As the new year dawns, the Ethereum ecosystem continues its dominance, with its Layer-2 networks establishing new highs in usage and Total Value Locked (TVL), reaching $23 billion on January 12, according to L2Beat.
The chains driving the growth include the ever-potent Arbitrum, in the top position with $10B in TVL, Optimism with $5B, and the recently-launched Manta Pacific. According to data by Artemis, however, Polygon PoS leads the daily activity chart, while zkSync Era is challenging Arbitrum in active addresses and transaction volume.
The numbers paint a rosy picture, but the tech game is far from over. Many of the networks are still in the early stages of their decentralization, while their performance and features are still nowhere close to the ideal.
Challenges L2s are Facing Today
The blockchain trilemma is alive and well in Layer-2 platforms today. While rollups are the most popular way of tackling this issue, their costs are still significant compared to alternative Layer-1 chains. As highlighted by Vitalik Buterin, there is an alternative in the L2 space that would sacrifice some of the decentralization and security properties of rollups in favor of speed.
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Validiums, which store data on independent “data availability layers,” can significantly cut down on transaction costs. The key difference with rollups is that storing the data outside of the Ethereum chain is cheaper, and this could be a valid solution for use cases such as gaming or non-financial uses.
Beyond performance, richness of features is another major factor in Layer-2 attractiveness. Most rollups are currently just fresh EVM block space — essentially, they’re many little Ethereums. But L2s could be used for much more, including the “holy grail” of blockchain: private smart contracts.
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Privacy opens up a great paradox in the crypto space. Anonymity was one of the most appealing features of Bitcoin. However, very quickly it became clear that complete privacy was not possible, as most blockchains need to be public in order to be verifiable. Privacy coins offered an improvement for normal transactions, but with the rise of on-chain use cases like DeFi and GameFi, this wasn’t enough.
Implementing private smart contracts requires a robust security model, which is where the Layer-2 model can shine. So, while the current stage of rollups is a rehash of previous architectures, there are a number of extremely interesting projects that could use L2s to bring about the next generation of smart contracts.
How New Projects Could Develop the Infrastructure for Crypto Killer Apps
Private smart contracts would enable a new paradigm of blockchain usage: securely storing sensitive data. It’s not just about financial applications — private smart contracts enable easy identity storage and verification, password-based wallets, unique applications in GameFi and many more uses yet to be found.
One of the more established privacy-centric L2s is Aztec, which has been quietly developing for several years. Aztec uses zero knowledge cryptography in an attempt to implement fully private and expressive transactions, powered by its custom smart contract language called Noir.
While development is in full swing, Aztec had to make several fundamental improvements to zero knowledge proofs to even have a chance at developing its vision. The road is still quite long, but the project has recently launched a new testing environment, Aztec Sandbox.
But there are many ways to skin a cat. Besides many other zk-based projects, two new competitors sprung up that could go out on the market sooner than expected.
Coti, a payments network and jack of all trades, has announced plans of implementing the V2 of its network as a private Layer-2. It uses a much simpler approach based on Multi-Party Computation and “garbled inputs,” a technology allowing the encryption of the functions used to transform some inputs into particular outputs. The end result is similar, with Coti enabling a private L2 network with full support for Solidity smart contracts.
Another project is Fhenix, based on Fully Homomorphic Encryption (FHE), a type of cryptography where the encrypted data can be used for computations without the need to decrypt it. Hence, the information is never public throughout the entire transaction execution process — it’s end-to-end encryption for Web3.
FHE wasn’t accessible until recently, as its development only gained momentum over the last five years. But now that the development hump is behind us, its implementation is much simpler than zk-proofs.
Fhenix also offers a key advantage over zero knowledge thanks to its full EVM compatibility. This means existing Solidity smart contracts can be used with no changes, which makes adoption much simpler. The Fhenix devnet already launched in July 2023, while the public mainnet is due for early 2025. The project is headed by Guy Itzhaki, former FHE executive at Intel, making Fhenix one of the better positioned teams for launching FHE in production.
The race for private L2s is heating up, and we might start seeing powerful solutions live as soon as next year. When ready, private computation could usher in an era of Blockchain 2.0, unlocking new cases and a much higher adoption ceiling.
