The Rise of Layer 2s Could Spell End for Altcoins (opinion)

[Hydrogen]

Phase 1 of the Bitcoin journey is complete. Over the past 10 years we have seen the Bitcoin network rebuff questions as to whether it would survive as a concept. Today, we see the bitcoin cryptocurrency gaining monetary premium as prominent institutional investors identify it as the ultimate inflation hedge. As we transition into 2021, observers are turning their attention to what a financial market built around the world’s first cryptocurrency will end up looking like.

The talk of the town over the past year has been focused on the potential of decentralized finance (DeFi) for digital assets and financial smart contracts, protocols and applications built on Ethereum. A development with equally promising potential to shake up crypto markets are layer 2 technologies, the overlaying network of services that expand on a blockchain’s capabilities.

This post is part of CoinDesk's 2020 Year in Review – a collection of op-eds, essays and interviews about the year in crypto and beyond. Edan Yago is a neuroscientist and entrepreneur who dropped everything nine years ago to focus on Bitcoin. He has most recently contributed to bitcoin-native DeFi platform Sovryn. Previously, Yago founded Cement DAO and Epiphyte to provide global remittance with bitcoin.

This year has seen the rollout of the first layer 2 projects. In fact, Ethereum co-founder Vitalik Buterin himself has stated that layer 2 is now the roadmap for Ethereum, and by extension other blockchains, too. This means that other scaling solutions, or ways to improve a blockchain’s functionality such as tokens – application specific bits of code – could become obsolete.

Will the success of layer 2 developments mean the demise of altcoins?

2020: The high watermark for altcoins

In the beginning there was only Bitcoin, and it did something quite remarkable – it created value out of nowhere. The Bitcoin blockchain had been designed to create only one thing – bitcoin. As others jumped onto this alchemist bandwagon, a multitude of alternative coins were created that were meant to function in a specific application like health care, identity or gaming. In reality, almost all of these projects ended up going nowhere.

There was one notable exception. Ethereum, and its provision of smart contracts provided real functionality even if the results of its open system are dubious. Its native currency, ether, is the second-most popular cryptocurrency after bitcoin and it is rapidly growing. Ethereum’s first “killer app” was the initial coin offering, a way to create more tokens.

However, with the rise of DeFi in 2020 Ethereum’s technological flaws have come into relief.

Ethereum is notorious for being incredibly slow, expensive to use and inefficient to the point where it is sometimes difficult to even get a transaction in. Progress has been frustratingly slow on Ethereum 2.0, the blockchain upgrade designed to address these issues. As a result, Ethereum developers in 2020 turned to layer 2.

Arise, layer 2

This year, the technologies around layer 2 have matured dramatically. On Ethereum, this has taken the form of DeFi projects being built on rollups (off-chain aggregations of transactions inside an Ethereum smart contract) consisting of both Optimistic rollups and zero-knowledge proofs or ZK-Rollups. When performing transactions on a rollup, the only confirmations made on Ethereum are in aggregate, meaning that for the vast majority of transactions Ethereum’s native currency doesn’t need to be involved at all. Such a move significantly alters the importance of the underlying chain.

On Bitcoin, DeFi applications are being rolled out on Lightning network and sidechains such as RSK. 2020 was also the year that interchain solutions such as Polkadot, NEAR and Cosmos went live, effectively as layer 2 solutions for Bitcoin and Ethereum connected via “blockchain bridges.” For instance, Sovryn, a decentralized bitcoin trading and lending platform, takes advantage of Bitcoin layer 2 technology while deploying a bridge to the Ethereum ecosystem. Keeping its native currency as bitcoin and giving primacy to stablecoins results in a solution that is faster, cheaper, more secure and easy to use. What this means is that the primacy of the “chain” is diminishing fast.

Fragmentation

Until now the success of a blockchain lay with the number of people willing to believe in its mission. Buying into an initial coin offering or a token was similar to betting on that particular chain succeeding against competitors in a crowded marketplace.

Layer 2 solutions represent a fragmentation of the chain-first approach. Because there are so many layer 2 methods and systems, and no clear way for the ecosystem to coalesce around any one of them, the fragmentation we have seen this year will worsen. While layer 1 systems like Bitcoin and Ethereum have built-in interoperable standards, layer 2 does not. The implication is that the network effect will no longer be in the chain but in the assets. Look at bitcoin and tether in 2020. Both have migrated massive value across chains because the tokens themselves are the focal point, not the chains.

IN FACE LAYER 1 IRRELEVANCY, THESE ALTCOINS WILL BY NATURE LOSE THEIR JUSTIFICATION TO EXIST.

As fragmentation accelerates, exchanging value will increasingly rely on interoperable or “cross-communication” solutions. The various different rollups will eventually need to subscribe to a common set of standards, and those standards will be the tokens or assets, rather than the chains. In this new world, altcoins will be at a severe disadvantage when up against the likes of bitcoin and stablecoins. This is because up until now altcoins have been based on the promise of a chain with unique properties. Their existence has been predicated on the idea that they would be the native currency for a chain that would gain in importance.

In other words, the value of these currencies is derived purely from the fact they are the “native currency” of a chain with unique features. In face layer 1 irrelevancy, these altcoins will by nature lose their justification to exist. Monetary premia will accrue instead to the things to which monetary premia traditionally accrues, which is broad acceptance and deep liquidity.

This trend towards irrelevance will include ETH. People have assumed ETH as an altcoin should be valuable, because Ethereum is popular. But something strange has happened on Ethereum in that there is as much value on the Ethereum chain in the form of bitcoin, stablecoins and other tokens, as in ether.

The dollars and bitcoin on the Ethereum chain effectively provide the ability to transfer value without the need for ETH. Smart contracts can easily be ported to a different chain when transferring tokens over on a bridge (which is what happens whether you’re moving to RSK, Polkadot or a rollup). What we will begin to see is the breakup of the Ethereum ecosystem in a world where two notably bigger currencies, dollars and bitcoin, are accepted and liquid forms of value transfer. The primacy of ETH is unclear, it’s future uncertain.

What's coming

Looking forward, it is expected that fees on Ethereum will very soon become so high that new and current users alike will be pushed out. Some of them will abandon DeFi and self-sovereignty altogether and go to exchanges. Some will migrate to layer 2 in the form of rollups. And some will take advantage of the interoperability provided by “bridges” via RSK, Polkadot or Cosmos.

The fragmentation of the smart contract space is expected imminently. Instead of consolidating around the different base layer blockchains, a consolidation will occur around assets.

Tokens will flourish more than ever, but the nature of these tokens will change. Rather than trying to capture a monetary premia, tokens will represent other types of asset classes such as equity and debt in the form of crypto bonds and derivatives.

What we’re going to realize in 2021 is that the decentralized monetary system is effectively represented only by bitcoin and stablecoins. That’s it – they’ve won that game. Now that the game is over the next challenge is going to be the decentralization of the financial layer, and the creation of financial tokens will play an important part in that. For bitcoin, we are at the end of the beginning.

No longer a proto-money, bitcoin is becoming the reserve currency of the future of finance. For altcoins we are at the beginning of the end. Bitcoin is no longer limited to a single chain, and the theory of chain specific currencies is being debunked.

https://www.coindesk.com/rise-of-layer-2s-altcoins-like-ethereum

....



Interesting read. One of the smarter and more informed opinion pieces I've had the pleasure of reading.

He contends blockchains will lose prominence in a paradigm shift towards off chain layer 2 applications. And that alts whose unique blockchain features are their main claim to fame will fall by the wayside as a result of them being less suited to survive and thrive in an off chain world.

Traders and investors could second this analysis as some alts are not maintaining pace with BTC ascension to $30k.

This seems like a good topic for discussion. How do you see things?

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[jackg]

To me, my favourite idea is the community that has the most good and active developers is the one that's going to see the most adoption. It could be bitcoin, eth or a few other coins. It might take a while for others to notice though which are more secure and more readily developed/forked.

[Bitbtc8]

Well the whole idea of Ethereum taking few years to fully migrate to POS is why I'm mad, it's even why this OP makes sense too, things could have change alot if Ethereum gas fee is fair enough honestly,  , we waited for the upgrade to get here in December 2020 and yet we have to wait for God knows when to fully migrate to POS finally, so lame

[fiulpro]

The whole idea does make sense for sure. I also believe strongly that ETH will rise high too , the ATH are too many to be considered something out of the blue. They are literally all focused on same things , I do believe there are many of them which have a different appeal but at the end of the day there is completion and that too very dominant. Right now BTC and ETH are two things that matters. I remember the time when people made a big deal out of ripple too but what happened to it ? Nothing
ETH is far more convenient when compared to BTC but BTC have a bigger hold of the market as a whole But the good thing is ETH and BTC , they work together mostly, they have more of a synergistic relationship rather than competition.
Stable coins are something that people have high hopes for since unlike gold 🥇 stocks you don't have to wait for 2 months or a specific time period to encash. So you really have the whole control of the situation.

To me, my favourite idea is the community that has the most good and active developers is the one that's going to see the most adoption. It could be bitcoin, eth or a few other coins. It might take a while for others to notice though which are more secure and more readily developed/forked.

I think with the quantum computing being developed now we would have to see " which one of them survives"
We need forks , we need subtle development over the years!! It is very essential now. I am really excited to see what development will happen in BTC and ETH, how secure the network will be and how much of a threat quantum computers really are.

[webtricks]

~snipped article https://www.coindesk.com/rise-of-layer-2s-altcoins-like-ethereum ~
Interesting read. One of the smarter and more informed opinion pieces I've had the pleasure of reading.

He contends blockchains will lose prominence in a paradigm shift towards off chain layer 2 applications. And that alts whose unique blockchain features are their main claim to fame will fall by the wayside as a result of them being less suited to survive and thrive in an off chain world.

Traders and investors could second this analysis as some alts are not maintaining pace with BTC ascension to $30k.

This seems like a good topic for discussion. How do you see things?

Yeah! This seems like a logical prediction to me. If we look at the current scenario, there are several notable blockchains which provide smart contract infrastructure like TRON, EOS, Stellar, etc. but Ethereum is undoubtedly king for smart contract creation (more than 98% DeFi apps are running on Ethereum). This shows that people prefer 'perceived value' over 'features that blockchain is offering'. Even though Ethereum network is facing scalability issue and high fees, people are still happy to host their dApps over it because they perceive higher value for ETH than EOS, TRX or other altcoins.

But with growing application, Ethereum may not sustain this for very long. So, layer 2 is kinda logical solution for the problem. People can create independent blockchains, host more complex applications over it and most importantly can use fuel currency which is pegged to the value of BTC/ETH. So, they can enter into new utility ventures and at the same time remain tension-free about the fall in portfolio's value in relation to BTC/ETH prices.

One of the reason why Layer 2 (or sidechain) isn't popular yet is the interoperability, especially for Bitcoin. Ethereum being smart-contract friendly blockchain can easily be bridged with other chains. But Bitcoin was specifically designed to be only used for storing and supporting financial transaction and still has no support for other data or utility. So, it was a long-standing challenge for developers to come up with 1:1 interoperability between BTC and on-chain currency in the most decentralized manner. As mentioned in articles, RSK and Polkadot have recently achieved good feat into this. RSK's PowPeg and Polkadot's Parachain can be stepping-stone for upcoming Bitcoin Layer 2 developments, who knows. I have written how RSK PowPeg works yesterday, here:  https://bitcointalk.org/index.php?topic=5305771.msg56001246#msg56001246

[The Sceptical Chymist]

Traders and investors could second this analysis as some alts are not maintaining pace with BTC ascension to $30k.

Could be.  I was kind of expecting altcoins to go nuts if bitcoin began to rise, but that has yet to happen--not that I'm all that much into altcoins, but there are some I like and root for.  ETH isn't one of those, however.

I don't have the technical knowledge to make any profound comments on the article, but the question seems to come down to whether any of the hundreds of altcoins on the market should or will have any value in the future.  Seems to me that there are way too many in existence, and most of them are just shitcoins that have no reason to exist.  I'm honestly not sure why some of them have survived this long.

ETH will likely remain #2 to bitcoin's #1 for a while--that's my best guess anyway.  Interest in it doesn't seem to be diminishing, even with all its faults.  In any case, it should be a very interesting decade for bitcoin and the rest of the crypto world.  We'll see how the landscape looks in 2030.

[South Park]

To me, my favourite idea is the community that has the most good and active developers is the one that's going to see the most adoption. It could be bitcoin, eth or a few other coins. It might take a while for others to notice though which are more secure and more readily developed/forked.

The idea that the better product wins in the end is probably right most of the time, however it is not always true, even if an altcoin had smarter developers and proceeded to include features that bitcoin did not had, what it is stopping the bitcoin developers to add the same functionality in the future denying in the process any reason for people to hold that coin in the first place?

This is why I do not hate altcoins as some other users do, altcoins are a sandbox where many features can be tested without affecting bitcoin and see if anything is worth to add to it, so if a coin really wants to beat bitcoin and become the leader of the market or at least survive as an independent coin then they need to have features that the developers of bitcoin cannot replicate.

[jackg]

The idea that the better product wins in the end is probably right most of the time, however it is not always true, even if an altcoin had smarter developers and proceeded to include features that bitcoin did not had, what it is stopping the bitcoin developers to add the same functionality in the future denying in the process any reason for people to hold that coin in the first place?

This is why I do not hate altcoins as some other users do, altcoins are a sandbox where many features can be tested without affecting bitcoin and see if anything is worth to add to it, so if a coin really wants to beat bitcoin and become the leader of the market or at least survive as an independent coin then they need to have features that the developers of bitcoin cannot replicate.

There's more of a chance the best team of developers will be able to win out with crypto. Bitcoin being the top now doesn't mean it has to always be the case and it leaves the spot for #2 and #3 open still even if bitcoin doest have to top spot just for being "Digital gold" or whatever institutions want to call it..

There could be an issue of things not being open source that'll come up soon if teams try to patent their individual work (before it's pushed to the public domain as source code).

I think with the quantum computing being developed now we would have to see " which one of them survives"
We need forks , we need subtle development over the years!! It is very essential now. I am really excited to see what development will happen in BTC and ETH, how secure the network will be and how much of a threat quantum computers really are.

I think qubits are still a "potential problem" most assumptions put it at us finding a few-qubit processor that way and working up from there. This may or may not happen but it'd be pretty irresponsible for anyone to just release a 256 qubit machine or even try to build one without requiring people to uplift their security standards to a higher bitrate.

[figmentofmyass]

Interesting read. One of the smarter and more informed opinion pieces I've had the pleasure of reading.

He contends blockchains will lose prominence in a paradigm shift towards off chain layer 2 applications. And that alts whose unique blockchain features are their main claim to fame will fall by the wayside as a result of them being less suited to survive and thrive in an off chain world.

edan yago has been saying this for 5+ years. IMO, he's overly focused on this idea that all value must converge on one cryptocurrency---bitcoin.

he never expected ethereum to blow up like it did. he expected rootstock to emerge way ahead of it. it flopped instead.

i don't trust his read on the market. he's biased. he puts his anti-altcoin politics first and foremost, which IMO clouds his judgment re where the market is actually headed as a whole. he's telling us what he wants to happen, not what is actually gonna happen. with his track record, there is a big difference.

[hatshepsut93]

These days smaller alts switched to trying to compete with Ethereum - they position themselves as a platform for some activity, usually smart contracts or some other stuff. Fast transactions, zero fees - that stuff hasn't been interesting for a while, all the coins that feature that (at the cost of complete centralization, of course) still failed to achieve any significant adoption. Lightning Network will just put a final nail in their coffin.

[jacafbiz]

The more Ethereum stall their migration to Ethereum 2.0 the more the arguement for layer 2 solutions is going to go stronger. We are going to see Dapps prefer to launch on layer 2 now and I believe most Dapps looking to launch this year will be looking at the available layer 2 solutions and how they fit into their own plans. The issue I have about these layer 2 is the loss of  decentralization

[Smartprofit]

Ethereum has a very large competitive advantage - this cryptocurrency has a large number of developers and software testers. 

An investor can easily sell Ethereum and buy Bitcoin.  It is not so easy for a developer to move from developing one software product to developing another software product.  To do this, he will need to gain new knowledge, perhaps even learn a new programming language. 

Ethereum has many disadvantages.  However, I am confident that this cryptocurrency has a future. 

The rise in the price of Ethereum in 2020 and early 2021 confirms this assumption.

[Hydrogen]

edan yago has been saying this for 5+ years. IMO, he's overly focused on this idea that all value must converge on one cryptocurrency---bitcoin.

he never expected ethereum to blow up like it did. he expected rootstock to emerge way ahead of it. it flopped instead.

i don't trust his read on the market. he's biased. he puts his anti-altcoin politics first and foremost, which IMO clouds his judgment re where the market is actually headed as a whole. he's telling us what he wants to happen, not what is actually gonna happen. with his track record, there is a big difference.

Dash's recent delisting via bittrex aligns with that. As do other recent events. A unified and coordinated front across multiple spectrums usually indicates an agenda of some type is being pushed. It would appear they're endorsing crypto assets they believe they can use or control. While simultaneously throwing shade at crypto assets under the control of others, not affiliated with them like dash. To centralize and consolidate markets as is so common in this day and age.

I don't agree with Yago's analysis or think what he said was valid. Only wanted to take the time to acknowledge his attempt was much better than Jamie Dimon's. He came at it from a smart angle that was much less obvious than the majority of attempts.

Ethereum's partnerships with microsoft and JP morgan could be its main saving grace atm.

[el kaka22]

Two layer systems that would make it off-chain would cause a big spike in "debt" like banks do. It is not going to be named debt, but if you could wrap anything you want and call it the real thing without actually owning the real thing, that is not going to end up very well. Look at banks for example, do you really think that they have enough money in their accounts to cover for everything they do?

All the investments, all the loans they give, all the insurance and reinsurance? They do not have nearly half of the money they claim they have, but they can deal with it why? Because they say they are going to make money with it so it is not a problem for them, the default rates are low so they should be profiting anyway, which is like me buying bitcoin with million dollars that I do not have and saying "but bitcoin will go up, so I won't be in debt", doesn't matter because I do not have that money, I should not be able to do it even if price of bitcoin goes up. Same will happen with layer twos.

[figmentofmyass]

Two layer systems that would make it off-chain would cause a big spike in "debt" like banks do. It is not going to be named debt, but if you could wrap anything you want and call it the real thing without actually owning the real thing, that is not going to end up very well.

"layer 2" refers to pegged systems that settle to the bitcoin blockchain. LN, RSK, liquid, etc all require that bitcoins be locked on the mainchain before layer 2 currencies can be issued in their place. unless there is specifically a protocol vulnerability---like the ones in bitcoin that would have allowed extra inflation---what you're talking about can't be done.

the issue you raise is more about asset tokenization by trusted third parties---things like WBTC or USDT which may not be fully backed. that's a different idea than layer 2.

[hatshepsut93]

Two layer systems that would make it off-chain would cause a big spike in "debt" like banks do. It is not going to be named debt, but if you could wrap anything you want and call it the real thing without actually owning the real thing, that is not going to end up very well. Look at banks for example, do you really think that they have enough money in their accounts to cover for everything they do?

Lightning transactions are real Bitcoin onchain transactions, you just don't broadcast them. You can't create more supply out of nowhere, that would make transaction invalid - it passes the same verification as Bitcoin's onchain transactions. Bitcoin's layer two is nothing like layers of fiat system.

[darewaller]

edan yago has been saying this for 5+ years. IMO, he's overly focused on this idea that all value must converge on one cryptocurrency---bitcoin.

he never expected ethereum to blow up like it did. he expected rootstock to emerge way ahead of it. it flopped instead.

i don't trust his read on the market. he's biased. he puts his anti-altcoin politics first and foremost, which IMO clouds his judgment re where the market is actually headed as a whole. he's telling us what he wants to happen, not what is actually gonna happen. with his track record, there is a big difference.

Dash's recent delisting via bittrex aligns with that. As do other recent events. A unified and coordinated front across multiple spectrums usually indicates an agenda of some type is being pushed. It would appear they're endorsing crypto assets they believe they can use or control. While simultaneously throwing shade at crypto assets under the control of others, not affiliated with them like dash. To centralize and consolidate markets as is so common in this day and age.

I don't agree with Yago's analysis or think what he said was valid. Only wanted to take the time to acknowledge his attempt was much better than Jamie Dimon's. He came at it from a smart angle that was much less obvious than the majority of attempts.

Ethereum's partnerships with microsoft and JP morgan could be its main saving grace atm.

I believe you are sort of right and that should be repeated a lot. SEC and all other government branches will not touch bitcoin, they are both making a ton of taxes from it, but there is really nothing they need to worry about, they are already putting in efforts to make it in a way that if you want to use an exchange based in USA you have to show which wallet belongs to you, basically making being anon a joke in bitcoin world, so they support bitcoin because of it.

ETH could find its place, hell even XRP could pay a fine fix some things and go back to business as usual. Simply put, I believe there is this "either play on our rules, or leave the court or we make you leave" type of situation, as long as you go nice on them, they will go nice on you, if you do not play with their rules, they are going to make you delisted and basically sue you until even your grandchildren are in debt.