Ethereum’s first-mover advantage has never been overcome and to this day it remains the foundation of the DeFi industry, with more than 50% of the total value locked in blockchain-based protocols.
But Ethereum’s dominance has led to significant challenges for DeFi protocols, as the world’s number one smart contract network has significant limitations in terms of transaction throughput and scalability.
Indeed, Ethereum has become infamous for its congested network, resulting in sky high gas fees and long waiting times for transaction confirmations, impeding the user experience. Solving this congestion is critical for the DeFi industry, because decentralized exchange platforms, lending and borrowing protocols and yield farming algorithms simply cannot operate as they should without real-time transactions and low costs.
The more Ethereum succeeds, the more it becomes a victim of its own success, as the network creaks under the strain of millions of users worldwide. Fortunately, the DeFi industry has been quick to innovate, giving birth to a number of alternative, Layer-2 networks that sit above Ethereum, enhancing its scalability by processing transactions off-chain.
Layer-2 networks use a range of mechanisms to do this, with one of the most common being “rollups”, which process multiple transactions off-chain and bundle them into one, larger transaction, only posting the end state onto the main Ethereum chain, significantly reducing the strain.
Some of the most prominent L2s have shown incredible potential, helping Ethereum to scale to support hundreds of thousands of transactions per second and paving the way for DeFi to take on the traditional financial world.
Polygon
As one of the first-ever Layer-2 scaling solutions in the industry, Polygon is often mistakenly referred to as a “blockchain” itself, but in fact it is the creator of a multichain ecosystem that provides several L2s designed to scale Ethereum.
Polygon utilizes zero-knowledge rollups as the basis of its scaling solution, facilitating rapid, private transactions with much lower gas fees than the main Ethereum network. Besides ZK-rollups, it also employs a novel proof-of-stake consensus mechanism to support sidechains like Mumbai, and it has its own, native token, called MATIC, which is used to pay for gas fees, staking to support network security and voting on governance issues.
The success of Polygon stems from its ability to support up to 65,000 transactions per second, dramatically outperforming the Ethereum network and also many other L2s. With its low transaction fees that are around 10-times cheaper than Ethereum itself, it is highly suited for DeFi applications, blockchain games and NFT marketplaces that need to facilitate microtransactions. To date, it has attracted more than $1.1 billion in total value locked, according to DefiLlama.
In addition, Polygon offers compatibility with Ethereum-based dApps through its Polygon zkEVM, as well as other notable blockchains like BSC (Binance Smart Chain). Its high performance and flexibility has enabled Polygon to cultivate a thriving ecosystem of DeFi applications, with leading protocols like Aave, Curve and SushiSwap all building on its network, plus NFT marketplaces like OpenSea and Rarible. It encourages this with a wealth of developer tools and its vibrant community, which paves the way for Polygon dApps to tap into new markets.
Fuse Network
Some might be confused to see Fuse Network’s mention in a list of leading L2s, as it’s also a Layer-1 blockchain in its own right. However, a key part of its growth strategy involves branching out as an L2 to support Ethereum and tap into the strength of its vast DeFi ecosystem.
Fuse is the creator of an infrastructure network for crypto and fiat payments, focused on enabling business-to-business and business-to-consumer transactions without borders.
The project has already achieved success, and its creators are now embarking on a new journey with the launch of its Ethereum-based ZK-proof L2 in late 2023. The new L2 leans on the considerable capabilities of the Polygon Chain Development Kit, which forms the basis of its highly efficient transaction capabilities. The plan is for the Fuse L2 to become the new native platform of every dApp that currently lives on the Fuse L1 chain, giving them access to Ethereum’s extensive ecosystem and vast liquidity.
One of the main advantages of using Polygon CDK is that it provides a foundation for the Fuse L2 to achieve unprecedented scale, with incredibly low transaction costs, high transaction throughput, instant clearing and finality. This is enabled partly through the integration of a zkEVM, which helps to enhance TPS to support instant transfers via a decentralized validator set with improved security.
The use of ZK-proofs means transactions can be validated without revealing any details, allowing Fuse to preserve full privacy for its users while interacting across any EVM-compatible chain. Interoperability comes by way of the Fuse Charge Bridge, which facilitates the free flow of liquidity between Fuse and Ethereum.
Fuse’s quest to transition from an L1 to an L2 is ambitious, and the project is still in its early stages, but it will bring enormous benefits to the businesses that leverage its global payments infrastructure, enabling them to tap into a much more extensive DeFi ecosystem.
Optimism
Built using a different technology called optimistic rollups, Optimism is another highly regarded L2 that provides broad compatibility with the Ethereum ecosystem, utilizing that network’s consensus mechanism as the foundation of its own security.
Optimism scales Ethereum to a peak of 4,000 TPS, meaning transactions are processed 26-times faster than the mainnet, with gas costs reduced by 90% or more. It’s highly focused on decentralization, with governance led by its community, which is shaped by a growing number of DeFi protocols, decentralized autonomous organizations and NFT marketplaces. The project is also heavily focused on catering to developers, offering a range of familiar tools for dApp builders to get started on its network.
Optimism’s native token OP exists for transaction fees, network governance and staking. Some concerns have been raised about the project, with its reliance on Ethereum carrying inherent risks and the need to monitor its decentralization process. However, it’s backed by a fanatical team of developers and host to a vibrant, enthusiastic community that is convinced of the merits of optimistic rollups versus ZK-rollups. With more than $680 million in TVL so far, the continuous development of its network should ensure that it plays a key role in the growth of DeFi for years to come.
Base
One of the newest kids on the L2 block, Base is the brainchild of the prominent crypto exchange Coinbase, and was built with the goal of enhancing the potential of Ethereum’s DeFi scene by boosting its transaction speeds and lowering costs for users.
It’s built atop of the OP stack and, like Optimism, it leverages optimistic rollup as the basis of its rapid transaction processing. It can achieve a maximum throughput of 2,000 TPS, meaning near-instantaneous transaction processing, and gas fees are reduced by up to 95% compared to the costs of transacting on Ethereum.
Also like Optimism, Base leverages the security of the Ethereum network to process transactions off-chain, ensuring the safety of user’s funds. It’s a developer-friendly platform too, with numerous tools for dApp developers that want to build native applications with streamlined deployment.
One major advantage of Base is that it has the backing of Coinbase itself, which is one of the biggest crypto exchanges in the world, enabling Base dApps to tap into an audience of millions of customers.
The Base L2 is still young and evolving rapidly, but it has already amassed an impressive $2.7 billion in TVL thanks to its association with Coinbase, which makes it one of the L2s to pay attention to. By building on what is already a solid ‘base’, the Base network can play a big part in helping Ethereum scale to meet the needs of the mainstream as DeFi’s popularity grows.
Coti
Coti started out as a Layer-2 solution for a different blockchain, Cardano, but is looking to adapt and evolve into a more privacy-centric scaling solution for Ethereum. The shift was prompted by a desire to support more affordable transactions that leverage Ethereum’s unparalleled security and interoperability, while ensuring maximum privacy for users.
The COTI token is the oil that runs COTI’s L2, paying for transaction fees, staking and governance, and also acting as the mechanism for merchant processing and user trust scores in the broader Coti network. As part of its evolution to cater to Ethereum, COTI itself is being migrated from Cardano to the Ethereum chain
In addition, Coti is moving from its Directed Acyclic Graph technology to an EMV-compatible architecture. Despite this shift, it will retain its primary privacy-enabling feature, garbled circuits, which ensures full confidentiality of all transaction data.
What’s most impressive about Coti is its claim to support a whopping 100,000 TPS, an astonishingly high throughput that’s enable through ZK-proofs. In addition, Coti has an expansive reach as its support for the Inter-Blockchain Communication or IBC protocol enables compatibility with the growing Cosmos ecosystem, in addition to EVM-based chains. On the downside, developers should recognize that Coti’s transition is a slow process that requires careful adaptation and through testing, which explains its comparatively low TVL of just $28.98 million.
Layer-2s Are Future Of DeFi
Layer-2 networks are rapidly emerging as the new foundation of the DeFi ecosystem, not only on Ethereum, but on most other blockchains. Not only do they scale the L1 networks they’re designed to support, but they also help to facilitate more seamless interoperability across them, creating a more interconnected DeFi ecosystem with greater privacy for every users.
This explains why L2 networks are no longer just a hot trend in DeFi – they represent a paradigm shift for the alternative financial industry, helping every protocol to converge into a larger, more expansive ecosystem. L2s are strengthening the foundation of the DeFi industry so it can scale to support the masses and unlock new opportunities for growth.
