Ethereum and Bitcoin, the world’s two largest blockchains, are facing significant challenges in scaling their networks. As more users and transactions move to Layer 2 (L2) solutions, the system could undermine the security and sustainability of Layer 1 (L1), with fees and rewards for miners and validators declining.
L2 Growth Raises L1 Concerns
Ethereum and Bitcoin are both facing a fundamental problem: How to scale their networks to accommodate growing user numbers without sacrificing security or decentralization.
Justin Bons, founder of Cybercapital, has theorized that L2 platforms are “parasitic” on Ethereum. Bons has long warned of the growing influence of Ethereum’s L2 solutions on the main chain, as well as other blockchains that have adopted L2 scaling methods. Here is an overview of the predicament facing L1 blockchains like Bitcoin and Ethereum.
Currently, neither blockchain can process transactions at the same speed as centralized systems like Visa or Mastercard, and the fees for using L1 can be very high. Since 2015, modifications to Bitcoin’s consensus layer to improve scalability have been controversial, leading to an increasing preference for L2 solutions like the Lightning Network by proponents. Ethereum core developers have also moved toward allowing L2s like Arbitrum, Optimism, Base, and Linea to thrive.
L2s Could Undermine the Long-Term Security of Ethereum and Bitcoin
L2 solutions, by design, move transactions from the root layer (L1) to a secondary layer. For Ethereum, L2s like Arbitrum and Optimism bundle multiple transactions into a single L1 transaction, reducing costs and increasing throughput.
For Bitcoin, the Lightning Network allows users to transact off-chain, settling only on the main blockchain when absolutely necessary. While these solutions have been praised for speeding up transactions and reducing fees, they also pose a potential threat to the economic model and security of L1 blockchains.
Ethereum has benefited significantly from the activity of L2s. As of November 2023, L2 solutions such as Arbitrum, Base, Optimism, and Linea contributed approximately $200,000 in daily rental fees to Ethereum’s L1. However, this financial support has since waned. From December 2023 to March 2024, L2 payments to Ethereum dropped below $250,000 per day, only to spike to around $1.7 million in early March. By the end of April 2024, these fees had plummeted to below $10,000 per day. This raises questions about the long-term sustainability of Ethereum’s L1 infrastructure if the majority of activity moves to L2.
Bitcoin faces a similar problem. When BTC is transferred to the Lightning Network or other Bitcoin sidechains, transactions bypass the main chain, leaving miners without the fees they would normally earn from processing transactions.
Bitcoin’s economic security depends on the incentives given to miners, both through transaction fees and block rewards, which are halved every four years (halving events). As fees move off the main chain, concerns are that Bitcoin miners may no longer have enough economic incentive to continue securing the network, potentially making it less secure over time.
L2 solutions may not ensure long-term sustainability
As of October 6, 2024, the capacity of Bitcoin’s Lightning Network (LN) is approximately 5,360 BTC. Miners only receive fees when BTC is moved into or out of Lightning channels, meaning no fees are paid to them when transactions occur off-chain on LN. Similarly, Wrapped Bitcoin (WBTC) and other tokenized forms of BTC do not contribute significant fees to L1 once they are converted.
Nikita Zhavoronkov, lead developer of Blockchair, also expressed concerns about Bitcoin’s diminishing security budget. The fundamental problem is that both Ethereum and Bitcoin are designed with the expectation that users will pay fees to use the root layer. These fees are a critical part of maintaining the security of the blockchain, especially as block rewards decrease over time. If too many transactions occur on L2s, L1 may run out of fees, reducing the incentives for miners and validators to secure the network.
L2 solutions like Arbitrum and Optimism, while providing immediate benefits in scalability and cost efficiency, could undermine the long-term sustainability of Ethereum’s L1 if they are not designed to contribute sufficiently to the root layer.
Similarly, Bitcoin’s Lightning Network, while solving some of Bitcoin’s scalability issues, removes miners from the transaction loop entirely, leaving BTC’s security model entirely dependent on diminishing block rewards.
While there is no doubt that L2 solutions provide a temporary solution to the scalability issues of both Ethereum and Bitcoin, they raise important questions about the long-term health of these networks. If L1 blockchains depend on a steady stream of fees to incentivize miners and validators, and if these fees are increasingly captured by L2 solutions, the economic models of these blockchains could become unbalanced.
The ultimate goal of both Ethereum and Bitcoin has always been to create secure, decentralized networks that can handle global demand. However, if L2 solutions continue to pull transactions out of L1 without providing sufficient fees to the underlying layer, the security and decentralization of these networks could be threatened. Finding a balance between L1 and L2 operations is essential for the future of blockchain scalability. The issue of rewards also does not address criticisms of L2 concepts, which are often seen as being significantly more centralized than the main chain, making them more vulnerable to attack and theft.
In short, while L2 solutions offer clear benefits in terms of transaction speed and cost, they also introduce significant risks to the long-term sustainability of Ethereum and Bitcoin. Without mechanisms to ensure that L2s make a meaningful contribution to the security and infrastructure of the underlying layer, these solutions may be more of a stopgap measure than a long-term solution. The Ethereum and Bitcoin communities will need to carefully consider how to scale their networks without compromising the fundamentals that make them unique in the world of decentralized finance.
As mainstream adoption approaches, the urgency for the Ethereum and Bitcoin communities to address these scaling issues is growing. If a sustainable balance between L1 and L2 is not established soon, the security and decentralization of these blockchains could be threatened in the years to come. Addressing these challenges is essential to maintaining the integrity of the networks and ensuring their long-term viability.