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Ethereum Upgrade Set to Shake Up Layer 2 Landscape, Token Values in Question

Last Updated February 15, 2024 1:21 PM
Teuta Franjkovic
Last Updated February 15, 2024 1:21 PM

Key Takeaways

  • Ethereum’s Dencun update puts pressure on L2 solutions, potentially impacting their value and role in the ecosystem.
  • Among L2s, Arbitrum and Optimism see the most adoption, while ZK-rollups trail in DeFi usage.
  • Despite recent L2 outperformance, an approved ETH spot ETF remains the major potential catalyst for sector growth.

Blockchains have historically faced scalability issues, with major networks like Bitcoin and Ethereum limited to processing only a handful of transactions per second, often accompanied by soaring network fees during periods of high demand.

To address these limitations, Ethereum has seen the rise of Layer 2 networks designed to alleviate congestion and enhance transaction capacity.

Ethereum’s Upcoming Dencun Update to Challenge L2 Dominance

These networks have experienced rapid growth, with some achieving valuations in the billions, thanks to their native tokens attracting substantial investment.

The relationship between these auxiliary networks and Ethereum has been a topic of speculation, especially regarding how they would fare if Ethereum significantly enhanced its scalability as anticipated. This speculation is set to be addressed imminently.

Ethereum is poised for a major update next month, known as Dencun, aimed at increasing its transaction throughput to an astonishing 100,000 transactions per second. This development could redefine the dynamics between Ethereum and its Layer 2 counterparts, impacting the valuation and utility of their respective tokens in relation to Ether.

Understanding L2 Rollups: Optimistic vs. ZK Approaches

Not all Layer 2 Ethereum scaling solutions are alike. Rollups, the most popular L2, bundle transactions for efficiency. Optimistic rollups assume transactions are valid with a dispute period, while ZK-rollups use cryptographic proofs for instant verification. Today, Optimism and Arbitrum dominate the optimistic rollup space, while Loopring, StarkWare, and zkSync are key ZK-rollup players.

Optimistic rollups
Credit: Forbes

In the competitive landscape of Layer 2 (L2) solutions aimed at enhancing Ethereum’s scalability, zkSync Era emerges as the frontrunner, boasting the highest throughput numbers and surpassing the market leader, Arbitrum.

Interestingly, despite the advances and efforts of L2 solutions to accelerate transaction processing, Ethereum itself currently outpaces all L2 networks in terms of transactions per second (TPS).

The peak daily TPS figures for these L2 networks are significantly higher than Ethereum’s current processing capabilities, highlighting the ongoing evolution and optimization in the blockchain scalability arena.

ZkSync Era
Credit: Forbes

Ether Leads L2 Rivals, ImmutableX Stands Out Amid ETF Speculation

Over the last year, Ethereum’s native token, Ether, has generally outperformed its Layer 2 (L2) counterparts, with ImmutableX (IMX), a gaming-focused platform, being a significant exception. ImmutableX experienced a notable surge in December following several major announcements.

However, in the past three months, the majority of these L2 tokens have overtaken Ether in terms of growth, likely driven by investor anticipation of a potential spot Ether Exchange-Traded Fund (ETF) launching this spring. This shift underscores the high-beta nature of L2 investments relative to Ether, highlighting their sensitivity to Ethereum’s broader market movements and speculative developments.

Immutable X impact
Credit: Forbes

The fate of Ethereum scaling solutions hangs in the balance. An approved ETH spot ETF could boost L2 tokens. However, its rejection could hurt the sector. This uncertainty looms as Ethereum’s Dencun update approaches, potentially boosting capacity and making some Layer 2 projects less essential. Despite this, experts like Kavita Gupta  of Delta Fund see L2s offering additional value beyond Ethereum expansion, making their long-term future promising.

Cosmo Jiang  of Pantera Capital predicts Dencun will lower L2 costs, boosting their utility. However, within the L2 world, zk-rollups face challenges due to their experimental nature and limited DeFi adoption. Jiang sees Arbitrum as the dominant force with its strong DeFi focus, enabling transactions that were previously too costly. While Optimism’s growth potential exists, challenges like Coinbase’s regulatory constraints could hinder its trajectory.

Leveraging L2 Tokens Amid Speculation of Spot Ether ETF

As anticipation builds around the introduction of a spot Ether ETF, investors looking for a high-beta strategy might consider diversifying into Layer 2 (L2) tokens. For those contemplating a long-term investment, prioritizing platforms that utilize optimistic rollups, such as Arbitrum and Optimism, could maximize the potential of an L2-focused portfolio.

While zk-Sync offers an intriguing diversification option, its current lack of a native token and the absence of announcements regarding any future token launch might limit its immediate appeal.

ImmutableX (IMX), though a smaller component, offers exposure to the burgeoning blockchain gaming sector; however, investors are advised to approach with caution. The sector’s nascent state suggests a cautious strategy would be prudent, with a recommendation for potential IMX investors to await a price normalization before committing funds.

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