Original title: The Economics of L3s
Author: Syndicate
Compiled by: TechFlow
As discussed earlier, L3s face real challenges of economic sustainability.
While Base earned over $30M in revenue in Q1 2024 from sequencers alone, what works for a handful of L2s like Base, Arbitrum, OP Mainnet, and Polygon doesn’t work for L3. Why?
Currently, L3 is growing in popularity for its ability to significantly reduce fees for users and developers—opening up the possibility of building new fully on-chain applications, games, and experiences. Just as cloud computing reduced the cost and time of building web applications thousands of times, L3 may do the same for Web3, enabling the new world web to be built thousands of times faster and cheaper. This is at least theoretical.
However, lowering fees by hundreds of thousands of times also creates significant economic challenges for L3: significantly lower fees mean that they cannot rely on sequencer fees as their main source of revenue unless they have L2-like transaction volumes, which is a problem for almost all It is not feasible for L3. Additionally, to achieve the thousands-fold expense reduction, L3 operating costs would still need to decrease another 10x to 100x from today's levels. This will require a complete transformation of L3's infrastructure rather than incremental improvements.
This creates a serious economic dilemma for L3. How does L3 hope to resolve this issue?
Break-even analysis of L3
Through our work with the emerging L3 ecosystem, the Syndicate team has seen L3 attempt to address this challenge by increasing network fees in order to generate a profit (or at least attempt to break even) from their sequencers. To date, these efforts have not resulted in profitability.
A few months ago, we ran economic scenarios for L3 — analyses relative to L2 at various on-chain activity and fee levels — to understand their breakevens and paths to profitability. The results were sobering.
If L3 fees are 10x cheaper than L2 today (or more), L3 will never be profitable unless it exceeds 50M transactions per month. This is equivalent to more than 50% of Base activity or 75% of Arbitrum activity.
Base and Arbitrum — two of ethereum’s most active L2s — typically see 50 million to 100 million transactions per month on their networks. But these are the biggest players. In the past 30 days, Zora saw 3.8 million transactions, Mode saw 3.8 million, and Redstone saw 1.1 million.
To break even, an L3 with 5 million transactions per month would need to set its fees within 3x of L2. This is a big challenge, especially if L3 competes primarily on lower fees. Simply being 3x cheaper than L2 is not nearly enough to attract users and developers to adopt a new network. Therefore, L3 must differentiate itself from L2 in other ways, such as scalability, customizability, and community ownership.
In the past 30 days, only two L3s have had more than 5 million transactions, and both of them are focused on gaming: Xai (275 million transactions) and Proof of Play Apex (69 million transactions). Xai’s network fees are nearly 200 times lower than L2, which means it may be operating at a loss. On the other hand, Proof of Play Apex’s network fees are 15 times higher than L2, which means it may be profitable, depending on who is paying the fees.
But given all of this, what is the path to sustainability and long-term value for L3 (and L2)?
Current arguments for L3s
Today, L3 can be viewed as an “operating cost” or “cost center” to kick-start the development of a new network and make it valuable over time. In addition, by running sequencers, setting network fees, and using custom gas tokens, L3 also provides operators with new economic tools to dynamically manage their ecosystem of users, developers, applications, and partners through targeted gas subsidies and incentives.
For example, consider a game that is fully on-chain on an L2 and pays a transaction fee for every on-chain action. To improve the user experience, the game developer may want to sponsor many (or all) transactions on behalf of the user, which can be very expensive as the game grows. Even with low gas fees on popular L2s today, if a game has 50,000 daily active users (DAU) and players perform an average of 100 on-chain actions per day, that adds up to over $10,000 in sponsored gas fees per day (or nearly $5 million in gas fees per year). For many L2s, this number could grow to $25-50 million per year! Therefore, games built on their own L3s reduce these variable costs to near zero, making many new mainstream social, gaming, and consumer applications — i.e., on-chain applications — economically viable.
The future of on-chain gaming
Being “fully on-chain” is also a major selling point for some games and applications. For example, Skyoneer is a fully on-chain game that exists on its strategy-focused L3 Gold. Pirates Nation is another fully on-chain game that exists on Proof of Play Apex L3, which says, “When a game is on-chain, it means we don’t have any servers running. We can’t shut down the game, it will live forever… Games on-chain… guarantee permanence, interoperability, and composability.” Here, lower costs aren’t a direct selling point, but they are a necessary condition to make the other benefits of having games fully on-chain possible.
Ultra-low fees also unlock new usage scenarios that users might not otherwise engage in. Consider that Ham Chain recently enabled a new tipping and microtransaction experience on its L3 by significantly reducing the cost of each transaction.
Therefore, the primary economic benefit of L3s is not in revenue generation, but in the value they provide to applications built on them. By drastically reducing transaction costs, L3s enable new applications and business models that might not be economically viable on more expensive L1 or L2 networks, and they allow applications to retain more value at a lower cost.
Future economic opportunities for L3
While L3 may be viewed as a cost center or negligible revenue source today, our team has a clearer vision for how L3 can become increasingly sustainable and valuable in the future. There are new models on the horizon that will profoundly reshape the economics of L3, both for developers and users.
The most obvious example is priority fees. As more applications, users, and transactions gradually migrate to L3, we may see priority fee markets emerge in popular L3s in the gaming, social, and financial sectors. Of course, priority fee markets will only open up when activity on L3 grows to the point where block space is no longer as abundant as it is today on Ethereum L1 and popular L2s like Base.
However, one of the more innovative models we have begun to see is the use of a native gas or staking token for the L3. For example, Degen Chain uses $DEGEN as its native gas token, creating additional utility for $DEGEN. New L3s in development plan to use not only their own custom gas tokens, but also custom staking mechanisms to help secure or co-operate the network, giving their tokens more utility. By using a native token — rather than focusing solely on value created through sequencer profits — many L3s are exploring ways to create value through their native tokens. In some cases, like Degen, this is a larger value driver and opportunity than sequencer profits.
There are even bigger economic breakthroughs to come. Our team has taken a deep dive into L3 development and issues in the fight for growth and long-term sustainability, and through this work we’ve uncovered big problems (and opportunities) related to how L3s are designed and operated, which ultimately limit their economic autonomy and potential today. However, if you can fundamentally change how L3s are designed and operated — you can unlock new revenues, new markets, and major structural advantages. This means that in the near future, L3s will not only be 1,000x cheaper, they will also be able to access new revenue and value generation opportunities that are not possible today. We look forward to sharing our research and work in this area in the coming weeks.
Future Outlook
As L3 continues to develop, we will see many new experiments in the area of value creation and capture, both from the perspective of chain operators as well as from the perspective of developers and users.
