The Melting Layer 2: How POS will affect the off-chain scaling solutions

The Ethereum blockchain is switching to a Proof-of-Stake mechanism. The network’s Merge will make transactions within the blockchain faster and cheaper, reducing the network’s electricity consumption by 99%. The whole crypto world has been waiting for this dramatic event for more than seven years. But how does this hard fork affect L2 solutions, which were created precisely to solve the problem of scalability and low transfer speed in Ethereum?

In centralized finance, there are payment systems like Visa and Mastercard, where processing centres confirm transactions, allowing the network to process 65,000 financial transactions per second. However, due to decentralization, Ethereum is capable of processing no more than 30 transfers. So, to solve the trilemma of blockchain scaling while maintaining decentralization, security and ensuring the speed of transfers, the Layer 2 solutions appeared (as well as the plans to migrate to POS, of course).

It is expected that with the transition of the Ethereum network to the Proof-of-Stake protocol, the number of processed transactions within the Ethereum blockchain will increase to 100,000 per second, which is even more than Visa can process. But will there still be a need for L2 solutions?

The Demand Circle

Regarding transaction speed and fee price, L2 solutions and Ethereum blockchain will be at parity after the transition to Ethereum 2.0. The scaling issue, however, will not disappear in the long run as users from L2 solutions will switch directly to Ethereum due to the low transaction fee at the main net. Thus, gas prices and network load will increase again, resulting in a rebound in demand for L2 services because people still want cheap and fast crypto transfers.

As of 2023, Ethereum developers plan to implement sharding in order to reduce growing transaction costs in the main net. This method will mean transaction processing will take place in isolated groups of validators, which is another blow to decentralization after the network’s transition to the POS protocol. Sharding could become an extra challenge for L2 protocols, the existence of which might be questioned once again because the off-chain scaling solutions need to provide even more advantages for their users, i.e. something more than only the fast crypto transfers.

The Inevitability of L2 Evolution

It is clear that not all projects will adapt to the new reality, but those that can evolve in time will remain on the market.

As you might know, processing operations outside the blockchain enable high-speed transactions in L2 solutions. This scaling approach is known as rollups. There are two types of these: Optimistic Rollups and ZK-Rollups.

Optimistic Rollups are based on the following principle. A smart contract does not verify every transaction at Layer 2, but instead assumes they are legitimate and true if no one disputes them.

Calculations are made only upon fraudulent transactions. Since Optimistic Rollups do not perform any calculations by default, this solution can improve scaling by up to 10-100 times. This number is expected to become even higher with the transition to Ethereum 2.0. Some L2 projects using these Rollups are Optimism, Arbitrum, and Boba Network.

In turn, Zero Knowledge Rollups combine hundreds of off-chain transactions into one single transfer and generate a zero-knowledge cryptographic proof to the mainnet, known as a ZK-SNARK. It allows one party to prove they have certain information without revealing it. Such a function ensures a high level of privacy in public blockchains and other networks.

ZK-SNARK is used to verify each block added to the network, eliminating the need to trust validators. While the Optimistic Rollups solution is based on the assumption that all validators act in good faith, ZK-Rollups verify their honesty using a ZK-SNARK mathematical proof. All transactions take place at level 2, and ZK-SNARK is placed at level 1. It turns out that ZK-Rollup does not need to rely on the honesty of validators, and the security of the L2 network is at the same level as the security of the mainnet.

In addition, ZK-Rollup has no delay when withdrawing funds from level 2 to level 1 since the proof of validity accepted by the ZK-rollup contract has already confirmed the fund’s transfer. So, unlike Optimistic Rollups, there is no need for a fraud check, which can delay withdrawals for up to a week.

According to a recent speech of Vitalik Buterin during ETHSeoul, despite Optimistic Rollups technology being more mature, Zero-knowledge Rollups will replace Optimistic Rollups in the long run. The reason is that ZK-Rollups are faster in moving funds to the mainnet, as there is no seven-day withdrawal period, which may lead to broader adoption. That’s why in 10+ years, according to Buterin, Rollups will be basically all ZK.

So to stay on the market after the transition to Ethereum 2.0, some Layer 2 projects have already announced plans to implement a compute environment called zk-EVM that will allow ZK-Rollups to run all types of smart contracts independently. Projects such as Scroll, zkSync and Polygon have already reported this.

How Will POS Affect the Market?

In the long term, POS triggers the arrival of more users, as it opens the possibility to create even more user-friendly apps that will match Web 2 solutions in terms of speed and the quality of functionality.

As for market indicators, in the short term, the very news of the transition to POS is a bull event because in case the implementation is successful, the demand for ETH will increase, and the price of L2 tokens may slump. But we need to consider that under the hood is a staking mechanism. Currently, more than 13 million ETH are staked on ETH 2.0 at a price below $1000. Therefore, there is a possibility that after the increase in the price of ETH, some funds will be released, but then the market will gradually recover.

Thus, for L2 solutions to remain on the market, they need to adapt to new changes and implement ZK-Rollups, ensuring the speed of transactions while maintaining the decentralization and security of the network. Not only this, but the projects need to consider the additional benefits they can offer their customers. After all, one way or another, it’s likely that the demand for L2 solutions will remain because Dex, Dapps, and projects in the Metaverse will still require fast transactions.