Ethereum's L2 Dilemma: Value Accrual Challenges and Bitcoin's Uncertain Future

In a recent episode of the Unlayered podcast, hosts Sal and Dave engaged in an insightful discussion with crypto analyst @0xBreadGuy about the current state and future prospects of Ethereum, its Layer 2 (L2) scaling solutions, and Bitcoin's long-term viability. The conversation delved deep into the complexities of blockchain scaling, value accrual, and the potential shifts in the cryptocurrency landscape.

The L2 Conundrum: Savior or Parasite?

The discussion kicked off with a critical examination of the relationship between Layer 1 (L1) blockchains and their Layer 2 solutions, with a particular focus on Ethereum. The central question posed was whether L2s are beneficial or detrimental to their parent L1 chains.

@0xBreadGuy offered a nuanced perspective, suggesting that the parasitic nature of L2s is not inherent but rather a result of messaging fumbles by settlement layer blockchains. He explained:

"L2s will come everywhere. And you see like, I've been pushing back pretty hardly against, 'cause I guess there's the parasitic label, but I don't think the parasitic label is a structural thing with L2s. I think the parasitic thing becomes a reality whenever it is an explicit messaging fumble by a settlement layer blockchain."

The analyst pointed out that when there's a 100% overlap in user applications between L1 and L2, and users are actively pushed towards L2s, it can lead to a situation where the L1 loses execution, user relationships, and ultimately, value accrual.

The ETH Value Accrual Dilemma

One of the core issues discussed was Ethereum's ongoing search for a credible value accrual narrative. The concept of ETH as "ultrasound money" was critically examined, with @0xBreadGuy suggesting that while it may have some memetic value, it's not necessarily sustainable or required for Ethereum's survival.

"Is it required? No, you probably need if they want it to be a money, probably needs a little bit of inflation needs to have a loss. It needs to be whatever, but is it good, memetically? And does it drive price valuation, which ultimately, you know, add security to the network? Yeah, probably a little bit."

The conversation highlighted the challenge Ethereum faces in maintaining its position as a top smart contract platform while potentially losing value to L2 solutions that capture most of the economic activity.

Data Availability: A Crucial Piece of the Puzzle

A significant portion of the discussion revolved around the importance of data availability (DA) in the L2 ecosystem. @0xBreadGuy argued that people might be overestimating the premium nature of Ethereum's block space and underestimating how shrewd L2s will be in cutting costs.

"I think people over index on how awesome Ethereum is block space, the state of everybody is. And I think, and how shrewd L2s will be in cutting their bottom line down because they are a business and they have almost a fiduciary duty to be like mindful of the money that they spend to make sure that they can prop up and, you know, their ecosystem has been safe and whatever."

This insight raises questions about the long-term sustainability of Ethereum's role as the primary data availability layer for L2 solutions, especially if cheaper alternatives become available.

The One-Sided Relationship Between L2s and Ethereum

An intriguing point raised during the podcast was the potentially one-sided nature of the relationship between L2s and Ethereum. @0xBreadGuy highlighted how L2s have significant control over when and how they interact with the Ethereum mainnet, often prioritizing cost-efficiency over consistent usage of Ethereum's block space.

He provided an example of how L2s adjusted their behavior during periods of high fees:

"So like we're seeing that these L2s would coordinate with each other. They will avoid posting. They will do things. They will automate things. They will make it intelligent to avoid a high fee environment for themselves because their businesses, of course, they'll do that."

This dynamic raises concerns about Ethereum's ability to consistently generate fees from L2 activity, potentially impacting its value accrual mechanisms.

The Future of L2 Development

When discussing which L2s developers should focus on, @0xBreadGuy emphasized the importance of user adoption and liquidity. He suggested that developers should consider the distribution effects and user base when choosing an L2 to build on.

"Developers want users, right? I mean, I think ultimately. They want users and money. They want users and money. I've, I've built apps like it's fucking sucks to build it in a hollow, dead ecosystem."

The conversation highlighted Base, Arbitrum, and potentially Blast as promising L2 options for developers, with Base's connection to Coinbase providing significant distribution advantages.

Reasons to Remain Bullish on Ethereum

Despite the challenges discussed, the podcast explored potential reasons to remain optimistic about Ethereum's future. The recent discussions from Ethereum developer Max Resnick about scaling the L1 were noted as a positive development.

Dave commented:

"And to be honest, it's the first time I felt slightly bullish about Ethereum and a long, long time. I'm not there yet, but if they did continue down that path and if it really, there was a ground swell of support to scale the L1, because a lot of change can happen even just like updating the software and making it more efficient and obviously getting the hardware up to, you know, a reasonably mid-range model from a couple of years ago, it doesn't feel like too much of a stretch."

This potential shift in Ethereum's scaling strategy could address some of the concerns raised about L2 value capture and help Ethereum maintain its competitive edge.

The Commoditization of Data Availability

An important theme that emerged during the discussion was the potential commoditization of data availability services. @0xBreadGuy argued that as L2s grow and require more throughput, they might be forced to look beyond Ethereum for their data availability needs.

"At some point, they will literally have to move DA off to an all DA system, right? Mega-eathe specifically cannot launch with Ethereum because the throughput is so high that Ethereum could not consume the amount of data."

This trend could lead to a diversification of data availability providers, potentially challenging Ethereum's role as the primary settlement layer for L2 solutions.

The End-State Architecture for L1s

The podcast touched on the potential end-state architecture for Layer 1 blockchains. Dave proposed a model similar to Cosmos but with a focus on creating a massive, decentralized central hub with high throughput, surrounded by numerous app-specific chains.

"I think it's going to look something like cosmos, um, except rather than building out the, uh, sort of interoperability layer and all the apps that are tying into the central hub instead, the focus should be what Solana is doing of just create this enormous central hub. Very, uh, very decentralized, but also with incredibly high throughput."

This vision aligns with Solana's approach of maintaining a single, high-performance state while allowing for specialized solutions to build on top of it.

The State of the Crypto Market

The conversation shifted to the current state of the cryptocurrency market, with @0xBreadGuy noting the uncertainty surrounding the upcoming U.S. election and its potential impact on crypto prices. He emphasized the long-term growth of demand for block space as a fundamental driver for the industry.

"I just know that the industry itself, like the global demand for block spaces is only going to go up. Now, whether it goes in Ethereum or goes in Solana or goes in Bitcoin or whatever, like TBD."

The discussion highlighted the cyclical nature of crypto markets and the potential for new catalysts to reignite interest and drive adoption.

Is Bitcoin a Special Snowflake?

One of the most controversial topics discussed was the long-term viability of Bitcoin. @0xBreadGuy expressed skepticism about Bitcoin's ability to maintain its dominance, citing concerns about its lack of programmability and potential security issues as block rewards diminish.

"It's going to get flipped by a smart contract platform, whether that's Ethereum or Solana or some gen three, four, five that we don't even know what's out yet. It's coming down."

He argued that without sufficient fee generation or programmability, Bitcoin might face significant challenges in maintaining its security and value proposition in the long run.

The Rise of Solana and Alternative L1s

While much of the discussion focused on Ethereum and Bitcoin, the conversation also touched on the potential of alternative Layer 1 blockchains, particularly Solana. @0xBreadGuy expressed admiration for Solana's approach to scaling and maintaining a unified state.

"Solana scaling at its pace, trying to scale further. But even in that, that paradigm, you have Zeta markets, you have grass, you have all these other things that are like talking about L2s on Solana, which is fine. But Solana is saying like, that's cool. It's additive. You guys are doing your niche thing, but we're like, we have the single state dominion and we can, we're going to continue to do that."

This perspective highlights the potential for alternative L1 solutions to address some of the challenges faced by Ethereum while maintaining a more straightforward scaling approach.

The Importance of User Experience and Adoption

Throughout the podcast, the importance of user experience and adoption was repeatedly emphasized. The hosts and guest agreed that ultimately, the success of any blockchain platform would depend on its ability to attract and retain users.

@0xBreadGuy noted:

"Devs care, right? Because I think they're like, there's cyberpunk credit. They want the values. They have all this up. devs find out users don't care. Devs don't care. That's the waterfall every time."

This insight underscores the need for blockchain platforms to balance technical considerations with user-friendly design and practical utility.

The Role of Meme Coins and Market Sentiment

The discussion touched on the recent cooling of the meme coin market and its impact on overall crypto sentiment. While acknowledging the current bearish mood, the participants noted the potential for rapid shifts in market sentiment driven by news or innovative developments.

"It's only going to take one or two stories. Like you just need something interesting to come forward or some big bullish news or some major fund to say like, you know, Russia's buying fucking Bitcoin and a hundred million a clip, whatever. And everyone's just getting excited again."

This observation highlights the volatile and reactive nature of the cryptocurrency market, where sentiment can shift rapidly based on external factors and emerging narratives.

The Potential for Chain Abstraction

An interesting topic explored during the podcast was the concept of chain abstraction, where users interact with multiple blockchains seamlessly without needing to understand the underlying technical details. While acknowledging the potential benefits, @0xBreadGuy expressed skepticism about the practicality and security implications of such abstraction.

"I find the abstract, like, because like the common argument is like, oh, no one knows if your website uses Azure versus AWS, right? Of course we're going to abstract the way this shit. And for me, I have a problem with that because we're building a system that's fundamentally built on security and sovereign ownership of your assets, right?"

This perspective raises important questions about the balance between user-friendliness and maintaining the core principles of blockchain technology, such as security and decentralization.

The Evolution of L2 Incentives

The podcast delved into the evolving incentives for L2 solutions and the potential for some to transition into independent L1 chains. While @0xBreadGuy acknowledged the possibility, he argued that the current profitability of being an L2 might discourage many from making such a transition.

"I will push back on L2 is becoming L1s because I think it's so fucking profitable to be an L2. I get such a great business model. Like if you can capture it, they, it's like why, well, like to go the progress going from L2 to L1 is like, okay, I have to spin up a validator set."

This insight highlights the complex economic considerations at play in the L2 ecosystem and the potential for long-term stability in the current L1-L2 relationship.

The Impact of ETFs and Institutional Adoption

The conversation touched on the recent launch of Bitcoin ETFs and their potential impact on the broader cryptocurrency market. While noting some initial challenges, the participants saw these developments as a positive sign for increased institutional adoption and exposure to traditional capital markets.

"We have that there, right? It's it's this huge massive thing that we've been looking forward to for 10, 15 years that has exposure to the remainder of traditional capital. And like now that's there, we have that on rapid should things happen."

This development was seen as a potential catalyst for future growth and adoption in the cryptocurrency space.

The Global Adoption of Cryptocurrencies

An interesting anecdote shared during the podcast highlighted the growing global adoption of cryptocurrencies, particularly in unexpected places. The example of Georgia using Tron for everyday transactions was cited as evidence of the real-world utility and adoption of blockchain technology.

"So like, yeah, there's green shoots. Just trying to get nothing to always get to you and all the I went chewing in each other's legs because they lost 20 grand on a meme coin or whatever."

This observation underscores the importance of looking beyond price action and market sentiment to gauge the true progress of cryptocurrency adoption and utility.

The Role of Solana in the Evolving Crypto Landscape

While much of the discussion focused on Ethereum and Bitcoin, Solana emerged as a promising alternative in the evolving cryptocurrency landscape. @0xBreadGuy expressed admiration for Solana's approach to scaling and maintaining a unified state, highlighting its potential to address some of the challenges faced by other platforms.

"Solana scaling at its pace, trying to scale further. But even in that, that paradigm, you have Zeta markets, you have grass, you have all these other things that are like talking about L2s on Solana, which is fine. But Solana is saying like, that's cool. It's additive."

This perspective suggests that Solana's strategy of focusing on L1 scalability while remaining open to complementary L2 solutions could position it well for future growth and adoption.

The Importance of Sustainable Fee Generation

A recurring theme throughout the podcast was the critical importance of sustainable fee generation for blockchain networks. @0xBreadGuy emphasized that living systems need fees to maintain decentralization and security.

"These are living systems that need fees. You need fees to sustain a decentralized network. And if you lose that, and you don't have fees from ordinals because it's not programmable, you don't have fees from actual transactions because it's not, it doesn't have the capacity to do fucking anything. Where is the fees going to come from?"

This insight underscores the need for blockchain platforms to develop robust economic models that can sustain their networks over the long term.

The Potential for Paradigm Shifts in Blockchain Architecture

The podcast explored the potential for significant paradigm shifts in blockchain architecture, particularly in how Layer 1 and Layer 2 solutions interact. The hosts and guest discussed the possibility of new models emerging that could reshape the current understanding of blockchain scalability and interoperability.

Dave proposed:

"I think it's going to look something like cosmos, um, except rather than building out the, uh, sort of interoperability layer and all the apps that are tying into the central hub instead, the focus should be what Solana is doing of just create this enormous central hub."

This vision suggests a future where highly scalable and decentralized Layer 1 platforms serve as the foundation for a diverse ecosystem of specialized applications and services.

The Role of Innovation in Driving Adoption

Throughout the discussion, the importance of continuous innovation in driving cryptocurrency adoption was emphasized. The participants noted that while market sentiment can be cyclical, genuine technological advancements and novel use cases have the power to reignite interest and attract new users to the space.

"It's only going to take one or two stories. Like you just need something interesting to come forward or some big bullish news or some major fund to say like, you know, Russia's buying fucking Bitcoin and a hundred million a clip, whatever. And everyone's just getting excited again."

This observation highlights the dynamic nature of the cryptocurrency ecosystem and the potential for rapid shifts in sentiment and adoption driven by innovation.

The Challenges of Predictive Analysis in Crypto

The podcast touched on the difficulties of making accurate predictions in the fast-moving world of cryptocurrency. @0xBreadGuy acknowledged the challenges of timing market movements and technological developments, emphasizing the importance of focusing on fundamentals and long-term trends.

"To be honest, like, I'm not much of a trader. It's hard for me to express to people like how, how unfocused I am on or how much brain space dollars, like the cost of the currencies, uh, takes up in my day to day."

This perspective serves as a reminder of the inherent unpredictability in the crypto space and the value of maintaining a long-term outlook.

The Potential for Cross-Chain Innovations

While much of the discussion focused on individual blockchain platforms, the potential for cross-chain innovations and interoperability solutions was also explored. The participants discussed how advancements in this area could lead to new possibilities for scalability, liquidity, and user experience across the crypto ecosystem.

This exploration of cross-chain potential highlights the ongoing evolution of the blockchain space and the opportunities for innovative solutions that bridge different networks and technologies.

The Impact of Regulatory Developments

The podcast briefly touched on the potential impact of regulatory developments on the cryptocurrency market, particularly in relation to the upcoming U.S. election. While not delving deeply into specific regulatory issues, the discussion acknowledged the importance of regulatory clarity in shaping the future of the crypto industry.

This recognition of the regulatory landscape underscores the complex interplay between technological innovation, market dynamics, and government oversight in the evolving world of cryptocurrencies.

Conclusion: A Dynamic and Evolving Landscape

As the podcast discussion demonstrated, the cryptocurrency landscape is in a constant state of flux, with new challenges and opportunities emerging regularly. From the ongoing debate about Ethereum's scaling strategy to the long-term viability of Bitcoin and the rise of alternative Layer 1 solutions like Solana, the industry continues to evolve at a rapid pace.

While uncertainties remain about the future dominance of any single platform or technology, the overall trend towards increased adoption, innovation, and integration of blockchain technology into various aspects of the global economy seems clear. As the space continues to mature, it will be crucial for developers, investors, and users alike to stay informed about the latest developments and to critically evaluate the strengths and weaknesses of different approaches to blockchain scalability and value accrual.

Ultimately, the success of any blockchain platform will likely depend on its ability to provide tangible value to users, maintain security and decentralization, and adapt to the changing needs of a global user base. As the conversation between Sal, Dave, and @0xBreadGuy illustrated, the path forward is likely to be complex and multifaceted, requiring ongoing innovation, collaboration, and critical analysis from all participants in the cryptocurrency ecosystem.

Facts + Figures

• Ethereum's L2 solutions are facing challenges in contributing to ETH value accrual, with some questioning their long-term benefit to the L1.
• Data from before the Dencun upgrade showed L2 profit margins in the 40-60% range, now exceeding 90% post-upgrade.
• Justin Drake estimates that in the future, 99% of transaction fees will come from data availability, with only 1% from MEV.
• Ethereum is projected to potentially process 10 million transactions per second on L1 with existing hardware, according to Justin Drake.
• The cost per transaction on Ethereum L1 is estimated to be about a tenth of a cent in the future scaling scenario.
• Some L2s, like Scroll, have completely turned off posting to Ethereum during high fee periods to avoid costs.
• Base (Coinbase's L2) has plans to increase throughput weekly for the next 40 weeks until reaching "one giga gas."
• Arbitrum and Base are currently the top-ranked L2s based on a blend of TVL, addresses, and DEX volumes.
• The global adoption of cryptocurrencies is evidenced by examples like Georgia using Tron for everyday transactions.
• Bitcoin ETFs have recently launched, marking a significant step towards institutional adoption of cryptocurrencies.
• @0xBreadGuy predicts Bitcoin could be flipped by a smart contract platform within 5-7 years.
• The podcast discusses the potential for Ethereum's block space to become overpriced compared to alternative data availability solutions.
• L2s are demonstrating the ability to coordinate and adjust their behavior to avoid high fee environments on Ethereum.
• The concept of chain abstraction, where users interact seamlessly with multiple blockchains, is being explored but faces challenges in balancing user-friendliness with security.
• Solana is highlighted as an example of a blockchain focusing on L1 scalability while remaining open to complementary L2 solutions.

Questions Answered

What are the main challenges Ethereum faces with its L2 scaling strategy?

Ethereum's L2 scaling strategy faces several challenges, primarily centered around value accrual for the ETH token. As more activity moves to L2s, there's concern that these solutions may not contribute significantly to Ethereum's fee generation and overall value. Additionally, L2s have shown the ability to coordinate and avoid high fee periods on Ethereum, potentially reducing the revenue Ethereum receives from settlement.

How does the concept of Ethereum as "ultrasound money" hold up under scrutiny?

The concept of Ethereum as "ultrasound money" is questioned in the podcast. While it may have some memetic value and contribute to price appreciation, it's not seen as essential for Ethereum's survival or success. The discussion suggests that a small amount of inflation might be more appropriate for a currency, and that the focus on deflationary mechanics might be overshadowing more important aspects of Ethereum's value proposition.

What are the potential risks to Bitcoin's long-term dominance in the cryptocurrency space?

The podcast highlights several potential risks to Bitcoin's long-term dominance. These include its lack of programmability compared to smart contract platforms, concerns about sustainable fee generation as block rewards diminish, and the potential for security issues if mining becomes unprofitable. @0xBreadGuy predicts that Bitcoin could be overtaken by a smart contract platform within 5-7 years, citing these factors as major challenges to its continued dominance.

How are Layer 2 solutions impacting the value accrual of Ethereum?

Layer 2 solutions are having a complex impact on Ethereum's value accrual. While they help scale the network, there's concern that they may be capturing too much value at the expense of the base layer. L2s have shown the ability to avoid high fee periods on Ethereum and may increasingly look to alternative data availability solutions, potentially reducing the fees and value flowing back to Ethereum. This dynamic is challenging Ethereum's current value accrual narrative.

What role does data availability play in the future of blockchain scalability?

Data availability is becoming increasingly crucial in blockchain scalability discussions. The podcast highlights that as L2 solutions grow, they may require more data availability throughput than Ethereum can provide. This could lead to the use of alternative data availability solutions, potentially challenging Ethereum's role as the primary settlement layer. The commoditization of data availability services could significantly impact the economics and architecture of blockchain scaling solutions.

How might the crypto landscape evolve in terms of Layer 1 and Layer 2 relationships?

The podcast discusses potential evolutions in the relationship between Layer 1 and Layer 2 solutions. One vision presented is a future where highly scalable and decentralized Layer 1 platforms serve as the foundation for a diverse ecosystem of specialized applications and services, similar to Solana's approach. There's also discussion about the potential for some L2s to eventually transition to independent L1 chains, although the current profitability of the L2 model might discourage this in the short term.

What are the key factors driving cryptocurrency adoption globally?

Several factors driving global cryptocurrency adoption are discussed in the podcast. These include the development of user-friendly applications, the integration of blockchain technology into everyday transactions (as seen in the Georgia example with Tron), the launch of institutional products like Bitcoin ETFs, and ongoing technological innovations. The podcast emphasizes that genuine technological advancements and novel use cases have the power to reignite interest and attract new users to the space.

How does Solana's approach to scaling differ from Ethereum's, and what are its potential advantages?

Solana's approach to scaling focuses on optimizing the Layer 1 to handle high throughput while maintaining a unified state. This differs from Ethereum's approach of relying heavily on Layer 2 solutions for scaling. The podcast suggests that Solana's strategy of maintaining a single, high-performance state while allowing for specialized solutions to build on top of it could offer advantages in terms of simplicity, user experience, and value accrual. This approach is seen as potentially addressing some of the challenges faced by Ethereum's more complex scaling strategy.