Ethereum’s decentralization journey with Layer 2 solutions

As the cryptocurrency landscape has continued to evolve, Ethereum now stands at a pivotal crossroads, which stands to shape its future in a big way. While ETH’s price and market cap fell by 10% between July and September, the asset still outperformed Bitcoin by 2%. 

Moreover, as per Messari’s State of Ethereum in Q3 2023 report, Layer-2 (L2) transactions accounted for two times as many transactions on the mainnet, i.e., nearly 66% of all transactions within the ecosystem. This shift towards L2 solutions has spurred several conversations regarding Ethereum’s scalability, security, and its commitment to decentralization.

The ongoing L-2 revolution cannot be ignored

L2 solutions are increasingly becoming the backbone of Ethereum’s scalability strategy. According to the Messari report, activity on Ethereum’s mainnet was quieter in Q3, with the total volume of ETH burnt decreasing by 48%. This resulted in a net supply inflation for the first full quarter since ‘the Merge’ took place (a software upgrade that swapped the platform’s consensus mechanism from a proof-of-work protocol to a proof-of-stake system).

More importantly, the study notes that average daily transactions on Ethereum trended slightly lower for the quarter — at about ~1 million — with Layer-2 transactions growing by 20%, thanks in large part to an activity boom on developer-friendly ETH L2 solution Base and increased adoption of decentralized social network friend.tech. 

Providing her take on these developments, Elena Sinelnikova, co-founder and decentralization coordinator of the MetisDAO Foundation, a high-performance ETH scaling solution, noted that it is not surprising that most Ethereum transactions are now taking place via Layer 2 systems, adding:

“L2s are faster, cheaper, and somewhat more secure, but they’re still a work in progress. For instance, Optimistic Rollups are still working on their Fraud Proof systems, and ZK Rollups are trying to ensure they work smoothly with Ethereum without any hiccups.”

A somewhat similar opinion is shared by Felix Xu, co-founder and CEO of Arpa Network, a decentralized/secure computation framework provider, who believes that a key reason why Layer 2’s are gaining traction is because of their strong focus on decentralization and security. He further noted:

“Even off the mainnet, Layer 2s maintain these crucial features, ensuring a secure environment for users and developers. Therefore, I see Ethereum’s dominance continuing to grow, especially as more assets from other chains continue to migrate to the ecosystem,”

A decentralization dilemma?

While L2 solutions undoubtedly offer high scalability, they also face certain challenges. As per Messari’s Kunal Goel, Ethereum’s total value locked (TVL) decreased by 19% in Q3, with DEX volumes dropping by 24% and NFT volumes by 49%. Moreover, transactions on scaling platform Optimism grew by 40%, but it cannibalized some activity on Arbitrum, where transactions fell by 36%. Despite this, the latter remains the largest L2 offering with 600,000 average daily transactions, compared to ~400,000 for Optimism and Base each.

Sinelnikova believes that a common issue with all of the aforementioned solutions is that they rely on a single sequencer, as a result of which they feature a single point of failure. “Having most transactions on centralized Layer 2 solutions is risky for the entire Ethereum system,” she warned.

Lastly, as the Ethereum network has continued to expand, it has faced greater regulatory scrutiny, especially after the U.S. Office of Foreign Assets Control (OFAC) sanctioned Tornado Cash addresses — resulting in major Ethereum relays having to censor transactions, adding another layer of complexity to the network’s ongoing decentralization dilemma in the process.

The Cancun-Deneb upgrade and beyond

A major development coming to the Ethereum network in the near future is the Cancun-Deneb upgrade, which aims to make roll-up transactions more cost-effective than ever before. To elaborate, the upgrade stands to be a game-changer for the ecosystem, making its L2 solutions even more competitive via the introduction of EIP-4844 or proto-danksharding, which will significantly reduce the costs of roll-up transactions.

Therefore, as we head to a future driven increasingly by crypto-enabled technologies, it stands to reason that L-2 solutions will continue to evolve and become more user-friendly, focusing increasingly on balancing scalability with the core principle of decentralization. Interesting times ahead, indeed!