Layer 2's Incentive War after the Optimism Airdrop

After Optimism’s OP Token Airdrop, the developing team immediately announced an Incentive program with 230M OP Token for protocols in order to bootstrap their ecosystem.

From my point of view, the above step will raise the market’s awareness of the Layer 2 category. And maybe, this will be a hotspot for Crypto, receiving cash flow in the future. 

What is this trend? How can we take advantage of the opportunity? Let’s get started.

Layer 2 is becoming hotter

Why does the market draw attention to L2? 

Layer 2 (or L2), the scaling solution for Ethereum with security inherited from this network, is getting a lot of attention from the market. Especially since Optimism launched OP.

In practice, there have been some Layer 2 solutions deployed on the market and have developed their own ecosystems. Boba, Metis, ImmutableX, Arbitrum, ZkSync, Optimism, etc. can be mentioned as specific examples.

However, according to my observations, there are only 4 remarkable names at the moment, which are Arbitrum, Optimism, ZkSync, and StarkWare. So why are these 4 names outstanding?

This is because they have not launched Tokens yet. Even though Optimism has its token OP, it is still not tradable.

⇒ Therefore, the market will keep an eye on those L2s as an investment opportunity in the context of the battle between the L1s (Avalanche, Solana, Terra, Near,…) being saturated and The Merge of Ethereum has not taken place yet.

Besides, L2 caught a lot of attention as the scale of capital raising and the valuation of these projects are not small, for example:

• Optimism closed the Series B funding round with $150M mobilized capital and a $1.65B valuation.
• Off-chain Labs (Arbitrum developer) is no less with $120M mobilized capital in the same funding.
• On the side of Zk-Rollup solutions, ZkSync raised $256M, additionally, the valuation of StarkWare is $2B after Series C.

Therefore, we will have a lot of chances from hunting Retroactive (such as Optimism), and Yield Farming to invest in L2 Tokens.

Learn more: What is Retroactive Airdrop?

Layer 2 at a glance

In relation to TVL, the total amount of value locked on Rollup solutions is around $2.6B. Of which, Optimism and Arbitrum account for more than 90% (data from Defi Llama).

At the time of writing this article, Arbitrum's TVL was $1.93B, which was 4.3 times as much as Optimism's (only about $451.52M).

Other ecosystems such as Metis and Boba are likely to have passed their peak and have limited shares of the TVL market (when TVL peaked, these 2 ecosystems accounted for 19% and 18% of TVL respectively in the overall L2s).

In terms of the number of Protocols, Arbitrum and Optimism proved superior to their competitors.

The number of Protocols is 79 and 37 in turn, which is greater than the number of 20 of Metis and 18 of Boba, It shows that these are the 2 most prominent and concentrated ecosystems of cash flow in L2s until now.

How about Zk-Rollup?

Among Ethereum scaling solutions, it can be seen that Zk-Rollup has the greatest potential (this is the reason why Starkware and ZkSync are highly valued). However, Zk-Rollup has difficulty in developing the ecosystem as it is currently not compatible with EVM and has to use its own programming languages.

In fact, Stakware has already developed products that use Zk-Rollup for Trading only (Specific L2), including ImmutableX, DyDx, Sorare, and DeversiFi. However, a complete version of L2 (where projects can deploy contracts on it) is Starknet which has not yet come into operation (Still sitting in the Infrastructure development phase). 

⇒ That explains the inferiority of Zk-Rollup compared to Optimistic-Rollup (Arbitrum, Optimism) today.

Layer 2's Incentive War 

Vampire Attack season?

It is clear for us to figure out the goal of Optimism's Token launch based on the data about TVL and the ecosystem context. In this way, the Optimism ecosystem can:

• Create attention in the market.
• Bootstrap ecosystem by Incentives program.
• Get more builders and users (we are talking about the real ones).

⇒ It will take the advantage of having tokens to become the center of the market, taking market share from Arbitrum as well as cash flow from other Sidechains for long-term development.

Just after the Airdrop announcement, Optimism launched the Incentive program - Stimpack, spending ~230M OP Tokens for the development of projects.

Up to now, although both Arbitrum and Optimism have not launched any Incentive program yet, they attracted a sizeable amount of TVL (about $2.4B) ⇒ Which demonstrates that using those solutions is quite “Organic” rather than “Synthetic” like some other ecosystems.

⇒ The launch of Optimism's Token will push the upcoming growth of L2 as a whole. Meanwhile, L2 projects will be more "aggressive" in deploying Tokens and designing Incentives to compete with each other.

Besides, from the Builder's point of view, the launch of Layer 2 Tokens (with a reasonable model design) will increase the security of the network as well as efficiently bootstrapping the ecosystem.

⇒ We will most likely see a vision of the L2 War with Vampire Attack and ongoing Incentives shown in 2022 like the way the L1 War was last year.

However, there is a problem with Incentive programs on L2, like the Case Study of Boba and Metis, which is the Pump Dump situation both in terms of ecosystem TVL and Token price ⇒ Short-term money.

Metis' TVL has split more than 3 times since its peak, and the price of the METIS token has also dropped by 85.5% since ATH.

Boba is in the same way as the ecosystem TVL even split 10 times.

This problem occurs due to the “inefficient” incentive design of the L2 Token ⇒ Unlike L1 or Sidechain, L2s on Ethereum inherit security from the main Chain, so there is no need to use Native Token as transaction fee as well as for security.

⇒ This significantly reduces the Use Case of L2 Token, making it difficult to create sustainable Flywheel ⇒ Incentive programs will have some difficulty in being effective and keeping cash flow in the long term.

Wen Token?

2 in 4 projects were confirmed to have Tokens, which are Optimism with OP and ZkSync through the photo below.

The question now is whether the other 2 projects (Arbitrum and Starkware) will have Tokens or not. There is no reason for Arbitrum to not launch its Token while Optimism did.

In addition, the tweet above from the Co-founder of Offchain Labs has implicitly confirmed that there is a high possibility of a Token coming from Arbitrum, just when and how to take advantage of that Token.

About Starkware with StarkNet Token, I have not seen any signs of having a Token. However, with the above pressure, I believe that StarkNet will have its Token soon (maybe in late 2022 or 2023).

In my opinion, you guys do not need to be too focused on StarkNet at the moment because they are still in the process of completing the infrastructure, so there are not too many opportunities to "skin in the game".

Are there any investment opportunities with Layer 2?

Where is the "gold mine"?

Based on the context of the current L2s that I have analyzed above, the opportunity will be in the Optimistic Rollup solutions:

• Both Arbitrum and Optimism already have a full ecosystem built on top, the infrastructures are quite mature.
• Deploying Token is a way to gain market share in the context of fiercely competitive ecosystems.

And this will be very beneficial to those who understand the game. Surely you still remember a lot of Case Studies of other L1s when implementing Incentive programs, which are investment chances with the ROI of up to dozens of times and huge Yield source from Liquidity Mining.

Going back to Zk-Rollup, with Stakware's $2B valuations and "definitely not inferior" to ZkSync, it is inappropriate to launch a Token at this time.

The reason is that these solutions are still in the infrastructure construction phase, and they are not ready to integrate Dapps and expand the ecosystem. Therefore, when issuing tokens, they will not be able to design a Use Case strong enough to retain users and investors like Optimistic Rollup.

At the same time, this will also damage their Backers, related to the current valuation, Zk-Rollup is much larger than Optimistic Rollup. Moreover, Starkware's $2B is still larger than Optimism's $1.65B even when Optimism already has an ecosystem with an economy around it.

⇒ Launching Token without a strong enough Use Case ⇒ Cash flow is not sustainable ⇒ Backers are likely to be unhappy. As a result, the reputation of the project will also decline, affecting future development.

In short, Arbitrum and Optimism shortly will be the place where we look for major investment opportunities.

How can we dig into it? 

After locating the "gold mines", the next question is How to utilize them effectively? Currently, I suggest 3 main ways:

• Retroactive Hunting.
• Invest in L2 Token as well as the Tokens in that ecosystem.
• Yield Farming.

1. Retroactive Hunting

With the above assumption, you will need to pay special attention to "skinning in the game" with Arbitrum to increase the ability to receive Retroactive as well as get the earliest profit.

Read more: Hunting Airdrop & Retroactive on Layer 2

Although Optimism has Tokens, there will still be more Airdrops in the future ⇒ , Of course, the requirements will also be much stricter ⇒ You need to become a "real user" to have a chance to claim it.

As for Zk-Rollup projects, we should still hunt for Retroactive as soon as possible. However, if it takes too much time as well as owning your capital for a long time, I think it is completely possible to keep it Pending.

2. Token Investment

For L2 Tokens like OP or Arbitrum, I think you can speculate in a short time when they have just been launched because the current L2 Token is still quite vague about the Use Case (I will talk about it later in the article).

In 4 Optimistic Rollup development projects (Boba, Metis, Arbitrum, Optimism), Boba and Metis already have Tokens with FDV at ATH of $4B and $3.2B respectively. With a valuation of up to $1.65B for Optimism, I think OP and Arbitrum can completely reach the FDV mark of $6B - $10B at ATH.

This number could be even more optimistic as we have seen FDV at IMX ATH (using Zk-Rollup) approaching ~$20B.

Based on this relative valuation, I guess you guys have already had your own entry-buy point to maximize profit.

3. Yield Farming

It is also a pretty safe way if you are Farming in Pool 1 (don't take the risk of Impermanent Loss as big as in Farming Pool 2).

However, this way will be more beneficial for those who have a certain amount of capital. In my experience, if your capital allocation for L2 is only a few thousand dollars, the more optimal way is still Token speculation.

Some important notes for L2 Token

The launch of Layer 2 Tokens is an inevitable trend, but I have not yet seen the ability to design Use Cases effectively to maintain demand in the long term.

Usually, in L1, tokens will be used for transaction fees, staking for network security or governance, etc., but for L2 on Ethereum, this is completely unnecessary:

• In terms of fees and security, in essence, transactions on L2 will be wrapped and sent to Ethereum and L2 will also have to pay ETH to the main Chain for the above Validators to validate.
• This fee will be Covered by Users ⇒ Therefore, it is quite expensive and unnecessary to apply an additional fee of the Native Coin (eg OP).
• The Governance feature applies to adding Incentives to Tokens, but I find that this is not a strong Use Case.

Therefore, current L2s are having trouble designing Use Cases to make sense when launching Tokens. Boba, Metis, or even Aurora in the Near ecosystem, due to not being able to find a solution to this problem, had to suffer a severe drop in the project coin price (even with AURORA, although the ecosystem TVL is still on an uptrend).

This is why buying L2 Tokens shortly is speculative (unless there is a reasonable use case design).

Thus, the design problem of Use Cases and Incentives of L2 currently does not have a satisfactory solution. We will have to wait for an answer from Optimism and Arbitrum. The Coin98 Insights team is researching to find the answer to this topic in another article soon.

Summary

I hope the article has provided you with useful insights about the recent warming up of Layer 2 solutions on Ethereum. I am trying to continuously update the Information and analysis and send it to you as soon as possible.

If there is anything you want to share, please comment below to discuss it with us.