Image source: crypto-economy.com
A highly anticipated scaling solution for Ethereum, called Optimism, is slated to launch this month. By helping Ethereum run computations off-chain and only publishing transaction data on-chain, testing has shown that Optimism can reduce Ethereum’s current fees by 100x or more. We have seen how alternate high throughput versions of Ethereum like Binance Smart Chain have grown (see charts below), which makes this scaling solution an undeniably positive catalyst for ETH and the applications built on the network.
Ethereum’s scaling issues have been a hot topic for debate over the past few months, and has become an attack vector for other blockchains. We would like to address these issues as Optimism launches this month.
Why are there issues?
Ethereum is a decentralised computer powered by nodes all over the world. Each node has to store and process data that goes through the Ethereum network, hence there is a limited amount of data that can be processed at any one time. We could increase the amount of data Ethereum processes, but nodes would have to upgrade accordingly. This reduces the number of individuals that can run a node as not everyone can afford a high spec computer, reducing Ethereum’s decentralisation and censorship-resistance.
The Binance Smart Chain (BSC) took this approach by forking Ethereum’s code and relying on a set of 21 validators to support the network, successfully creating a thriving ecosystem. However, this solution comes with its own issues. There was an exploit on a protocol in BSC, stealing $31 million of users’ funds. In response, Binance announced that it will freeze these funds if it makes it onto their exchange, the only way to withdraw from BSC at the moment. Binance was able to thwart the efforts of malicious actors but has shown that they have the power to decide which transactions get approved.
This goes against the ethos of Ethereum, which wants to build a credibly neutral platform capable of supporting a global ecosystem of finance and other applications. So how does Ethereum solve this? Through Optimistic Rollups.
Optimism is a Layer 2 scaling solution for Ethereum that can support all of Ethereum’s Dapps. Instead of running all computation and data on the Ethereum network, Optimism puts all transaction data on-chain and runs computation off-chain, increasing Ethereum’s transactions per second and decreasing transaction fees. Tests have shown a 143x decrease in transaction fees on Synthetix Exchange and up to a 100x decrease on Uniswap. Since transaction data still stays on the Ethereum network, this scaling solution does not sacrifice Ethereum’s decentralisation or security for scalability.
What does this mean for ETH the asset?
At first glance, you may question, “since there is a large reduction in transaction fees, would this mean that the requirement for ETH drops, reducing demand for ETH?”
We believe that with Optimism, usage of Ethereum will increase accordingly; the volume of transactions will offset the reduction in fees.
Currently, Ethereum already has:
- User-friendly wallets like Argent and Dharma
- Money markets that yield much higher rates than banks
- Exchanges like Uniswap that allow peer to peer trading and users to provide liquidity, earning yield on their assets
- Asset managers and yield aggregators like Yearn.Finance
- A thriving ecosystem of financial applications
The missing piece to onboard millions of users is scaling. BSC has shown us the potential for Ethereum’s growth once we have achieved cheap and fast transactions: in 6 weeks, the number of unique addresses on BSC has grown from approximately 1 million to 60 million.
Value locked in BSC protocols has grown to $12 billion.
The value of Binance Coin has grown from $37.56 to $257.66 from Jan 1st 2021 to Mar 16th 2021.
Although the growth of BSC should not be extrapolated to Ethereum, it gives us a rough idea of what we might see once Optimism launches.
We have covered the main gist of how Optimism works and its potential impact. In this section we dive into the technical details for interested readers. If that is not you, you could skip to the conclusion.
Sequencers on Optimism are responsible for executing computation off-chain and publishing compressed transaction data onto a smart contract on Ethereum at regular checkpoints. Since computation is resource-intensive, moving it off Ethereum allows it to scale by orders of magnitude.
But what if sequencers are malicious and send fraudulent data? When the sequencer publishes transaction data, there is a window of time where anyone can run their own computation to determine if the transaction data is fraudulent. If the data was indeed fraudulent, the verifier runs the computation on-chain and the smart contract will verify the data. The sequencer will then lose their deposit, a part of which will be sent as a reward to the verifier, and the other amount burnt. As all transaction data is submitted on-chain, a new sequencer will be able to compute the data and replace the role of the previous sequencer.
- An economic incentive for sequencers to act honestly
- An economic incentive for verifiers to check on the sequencers
There will also be other parties that are incentivised to verify sequencer data, such as stakeholders on Optimism or stakeholders of Dapps deployed on Optimism.
However, there are still two issues with Optimism:
- Seven day lock-up periods for withdrawing back onto Ethereum
Since there is a window of time where verifiers run fraud proofs to check on sequencers, users have a waiting period before withdrawing their funds back to Ethereum. This issue is easily solved with liquidity providers that help users instantly withdraw funds back to Ethereum for a fee.
Dapps on Optimism cannot interact with other Dapps deployed on Ethereum or other Layer 2 scaling solutions in the same transaction. But since every application on Ethereum can be copied onto Optimism easily, there may be not much need for cross-chain composability. That said, Connext Network will be tackling this issue.
The prospect of scaling for Ethereum is positive news for the network and the Dapps on Ethereum. An increase in the number of users would mean more people are holding ETH to transact on the network, and cheaper fees would allow for larger trading volumes on exchanges like Synthetix and Uniswap. The narrative for Ethereum has never been better, through the growth of DeFi, NFTs, EIP1559’s slated launch and its upcoming scalability.
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Zerocap provides digital asset investment and custodial services to forward-thinking investors and institutions globally. Our investment team and Wealth Platform offer frictionless access to digital assets with industry-leading security. To learn more, contact the team at [email protected] or visit our website www.zerocap.com