On-chain Analysis of Ethereum and its Layer 2 Ecosystem: IntoTheBlock
CMC Research

On-chain Analysis of Ethereum and its Layer 2 Ecosystem: IntoTheBlock

1 year ago

IntoTheBlock takes a look at the impact of layer 2 solutions on Ethereum's fees and the value of ETH, as developments in the L2 space ramps up.

On-chain Analysis of Ethereum and its Layer 2 Ecosystem: IntoTheBlock

The Ethereum ecosystem has received traction recently with the developing zkEVM environment and the announcement of Base, a new Optimistic rollup built by Coinbase. This article seeks to discuss the impact of layer 2 solutions on Ethereum's fees and the value of ETH. It suggests that while these solutions may result in lower fees, they can still be valuable for ETH holders in the long run. However, in the short term, reduced fees on layer 2 solutions may lead to lower profits for Ethereum, resulting in a less deflationary ETH.

The number of long-term holders, or "hodlers," of ETH has reached an all-time high as they come together to support the cryptocurrency's surge to $1,600.

Source: IntoTheBlock’s Ethereum Analytics

For the first time ever, the quantity of Ethereum held by addresses that have held onto it for one year or more has exceeded 70% of the total amount in circulation. Throughout 2022, this proportion has been steadily increasing, emphasizing the shift from ETH being held by those who are likely to sell quickly to those who are committed to holding it for the long-term. A similar pattern of accumulation has been observed in other assets such as Bitcoin, which indicates that the strong believers group has been growing.

Coinbase recently revealed that it has plans to introduce a new Ethereum layer 2 solution called "Base". This solution is built on Optimism's OP stack and aims to attract over one billion users to the world of cryptocurrency by enabling faster transaction processing and lower fees. In order to grasp the significance of Base, it is beneficial to take a closer look at the current status of Ethereum and the layer 2 solutions that are already in place.

Source: IntoTheBlock’s Ethereum Analytics

There has been a significant increase in fees on the Ethereum network, with average fees reaching the $8 level which had not been seen since June 2022. Although high fees can have a positive impact on burning ETH, they also create a barrier that hinders the mainstream adoption of blockchain applications. At present, basic transactions typically require a fee of around $5 to $10, while the cost of smart contract interactions for dapps can be as much as four times higher.

The limitations of Ethereum's mainnet have been evident for several years, prompting Vitalik to emphasize a rollup-focused roadmap since 2020. Over the past three years, Ethereum has already taken significant steps in this direction.

Data through IntoTheBlock's network indicators and Etherscan

For the first time Layer 2 are recording a higher number of transactions occurring when compared to Ethereum's mainnet ecosystem. This means that there are now more transactions and activity on L2 than on Ethereum’s L1 ecosystem. Although the daily number of transactions on Ethereum's mainnet has been slightly decreasing over the past year, the emergence of Arbitrum and Optimism has compensated for this decline and even surpassed it.

In 2022, the average number of transactions for both Optimism and Arbitrum increased by over four times their previous amount. Just recently, we achieved a new record high as Arbitrum alone processed over 1 million transactions in a single day, and the combined number of transactions between Ethereum, Optimism, and Arbitrum reached 2 million. The development of a roll-up focused Ethereum ecosystem has been developing for some time now and could gain momentum with future launches like Base.

When on-chain activity shifts from L1 to L2s, it will involve a trade-off between a reduction in revenue (fees) and an increase in the number of users. If economic activities were to shift to L2s that are more efficient in terms of gas, the total amount of ETH spent on fees would immediately decrease. It's worth noting that despite processing more transactions, L2s only accounted for 4% of all ETH fees during last week.

As accessibility increases, it should attract more ETH holders and users of Ethereum applications. Currently, there are 87 million addresses holding ETH on the mainnet, while only 3 million addresses are present in both Arbitrum and Optimism. As technology advances and enables a more straightforward onboarding process into an Ethereum L2 rollup, these numbers are expected to grow and potentially even surpass those holding Ether on mainnet.

In the future, if the expected increase in usage actually happens, total fees could rise back up to their current levels even if most transactions occur on layer 2 solutions. However, in the short term, layer 2 solutions are likely to result in reduced profits for Ethereum, leading to a less deflationary ETH. Although Base and other layer 2 solutions may result in reduced fees, the increased adoption signals a positive outlook since they can provide benefits like mass adoption.

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