What is the block space war?
The cryptocurrency industry is progressing at a rapid pace. As the technology advances, there is more simultaneous use by the general public and more applications being built. The capabilities of blockchain are promising, and people are beginning to realize how they can take advantage of it. While this is all spectacular for the future of cryptocurrency, it has brought some shortcomings as well.
Scaling is an issue that has been discussed at great lengths for cryptocurrencies like Bitcoin (BTC) and Ethereum (ETH). Without proper scaling initiates, many crypto detractors argue that the industry could never be able to meet the demands of the financial world. How can BTC or ETH replace Mastercard or Visa transactions when their networks are constantly becoming congested through relatively moderate use?
Block space
As long-term scaling solutions are being planned and crafted, measures must be implemented to help with the bulk of ETH transactions. This has led to the rise of so-called Layer 2 (L2) protocols. These L2 solutions act as side roads from the main ETH highway, alleviating some of the congestion of the ETH network by providing alternative routes to sort the data and transactions.
The key factor to understand here is block space. This term refers to the essential commodity that is integral to the function of crypto networks. Network miners compete for block space, the right to mine blocks, to ultimately earn rewards for their services. If one organization was able to take all of the available block space, they would be entitled to all of the rewards that are generated from the fees collected from ETH network users.
The competition for ETH’s block space has given rise to this Ethereum block space war. It was clear from the start these L2 solutions would compete against each other, but it appears as though they have successfully begun to take a lot more block space from ETH than initially anticipated. According to our research, up to 35% of all daily ETH transactions are now facilitated by two L2s, Optimism and Arbitrum. This has major implications for L2 solutions as a whole, as well as control of the ETH network.
Sources: Glassnode, Arbiscan, Optimistic Etherscan Assess
Why is this happening?
From social media to software, it seems like every technology-related field is a battleground of some sort. Blockchain is much the same as companies struggle for their share of market dominance. While users remain frustrated with the current capabilities of the ETH network, alternatives will continue to be developed that provide a better experience.
The Ethereum network runs on gas
It all revolves around Ethereum’s gas model. If you are unfamiliar with the way Ethereum processes transactions, this is the most important factor to keep in mind and we cover gas in our article here. From sending ETH to launching smart contracts, or minting NFTs, every action on the Ethereum network costs gas, and this gas is used to pay the miners that validate the blocks and transactions.
In addition, each block that is mined has a gas limit. Therefore, network miners will seek out the transactions with the highest allocated gas, effectively creating priority transactions. This leads to a scenario where the users that can afford to pay the most for gas automatically jump the queue over users that have been waiting for a transaction to process. For many crypto evangelists, this is simply unfair and an indication that these networks have the potential to be manipulated by entities with large cash reserves.
H3: ETH gas trends
Source: Etherscan
Over the past few years, the Ethereum network has proven in numerous critical moments that it is not yet capable of handling large amounts of transactions. In the graph above, we can see that the cost of transactions has risen immensely over the last two years. This corresponds with certain trends such as the influx of participants of so-called “killer” decentralized apps (dApps) like CryptoKitties or Axie Infinity, and the overall NFT mania.
However, the effects of this are felt across the entire Ethereum network. As users send thousands of transactions, while trying to mint the latest NFT for instance, every other action on the network is constrained. This extends to simple transfers and more complex smart contract features. Users will then attempt to increase their gas allowance to complete their transfers faster, and this becomes an endless cycle with the price of a transaction going parabolic. There are even moments where many transactions are never completed at all, despite the extra gas being spent.
Layer 2 solutions
Source: Crypto News
Layer 2 solutions were born out of necessity. It seems that an overall trend with the major cryptocurrencies like Bitcoin and Ethereum is the unwillingness or inability to scale and adopt new features. This is what makes L2s and sidechains possible in this landscape. As of now, it’s clear that Ethereum’s L2 protocols, like Optimism and Arbitrum, have been a welcome addition in the mind of most users and are clearly controlling sizeable amounts of block space.
Optimism and Arbitrum have quickly become some of the most powerful L2s on the Ethereum network. Currently, these L2s account for nearly 35% of all transactions, up from just 4.5% in the last 60 days of 2021. As these L2s are among the biggest on Ethereum, let’s take a quick look at their defining traits.
Optimism (OP)
Optimism revolves around optimistic rollups as a scaling solution. Using off-chain computation, Optimism manages to trustlessly record transactions using these rollups, while still benefiting from Ethereum’s security measures. At the time of this writing, Optimism has $464 million in Total Value Locked (TVL). Optimism also uses its own token, OP, for governance and transfers.
Arbitrum
Like Optimism, Arbitrum has also implemented optimistic rollups as their scaling solution. However, it does not have a token. Artbitrum has the distinction of being one of the L2s that is most compatible with the Ethereum Virtual Machine (EVM). This means it could possibly be the ideal platform for developers in the future because they do not need to learn a new programming language. Also impressively, Arbitrum currently has over $1 billion in TVL.
What scenarios could play out in the near future?
The cryptocurrency industry is an evolving space in a constant state of metamorphosis. We can try to look ahead, but there is little certainty about the future. While scaling the Ethereum network and reducing the costs of transactions are certainly primary concerns, there are arguments for two distinct outcomes in the near future. On one hand, gas prices could potentially stay as low as they currently are. On the other, they could also exponentially increase in time. Let’s look at the case that could be made for both outcomes.
Gas prices experience less pressure
In the event that the Layer 1 protocol (Ethereum) generally recedes in transaction volume while other L2s like Optimism or Arbitrum continuously control more block space, this would likely cause gas prices to drop over time. Currently, this is similar to what we are currently experiencing in the market, though there are other factors at play as well. We may also be seeing less volume from less general use overall, as consistent selling across all cryptocurrencies has been witnessed over the last year. With fewer users participating, less gas is required to send transactions.
Gas prices experience more pressure
Theoretically, there is also the possibility of gas prices experiencing even more pressure over time, resulting in higher transaction fees. If demand for Ethereum and L2s were to increase together, transaction costs would almost certainly be affected. This is a possible scenario, as the amount of users on the Ethereum network has clearly increased dramatically in the last decade.
When we review metrics like the number of ETH wallet addresses, Ethereum Name Service (ENS) domains, and of course the extensive list of dApps being developed, most analysts would agree that increased L1 and L2 demand is a likely scenario.
The upcoming Merge and its network effect
With all this discussion regarding L2 solutions, it’s easy to forget a massive development that is on the horizon for Ethereum. The upcoming Merge, Ethereum’s long-awaited switch from proof of work (PoW) to proof of stake (PoS) is now scheduled for September 19, 2022. While this may not instantly solve the scaling problem, or the gas crisis, it certainly has implications for these factors down the road.
Ethereum’s block size will not increase as a result of the Merge. However, it does set the stage for sharding, a process of splitting the Ethereum database into smaller parts to bypass the scaling roadblocks it has encountered. In a world where Ethereum is able to meet the demands of its user base, it is possible that most L2 protocols would not be able to survive. However, it is also possible that these L2s will retain their usefulness and still manage to contribute to the network. Regardless of the outcome, this fall is likely to be a hectic period for the Ethereum team and its fanbase.