This article is imported from my 0xjim Medium blog from April 28, 2021.
As always, this article is made for educational purposes. This does not constitute financial advice nor trading advice. Past performance does not indicate future results.
Two days ago, I cheekily stated that “Layer 2s will save Ethereum”.
Since Ethereum has been been suffering from high gas fees due to an overload of its network, many have claimed that Layer 2s will be the end-all-be-all: the silver bullet that fixes Ethereum’s pesky gas problem forever.
Frankly, as of until a few weeks ago, I thought that as well — that once Layer 2s hit critical mass of the transactions on Ethereum, Ethereum will be the absolute perfect crypto platform.
But as I started digging deeper into the Layer 2 solutions and started participating more in the in-depth conversation around Layer 2s on Twitter and Discord, I started to realize that — while Layer 2s are a much needed and logical solution to scaling Ethereum — they come with their own question marks and potential issues that may hinder the platform from reaching its true vision of the world’s super computer.
Layer 2s come with their own question marks and potential issues that few people are aware of or seem to be talking about
With that said, Layer 2s are absolutely still a step in the right direction, and they are needed even with the eventual merge of ETH2 later this year. The throughput and speed that they offer cannot be done purely on Ethereum 2.0’s Layer 1 network.
But they are far from perfect. Maybe that’s way there are just so many solutions to scaling Ethereum: sidechains, childchains, payment channels, roll-ups…
Here are some of the potential issues / unanswered questions that I’ve seen from the current Layer 2 scaling solutions.
Yesterday, I talked about how the true power of decentralized finance was composability — arising from the open source nature of the technology.
Personally, I think that composability is the most powerful aspect of DeFi.
Yes, open finance is great — allowing for unprecedented access to financial services, something that has excluded nearly 2 billion people in the world from accessing.
It’s also great that, for the first time since the rise of Web 2.0, individuals are taking back control of their finances, their data, and their possessions from intermediaries like Facebook, banks, etc.
But for me, the added layer of composability really takes the cake. It creates brand-new, never before seen financial products that change the way that we view finances.
The inner kid in me sees DeFi and sees a never-ending web of innovation. Just like how the Internet created companies that we never thought possible in the 90s: Netflix, Postmates, Zoom.
Unfortunately, composability may be limited — or gone completely — with the implementation of Layer 2s because Layer 2s currently do not interoperate with one another.
Said another way, dapps on one Layer 2 cannot easily communicate with another dapp on another Layer 2 — breaking the power of composability.
In L1, a single transaction can interact with multiple DeFi protocols to create a brand-new financial product.
On L2, that transaction can only interact with the DeFi protocols that exist on its own chain.
Let’s say Aave is only available on Polygon, and Uniswap is only available on Optimism (factually correct at the time of writing). We wouldn’t be able to compose one transaction that calls both the Aave’s and Uniswap’s smart contracts.
As a result of this fragmentation, composability is limited and thus the magic of DeFi is limited drastically.
This can be remediated by an interoperable layer like Polygon, that’s seeking to connect all the L2 solutions in a standard framework. However, it’s going to be a long journey to get all the solutions to build according to Polygon’s standards and platform.
Another issue from the fragmentation of dapps on different L2 chains is that their associated liquidity is split up as well.
Liquidity is incredibly important in any financial market, as it provides a healthy market in which buyers and sellers can meet in the open market and exchange goods with compromising too much on the bid-ask price and without causing crazy volatility in the price.
Currently, all liquidity exists on Ethereum — which provides for a healthy and deeply liquid market for all the financial products and tokens on the platform.
With the move to L2s, we’ll see the existing liquidity being split across the Ethereum L1 and the different scaling solutions — instead of having all the liquidity available on the Ethereum.
Lastly, because we’re approaching an end-state of a multi-chain L2 world on top of Ethereum, there’s going to be serious friction moving between each Layer 2 in order to interact with DeFi.
We’ll likely see a lot of bridges between the L2s, so expect to have long onboarding times as we try to move funds between chains.
Also expect to have multiple accounts — one or more for each L2 chain. Keeping track of the funds across those scaling solutions will be a headache from a UX perspective.
Let’s say we have AAVE on Polygon and we want to swap it for UNI using Uniswap on Optimism.
Not only would we have to withdrawal our AAVE from Polygon back to Ethereum (for now — cross-L2 bridges should be coming), we’d also have to move our AAVE from Ethereum L1 onto Optimism.
The withdraw time for Polygon takes ~15 minutes (I timed it), and Optimism hypothetically has a 1–2 week onboarding time due to its use of the optimistic roll-up (recall that ORUs have a long onboarding time due to the ‘challenge period’ to find fraud in the proofs).
Of course, these issues are definitely solvable, and probably will be solved shortly after the public release of all the major L2 scaling solutions — due to the sheer firepower of the Ethereum developer community.
I do think that we’ll eventually see some consolidation in the L2 space — where a handful of winners come out on top based on what each technology is good for (e.g., DEXes, payments).
My hope is that there will also be a strong interoperable protocol between them in order to maintain composability and liquidity — whether through the Polygon framework or through a robust network of L2-to-L2 bridges.
Anthony Sassano said it best:
You can think of what’s happening in the layer 2 ecosystem right now as the “adoption and innovation” phase where many different solutions are being tried and tested at once in parallel. Of course, not all of them will succeed over the long-term. Ultimately I don’t think there will be just one solution that “wins” the scalability wars. As I said, each scalability solution comes with its own trade-offs, trust assumptions and general strengths & weaknesses. Some are really good for payments, some allow for EVM-compatability and some offer greater scalability at the cost of decentralization.