The decentralized finance (DeFi) sector has grown substantially over the last couple of years. Total Value Locked (TVL) in the ecosystem peaked at over $250 billion by the end of 2021, catalyzed by an ever-expanding array of decentralized apps (dApps).
Ethereum has been one of the market's major players since its genesis and remains in a position of dominance to this day. The network is even pegged to lay the foundations for Web3 and metaverse. But there’s a catch; Ethereum has a major scaling problem.
The limitations on throughput and the ever-increasing cost of transactions are crippling the user experience and hindering widespread adoption. Ethereum’s inability to scale has galvanized en masse migration to competitor layer-1 platforms, such as Binance Smart Chain, Polkadot, and Solana. While these so-called “eth killers'' have proven popular, Ethereum still dominates 54% of the DeFi market, commanding $111 billion in TVL. This is primarily because of the higher levels of security and decentralization offered by the network.
To allow Ethereum native dApps to scale and serve more users, many developers are tapping into the power of “Layer 2” blockchain solutions.
Layer 2 protocols come in multiple forms, but generally speaking, they are separate blockchains designed to sit “on top” of Ethereum and offload transaction bulk from the main chain. This dramatically increases capacity, minimizes latency, and reduces fees — making DeFi activity on Ethereum viable once again.
There are multiple strategies available that work to scale Ethereum, each with its own advantages and disadvantages.
The Race to Scale Ethereum
Optimistic Rollups work by leveraging smart contracts to pass transaction data from the main Ethereum chain onto a Layer 2 network. The protocol bundles multiple transactions into larger batches then submits the verification for the whole collection back to the main chain through a single transaction. This massively reduces traffic on the underlying network, improving latency and transaction costs.
Unlike their brethren, ZK Rollups, Optimistic Rollups don’t perform verifications on every single submitted proof. To save computation power, Optimistic Rollups assume that all transactions are valid, except when a given proof is challenged. Only then are cryptographic confirmations run, which still provides for security while minimizing resource spend. One particular benefit of this form of rollups is that they are inherently compatible with the Ethereum Virtual Machine (EVM) and Solidity, making them an obvious choice for scaling Ethereum.
There are even platforms that leverage both Optimistic and ZK rollups. ZK rollups are also able to validate data off of the underlying blockchain, but unlike the Optimistic variety, they offer more complete finality and security at a cost of additional resources. By leveraging multiple types of rollups, networks are able to be incredibly flexible as far as when and how they achieve consensus, utilizing more or less network latency as a given situation requires.
Other key developments are important too, such as the ability to transfer value in and out of the network in minutes by leveraging on and off-ramps backed by liquidity pools. This ensures that funds don’t get “locked” on the network — a common problem with L2 solutions.
Then there are processes such as “hybrid computation,” which enable Ethereum developers to run code off-chain via web-scale infrastructures, such as AWS Lambda. This allows developers to execute more sophisticated algorithms such as machine learning models that are too complex or otherwise too expensive to be performed on-chain.
Lastly, there are sidechains, which act as additional blockchains that can process data “on top” of the underlying network. This takes much of the traffic off of the first layer, and multiple sidechains can work in tandem for open-ended scaling. All information on these other layers is secured utilizing the rollup technology we’ve described, meaning that these transactions continue to stay safe and trusted.
In the end, with many of these solutions pointing in the same direction, the race to scale Ethereum will likely have multiple winners. Marrying increased speeds and lower costs with improved interoperability delivered by connecting these protocols, will foster greater inclusion and liquidity in the space. This stands to incentivize developers and users alike, offering a path to bring the true vision — and functionality — of DeFi to realization.
About The Author
Alan Chiu is the CEO of Enya.ai and Boba Network. Alan also serves on the Stanford Graduate School of Business Alumni Board, and he volunteers as Co-President of Stanford Angels and Entrepreneurs, a Stanford alumni club with over 2,000 members active in the startup ecosystem.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.