LK Venture Report: Can Layer3 bring about a big breakthrough in the application chain ecosystem?

LK Venture Report: Can Layer3 revolutionize the application chain ecosystem?

Why do we need Layer3 with Layer2? Layer2 will maintain decentralization as a universal computing layer, providing composability, while Layer3 should serve as an application-specific chain that meets unique application needs such as compatibility, efficiency, privacy, and more.


From Layer1 to Layer2

  • How is scalability achieved technically? Ethereum sees Rollup as the only Layer2 solution because it expands Ethereum without sacrificing decentralization and security. From a modular perspective, Layer2 is responsible for execution, while settlement, consensus, and data availability are handled by Layer1.

From Layer2 to Layer3

  • What is the difference between Layer2-Layer3 and Layer1-Layer2? Although Rollup technology solves Ethereum’s computational bottleneck, it does not solve the problem of data availability. The upper layer needs to compress transaction data to pass it on to the lower layer, but compression cannot be repeated, and the Layer2-Layer3 performance cannot bring significant improvements.

  • Why do we need Layer3 with Layer2? Layer2 will maintain decentralization as a universal computing layer, providing composability, while Layer3 should serve as an application-specific chain that meets unique application needs such as compatibility, efficiency, privacy, and more.

  • What is the difference between Layer3 and Cosmos as application chain ecosystems? Layer3 relies on the Ethereum ecosystem and is more likely to obtain users and funds, but due to its high degree of binding with Ethereum, it also loses some sovereignty, such as capturing token value.

From Layer3 to LayerX?

  • The development status of Layer3: Arbitrum released Orbit Chain on June 22; zkSync announced that it will launch ZK Stack within a few weeks on June 26; and madara in the Starknet ecosystem helped a project deploy a Starknet Layer3 application chain within 24 hours during a hackathon.

  • With the arrival of Layer3, will Layer4 and Layer5 be far away? From a technical perspective, LK Venture believes that Layer3 can no longer achieve performance leaps through simple stacking. Although the ecological relationship between Layer1-2-3 is close (Ethereum ecosystem) and the interoperability is stronger than traditional heterogeneous chains (cross-chain is cheaper), they still cannot fully inherit the ecology from each other. The narrative of Ethereum’s scalability may end in Layer3.

From Layer1 to Layer2: Scaling

There exists an impossible triangle in blockchain, that is, security, decentralization, and scalability cannot be achieved simultaneously. Ethereum chooses the first two, but its support for the latter is insufficient. On a regular day, a swap in Ethereum requires a $3-$4 gas fee, and during a bull market with high transaction volume, a swap may even require nearly $100 gas fee, showing strong congestion.

Relying on the huge ecosystem established with the first-mover advantage, although many new public chains that focus on scalability have emerged continuously since 2018, Ethereum still maintains an absolute dominant position in the market. People then turn their attention to the scaling solutions built on Ethereum.

Among them, the three widely used solutions are sidechains, Validium, and Rollup, which have different trust assumptions.

  • Sidechains are independent blockchains running independently of Layer1 and connected to the Ethereum mainnet through a two-way bridge. Sidechains can have separate block parameters and consensus algorithms, enabling efficient processing of transactions, but do not inherit Ethereum’s security attributes.

  • Validium uses off-chain data availability and computation to process transactions off-chain to improve throughput and publishes zero-knowledge proofs on Layer1 for verification of off-chain transactions to obtain security.

  • Rollup performs calculations off-chain but uses Layer1 as the data availability layer. It verifies off-chain transactions in Layer1 smart contracts by publishing fraud or validity proofs to inherit Ethereum’s security.

Ethereum regards Rollup as the only Layer2 solution, because it achieves the expansion of Ethereum without sacrificing decentralization and security. From a modular perspective, Layer2 is responsible for execution, while settlement, consensus, and data availability are all handled by Layer1.

Rollup can be divided into Optimistic Rollup and ZK Rollup according to different types of submitted proofs.

For Optimistic Rollup, Rollup executes transactions in batches and sends the batch of transactions, pre-execution state, and post-execution state to the Rollup contract deployed on Layer1. Layer1 does not verify the state transition process. As long as the initial state submitted by Rollup is the same as that saved in the contract on Layer1, it optimistically transfers the state to the new state submitted by Rollup.

Prevention of fraudulent behavior is ensured through fraud proof. During a period of dispute, other verifiers can challenge the state root by sending a fraud proof to the Layer1 Rollup contract. This will cause the Rollup state to revert to the determined state before the dispute and recalculate the legitimate state based on the result to punish the verifier. In fact, fraud rarely occurs, so optimistic state transfer actually saves a lot of verification resources.

The difference between ZK Rollup and Optimistic Rollup is that the state transition needs to be verified, not by the Layer1 Rollup contract, but by verifying the validity proof in the contract. After the verification is completed, the state transition immediately obtains finality without waiting for a one-week dispute period.

In projects that use the Optimistic Rollup technology, the most mature are Arbitrum and Optimism, both of which have been launched on the main network. Among them, Arbitrum has implemented fraud proof, but it is limited to whitelist submissions, while the fraud proof of Optimism is still under development. Both are actively promoting the decentralization process, including the decentralization of the sequencer and validator.

According to L2Beat data as of June 26, 2023, the TVL of Arbitrum One and Optimism are $5.81B and $2.25B, respectively. Other projects that use the Optimistic Rollup technology include Boba Network, Zora Network,, Fuel, BNBOP, Coinbase, etc., some of which are developed using the OP Stack open sourced by the Optimism team.

In the projects that use ZK Rollup technology, the main ones that support the virtual machine are zkSync Era, StarkWare, and Polygon zkEVM, which have already gone live, with TVL of $618M, $68.11M, and $42.65M. Those that only support specific types of transactions include dydx, Loopring, zkSync Lite, with TVL of $350M, $98.47M, and $97.69M. The development direction of ZK Rollup is better Ethereum compatibility, and the zkEVM projects under development include Taiko, Scroll, Linea, etc.

From Layer2 to Layer3: Customization

Layer2: 100x, Layer3: 100x^2=10000x?

From Layer1 to Layer2, the cost is reduced by 1/100. Therefore, it is natural to think of building Layer3 by performing the same operations on Layer2, and the cost of Layer3 will be reduced to 1/10000. Unfortunately, the answer is negative.

Rollup indeed solves Ethereum’s computing problem by transferring execution off-chain. L1 nodes no longer need to execute each transaction in the batch to verify the correctness of the state transition. Thanks to recursive proof technology in cryptography, computation can be recursively processed to obtain unlimited performance. However, data availability cannot be stacked.

  • Privacy: Set up a dedicated privacy chain, settled on Layer2, but cannot be observed publicly.

In addition, because the application chain is dedicated, it will not be directly affected by other applications, and the performance and cost of the chain are relatively certain. At the same time, bridge transactions do not need to be sent directly on Layer1, and the cost is lower. The bridging between L2-L3 and L3-L3 is cheaper.

Layer3 also has a clear advantage in batch transaction submission. The fixed Gas required to submit a batch transaction is lower, and there is no need to wait for more transactions to be submitted together to reduce the average Gas. This can significantly alleviate the dilemma between confirmation time and cost in Layer2.

What is the difference between Layer3 and Cosmos as application chain ecosystems?

Cosmos can be said to be the project that first proposed the concept of application chains. Through Cosmos SDK, users can easily customize and issue their own application chains. Cosmos IBC is even targeted at the TCP/IP protocol in the Internet, providing native interoperability for application chains built using Cosmos SDK. In short, Cosmos’s vision is to build a blockchain universe that connects thousands of chains.

Layer3 has also worked hard on interoperability. Due to the same technical architecture and low transaction costs, cross-chain between Layer3 will be trustworthy, fast, and cheap, so it can be considered that the liquidity between Layer3 is shared. From the perspective of interoperability, the functions brought by Layer3 and Cosmos are almost the same.

LK Venture’s investment research team believes that the biggest difference between Layer3 and Cosmos is its binding with the Ethereum ecosystem, which is both an advantage and a disadvantage.

Speaking of advantages, it mainly lies in the huge liquidity and user base of the Ethereum ecosystem.

Although Cosmos is powerful and is the first choice for many giants to launch chains, it still cannot escape the fate of low market share. According to DeifLlma’s data, as of June 26, 2023, Ethereum’s TVL is $26.2B, while the entire Cosmos ecosystem is only nearly $1B. If Layer3 wants to succeed, the Ethereum ecosystem is a key element.

Speaking of disadvantages, it mainly lies in the high binding with Ethereum, which loses part of its sovereignty.

For using the Cosmos chain, the token model is completely designed by the project party according to demand, and the token empowerment is strong. However, the native tokens of Layer3 chain will be restricted by Ethereum. Although the project party can empower the native token as the Gas token, it is undeniable that the ultimate transaction data submitted to Ethereum consumes $ETH. Therefore, if the Gas token is not $ETH but the native token issued, the project party needs to constantly exchange the native token for $ETH to submit it, and the final empowerment is still transferred to $ETH.

Another characteristic of Layer3 is that anything done on Layer3 can actually be migrated to Layer2 and only depends on the choice of DA layer. If the Layer2 settlement that Layer3 depends on has security vulnerabilities or decreased activity, Layer3 can be migrated to other Layer2 at low cost, or even directly rely on Layer1 for DA and settlement, becoming Layer2. Due to its high binding with the Ethereum ecosystem, many innovative gameplay may emerge on Layer3.

Prospects from Layer3 to LayerX

Development status of Layer3

On June 22, Offchain Labs released tools for issuing Arbitrum Orbit Chain. Orbit Chain is a Layer3 on top of Arbitrum Layer2 and can choose to settle on one of the three Layer2s, which include Arbitrum One, Arbitrum Nova, and Arbitrum Goerli.

Users can choose to use Rollup or Anytrust technology, the difference being that Anytrust uses DAC without submitting transaction data to the chain, which is cheaper but less secure. The advantages of Orbit Chain are its simple chain issuance process, interoperability with the Arbitrum ecosystem, Nitro’s instant updates, and Stylus’s EVM+ compatibility (supporting Rust, C, C++ writing, running on WASM virtual machine).

Users can customize and issue any Orbit Chain without settlement on Arbitrum Layer2, but they need to contact Offchain Labs or Arbitrum DAO for authorization.

On June 26, zkSync announced that it will modify the existing open source code in the next few weeks and launch ZK Stack, allowing users to use its customization to build their own ZK super chain. Unlike Arbitrum’s Orbit Chain, ZK Stack emphasizes sovereignty and interoperability. Users can fully customize it according to their needs. The chain built using ZK Stack can achieve bridgeless interoperability. ZK Stack can be used to build both Layer2 and Layer3, and the official does not limit it, nor does it require settlement on zkSync. From this point of view, ZK Stack seems to provide stronger sovereignty.

As the StarkWare team, which first proposed the concept of Layer3, is also vigorously cultivating the development of Layer3 in its Starknet ecosystem, Madara is testing the Stack for the public. At the @PragmaOracle hackathon, a team used Madara to complete the issuance of the application chain within 24 hours.

However, due to the unique zk-STARK proof technology used by Starknet, the technical maturity is relatively low, and it may take longer development to improve the product, and then release Starknet Stack to the public.

Currently, the Layer3 ecosystem is still in its early stages, but with the introduction of convenient Layer2 tools, it is believed that Layer3 will soon be running officially. As the infrastructure gradually improves, how to attract users has become the most important issue for all chains.

Layer3 is here, will LayerX be far behind?

From a technical point of view, Layer3 can no longer achieve a performance leap through simple stacking. Of course, Layer3 can obtain specific advantages through customization, but the loss of generality will make further stacking difficult. Of course, as long as you are willing, this hierarchical stacking can be infinite, but LK Venture’s research team believes that at present, this stacking cannot meet any needs and will cause the geometric rise of system complexity.

The most important point is that although the ecological correlation between Layer1-Layer2-Layer3 is close (Ethereum ecosystem) and the interoperability is stronger than that between traditional heterogeneous chains (cross-chain is cheaper), they still cannot fully inherit the ecology from each other. Contracts deployed on Arbitrum One cannot be directly called on Orbit Chain; the liquidity of the DEX deployed on zkSync cannot be directly aggregated on ZK Stack.

Now, the situation is that the mall has been built, and it is getting taller and taller, but there are not many merchants and customers. Although the first floor of the mall is crowded (Ethereum), people still don’t want to go to the upper floors of the mall to consume because there are fewer merchants on the upper floors than on the lower floors.

Therefore, LK Venture’s research team believes that it is difficult to achieve a high number of users for Layer3 before blockchain technology achieves large-scale applications. As for Layer4, Layer5…LayerN, even if some applications have specific requirements, I believe they will not be promoted under the banner of LayerN.

The ancient saying goes: The Dao gives birth to one, one gives birth to two, two gives birth to three, and three gives birth to all things. Will the narrative of Ethereum’s expansion end in Layer3? It may take time to verify.