Key Takeaways
- A layer-2 (L2) protocol is a secondary framework built on top of an existing, more secure blockchain network to make it more accessible.
- They enhance transaction efficiency by offloading the process from the main chain and have close similarities to the SWIFT messaging network in TradFi.
- Investors can invest in the tokens of these layer-2 projects, which they can hold or stake to identify the long-term winners.
Table of Contents
- What Are Layer-2 Blockchains?
- Top Layer-2 Blockchain Solutions
- Types of Layer-2s
- Where Are Layer-2 Blockchains Used?
- Investor Outlook for Layer-2
- Investor Takeaway
Imagine you're building a city on a small island.
You start with a solid foundation of roads to support the growing city. But as more people and businesses flock to the island, you realize that the infrastructure is straining. To accommodate the increasing demand, you need to construct additional layers, like bridges, tunnels, and efficient transportation systems.
In blockchain technology, the layer-1 (like Ethereum) serves as the foundation. However, as the network grows, it can become congested and expensive. This is where layer-2 solutions come into play.
Just as bridges and tunnels alleviate traffic congestion in a city, layer-2 protocols help scale the blockchain network, enabling faster transactions and lower costs.
In this guide, we’ll dive into the top layer-2 solutions. By understanding the strengths and weaknesses of each L2, you’ll be better equipped to identify the tokens most likely to be the best long-term investments.
What are Layer-2s?
Layer-2 refers to a set of technology solutions built on top of layer-1 to reduce bottlenecks (i.e., to help the underlying blockchain run faster and cheaper).
Today, Ethereum is the most popular layer-1, but it hasn’t scaled well. So layer-2 solutions like Arbitrum, Optimism, and Base have been built to make Ethereum run faster and cheaper.
Rather than recording each transaction on-chain, layer-2s do many transactions off-chain, then roll up the transactions into one blockchain transaction. This makes them faster and cheaper, while retaining security and decentralization.
Unlike traditional financial systems like SWIFT, which rely on centralized intermediaries, layer-2 solutions use blockchain technology to let people send value anywhere in the world, quickly and easily.
Top Layer-2 Blockchains
Polygon
Market cap: $5.01b
Daily Active Users: 1.06m
Revenue: $88.56k
Originally founded in 2017, Polygon was one of the first layer-2 solutions that looked to solve Ethereum’s scalability problems. Polygon (MATIC) is a layer-2 solution used to govern and secure the Polygon network. Polygon is ideal for high-volume applications, using a technology called ZK Rollups.
Polygon is a proven layer-2 solution with a long track-record of success. However, it has lost market share to current layer-2 leaders like Arbitrum and Base.
Read our Polygon Investor Scorecard here.
Base
Market cap: N/A
Daily Active Users: 895k
Revenue: N/A
Base is a Layer 2 blockchain built on Ethereum, designed to offer a scalable and cost-effective environment for decentralized applications (dApps). Developed by Coinbase, Base aims to simplify the process of building dApps by providing a user-friendly platform with lower transaction fees and higher throughput compared to Ethereum's mainnet.
It leverages optimistic rollup technology to achieve these improvements while maintaining compatibility with Ethereum's security and ecosystem. Base is part of Coinbase's broader strategy to onboard the next billion users into the crypto economy by offering a more accessible and developer-friendly blockchain infrastructure.
Mantle
Market cap: $5.10b
Daily Active Users: 19.02k
Revenue: N/A (information not made public)
Mantle is the world’s first DAO-created L2 solution, known primarily for its substantial treasury. The Mantle network is empowered by a growing dapp community, proactive investors, and future-focused initiatives to further crypto adoption. Mantle presents itself as a fast-growing ecosystem focusing on massive mainstream adoption.
Stacks
Market cap: $3.56b
Daily Active Users: 6.01k
Revenue: N/A (information not made public)
As opposed to other platforms that leverage Ethereum as their base layer, Stacks is a layer-2 built atop bitcoin. This project grants users access to a coin with over $1 trillion in market capitalization while adding previously unavailable features like smart contracts to the network.
Stacks is an investment opportunity if you believe bitcoin has a future as a leading smart contract platform (which is not part of its original design).
Download our Stacks Investor Scorecard here.
Arbitrum
Market cap:$7.12b
Daily Active Users: 486.57k
Revenue: $973.64k
Arbitrum is an Ethereum-based layer-2 solution built for efficient transactions. It highlights speed and low fees for users by merging transactions into batches and recording them on the Ethereum network through a technology called “optimistic rollups. “
As the project with the largest market cap on this list, Arbitrum is the current layer-2 leader, with substantial investor backing, though there is some question whether it can retain this lead.
Download our Arbitrum Investor Scorecard here.
Immutable
Market cap:$2.88b
Daily Active Users: 273.46k
Revenue: $527.84k
Immutable is a layer-2 solution built primarily for NFTs and Web3 game economies. Through tokenization, the Immutable platform provides developers and gamers with the ability to own the digital assets they collect in-game.
The gaming industry generates more revenue than the music and film entertainment industries. Its predicted compounded annual growth rate of 13.1% between 2023-2030 presents an opportunity for investors who believe Immutable can lead this niche.
Download our Immutable Investor Scorecard here.
Optimism
Market cap:$7.30b
Daily Active Users: 68.20k
Revenue: $1.87m
Established in 2022, Optimism is an Ethereum-based layer-2 solution with a focus on EVM compatibility, meaning that developers can write and deploy code on Optimism without having to learn a new programming language or rewrite their code from scratch.
Optimism is an efficient and secure L2 ecosystem trusted by many high-value projects, including MetaMask, Farcaster, and Synthetix.
Read our Optimism Investor Scorecard here.
Starknet
Market cap: $5.39bn
Daily Active Users: 8.07k
Revenue: N/A (information not made public)
Starknet integrates zero-knowledge rollups to ensure the validity of transactions at a faster pace without sacrificing security.
A key advantage that Starknet has over solutions like Polygon is its on-chain governance. This allows investors to vote on decisions that affect the project’s roadmap. On-chain governance may appeal to investors who want a say in a project’s direction.
zkSync
Market cap: $3.30bn
Daily Active Users: 134.61k
Revenue: $200.12k
zkSync is a user-centric layer-2 protocol for scaling Ethereum-based transactions. Its ecosystem features a list of user-friendly NFTs, gaming, or crypto trading projects.
Compared to other solutions, zkSync’s architecture allows developers to work with languages beyond Solidity, Ethereum’s official programming language. This makes using different tools and frameworks easier, attracting projects whose developers might prefer other languages.
Read our zkSync Investor Scorecard here.
Types of Layer-2s
Each type of layer-2 solves the problems of scalability using a different technology. These solutions are fiercely debated in crypto circles, but as with many technologies, what matters most is not which is technically superior, but which company will command the most layer-2 market share. The best technology does not always win!
- State Channels: A state channel is a solution allowing users to perform unlimited private transactions off-chain. This is ideal for situations that require frequent, bidirectional transactions, like in-game microtransactions and live-stream donations.
- Optimistic Rollups: To process transactions quicker, rollups aggregate multiple off-chain transactions into one, assume that they’re valid by default, and only run computations in case of a dispute. These “optimistic” assumptions are perfect for dapps and DeFi platforms.
- ZK Rollups: Zero-knowledge rollups create safer blockchains than optimistic rollups by compressing transaction data, validating the transactions off-chain, and sending this information to the main chain. Like optimistic rollups, this type of layer-2 is great for dapps and DeFi platforms, offering enhanced privacy and efficiency.
- Plasma: Offering the highest degree of security among layer-2 types, plasma chains create a series of secondary chains that assist the main blockchain with verifications, connected by smart contracts that enable the main chain to guide the secondary chains.
- Sidechains: Sidechains are independent blockchains that run parallel to the main blockchain. This works for applications that require customizable features and independent governance from the main chain, while still communicating with the base layer.
Where Are Layer-2 Blockchains Used?
Because layer-2 protocols extend the capabilities and scalability of a central blockchain network, they empower these projects to support (and disrupt) industries much more readily. Some of these industries include:
DeFi
Improving transaction speed is critical for DeFi, especially in trading, where timely execution is the difference between profits and losses. Loopring, for example, uses ZK-Rollups to facilitate high-speed trades and transfers for their traders.
Dapps
With batch processing and enhanced interoperability, dapps could process more transactions across many applications. Polygon is a layer-2 scaling solution that allows dapps to function across different blockchain platforms without compromising performance.
Micropayments
As a layer-2 solution lowers average transaction fees, micropayments come at a much lower cost for users. Gaming ecosystems and live streamers can use this feature for monetization purposes or pay-per-use models.
Investor Outlook for Layer-2s
The history of technology can give us some clues as to how the layer-2 race will play out.
Typically, a new technology sees an explosion of new competitors (search engines, social media sites, etc.), which gradually coalesce into a few scenarios:
- Monopoly: You have one dominant solution that gains most of the market share because it becomes too inconvenient to use anything else. (Think Google in search.)Under this scenario, one big layer-2 will dominate each of the primary layer-1 blockchains. (And there may only be one primary layer-1 blockchain as well.)
- Oligopoly: You have two or three dominant solutions that effectively crowd out the rest of the market (think Apple and Windows or iPhone and Android).A few layer-2s could survive in this scenario, each offering significantly different developer benefits. For investors, the layer-1 bet would still probably be Ethereum (ETH), but the layer-2 bets would still be too early to tell.
- Disruptive Technology: Sometimes, the fundamental technology changes or is disruptive. (Disk drives, CD-ROMs, digital music stores, etc.).No layer-2 may win out in this scenario because layer-1s figure out a way to become more scalable without them. Ethereum (ETH) would be the primary long-term investment in this case.
For the time being, layer-2 solutions are adding value. But it will likely be a winner-takes-all or a winner-takes-most outcome. Unless, of course, layer-1s like Ethereum improve significantly, rendering layer-2s worthless.
Investor Takeaway
For investors, layer-2 solutions present both opportunities and challenges.
An intelligent investor should research the distinct features of each layer-2 solution, but more importantly, their market traction. Are they attracting real users – not just investors hoping for the airdrop, but real users using them and real developers developing on them?
It’s still early days for layer-2s. In the future, they will either consolidate or be rendered obsolete. Quality layer-1s like Ethereum (ETH) are still likely the safer investment for most investors.
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