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Gravity Fund

ETH’s L2 Growth Story

As a quick refresher, let’s touch on what Ethereum Layer 2s (L2s) are and why they’re necessary on ETH. Simply put, a L2 is an umbrella term to describe solutions that build on top of ETH mainnet (Layer 1) to improve the scalability of the network. ETH is the second largest cryptocurrency by market cap after Bitcoin. It was the first blockchain to implement smart contracts, which has helped create a decentralized financial system (DeFi), a non-fungible token ecosystem (NFTs), and much of the innovation in the crypto sector. We owe a debt of gratitude to ETH for forging a path on these fronts. Unfortunately, ETH became a victim of its own success. The ETH mainnet saw demand surge to a level much greater than network capacity could support. This caused the network to become congested, which in turn pushes gas prices (network transaction processing fees) to exorbitantly expensive prices. As the average cost of transacting on ETH layer 1 increased, more and more users were priced out of using decentralized applications (dapps) like decentralized exchanges or NFT marketplaces.

Enter ETH L2s. There are a number of different L2 implementations on ETH, each with their advantages and drawbacks, but at their core they all address the ETH L1 congestion problem. They achieve this by validating transactions on the L2 blockchain at high speeds and low fees, batching those transactions, and settling to an ETH L1 block for finality and security. Thus providing ETH a solution that allows users to transact quickly and inexpensively, while retaining the underlying security of the ETH L1 chain.

At Gravity Fund, we have primarily focused on the BTC Layer2 (L2), Solana and TAO ecosystems over the past few quarters, but have kept close tabs on the ETH L2 ecosystem as well. We wanted to touch on this topic because ETH L2 growth in terms of users, transactions, developers and total value locked (TVL) has been significant. It is becoming abundantly clear that L2s will be the primary ETH growth drivers in the coming cycle.

Let’s take a look at some of the growth metrics that we track, starting with developer traction. Developer traction is important because significant developer traction is a necessary prerequisite to user traction, which is a prerequisite to transaction volume traction and TVL traction. Developers create applications that users want to use, which kicks off the entire growth flywheel. We use Electric Capital’s developer reports (https://www.developerreport.com) to track this data.

We’ll start with the longest tenured ETH L2s before moving into some emerging competitors that have picked up significant steam lately. Looking at this first group, Polygon holds a substantial lead in terms of active devs, full-time devs, repos and commits. This group experienced a decline in developer activity in 2023, which wasn’t unexpected. ETH active devs also fell by 25% in 2023 (to be expected in a bear market). Matic fell by ~38%. ARB and OP fell by ~15%. Across MATIC, ARB and OP, most devs who left were newcomers. Established devs grew over the same period by 36% (MATIC), 48% (OP) and 52% (ARB) respectively. Established ETH developers grew by 37% overall. Established devs are important. They push 75% of all code. The growth of established developers in this group was impressive in a bear market, and directly contributed to some of the downstream growth metrics we’ll look at later on.

Next, let’s look at developer activity across emerging L2s.

This cohort attracted significant developer growth in 2023, bucking the broader ETH downtrend. Active devs grew by 179% (BASE – Coinbase’s L2), 72% (PolyzK – Polygon’s ZK L2), 39% (STARK – Starkware) and 33% (ZkSync). Where these projects really shined was in established developer growth. Established developers grew by 140% (BASE), 101% (STARK), 93% (ZkSync) and 84% (PolyzK). While the total number of developers working on these networks is smaller than the total devs working on established projects, the growth rates are impressive and will narrow the total developer gap in short order if they hold.

Next, let’s look at active user growth. We use daily active addresses as a proxy for user growth, starting with the more tenured cohort.

As with developers, Polygon holds a substantial lead in terms of active users, MATIC (870k), ARB (170k), OP (98k). For context, ETH averages ~500k daily active users. ETH active users were flat Feb 2023 to Feb 2024, which makes the growth of active users in this cohort of L2s impressive- Matic (+216%), OP (+205%), and ARB (+41%). While ETH active users were flat, L2s added 711k active users to the ETH ecosystem over the past year. Our first clear on-chain indicator that ETH growth this cycle will come from L2s.

Next, let’s look at daily active users across emerging L2s.

Daily active users is where the emerging L2s really begin to shine versus their more mature counterparts. zkSync routinely surpasses 400k (more than OP and ARB. On par with MATIC and ETH L1). Base stands at ~120k (more than OP, on par with ARB). STRK spiked to ~300k Tuesday 2/20, and routinely breaks above 150k (again, more than OP, on par with ARB and approaching MATIC on certain days). Base active users have grown 179% since ~July ‘23 launch. This short operational runway makes BASE’s user totals even more impressive. zkSync users have grown 464% since April ‘23. STRK active users grew a whopping 4,700% Feb ‘23 – Feb ’24. PolygonzK lags in this metric, but surpassed 50k active addresses on 2/19. This cohort added ~850k active users over the past year, surpassing the total of the OG L2 cohort. Combined the new kids and OGs added ~1.5m users to the ETH ecosystem in 2023. Impressive numbers in a bear market, when the underlying L1 active user tally stalled.

The next important KPI that we track is network transactions. Again, we’ll start with the elder statesman cohort.

ETH daily transactions were flat Feb 2023 to Feb 2024. The shear volue of transactions processed accross this cohort is impressive, standing at nearly 5M transactions per day. To put this in context, ETH L1 processes 1.3M transactions per day. OP (+108%) and MATIC (+53%) put up impressive growth over the same period, while ARB was flat, mirroring activity on ETH L1. Clearly we are witnessing the thesis of pushing transaction volume to L2s, and relying on ETH L1 for finality and security play out.

As we saw with daily active users, the emerging L2s are standing toe-to-toe with their more established peers in terms of daily transaction volume.

zkSync is in a league of it’s own in this cohort in terms of daily transactions. Routinely processing more than 1m per day and approaching 2m. Only MATIC and ARB can boast of sustained transaction activity at this level. STRK has routinely averaged 200k txns per day in Q1 2024. Base has grown from 100k to 150k txns per day over the same period. Both saw significant txn activity in Q4 2023. PolygonzK lags in daily transactions (as we expected, given the lag in users), and processes roughly 25k transactions per day. Put together, this cohort is processing 1.375M transactions per day, on par with ETH L1 daily transactions, and with activity spikes approaching 3M transaction per day. Combined with the established cohort, these L2s are processing 6.375M transactions per day. This is ~5x more transactions than are processed on ETH L1. Another clear indication where ETH’s growth will come from, and that its scalability thesis is playing out.

Finally, let’s look at Total Value Locked (TVL) accross the ETH L2 ecosystem.

TVL is a good proxy for DeFi activity on a given network. Users lock up their assets to generate yield on those assets by providing liquidity to the underlying DeFi protocols. In exchange for providing liquidity, users earn a portion of transaction fees from user activity on DeFi applications. Again, we see tremendous growth here, with TVL growing ~4x over the past year. Total L2 TVL of $29B is approaching the TVL of ETH L1, which stands at $45B.

Putting all of that data together, we see a compelling picture of the ETH L2 growth and scaling thesis playing out in real time. We expect to see this growth continue as this crypto cycle continues to heat up. Additionally, there are L2 specific growth drivers that we expect to accrue significant growth in coming quarters. BASE is Coinbase’s L2. Coinbase has yet to push its userbase to activate on BASE in a meaningful way, and hasn’t seamlessly integrated BASE into its platform as of yet. This will unlock 5M monthly transacting users as Coinbase brings on-chain functionality to its existing users. zkSync is expected to airdrop a token to its users in the coming quarters. As we have seen with other projects, airdrops, especially highly anticipated airdrops, drive significant user activity leading up to the airdrop. The zkSync airdrop is one of the most anticipated airdrops on any chain this cycle.

Ultimately, it remains to be seen which ETH L2 will ‘win’, but we’re excited to watch this all play out as activity, and competition, continues to heat up. Polygon has been the leader for a long time, but the narrative that it’s not a true ETH L2 because it derives security from its own Proof-of-Stake mechanism grows louder every day. Arbitrum has shipped tech fast, which has enabled them to jump out to a lead amongst the zero knowledge (ZK) and optimistic rollup projects. ARB’s most formidable challenger in these early rounds has been Optimism. Both ARB and OP are optimistic rollups, and Vitalik himself has called ZK rollups the ‘holy grail’ of L2 scaling solutions. We are beginning to see tremendous growth on both zkSync and STARK. We expect that this will continue and ZK rollups will be the go-to way to scale for most applications. We don’t believe this will be a winner takes all market, but it very well could be a winner takes most market. Regardless, of which L2 ‘wins’ the ETH ecosystem as a whole is a clear winner, as it’s becoming glaringly obvious that its growth and scalability thesis is playing out.

We’re excited to watch how this all plays out over the coming quarters for another reason. There are analogs to be learned from the ETH L2 ecosystem that can be applied to more nascent L2 ecosystems, most notable BTC. This topic deserves a post of its own, but suffice it to say, for now, that we are actively learning from and looking for parallels to the ETH L2 ecosystem as the BTC L2 ecosystem continues to emerge. We are actively investing in this sector, and will follow-on with additional BTC specific insights.

Onward!