Arbitrum Currently Leads Over Optimism, but Competition Expected to Intensify in 2024

Translated by LC

Table of Contents

Intro

1. The Past: Arbitrum and Optimism with Different Management Goals and Backgrounds

1-1. The Founders of Arbitrum and their Princeton Roots

1-2. Optimism’s Roots Lie in a Non-Profit Ethereum Research Foundation

1-3. Different Backgrounds May Have Shaped the Direction of the Two Solutions

2. Present: Arbitrum's Real Yield Narrative Sets it Apart

2-1. Ecosystem Activity Comparison through On-Chain Metrics

2-2. Arbitrum’s User-Focused Approach Sets It Apart from Other L2 Solutions

3. Future: Optimism and Arbitrum in a Battle for L2 Dominance

3-1. Superchain vs Arbitrum Orbit

3-2. RPGF vs DAO-Driven Funding

Closing Thoughts

 

 

 

 

Intro

As the battle for the top spot in Ethereum's Layer 2 (L2) ecosystem heats up, Arbitrum and Optimism are emerging as the top contenders. Both solutions are poised to make significant contributions to expanding Ethereum's reach in the future. While the technical potential of Optimal Rollovers (ORs) was discussed in a previous article titled “Would Optimistic Rollup Remain as a Viable Candidate Even After ZK Rollup Is Fully Developed?” back in August 2022, this article will delve into the history and current state of both Arbitrum and Optimism, and provide insights into the future of these two projects.

* Please note that this article will not delve into technical discussions of rollups; for an understanding of L2 types and principles, including OR, please refer to "Ethereum Layer 2 Solutions."

1. The Past: Arbitrum and Optimism with Different Management Goals and Backgrounds

“The Ethereum ecosystem is likely to be all-in on rollups (plus some plasma and channels) as a scaling strategy for the near and mid-term future.” - Vitalik Buterin

Although rollups gained prominence in the crypto space in 2020 when the Ethereum Foundation shifted the network's long-term focus towards them (rollup-centric Ethereum roadmap, 2020), discussions about L2 solutions have been ongoing since 2016-2017. While concepts such as rollups and danksharding were not yet in existence, the Ethereum and Bitcoin communities had recognized for some time that Ethereum's scalability limitations could potentially hinder its mass adoption. In 2018, the co-founders of Offchain Labs and Optimism PBC began working on L2 solutions, with both projects taking different approaches and management goals.

Source: Rollup-centric Ethereum roadmap by Vitalik Buterin

1-1. The Founders of Arbitrum and their Princeton Roots

Offchain Labs, the team behind Arbitrum, was co-founded by Ed Felten, Steven Goldfeder, and Harry Kalodner, all of whom met while studying at Princeton University in the early 2010s. Ed Felten, a well-known computer science professor, had been teaching at Princeton since 1993, while Steven Goldfeder and Harry Kalodner were his students. During their time at Princeton, Goldfeder, and Kalodner developed a keen interest in cryptocurrencies and often pursued dissertation topics related to Bitcoin, cryptography, and blockchain. In 2016, they co-authored a book on Bitcoin and Cryptocurrency Technologies, which provided a comprehensive overview of Bitcoin and blockchain, including a chapter on Bitcoin Layer 2. The trio founded OffChain Labs in 2018, with Felten leaving his position as CTO at the White House to join the company full-time.

Source: The Block

Since then, OffChain Labs has raised $124M in funding from high-profile investors such as Lightspeed Venture Partners, Polychain Capital, and Pantera. The company launched the Arbitrum One testnet two years after its founding and the mainnet almost three years later in September 2021. OffChain Labs now operates two mainnets: Arbitrum Nitro (formerly Arbitrum One), its flagship service, and Arbitrum Nova, a lesser-known Anytrust chain that specializes in gaming and social apps due to its speed and low fees. Transactions on Arbitrum Nova are submitted to a Data Availability Committee (DAC) rather than on-chain.

1-2. Optimism’s Roots Lie in a Non-Profit Ethereum Research Foundation

Optimism PBC was rebranded in January 2019 by Plasma Group, a non-profit Ethereum research foundation. Established in late 2017-2018, the Plasma Group focused on Plasma* and L2 technology and was a group with a strong understanding of L2, often referenced in Vitalik Buterin's blog posts.

In the second half of 2018, the Plasma Group shifted its focus from Plasma research to building an OR solution, which is what Optimism is today. The reason for this pivot was the lack of need for a non-transparent solution in a crypto market that prioritizes transparency and decentralization. However, there are many similarities between Plasma and OR, so the transition was not difficult for the Plasma Group.

Optimism PBC is led by Jinglan Wang, Karl Floersch, and Ben Jones, all of whom are Ethereum OG. Karl Floersch and Ben Jones are former Ethereum Foundation researchers. With this background, Optimism was able to onboard Synthetix, Uniswap, and Coinbase faster than anyone else in the early days. Synthetix is still only onboarded on Optimism, and the network they have will help them bring in more projects in the future.

*Plasma is a layer 2 scaling solution proposed by Vitalik Buterin and Joseph Poon in 2017. It shares some similarities with Optimistic Rollups (OR) in that it employs a Proof of Fraud mechanism for transaction validation. However, Plasma differs in that it writes only the block header hash to the L1 chain off-chain, whereas OR writes the entire block data to L1.

Source: The Block

1-3. Different Backgrounds May Have Shaped the Direction of the Two Solutions

The founding teams behind Arbitrum and Optimism have distinct backgrounds that may have influenced the behavior of both projects and their future outlook. Arbitrum was established by a group of highly-educated academics, while Optimism began as a non-profit organization focused on Ethereum research. This difference is important to understand how each project operates. Non-profit organizations typically prioritize creating social value rather than generating profit, and they have a longer-term vision for achieving their goals. When non-profit organizations do generate revenue, they often invest it back into the community. Therefore, it is logical that Optimism, which started as a non-profit company, is building an open ecosystem for the long term and plans to use all of its revenue to fund public good, rather than focusing on generating short-term profits. This will be discussed further in Section 3.

2. Present: Arbitrum's Real Yield Narrative Sets It Apart

Arbitrum, which launched its mainnet before Optimism, has achieved greater ecosystem activity compared to Optimism. Arbitrum incentivized users with $OP airdrops and the Optimism Quests. However, after a week of launching in June 2022, Arbitrum suspended its Odyssey program. The on-chain metrics below reveal Arbitrum's lead in various aspects of network activity.

2-1. Ecosystem Activity Comparison through On-Chain Metrics

Revenue: In 1Q 2023, Arbitrum's Sequencer revenue* reached an all-time high of 2,354 ETH due to the $ARB airdrop, which was a 322% increase from the previous quarter and 301% higher than Optimism's revenue in the same quarter. In contrast, Optimism's revenue was 586 ETH, driven by a sharp decline in transactions following the end of Optimism Quests, an incentive program that rewarded users with NFTs in January.

* Sequencers are entities that process users' transactions, write them to L1, and generate L2 blocks. Here, sequencer revenue is the sum of fees paid by users to sequencers to generate transactions.

Network Activity: Arbitrum has shown steady growth in terms of network activity since July 2022 and surpassed Ethereum's daily transaction count after the $ARB airdrop event in March 2023. The average monthly number of transactions on Arbitrum has been around 1.1M, which is 300% higher than Optimism. On the other hand, Optimism experienced a sharp drop in transactions after the end of Optimism Quests, with daily transactions peaking at 800K and dropping to 200K shortly after. Although the number of transactions is slowly recovering, the gap with Arbitrum has significantly widened. The daily active wallets on Arbitrum are around 200K, while Optimism has 70K, with the total wallets being around 5M and 3.3M, respectively.

Development activity: The number of smart contracts being deployed on each mainnet daily is the measure of development activity, and Arbitrum leads by a significant margin. The total number of contracts deployed on Arbitrum and Optimism in 2023 is 940K and 190K, respectively, which is about 400% higher on Arbitrum. The number of protocols onboarded on Arbitrum and Optimism on a per-deployment basis is 289 and 123, respectively.

TVL: The gap between Arbitrum and Optimism's total value locked (TVL) is also widening. As of April 10, Arbitrum's TVL was around $2.5B, more than double Optimism's TVL ($1.1B). Stablecoin inflows into Arbitrum have been particularly impressive, with USDC and USDT volumes growing 30% and 91% month-over-month, respectively. The significant increase in Arbitrum's TVL has led to excitement about the performance of Arbitrum-based tokens this year.

Looking at the distribution of DeFi services by sector based on TVL, Arbitrum has a high share of derivatives and lending services in addition to DEX. The derivatives market is dominated by GMX, which has a share of more than 99% and a 25.5% dominance in terms of total TVL. The lending market is split between Aave V3 ($142M) and Radiant Capital ($132M), a cross-chain lending platform built using LayerZero technology.

Optimism has nearly half of its total TVL deposited on DEX services, with Velodrome, Optimism's native DEX, accounting for the largest share (28.5% dominance). Velodrome is a DEX forked from Andre Cronje's Solidity, notable for introducing ve(3,3) tokenomics, an interesting mix of Curve's ve model and Olympus Dao's (3,3) game theory.

2-2. Arbitrum’s User-Focused Approach Sets It Apart from Other L2 Solutions

Arbitrum's success can be attributed to its focus on building a strong ecosystem with real users, rather than solely relying on investor interest. While some have criticized Optimism for its early whitelisting policy, which restricted free project onboarding, it's worth noting that Arbitrum also had a similar policy in place until October 2021. In fact, for newer networks with less stability, whitelisting can be a useful policy as it allows for direct communication with projects and quick feedback on issues.

The real reason for Optimisms’s lackluster growth compared to Arbitrum is the lack of meaningful services available to users. With more investors than actual users, Optimism's metrics have only shown temporary improvements when incentivized, followed by a sharp decline in activity. In contrast, Arbitrum has seen a surge in popularity due to its focus on attracting real users through its ecosystem of killer services, such as the derivatives DEX GMX and gaming platform TreasureDAO (see chart below). GMX, in particular, has been a major contributor to Arbitrum's success thanks to its unique "real yield" narrative that exists within the Arbitrum ecosystem.

GMX distributes fee revenue from DEX transactions to $GMX holders in ETH. This sustainable and stable revenue structure has attracted investors and users alike, setting Arbitrum apart from other DeFi solutions that rely on short-term incentives. Since its launch, other DeFi services on Arbitrum such as GNS, Radiant, and Camelot have also followed a similar tokenomics model, offering real yields to users and investors.  

3. Future: Optimism and Arbitrum in a Battle for L2 Dominance

Arbitrum has already built a solid ecosystem around GMX and TreasureDAO, but Optimism is not far behind. Optimism has recruited several partners to join its Superchain and has been aggressively investing in the ecosystem since last year. The battle between the two is set to intensify, with Optimism expected to hit its growth trajectory in earnest next year. Here's a breakdown of Optimism's strategy:

3-1. Superchain vs Arbitrum Orbit

Optimism’s core strategy is to create a Superchain ecosystem by releasing numerous OP Chains through OP Stack, an open-source module. With OP Stack, anyone can easily build an OP Chain (L2) on top of Ethereum, and the set of built OP Chains is called a Superchain. In other words, you can understand Superchain as Optimism's L2 platform. The advantage of superchains is that they have high interoperability and composability between OPchains and are highly connected using the same cross-chain messaging protocol. It's akin to building bridges across the current L2 ecosystems, each of which is reminiscent of a remote island nation. Also, since OPChains all share a sequencer, they can share security, which is attractive to newer L2s.

Several projects are set to join the superchain, including Base, Conduit, Unidex, OP Clave, Aevo, and Mantle. Among them, Base is an OP-chain built by Coinbase, the largest coin exchange in the United States, with 110M users, $80B in assets, and $83B in annualized trading volume (as of 2022), and has the potential to disrupt the L2 market. Base launched its testnet in late February and is expected to launch its mainnet later this year, possibly in 2024.

While some argue that Superchains may potentially cause cannibalization by offering more choices to decentralized users, which can lead to fewer transactions on the OP chain, this argument is only partially true. While growth in the OP Chain may cause users to disperse, the growth of the Optimism chain is proportional to the growth of the Superchain. There are two reasons for this: 1) Optimism PBC participates as a sequencer in all OP Chains, so as the number of OP Chains increases, so does Optimism's revenue, and 100% of Optimism PBC's sequencer revenue is reinvested in the Optimism ecosystem. Therefore, as the number of Superchains grows, so does the funding for the Optimism ecosystem. 2) A portion of the fee revenue from Base and other OP Chains is distributed to Optimism's treasury, which is also likely to be reinvested into the ecosystem.

Arbitrum has announced Arbitrum Orbit to compete with the Optimism Superchain, which is similar to the Fractal Scaling structure proposed by Starkware. Fractal Scaling adds L3 and L4 on top of the underlying L2, with the advantage that the growth of L3 chains is directly tied to the Arbitrum mainnet. While L3s can be built freely, new L2s must be voted on by the DAO. However, since the Nitro stack is not open source, it is unlikely that other projects will L2 on Arbitrum. This closed ecosystem structure leads to low interoperability and coupling between Arbitrum L3 and other L2 chains on Ethereum, which makes it inconvenient for users to interact with other chains and requires two steps for transactions to be finalized (and recorded on Ethereum L1).

3-2. RPGF vs DAO-Driven Funding

Another core strategy of Optimism includes Retroactive Public Goods Funding (RPGF) to accelerate ecosystem growth. The platform has allocated 45% of its total $OP issuance to funding, with 25% going to ecosystem funds (5.4% Governance Fund, 5.4% Partner Fund, 5.4% Seed Fund, and 8.8% undecided) and the remaining 20% to RPGF funds. Optimism PBC will also reinvest 100% of sequencer revenue back into the ecosystem, which has been approximately 2,440 ETH in the past year.

RPGF is a funding method introduced by Vitalik and others in their 2018 paper "Liberal Radicalism." It involves a process of verifying the impact of public goods (projects) before funding them. Unlike typical funding, RPGF incentivizes projects that have already proven their worth:

Motivation: RPGF can be a great incentive for companies to invest in their projects because they have to prove that they can deliver results.

Reduces dependence on external funding: RPGF makes projects less dependent on external funding, which can encourage projects to explore more sustainable business models.

Reduces risks: RPGF reduces the risk of wasting resources by allocating funds based on actual results.

Promotes efficiency: RPGF rewards organizations that can achieve success without relying on external funding, which encourages organizations to operate efficiently and make the best use of available resources.

Optimism aims to create a virtuous cycle where sequencer revenue is used to fund the PRGF to support projects and project growth ultimately increases demand for blockspace. Ultimately, Optimism's success will be determined by whether or not it can create this virtuous cycle. The decision to fund the RPGF is made by Token House, a group of $OP holders, and Citizen's House, an organization established for the PRGF. The results of the second round of the RPGF were announced on Mar 31, 2023.

Source: Optimism Docs

Arbitrum, in contrast to Optimism, does not set aside a specific amount of funding for ecosystem development. Instead, it allocates 35.8% of the $ARB to the DAO Treasury, leaving the remaining funding to be provided by the community. However, 7.5% of the DAO Treasury is dedicated to the Arbitrum Foundation's operating expenses and Special Grants. The pace of funding for the Arbitrum ecosystem may be slower than that of Optimism due to the need for each investment proposal to undergo a governance vote process. Nevertheless, to ensure transparency and fairness, Arbitrum has a built-in treasury system operated by smart contracts, and the DAO treasury will be governed in accordance with The Constitution of ArbitrumDAO and The Anatomy of an Arbitrum Improvement Proposal (refer to the figure below).

Source: Arbitrum Docs

Closing Thoughts

Since its recent launch, Arbitrum has gained a lot of attention from the crypto community and has seen remarkable growth, especially toward the end of 2022. With popular apps like Uniswap, Exchanges, and Steppen already on board, it's unlikely that Arbitrum will lose its position as the number one rollup any time soon, especially with other promising projects like GMX and TreasureDAO in the mix. However, it's still too early to say for certain. Optimism has already recruited six OP-chain partners, including Coinbase's Base and BitDAO's Mantle, and is investing heavily in the ecosystem. The potential for a Superchain is huge, especially considering that Coinbase can onboard its 110M users to Base. We will have to wait and see how this competition unfolds, as Optimism gears up for a fightback starting next year.