L2 to L1 Value Accrual | Christine Kim - Galaxy

today I am here to talk with you guys about the impact of L2 fees on L1 Revenue um this is based on a report that I wrote a couple of months ago on this very topic we're also going to be talking a little bit about what you can expect from EIP 4844 which is the main code change going into the denune upgrade and the dencon upgrade is the next major upgrade happening on ethereum in 2 weeks time um so I actually have a report also on Proto iding on EIP 4844 so this presentation is a little bit of an amalgamation of those two reports um so if any of the data and the content that I'm talking to you about today is of interest to you and you want to dig deeper into it please do check out those reports on the website galaxy.com resesarch um a quick disclaimer before I start my presentation everything I'm about to say is not for investment reasons or advice it is all informational um all for informational purposes so let's get started by talking about the present Outlook how l2s are being used on ethereum and a little bit of their activity as you can see from these charts um the activity on l2s is increasing quite dramatically um the the bandwidth and the the uh ability for ethereum to be able to process a certain number of transactions every second or in a set block has remained quite constant because of the constraints of the ethereum blockchain and the lack of scalability on ethereum um but in contrast as you can see the activity on l2s and the transaction activity happening on these protocols has really been growing and that's for two reasons really the first is that the adoption of l2s is definitely growing the popularity of using um protocols like arbitrum and optimism to transact is definitely becoming more popular but also there's just been a ton of more l2s that have launched um ethereum is one network but the black line shows the combined activity of layer 2 rollups and over the last say year or so there's been a ton of new rollups that rollup projects that have launched that are close to launching um scroll very recently um I think it was last year or we'll have scroll the scroll team up in a a little bit after this talk to talk about um their road map but they too are kind of like a new rollup that's um starting to to process transactions um so the black line ethereum has always had this constant um limitations for scalability but one of the reasons why we see the black line growing is not only because of the adoption of existing l2s but there's just more l2s that are launching more protocols that you could consider a lay or two roll up let's keep talking about what's happening with l2s right now l2s are becoming um a a primary purchaser of the ethereum block space um before l2s the primary people that we're using ethereum and paying for transactions are smart contract developers and and users if you want to send eth to another person you're going to use your um eoa your externally owned account and send e to another person you're interacting with decentralized Finance applications Unis swap used to be like the top gas guzzler on E ether scan that's kind of like a page that shows who are the top consumers of gas um gas is a unit of measurement to measure the computational resources required to execute whatever you want on ethereum obviously unlike Bitcoin um on ethereum there's so many different types of transactions and and operations you can do and each of these operations have different computational resources that they require from nodes and that's all measured in in units of gas um so the fact that the percentage of gas in a block that is used up by an L2 that is paid for by an L2 the fact that it's growing um is a really uh very interesting indicator that the um primary purchasers of block space um could one day be Roll-Ups primarily as opposed to end users and smart contracts um it's still you know not super high right now and over the last couple months it's actually been declining but generally you can see that you know from what like below 10% now it's hovering at like 16% of of monthly gas used on ethereum um so this is another kind of interesting CH chart that illustrates that the activity and the um the amount of of um the amount of adoption for l2s is growing and um they're their presence on the ethereum blockchain them using ethereum's resources um the the way that l2s are using ethereum's resources is is also growing um over time and it's kind of interesting to see um going back to the gas guzzlers page um seeing how L2 sequencers like for arbitrum and optimism how they also rank extremely high as being some of the top like consumers of um gas on ethereum so let's talk about those two Trends and kind of think project into the long term um what might happen in the future if you know adoption and activity for l2s continues to increase um okay eight minutes great um what happens if it continues to increase like I said um you could imagine a future where the primary people that are driving free Revenue driving Revenue to ethereum are uh rollups they're the ones paying for for blocks based on ethereum um and the whole idea of rollups is that ethereum right now is just too um it's too expensive um and so when you have certain certain applications that you want to build on ethereum it's not possible because all every single transaction on ethereum is just too expensive um so the fact that as adoption for l2s grows um you might see new use cases being unlocked for blockchain based applications um maybe certain applications that are possible on blockchains like salana um say like decentralized public infrastructure you're able to run start running those on l2s that inherit the same level of decentralization and security as ethereum um so so one of the the long-term trends that you can think about is that l2s unlock these use cases that were not economically feasible before um but do become feasible for across Industries like gaming social media entertainment payment a lot more and that that adoption brings magnitudes more users into crypto and we're not talking about like the Deens that have always been in crypto and are just like rotating through different airdrops no no no we're talking about like mainstream users um and we're talking about um you know like millions of more people and if you think about all those people and and the the magnitudes more um activity I'm talking about that's a ton of revenue for the L2 right that's a ton of people paying for transactions on the L2 and so no matter how cheap the L2 is um the fact that that amount of Revenue at least a portion of it would go back to the L1 because l2s again are paying ethereum to use that block space to commit data back down to ethereum um when you think about um you know an increasing L2 Revenue um that part of that Revenue also coming back down to ethereum as rollups become the primary purchase of res of block space this is a very symbiotic relationship um L1 Revenue increases as L2 Revenue increases um the willingness of l2s to be able to pay more to the L to ethereum itself to confirm all these transactions to um post data down to ethereum because they're seeing so much Demand on their protocol and they're competing with all these other l2s to get their data you data batched down data confirmed down to ethereum um in a timely manner you can see that um l2s really might be able to um make it even such that the L1 is so expensive that end users are not even able to really compete and send a transaction because you're competing now with L2 sequencers and L2 um layer 2 you know rollup operations for the block space um so in the long term you can really see that um L2 revenue is a positive positive could be a positive force for ethereum L1 um because it increases the adoption for blockchain based applications in general um and it allows um higher um allows like the cost of ethereum's block space to achieve levels that weren't possible before with just the types of of use cases that we know and love today um with Defi and you know nfts and whatever else we have going on on ethereum right now um so this is a very positive outlook you know l2's benefiting L1 making sure that the purchasers of ethereum's block space over the long term are um bringing in new users bringing in those fees bringing in that Revenue but in the short term um there's quite a few hurdles before we really get to seeing um rollups being able to achieve that vision and being able to unlock those use cases and inherit all those users the main hurdles that I'm talking about are stability ility decentralization security interoperability composability and the user experience it's a little bit of a mouthful there's a ton that really needs to happen with rollups um and I want to get into that with the panel that we're about to get into um soon um but rollups themselves are not immune to fee volatility they also have scalability limitations of their own sure you could be like oh well this rollup is very is very expensive tons of fees fees are too high on this rollup Let's Just Launch it new rollup but then you get you know these these problems and these concerns with interoperability between the users and the activity that is on one rollup versus another um we still have so much work that needs to be done with actually enabling fraud proofs um the the operations that that make um that make the activity on rollos very secure um and permissionless so another kind of big topic and and a little bit of a buzzword is this idea of a decentralized sequencer sequencers are kind of like block producers on l2s um and and the road map to being able to achieve decentralized block production on l2s um so there's really quite a few different hurdles um that rollups are facing right now that I do believe is um a headwind to rollup adoption and therefore a headwind to L2 fee Revenue in the short term and combined with all of this idea that you know fees on l2s might not be as high as we really think um it's going to be in the short term there's also the upgrade which we're going to talk about now EIP 4844 that will further reduce the cost of block space for rollups for users for us normies that are end users smart contract developers um the fees are going to stay the same we're all in the same Market here um the this this me pool you know where you submit your pending transactions but now RPS are going to have a dedicated Market just for their own um operations which is primarily data availability um so they get to enjoy the this um you know this Premiere this like dedicated block space block space for just their operations and it's going to make fees on l2s a lot cheaper I was just talking to the prison team which is um a consensus layer client on ethereum and they were saying at a minimum it's going to make fees uh four times cheaper probably a lot higher than that um but at the very minimum and so if you think about not only like the the headwinds to roll up adoption but also the fact that this upgrade is going to reduce the fees you can already see that any of the users that would have normally gone to ethereum to pay their transactions and now they're going on l2s they're not paying as much that revenue from l2s to back to ethereum is not as large um and is not frankly not enough to really uh increase or or be a main driver of revenue for ethereum um so in the in the short term layer twos are expected to reduce not increase ethereum's um ethereum's fee Revenue um and so this is kind of like a a really key point that I think um makes the denune upgrade the next upgrade perhaps not as um exciting for the ethereum community as people think um so let's talk a little bit more about the next upgrade that will in fact reduce fees on l2s and also reduce uh fee revenue from l2s to ethereum um so um we already talked about the first two we already talked about the first two um we talked about how um we're creating a dedicated transaction uh a specific transaction type which is called blob transactions um and they give dedicated block space 128 kilobytes per blob um for rollups to commit down um their batch transaction data and this is a really good feature I mean separately it's just a very good feature to use ethereum as a data availability layer because ethereum has the most robust data availability it is the most decentralized blockchain general purpose blockchain out there um it is extremely reliable it's been a blockchain that's been around for a long time so if you're if you have data that you want to um distribute and and give to many different nodes um ethereum is one of the best networks to do that for and it just uh increases kind of the security of the data that you're posting because it's shared by all ethereum nodes and propagated by all ethereum nodes so data availability um is a very unique um well it's something that ethereum does as well I mean ethereum does well on execution too but um topic for a a separate talk um so creating dedicated block space for Roll-Ups to use da and that dedicated SP block space allows um the costs to be reduced because right now rollups are competing with end users smart contract developers all for the same um all in the same Market um but now they'll have their own separate market and sometimes you know if there's not a lot going on for rollups and there's just really only one rollup that wants to post a blob transaction who knows that transaction might even be free like just almost not negligible gas costs to be able to commit data if there's not a ton of competition in that market in the blob Market um so those are two of the main ones the third one that I really want to quickly go over is um dink sharting full dink charting um right now there's a limited number of blobs that can be included per block um but with folding sharting then you can have data availability sampling and be able to increase the number of blobs that you can include in a block and so further reduce fees by like multiples more um and I know this bullet says no further changes necessary on the execution layer technically if you want to increase the blob number you do have to make a change to the execution layer but um if you just want to um enable data availability sampling you don't actually need to change the execution layer um and then the final one is experimentation with ZK proofs um who knows about the trusted setup Center did anyone participate in the trusted setup ceremony um yes amazing so these are these are novel kind of um um exercises for the ethereum community to get engaged with to be able to enable um zero knowledge uh proofs on ethereum and um it's it's a it's a very cool um it's a cool way to start uh leveraging more cuttingedge technology to improve the privacy and the scalability of ethereum so I am a little bit over time but that is a little bit of an overview of EIP 4844 and some of the benefits um we're going to talk now with our panelists um about the L2 road map and and a little bit deeper on these like hurdles that I'm talking about um in in the short term for for roll of adoption and and we're going to get a little bit deeper into into fewe revenues so here are my lovely panelists welcome welcome