Over the past few weeks, the crypto market has seen increased adoption of alternative layer 1s and Ethereum layer 2s and side chains. Demand for cheaper on-chain activity appears to have grown by multiples as normal users have been priced out of interacting with Ethereum’s base layer. To meet this increased demand, approaches to scaling Ethereum include alternative chains like Solana and Avalanche, layer 2s like Optimism and Arbitrum, and side chains like Polygon.

As the alternatives to Ethereum’s base layer moved to the forefront of crypto, I had a few doubts as to the technology's immediate success. From a decentralized finance (DeFi) perspective, total value locked (TVL) came and went with incentives, even on major Polygon decentralized applications (dapps). TVL measures how much capital has been parked in decentralized finance applications and is incredibly important in creating efficient markets. Decentralized exchanges need access to abundant capital to provide deeper trading markets, and lending platforms need enough capital to provide accurate interest rates.

A unique approach to onboarding third-party capital, called liquidity mining, is being used by both blockchains and applications built on top of them. Polygon, Avalanche and Fantom are providing billions of dollars in their native tokens to users supplying capital to applications. However, after liquidity mining incentives end, how does a single chain retain enough liquidity to keep its DeFi ecosystem efficient?

Outside of liquidity, I worried that Arbitrum One’s seven-day withdrawal period would push users away. A week in DeFi feels like a year in the real world, which could leave traders at a significant disadvantage. With long wait periods and volatile liquidity, I was worried layer 2s might not provide answers Ethereum users have been hoping for.

Fortunately, I stumbled upon a u/Liberosist Reddit post, “Addressing common rollup misconceptions.” u/Liberosist immediately addressed withdrawal and composability issues, noting that interoperable solutions like Hop and Connext will allow users to bridge seamlessly using third-party liquidity.

Next, the user introduced Distributed Automated Market Maker (dAMM), a project attempting to solve liquidity fragmentation by aggregating liquidity across layer 2s into a single layer 1 pool. Liquidity providers will theoretically be exposed to trading volume across all layer 2s and traders will have access to a much larger pool of liquidity.

The road to efficient crosschain DeFi is a difficult one, but developers have been creating solutions faster than I can think of problems. I believe there will be growing pains in the short term, but the success of multiple layer 1 and 2 ecosystems will continue to make decentralization cheaper, faster and more accessible.

Feel free to reach out with your thoughts and ideas for the newsletter by responding to this email or commenting on Twitter.

Welcome to another edition of Valid Points.

–Teddy

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Arbitrum One’s total value locked (TVL) passed $1.5 billion within 11 days of launch. TAKEAWAY: With one dapp, Arbinyan, making up around 88% of TVL, Arbitrum is ripe for new development. Protocol builders and incentives programs have had difficulty keeping up with the demand for layer 2 usage. Early developer teams have a significant opportunity to access capital.

Yearn Finance released its quarterly report for Q2 2021 in a move that brings increased transparency to DeFi. TAKEAWAY: While on-chain data is as transparent as it gets in the financial world, the majority of non-crypto investors may have difficulty using block explorers. Dashboards like Token Terminal and formalized reporting could expose new users to the cash flow within DeFi and attract new investors.

Total value locked metrics show DeFi speculation is still falling far short of May highs. TAKEAWAY: Investors were giving TVL nearly twice the premium during May, and governance tokens are struggling to reach their previous highs. Either the recent move has more room to run or investors are evaluating DeFi from a new perspective.

OpenSea volume is down over 50% from its highs, showing a slight cooling within the NFT market. TAKEAWAY: After peaking at over $300 million on Aug. 29, OpenSea daily volume has fallen continuously to below $100 million. However, before the start of August, trading volume rarely reached over $15 million.

A message from Messari

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Valid Points incorporates information and data about CoinDesk’s own Eth 2.0 validator. All profits made from this staking venture will be donated to a charity of our choosing once transfers are enabled on the network. For a full overview of the project, check out our announcement post.

You can verify the activity of the CoinDesk Eth 2.0 validator in real time through our public validator key, which is:

0xad7fef3b2350d220de3ae360c70d7f488926b6117e5f785a8995487c46d323ddad0f574fdcc50eeefec34ed9d2039ecb.

Search for it on any Eth 2.0 block explorer site!