CMC Crypto Playbook: Layer-1 blockchain

Considering the standards of 2022 and all that has happened in the crypto space, layer 1 (“L1s”) can still be said to have had a very interesting and eventful year. Many notable events have taken place in the L1 space over 2022.

From Ethereum’s transition from proof-of-work to proof-of-stake in September, to the implosion of the Terra ecosystem in May. New layer 1 were announced, with Aptos launching its mainnet and Sui expected early to do so next year.

Notable incumbent, BNB Chain and leading layer-2 (“L2”) solution, Polygon, gained market share in the vacuum left by Terra, while Solana had a more challenging year, being one of the layer 1 more impacted by the recent FTX saga. The year was rife with material events in arguably the most important sub-sector within crypto.

What has happened?

Key Observations

• Market cap is, of course, lower for a multitude of reasons that we are not going to dedicate this piece to. However, we should very clearly note that market cap does not necessarily correlate to very important on-chain metrics in terms of daily transactions and active addresses. As we can see, BNB Chain and Solana excel here, while Ethereum, despite the greater market cap, is evidently lower in terms of daily activity.
• Ethereum: The Merge! Since this topic has been covered ad nauseum by everyone and their cat, rather than repeating, we wanted to talk about its impact. Data shows that since completing the transition to proof-of-stake in mid-September, $ETH supply growth is massively down (from 3.58%/y to 0.005%/y). In fact, in combination with its burn mechanism, $ETH spent the majority of November as a deflationary asset and currently sits very close to that level.
• BNB Chain: a commendable year for BNB Chain, with market cap down only ~45% YTD, quite a bit better off than major competitors Ethereum (-64% YTD) and Solana (-90% YTD). BNB Chain was one of the major L1s helping onboard developers displaced by the Terra and FTX scandals. Daily activity metrics remain extremely high, with the launch of BNB Liquid Staking and zkBNB being notable highlights. Innovation and partnerships in the NFT space are also continuing in full swing, with OpenSea recently announcing support for BNB Chain NFTs on its platform.
• Solana / Avalanche: 2022 was challenging for the classic “alt-L1” trade of 2021. Solana saw some strong traction in their NFT ecosystem, with growth in collections, volumes and marketplaces. Avalanche saw positive headlines on the back of their Subnets, which offered scalability for decentralized applications (“dApps”), particularly in the gaming space. However, both alt-L1s have suffered from poor publicity (for Solana this came via the FTX scandal, while for Avalanche this was a product of some not-so-flattering news that got leaked a few months ago). Solana has also continued to suffer from regular outages, calling into question the reliability of the network.
• Layer 2s: While L2s are technically one step removed from the L1, any discussion on L1s is incomplete without at least commenting on the growing scaling market. Polygon is the undoubtable leader here, with its numerous solutions across the board. It has been a strong year for Polygon, with their business development continuing to shine (Starbucks NFTs, Reddit NFTs, Instagram/Meta NFTs to name just a few recent headlines that Polygon has been behind). More pure-play L2s, Arbitrum and Optimism have also performed strongly over the past year and continued to increase activity / take market share from some of the smaller alt-L1s. The OP token’s launch was a notable moment for Optimism earlier this year, while Arbitrum continued to focus on their core product offerings with their launches of Arbitrum Nitro and Arbitrum Nova.

Expectations for 2023

Now that we have got some idea of how the major L1s have moved through the year and some of their notable events, what about the coming year? What are our tentative expectations?

Layer 1 (particularly some of the smaller alt-L1s) will feel the pressure of L2s

• One of the major narratives of the year was so-called “L222” referring to 2022 being the breakout year for L2s. Did we see this? L2 total value locked (“TVL”) figures show that there was an increase of 118% (in ETH terms) since the start of the year. So, in a way, yes. It certainly has been the biggest year that L2s have had so far. However, in absolute terms, total TVL locked in L2s is only around US$4.5B. When we compare to total DeFi TVL in Ethereum (around US$25B), and total crypto market cap sitting near US$900B, we can contextualize how far L2s still have to climb.
• Consider also the fact that, as shown in Figure 1, both Arbitrum and Optimism exceed Avalanche in terms of daily on-chain activity. Add to this the increasing deployment of alt-L1s dApps on L2s e.g. Trader Joe of Avalanche recently announced their deployment on Arbitrum, and it will be interesting to monitor what happens with some of the smaller alt-L1s. There has been an idea that has been discussed among many in the crypto space that the major L1s will simply become settlement layers, while execution and activity happens on the L2s. While we are seeing a little bit of this already, 2023 might very well be the year that we see this happen on a much larger scale.

New L1s could survive if they truly bring something new to the table

• Consider the most well-known new entrants in the L1 space, Aptos (who went to mainnet in Q4 of this year) and Sui (who are expected to launch in early 2023).  Both of these L1s bring various new innovations with them, including the Move programming language. Given the background of this language and all that it promises, alongside the potential increases in transaction speed with both L1s, there is a potential for some true innovation. It should be worth keeping a close eye on whether either or both of these L1s are able to utilize their new technologies to bring about a step change in the crypto market.