How the Hunt for Yet-to-Exist Tokens Is Shaping Ethereum’s Layer 2 Landscape

Arbitrum, the layer 2 “rollup” network for the Ethereum blockchain, has become the clear frontrunner in a crowded race among networks competing to offer lower fees and higher speeds to users.

The competition to help scale Ethereum is developing at a rapid pace – viewed as an attractive and potentially lucrative arena for entrepreneurs, venture capitalists and technologists looking to attract the next wave of crypto-users, by offering them easy access to the second-biggest blockchain. In the past two months alone the venture capital giant Andreessen Horowitz (a16z) and exchange behemoth Coinbase have both said they were building Ethereum layer 2s, which is the term used to describe these blockchain scaling systems.

One could argue that tracking this space has never been more crucial, with Ethereum at an inflection point having just completed its transition to a fully functional proof-of-stake blockchain. New entrants to the competition known as “zkEVMs” – layer 2 scaling products built on an increasingly popular type of cryptography known as zero-knowledge proofs – have sprung onto the scene.

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What can sometimes be hard to tease out, however, is how much of any given project’s success is due to its technological superiority or merely due to users trying to capture a slice of funnel-down marketing dollars in the form of rewards tokens or other freebies. The layer 2 race has highlighted how the crypto industry’s proclivity for “airdrops” and other handouts – new tokens that get printed out of thin air and distributed to project users – remains a driving force in shaping the sector.

Arbitrum has long been a leader in Ethereum’s scaling race, but it saw a surge of growth last month when it released ARB – a new token that was “airdropped” to people based on how much they’d used the network in the past. The potential for more surprise paydays is shaping the layer 2 landscape beyond Arbitrum as well, sending users to projects such as zkSync that have yet to launch tokens, and away from projects like Polygon zkEVM that already have.

Airdrops, and the prospect of them, have proven a compelling customer acquisition strategy for up-and-coming chains. Whether this familiar formula for attracting users and capital is sustainable, however, remains uncertain.

A key takeaway is that the money-grabs may obscure the early data signals on which technological platforms work the best.

What are Ethereum’s rollup networks?

Ethereum is the second-largest blockchain behind Bitcoin, based on the total value of crypto locked into its ecosystem. More than a means of tracking and trading its native currency, ETH, Ethereum is a multibillion-dollar platform for blockchain-based games, financial apps and countless other tools and tokens.

Rollup networks emerged as a result of Ethereum’s high fees and relative sluggishness – which became a massive deterrent for many would-be Ethereum users during the last crypto bull run, when high user demand clogged up the network and its speed and cost issues became more apparent.

Ethereum’s core developers – co-founder Vitalik Buterin among them – eventually expect rollups to become the primary on-ramp by which users access the chain, and combined traffic across all layer 2 platforms (a loosely defined category that includes scaling solutions like rollups) has recently begun to surpass that of the base Ethereum chain.

Arbitrum, one such rollup network, operates like a separate blockchain alongside Ethereum. Like all rollups, it bundles up transactions from users and then passes them down to Ethereum for “settlement,” where they’re officially written to Ethereum’s digital ledger book.

Rollups have special systems in place to prove that the transactions they pass down to Ethereum borrow that main network’s core security apparatus – meaning that if a user makes a transaction on a rollup network, the user can (in theory) take solace knowing that it will be passed down to Ethereum with zero alterations.

Arbitrum’s spot at the top

Arbitrum was the first Etheruem rollup network to launch, and it remains the largest by far in terms of transaction volume and the value of crypto locked into its ecosystem. According to L2beat, a website that tracks Ethereum’s layer 2 landscape, the chain has $6 billion worth of crypto circulating on it (total value locked, or TVL) and has processed more transactions in the past month than Ethereum itself.

Arbitrum’s primary competitor, Optimism, has a TVL of $1.93 billion and has processed one-third as many transactions in the past 30 days.

Arbitrum’s lead over Optimism expanded significantly last month with the release of ARB – a governance token that can be bought and sold, and grants holders the right to vote on changes to Arbitrum’s ecosystem.

ARB was framed publicly as a way to decentralize the Arbitrum blockchain, moving ultimate control of the chain from its original developers, Offchain Labs, to newly minted ARB token holders. The real reason a project like Arbitrum might launch a token is more complicated than “decentralization,” however.

On the more cynical end, a new token can be a way to reward early contributors without catching the eye of securities regulators: Around half of ARB’s supply went to Offchain’s employees and investors. (Some investor/employee tokens were subject to lockup periods, similar to how traditional companies may delay the delivery of equity to prevent an immediate sell-off.)

But beyond rewarding contributors or bringing Arbitrum more in line with crypto’s decentralized ethos, the ARB token accomplished something before it even existed: It helped grow the chain’s user base.

Arbitrum airdropped a percentage of ARB’s circulating supply to existing users of the chain – a welcome surprise to many, but a long-awaited payday for those who had only ever used Arbitrum to “farm” for potential ARB tokens.

Using an airdrop – or the prospect of one – to attract users can be like walking a tightrope. If done wrong, mercenary airdrop farmers will just sell their new tokens and move on to other soon-to-tokenize chains.

By all early measures, Arbitrum seems to have done a good job of retaining users since the ARB token launch. Though there was a sharp rise and steep drop in network activity around the time of ARB’s release, it’s now been around a month since the ARB airdrop, the chain now processes around 35% more transactions per second than it did before ARB was announced.

Arbitrum’s success with ARB contrasts with the blunder that was the OP airdrop – the token launch for Optimism. Both networks faced technical challenges and scored some own-goals in the execution of their airdrops, but the Optimism token price plummeted in the month after it launched, whereas Arbitrum’s has stayed somewhat stable. A month after the Optimism airdrop, moreover, activity levels on the chain were similar to where they were before the drop – hinting that OP may not have helped much in terms of retaining new users.

One argument for why ARB has so far succeeded where OP struggled may be that Optimism deployed its token prematurely.

Nansen, a crypto analytics firm, helped Arbitrum set the parameters for its airdrop. According to Nansen research analyst Yohji van Weert, “Arbitrum did it better than Optimism in the sense that they already had a very mature ecosystem” when it announced ARB. By contrast, says van Weert, Optimism – which came out around the same time as Arbitrum but released its token nearly a year earlier – “was at a pretty early stage when they released their token” and struggled to retain users as a result.

ZkEVMs take center stage

Arbitrum may be the current frontrunner in Ethereum’s rollup race, but its spot at the top of the layer 2 hierarchy may not last for long.

Most watching Ethereum’s rollup race have moved beyond optimistic rollups like Arbitrum and Optimism towards their fancier new cousins – zkEVMs. ZkEVMs (Zero-knowledge Ethereum virtual machines) are an up-and-coming type of rollup that operate with the same bundle-and-settle principle as Optimistic rollups but use zero-knowledge cryptography to power their security.

Read more: The Sudden Rise of EVM-Compatible ZK Rollups

ZkEVM tech is at an earlier stage of development than Optimistic tech, but zkEVM builders such as Matter Labs and Polygon have already launched beta versions of their ecosystems to plenty of community hype.

After months of public posturing and social media spatting by their CEOs regarding which company would be “first” to market, zkSync surged decidedly ahead of Polygon zkEVM when the platforms opened to users within days of one another. Today, there is $240 million circulating inside of zkSync Era’s ecosystem and just $5 million in Polygon zkEVM.

Matter Labs will say that zkSync’s success comes from superior technology. But Polygon’s tech, by all early measures, is nothing to scoff at. “It’s very easy to deploy a contract” on Polygon zkEVM, van Weert explained. “It’s almost as simple as on Ethereum.”

The problem for Polygon is with incentives. “Most of the capital is flowing into zkSync,” explained van Weert, “mainly because of the airdrop speculation.” The ARB airdrop “led to a lot of capital rotating from Arbitrum to zkSync in hopes of a potential airdrop, whereas Polygon – they already have a token.”

ZkSync is expected to eventually distribute a token. In interviews and public statements, Matter Labs – like Offchain ahead of the ARB airdrop – won't confirm or deny if a zkSync token is coming. Polygon, however, already has the MATIC token, which powers its older Polygon PoS blockchain.

ZkEVMs beyond zkSync and Polygon

Van Weert named three factors that can determine the success of a rollup: First, he says, the chain is “not tokenized yet.” Second, it begins “onboarding widely recognized protocols at a very early stage.” And third, “the developer experience should be very smooth.”

“Once there are good protocols, the users will follow,” van Weert said.

The zkEVM race doesn’t end with zkSync and Polygon. The Ethereum research and development firm ConsenSys is building a zkEVM, as are a handful of other startups. If any is to attract the users needed to compete with Arbitrum and Optimism, it will need to add blue-chip decentralized finance apps like Uniswap (which has committed to deploying on Polygon zkEVM) and Aave (which seems poised to launch on zkSync).

One yet-to-tokenize, yet-to-launch zkEVM protocol to keep an eye on, according to van Weert, is the zkEVM startup Scroll – which has yet to deploy on Ethereum’s main network but has partnered with some big-name protocols. “They already have a very mature ecosystem on their testnet, whereas on zkSync it is lacking. I mean, the capital is there, but a lot of people are sort of sidelined on zkSync because they have already bridged their funds over, but there isn't enough to play around with right now.”