User growth on Layer 2 protocols like Arbitrum and Optimism have increased significantly in 2022. In fact, Optimism has recently been collecting more daily transaction fees than Avalanche, Cardano, and Near. However, validators and token holders do not earn these fees through staking and delegating since Layer 2s on Ethereum (besides Polygon) are currently centralized in their block production.
Networks like Arbitrum, Aztec, Fuel, Optimism, Starkware, and zkSync all have decentralization of block production in their roadmap, but what would this look like in practice and how much could token holders earn through staking?
What is an L2?
Layer 2 protocols are inherently different than Layer 1s since they leverage the security of the underlying network, like Ethereum, they are built on top of.
Essentially, rollups are designed to make executions of transactions for end-users faster and less expensive through data compression and batching of transactions. This lowers gas fees significantly and frees up block space on the underlying network. Arbitrum and Optimism on Ethereum consume roughly around 2% of all gas on Ethereum, but account for around 40% of transactions, which is a huge scaling improvement.
This added efficiency can result in future “induced demand”of blockspace on Ethereum, which will become cheaper as the L2 ecosystem scales. So how do you value specificLayer 2 networks?
Value Accrual on L2s
Because secured rollups on Ethereum leverage the data availability, consensus, and settlement of Ethereum, the baseline economic models for rollups are relatively simple. Ultimately, rollups purchase blockspace on Ethereum and optimize that space that they then sell back to users at a premium.
Though earnings are currently relatively small given the recent decline in user activity, a rollup is capable of improving margins by offering a more performant execution environment that offers features that do not exist on Ethereum or other rollups.
Outside of being less expensive than executing on Ethereum, the benefits of executing transactions on a rollup include:
- Private
- Known Counterparties (KYC’d rollup)
- MEV Reduction
These added features can create more value accrual to a rollup separate from Ethereum. So where does this value go?
How Staking Would Work
The value created from a rollup currently goes to the centralized sequencer. That said, most rollups and L2 scaling solutions will eventually decentralize their infrastructure and launch tokens that will create decentralized incentive models to validate transactions on a rollup.
This will give the community of token holders the opportunity to stake tokens and earn fees (and potentially inflation) generated by the protocol. The added utility results in a value accrual mechanism for the rollup’s native token.
As usage of L2s grow, so would the amount of fees earned by the sequencers on a rollup.
(Source:https://dune.com/msilb7/l2-benchmarks)
Arbitrum and Optimism have both experienced days where their fee margin have been 300+ ETH and 100+ ETH respectively, and have earned a highly attractive amount in USD.
If these rollups were decentralized on these dates, this ETH would be earned by a distributed group of sequencers and token holders who are staking. Also, depending on the staking mechanics & staking participation, the amount of tokens required to stake to capture a large portion of this value could be low compared to other Layer 1s.
Governance
Similar to other Layer 1s like Polkadot and Cosmos, native tokens on L2s will likely be used to participate in network governance. Optimism is already leveraging a token based governance model in the form of their native OP tokens as well as non-transferable NFTs.
Token holders would be able to propose:
- Network Upgrades
- Fee Changes
- Inflation Changes
Treasury Distributions
This will allow rollup communities to continue to scale their ecosystems and ensure that sequencers and stakers are properly compensated for their work as the network decentralizes over time.
Timeline
As mentioned before, networks like Arbitrum, Aztec, Fuel, Optimism, Starkware, and zkSync all have decentralization of block production in their roadmap, but it is still TBD on when this will be rolled out on every network, and there will likely be nuances in staking mechanics on a network by network basis.
As of now, only Optimism has a live token, but we can expect more L2 native tokens to launch later this year and in 2023.
Given the growth of adoption on L2s recently, staking on L2s will likely be a great opportunity to capture further value within the Ethereum ecosystem once rollups begin to decentralize.
