Ethereum Watch

• Use of Layer 2 solutions has risen in 2023.
• Leading platforms Optimism and Arbitrum closed the year with high network fees and revenue.

Ethereum’s [ETH] network has grappled with scalability limitations for years. High transaction fees and network congestion have often prevented innovation and widespread adoption.

For example, by May 2022, the average transaction fee on the Layer 1 (L1) network was $196, significantly higher than the $2 average two years earlier.

This surge made the user experience on Ethereum significantly expensive and resulted in the chain experiencing a slower transaction processing rate, compared to networks like Solana [SOL].

Layer 2 solutions (L2s) emerged to address these challenges, offering a remedy whereby transactions are processed separately and consolidated before a compressed version is transmitted to the Ethereum main network for settlement.

2023 saw increased L2 usage

Ethereum’s transition from a proof-of-work (PoW) to a proof-of-stake (PoS) consensus mechanism – “Merge” – in September 2022 propelled the demand for the network.

Due to this, 2023 kicked off with a significant uptick in demand for L2 scaling solutions. This was evidenced by the notable hike in monthly gas fees spent by these protocols to settle activity on the Ethereum base layer.

According to a Dune Analytics dashboard by Funny King, between February and March, these fees rallied by 138%.

For context, in February, these protocols spent 106.56 billion GWEI to settle activity on the Ethereum base layer. By the end of March, this had more than doubled to 253.91 billion GWEI.

The spike in L2 activity in March was associated with anticipation around the airdrop of Arbitrum’s ARB token, which eventually occurred later that month. L2 activity skyrocketed as the ecosystem saw new entrants who completed on-chain transactions so as to be eligible for the ARB token airdrop. 

On 23rd March, Arbitrum completed this airdrop, which saw the release of 1.27 billion ARB tokens to over 600,000 eligible wallets. On that day, daily transactions count on the L2 totalled 2.73 million, marking the year’s first single-day high in daily transactions, according to data from Arbiscan.

While the first half of the year saw a significant decline in the prices of many crypto-assets, gas fees in the L2 sector continued to rise. This highlighted that user engagement on these platforms in 2023 did not just increase, but there was consistent retention. 

According to the Dune Analytics dashboard, the monthly gas fee spent to settle L2 activity on the Ethereum mainnet between March and September climbed to 527 billion GWEI, rising by 108%. 

Although this amount trailed downward for the rest of the year, the monthly high gas fees showed that L2 platforms recorded historical peaks in user activity in 2023. 

Base’s not-so-brief stint at the top of the world

In August, the launch of Base, Coinbase’s scaling solution built on Ethereum, onboarded a new cohort of users into the L2 ecosystem. Less than a month after Base launched, user activity on the network surpassed that of already-existing protocols such as Arbitrum and Optimism [OP].

Data from IntoTheBlock revealed that the L2 network recorded an average count of about 888,000 daily active addresses during this period. This accounted for 60% of all on-chain addresses that engaged the services of optimistic roll-ups within the same window. 

In just 2 months, Coinbase’s Base L2 has skyrocketed, topping the charts in transactions and unique addresses. Much of this growth is fueled by the new social app, FriendTech. pic.twitter.com/CdVrTcFqot

— IntoTheBlock (@intotheblock) September 16, 2023

For example, on 14 September, Base recorded 1.88 million successful transfers, more than the total recorded by both OP mainnet and Arbitrum. On the same day, the chain recorded its highest transaction throughput of 21.29, according to data from L2Beat.

In the same month, due to the increased Base usage, its decentralized finance (DeFi) total value locked (TVL) briefly surpassed that of leading L1 network Solana. 

In fact, AMBCrypto found that on 6th September, BASE’s DeFi TVL clinched an all-time high of $411 million. On the same day, Solana’s TVL was $315 million. Base’s TVL outpaced Solana for the rest of the month until 13th October, when the latter began to see an uptick in its DeFi activity. 

Base’s success story in the first two months following its launch is not complete without discussing the impact of the explosive popularity of decentralized social app friend.tech.

Launched on Base on 10th August, friend.tech lets users buy and sell tokenized shares of crypto-personalities. As many flocked to the social app to try it, its monthly active address count rallied above 350,000 by the end of September. 

In the same month, its transaction fees and revenue hit respective all-time highs of $26 million and 47 million, according to data from DefiLlama. 

However, as the hype around friend.tech faded, its active user count, network fees, and revenue plummeted to their lowest levels by the end of December. 

User activity on Optimism and Arbitrum in December

The last month of the year saw an uptick in user activity on Optimism. According to data from Etherscan, daily transaction count grew by 40%.

Interestingly, this rally occurred despite a 24% drop in the number of unique addresses that completed transactions on Optimism over the same timeframe.

On Arbitrum, daily transactions rose by 58%. In fact, AMBCrypto found that the network recorded an all-time high of 5.09 million in daily transactions on 16 December. 

Impacted by the general growth in the DeFi sector that marked the last three months of 2023, Optimism and Arbitrum saw TVL growths. 

According to data from DefiLlama, between 1st October and 27th December, Optimism’s TVL appreciated by 36%. At $897 million at press time, Optimism’s TVL closed the trading year on a five-month high.

Within the same period, Arbitrum’s TVL surged by 39%. With figures of $2.4 billion at the time of writing, Arbitrum’s TVL stood at a seven-month high.

As a result of the increased user activity on both L2 protocols in December, network fees and revenue also saw some growth. On Optimism, data from Token Terminal showed that network fees and revenue from the same grew by 31%.

During the year, the protocol’s revenue totalled $55.16 million, hiking by an annualized rate of 71.35%.

As for Arbitrum, monthly network fees and revenue closed the year at their highest levels during this 12-month period. In December, transaction fees totalled $10 million, while revenue from the same amounted to $9 million. 

With 2023 coming to an end now on the back of a general market uptrend, there is a lot of positive anticipation associated with L2s. Only time will tell whether 2024 will fare better than 2023, as it is expected to.

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