ETHEREUM ROLLUP: Economic Model & New Designs

 

The rollup concept has drawn community attention since Vitalik Buterin unveiled Ethereum's rollup-centric strategy in early 2020. After over three years of development, secure rollup systems show robust and seamless operation with billions of dollars in Total Value Locked (TVL).

 

Key Takeaways

• Currently, operating rollup profit is derived by subtracting operating costs and L1 (Layer 1) costs from user transaction fees.

• Most rollups are functioning smoothly, however certain aspects need to be enhanced to improve fault tolerance and resilience.

• Rollup Operators will be specialized to make the network more flexible and adaptable. Thus, each specialized role has more space to grow.

• Along with data availability (DA) and settlement, rollups are exploring shared services that could improve other aspects of the process.

• DA is a highly competitive segment with enormous potential for capturing value in the Rollup Tech Stack. Ethereum is leading the way and will progressively upgrade to this new vision.

Rollup Overview

Rollup is an off-chain scaling solution that aims to increase the throughput of the base layer (Layer 1) without requiring changes to the existing protocol. By executing transactions off-chain, rollup allows the computation, storage, and state transitions to occur outside Layer 1.

 

Rollups use two methods to verify accuracy and prevent fraud:

• Fraud Proof: A challenge period begins when a rollup transmits a state root to Layer 1, allowing anyone who disputes its accuracy to present proof of fraud or errors. If no complaints are received after this period, the state root is true.

• Validity Proof: Generates valid proofs for state updates (state root) utilizing ZKP (zero-knowledge proof) technology. The proofs will subsequently be validated on Layer 1 to ensure the state is correct.

State root: The hash function captures the blockchain's current state, including transaction balance, smart contract status, etc.

Transaction data is also crucial to rollup systems. It can be used to calculate and create the proper state in case of fraud or dispute. Publication of transaction data determines rollup classification:

• On-chain data availability: Publish directly to Ethereum.

• Off-chain data availability: Publish to an alternative solution (outside of Ethereum) to save costs.

In general, “rollup” refers to systems that validate state and publish transaction data on Ethereum.

Figure 1: Rollup classification

The Basic Rollup Economic Model

Rollup economics can be summed up in a simple model that includes income, costs, and profits from three main groups: the users, the rollup operator, and the base layer.

Three main rollup system components

Rollup Economics has three main entities: users; rollup operator and base layer (Layer 1).

Users: Users are participants in the rollup ecosystem who conduct transactions and smart contract interactions. 

Rollup Operators: Rollup operators manage the infrastructure and operation of the rollup chain. Rollup operators perform a variety of duties, including:

• Transaction Sequencing: Ordering user transactions sent to the rollup, grouping them into transaction batches, and periodically sending these batches to Layer 1.

• Transaction Executing: Storing, executing computations, and updating the state on the rollup. 

• Proposing: Proposers are responsible for periodically updating the state root of the rollup on Layer 1.

• State Root Challenging: Challenging the state root on Layer 1 by submitting evidence of state root fraud (Optimistic rollups only).

• Proving: Creating validity proof for each state root state update from rollup to L1. (ZK Rollup and Validium only).

 

Note: These roles and tasks can vary across different rollup projects and the names of some roles may not match these descriptions. 

 

Base layer (Layer 1): Rollup publishes transaction data and updates the root state to Layer 1 after processing the transaction to achieve consensus.

 

Note: Optimistic Chain/Validium does not publish data to Layer 1.

Rollup revenue, cost and profit model

The three roles above provide a basic framework for visualizing rollup protocol income, cost, and profit.

Figure 2: Rollup's business model

Rollup Revenue

Rollup’s revenue comes from two sources:

• MEV (Maximal Extractable Value): MEV is generated within the rollup itself or through cross-chain MEV (intra-domain and cross-domain MEV). 

• Transaction Fee: The total fee that users pay when interacting with the rollup. 

Transaction fees are the rollup protocol's only revenue source as MEV is unavailable for now.

Note: Some specific rollup projects, like dYdX and Immutable X, may offer gasless transactions to encourage platform use. They may charge fees for products or services, such as trading.

Rollup Costs

Rollup has two main costs:

• Rollup Operational Cost: This includes the various costs associated with running the rollup protocol. 

• Layer 1 Cost (L1 Cost): The expenses associated with Layer 1.

Rollup operational cost:

Rollup operators pay various fees to operate the protocol. Hardware/VPS expenses; operating and maintenance costs for rollup nodes, including utilities, internet, hardware maintenance, etc.

Layer 1 cost:

Rollup must cover Layer 1 costs:

• The cost of updating the state root on Layer 1.

• Data publishing costs on Layer 1.

• ZK rollup/Validium requires additional payments for Layer 1 ZK proof verification.

In most cases, Layer 1 costs are the most significant expenses. Specifically, publishing transaction data often accounts for the majority of Layer 1 costs.

 

Most rollup protocols choose Ethereum as their base layer. Ethereum transaction data is published as calldata, and the cost is calculated using these rates:

• 16 gas per non-zero byte.

• 4 gas per zero byte.

Calldata is the data passed along with Ethereum transactions that allows users to send messages to other entities or interact with smart contracts.

Rollup Profit

At the minimum level, rollup charges users (directly or indirectly) a rollup fee based on their Layer 1 and rollup operational costs. 

In simple terms, the rollup's transaction fees will cover or surpass its expenditures. Surplus is rollup profit.

 

Rollup Profit = Rollup Fee - Rollup Operational Cost - Layer 1 Cost

 

Figure 3: Rollup Profit

 

The State of Rollup Tech Stack

Rollup Tech Stack refers to a bundle of technologies used to build rollup apps.

Since early 2020, when Vitalik Buterin unveiled Ethereum's rollup-centric vision, the Rollup Tech Stack has undergone substantial growth. At present, rollup systems secure a total value locked (TVL) of 10 billion USD and function with excellent efficiency.

 

However, there remain numerous aspects that require further development, two prominent concerns that rollup users may encounter are:

• Centralization Risk: Core development teams often play critical function within the network, which can lead to centralization risks.

• Technology Incompleteness Risk: Rollup solutions need to enhance their tech stack to mitigate risks for users (Figure 4).

Figure 4: Top Rollup Projects' Risk Analysis

From a positive perspective, competition will accelerate rollup development. The Rollup Tech Stack is likely to become more sophisticated in the next 6–24 months as rollup projects explore new ideas including transaction ordering policies, fee mechanisms, shared services, and more.

 

Rollup operators in Ethereum PoS will be divided into specific roles like miners in Ethereum PoW were divided into block builders and proposers for block production to boost network flexibility and efficiency. Therefore, the growth space for each system role will increase.

 

While designing a rollup, developers have many options, each of which comes with trade-offs in terms of cost, security, integration with the Ethereum ecosystem, etc. 

 

And how will rollup protocols change in the next 6 to 24 months? 

Shared Services

Shared services (SS) refers to common infrastructure or features that can be leveraged by multiple different rollup protocols to obtain various benefits:

 

• Improve the system's resilience, ensuring it continues to function normally even in the presence of errors or issues like offline nodes or network attacks.

• Facilitates cross-rollup interoperability

• Shared services can enhance the security of rollup solutions

• Offer various economic benefits, including cost savings, economies of scale, and the ability to extract MEV (Maximal Extractable Value).

• Support for technology by providing SDK rollups.

 

In the most basic design, many rollup projects use Ethereum as the base layer to update state, validate authenticity or fraud proofs, and publish shared data. These are the most typical rollup shared services.

The market will soon see other types of shared services targeting various aspects of rollup operations and giving benefits to participating rollup projects.

Rollup projects still have economic limitations, as they incur fixed costs and variable costs related to settlement and transaction processing. These costs include:

 

• Fixed Costs: Sending transaction batches to Ethereum even when the rollup has no transactions.

• Variable Costs: Costs vary based on rollup transaction activity.

 

Segments relating to rollup operational costs will remain a priority:

• Transaction Sequencing on Rollup → "Shared Sequencer"

• Data Publishing on L2 → "Data Availability" or "Shared Batch Publishing"

• Validity Proof Verification → "Proof Aggregation"

• Generate Validity Proof → "Proof Market"

• Cross-Rollup Communication → Cross-chain Messaging.

 

From an objective standpoint, shared services are only one rollup development option. Before determining a development path, rollup developers must consider the opportunity costs. 

Aside from settlement and data availability, major players in the rollup space such as Arbitrum, Optimism, zkSync, Starknet, Polygon… decide not to engage in additional shared services to avoid technology dependencies on external parties. 

Instead, they might opt to create their own shared services to build a more robust network effect and accrue value to their network. For example, Optimism has designed Superchain, zkSync has Hyperchain, and Polygon has introduced Polygon 2.0.

DA Layer: The competition between Ethereum and alternative DA solutions

Data Availability (DA) layer refers to nodes’ ability to access and retrieve network data. Rollup protocols must publish transaction data to Layer 1 to recreate the off-chain state when needed.

Ethereum rollup projects, especially Optimistic Rollups like Arbitrum One and Optimism Mainnet, can spend over 90% of their expense budget on DA. Leading players are interested in the Rollup Tech Stack's DA layer, which is considered to be promising for value capture.

Rollup protocols usually utilize Ethereum as their DA layer. This helps them to profit from a connection with the major crypto ecosystem, making ecosystem development easier, especially for general-purpose rollups. However, this also drives higher DA expenses. 

 

Figure 5: Data availability & settlement of top 10 rollup projects sorted by TVL

Rollup projects may utilize a less secure and lower-cost DA layer but developers and users may be less interested.

Economically, utilizing Ethereum as the DA layer is a trade-off between cost efficiency and alignment with the Ethereum ecosystem.

Figure 6: Trade-off between Ethereum DA and Off-chain DA

Ethereum Proto-Danksharding (EIP-4844)

EIP-4844, also known as Proto-Danksharding, is a major Ethereum upgrade scheduled to be implemented on mainnet in Q1 2024. 

After implementation, Ethereum will provide dedicated storage for rollups to publish transaction data in "blob" format. These data will be stored on the consensus layer for 18 days (4,096 epochs) before being removed from Ethereum.

In addition to the blob format, EIP-4844 introduces a new fee market called the "data gas fee market" to set the prices for blob transactions..

Blob data resources are not part of the usual gas fee market that EIP-1559 formed. Instead, their prices are set by the supply and demand for blob data.

The standard transaction prices remain unchanged, with calldata being charged at 16 gas per non-zero byte and 4 gas per zero byte.

Only blob transactions could utilize both markets:

• The EVM activities within the transaction are priced based on the standard gas fee market.

• The blob data within the transaction are priced based on the data gas fee market.

Rollups can publish transactions as calldata using the one-way fee mechanism (EIP-1559) or as blob transactions using the two-way fee mechanism (EIP-1559 and EIP-4844).

Currently, the gas data fee mechanism in EIP-4844 is derived from the EIP-1559 mechanism. Data storage space is sold in integer units of blobs, with each blob equivalent to 128 kB. 

• The standard level is 3 blobs/block, or 384 kB (0.375 MB). When using more than 3 blobs, the next blob costs 12.5% more. Blobs cost 12.5% less when used in amounts of 3 or fewer.

• The maximum level is 6 blobs/block, or 768 kB (0.75 MB). 

According to the data of Arbitrum's transaction data publishing history, the highest data publishing day was on March 23, 2023 - the day the ARB token launched. 

Arbitrum consistently published 3,398 batches of approximately 100 kB each batch. After The Merge, Ethereum's block time will be fixed at 12 seconds per block. On average, there are approximately 7,200 blocks in a day.

With this data, the estimated data publishing demand of Arbitrum on March 23, 2023, was around 47.2 kB per block. This provides an example of the storage limits that EIP-4844 can bring to rollup protocols.

The data publishing demand of all rollup protocols is currently fluctuating around 1.5 times the data publishing demand of Arbitrum on March 23, 2023, which is approximately 70 kB per block.

According to current EIP-4844 fee mechanism settings, blob prices will remain low until data publishing demand exceeds the standard of 3 blobs per block (~384 kB), estimated to be around 8 times the current demand, assuming maximum utilization of data space within blobs. We expect the market to reach that level in 1–3 years.

Based on the above reasoning, EIP-4844 should minimize batch publishing fees for rollups by 65-90%, depending on blob demand. 

Since the Ethereum data availability layer will charge a "low enough" price for rollups after EIP-4844, the trade-off between cost-effectiveness and Ethereum ecosystem association may no longer become apparent.

Alternative DA solutions

While Ethereum remains the top choice for the data availability (DA) layer, there are also alternative solutions and competitors (directly or indirectly) to Ethereum in the alt-DA space. 

Figure 7: DA solutions for Rollups

 

New shared DA solutions use Layer 1 blockchains to optimize data availability. Notable projects include:

• EigenDA: EigenDA is a DA Layer that built on the concept of restaking. The project also draws on core ideas and libraries (store the Ethereum Danksharding codebase).

• Celestia: A pioneer in the modular blockchain sector, Celestia leverages the Cosmos SDK to build a specialized blockchain optimized for data availability.

• Avail Project: A Layer 1 blockchain optimized for data availability, led by Anurag Arjun, a co-founder of Polygon.

DA solutions customized for the requirements of specific rollup projects: zkPorter by zkSync; Anytrust by Arbitrum; Starkex DAC.

“Old Layer 1” blockchains upgrade themselves to become more friendly for publishing transactional data from rollups. Tezos is an example with its approach is based on the same idea as Ethereum.

Considering Layer 1 data availability, EIP-4844 may be sufficient for most high-value financial applications. Another market sector that alternative DA solutions may target is non-financial applications that need additional data and bandwidth.

Rollup fee models

Each rollup user transaction uses both Layer 1 and Layer 2 resources. Each network charges differently for resource consumption. Therefore, rollup transaction costs have two essential components:

• The cost of utilizing resources on Layer 1.

• The cost of utilizing resources on Layer 2.

Rollup operators usually charge users for Layer 1 activity (entirely or partially). They can customize rollup resource measurement and pricing models to meet their needs.

 

Arbitrum, zkSync Era and some other projects have implemented a fixed floor gas price to prevent network spam and maintain competitive transaction fees while ensuring the security and effectiveness of the Layer 2 solutions.

• Arbitrum One has a fixed floor gas price of 0.1.

• Arbitrum Nova has a fixed floor gas price of 0.01.

• zkSync Era uses a fixed floor gas price of 0.3.

• OP Mainnet, after upgrading to Bedrock, applied EIP-1559 with custom parameters to establish a Layer 2 fee market with gas prices that fluctuate based on the supply and demand for OP Mainnet blockspace.

 

transaction_gas_price = l2_base_Gas_price + l2_priority_gas_price

l2_transaction_fee = transaction_gas_price * l2_gas_used

l2_base_Gas_price: The basic gas price within a block. Base gas prices rise 10% when a block consumes more gas than the target. Otherwise, the base gas price drops 2% if the block uses less gas.

l2_priority_gas_price: Priority gas prices are specifically set for each transaction in the block. Typically, transactions are arranged and processed based on their priority fees.

Figure 8: EIP-1559 data on Op Mainnet

Transaction fees are essential to the rollup economic model's value accumulation. Rollup projects need a Layer 2 fee mechanism that aligns with their project's direction to efficiently extract value with reasonable trade-offs.

However, Layer 2 transaction fee models are generally connected to the rollup's transaction ordering mechanism and may require protocol modifications or additions. For example, to fully implement EIP-4844, OP Mainnet developers added mempool design to the protocol.

Transaction ordering policy refers to how blockchain transactions are arranged and included to a block, such as first-come, first-served, or first auction.

In the future, new transaction ordering policies will be implemented on rollup protocols, accompanied by changes in the rollup's fee model to extract value more effectively (compared to the current fee model of Arbitrum).

Figure 9: Ordering Policy & Fee Mechanism

Layer 3: Customize the rollup to its specific purpose

Layer 3 (L3) refers to building rollup on top of existing rollup protocols. While L2 focuses more on scalability, L3 emphasizes rollup use cases. The purpose of Layer 3 rollup can be clarified and distinguished from L2 as follows:

• L2 is designed for scaling general applications (general rollup).

• L3 is customized for unique applications or use cases (specific rollup/appchain).

Many prominent rollup projects have plans to provide SDKs to developers for the purpose of building their own Layer 3 solutions on top of their L2 rollup protocols. 

Most major rollup initiatives seek to deploy L3 on top of L2 because it adds a revenue source. Examples include Arbitrum's Arbitrum Orbit, Optimism's Op Stack, and zkSync's Hyperchain.

Figure 10: Popular SDK for Layer 3.

Some final words

Rollup ecosystem expansion has been remarkable. While most rollups operate stably and smoothly, they still face challenges related to centralization risks and incomplete technology. 

However, the good news is that rollup developers are currently exploring methods to make the Rollup Tech Stack more efficient, secure, and prevent single points of failure.

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