Even with Ethereum 2.0 underway, L2 scaling is still key to DeFi’s future


The Ethereum network has come a long way in the past few years. Everything from the rise of decentralized funding (DeFi) to the recent London upgrade has made the network the most compelling attempt at installing a “world computer”, but there is still much to be done.

For global adoption to be the backbone of Web 3.0, the network needs the benefits that the Eth 2.0 upgrade promises. However, to scale up for a new wave of distributed applications (DApps) it will take a lot more, and it looks like layer two solutions may be the only answer.

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The Promises of Eth 2.0

In August, Ethereum saw the implementation of its highly acclaimed London upgrade. This hard fork marks the first stop on the road to Ethereum 2.0 and has implemented several important updates for the network to prepare it for the transition. London arrived as Ethereum continued to struggle under the weight of recent booms in both the DeFi and non-fungible token (NFT) markets. Transaction speeds and costs have sometimes made many DApps completely prohibitive and undermined the benefits that decentralized systems are geared towards.

One of the most notable features implemented by London is EIP-1559, which aims to improve inflation rates and stabilize transaction fees on the network. To do this, it implements a system where the base fees for transactions are burned instead of paid to the miners. Miners continue to receive block rewards, and users can voluntarily add “tips” to their transactions to prioritize, but now each block removes a certain amount of Ether (ETH) from the network forever.

In contrast to Bitcoin, Ethereum does not have a fixed upper limit, so its total supply increases with each block. This has worried many about long-term inflation because of the perpetual growth. While EIP-1559 doesn’t make Ethereum deflationary, it certainly controls how quickly supply can expand.

While London was a crucial first step, it was only the tip of the iceberg when it comes to scaling Ethereum.

The call for 2.0

Most of Ethereum’s operational issues stem from the network’s native transaction speeds being throttled by its inherent lack of scalability. For comparison: The Ethereum network can currently process around 30 transactions per second (tx / s). In comparison, a traditional payment system like Visa is designed for 1,700 tx / s.

Ethereum needs to catch up, and that’s what Ethereum 2.0 is all about. For one, the network will move from Proof-of-Work (PoW) to Proof-of-Stake (PoS), which means a move from computers competing to solve complex math problems to one where nodes stake out assets, to validate blocks. Although PoS is much more efficient than PoW and improves network speed to around 50 tx / s, it is far from the requirements of a global payment system.

This is where another important development of Ethereum 2.0 comes in: Sharding. Sharding is a process in which each block is divided into 64 “shards” that can be processed in parallel. Essentially, this means we can take the estimate of 50 tx / s and multiply by 64, which would give us a little over 3,000 tx / s – well ahead of Visa and more than enough to serve as a competing payment network.

Related: Ethereum’s 2.0 upgrades aren’t the game changer that could bring more users

Hitting the visa is not enough

While sharding would allow Ethereum to hit or even beat the old payments infrastructure, it still may not be good enough. The traditional payment systems deal mainly with relatively simple transactions. This has been fine for many years, but the internet, and now DeFi, is pushing things beyond what we could ever have imagined.

Now let’s look at decentralized exchanges around the clock, NFT markets, NFT-powered virtual worlds, and blockchain games. All of this inherently requires a much higher frequency of complex transactions than most traditional payment systems could handle. For example, in a blockchain game, a single player can make multiple transactions every minute, and pausing the game to wait for each transaction to complete just won’t work. Combine that with DeFi’s ambitious vision to undermine the traditional financial sector and you begin to understand how much weight the Ethereum network may have to carry.

The point is that even 3,000 tx / s couldn’t support these services if they managed to get global adoption numbers.

However, through the integration of additional scaling solutions – such as “rollups” and “sidechains” – Ethereum has the potential to achieve up to 100,000 transactions per second. This would align very well with the high throughput applications DeFi promises to offer, but what do these answers look like?

Scaling for tomorrow

First of all, there are rollups. These come in a variety of forms including Optimistic, Validium, Plasma, and ZK. Rollups are a scaling solution that shoulder transaction loads by executing them off-chain and, when completed, writing a cryptographic validation to the chain. This frees up resources in the main chain and can increase the overall speed.

Next are sidechains, sometimes referred to as “second-layer” solutions. These are essentially parallel secondary blockchains connected to the main chain. These can be used multiple times and process different processes, which in turn relieves the base layer considerably. The added benefit of sidechains is that they also act as interoperable “bridges” across multiple backbone networks, providing additional liquidity, throughput, and cross-compatibility for connected chains.

Imagine a cryptocurrency future where there is an entire ecosystem of primary chains like Ethereum, all of which interact with one another through a number of side chains. Different networks could be used for their specific solutions, but cryptographic techniques would keep the data verifiably secure everywhere. This can finally provide the necessary speed at low enough cost to finally realize the true vision of DeFi, a financial system that is accessible and affordable for everyone.

This article does not provide investment advice or recommendations. Every step of investing and trading involves risk, and readers should do their own research when making a decision.

The views, thoughts, and opinions expressed herein are those of the author alone and do not necessarily reflect the views and opinions of Cointelegraph.

Sandeep Nailwal is co-founder of Polygon, the platform for Ethereum scaling and infrastructure development. In the crypto space since 2016, Sandeep has been involved with many tech companies since its inception. Together with Jaynti Kanani and Anurag Arjun, he founded Polygon to solve the scalability problem. His primary responsibilities include directing branding, marketing, operations, and working with key stakeholders to advance Polygon’s vision. Sandeep holds an MBA from the National Institute of Industrial Engineering (Nitie), one of the best schools in India.