ETHEREUM LAYER 2S: POTENTIAL FOR $1T VALUATION BY 2030 SAID VanECK

INTRODUCTION
Layer 2 is often praised for its ability to increase the throughput of the Ethereum network. However, the metric we're most interested in is cost per throughput. Using Ethereum's first layer can become comically expensive as we try to push its limits. Even with the 64x increase in gas limit on the beacon chain, it's tough to say whether we'll see the chain run at 64x capacity. That and the fact that 64x what it already does is likely still nowhere near enough for the needs of global scaling. In which case, having solutions that allow us to leverage the security of the Ethereum base layer, while getting more than 64x bang for our buck is very desirable.
A lower cost per throughput is something that can be a reality with layer 2. If we are able to have enough throughput on layer 2 such that an individual or company never has to transact on the first layer, it has the effect of making Ethereum more cost-effective for small transactions and essentially reserves its security and decentralization for high-value transactions. L2 can also allow for consumers to do price arbitrage between non-custodial and custodial services to get the best settlement rate for moving funds between different chains. As of right now, the only real way to push the cost per throughput below what an optimally gas-priced transaction on layer 1 would cost is to increase the gas limit and thus increase the total cost for any given amount of throughput.

More complex or expensive scaling solutions can be viable if they still save money per operation compared to using the first layer. Either way, the possibility to reduce gas usage relative to the amount of activity on Ethereum is something that consumers and developers both stand to benefit from. This is an increasingly important optimization in light of concerns for the increasing file size of the Ethereum state trie.

Ethereum Layer 2s refers to a host of solutions that aim to scale the Ethereum network by taking the burden of its processing and moving it off-chain. In terms of security promises, these solutions are a very large departure from Ethereum's current Proof of Work security model. Rather than trying to individually secure each and every plasma chain or state channel with its own unique security model, these chains look to rely on Ethereum itself as a sort of court system.

Data is uploaded to Ethereum in batches which create cryptographic proofs, and those proofs can be used to resolve disputes or to claim the latest state. This reduces the trust assumptions of individual off-chain systems and it allows them to more deeply benefit from the security of the Ethereum root chain.

OVERVIEW OF ETHEREUM LAYER 2S

Ethereum is an open-source blockchain that allows developers to use a decentralized platform to build and deploy smart contracts and decentralized applications (dApps). Over the years of growth in popularity for decentralized platforms, it has gained great interest, which has since seen high demand resulting in slow transaction speeds and high fees. Solutions like the development of Ethereum Layer 2s have since taken interesting approaches in solving these scaling issues. Currently, Layer 2s have been broken down into two types: state channels and side chains. While state channels such as the Lightning network, Raiden network, and Spankchain only encompass the transfer of state off-chain and only opening or closing the channel is recorded on-chain. Side chains fully move computation off-chain but have the security of the Ethereum main chain by having decentralized validators and checkpoints. State channels have a smaller scope and only fulfill a subset of what Ethereum is trying to accomplish. In the case of channels like the Lightning network, because it only supports value transfer, dApp and smart contract support becomes an afterthought, and it may only be beneficial to those looking to only transfer value between addresses.

This makes state channels an unattractive choice for anyone building or interacting with dApps. Take a Layer 2-esque platform like POA network. It's using a separate chain, it has scalability through increased transactions per second, and cost efficiency through lower fees, but it's doing it at the expense of security and the potential funds lost due to lack of decentralization.

This is because it lacks the finality of transactions that the main chain offers, and it is more centralized with a set of validators chosen by the POA network. Side chains have similar issues with the loss of security and centralization, and both types take away from the security provided by the main chain and disjoint the Ethereum network into separated platforms.

IMPORTANCE OF BASE EVALUATION

Ethereum Layer 2 scaling solutions have the potential to revolutionize the blockchain industry and the broader internet alike. As was explained in the previous section, the primary function of a Layer 2 is to decrease the amount of data that must be stored on the Ethereum blockchain. This is achieved by moving some data and/or computation off-chain (i.e. away from L1) while still retaining security and decentralization that comes from Ethereum. By doing so, this immensely decreases the cost of transacting on Ethereum. Users will be able to make near-instantaneous transactions at a fraction of the cost compared to L1. Furthermore, the increased scalability will allow Ethereum to host a much larger number of users and decentralized applications (dapps) compared to now. In a time where DeFi and other blockchain-based technologies are rapidly gaining mainstream traction, Ethereum in its current state is not equipped to support these growing demands. This has resulted in the majority of blockchain users and companies migrating towards other competing chains with lower fees and higher scalability. If successful, a transition to a Layer 2-centric Ethereum would reverse this trend and result in Ethereum once again being the epicenter of blockchain technology.

FORECASTED VALUATION BY 2030

The equation in section 1.2 (Part 2) enables us to forecast the overall potential of all L2s. Using this equation, wide and optimistically adopted numbers for the previously stated 'potential extra annual revenue from L2 adoption' of $20 billion, and a modest x5 price/revenue to market cap valuation. The equation was multiplied by 4 due to the allowance of only 1/4 of the Ethereum economy needing to go through the L2 itself before near 'full' adoption is achieved. This was to cautiously account for the fact that the exact branding of 'extra revenue' is not an entirely identifiable metric. Running this $20,000,000,000 * 4 * 5 into the equation with a cryptocurrency adoption of 1/4 (0.25) of the world's economy at a Revenue: Market Cap ratio of 20, the total figure is: 1,000,000,000,000. This is due to the fact that the potential revenue is a fraction of the total volume (20), and the fact the equation is only for the L2 economy (0.25 of the Ethereum economy * 4 gives a total of 1). Multiplying the figure through by different revenue/market cap multipliers produces no change, a potential total market cap valuation of $1 trillion is an optimistic and reasonable prediction that should be appropriately scalable to any variations in the other inputs.