Ethereum’s Layer 2s have addressed the gas fee challenges but they have also fractured its ecosystem in the process. Now with more than 140 live networks, what started as a clever fix has morphed into a messy web of isolated L2s, risky bridge solutions, and development teams competing for the same users.
L2s are responsible for scaling Ethereum’s ecosystem, reducing transaction fees and improving speeds for users. But the proliferation of new protocol launches has also led to a massively fragmented ecosystem, while most of the accrued revenues and user growth comes from protocols without an investable token (i.e. Coinbase Base).
With so many L2s each with their own unique scaling models and ecosystems, the lack of a cohesive framework and their inability to recycle economic value back to Ethereum has now become a significant challenge for the leading smart contract platform.
Interoperability challenges for L2s
Ethereum initially captivated users and developers with its revolutionary ‘money lego’ composability – in other words, providing an infrastructure where protocols can interact seamlessly within a single economic environment. This has always been one of Ethereum’s core value propositions.
Fast forward to today, and we could argue that this composability has been compromised.
Although L2s have to post their transaction data back to Ethereum in order to inherent its security, they are designed to operate independently from the underlying blockchain. This independence, however, means each L2 has its own built-in consensus and scaling model, so naturally they struggle to communicate directly with one another.
For users, this means transferring assets between them requires the usage of complex and risky bridge solutions.
The bridge infrastructure connecting these networks has proven particularly vulnerable, with over USD2.3 bn lost to bridge exploits since 2021. Users have to bear the additional costs too, with bridge transactions often requiring multiple gas fees – one for exiting the source L2, another for the Ethereum mainnet transaction, and a third for entering the destination L2.
DeFi protocol integrations that once executed atomically now require a complex, multi-step process vulnerable to MEV extraction at each layer. This means many users are getting squeezed with higher fees, as each extra step allows frontrunners to extract more value off these transactions (especially during peak network activity).
But these L2s still provide a far better alternative to using Ethereum directly, and popular L2 rollups such as Base, Arbitrum, Optimism and zkSync have quickly grown to process more transactions than Ethereum itself. These L2s achieve this by bundling transactions off-chain, then use a centralised sequencer to determine their final order. Once this is done, the rollup batches are then submitted to Ethereum’s mainnet for settlement.
This model has proven highly lucrative for many L2 protocols, with Base capturing around USD 93mn from its own sequencer fees. But it also means a single, company-controlled sequencer is responsible for passing the transaction data between the different blockchain layers. Transaction censorship or manipulation is therefore possible, and if the single sequencer fails, it can freeze the entire L2 network.
A new solution known as based rollups appears to be addressing this conundrum, proposing a scaling framework to realign Ethereum’s L2 ecosystem by returning transaction sequencing control back to its decentralised validator network.
How exactly do based rollups work?
Based rollups were first proposed by Ethereum researcher Justin Drake back in 2023. Instead of each L2 having its own sequencer, based rollups (technically L1-sequenced rollups) hand transaction ordering over to Ethereum’s large validator network. This fixes three big problems:
- Layer 2 interoperability – Letting Ethereum’s consensus layer handle ordering across L2s offers more atomic composability between siloed networks. In practice, this may look like using an Arbitrum decentralised exchange with an Optimism lending protocol without any need for bridges. The based rollup project Taiko is already showing that this can work by bringing more revenue back to Ethereum than other L2s.
- Reducing single points of failure – Based rollups spread the transaction sequencing across Ethereum’s decentralised validator network, thereby reducing the risk of single point failures. In addition, no single entity would be able censor or manipulate transactions.
- Better economics for Ethereum tokenholders – If L2 sequencer revenue gets redirected to validators, ETH issuance could slow down allowing stakers to earn more without relying on inflation. If a part of those fees is also burned, an increase in L2 network activity could further reduce ETH’s supply.
Why would L2s give up their cash cow?
This is a fair question, as integrating based rollups would require Layer 2s to voluntarily cut into their profit margins. Base made about USD 93mn, Abritrum USD 42mn, and Optimism USD 26mn from sequencer operations in the last year alone.
But several leading L2s seem prepared to do so. Base’s Jesse Pollak claims rollups will make “Ethereum feel like Ethereum again.. and based sequencing and native execution feel like the tools to do it”, while Optimism’s Ben Jones talks about prioritising a stronger bond between Ethereum and its L2 ecosystem.
Other L2 developer teams have also shown support, including those from Arbitrum, NethermindETH, Unichain, and Scroll, among many others.
Challenges
There are also technical hurdles to consider.
Ethereum’s 12-second block time falls short of the sub-second finality that some L2s offer, which can be a drawback for decentralised applications with high-throughput demands. In addition, based rollups need to generate and publish proofs every 12 seconds (same as Ethereum’s block time), while current L2s either use zero-knowledge proofs (transactions are finalised in minutes) or optimistic proofs (can take up to a week to detect fraud).
Validators controlling the transaction ordering across multiple Layer 2s may also lead to complex MEV opportunities that may undermine fairness, especially since they are profit-driven.
And lastly, moving existing applications to a based rollup model would demand substantial protocol changes and a collective effort between many projects and their developer teams.
Outlook
Despite some of these misgivings, the Ethereum community is warming up to based rollups alongside several teams tackling the L2 conundrum from different angles.
Development teams across Ethereum are proposing a community effort dubbed “Fabric”, to develop based rollup infrastructure and collectively agree on standards to help drive the based rollup ecosystem forward.
Meanwhile, shared sequencer approaches like Espresso Systems and standards like ERC-7683 and EIP-7781 are also promising developments. There is also Polygon’s AggLayer, and the RIP-7755 rollup improvement proposal.
Based rollups may only be part of solution to Ethereum’s longstanding interoperability challenges, but their success could certainly restore some confidence in the large smart contract platform’s core value proposition. In any case, working towards a unified ecosystem is far better than a fragmented one.
ENDS
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