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$L2DEFI Overview

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$L2DEFI Composition & Weights
To compete with alt-L1s, rollup tokens should heavily incentivize L2 migration through aggressive airdrops, staking/liquidity mining programs, and ecosystem funds. Cross-L2 token bridges will allow rollups to overtake more centralized L1s.
“I believe rollup tokens will arrive late 2022 and sometime in 2023 in the following order:

-> zkSync (confirmed) -> StarkNet (no comment) -> Arbitrum -> (no comment) -> Optimism (public denial) followed by launch of $OPT-May 2022

Ethereum Tracking Dashboard

EVM Layer 2 DeFi - the future of Ethereum?

Investment theme: Will most Ethereum TVL/fees just move ‘up’ to L2? PowerPool is proposing $L2DEFI, a basket of sub-baskets representing major L2 scaling technology platform with auto-harvesting of intrinsic yield and meta-governance-driven extrinsic yield from staking/lending, plus hedging options through borrowing/shorting.

Many believe that in the coming ‘liquidity wars’ the majority of DeFi TVL/fees will not move ACROSS to ALTL1 chains, but rather will move UP to one of several Ethereum Layer 2 (L2) scaling sidechains/rollups/zero-knowledge (zk) proof environments designed to dramatically increase Ethereum throughput and reduce gas costs. Some believe that these complimentary ‘second’ layers (L2s) can create a situation where effective per-transaction Ethereum gas costs actually FALL with INCREASED usage, greatly diminishing the value of DeFi deployed on proliferating ALTL1 EVM chains, given the established network effects and liquidity attracting advantages of Ethereum EVM ecosystem.

For those who believe in long-term ETH+L2 DeFi dominance, TVL/fees will migrate ‘up’ to whatever scaling technology, perhaps sidechains like Polygon, or Gnosis/xDAI, or perhaps rollups like Arbitrum, Optimism, zkSync, Starkware, etc.

But which scaling technology will win the majority of TVL/liquidity? How much TVL/liquidity will still prefer ALTL1 DeFi? Non-EVM chains like Solana? Which one(s) will win increased TVL over one year? What will Ethereum Layer 2 look like in 5 years? No one knows.

Successful VCs (and all DeFi token holders are essentially VCs) do not try to ‘pick winners’. They pick a theme like L2DeFi and often invest in direct competitors. However, in DeFi much of the investment case relies not just on pure speculation, but on the additional value of periodic rewards/yield. Harvesting rewards/yields across a diversified portfolio of ‘baskets’ with ever-expanding numbers of tokens each with volatile yield generation options requires an automation network like PowerAgent.

Given that crypto investing is like early stage venture capital, with everything speeded up by open-source software, a diversified basket of Ethereum Layer 2 DeFi tokens across multiple scaling layers WITH PowerAgent automation to auto-harvest the rewards/yield that are the main weapon in the cross-chain/cross layer competition for TVL, PLUS analytics-driven DAO management of re-balancing across staking options, and the proportion of individual tokens in chain-specific sub-baskets, and even the proportion of sub-baskets in higher-level pools-of-pools seems the best approach for responsible investing (as opposed to degen ‘aping’ and/or trading).

PowerPool technology makes it possible not only to optimise and auto-harvest intrinsic yield on tokens in each basket, but also leverage aggressive meta-governance power to generate extrinsic yield opportunities from staking/lending each basket token, while also managing leverage and hedging options via borrowing and shorting entire baskets/pools, or even pools-of-pools. Delta-neutral hedging of a broadly-diversified pool-of-pools auto-harvesting rewards during a continuing ‘liquidity war’ should be a very attractive risk-adjusted investment.

Overview of L2 scaling technologies

(For more detail on motivation & rationale for the L2 scaling thematic pool, see Ethereum 2.0)

Arbitrum and Optimism now. Then EVM zk-rollups. And then eventually Ethereum data sharding will massively boost the throughput of all Layer 2 scaling solutions.

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Layer 2 Data Tracking

Ethereum Scaling Sidechains/Roll-Ups Overview

TL;DR: In the coming liquidity wars, no one knows how DeFi TVL and fees will distribute across various Ethereum L2 scaling options. Given that DeFi is venture capital investing, a broadly-diversified L2 basket token/index, with auto-harvesting of intrinsic yield, and the size/meta-governance power to achieve listings allowing staking/lending and other options for extrinsic yield is the best investment longer term.

While solutions like Arbitrum and Optimism will directly compete for market share, for DApps, there is only upside to using both. Deploying on multiple platforms makes the social consensus problem easier to manage. DApps adopting parallel solutions with each other enables inter-protocol transactions to remain on L2. Uniswap adopting both Optimism and Arbitrum will increase the number of DApps that it can have L2 to L2 transactions with.

It is likely that many DeFi protocols will deploy on more than one L2, and that is why a pool-of-pool like $L2DEFI will be used to capture this trend, as more and more protocols become multi-L2 layer.

But rather than put all Ethereum sidechain and rollup DeFi in the same pool, it will have marketing advantages to build up the composition of the $L2DEFI pool-of-pools with several individually promotable sub-pools reflecting the finncial backing of each sidechain/scaling solution, starting with at least one initial sub-pool focussed on the broadest scaling ecosystem with the most traction to date: Polygon

Sidechains for Ethereum Scaling

Note: BitGo/institutional custodians currently don’t even have concrete plans for L2s thereby restricting the institutional accessibility of L2s.

Polygon/MATIC = Sidechain+

$POLYDEFI: Polygon L2 Ecosystem
$POLYDEFI: Polygon L2 Ecosystem

But isn't Polygon a Plasma, Rollup and Sidechain all in one?

In its current implementation, Polygon is a modified Plasma PoS sidechain with validators solely responsible for validating Polygon transactions. The main advantages that other Rollup-based L2s have over Polygon is that they inherit their security from the main Ethereum blockchain. This is not the case for sidechains like Polygon. Sidechains are separate blockchain networks that introduce their own layer of risks, the main associated risks being: censorship resistance, finality, and guarantees about owning funds.

Polygon may have benefited from being a scaling front-runner, but with competition from other sidechains like Gnosis/DAI, and with major ETHL1 DeFi projects like Synthetix, Uniswap and MakerDAO launching composable L2 solutions on Optimism, Arbitrum (or both), and/or zero-knowledge options like zkSync and Starkware, Polygon’s L2 dominance is far from assured. Indeed, Polygon has already started to diversify their approach by investing about $US 1.0 billion in Polygon Zero, an implementation using zero knowledge proofs. They’ve acquired several cutting-edge teams and are developing several projects such as Miden, Nightfall, Zero, and Hermez. Their operational zk rollup product is Hermez, which only performs simple payments at the moment and has some compromises in terms of security.

Polygon MATIC’s 2021 price surge is rooted in the fact that Polygon is currently being utilized by blue chip DeFi projects such as Aave, Sushiswap, and Curve. Polygon’s TVL has already surpassed $10B and has been directly responsible for Aave’s surge to the largest DeFi protocol by TVL on Ethereum.

Gnosis (xDAI) Sidechain

$GNOSDEFI Gnosis Sidechain DeFi
$GNOSDEFI Gnosis Sidechain DeFi

The merger of xDAI and Gnosis has created another Ethereum sidechain launching a DeFi “village”

Ethereum L2 Rollups with Proofs

For the details and theory behind rollups, check out Polynya’s blog: https://polynya.medium.com/

Depending on whether Validity Proofs or Fraud Proofs are used and what is the mechanism for data availability we can broadly categorize roll-up L2s into the following categories:

  • zkRollups - Validity Proofs with data on L1 Ethereum,
  • Optimistic Rollups - Fraud Proofs with data on L1 Ethereum,
  • Validium - Validity Proofs with data kept off-chain,
  • Plasma - Fraud Proofs with data kept off-chain.

Overviews of Evolving Ethereum L2 Rollups

Arbitrum Overview

Arbitrum – The largest rollup by TVL and by number of deployed dApps. Arbitrum uses fraud proofs for security, and usage is very similar to mainnet. Currently centralized and does have admin keys during beta. Fees are a few dollars.

Although Arbitrum intends to be fully decentralized, right now the team has significant control over the network. This is not dissimilar to approaches taken by other Etheruem scaling solutions such as Polygon and Optimism, which each have their own unique set of safeguards in the wake of their respective launches.

For instance, the Arbitrum team can modify many of the key contracts within the system using a proxy contract that is controlled by a single private key (Unclear who is in possession of this key and how it is managed).

The contracts that fall under the purview of the proxy include the token bridge from Ethereum, the sequencer contracts (the entity that batches transactions), the rollup contracts on mainnet, and several others. While it is critical to note that this safeguard has put in place to ensure the stability of the network in its early days, it does represent a major centralization vector in that one entity has the control over the network, including the ability to shut it down. (It is also worth mentioning that the team has made clear they may halt network activity in the event of a technical or security issue).

Along with these centralization vectors, the team has also put in place what’s known as a “speed limit.” This acts as a cap on the capacity of the network, and is currently at a level that brings the network’s capacity in line with that of Ethereum L1. This is why transaction fees may seem high on the surface. Gas fees will initially be elevated, with the potential to rise further as usage of the network increases. However, the team has also stated that they plan to raise the speed limit and increase network capacity over time.

Finally, like all Optimistic Rollups, Arbitrum users are subject to a seven-day withdrawal period. This is another factor for users to consider when deciding whether to migrate funds to Arbitrum, though it is worth noting that there are third-party services which allows users to work around this issue.

For instance, the Arbitrum team can modify many of the key contracts within the system using a proxy contract that is controlled by a single private key (Unclear who is in possession of this key and how it is managed).

The contracts that fall under the purview of the proxy include the token bridge from Ethereum, the sequencer contracts (the entity that batches transactions), the rollup contracts on mainnet, and several others. While it is critical to note that this safeguard has put in place to ensure the stability of the network in its early days, it does represent a major centralization vector in that one entity has the control over the network, including the ability to shut it down. (It is also worth mentioning that the team has made clear they may halt network activity in the event of a technical or security issue).

Along with these centralization vectors, the team has also put in place what’s known as a “speed limit.” This acts as a cap on the capacity of the network, and is currently at a level that brings the network’s capacity in line with that of Ethereum L1. This is why transaction fees may seem high on the surface. Gas fees will initially be elevated, with the potential to rise further as usage of the network increases. However, the team has also stated that they plan to raise the speed limit and increase network capacity over time.

Finally, like all Optimistic Rollups, Arbitrum users are subject to a seven-day withdrawal period. This is another factor for users to consider when deciding whether to migrate funds to Arbitrum, though it is worth noting that there are third-party services which allows users to work around this issue.

Optimism Overview

Optimism – Arbitrum’s main fraud proof competitor. Usage is again very similar to mainnet and has a decent number of deployed apps. Currently centralized with admin keys and the fraud proofs are not yet operational. Has been un-whitelisted since December 2021, and fees are a bit lower than Arbitrum’s. For true composability, it’s important to have EVM equivalence, not EVM compatibility. Metis DAO and Optimism have EVM-equivalence. Optimism 2.0 integrates an EVM interpreter in their Geth clients instead of having to reimplement the EVM on-chain.

  • Metis Andromeda – A fork of Optimism, Metis has set out to be a home for DAOs so that they can more seamlessly cooperate with each other and with the broader digital economy. They currently share all of the drawbacks of Optimism, although there is a METIS token available.
  • Boba Network – Another optimistic rollup made with forked code from Optimism, Boba is built by the Enya team at the OMG foundation. They share the same vulnerabilities as the other Optimism forks, and like Metis they do have a token (BOBA). It’s still relatively early days for Boba, and it remains to be seen how well they stack up against competitors since they’re also aiming to be a general-purpose L2.

While Optimism is a true layer 2 secured by Ethereum, the protocol is still in its infancy. It’s not yet a finished product, with a fully public, permissionless, and decentralized mainnet. Because of this, early users will be taking on considerable trust assumptions.

For starters, the Optimism core team essentially has complete control over the network. The team has the ability to make changes to the contracts controlling the Optimism Gateway bridge, meaning that there is one central point of failure from which user funds can be lost, seized, or stolen.

While less of a concern for users, the team also has the ability to whitelist contracts and assets, meaning they have authority over what projects deploy to, and what assets are supported by, the network. In addition, at least one planned upgrade to Optimism within the next few months, which could cause the network to go down (the team will give warning in advance). This means that users will not be able to conduct any transactions during this time.

It’s important to note that assumptions like these are not out of the ordinary when it comes to a brand new network, as developers will often put safeguards in place to catch bugs and ensure the protocol is functioning properly. Furthermore, these risk factors have also been communicated by both the Optimism and Uniswap teams.

Finally, due to the architecture of Optimistic Rollups, there is a seven-day withdrawal period when bridging tokens from Optimism back to Ethereum L1, meaning that funds will be completely inaccessible during this period. This will not go away when the protocol launches its public mainnet, however there are solutions in the works, such as Maker’s Optimism Dai Bridge, to get around this issue.

MakerDAO, like many projects, has been exploring a plethora of scalability solutions to support their ecosystem, including Arbitrum and non-rollup solutions such as Polygon, Binance Smart Chain, and Avalanche; however, the only community approved solution has been Optimism. The Optimism Dai Bridge will allow locking up L1 DAI to mint L2 oDAI. Once fast withdrawals are enabled in Q3/Q4, oDAI can be burned in exchange for near-instant access to L1 DAI, escaping the one week lockup period associated with Optimism.

Starkware Overview

StarkWare – Creators of StarkNet and StarkEx. StarkNet is their general-purpose rollup which is currently in mainnet alpha and only has “test” apps right now. StarkEx is the rollup tech powering dYdX, ImmutableX, DeversiFi, and Sorare. Uses validity proofs for security, and each StarkEx app has different security attributes. StarkEx apps have over a billion dollars in combined TVL, easily the 2nd largest rollup by that measurement. (Loopring/LRC...)

  • Loopring – Everyone has probably heard of LRC by now, but you might not know that it was the first operational validity proof rollup! LRC has been operational for well over a year now and recently launched their L2 smart wallet app. They’re one of the few rollups with a token right now. Loopring has fairly good security, their main flaw is that there is no delay on code updates; they do have an operational “escape hatch” however. Fees are generally under $1 for transfers.
zkSync Overview

zkSync – Created by Matter Labs, zkSync is aiming to be a major player in the zkEVM space. Their current product “zkSync 1.0” is available today with transfers/trades and limited NFT functionality, but 2.0 is in testnet which is aiming to have full EVM compatibility. ZkSync is arguably one of the safest rollups currently with a 14-day delay on code updates and an operational escape hatch should the operator go down. There is currently no token, although zkSync has confirmed that they intend to move to community governance in the future. Fees are generally under $1 for transfers.

  • Aztec – Also known as zk.money, Aztec is the only operational rollup aiming to be a privacy network. Currently zk.money 1.0 is live and available for “shielding” transactions, and they plan to launch 2.0 in 2022 along with “decentralization”. If they’re able to achieve EVM compatibility, you could essentially have monero-like privacy while using Ethereum-based assets and apps. They currently have some of the strongest rollup security with zk.money 1.0, although it is limited to simple payments.
  • ZKSwap – Similar to Loopring, ZKSwap is designed to be a validity-proof-based L2 DEX with transfers and an NFT marketplace. There are subtle differences in the tech design of ZKSwap vs. Loopring which I won’t get into here. ZKSwap does have an 8-day delay on updates and an operational escape hatch function, and it also has a token (ZKS). Edit: As the comments in r/Ethereum point out, ZKSwap is a direct fork of zkSync.

In the future we expect to see hybrid solutions using a mix of the above techniques.

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Arbitrum & Optimism Basket/Index

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$OPARDEFI L2 Scaling Pool

Arbitrum, like Optimism, is an Optimistic Rollup based scaling solution. There are few differences between the two. The benefit to both is that they are easy to integrate with DApps because they require very few changes to DApps’ underlying smart contracts. Because of this, the two solutions have become top picks for many developers. Arbitrum and Optimism are similar enough that many protocols will see very little effort not to run on both. At this stage we are planning to launch only a single basket to capture prospects for both.

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Starkware/StarkNet/StarkEx & zkSync Basket/Index

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$ZKL2DEFI L2 Scaling Pool