Are L2s extractive to Ethereum?

[Music] [Music] cool uh thanks for coming um I know it's been a long day uh today I'll be talking about the topic of R l2's extractive to ethereum my talk I'm going to cover three main areas um the first is um on the topic of l2s keeping fees and not paying enough for blobs this is quite a nuanced topic and I'm going to dive into it the second um what I think is a more important question is are L2 is generating eth denominated activity in terms of eth being used as a gas token eth being used as an asset and has it generated new holders of eth and I think the the third topic that I'm going to touch on is what is that dynamic between l2s and ethereum so if you go on crypto Twitter if you read forums blog posts Etc one of the most popular narratives is l2s are keeping the fees that they're generating and they're not paying enough for blobs and you can kind of see this when you look at the margins for layer tws post EIP 4844 going from 20 to 30% margin on on on fees to upwards of 99.99% but I think the Nuance behind this is that blobs are still in the cold start period and what that means is that it is a byproduct of the mechanism of 4844 and David crapus predicted the cold start problem actually last year and he ran a simulation from March 2023 using a assumptions from the transaction volume on arbitrum and optimism at that time and it would take roughly 250 kilobytes per block to get into price Discovery for for blob pricing that's roughly 1.8 gigabytes per day um and in some of the later charts what I'll show you is that we're basically there on average per day but not yet on a block byblock basis and actually there have been some notable periods when blob pricing has gone into price Discovery um this is an example from earlier this year which shows the blob fee breakdown between blob space fees and execution fees during the layer zero airdrop and you can see that for a period of roughly 1 to two hours blob fees actually dominated compared to the execution fees and actually actually most more recently blobs have been getting really really close to the Target amount of blobs past which The Blob pricing would go into price Discovery and you would see this drastic increase in the cost of blobs uh faced by the l2s but one of the interesting Dynamics behind this is that layer twos are fundamentally businesses um and when you see a fee SP like for blob pricing um we tend to see that layer 2os actually start to uh slow down the pace that they post blobs in order to dodge these high high Spike moments another way to see this is through the distribution of blobs per block so the gray color um are blocks with no blobs um these are kind of these blocks serve as a temporary buffer where for for instance you might have a day where the total amount of data posted might imply that the blob fees should go into price Discovery but if you uh but that mechanism is actually triggered on a block byblock basis but we're we're going from a world where half of the blocks had no blobs to a world where only 20 to 30% of the blocks have no blobs and and the same is true on a capacity basis so in the summer of 2024 uh roughly roughly 20 to 30% um of the data capacity in terms of bytes um was unused and now we're approaching a period where only 10 to 20% is unused and overall blobs inflow per day are quite healthy they're actually well above the 1.8 gigabyte Target um through which if that were true block by block blob fee pricing would go into price Discovery um um so I think we're actually well on our way to that so now that I covered some of the nuances be behind the blob fee market and that it's not necessarily a byproduct of the l2s not wanting to pay for blob storage it's more that the way that the mechanism is designed um is what uh is precipitating what we're seeing um for the blob fees at the moment um so the second topic I want to dive into which I think is the more important topic is are l2s generating activity and usage of eth the asset so if you look at L2 beat um and various block explorers I'm sure everyone has seen a chart that looks something like this where the L2 activity has grown tremendously over the past year going from around 50 TPS um up to 170 180 TPS across the l2s but l2's usage of eth as a gas token has only grown modestly due to lower L1 settlement fees despite higher activity that's partially contributing to things like lower burn a lot of uh concern from the community um but again this is more of a byproduct of the mechanism of 4844 and less about any nefarious intention but I thought this chart was actually pretty interesting so if you zoom out and you look at the collective fees in terms of eth being used as a gas token and you compare that to uh the gas fees used on mainnet you can barely see the L2 line um which is great for users in that they're transactions are quite cheap um but potentially some concern um around the security of of main net on the flip side the el2 usage of eth as an asset has grown tremendously so what we see here is a chart of the total value locked stacked by type uh the purple on top is a canonical bridg e um and that's just gone uh pretty much up only since since l2's launched so in summary to cover the first half of the talk in terms of the current state there is not enough L2 blob demand to consistently get blob blob space into price discovery that requires consistently block by block um l2's consistently posting blob blobs in order to trigger the price Discovery mechanism behind 4844 but think think we're almost there blob pricing today is currently in a bootstrapping period it has shown periods of price Discovery this is known it's been posted on the eth research forums in 2023 there's nothing inherently wrong with the network or or the way that the pricing is working and it's actually approaching data inflow levels that would actually start to trigger and begin price Discovery um and looking at activity on the l2s we do see a lot of new usage of e as an asset in terms of being used in staking protocols in Defi and Etc but very minor usage of eth as a gas token relative to main net so the second half of my talk I'm going to talk about the dynamic between l2s and ethereum so at the limit l2s and mainnet appear symbiotic Tim Tim Robinson had a great post um and he actually built this really great calculator where he shows that he's showing a scenario under which ethereum um for ethereum's blog Market post surge um so what this shows is a simulation for 10,000 TPS across l2s which is pretty feasible and reasonable I think 16 megabytes of blobs per block and that would imply a 6.5% yield on eth given some reasonable user price sensitivity assumptions so what that means is is when the transaction fees go up uh a smaller percentage of the users are willing to transact at that price because they might be sensitive to higher transaction fees but I think where we are in reality is here where um we're at this temporary lull where the L2 fees are very low and we're in a period where we're probably most likely going to exit the bootstrapping period of blob pricing and we we'll like see a period where the LT fees tick up so for example in this scenario here um this uses the current specifications for based on 4844 um in this scenario it assumes five rollups 300 TPS per rollup the same user price sensitivity assumptions and what you can see in this chart and I think the interesting line to call out um is the green line which is the actual TPS um that reflects user Sensi user sensitivity to higher transaction fees and in my opinion five rollups and 300 TPS if you look at the number of projects kind of in the pipeline that is uh pretty doable in terms of what we might expect to see over the next year um and what we can actually see in this chart is it implies that the ethereum blob Market could potentially serve as a constraining factor on the ability for these rollups to increase their throughput and increase activity so in terms of in terms of the question are l2s extractive I think I think the question is actually very nuanced and is actually quite complicated and I think the true answer is that we don't actually know and I think there are three reasons for that the first is the L1 settlement fees have never actually been high enough to test ethereum's Network effect so what that means is we've never actually seen a scenario where l2s have been faced with increasing L1 settlement fees so we're really uncertain about how the l2s might react in that type of scenario whether they might look to an alternative da solution whether they might uh be forced to decrease their margins whether they might um potentially even become an L1 on their own so I think that first scenario we've never actually really seen that in practice so we don't we don't really want to impose that judgment um upon the layer twos so the second point is that there's a there's a lot of value for for l2s being l2s and I think um Beyond just the label of what people might say oh like I'm going to launch an L2 on top of ethereum what they actually get is quite a lot so imagine having to write your own block Explorer your own virtual machine your own smart contract programming language recruiting developers to learn your smart contract developing uh language um and I think the reality is that the l2s are relatively new and because they are relatively new they benefit tremendously from being able to bootstrap their virtual machine tooling developers users Community assets from ethereum and even in terms of applications as well and I think the third reason why we don't actually know whether l2s are extractive today is that most of the analysis in terms of even Tim Robinson's dashboard um tends to assume that you have n equal siiz l2s um which one might consider the current state because we're kind of In This Moment In Time where there isn't a clear breakout L2 winner and whether you look at tvl whether you look at transactions whether you look at number of wallets whatever metric you look at generally you tend to see fluctuating periods where you have three dominant l2s and they're all splitting market share at different points in time um and I think and I think that type of analysis and thinking about the current state is probably not likely to hold into the future so it doesn't really consider the case where you have one or two l2s that take 80 to 90% of activity and and and economic value whereas the remainder have marginal economic activity and I think this is actually a really important case and scenario to think through because when you look at these Financial networks generally you do tend to see Power law effects and I think the scenario in which you have one or two very dominant l2s the question about where does where does the market power and The Leverage between the twos and mean that at what point might that flip um and I think probably more work has to be done on that side so in in the final few minutes here I want to talk about some of the hypothetical conditions uh where l2s could become more attractive more more um so so the first is um about if the L1 has limited transaction processing capability um and I think this is important because I think first off the economic situation of e the asset could become more risky if the if if the amount of fees that are being generated on Main net um are not high enough to uh ensure that a large portion of the network ends up being staked I think l2s also tend to benefit from highly developed Financial system on the L1 um and I think the second scenario which I talked about a bit earlier is the case where you have a power law effect for L2 so for example a dominant L2 would be the majority blob purchaser and with very clever batching they could potentially pin blob pricing below price Discovery that's actually happening organically today so if you look at how the l2s behave in periods where blob pricing does Spike we're already seeing uh behavior that suggest that there willing to spread out how quickly they syn their state across time um and the consequence of that is that users who might want to look for a unilateral exit from the L2 might not be able to do that um if the um if the l2s are being more cautious and doing more optimization about how frequently they post the next hypothetical uh scenario is a case where the incentive structures for L2 tokens or not on E gas tokens become more prominent so if you look at the breakdown of activity on l2s and you look at the split between the l2s that are using eth as a gas token and the L l2s in quotation marks or l3s that aren't using eth as a gas token today that split is actually 50/50 um so I think the the notion that every single rollup necessarily has to you use eth as a gas token we're already seeing some scenarios in which that might not necessarily be the case and I think that's related to one of these other points which is the notion of a siloed L2 with their own settlement kingdoms for l3s or similar types of similar types of rollups that's another scenario in which um the l2s might uh push for an alternative gas token which again would not benefit eth as an asset um and and I think the final point is um potentially uh incentive structures for l2s um in which they start to develop competing security models in terms of being able to use their native governance token for things other than just governance could potentially uh be a condition in which the l2s could also become more extractive um so that concludes my talk um I think it's still ultimately too early to tell in terms of whether the l2s are extractive or not the reason for that is we've never actually seen a scenario in which uh the l2s have been put in a position to make a choice whether they stay as an L2 or they use an Alda layer or they become an L1 or they do something else um but I think that time is actually coming very soon so probably likely over the next one year we'll start to see some of these choices being forced um just by the nature of the blob fees going into price Discovery thanks all right thank You Ren uh you feel free to come to the center over here yeah this one would be fine so let's go over some questions uh let's start from the first one do you think the exact copy of EIP 1559 mechanism determining L1 fees is the right approach for determining blob fees yeah um I think this is a really tricky question um so I think where my mind jumps immediately is I look at the amount of execution that has been moved off of from the L1 to the L2 and the amount of transactions on the L2 today greatly outweigh uh the amount of transactions ever in ethereum's history in terms of like per second or per block um but in terms of the denom or in terms of e being used as a gas token for those transactions um it's actually quite minimal even compared to like the earliest periods in like ethereum's history so I think um one of the things to consider is that that ratio might be slightly off um and I think the only way you really see that settle is blob pricing has to go into price discovery which means there needs to be more l2s and that will likely happen over the next year cool and another question currently the L2 mainten n seems symbiotic but what if they started paying fees in their own tokens they have a fair amount of incentive to keep assets logged in their system without interoperability yeah um I talked to this point in the last slide about hypothetical scenarios so I think some of the highest forms of risk um are exactly that so for example l2s in their current State as having their tokens as a governance token it's highly likely that's it's probably more likely that changes in the future then stays the same so I think that is a that is a very real risk uh have you or others been able to isolate the decrease in L1 execution demand due to real transactions from the reduction in call data demand will L1 execution demand go to zero uh so I don't think L1 execution demand will go to zero um so a chart that I didn't include um just because it's it's a very basic chart is that the transaction the number of transactions on ethereum has actually not gone down and the amount of gas in terms of gas consumed has not gone down it's that the nature of the transactions have changed so um historically the transactions on ethereum had been uh transactions that had a lot more right conflict or right contention and right contention leads to higher fees because people want to um people tend to uh be rushed in terms of those types of transactions so for example like if people are trading uh various forms of assets there's a high degree of urgency that those transactions land um um but most of that activity at the moment at least has has shifted to the l2s perfect and how to prevent a single L2 from eating up all the space or Spotlight AKA base not from the tech perspective but from the marketing public perspective uh yeah so I don't necessarily want to call out a single L2 um but I think uh the hypothetical scenario of an L2 becoming the dominant L2 where 80 to 90% of the economic activity flows through there I think I think that's a very real risk um there hasn't NE I don't believe there's been very many payment networks in the past where you haven't seen a monopoly or oligopoly type of structure just due to the nature of network effects in in these types of financial systems so I think that risk is very real perfect and I think this is a great comment to close off the speech thank you so much