Coinbase discusses Ethereum development, comparing the advantages and disadvantages of Layer1, sidechains, and Layer2 scaling solutions.

Coinbase recently published a post on their official blog discussing the future of multi-chain development, sidechains, and Layer 2 solutions. This translation and summary will focus on the key points of the article.

The original article titled "Scaling Ethereum & crypto for a billion users" was written by Justin Mart and Connor Dempsey.

Current Issues with Ethereum

As of today in 2021, Ethereum has hosted thousands of applications, including DeFi, NFTs, and gaming, among various other sectors. The network settles transactions worth over a trillion dollars annually, with current platform lockups exceeding $170 billion.

However, Ethereum's decentralized design and its limit of only 15 transactions per second have ultimately restricted its transaction throughput. This has resulted in long transaction wait times and high Gas Fees, sometimes exceeding $200 per transaction. As a result, many users are deterred by the costs involved, limiting the types of applications Ethereum can currently support.

To develop a blockchain based on smart contracts that can support billions of users for financial and Web3 applications, a scaling solution is essential. Recently, several proposed solutions have been launched.

How to Address the Issues

To address the current problems, the article proposes two solutions: 1. Establish a new network that competes with Ethereum, capable of handling more activities. 2. Create a complementary network that can handle excess capacity from Ethereum.

Overall, these solutions fall into three categories:

• Layer 1 Blockchains competing with Ethereum
• Sidechains providing certain complementary features to Ethereum
• Layer 2 networks complementing Ethereum

While these three have different architectures or methods, their goal remains the same: to allow users to practically use the network (e.g., interact with DeFi, NFTs, etc.) without paying high Gas Fees and enduring long wait times.

Layer 1 Network

Ethereum is considered a Layer 1 blockchain: an independent network where user funds and transactions are executed in the same place, allowing the use of applications like DeFi platforms such as Uniswap for token exchanges.

To compete with Ethereum, new Layer 1 networks need to be built from the ground up. The main difference lies in the new system design, aiming to achieve higher throughput by lowering transaction fees, often at the expense of increased decentralization.

In the past 10 months, emerging Layer 1 networks have been launched, with Solana, Avalanche, Terra, and Binance Smart Chain leading the way, each ecosystem continuously growing with total value locked (TVL) exceeding $10 billion.

All Layer 1 networks are competing to attract developers and users, but without tools and infrastructure similar to Ethereum to make it easy to build and use, it will be challenging to attract newcomers and develop the ecosystem. To bridge this gap, many Layer 1 networks utilize a strategy known as EVM compatibility.

EVM stands for Ethereum Virtual Machine, essentially the brain that executes computations and processes transactions on Ethereum. By making a Layer 1 network compatible with EVM, Ethereum developers can easily deploy existing Ethereum applications to the new Layer 1 network. Users' existing wallets can also easily access EVM-compatible Layer 1 networks, simplifying the migration between chains.

For example, with the launch of an EVM-compatible network, adjusting consensus to achieve higher throughput and lower transaction fees, Binance Smart Chain saw a dramatic increase in usage, spawning dozens of DeFi protocols, many of which are similar to popular Ethereum protocols like Uniswap and Curve. Avalanche, Fantom, Tron, and Celo have adopted similar approaches. In contrast, Terra and Solana are currently not EVM compatible.

Interoperable Chains: Slightly Different Layer 1 Networks

Cosmos and Polkadot, for example, choose to establish new standards that allow developers to create specific application blockchains that can communicate with each other, rather than building new independent networks. In essence, Ethereum is facing an increasing number of direct competitors, and this trend is expected to continue.

Sidechains

Sidechains have a blurred distinction from Layer 1 networks. They are similar to Layer 1 networks compatible with Ethereum's EVM, but sidechains are primarily built to handle the excess transaction volume on Ethereum, rather than to compete directly. These ecosystems have a close relationship with the Ethereum community, complementing the Ethereum ecosystem.

An exemplary case is Ronin, the sidechain for Axie Infinity. Initially built on Ethereum, Axie Infinity faced high Gas Fees on Ethereum, prompting the creation of the Ronin sidechain, allowing users to transfer their NFTs and tokens to an environment with lower Gas Fees, enabling more users to afford the game. Ronin was established before the game's explosive growth.

Polygon POS

Sidechains like Ronin, tailored for specific applications like Axie Infinity, while others are suitable for a broader range of use cases. Currently, Polygon's proof-of-stake sidechain (POS) is a leader in the industry, valued at nearly $5 billion. It has deployed over 100 DeFi and gaming applications, such as Aave, Sushiswap, and Quickswap, a Uniswap clone.

While Polygon's POS sidechain is similar to Layer 1 networks compatible with EVM, its main goal is to scale Ethereum rather than compete with it. The Polygon team believes Ethereum will remain the dominant blockchain with high value in the future, while daily transactions will move to Polygon due to lower costs.

With extremely low transaction fees and incentive programs, users are flocking to Polygon, surpassing Ethereum's daily transaction volume.

Layer 2 Networks: Rollups

Layer 1 networks and sidechains face a significant challenge: ensuring the security of the blockchain. To achieve this, they must pay miners and validators rewards to ensure transactions are processed correctly, typically in the form of base tokens like Polygon's MATIC or Avalanche's AVAX.

However, there are two notable drawbacks:

• Having base tokens naturally makes the ecosystem more competitive rather than complementary to Ethereum.
• Verifying and ensuring transactions is a complex and challenging task, for which the network is ultimately responsible from start to finish.

The goal of Layer 2 networks is to create a scalable ecosystem while leveraging Ethereum's security, primarily using "rollups" technology. In essence, Layer 2 networks are independent ecosystems on Ethereum without native tokens, essentially part of Ethereum.

Operation Principle of Rollups

Layer 2 networks are often referred to as Rollups because they "roll up" or "bundle" transactions and execute them in a new environment before returning the updated data to Ethereum. Instead of having Ethereum process 1,000 Uniswap transactions individually, which is costly, the calculations are stacked on Rollups before being submitted to Ethereum, making it cheaper.

However, once the results are sent back to Ethereum, how does Ethereum know the data is correct and valid? How does Ethereum prevent anyone from posting incorrect information? These are critical questions that differentiate two types of Rollups: Optimistic Rollups and ZK Rollups.

Optimistic Rollups

When submitting results back to Ethereum, optimistic rollups optimistically assume they are valid. In other words, rollup validators can submit any data, including potentially erroneous/fraudulent data, assuming it is correct.

However, there are methods to combat fraudulent behavior. As a form of checks and balances, there is a period after any withdrawal where any observer can check for fraud—blockchains are transparent, allowing anyone to observe what is happening on the chain. If one of these observers can mathematically prove fraudulent behavior by submitting proof of fraud, the rollup network will reverse the fraudulent transaction and penalize the wrongdoer, rewarding the observer.

The downside is that there is a brief delay while waiting to see if any observers discover fraud when funds move between the Rollup network and Ethereum. In some cases, this delay can be up to a week, but it is expected to decrease over time.

Arbitrum and Optimistic

Arbitrum by Off-chain Labs and Optimistic by Optimism are the two main projects currently adopting optimistic rollups technology. It is noteworthy that these projects are still in the early stages, with both companies operating centrally, but planning to gradually decentralize over time.

When mature, optimistic rollups are estimated to provide Ethereum with 10-100 times scalability. Even in the early stages, DeFi applications on Arbitrum and Optimism have accumulated billions in network value.

Optimism, still in its early stages, currently has over $300 million TVL across 7 DeFi applications, including Uniswap, Synthetix, and 1inch.

Arbitrum, on the other hand, is more advanced, with over $2.5 billion TVL across 60 DeFi applications, including Curve, Sushiswap, and Balancer.

Arbitrum has also been selected as Reddit's scaling solution for their long-awaited community points tokenization. Reddit boasts up to 500 million monthly active users.

ZK Rollups

Unlike Optimistic Rollups, ZK Rollups provide actual proof to Ethereum that transactions are valid, rather than assuming validity.

Along with the bundled transaction results, they submit what's called a validity proof to Ethereum smart contracts. Validity proofs allow Ethereum to verify if the transaction is valid, making it impossible for intermediary nodes to deceive the system. This eliminates the need for a waiting period to verify if transactions are fraudulent, making fund transfers between Ethereum and ZK Rollups virtually instantaneous.

While instant settlement and no withdrawal waiting time sound appealing, ZK Rollups come with a cost. Firstly, generating validity proofs is computationally intensive work, requiring high-powered machines. Secondly, the complexity surrounding validity proofs makes supporting EVM compatibility more challenging, limiting the types of smart contracts that can be deployed on ZK Rollups. Therefore, Optimistic Rollups have taken the lead in the market and have a better ability to solve Ethereum's current scalability dilemma. However, in the long run, ZK Rollups may offer a better technical solution.

ZK Rollup Supporters

Many teams and projects are developing ZK Rollups, including Starkware, Matter Labs, Hermez, and Aztec. Currently, ZK Rollups mainly support relatively simple applications like payments or exchanges. For example, the derivatives exchange dYdX has adopted Starkware StarkEx's ZK Rollup solution to support nearly 5 million transactions per week and over $10 billion TVL.

However, the real winners will be ZK Rollup solutions fully compatible with EVM, which will support a variety of applications without the withdrawal delay of optimistic rollups. Major players in this field include MatterLab's zkSync 2.0, Starkware's Starknet, Polygon Hermez's zkEVM, and Polygon Miden. They are currently working towards mainnet launches. Meanwhile, Aztec focuses on applying zk proof mechanisms to privacy.

Many industry insiders, including Vitalik, are integrating ZK Rollups with Ethereum 2.0 as a long-term scalability solution for Ethereum because they can fundamentally process hundreds of thousands of transactions per second without compromising security or decentralization.

A Fragmented World

In the long run, will new Layer 1 networks like Avalanche or Solana continue to develop and compete with Ethereum? Will blockchain ecosystems like Cosmos or Polkadot thrive and expand? Will sidechains continue to operate harmoniously with Ethereum, handling its excess transaction volume? Or will rollups integrated with Ethereum 2.0 emerge victorious?

No one can provide a definitive answer, but we believe we will ultimately view winning scalability solutions in the same light.