Original author: Revelo Intel

Original compilation: Deep Chao TechFlow

Introduction: Understand the economic principles of Rollup

Ethereums scalability roadmap is increasingly focusing on Rollup solutions, and with continued adoption and the anticipated EIP-4844, Ethereum Layer 2 (L2) solutions are gaining lasting importance.

However, evaluating L2 solutions is far from simple. Unlike L1 networks such as Ethereum, which have clear revenue streams from transaction fees and clear fees from token issuance, L2 solutions pose unique valuation challenges.

This report explores the complexities of evaluating Ethereum Layer 2 solutions and provides insights into the economic factors underpinning their value propositions.

Overview

The significant advancements in technology that Rollup solutions have made in recent years cannot be ignored. Since the advent of Rollup technology in 2018, a large amount of talent and research investment has brought significant technological progress, including a Rollup implementation equivalent to the Ethereum Virtual Machine (EVM), bridging technology based on fraud and validity proof, and batch data compression. breakthrough, and the launch of the Rollup Software Development Kit (SDK). It is worth noting that multiple Rollup solutions such as Optimism, Arbitrum, Base, zkSync and StarkNet have entered the market, promoting the formation of a thriving ecosystem, leaving other Layer 1 solutions vulnerable and exposed in the battle for market share s position.

While current adoption rates are in line with expectations and demonstrate the feasibility of attracting the next generation of users, the growth trajectory for Layer 2 solutions (L2) will accelerate in the coming months. With the impending arrival of EIP-4844 and the launch of new chains such as Scroll, Linea, and Base, L2 is now in the spotlight.

EIP-4844: Cost Tree

The upcoming Dencun (Cancun) upgrade brings an important feature - EIP-4844, also known as Proto-Danksharding, which marks a significant reduction in the operational costs associated with Rollup. While the specific specifications for Danksharding continue to evolve, EIP-4844 paves the way for a seamless transition of the Ethereum protocol architecture to accommodate future Danksharding implementations.

Current Rollup implementations face two major challenges. First, since L2 processes millions of transactions every day, aggregates them and submits transaction proofs to Ethereum, there is a data storage bottleneck. Second, there are transaction costs associated with transmitting transaction data from L2s to Ethereum.

At the heart of EIP-4844 is the concept of Blobs (binary large objects). Essentially, a blob is a block of data associated with a transaction, unlike a regular transaction. These blobs are stored exclusively on Beacon Chain and incur minimal gas fees. They allow Ethereum blocks to add more data without increasing their size. Simply put, leveraging blobs can increase the amount of data stored by almost 10x compared to the average block size.

The main purpose of blobs is to significantly reduce data availability (DA) costs, especially for Rollups L1 releases. Unlike traditional approaches, where all Rollup data is stored in Ethereum’s calldata space, blobs provide an efficient and cost-effective alternative. Since the consensus layer manages blob storage, blob transactions impose no additional requirements on validators. In addition, blob data is automatically deleted within the recommended 30 to 60 days, in line with Ethereum’s goal of pursuing scalability rather than indefinite data storage.

Before the implementation of EIP-4844, L1 release costs accounted for more than 90% of the total Rollup expenses. Going forward, EIP-4844 introduces the concept of data gas, a new fee category for blob transactions. This separates the cost of publishing L2 data to Ethereum from the standard gas price. With dynamic pricing based on blob supply and demand, L2 can achieve significant cost reductions when submitting its data to Ethereum, with potential cost reductions of up to 16x, or 90% of current gas fees.

Blobs are like blocks of data that make Ethereum run more efficiently. They are stored separately, do not interfere with validators, and disappear when no longer needed. This means lower costs and more space for data, making Ethereum faster and cheaper.

The Economics of Rollup

In order to understand the significance of EIP-4844, it is key to grasp Rollup’s business model. The upgrade results in significant cost reductions, while revenue expectations are likely to remain stable or increase as on-chain activity increases.

In order to fully understand the impact of EIP-4844 on the Rollup economic model, their revenue sources must be analyzed in detail. Rollup generates revenue from network fees and Miner Extractable Value (MEV). Currently, MEV capital is controlled by a centralized Sequencer that has a monopoly on MEV.

In terms of costs, Rollup faces fixed and variable expenses. Fixed costs come from operations such as publishing state roots to Rollup smart contracts, validity proofs for ZK Rollup, and base transaction fees on Ethereum. Variable costs include L2 gas fees and L1 issuance fees required to store batches of data into Ethereum.

EIP-4844 introduces a dynamic blob fee system where fees are determined based on blob supply and demand independently of block space requirements, unlike the traditional fee model. Therefore, the fee market of Ethereum after EIP-4844 includes two dimensions:

• Regular transaction fee market based on EIP-1559: This dimension retains the existing EIP-1559 fee market for regular transactions, with unique dynamics including base fees and priority fees consistent with EIP-1559 principles.

• Blob fee market: The second dimension introduces a blob fee market, where fees are determined entirely by current blob supply and demand. This creates a separate ecosystem from the regular transaction fee market, ensuring that blob fees are not affected by fluctuations in block space demand.

Analysis of the EIP-4844 fee market reveals several noteworthy results:

• As the number of application chains and generalized L2 increases, blob demand is expected to gradually rise. EIP-4844s price discovery mechanism may cause data gas prices to increase in situations where demand exceeds the blob target.

• Data gas costs are expected to grow exponentially as demand surges. If blob demand exceeds the target level, the cost of data gas will increase rapidly and exponentially, possibly more than tenfold in a matter of hours. Once blob demand reaches the target price, the data gas price will increase exponentially every 12 seconds.

EIP-4844 changes the way Rollup makes and spends money. With dynamic blob fees, one part of the fee market follows regular rules, while another part adjusts based on blob supply and demand. As blob demand grows, so does gas cost.

Rollups as a Service

As the number of specific application chains increases, the Rollups as a Service (RaaS) business model becomes increasingly important. For example, Ethereum Layer 2 has clear advantages over application-specific chains on platforms like Cosmos, largely due to the emergence of RaaS solutions.

A major reason for this advantage is the reduction in infrastructure overhead. In the context of Ethereum Layer 2, this process is significantly simplified thanks to RaaS solutions. These services simplify the deployment, maintenance, and management of customized Rollups, effectively solving the technical complexities that developers often encounter when developing mainnets. Therefore, RaaS enables developers to focus on application layer development, improving their overall productivity.

RaaS also offers a significant degree of customization. Developers can not only choose their preferred execution environment, settlement layer, and data availability layer protocols, but also gain flexibility in key aspects such as orderer structure, network fees, token economics, and overall network design. This adaptability ensures that RaaS can be customized to the specific needs and goals of a wide range of projects, enhancing the versatility of Ethereum’s second-layer solutions.

We can distinguish two main types of services:

• SDK (Software Development Kit): These are development frameworks deployed as Rollup, including well-known options such as OP Stack, Arbitrum Orbit for L3s, Celestia Rollkit, and Dymension RollApp Development Kit (RDK).

• Codeless Rollup deployment services: To simplify design, these services enable rollups to be deployed without in-depth coding knowledge. Solutions such as Eclipse, Cartesi, Constellation, Alt Layer, Saga, and Conduit fall into this category. They lower the barrier for developers and organizations to take advantage of Rollup technology.

We could also include a third category for a shared set of sequencers that serve multiple rollups simultaneously, such as Flashbots Suave or Espresso.

While the current market landscape shows modest demand for custom rollup creation, there is widespread expectation that RaaS may inspire the emergence of hundreds to thousands of rollups as macroeconomic conditions improve and product-market fit becomes clearer.

RaaS makes developers lives simpler, faster, and more flexible. This gives them more time to prioritize and focus on the core logic and business model of the application.

Questioning the usefulness of L2 tokens

The success of Rollup solutions like Optimism, Arbitrum, Mantle, zkSync, etc. is unquestionable. However, looking at Rollup governance tokens such as $OP or $ARB from an investment perspective, the situation becomes more complicated.

Bear market: limited upside

In traditional financial markets, shareholders enjoy a range of rights, including dividends, voting rights and claims on assets, which provide stocks with intrinsic value and make them an attractive investment. In contrast, tokens that merely represent governance power lack these guarantees and are limited to voting on governance proposals. Since Sequencer revenue generated from transaction fees does not flow to token holders, network growth does not necessarily translate into an increase in token value. This raises legitimate questions about the Rollup token value proposition.

While governance rights have inherent value, especially in second-layer solutions where token holders have significant influence (as seen with Optimism’s RPGF and Arbitrum’s STIP), the lack of dividends or other revenue streams makes them a Different forms of investment.

In todays high interest rate environment, assets that do not provide real income may be less attractive to conservative investors. Rising interest rates increase the cost of capital, making the opportunity cost of holding non-income-producing assets more important. Against this backdrop, ETH with its stable staking returns may be a better choice for risk-averse investors, despite the growth potential of the Rollup token.

Bull Market: The Growth Narrative

In financial markets, a companys value is tied to more than just profits or dividends. For example, growth stocks are valued based on their long-term growth potential and reinvestment strategies. Investing in Rollup governance tokens can also be similar to investing in non-dividend growth stocks. Historically, companies like Amazon have chosen not to pay dividends, instead reinvesting profits into expansion and innovation. Investors in such companies are not necessarily looking for immediate returns through dividends; instead, they expect long-term growth and appreciation in value. In the case of Optimism and $OP tokens, there is a clear commitment to reinvest profits into ecosystem growth, promoting a virtuous cycle of increased demand for their native dApps, sequencer revenue, and RPGF. Additionally, with initiatives like Superchain on the horizon, the bandwidth of the OP Stack continues to expand, ultimately creating a strong moat that is difficult to ignore due to network effects.

Industry Outlook

L2 is developing into a highly competitive space, and the implicit expectations of airdrops can significantly affect user behavior within any given L2. However, it is important to recognize that the valuation of a particular L2 is intrinsically linked to the value of the L1, with network effects being the differentiating factor.

This connection becomes apparent when we examine the current operation of Rollup. They charge gas fees in ETH and must pay data availability fees to Ethereum in ETH. Essentially, these rollups cannot enforce their own monetary policy; Ethereum dictates how much they must pay to the underlying chain.

Therefore, there is no unique monetary premium for L2. Still, the way L2 tokens are currently traded doesn’t always align with this reality. However, as long as they can build strong ecosystems and promote network effects, these L2s have the potential to become sovereign entities in the future, and the market may seek to anticipate and preempt this opportunity.

Airdrops can indeed influence user behavior. But here’s the thing: L2’s value is closely tied to Ethereum (L1). L2 charges and pays in $ETH, so they dont have their own currency rules. Against this backdrop, the current L2 operating model appears clear: they charge fees to end users and retain a portion of these fees to cover Ethereum’s settlement and data availability costs. Owning the relevant governance tokens is effectively equivalent to holding a portion of the profit difference generated by L2.

Things get even more interesting when multiple instances can be created, as is the case with Optimism. In these scenarios, the difference in profits generated by these instances can flow back to token holders. Base, for example, allocates 10% of its fees to Optimism.

This model unlocks greater potential for scalability of L2 assets, setting a precedent for sharing a portion of fees with other chains as an implicit licensing agreement. This dynamic not only adds depth to the L2 ecosystem, but also strengthens the value proposition of L2 tokens as they continue to evolve and adapt within the competitive landscape.

current situation

Ethereum is currently trading at approximately $301.4 billion, and its value is expected to rise as rollups built on it grow. In addition, the introduction of Rollup as a Service (RaaS) is expected to bring a wave of general and application-specific rollups into the market.

But even though we can expect the base layer to increase in value, L2 generally has a higher beta compared to $ETH. Additionally, investors may view their tokens as a bet on the entire ecosystem. We recommend caution with this approach, as it is common for individual projects to move to the latest and most popular L2 at any given moment.

Additionally, L2 is positioned to attract more users, thereby increasing the value flowing back to Ethereum. This dynamic may follow a power-law distribution, although not as pronounced as that observed in liquidity staking. Therefore, it is possible that, conversely, ETH is an underlying that investors may be more willing to hold. As more L2s enter the market and dApps end up spreading across multiple L2s, the chain of selecting the ultimate winner becomes more complex. Regardless of who the ultimate winner is, however, ETH holders and Ethereum validators will benefit from increased rollup activity.

all in all:

• The value of Ethereum rises with the growth of Rollup technology, and Rollup as a Service (RaaS) will bring a wave of Rollup in the market

• The volatility of L2 is different from that of ETH, and projects can quickly switch between L2

• L2 will attract more users, benefiting $ETH holders and validators, but picking winners becomes complicated in L2

• Ultimately, holding ETH is probably the safest bet.

Do we need other alternative L1 solutions?

The days of L1 as a rotational trade seem to be a thing of the past. As L2 solutions effectively address Ethereum’s scalability challenges, it becomes important to question the value proposition of other L1 blockchains such as Near, Avalanche, Solana, Fantom, etc.

A key difference is the ease of launching Total Value Locked (TVL). L2 enjoys an advantage in this regard because users and developers are already familiar with the tools on Ethereum. They only need to bridge assets to the L2 chain to take advantage of reduced transaction costs. Essentially, TVL, originally on Ethereum, was simply looking for a more cost-effective trading environment.

However, it is important to recognize that other L1 solutions still serve specific purposes and offer unique features that may appeal to certain use cases.

• Diverse ecosystems: Other L1s have cultivated their own ecosystems, often with different communities, projects, and innovations. These ecosystems may serve the needs of a specific market or industry.

• Specialized features: Some L1s prioritize features such as high throughput, low latency, or specific consensus mechanisms. These properties may make them more suitable for certain applications, such as high-frequency trading or gaming.

• Diversification: From an investment perspective, diversifying investments across different L1s can reduce risk. Although Ethereum remains dominant, other L1s may offer diversification opportunities. For example, investing in Solana could be a way to combat the dominance of the EVM (Ethereum Virtual Machine) (imagine a zero-day vulnerability discovered in the EVM).

Those L1s that can bring unique value to the ecosystem (such as Solana, Monad, etc.) will survive. It is no longer enough to just provide an EVM-compatible chain with lower gas fees. This may seem obvious now, but in the past there have been many instances where EVM-compatible chains with lower gas costs reached inflated valuations. Take Moonriver, for example, an EVM-compatible chain on Kusama (Polkadot’s canary chain) that reached an all-time high of $494 in Q4 2021 and now trades at $4.

all in all:

• L2 reduces the need for L1 rotation transactions. While other L1 blockchains still serve unique purposes, L2 has an advantage in total value locked (TVL) because they offer familiar tools and lower transaction costs.

• However, the diverse ecosystem, specialized features, and diversification make other L1s still attractive for specific use cases and risk mitigation.

• Surviving L1 will bring unique value beyond EVM compatibility and lower gas charges

Key takeaways

• The traditional valuation method is more suitable for L1, with transaction fees as revenue and token issuance as expenses. L2 poses unique challenges to valuation.

• Although cryptocurrencies and stocks are structurally different, the basic investment logic still applies – investing in assets with long-term growth potential can be an attractive strategy.

• L2 operates by capturing the spread, a model that is reinforced when implicit revenue sharing agreements are formed with other chains, such as Base allocating 10% of fees to the Optimism treasury.

• ETH can be considered an “index” asset, while L2 functions like a personal “stock pick.” Regardless of which L2s are most active, both ETH holders and Ethereum validators will benefit from increased rollup activity.

in conclusion

One way to look at this is that EIP 4844 will significantly reduce the cost of L2, while its revenue will grow over time. The difference between the two is the profit margin of these L2s. As this gap widens, the likelihood increases that they decide to start sharing those profits with token holders. If youre willing to wait for the pieces to fall into place, thinking about this logic ahead of time is a sound approach.

As we chart a path for the future of Rollup governance tokens like $OP or $ARB, it’s clear that the space is poised for transformation. The rise of EIP 4844, ERC 4337, and the emergence of RaaS (including SDKs and no-code deployment services) heralds a wave of Rollup adoption to come.

This wave of adoption will likely see the rise of thousands, perhaps even tens of thousands, of Rollups. However, investors are divided on the value of these governance tokens. On the one hand, challenges like the lack of traditional value capture mechanisms and the impact of a high interest rate environment may limit the potential upside of the Rollup token. On the other hand, some investors may compare these tokens to non-dividend growth stocks like Google, Amazon, and Tesla, recognizing their potential for higher valuations due to their long-term growth prospects.

As we move into a more competitive space, it is critical to remain adaptable, given the ever-changing dynamics and unique qualities of the Rollup governance token.