How Layer 2 Will Shape Ethereum's Future

This post is taking part in the Lens x Kiwi Writing Contest.

Since Ethereum started in 2015, the network has grown a lot, but few expected the quick rise of Layer 2 solutions. As Ethereum remains the base for decentralized apps, L2s have become essential, solving Ethereum’s scalability issues.

In 2023 alone, the total value locked (TVL) in L2 solutions went over $10 billion, up from just $50 million in early 2021, showing their fast adoption. With transaction speeds up to 100 times faster and fees cut by more than 90%, L2 solutions like Arbitrum, Optimism, zkSync, and StarkNet are not only improving Ethereum’s scalability but also creating new cultural identities within the ecosystem. Ethereum is now a network that is not just scalable but also increasingly L2-focused, leading to a future of diversity and collaboration.

Let's see where this can go.

L2 as a Subculture

We know L2 as a scalability solution for Ethereum’s low transaction speed and transaction throughput (number of transactions per second). But what L2 also represents is different cultural identities within Ethereum.

The cultures of various Layer 2 solutions on Ethereum differ in their technical approaches, community goals, and ecosystem philosophies. While they all aim to address Ethereum’s scalability challenges, their unique cultures shape their development priorities, user base, and strategic direction.

L2 solutions like Arbitrum, Optimism, zkSync, and StarkNet each have their own unique cultures based on their technical approaches and community goals. Arbitrum and Optimism, built on Optimistic Rollups, focus on being practical and developer-friendly. They offer fast, scalable solutions that are easy to integrate with existing Ethereum dApps. Their communities prioritize usability and quick adoption, making them popular in DeFi.

On the other hand, zkSync and StarkNet, based on Zero-Knowledge Rollups, have a more research-driven culture. They value cryptographic innovation and long-term scalability. StarkNet’s community is very technical, focusing on advanced cryptographic security, while zkSync aims to balance complexity with accessibility, trying to make zk technology more mainstream. These differences show a range where some L2s focus on immediate, practical scaling solutions, while others prioritize deep technological advancements and future-proof designs.

Differences in cultural values and priorities are the reason for this diversity. Blockchains not only make unique technical trade-offs but also have distinct cultures. And this is a good thing.

Why is this good for Ethereum?

L2 solutions with different cultural values and builds can greatly benefit Ethereum by addressing various aspects of blockchain utilities. Greater diversity can make the ecosystem more creative and innovative. Here are some benefits the ecosystem can gain from this:

• Optimized Performance: Designed for specific applications like DeFi and gaming, offering higher throughput and lower fees.
• Enhanced Security: Uses specialized security models for sensitive or high-value data.
• Improved User Experience: Provides intuitive, application-specific interfaces and simplifies user interactions.
• Efficient Scalability: Scales vertically to handle high-volume or frequent transactions.
• Specialized Features: Offers unique functionalities or governance models tailored to specific industries or use cases.

Cultural diversity enables one group to concentrate on core development while another expands the ecosystem's "edges".

Challenges

No matter how good it seems, the rise of L2s can also bring some potential risks to the ecosystem. Some of the most concerning ones are:

1. Interoperability Challenges: The growth of many L2s, each with its infrastructure and standards, can make it hard to ensure smooth communication and asset transfers between them and Ethereum’s Layer 1 (L1). Without efficient cross-rollup interoperability, users might experience difficulties moving assets between L2s, limiting the overall functionality and integration of the ecosystem.
2. Monoculture: As some L2s become more dominant, there's a risk of monoculture, where one or a few L2s gain too much influence, stifling innovation and competition. This could lead to centralization of power in certain L2s, undermining Ethereum's decentralization principles.
3. Complex User Experience: With many L2s available, users might face a more complex onboarding process, needing to navigate multiple networks, bridges, and wallets. This could cause confusion, increase transaction costs, and discourage new users from engaging with Ethereum-based applications, reducing the ecosystem’s accessibility.
4. Fragmentation of Liquidity and Users: As multiple L2s emerge, liquidity and user activity may spread across different L2 platforms. This fragmentation can reduce composability (the ability to interact seamlessly across dApps) and lead to a less efficient ecosystem, where assets are siloed across separate L2s, reducing the effectiveness of decentralized finance (DeFi) applications.
5. Economic Centralization: The growth of L2s might lead to economic centralization, where a few L2s capture most of the economic value, while others struggle to attract liquidity and users. This can distort incentives and limit the long-term viability of smaller L2 solutions.

The ecosystem must avoid falling into these traps. Now, let's see how we can avoid these potential risks.

Overcoming Challenges

There are many factors to consider when discussing collaboration, but these are some of the most important for the future of the ecosystem.

Standardization of Protocols

A critical aspect of fostering a collaborative relationship between L1 and L2 is the standardization of protocols. This means creating common frameworks and specifications that all L2 solutions can use. It makes it easier for developers to build applications that work across multiple L2s and for users to interact with different L2 platforms smoothly.

One key area for standardization is token standards. Just like ERC-20 and ERC-721 standardized fungible and non-fungible tokens on Ethereum, L2-specific token standards could be created. These standards would define common interfaces and functionalities for tokens across different L2 solutions. This would allow wallet providers and decentralized applications (dApps) to support multiple L2s more easily without needing custom integrations for each one.

Another important aspect is developing standardized messaging protocols for communication between different L2s and between L2s and L1. These protocols would define message formats, addressing schemes, and confirmation mechanisms, enabling true interoperability within the ecosystem. For example, the Connext Protocol is working on creating a standardized cross-chain communication layer using a combination of optimistic and zero-knowledge proofs.

Creating a unified transaction format across L2s is also crucial. This would simplify the development of wallets, block explorers, and other tools that need to interact with multiple L2 solutions. The Ethereum community is already working on proposals like EIP-4844 (Proto-Danksharding), which introduces a new transaction type that L2s could adopt to improve data availability and reduce costs.

While standardization offers many benefits, it also faces challenges. Different L2 solutions may have unique requirements that make full standardization difficult, and reaching a consensus among various L2 developers and communities can take time. Despite these challenges, efforts are ongoing, with initiatives like the L2 Beat project aiming to provide standardized metrics and information about different L2 solutions. By continuing to work towards these standards, the Ethereum ecosystem can create a more cohesive and user-friendly experience across different scaling solutions, ultimately driving greater adoption and utility for the entire network.

Market-oriented development

Market-oriented development in the context of L2 solutions refers to allowing user preferences and market demands to guide the evolution of these scaling solutions. This approach ensures that L2 development aligns with the actual needs of the Ethereum community rather than being driven solely by technical considerations.

Different L2 solutions can focus on specific features or use cases based on user demand. For example, some L2s might prioritize low transaction costs for microtransactions, while others might focus on high throughput for decentralized exchanges or emphasize privacy features for sensitive applications. By allowing users and developers to gravitate towards the L2s that best meet their needs, the market naturally highlights which features are most valuable.

This approach encourages healthy competition among L2 solutions, driving innovation. L2 projects compete to offer the best user experience, leading to improvements in areas like transaction speed and user interfaces. Competition for developer mindshare pushes L2s to create better development tools and documentation. For instance, the competition between Optimistic rollups (like Optimism and Arbitrum) and ZK-rollups (like zkSync and StarkNet) has led to rapid advancements in both technologies, benefiting the entire Ethereum ecosystem.

Market-oriented development also allows for a diverse ecosystem of L2 solutions, each catering to different niches. Gaming-focused L2s might optimize for frequent, small transactions, while DeFi-centric L2s could prioritize composability and liquidity. This diversity ensures that the Ethereum ecosystem can support a wide range of use cases and applications.

As some features and methods become popular across different L2s, they naturally turn into common standards. Widely used bridging methods might become official standards, and popular smart contract patterns could be formalized for L2s. For example, the Account Abstraction (EIP-4337) idea, which started on the Ethereum mainnet, has been quickly adopted by many L2 solutions because of its popularity and usefulness.

While market-oriented development has many benefits, it also has challenges like potential fragmentation and short-term focus. To tackle these issues, the Ethereum community is creating cross-L2 interoperability standards to reduce fragmentation and long-term incentives to encourage sustainable development. By embracing market-oriented development and being aware of its drawbacks, the Ethereum L2 ecosystem can grow in a way that truly benefits its users and supports the network's long-term growth.

Shared Development Resources

Sharing development resources across different L2 solutions is a strategy to reduce redundancy, improve efficiency, and create a more unified experience for users and developers in the Ethereum ecosystem. This approach involves collaborative efforts to build common infrastructure and tools that can be used across multiple L2 platforms.

One important area for shared resources is creating unified block explorers. Block explorers help users and developers track transactions and interact with blockchain networks. A unified block explorer for multiple L2s provides a consistent user experience, lowers development and maintenance costs, and makes cross-L2 transaction tracking easier. For instance, Etherscan, a well-known Ethereum block explorer, now supports multiple L2 solutions like Arbitrum, Optimism, and Polygon, letting users switch between different L2s easily within the same interface.

Building common development tools that work across multiple L2s can make it much easier for developers and encourage cross-L2 projects. This includes unified testing frameworks, smart contract libraries that work on different L2s, and shared deployment tools. Hardhat, a popular Ethereum development environment, is expanding its support for various L2 solutions, allowing developers to use familiar tools across different scaling platforms.

Developing robust and efficient bridges between different L2s and between L2s and L1 is crucial for the ecosystem's interoperability. This involves creating standardized bridging protocols, conducting shared security audits, and collaborating on efforts to improve bridge efficiency and security. Projects like Hop Protocol and Connext are working on creating generalized bridging solutions that can work across multiple L2s, reducing the need for each L2 to develop its bridging infrastructure.

Pooling resources for research and development can speed up innovation and solve common challenges, with the Ethereum community working on neutral governance structures and modular designs to ensure compatibility and foster collaboration across different L2 architectures.

Cross-Layer Incentive Programs

Cross-layer incentive programs are designed to encourage developers, users, and liquidity providers to engage with multiple Layer 2 (L2) solutions and foster interoperability between L2s and Layer 1 (L1). These programs aim to create a more integrated and collaborative Ethereum ecosystem by offering rewards and benefits for cross-layer activities.

One key part of these programs is joint yield farming initiatives. These encourage users to provide liquidity across multiple L2s and between L2s and L1 by offering extra rewards for multi-L2 liquidity pools, incentives for balanced liquidity across different layers, and bonus rewards for users who bridge assets between L2s and L1. For example, an "Ethereum Scaling Alliance" could start a program where users earn extra rewards for providing liquidity to the same asset pair (e.g., ETH/USDC) across multiple L2s and L1, helping to spread liquidity more evenly across the ecosystem.

Offering grants for projects that build applications or infrastructure that work across multiple L2s can drive innovation and interoperability. This could include funding for cross-L2 messaging protocols, grants for developing multi-L2 compatible wallets, and support for projects that enhance L2-to-L1 communication. The Ethereum Foundation, in collaboration with major L2 projects, could establish a dedicated grant program for cross-layer development, similar to existing initiatives like the Ethereum Foundation Grants Program.

Organizing hackathons and coding challenges that focus on cross-layer solutions can spark innovation and attract developer talent. These events could include cross-L2 interoperability hackathons, challenges for optimizing L2-to-L1 communication, and competitions for creating user-friendly cross-layer experiences. For instance, ETHGlobal, a major Ethereum hackathon organizer, could host a special "L2 Interop" event, bringing together developers from different L2 communities to build cross-layer solutions.

Creating ecosystem-wide token incentives that span multiple L2s and L1 can encourage users to explore different scaling solutions. Still, it requires robust monitoring and anti-abuse measures to ensure fair distribution and prevent exploitation, ultimately fostering greater collaboration and a more integrated Ethereum ecosystem.

Cross-L2 Liquidity Pools

Cross-L2 liquidity pools are an innovative approach to addressing the fragmentation of liquidity across different Layer 2 (L2) solutions in the Ethereum ecosystem. By enabling the sharing of liquidity between multiple L2s and Layer 1 (L1), these pools can significantly enhance capital efficiency, reduce slippage, and improve the overall user experience in decentralized finance (DeFi) applications.

A key component of this approach is the development of unified liquidity protocols that allow liquidity to be shared across multiple L2s and L1, creating deeper and more efficient markets. This involves creating smart contracts that manage liquidity across different layers, implementing automated market makers (AMMs) optimized for cross-layer operations, and developing liquidity aggregation mechanisms that source the best rates across multiple L2s. For example, Curve Finance, a popular decentralized exchange, has implemented a "meta-pool" concept that allows for efficient stablecoin swaps across different L2s and L1. This approach could be extended to create a more generalized cross-L2 liquidity protocol.

Creating yield optimization strategies that work across multiple L2s can attract more liquidity to the ecosystem. This could include auto-compounding strategies that maximize yields across different L2s, dynamic rebalancing of liquidity based on yield opportunities, and risk management tools that diversify liquidity across multiple layers. Yield aggregator protocols like Yearn Finance could potentially expand their strategies to include cross-L2 yield optimization, automatically moving users' funds to the most profitable opportunities across different scaling solutions.

Developing efficient bridging mechanisms specifically designed for moving liquidity between L2s and L1 can reduce friction and costs. This involves implementing fast and low-cost liquidity transfers between layers, automated liquidity rebalancing based on demand, and secure multi-sig or threshold signature schemes for managing bridged assets. Projects like Hop Protocol and Connext are already working on creating more efficient cross-L2 bridges, which could be further optimized for large-scale liquidity movements.

Joint yield farming programs with cross-layer incentives encourage users to provide liquidity across multiple L2s and between L2s and L1. They offer extra rewards for multi-L2 liquidity pools, balanced liquidity incentives, and bonus rewards for bridging assets. For example, an "Ethereum Scaling Alliance" program could reward users for providing liquidity to the same asset pair across multiple L2s and L1.

Creating smart order routing systems that can split and execute trades across multiple L2s to get the best prices is also crucial. This means developing algorithms to find the best way to distribute trades across different L2s, using fast cross-L2 bridges for smooth execution, and combining liquidity from various L2s to reduce slippage for large trades. DEX aggregators like 1inch could expand their services to include cross-L2 order routing, helping users get the best prices by accessing liquidity from multiple L2s at the same time.

Joint yield farming programs in cross-layer incentives encourage users to provide liquidity across multiple L2s and between L2s and L1. They offer extra rewards for multi-L2 liquidity pools, balanced liquidity incentives, and bonus rewards for bridging assets. For example, an "Ethereum Scaling Alliance" program could reward users for providing liquidity to the same asset pair across multiple L2s and L1.

The key to making this work is to enhance user and developer experience along with rising plurality. Creating ways for collaboration between different L2s with each other and with L1 will encourage newcomers to the ecosystem, driving innovation and development even further.

Conclusion

Cultural values play a crucial role in development and, as Vitalik correctly mentioned in his blog, incentives. These values determine who is attracted to an ecosystem and who stays away. They shape the actions people are encouraged or able to take and define what is seen as legitimate, both in protocol design and across the ecosystem and application layers. This diversity is leading Ethereum towards plurality.

Balancing plurality and cooperation between L2 and L1 will determine the success of this experiment and the future of the ecosystem.