheduled to go live later this year but is just the first of five major concepts that make up the future of Ethereum. The big throughput upgrade is sharding, and that will not happen until 2022 or 2023. Sharding itself will be deployed in stages and could take additional time beyond that to fully roll out.

The bottom line? No amount of Ethereum 2.0 scaling will ever be enough to meet demand. Users will always want the network to be cheaper and faster.

Vitalik Buterin, in response to whether L2 scaling solutions will still be relevant upon the release of ETH 2.0, stated:

“Fully off-chain L2s based on channels and Plasma will continue to be relevant … an ecosystem where Ethereum covers the world could easily have a need for even more, especially for micropayment-oriented applications. TLDR: the "layer 2" space is about to get a lot more interesting.”

There won’t be a battle between Ethereum 2.0 and Layer 2 solutions. Instead, the two will work together synergistically. Ethereum is and always will be the main highway. Layer 2 provides the surrounding roads, bridges, on-ramps, and additional infrastructure necessary to grow Ethereum into a robust and globally scaled network. The Ethereum Layer 2 ecosystem is thriving, and it’s only just getting started.

Sources:

• https://dappradar.com/polygon/defi/aave
• https://defipulse.com/polygon
• https://defipulse.com/xdai
• https://twitter.com/L2Wars
• https://info.uniswap.org/#/