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The Layer-1 Landscape: Ethereum’s Struggles And Competitor Analysis

By Shane Neagle. Originally published at ValueWalk.

Ethereum

What do you do when you are popular, but you can’t handle the heat? This is the question Ethereum has been struggling with for the last two years, after much development since its launch in 2014. As the first blockchain network to deploy and popularize dApps, Ethereum has skyrocketed in popularity since 2020. In fact, without Ethereum, decentralized finance (DeFi) wouldn’t exist today as we know it.

What was once reserved for banks and exchanges, Ethereum recreated with smart contracts stored in its blockchain, linked with decentralized applications (dApps) as the end-point user interface. Overnight, it seemed that the days of banking tellers and other bureaucrats were numbered. From lending and borrowing, to gaming and NFT marketplaces, Ethereum’s dApps now store $120.91 billion worth of cryptocurrencies across 2,945 dApps.

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Ethereum

Total value locked (TVL) in Ethereum. Its activity ramped up drastically in the summer of 2020. Source: DeFiLlama.com

This is a 20,000% rise from April 2020, indicating that an entire new financial market was forming. Moreover, Ethereum’s native cryptocurrency, ETH, went from $200 to over $3,000, mirroring the establishment of Finance 2.0. In fact, this growth is similar to Elon Musk’s Tesla popularizing electric vehicles, reflected by the stock’s appreciation by over 1,000% since January 2020.

Unfortunately, there was a cost to be paid for Ethereum’s explosive growth. The more people started using it, the more its network became congested, souring the experience with enormous fees and slow transaction speeds.

Ethereum’s Gas Fee Woes Explained

As any computer network, Ethereum can handle only so much traffic. After all, there is no such thing as infinite throughput. In the blockchain world, this is particularly significant because users don’t just experience a slowdown when they want to execute a transaction. On top of that, they also experience high transaction fees when making them.

Even simple transactions, such as exchanging USDT for ETH on decentralized exchanges (DEXes), costs an arm and a leg, especially compared to centralized exchanges (CEXes) like Binance or Coinbase.

Ethereum

Some of Ethereum’s DEX dApps (protocols) are very expensive to use. More complex smart contract interactions, like NFT minting, can run in the hundreds of dollars at peak network congestion. Source: Crypto.com

To make matters worse, because a single ETH is much more valuable than a single dollar, even tiny percentage fees translate to big expenditures, as they are denominated in Gwei (one billionth of an ETH). Additionally, the higher Ethereum’s demand due to use, the more valuable it becomes.

In turn, the more popular Ethereum becomes, the more expensive it becomes to use it. Kind of a self-defeating problem to have, isn’t it? Indeed, it is a very difficult problem to solve, called the blockchain trilemma. Every blockchain can be rated by its three main attributes:

  • Decentralization: How many nodes (computers holding blockchain’s entire record) are making up the network—and how is authority distributed among these nodes?
  • Security: Based on its incentive mechanism and node count, how difficult is it to tamper with the network?
  • Scalability: How many clients can the network serve in a fast and affordable manner without compromising decentralization or security?

This is a trilemma because increasing one attribute tends to decrease the other one. Specifically, if a blockchain is more decentralized, it takes longer to confirm transactions because there are more nodes (run by validators) to run it through.

Likewise, if there is less decentralization, there is more likelihood of the network being compromised because there are fewer nodes providing redundancy. In turn, if there are more nodes for greater decentralization, it is more difficult to cost-effectively scale up the network.

Suffice to say, Ethereum is highly decentralized and secure, but it lacks scalability. The big question then is, what are Ethereum developers doing, headed by Vitalik Buterin, to alleviate this problem?

Ethereum’s Scalability Solutions

Contrary to popular belief, Ethereum’s upcoming transformation from proof-of-work (PoW) to proof-of-stake (PoS) consensus is not aimed at solving its volatile and high transaction fees. Both Bitcoin and Ethereum have been using energy-demanding PoW to process transactions and add new blocks (i.e. groups of transactions).

However, because PoW uses computational work to prove transaction validity, such a blockchain network is an energy hog. This is best exemplified by how much less energy Ethereum will use after it transitions to PoS-only.

Ethereum

By going full PoS by the end of 2022, Ethereum is poised to reduce its carbon footprint by a factor of 2,000x. Image credit: Ethereum Foundation.

While it is nice to know that Ethereum will go green, as this will open up the doors to institutions concerned with socially responsible investing, this is a far cry from scalability. Essentially, the scalability problem is one of computing and storage of transactions, regardless of how much power is needed to make it happen. It is this computing resource that is measured as “gas”.

Instead, what might improve Ethereum’s scalability during its 2.0 upgrade process is sharding – partitioning the network into smaller and independent chains (shards). This way, split big data chunks would allow for greater network speeds and lower fees. In Ethereum’s case, this splitting will happen across 64 shards, but only some time in 2023 or 2024.

In the meantime, the simplest way to increase scalability would be to increase the blockchain’s block size. As the name implies, each blockchain is composed of blocks chronologically chained to make up an immutable ledger. This way, if one were to tamper with a single record on that chain, a new one would have to be created, called a hard fork.

Moreover, if the size of those data blocks is increased, allowing for more transactions to be stored within a single block, this would reduce the fees. By the same token, if block time (how long it takes to add a new transaction) is also increased, this would lower fees still. In fact, this is so obvious a scalability solution that Elon Musk proposed it for Dogecoin (DOGE).

Vitalik Buterin himself, the co-founder of Ethereum, stepped in and dismissed the idea, saying that it would compromise blockchain’s decentralization. That’s because increasing the block size would elevate hardware and internet requirements to run a node, effectively reducing their number.

In the end, Ethereum’s scalability resolution will come from both sharding and layer 2 networks. The latter are simply attachments to Ethereum’s main chain (layer 1), just as one would attach a road to a highway to relieve it of its congestion. There are a number of such L2 networks to choose from, as they import Ethereum’s dApps and grow their own affordable ecosystems.

Ethereum

Ethereum’s top 10 layer 2 networks. Some are universal, while some cater to specific niches, such as feeless NFT trading. Image credit: L2beat.com

To illustrate their effectiveness, on April 7th 2022, normal ETH gas fee costs $3.73, while Arbitrum reduces it to a negligible $0.059.

Ethereum

However, is it possible to achieve scalability without resorting to attached L2 networks?

What Are Other Blockchains Up To?

Ethereum may have pioneered DeFi and spawned its ample $203 billion market, but other blockchain projects were not idling. Although they are far from reaching Ethereum’s DeFi dominance, Ethereum has left its gas fee doors wide open for them to step in.

Ethereum

Ethereum hovers above other smart contract platforms as its own category. Image credit: The Block.

Foremost, Ethereum alternatives are all proof-of-stake blockchains, just as Ethereum is about to be. This means they all have very low energy draw as they don’t use computational transaction proofing known as mining. With that said, there are some significant differences.

Algorand (ALGO)

Algorand (ALGO) is a pure proof-of-stake blockchain (PPoS), so all ALGO token holders receive network rewards. In contrast, only Ethereum’s validators receive transaction fees with the requirement being pretty high – 32 ETH stake or $102.2k.

However, because Algorand has an exceedingly low barrier to entry, at just 1 ALGO stake ($0.78), this translates to increased network invulnerability. After all, higher stake equals greater care to not misbehave. This is exacerbated by Algorand not having a slashing mechanism (stake reduction) for malicious behavior.

There was an attempt to implement it last year, but the proposal wasn’t accepted. Nonetheless, because Algorand uses a two-tier architecture, in which one chain layer handles simple transactions, while the other one handles more complex ones, this makes it inherently hold a scalability solution that Ethereum seeks in external L2 networks.

For this reason, Algorand vastly outcompetes Ethereum in transactions per second, at 1,000 tps vs 14 – 17 tps respectively. Furthermore, its minimum fee is only 0.001 ALGO. On the other hand, the Algorand ecosystem is a fraction of Ethereum’s, with fewer than 80 dApps. This is reflected in ALGO’s price performance.

Ethereum

ALGO vs. ETH year-to-date (YTD) price performance comparison. Image credit: Trading View

Terra (LUNA)

Terra (LUNA) is the biggest surprise among Ethereum alternatives. A year ago, its TVL market share was merely 1.21%. Today, it is 13.45% ($30b TVL), second only to Ethereum itself. Even more surprisingly, Terra is built from another platform – Cosmos SDK – an open-source framework for building PoS blockchains.

For this reason, Terra also borrows from the Cosmos’ consensus engine, Tendermint Core. Without going into minutia, it was designed for enterprise-grade use, so its transaction speed can go up as much as 10,000 tps. Furthermore, Terra’s gas fee is set at 0.6%.

Because Terra was envisioned as a blockchain counter to Visa, the resulting gas fees are exceptionally low, ranging between $0.13 and $0.16, according to Statista. For this reason, Terra is hugely popular in South Korea, its home base. For instance, the CHAI payment app uses Terra blockchain for cheap and fast money transfers.

As a cherry on top, Terra tries to make life easier for crypto users by avoiding crypto volatility. It accomplishes this with its own algorithmic stablecoin TerraUSD (UST), which is pegged to the dollar at a 1:1 ratio. This is the engine that powers Terra’s ecosystem as UST’s peg is dynamically maintained by expanding and contracting LUNA tokens.

In turn, staking LUNA tokens to stabilize UST yields rewards as passive income. Lastly, Terra’s foundation, Luna Foundation Guard (LFG), is slowly acquiring Bitcoin (BTC) to further fortify UST’s peg of up to $10 billion collateral. With these tailwinds, Terra (LUNA) is the rare exception in outperforming Ethereum.

Ethereum

LUNA vs. ETH year-to-date (YTD) price performance comparison. Image credit: Trading View

Binance Smart Chain (BSC)

Recently rebranded into BNB Smart Chain, this blockchain network represents the attempt by the world’s largest crypto exchange – Binance – to take a bite from the expanding smart contract pie. This way, when people use it, Binance gets an additional source of income on top of its core business model.

Consequently, BNB is a highly centralized network with only 21 validators, although there is a plan to increase the number to 41. Yet, this very same centralization means that it is a superior performer. Its block time is around 3 seconds, while Ethereum’s is at under 5 minutes.

Likewise, at peak congestion, BNB can handle up to 160 tps, with a $0.3579 average transaction fee. This can be further reduced with a 25% discount if paying for fees with the native BNB tokens. Such perks add up with the fact that Binance is the most convenient way to trade cryptos.

Accordingly, BNB price closely follows Ethereum despite being on the opposite end of the decentralization spectrum.

Ethereum

BNB vs. ETH year-to-date (YTD) price performance comparison. Image credit: Trading View

Is Ethereum Too Entrenched to Be Dethroned?

Similar to how the first mover advantage benefited certain social media platforms, so too did Ethereum snowball into its current DeFi king status. Its next big update to PoS will be a big test whether it can maintain this dominance. Will Ethereum eventually be labeled as the “MySpace” of the blockchain space—or something closer to “Facebook”?

If the transition goes smoothly, without major bugs and code exploits, Ethereum investors can rejoice. Yet, fixing its gas fees is a long-term project, especially if its popularity is boosted again as a result of successful PoS transformation. This makes Ethereum alternatives as relevant as ever.

The good news is that crypto’s adoption rate remains comparatively small, and is anticipated to grow. Perhaps there’s room for more than one smart-contract blockchain at the top of the mountain—but this will all come down to user experience and how these blockchains successfully navigate the existing ‘trilemma’.

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