Arbitrum co-founders see opportunity for continued layer-2 growth through DeFi, gaming

As we segue into March, the Ethereum layer-2 space is continuing to see strong demand: One of its largest scaling solutions, Arbitrum, is seeing renewed exponential growth through subsectors in the ecosystem.

While base blockchains (layer ones, or L1s in crypto-speak) remain the bedrock of the web3 landscape, technology built on top (layer two chains, or L2s) are exploding. Arbitrum recently surpassed the Ethereum chain that it is built on in terms of total transactions processed.

Arbitrum is an L2 Ethereum-focused scaling solution that aims to act like Ethereum but with transactions that cost way less and processing that’s way faster. It makes up about 54% of the market share on Ethereum and has about $3.38 billion total value locked, according to L2Beat data. The TVL, which is tracked through the amount of tokens locked in all escrow contracts for an L2, is near its highest point since May 2022, the data shows.

L2 scaling solutions like Arbitrum, Optimism, Immutable X, StarkWare and others are built on top of layer-1 blockchains like Ethereum. But L2s function in a faster, cheaper way and reduce the load on L1s by bundling up transactions and only recording final results on the main blockchain. That way it doesn’t clog up the network.

Growing DeFi and other use cases

Decentralized finance continues to dominate most demand for L2s, but there may be other areas that could gain stronger traction, such as gaming. “In the short term, DeFi is showing the most traction,” said Harry Kalodner, CTO and co-founder of Offchain Labs, a developer of Arbitrum. But DeFi may not be the path to onboard “hundreds of millions of users,” he added.

“The path to mass adoption is where the user doesn’t know they’re using a blockchain and can just get the benefits of using it,” Kalodner said. “It seems like gaming and social applications could [drive] that.”

“This growth feels very real because we’re seeing it across all metrics with new addresses, number of transactions and TVL: Across the board we’re seeing an increase,” Kalodner said.

If transaction volume is “way up” and everything else were deflated, that wouldn’t make sense, but all the core metrics are higher, said Offchain Labs co-founder and CEO Steven Goldfeder.

The broadly positive movement in metrics may imply that the L2 boom is not predicated on a fad, or single-point distortion in the incentive structure of Ethereum-focused transactions; at times in crypto’s history, changes to business models, the introduction of new chains, and at times even hacks have led to swings in different activity levels. The L2 market can simply claim growth as the reason for its changing numbers — growth that, by our understanding, appears predicated on regular use instead of near-term arbitrage.

On Feb. 21, Arbtirum passed Ethereum in total daily transactions at 12.77 transactions per second compared to Ethereum’s 12.55 TPS but has since fallen back into second place, according to L2Beat data. But the average total L2 TPS across all scaling solutions has been higher than Ethereum’s for the past few months, meaning that the user base is depending more and more on L2 solutions to handle transactions than the core Ethereum L1 chain?

Think of it like uploading a PDF file: Uploading every word in a document would take up a lot more space and time than bundling it into one document and shipping it out. Now apply that to transactions on the blockchain.

Growing the pie

Going forward, the focus for 2023 is “growing the pie,” Kalodner said. “That’s the path to even more growth.”

While its DeFi ecosystem will be “growing itself” in the short term, the team also plans to make an active effort to expand scaling solutions further for gaming and NFTs so nontechnical and nonfinancial users could also expand on the platform, Kalodner said.

“We don’t pick favorites; we work with everybody and we want as broad of an ecosystem as possible,” Kaldoner said. “But we’re much more focused on gaming and NFTs for active outreach.”

Arbitrum is also “very much going after the crypto-native adoption as well as institutional adoption including financial institutions, social platforms,” Goldfeder said. “Fundamentally we have dominant market share in DeFi today and our focus is pretty general, but definitely DeFi and gaming are our strongest spots right now.”

But in order to grow the pie, so to speak, Arbitrum has to make its platform more inclusive to developers and users, Goldfeder said. “Our thesis is we have to bend our technology to developers instead of making them bend to us … the way to get [a] billion users is through the next million developers. We have to expand the pod.”