These are the possible solutions

Ethereum has a scaling problem. This has become clear at different times since the beginning of the year: This problem was more noticeable in the first few months. If you wanted to perform a smart contract transaction, like a token swap on a decentralized exchange like Uniswap or Sushiswap, you were in the unfortunate situation that the transaction costs alone sometimes amounted to over US$100.

The reason for this can be found in the so-called blockchain trilemma. According to this, a blockchain must make compromises in terms of security, scalability and decentralization. To put it very simply, developers have to decide which of these two properties they want to optimize for. For example, if you want to provide some level of security, you should be aware that scalability is inversely proportional to decentralization in this case. Comparable to Bitcoin, the Ethereum blockchain has been optimized for security and decentralization while sacrificing scalability.

Figure 1: The triangle shows the three basic properties of a public blockchain, only two of which can be achieved at the same time. Source: SEBA Bank

network congestion

With an increasing number of transactions, the Ethereum network is increasingly used to capacity – if users still want to use the Ethereum blockchain, they are forced to pay excessively high transaction fees. Optimized scaling of the Ethereum blockchain and lower associated transaction fees would lead to increased usability and the development of new use cases. In either case, new users would enter or use the network (see Figure 2).

Figure 2: Relationship between fees and new use cases. Source: Vitalik Buterin, Banque SEBA

compromise of competition

Competing blockchains such as Solana, Avalanche, Polkadot and Co., who like to call themselves Ethereum killers, often optimize in terms of blockchain scaling and accept an increased level of centrality in return. The following graph shows a comparison of transactions per second (TPS):

Figure 3: Comparison of transactions per second of Ethereum and “Ethereum killers”. Source: SEBA Bank

Rollups – the solution to the blockchain trilemma?

If Ethereum wants to keep up with the growing competition, innovations are needed. According to Vitalik Buterin (co-founder of Ethereum), the key to Ethereum’s scaling problem lies in rollups. But what exactly is behind this technology?

Rollups are a scaling solution where transactions are bundled and compressed off-chain before being verified at the consensus layer. Ultimately, multiple transactions can be “summarized” into a single on-chain transaction. The consequence of verifying multiple transactions simultaneously is increased efficiency; At the same time, the number of possible transactions that can be performed increases, resulting in increased scalability.

Suddenly, Ethereum can scale from formerly 15 transactions per second (tps) to over 3000 tps – without having to compromise on security.

Rollup Types

There are two types of aggregates:

1. Upbeat roll-ups use so-called evidence of fraud (used for example by Arbitrum, Optimism)

Optimistic cumulations assume an “optimistic” view of the world. The basic assumption is that the rollup data, i.e. the compressed groups of transactions mentioned above, is correct. Based on this basic assumption, these data are published without verification of their accuracy. Driven by the prospect of a financial reward for discovering a faulty publication, each market player can then use proof of fraud provide evidence that the new data published by an aggregate is wrong. Evidence of fraud is therefore only used when it comes to assessing whether fraud has taken place, i.e. whether incorrect transactions have been posted, for example. As long as there is no dispute, no proof of fraud is required, nor necessary.

Assuming the data is correct increases the likelihood that a rollup will release fraudulent datasets. To avoid this, a dispute period (known as a dispute window) is inserted. If, for example, the parties involved in a transaction suspect errors in the data, they can launch a dispute within this time window.

The longer this challenge period, the greater the likelihood that incorrect data will be prevented from being published on Ethereum Layer 1. Logically, it is directly in the compromise that it takes longer for the transaction to be finalized on Layer1. In practice, this means that it takes up to seven days if you want to withdraw your funds from Arbitrum. Intermediaries can remedy this situation by disbursing the user their funds immediately on Layer1 for a fee and accepting this waiting time and the risk of an incorrect transaction.

If there is a dispute after the rollup is published and the proof of fraud is found to be correct (i.e. the data published by the rollup is incorrect and has been proven by the proof of fraud), all data will be uploaded up to the last known. undisputed whole. This means that all swaps, trades, and other interactions that were in the erroneous stack stack are reversed.

2. ZK aggregates use so called Validity Profs (used by ZKSync, StarkNet, Polygon Hermez)

Validity evidence assumes a “pessimistic” worldview. They are used to prove that a dataset generated by the rollup is correct. Unlike proofs of fraud, proofs of validity are generated with each batch and presented with Layer1 data to prove that all data is correct. This cryptographic proof (called ZK-SNARK) can be easily verified on-chain for its correctness, regardless of the size of the data packet or the computing power required for the transactions it contains. This is where the benefits of stacks come into play; the decentralization is maintained by the fact that a conventional laptop computer, which itself would not have enough computing power to carry out these bundles of transactions, can nevertheless easily verify the accuracy of the result of this on-chain computing power with minimal effort.

Due to the simultaneous existence of the proof of validity, it follows that no challenge period is required here – the transaction receives the finality directly on the Layer1 blockchain (so no 7 day timeout if want to withdraw your funds from Layer2).

The disadvantage here is a loss of efficiency due to the fact that proof of validity must be produced with each cumulation – in contrast, proof of fraud is only produced if the accuracy of the cumulation is disputed.

Ethereum scalability – what next?

Everything indicates that the future of Ethereum scalability lies in rollups. Without a doubt, they are the first and best way within the blockchain industry to achieve mass adoption without having to compromise on security and decentralization at the same time. It remains to be seen how important decentralization really is for end users and the market. Faced with the choice between the abysmal transaction fees on Ethereum Layer 1 and the less decentralized Ethereum killers like Avalanche and Solana with extremely low transaction fees, many investors and retail users opted for the latter option.

In the long term, however, the chances seem good that the decentralized variant will prevail due to its superior properties – it will become dangerous if Layer 2 solutions develop so slowly that new users despite the centrality of these protocols due to the effects of advanced networks because Ethereum killers decide.

However, this chance is relatively small – the ecosystem of protocols available on Ethereum L2 is growing day by day. (see below, for example, dydx or loopring, on which huge volumes are already processed) And unlike Ethereum’s L1, transaction fees do not become more expensive as the number of users increases, but cheaper. One reason is that the more user transactions go into an aggregation dataset, the cheaper it becomes for individual users, as L1 fees can be shared between multiple heads.

So we can not only prepare for a scalable DeFi future, but also for a decentralized future – long live DeFi!

Figure 4: Comparison of transfer and exchange costs of ETH on L2 in pink and Ethereum in white. Source: SEBA Bank

About the authors

Manuel Jungs is a German language researcher Newsletter Insight DeFi. Known for his detailed analyses, he wants to competently and concisely inform a broad mass of people about the events, opportunities and risks of the new decentralized world around Bitcoin and Co. He is also active on Twitter On my way.

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