“Layer 2” crypto technology has come into further focus recently as it becomes crucial for growing blockchains to successfully scale. Stockhead chats with DeversiFi’s Will Harborne and Polygon Hermez’s Tony T about this powerful crypto narrative (and a few other things).
Layer 2s – what’s the deal?
Hi both… can you please give me a sense of the importance of Layer 2 scaling solutions and how they impact greater financial inclusion in crypto?
Will Harborne (CEO, DeversiFi): Sure, so as crypto reaches ever larger numbers of people, we need to find ways to scale the technology.
Crypto has the potential to give people who are on the fringes of the financial system a free wallet in their pocket that is automatically connected to trade, spend, and borrow. However, today with L1s the cost of participating and getting started is just too high for most.
Layer 2s [secondary blockchain protocols built on top of Layer 1 chains such as Ethereum] will change this radically, with transactions costing only fractions of a cent, and the ability to create a wallet and start using it for free.
Tony T: (Head of Comms, Polygon Hermez): L2s are important because they further reduce the entry barriers helping people enter the DeFi [decentralised finance] and NFT [non-fungible token] sectors. In the past, users had to go through the Ethereum Layer 1, congesting the network and having to pay high gas fees. However, the L2 solutions now being built are pretty much reducing gas fees substantially.
Won’t the (eventual) completion of Ethereum 2.0 make Layer 2 solutions less relevant for that network? Isn’t Eth2 meant to be fixing congestion/gas fees and scaling issues?
WH: Eth 2.0 and Layer 2 will work in tandem to help scale the Ethereum ecosystem. Either of them on their own improve the situation, but demand for block space will keep growing exponentially as more and more applications come online. Just as with the growth of the internet, we are only just seeing the first stage of potential use cases, and as it grows we will need more space than either Layer 2s or ETH 2 with sharding can provide on their own.
ZK-rollups – next big L2 narrative
I’ve been seeing ZK-rollups (zero-knowledge) scaling technology referred to as crypto’s “next big narrative”. Do you agree? Are there good investment opportunities in that particular L2 area?
WH: Yes, this is certainly shaping up to be one of the biggest narratives of 2022. Many people are seeing that ZK-rollups are setting up to go head to head with the big L1s of 2021 (Solana, Avalanche, and LUNA). Most of these rollups have not yet launched tokens, but many are guessing that once they do, the narrative will really come into its own and attract huge amounts of capital, development, and projects to launch on ZK-rollups.
So far there are a few live tokens, such as MATIC, DVF, or DYDX which are aligned with this potential opportunity, but in the future, we may see StarkNet launch a token, as well as zkSync, and other rollups. There will be a huge number of opportunities for investors in this sector, but it’s still early!
TT: Absolutely, so Polygon Hermez is an open-source ZK-rollup. And Polygon (MATIC) is on a spree to solve Ethereum scaling solutions. The investment in Hermez is one of the many steps Polygon has taken to enhance Ethereum’s capabilities via ZK-rollups.
The Polygon connection
Can you give me a bit of background on Polygon and its role as a Layer 2?
WH: Polygon was one of the first networks to offer a solution where people could access DeFi at a much lower cost, which resulted in a lot of developers and builders starting to use its solution. But its initial version was “proof of stake”, which is not the most secure way of operating in DeFi.
So today, Polygon has a vision to start upgrading its system to use zero-knowledge proofs and build rollups that will become a game changer to scale Ethereum. But DeversiFi has actually been prioritising the ZK-proof scaling solution from much earlier.
You not long ago launched an L2 bridge between the Polygon network and DeversiFi platform, is that right?
WH: Yep, so there are these two ecosystems, a Polygon one – a network with many different applications and developers, and DeversiFi – a network optimised for decentralised finance on ZK technology.
By offering this bridge, we’ve enabled the two to be connected together, where we can have people moving funds at the lowest cost possible. In fact, it is the most affordable way to move funds between Ethereum and Polygon.
And could you tell me a bit more about the Polygon and Hermez relationship, Tony?
TT: Hermez is a highly technical team led by Jordi Baylina, a top contributor to the Ethereum network and also one of the best cryptographers in the space. While Polygon’s market capitalisation is currently valued at billions and is a household name when it comes to enhancing Layer 2 solutions.
So, by combining the two, Polygon Hermez is able to achieve the developments within the Ethereum network that would possibly take two to three years within just a matter of a few months. It’s the perfect blend between resources and technical ability.
What is it that gives Polygon’s MATIC token its value?
TT: Polygon has implemented the London Fork and EIP-1559 which will make the MATIC token become deflationary. Considering Polygon’s exceptional user growth which includes over 200,000 new user addresses per week, MATIC tokens naturally are one of the most traded and held tokens.
The L2 advantage for DeversiFi
What’s DeversiFi aiming to achieve by using Layer 2 tech?
WH: Our number one goal with DeversiFi is to make decentralised finance accessible for everyone.
We initially launched using the Starkware scaling technology called StarkX, a ZK-rollup that assists the technology we built for our DeFi platform, making actions like trading, swapping and transferring tokens extremely optimised and cheap.
So if one compares a transaction on Ethereum, which today can cost between US$30 and US$100, a transaction on DeversiFi uses a miniscule amount of gas on the Ethereum main chain that’s actually paid for by our team as the operator. In comparison, DeversiFi has a transaction cost of US$0.1 – US$0.4.
So it’s about 100 times cheaper than transactions that would be directly on Ethereum. And that’s great for users because it means that they can start to access and experience DeFi with all the benefits that it has, including self-custody, full control, openness without the disadvantages which is the cost, but also the friction.
There’s a lot of frustration when you’re using DeFi on Ethereum, because you have to move between many different accounts and use all kinds of bridges, pay gas cost for failed transactions, and all of that is taken away by using DeversiFi. And we really want this to be the most accessible way ever to start using DeFi.
Potential L2 challenges
Are there any particular roadblocks or challenges either of you see ahead for L2 technology and/or your projects?
TT: Yes, while solutions are ramping up for L2 tech, there are also some challenges that can’t be overlooked. One of the major concerns is building a good user experience. Eventually, the goal is to have users skip Layer 1 without them even knowing if they are on an L1 or L2 network.
Sadly, we’re still far from that moment – it’s not the reality right now as UX/UI is still a major challenge that has stopped many from entering the DeFi action.
That being said, I think we can eventually expect to see the emergence of a one-stop app for investing and exploring different protocols within various crypto platforms.
WH: The biggest challenge for L2 technology and for DeversiFi is really that L2 tech is still very much in its early adoption phase.
There are challenges around wallets that I think is going to be one of the major things that’s going to stop many more people from using the Ethereum network. Today, the main wallet that people use in the Ethereum ecosystem is MetaMask but the problem is that the wallet is only adapted to using L1.
But, L2 has a very different user experience – there are no failed transactions and the cost is much lower. So you get extremely fast transaction confirmation. And this is something that a lot of them are designed for. So in order to get bigger adoption, we need end-wallets to start directly offering ways of getting funds under L2 and using it.
Are the big wallets working on this solution, then?
WH: Well, it’s something DeversiFi is currently involved in, yes. So we’re working with a cryptocurrency wallet that’s one of the biggest in the space and we’re going to be the provider of the infrastructure behind that wallet so that users of it will be able to access L2 seamlessly from within their current application.
Behind the scenes, it will be powered by DeversiFi so they can transfer and make swaps all on there, too, without paying gas cost from the wallet that they’re used to using.
What has you most excited about crypto right now?
TT: The pace at which mainstream adoption of crypto is taking place is getting very exciting.
The crypto industry took a very interesting turn in 2021 with the emergence of NFTs and blockchain gaming, which has taken the world by storm. NFTs have become the gateway for more people who previously had no idea about crypto to get in on the action.
People are finally beginning to understand the value brought in by blockchain technology, for example for NFTs as ownership receipts that can’t be replicated, which has been one of the biggest concerns in art and music since the rise of the internet.
Even blockchain gaming is driving mainstream adoption in different parts of the world, especially emerging markets like Asia where people are playing games like Axie Infinity as a source of income.
WH: One of the things that is really getting me excited is that we are on this cusp, the turning point that we’ve been talking about for years – and that’s scaling blockchain technology.
Most of the early attempts at that have made compromises that we don’t think are acceptable in terms of security or other things. But finally, we’re on this next wave, which I really believe is bigger or as big as the last huge revolution in cryptocurrency, which to me was smart contracts. And the next wave is ZK-rollup scaling.
Crypto 2022 predictions
Lastly, have either of you got any crypto-based predictions you want to share?
TT: I think we’ll be seeing far more adoption of cryptos in real-world scenarios this year. For example, real estate tokenisation. What used to be a market previously for only the wealthy is now being opened up for anyone with small funds. People now are able to own a portfolio of houses globally thanks to projects like RealT. This is just one of the few ways the technology is spreading towards mainstream markets.
And as for DeFi, at the moment it’s still in its nascent stages and we predict it to mature in innovation far more quickly in the next few years. DeFi in 2020 and 2021 has somewhat copied TradFi, but as we move forward into the new year, I anticipate more innovations and complex ideas bubbling in the space that were not previously possible in TradFi.
A few companies who are already taking the step forward include Alchemix, a self-repaying loan service and Pendle Finance, a platform that allows traders to earn profits via future yield tokens.
WH: This year we’ll see the first multi-chain applications, which use multiple Layer 1s as part of their core protocol by default. With more new chains entering the space, we’ll see an ecosystem of multiple blockchains working together. To give us an idea of this we can look to Cosmos and Polkadot, which are both multi-chain ecosystems.
Like I was saying earlier, during the next three to six months, we’re going to see all of those ZK-rollup scaling solutions start to compete, which is good for everyone, it will mean that they’ll get better and better and the opportunities will improve for developers and users.
And that’s going to mean that by the end of 2022, much more activity in terms of trading volume in DeFi will happen on L2 rather than L1.
It also means that we can have not just one million people using DeFi, but a billion people. We can scale this to everyone in the world. The magic about ZK proofs is that the more people use them, the more transactions it has, the lower the cost gets for everyone.
DeversiFi is a “decentralised exchange that allows users to invest, trade, and send tokens without paying gas fees”. Find out more here.
Polygon Hermez is an “open-source ZK-Rollup optimised for secure, low-cost and usable token transfers on the wings of Ethereum”. Find out more here.
This article has been edited lightly for clarity. Stockhead has not provided, endorsed or otherwise assumed responsibility for any financial product advice contained in this article.
At the time of writing, the author holds several crypto assets, including Bitcoin and Ethereum.
Follow the author on Twitter, as well as Stockhead’s new crypto Twitter account, Coinhead. Also, join our Cryptohead Facebook group to discuss all things cryptocurrency.