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Sharpen your crypto knowledge with Unqualified Opinions, featuring insights from crypto's leading team of analysts
This episode of Unqualified Opinions is brought to you by HireChain. Your next hire could come from anywhere, a recruiter, a job board, a referral network, or a conference. HireChain manages hundreds of candidate sources for you so you only see relevant applications and can focus on picking the best person for your team. On average, our customers fill open roles faster and 30% cheaper than with traditional recruiters. Leading companies like The Graph and Messari already use HireChain. So get your time back. Talk to HireChain today, and I hire the best, fast. Visit higherchain. Io/messari for prioritized onboarding.
Messari Legal:This podcast is meant for informational purposes only and is not meant to serve as investment advice. Hosts and guests may hold cryptocurrencies discussed in this episode. Opinions expressed may not reflect the opinions of Messari.
Seth Bloomberg:When growing a new product, every founder has to solve problems. Sometimes those problems are bad problems like customer churn, competitive threats, or departures of key talent. 4 years ago, Ethereum founder Vitalik Buterin faced a good problem.
Will Nuelle:You know, Ethereum is kind of lapping the field when it comes to what users are actually willing to pay to access that that commodity product. Right? Ethereum users are paying, on average, $10,000,000 a day to access that block space. So the one question you have to ask is, what's accounting for those differences? And one of the fundamental reasons is because Ethereum has been able to generate a network effect around its, app you know, applications deployed, developers, users, capital, and liquidity in applications.
Seth Bloomberg:The layer 1 blockchain had exploded in popularity. But at that time, Ethereum wasn't built to handle that much activity. Ethereum was built to be highly secure and reliable, but not necessarily lightning fast or cheap. Transaction fees to use Ethereum became prohibitively high, forcing many apps built on Ethereum to shut down. Patelik and his team had anticipated this and released a roadmap to address it.
Seth Bloomberg:But even they admitted that, quote, base layer scalability for applications is only coming as the last major phase of that roadmap, which was still years away. So Vitalik delivered a clear message to Ethereum's developer community. If Ethereum were to continue to grow in the near and midterm, it would likely need to be all in on roll ups. The idea behind roll ups is to essentially outsource the most resource constrained part of operating a blockchain, the actual compute of the transaction, to a new second player called a roll up. Once that's completed, the roll ups store the confirmed transaction data back on Ethereum.
Will Nuelle:Roll ups are ultimately gonna bring the cost of goods sold. That cost of call data is coming down substantially, which increased the gross margin from something like 20 5% to up to, you know, 70 or 80% plus, which is a really interesting business model when you think about high scale, high gross margin businesses with extremely low or net or or 0 OPEX.
Seth Bloomberg:Generally speaking, this strategy worked extremely well. Developers built roll ups, transaction fees stabilized, and Ethereum's token price soared from just under $400 when he announced his roll up vision to over $4,000 12 months later. Roll ups started to accumulate active addresses in the beginning of 2023. And as of April 2024, Musari data shows that the 9 largest Ethereum layer 2 rollups combined have more than 3 times the number of daily active addresses than Ethereum itself. But these roll ups are starting to run into growth problems of their own.
Seth Bloomberg:And as newer alternatives to Ethereum that offer faster settlement times, cheaper fees, are proving reliable at scale. The future of Ethereum may hinge on its developer community's ability to build the key tools that allow it to grow again. I'm Seth Bloomberg, and here's the story.
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Stephanie Dunbar:Obviously, there's a lot of things to consider with this. We've never built these kind of systems before, and I think that a lot of people are afraid of building in the modular context just because it is so new and there are a lot of open questions.
Ryan Selkis:Hey, Seth. How's it going?
Seth Bloomberg:Hey, Ryan. Thanks for having me.
Ryan Selkis:In your intro, we heard you and Will Nelly of Galaxy Ventures lay out the promising business case for roll ups. But we also just heard Stephanie Dunbar, now O'Fluen, talk about how intimidating building them can be. You are Messari's expert on all things Ethereum, growl ups, 0 knowledge, and you put out some research recently that highlighted the critical moment that ecosystem is in right now.
Seth Bloomberg:Yeah. Especially with the growing popularity of other layer ones like Solana. The Ethereum ecosystem seems to be, again, at something of an inflection point, especially with regards to scalability.
Ryan Selkis:Can you just remind people how we got here and what some of the key developments have been?
Seth Bloomberg:Sure. So in 2020, Vatalik laid out his vision for Ethereum's future powered by roll ups, and 2 primary types of roll ups came out of that, optimistic roll ups and 0 knowledge or z k roll ups. To oversimplify, the most resource constrained function a layer 1 performs is the act of verifying a transaction as valid. Optimistik and zkrollups both address this problem, but in 2 very different ways. Let's say user a says, I want to send 10 units to user b.
Seth Bloomberg:Before the layer 1 will let that happen, it needs to confirm that user a has those 10 units to send to user b. Optimistic roll ups assume that all transactions that a wallet tries to execute are valid and relies on incentivized third parties to produce a certain type of proof that a transaction is invalid. Zkrollups take a much different approach. Instead of relying on users to watch the network and detect invalid transactions, every transaction is always cryptographically proven to be valid. There are a ton of practical differences that come out of these two approaches to verification, but the one key one I should highlight here is the difference in settlement times.
Seth Bloomberg:Optimistic roll ups can't settle a transaction until they give their users time to challenge your transaction. They inherently need to set these challenge periods, which can last multiple days. But since ZK proofs, by default, have to validate every transaction, they get started on that immediately, So transactions are typically settled in a matter of minutes, not days. This doesn't mean that z k roll ups are inherently better or worse than optimistic roll ups, just that they're designed to serve different use cases. And generally speaking, both offer dramatic improvements in cost and speed over processing a transaction directly on Ethereum L1.
Ryan Selkis:You mentioned that those roll ups now make up roughly 3 quarters of all unique daily active addresses on the Ethereum ecosystem. So, clearly, Vitalik's roll of vision has come into focus, but those roll ups are also running into problems now. Right?
Seth Bloomberg:Yeah. I think it's becoming the norm for a net new user to have their first interaction be with a roll up instead of Ethereum directly, which is a huge change, but one that many believe is necessary for the ecosystem to grow. There are 2 broad types of problems they're running into. 1st is the simple cost and ability to build, maintain, and evolve these roll ups. It's really challenging as a founding team starting one of these projects to be best in class at all the different technical pieces associated with roll ups that their customers need.
Seth Bloomberg:So what we're seeing is that many roll ups are actually becoming specialists who then benefit from interacting with other specialists. Loosely, this is analogous to the API based microservices economy that became so popular in the web 2 world over the last decade or so. And this is where zk roll ups start to separate themselves from optimistic rollups. Technically speaking, it's much much easier to make a zkrollup interoperable than it is to make an optimisticrollup interoperable. Now to help these roll ups come to market, we're seeing a couple of different key elements emerge.
Stephanie Dunbar:Something to watch out for are roll ups as a service provider to help build make building roll ups easier for developers. So roll ups as a service specifically, it's like a traditional SaaS model where a roll up developer can come and say, okay, I wanna build this this application. And all they really know is that they're selecting, like, from an interface, and in a few clicks, they have a roll up that does the function that they wanna have. So a roll up is only as strong as its weakest layer. And this is a certainly a concern, role up developer to choose from a bunch of specialized providers and, like, make the trade off between cost and security about all of the other layers and, you know, because security guarantees that would otherwise they'd have to think about if they were building a full on full blockchain.
Seth Bloomberg:The first are roll out development stacks like Polygon's chain development kit. These enable roll up developers to easily spin up a roll up. The second are roll up as a service providers. These teams integrate with these roll up development stacks, and they also integrate with other critical roll up infrastructure, and more broadly can help roll up developers navigate what can be a very complicated process. Historically, developing and operating a z k roll up required significant funding, deep r and d, and likely a team of cryptography experts.
Seth Bloomberg:But now, thanks to teams like Polygon, succinct, risk 0 and many others, zkavms or more general zkvms are dramatically more easily accessible to roll up creators.
Ryan Selkis:That's how you know crypto is going mainstream when VC investment thesis start to end in as a service.
Seth Bloomberg:There's no escaping it.
Ryan Selkis:Okay. And the second problem?
Seth Bloomberg:The second problem is just sheer z k compute power. These roll ups have designed great systems to quickly process these transactions, but they still need the hardware and the node operators to actually execute on them. So we're seeing the emergence of zk proof marketplaces. Proof marketplaces are simply a place to go to access zk proof compute capacity. A roll up sets its demand side needs.
Seth Bloomberg:A node operator offers its supply side compute, and off they go. This is obviously a significantly more efficient way to power these roll ups, and to bring it back to Vitalik's original problem from 4 years ago should continue to drive down transaction costs even further. The roll up industry is really just doing the same thing Ethereum did and many industries have done for decades, outsource their most difficult problems to specialists who can do it faster, better, and cheaper. When done well, which is no guarantee, it can be a reliable way to allow individual companies and industries as a whole to scale.
Jon Kol:One thing we've noticed, there's a lot of excitement about this modular future and everyone transitioning individual apps into roll ups. What's been, I'd say a frustration of my part of it is our own failure as well. No one's done a great job of illustrating what is that gonna look like when you're now dealing between 5, 6 roll ups. What are the baked in assumptions? And I think that lack of understanding, we encounter it all the time now as teams are, call it, halfway done with their transition from an app on an L one to an app specific roll up, that they're like, oh, shit. Did not think of that. Wait. So that's gonna happen?
Ryan Selkis:That was Jon Kol of Hyperlane talking about 1 pieces of the space he thinks needs more work interoperability. How do you think the developer's movie has done broadly speaking in executing against Vitalik's original role at Vision from 4 years ago, and what are the challenges you think that still need to be addressed?
Seth Bloomberg:There are a tremendous number of talented developers building in the rollout space. Just a couple of years ago, it was often considered impossible or infeasible to reach even the current performance levels that zk roll ups are seeing. Zkcompute is still relatively extensive. That's definitely an area for improvement, and we're already starting to see some early traction there too. But it feels like we're sort of at an inflection point now, and I expect to see more and more applications tapping into z k technology sooner rather than later.
Ryan Selkis:Okay. That's all clear. But ultimately, why should we care about this? What's the impact?
Seth Bloomberg:Ethereum was the first chain with smart contract functionality to become a brand that extended beyond core crypto people into the awareness of the general public. And as a result, a ton of projects were built on top of it. It became the industry standard to launch your token on. It became the backbone of a lot of the first blockchain projects that addressed the end user. And that number of projects, both in the infrastructure layer and the end user layer, is only going to continue to grow.
Seth Bloomberg:But if Ethereum and its ecosystem can't evolve to handle that growth, other layer ones are ready to take that market share. We are already seeing signs with this. Solana is a very popular place for a lot of deep in and AI projects to launch their tokens. Ordinals on Bitcoin are taking attention away from NFTs on Ethereum. Ethereum is the massive incumbent that still has a dominant presence at the end of the day.
Seth Bloomberg:But tech history of all types, not just crypto, is littered with incumbents that blew a large head start to a more nimble challenger. These new developments, ZeeK Group Marketplaces, Rollup as a Service Providers, are definitely promising, but they're no guarantee. And if they can't deliver, the projects that will drive the end user adoption that we all think is coming to the industry won't hesitate to look elsewhere if they're not getting what they need from Ethereum.
Ryan Selkis:Seth, thanks.
Seth Bloomberg:This episode was written and produced by Steve Bickler based on the report I wrote called A Deep Dive Into Proof Marketplaces written for Messari's enterprise research product in April 2024. To read the latest on zkrollups, marketplaces, and why I think zkrollups are set to see a wave of growth, please consider subscribing to Messari pro at Messari dot io.