April 13, 2024

Layer 2 networks hit $13B TVL, but challenges still remain

Ethereum layer-2 networks reached a new milestone on Nov. 10, reaching $13 billion of total value locked (TVL) within their contracts, according to data from blockchain analytics platform L2Beat. According to industry experts, this trend of greater interest in layer 2s is likely to continue, although some challenges remain, especially in the realms of user experience and security.

Ethereum layer 2 TVL. Source: L2Beat

According to L2Beat, 32 different networks qualify as an Ethereum layer 2, including Arbitrum One, Optimism, Base, Polygon zkEVM, Metis and others. Prior to June 15, all of these networks combined had less than $10 billion of cryptocurrency locked within their contracts, and their combined TVL had been declining since April’s high of $11.8 billion.

But beginning on June 15, layer-2 TVL growth turned positive. And by Oct. 31, these networks had reached a new high of nearly $12 billion combined TVL. From there, investment in layer 2 apps continued to climb, passing the $13 billion TVL mark on Nov. 10 and continuing to nearly $13.5 billion at the time of publication.

This rise in TVL is even more dramatic when compared with the rate that existed during the bull market of 2021, when overall crypto investment was much larger than it is today. On Nov. 12, 2021, when the market cap of all cryptocurrencies reached an all-time high of $2.82 trillion, layer 2s had less than $6 billion locked within their contracts. Today, the total market cap of cryptocurrencies is a more modest $1.4 trillion, according to CoinMarketCap, yet the TVL of layer 2s is greater than ever.

In a conversation with Cointelegraph, Metis decentralization coordinator Elena Sinelnikova proposed a theory for why layer 2s are growing in spite of the continuing bear market. According to her, Ethereum’s high gas fees during the bull market left an indelible impact on users, leading to a desire for alternatives when demand started to come back, as she stated:

“At the time of [the] bull market, Ethereum at peak times was very nonscaleable, which meant that transactions were slow and very expensive because of the bull market. It would be hundreds of dollars just in transaction fees for one transaction, so therefore it was not sustainable.”

According to Sinelnikova, another reason that layer 2 networks have thrived in the bear market is because of the successful marketing efforts of their development teams, which has led to high user activity and, therefore, high yields. “They are deploying capital to attract new users and to attract new business into DeFI [decentralized finance],” she stated. “DeFi people from all ecosystems, they always go where there are big yields, […] and this is just naturally happening, and is […] the nature of business.”

Related: Aave v3 launches on Ethereum layer-2 network Metis

However, Sinelnikova warned that layer 2s still face challenges in the realm of user experience. Optimistic rollup networks require users to wait seven days for a withdrawal to be processed, which can lead to frustration. On the other hand, newer zero-knowledge (ZK) proof networks can process withdrawals instantly, but they are still in an early stage of development and tend to crash more often than older networks. The Metis CEO claimed that her team is working on a “hybrid” layer 2 network that will combine the best of both worlds, giving users the option to withdraw using either an instant ZK prover or a seven-day optimistic process.

Kelsey McGuire, chief growth officer for layer 1 network Shardeum, told Cointelegraph that layer 2s face another serious challenge that is often overlooked: centralization. “While layer-2 solutions have gained popularity for their scalability enhancements over the last year, they often introduce a trade-off in decentralization,” she stated. She continued:

“At the execution layer, where transactions are processed, centralized sequencer nodes are employed, raising concerns about potential censorship or government interference. This centralized aspect in layer-2 implementations challenges the core principles of decentralization and trustlessness that have underpinned the blockchain space.”

McGuire expects competition from layer 2s to spur improvements to layer 1s, ultimately leading to higher throughput for the foundational layers themselves. As she stated, “There may be fewer and fewer new L1s, and we’ll start to see a refocus on true scalability (as in high TPS paired with low gas fees) at the foundational layer as opposed to relying solely on L2s to provide scalability.”

In addition to their TVL increasing, the number of layer 2s also continues to rise. On Nov. 14, crypto exchange OKX announced that it is building a layer 2, and there have been rumors that Kraken is building one as well.