Galaxy: How modularity and rollup affect Ethereum value
Original title: How Modularity and Rollups Impact ETH Value
Original author: Christine Kim
Original compilation: Luccy, BlockBeats
Editors note: Christine Kim, vice president of research at Galaxy, combined the impact of re-staking and account abstraction as well as the Cancun/Deneb upgrade to write an in-depth study of the short-term and long-term prospects of L2s value accumulation on Ethereum. The report reveals the possible negative impact of L2 on the value of Ethereum in the short term, but also points out that as Rollup technology matures and the DA function on Ethereum improves, the value of Ethereum is expected to perform well in the long term. BlockBeats compiles the original text as follows:
Summary
The upcoming Ethereum Cancun/Deneb upgrade is expected to reduce the block space fees paid by rollup operators, so in the short term, this may act as a headwind for Ethereums fee-based protocol revenue. As rollups built on Ethereum become increasingly interoperable with other settlement and DA chains that are more powerful and relatively cheaper, Ethereum may underperform as a result. In the long term, if the blockchain modularity argument holds true, the main network fee driver for L1 blockchains such as Ethereum and Celestia will be L2 rollup service providers, not end users. Combined with the increasing adoption of account abstraction on L2, it can be expected that the primary individuals holding Ethereum for blockspace payment purposes will be rollup operators rather than end users.
introduction
An age-old question in the crypto industry is how to scale a blockchain while maximizing (or at least maintaining) the network’s properties of decentralization and security, and the launch of Celestia marks an answer to the blockchain scalability trilemma. The maturity of a new solution. Celestia is the first public blockchain to be highly optimized to provide DA (DA) for rollups. As a DA layer, Celestia does not have the ability to execute transactions natively. Instead, Celestia provides block space for rollups to temporarily publish batches of user transaction data. As the DA layer, Celestia adopts strategies such as DA sampling (DAS) to specifically reduce the cost of block space for use by the execution layer (such as smart contract rollup to publish data on the chain on behalf of users).
Ethereum is also working to reduce the block space cost of DA (DA), but this comes at the expense of higher node requirements. Proto-danksharding is a major code change coming to Ethereum’s next network upgrade. This upgrade, known as the Cancun/Deneb upgrade, is expected to increase the temporary data storage space of Ethereum nodes by 768 kB. The additional block space for rollup transactions is expected to reduce DA costs on Ethereum by at least 10 times.
The core idea of the modularity argument related to blockchain scaling is that rather than having a single network perform all the core functions of general blockchain computing (i.e. the monolithic or integrated blockchain argument), the responsibility (such as execution or DA) Outsource to specialized infrastructure providers for functionality and performance enhancements. Read this Galaxy Research report to learn more about Celestia and modularity.
As Ethereum implements network upgrades to better support L2 rollups, the share of protocol revenue coming from rollup sequencers may exceed the share coming directly from L1 end users. The rollup sequencer is the entity that publishes end-user data to the DA layer. Currently, rollup accounts for approximately 12% of all gas payments, an increase from 3% at the beginning of the year.
This report will delve into the short- and long-term outlook for value appreciation from L2 to L1 blockchains, taking into account the impact of restaking and account abstraction. The launch of recent upgrades like the Cancun/Deneb upgrade, as well as the increasing flexibility of L2, the option to migrate from Ethereum to other blockchains as settlement and DA layers, may have a short-term impact on the value of Ethereum Negative impact, although in the long term, as Rollup technology matures and the DA function on Ethereum improves, the value of Ethereum is expected to outperform.
This report is a follow-up to our previous report on the modularity argument for blockchain.Understanding blockchain modularity, the report introduces a number of terms and concepts relevant to the modularity argument and provides additional insights into the fee generation and revenue drivers of layered blockchains.
L2 adoption on Ethereum in 2023
Transaction activity on Ethereum’s L2 has more than tripled since January. In 2023, L2 saw the largest growth in total daily transaction volume, both nominally and in percentage terms.
In L2, Optimism and Arbitrum experienced significant TVL drops in Ethereum L2 in 2023, down 11% and 7% respectively. Base and zkSyncEra achieved significant growth in TVL in L2, increasing by 9% and 4% respectively. Note: TVL This metric is based on the USD value of the token and does not necessarily represent changes in the nominal amount of tokens deposited into the protocol.
It is worth noting that Base, the rollup project launched by cryptocurrency exchange Coinbase this year, has quickly gained adoption and popularity among L2 users. As of December 12, Base has accumulated the third highest TVL (TVL) in L2. In terms of trading activity, Base’s daily transaction volume is sometimes higher than Arbitrum and Optimism, the latter two being the largest L2s in Ethereum TVL.
Among the top three L2s by TVL on Ethereum, Bases sequencer generates roughly 20% of the total revenue from sorting user transactions and batching them into blocks. To date, Optimism, Base, and Arbitrums sequencers have generated $140 million (USD) in revenue from user fees.
Looking ahead to 2024, with the launch of the Cancun/Deneb upgrade, the cost of batching user transactions and completing them on Ethereum will be significantly reduced, thus increasing the profit margins of rollup sequencers while reducing fee revenue on Ethereum.
Cancun/Deneb Upgrade
The major code change in the Cancun/Deneb upgrade is Ethereum Improvement Proposal (EIP) 4844, also known as proto-danksharding. Proto-danksharding creates dedicated block space blobs for rollup transactions. blobs transactions will be priced according to a separate fee market from regular user transactions and will only temporarily store transaction data for about three weeks. By activating EIP 4844, each block will create an additional 768 kB data space for rollup.
The Cancun/Deneb upgrade may reduce Ethereum fee revenue in the short term, as EIP 4844 reduces fees rolled into the Ethereum block space by more than 10x. Furthermore, due to the technical challenges associated with rollups, including its lack of scalability, decentralization, and interoperability, the majority of Ethereums fee revenue will likely still come primarily from end-users executing their transactions directly on Ethereum, while Not on L2. Ethereums revenue may not benefit significantly from EIP 4844 until rollup technology matures.
Short-term technical challenges
Heres a closer look at three key areas of development that rollup operators are prioritizing in 2023 and continuing to drive in 2024:
Scalability:Rollup is not immune to fee fluctuations. As we highlighted in our previous reports on blockchain modularity, transaction fees for Ethereum’s major rollup Arbitrum briefly surpassed Ethereum in June 2022, when Project Galxe’s Arbitrum Odyssey marketing campaign triggered a surge in on-chain activity . Since then, with the launch of Nitro in August 2022, fees on Arbitrum have dropped significantly. Optimisms Bedrock upgrade, completed in June 2023, also aims to improve network scalability and reduce gas fees. Scalability of rollups is an area of active development where developers are focusing on improvements.
Decentralization and security:Another area of development that rollup developers are focusing on is decentralization. All rollups on Ethereum are vulnerable to centralized attack vectors because they rely on a single node operator to order transactions and produce blocks. The three core focus areas rollup is focusing on to improve decentralization and security include: (i) implementing validity/fraud proofs, (ii) expanding the set of operators for validation and ordering, and (iii) removing administrators through governance Privileges and decentralizes control of rollup.
Interoperability:One of the main reasons why Ethereum dominates the general-purpose blockchain market share is the strong network effect. As more users join Ethereum, and the liquidity of the assets users interact with on Ethereum increases, the value of the network also increases in a positive feedback loop. This dispersion of liquidity is a barrier to rollup adoption. The DeFi ecosystem benefits from the centralization of liquidity and the composability of dapps to a protocol. Therefore, solving the seamless migration of assets from L1 to L2 and within the L2 ecosystem is an important area of development that will help drive end-user migration from Ethereum to L2.
Advantages of alternative DA solutions
In the short term, Ethereums revenue is still mainly generated by end users launching exchanges directly on L1. As transaction cost savings from scalability upgrades on L2 increase, and rollup decentralization and interoperability improve, user adoption of L2 will grow. Additionally, choosing to use an alternative DA layer like Celestia for cost-effective rollups may enable higher profit margins by passing only a portion of the cost savings to rollup users. In addition to Ethereum and Celestia, other L1 blockchains, such as NEAR, have announced their intention to move to better serve rollup as the DA layer.
On L2, the transaction fees paid by users can be more than 90% less than on Ethereum, as shown in the figure below:
By publishing user transaction data to Celestia instead of Ethereum, rollup operators can expect to realize higher profit margins due to lower transaction fees on Celestia. On average, fees on Celestia tend to be several times lower than on Ethereum, although this is largely due to the fact that Celestia is a new chain that only launched on mainnet on October 31, 2023. The chart below shows the fee ratio between Celestia and Ethereum based on each protocol’s average daily transaction fees (in USD). Daily transaction fees on Celestia are on average 80 times cheaper than on Ethereum. (Note: The following data depicts fees for all types of user transactions on Celestia and Ethereum, not just transactions paid by rollup sequencers.)
As a brand new blockchain that has just been online for less than two months, Celestia has not yet been widely used for DA by L2 like Ethereum. The major part of trading activity on Celestia is not the confirmation of blob transactions, but activities related to the pledge and pledge delegation of Celestias native assets. As blob trading activity increases on Celestia, transaction fees may fluctuate and trend upward. However, since Celestias optimizations for DA do not currently exist on Ethereum, unless everything else is equal, it is unlikely that rollup fees will trend higher on Celestia than on Ethereum.
In summary, we expect Ethereum network revenue to decline with the activation of the Cancun/Deneb upgrade in 2024, as the block space cost of rollup on Ethereum decreases with the activation of the Cancun/Deneb upgrade, or at least becomes lower than without it Cancun/Deneb level up. Additionally, due to ongoing challenges related to rollups scalability, decentralization, and interoperability, it is expected that the major portion of Ethereum network revenue will still come from end users rather than L2. Finally, if the sequencer does not pass all DA cost savings to rollup users who pay the fee and migrate to using alternative DA solutions such as Celestia, rollup margins are expected to increase in the short term.
In the long term, five years or more, as the mass adoption of blockchain-based applications and services and the use of rollup for transaction execution will exceed Ethereums by more than 10 times, Ethereums revenue is likely to increase. rise. Cheaper fees on L2 can unlock new use cases in blockchain-based applications across multiple industries including gaming, social media, entertainment, sports, and more. New use cases driving wider adoption of DApps are expected to increase overall demand for block space on Ethereum, thereby increasing overall revenue. In this case, Ethereums main source of revenue comes from providing the settlement and DA layer for rollups. Additionally, rollup sequencer margins will become tighter as competition for end-user activity increases.
The existence of multiple highly optimized DA layers in the next few years may accelerate the migration of Ethereum L2 from exclusively publishing data to Ethereum to other DA layers that provide cheaper block space. These new DA layers may eventually challenge Ethereum more directly, which could erode its current position as the most widely used base layer for rollups. However, as discussed in the previous section, network effects are important, and rollup developers are working hard to improve interoperability and composability between DApps launched on different rollup protocols. To ensure that users and their liquidity can easily switch to different DA layers in the future, projects like Caldera, Hyperlane, and Polymer are building tools so that rollups can run smoothly on multiple DA layers without affecting the user experience. To the extent that shared settlement and DA layers (like Ethereum) provide user experience advantages when users move their assets between rollups and across the DApps running on these rollups, Ethereum is likely to continue to occupy the most valuable DA layer. status.
Ethereum’s competitive advantage
Although Ethereum dominates the market in 2023 as the settlement and DA blockchain reaching the highest levels of security, value, decentralization and network effects, there will be increasing competition from chains such as Celestia, These chains were designed from the outset specifically to support rollup activities. Although small in number and early stage of development compared to Ethereum, Ethereums dominance as a rollups DA blockchain may diminish over time, although this remains highly unlikely. To this end, Ethereum core developers are working hard to launch upgrades like Cancun/Deneb and other upgrades to enhance Ethereum’s DA capabilities. However, when discussing the long-term impact of L2 rollups on Ethereum revenue, one scenario that must be considered is whether the rollup can successfully provide users with the same level of decentralization, security, and interoperability as the base layer.
While cheaper fees are an advantage, the dispersion of liquidity across the application layer via L2 rollups will likely anchor the majority of user trading activity to Ethereum in both the short and long term. In this case, even if Celestia outperforms Ethereum in its role as a DA layer, Ethereums competitive advantage as the worlds most decentralized, universal single blockchain may continue to prevail and attract new users. As a result, Ethereums revenue will continue to be extremely volatile and dependent on the number of users interacting directly with its base layer. Some users may choose to perform their transactions on Ethereum compared to the cheaper L2 and alternative L1 to take advantage of the decentralization and security that the network as a general-purpose blockchain cannot match.
In the short term, as mentioned earlier, the vast majority of end-user activity remains on Ethereum rather than migrating to L2, which will result in high fees and a temporary spike in network revenue. However, without scalability, Ethereum’s revenue will be limited by limited transaction throughput and remain unpredictable due to a lack of sufficient block space to meet growing demand. A brief increase in user fees, ultimately weighed down by the networks inability to support higher levels of user activity, will negatively impact Ethereums value as a general purpose blockchain in the long term.
Here is a chart showing the volatility of average daily transaction fees for Ethereum’s native Ethereum units:
In the first six years of Ethereum’s genesis block, miners, Ethereum’s block producers, collectively voted to increase the block gas cap, effectively increasing the number of transactions that could be accommodated in a single block by at least 12 times. In August 2021, Ethereum core developers performed a hard fork (a backwards-incompatible network-wide upgrade) that increased the maximum block gas limit from 15 million to 30 million and redesigned fees market to reduce the volatility of fees.
Here is a chart illustrating the increase in Ethereum block gas cap due to user demand for block space:
Although Ethereum block gas caps have changed over the years, fee volatility and limited network scalability remain a persistent issue, which could be a problem if rollups prove to be ineffective at inheriting a large portion of end-user activity over the long term. A long-term solution will be needed.
Other considerations
When discussing the topic of L2 to L1 value accumulation over the long term, two other considerations worth discussing are the activation trend of the local account abstraction on L2 and the re-staking solution on Ethereum.
Account abstraction
If L2 rollups serializer ends up becoming an intermediary service provider for end users to interact with blockchain-based applications, rather than dealing directly with Ethereum, then in this future, users may stop holding Ethereum directly, Instead, the ability to pay transaction fees using stablecoins, or even fiat currencies, depends on the design of the serializer and rollup, which converts these payments to Ethereum on behalf of the user to cover Ethereum transaction costs.
The increased flexibility and programmability of payment fees on L2 relies heavily on a technology called “account abstraction” that has not yet been implemented on Ethereum and may not be implemented in the near future. While account abstraction has many benefits to user experience, there is a lack of coordination among Ethereum core developers to prioritize its implementation ahead of other more urgent code changes, which include increasing the maximum valid balance of validators, Verkle trees , Ethereum Virtual Machine object format, established proposal builder separation, etc.
While there is a proposal to implement account abstraction (ERC 4337) without changing the core Ethereum protocol, this proposal is unlikely as it relies on dapp developers updating their smart contracts and end users choosing to use alternative mempools Be widely adopted. On the other hand, as an emerging technology, rollup itself is a perfect testing ground for implementing local account abstraction at the protocol level. The fact that rollups like zkSync and Starkware are already doing this means that end-user accounts created on these protocols automatically have enhanced programmability and usability.
The local account abstraction on rollup will be a revolution in the interaction experience between users and dapps, because the account abstraction unlocks a number of new features for user transactions, including but not limited to:
Improve user experience for repeat or frequent transactions:For some on-chain games and DeFi applications, users need to submit multiple transactions. ACs can be programmed to automatically allow interactions with certain dapps so that users do not need to use private keys to repeatedly authorize interactions with the same smart contract.
The ability to suspend the flow of assets in the event of a hacker attack:A users account may have built-in logic that stops the flow of funds when certain withdrawal limits are exceeded.
Supports social recovery of private keys:A users account may also be designed to rely on the users private keys and other social recovery devices to transfer funds. If a user loses their private key, one account may be programmed to regenerate a new key using 3 of 2 others or 3 of 5 other social recovery devices.
re-pledge
Another consideration related to value accumulation from rollups to Ethereum over the next five years is the maturation of restaking protocols like EigenLayer. As explained in a Galaxy Perspectives article on re-staking, EigenLayer will enable end-users to repurpose their staked Ethereum to provide security for other protocols and Dapps for higher yields. As of December 2023, the developers of EigenLayer are testing the restaking workflow for EigenDA, another DA layer secured by staked Ethereum, and rollups will be able to publish data to this layer instead of directly to Ethereum . Validation node operators who choose to re-stake via EigenLayer will be subject to additional cutback conditions (penalties) on their transaction validations on Ethereum and EigenDA, but in return they will receive benefits from staking on two protocols instead of one higher returns. The EigenLayer team expects to launch EigenDA on the mainnet in the first half of 2024. Thereafter, EigenLayer will introduce a new protocol whereby validator operators can re-stake it outside of EigenDA.
It may take years for a restaking protocol like EigenLayer to mature and become widely used on Ethereum. The first batch of Active Validation Services (AVS) on EigenLayer will initially be carefully curated and battle-tested for node operators to support via restaking. The developers of EigenLayer intentionally limited the amount of Ethereum and liquid staking tokens that can be deposited into the protocol. Currently, the EigenLayer team has set the initial mortgage Ethereum deposit limit for EigenDA AVS to 117,000 Ethereum. This limit will increase to approximately 200,000 Ethereum on December 18, 2023. Additionally, on December 18, 2023, EigenLayer will also begin accepting deposits from six new liquid staking tokens (os Ethereum, sw Ethereum, o Ethereum, EthereumX, WEB Ethereum, and Ankr Ethereum) deposit.
Total staked Ethereum deposits from liquid staking tokens (including r Ethereum, st Ethereum, and cb Ethereum) as well as native Ethereum tokens as of December 14, 2023, as a share of total staked Ethereum on Ethereum The proportion is less than 1%. The EigenLayer team will gradually increase the pledged Ethereum deposit capacity for EigenDA and other AVS to ensure that the economic security of Ethereum and related AVS will not be jeopardized before the protocol is fully tested in practice. EigenLayers full development roadmap will likely take several years and involve some unexpected bugs, especially as the AVS pool grows.
Where re-staking becomes reliable and scalable, similar to the level of liquid staking activity that has become so popular through the Lido protocol, rollups are expected to gain additional security from re-staking Ethereum for operations such as sorting )etc. Additionally, while Ethereum’s issuance declines over time due to a reduction in additional validator operators, staking returns on Ethereum are expected to increase, which may push Ethereum demand beyond rollup sequencers to DeFi applications and foundations. Re-staking activity creates potential opportunities for strong returns, even as transaction execution utility on Ethereum declines and rollup adoption rises, which may encourage individuals and entities (other than rollup operators) to purchase and stake ether Square.
in conclusion
Ethereums revenue will benefit from maintaining larger transaction activity through L2, although in the short term, the network may face reduced revenue due to insufficient rollup adoption and implementation of upgrades to subsidize rollup costs. Since upcoming upgrades are supposed to reduce rather than increase fee payments, Ethereum is likely to underperform in the short term, at least when investors measure Ethereums value based on its fee-based protocol revenue. Rollup is an emerging technology that faces some technical challenges and adoption barriers in the short term. Over time, as rollups become more scalable, decentralized, secure, and interoperable, most end-user activity will likely migrate from Ethereum to L2. As this process occurs, competition among L2s for users will intensify, and rollup operators profit margins may decrease. In the long term, technologies such as native account abstraction on L2 will further reduce the need for end users to hold Ethereum directly. What is more likely is that as liquid staking solutions exist and re-staking solutions like EigenLayer mature, end users and DeFi protocols will hold token representations of Ethereum and their accumulated returns. The main holders of direct native Ethereum are likely to be rollup operators, who use the token to purchase block space on Ethereum on behalf of end users. Further research areas related to L1 value accumulation for L2 are the impact of maximum extractable value on modular blockchain ecosystems and the evolution of zero-knowledge proofs in terms of rollups, their bridges and economic design.
