Layer 2 networks are boosting Ethereum’s DeFi market share amid the downturn.
Arbitrum and Optimism now rank as the fourth and sixth-largest smart contract chains respectively, according to data from L2beat.
The bear market has taken a particularly harsh toll on DeFi, as the total value locked (TVL) in the sector has fallen by 60% in four months.
Low-cost Layer 1 (L1) networks offering cheap transactions and EVM compatibility are among the hardest hit. Despite posting spectacular growth in late 2021 as developers rushed to recreate Ethereum’s DeFi ecosystem without the then-skyrocketing fees, Fantom is down 92%, Avalanche has shed three-quarters of its TVL, and Terra Classic is no more, according to DeFi Llama.
But the promise of low fees and fast transactions has drawn DeFi users to another sector: Ethereum’s Layer 2 ecosystem is surging.
Data from DeFi Llama shows that the TVL of the broader decentralized finance ecosystem stands at $69.5B, down 62% from its December peak of $186B. In contrast, L2beat estimates that Ethereum’s Layer 2s are worth $6.04B, down just 18% from all-time highs seen in May.
Arbitrum Overtakes Avalanche
Arbitrum continues to lead the sector, representing 43.5% of L2 TVL with $2.7B. Although Arbitrum’s TVL is down by a third from its peak, data indicates that the network is $200M larger than Avalanche — making it the fourth-largest smart contract network behind Ethereum, Binance Smart Chain, and Tron.
But Arbitrum’s lead may be short-lived, with rival Optimism’s TVL tripling in the past four weeks to $2.32B. Optimism’s TVL ranks it behind Avalanche and above Solana, with the once-surging Solana network currently hosting just $2.04B of assets.
Aave Attracts Users To Optimism
Optimism’s impressive growth follows the launch of a liquidity mining program last week for Aave’s deployment on the network. On Aug. 4, the leading decentralized money market announced that 5M OP tokens have been allocated to a 90-day program to incentivize Aave users to migrate to the L2.
The campaign is proving to be successful in the short term, with the TVL of Aave v3 on Optimism surging by nearly $500M since August 4. Optimism now hosts the second-largest deployment of Aave v3 with $565M locked, sitting behind Avalanche’s $948M.
Velodrome, the Optimism-native decentralized exchange, also posted impressive growth from $14M at the start of July to $128.5M presently. According to DEX Screener, Velodrome hosts eight of the top ten trading pairs by volume on Optimism, after the exchange overtook Uniswap last month. However, Velodrome’s TVL growth appears to have stalled after $350,000 was stolen from an operational wallet held by the project’s team on Aug. 4.
Arbitrum and Optimism currently represent 80.5% of L2 TVL with their unique versions of optimistic rollups.
Scaling Ethereum With Rollups
Rollups bundle together transactions executed on a Layer 2 network to be submitted in batches for validation on Ethereum’s base layer. Optimistic rollups assume that transactions are accurate but allow network participants to contest them, with validators found to be submitting inaccurate transactions at risk of losing significant collateral. However, users attempting to withdraw assets back to Ethereum’s Layer 1 from an optimistic rollup must wait seven days to allow sufficient time for potential fraud to be detected on the L2.
Optimistic rollups may soon be facing serious competition in the form of rollups powered by zero-knowledge (ZK) proofs. ZK rollups are expected to offer significant speed and privacy benefits over their optimistic counterparts, removing the need for fraud contestation and preventing anyone other than the counterparties in a transaction from accessing detailed data relating to the transaction.
On July 21, development teams from Polygon, Matter Labs, and Scroll separately announced that they are working on ZK rollups offering Ethereum Virtual Machine (EVM) equivalence — meaning that any smart contracts or tooling written for Ethereum can be ported directly onto the Layer 2s.
Optimism also appears to be throwing its hat into the ZK rollup race with its upcoming Bedrock upgrade. Announced in May, Bedrock is tipped to drive significant savings and reduce deposit times from Layer 1 for the already low-cost network, and developer Kelvin Fitcher recently hinted that the upgrade will also be compatible with zero-knowledge proofs.
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