Ethereum Layer 2 Networks Hit 'Critical Mass' as The Merge Approaches

All eyes are on The Merge. When Ethereum’s mainnet joins with the beacon chain Proof of Stake system everything will change — the Proof of Work era will draw to a close and a new period will dawn for the most important blockchain network in DeFi.

Ethereum’s next generation Layer 2 networks are pumping, with their total value locked (TVL) hitting $7B several days after posting a record high of $7.4B on April 2, according to L2beat.

High Speed Transactions

Layer 2s such as Arbitrum and Loopring offer reduced transaction fees and high-speed transactions compared to Ethereum’s Layer 1 mainnet. While fees on Ethereum’s mainnet are notoriously high, simple transfers on L2s tend to cost less than $0.2 to execute and complex smart contracts are priced below $2, according to L2Fees.

The growth signals renewed support for Ethereum’s L2-based scaling roadmap, with L2 sharding comprising one of its major milestones moving after the forthcoming Eth2 chain merge. Ethereum’s current scaling roadmap will culminate in danksharding — when Ethereum’s L2s will execute in parallel as unified shards.

Seraphim Czecker, the head of risk at Euler Finance, told The Defiant that Ethereum’s L2 ecosystem “has reached critical mass to support substantial volumes” and activity.

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The Defiant

“The liquidity locked into DEXes on Layer 2s create a virtual cycle: liquid markets create favorable conditions for lending protocols, liquidations, vaults, etc.,” he said. “This will lead to an explosion of retail volumes as L2s will make DeFi affordable for millions of new users.”

General confidence in Ethereum also appears to be surging ahead of The Merge, with the price of ETH up 43% in three weeks. The bullish market conditions have also prompted deposits to the Eth2 staking contract to spike, with March setting a new record for ETH deposited to the beacon chain.

Arbitrum is leading the L2 charge. It has a TVL of $4.1B after pushing above $4B for the first time on March 31. Arbitrum is up nearly 7% in as many days, and now represents 55% of the combined Ethereum L2 TVL

Network Effects

Rival Optimistic rollup, Optimism, also surged into new all-time highs last week. The network has $682M locked after growing more than 18% in roughly one week.

Darren Langley, general manager of Rocket Pool, an Ethereum staking provider allowing deposits of less than 32 ETH, also told The Defiant that the migration of Ethereum users to Layer 2 has recently “hit a critical masswhere L2s are now benefiting from network effects” in comments to The Defiant.

Deposits to the Eth2 beacon chain’s staking contract have also spiked to record levels in recent weeks.

Data from Dune analytics shows that a record number of Ether was deposited to the beacon chain in March, with more than 1M ETH being sent to the deposit contract.

Monthly ETH deposits to the beacon chain. Source: Dune Analytics

Under Proof of Stake, token holders can participate in processing transactions on Ethereum by locking their coins. They’re called validators.

On April 2, the number of validators that can be initiated on the beacon chain was upped from four to five per epoch (roughly 6.4 minutes), increasing the speed with which validators can onboard or exit. Anthony Sassano, the influential podcast host and Ethereum commentator, noted that nearly 14,000 validators were pending on the same day.

Mainstream Adoption

Langley said that the surging amount of staked Ethereum is partly due to anticipation that these queues will only get longer from now on. “It is anticipated that demand will get stronger and stronger over time,” he said.

“Additionally, we are seeing the start of early mainstream adoption – this year has seen a profound shift in how the mainstream views crypto assets,” he continued. “Staked Ethereum is well placed to capture some of this attention.”

Spencer Noon, the co-founder of Variant, said the recent surge in deposits to Ethereum liquid staking service, Lido, suggests new stakers are joining the beacon chain.

“Until recently most depositors were seemingly techies, ETH heads, and large long-term holders (e.g. ConsenSys) who rolled their own staking solutions. This is new money,” he tweeted.