By IOSG Ventures
background
Currently, the Ethereum Rollup L2 ecosystem is taking shape, with an overall daily TVL of more than $37b, more than three times that of Solana and more than one-third of that of Ethereum. From a user's perspective, the recent average daily number of users of mainstream L2 has reached 158k, exceeding Solana's data by about 100k.
However, the short-term performance of Rollups is not as good as expected. In terms of market value, among the mainstream Rollups, Arbitrum has a market value of $7.8b, Optimism has a market value of $7.3b, Starknet has a market value of $6.9b, and zkSync, which has just completed its airdrop, has a FDV of $3.5b, while Solana's FDV reached $74b during the same period. zkSync was recently launched, and its poor market performance did not meet the market's expectations for Rollups.
From the perspective of revenue, Ethereum's revenue in 2023 reached $2b, while Arbitrum and Op Mainnet, which performed well in the same year, had annual revenues of $63m and $37m respectively, which is a big gap with Ethereum. Base and zkSync, which entered the market this year and performed well, respectively earned $50m and $23m in revenue in the first half of 2024, while Ethereum generated $1.39b in revenue in the same period, and the gap has not narrowed. Rollups have not yet achieved a revenue scale comparable to Ethereum.
The low activity of some Rollups is certainly a reason, and this is a problem faced by most public chains. What we want to know more is how well Rollups have fulfilled their mission as mass adoption infrastructure, and whether their value is underestimated due to the current low activity?
Everything still has to go back to the earliest proposition. The birth of Rollups originated from the increasing congestion of Ethereum, and the fees reached a level that users could not accept. Therefore, Rollups came into being with the inherent purpose of "reducing transaction costs". In addition to the well-known Ethereum L1-level security, the advantages of Rollups also include its disruptive cost structure, the so-called "the more users, the cheaper Rollups".
If this can be implemented well, we believe that Rollups will have irreplaceable value. A more reasonable cost structure can also improve the resilience of Rollups in the face of market changes. Continuous investment brought by healthy cash flow is the source of competitiveness, and protocols with advantages in profit margins will naturally have higher valuations and long-term competitiveness. This article briefly analyzes the current economic structure of Rollups and looks forward to future possibilities.
1. The business model of Rollups
1.1 Overview of the Rollups Protocol
Using Sequencer as the break-even point, users are charged fees for transactions on Rollups to cover the costs incurred on L1 and L2, as well as to obtain additional profits.
On the revenue side, Rollups charges users the following fees:
Basic Fee (including congestion charge)
Priority fees L1 related costs
Potential fees that the protocol could capture by developing its own policies include:
MEV Fees
The cost side includes the L2 execution cost, which currently accounts for a small proportion, and the L1 cost, which accounts for the majority, including:
DA Cost
Verification costs
Communication costs
The difference between Rollups and other L2 business models lies in its cost structure. For example, the DA cost, which accounts for the largest proportion, is regarded as a variable cost that varies with the amount of data, while the verification cost and communication cost are more regarded as fixed costs to maintain the operation of Rollups.
From a business model perspective, we hope to clarify the marginal cost of Rollups, that is, the extent to which the additional cost of an additional transaction can be less than the average cost of each transaction, to verify the specific extent to which "the more users, the cheaper the Rollup" is true.
The reason behind this is that Rollups batches data, compresses data, and verifies aggregation, resulting in high efficiency and low marginal costs compared to other public chains. In theory, the fixed cost of Rollups can be well amortized to each transaction, so it can even be ignored if the transaction volume is large enough, but this also needs our verification.
1.2 Rollups Revenue 1.2.1 Transaction Fee Revenue The main revenue of Rollups comes from transaction fees, i.e. gas. The purpose of the fees is to cover the cost of Rollups and obtain part of the profit to hedge the risk of long-term L1 gas changes, as well as to obtain part of the profit. Some L2s will charge transaction priority fees to allow users to prioritize urgent transactions. Aribtrum and zkSync adopt the FCFS mechanism, that is, the order of transaction processing is first come first served, and does not support "queue jumping" requests. OP stack has adopted a flexible approach to such issues, allowing "queue jumping" for transactions paid for priority fees.
For users, the fee of Rollups L2 is determined by the lower limit of the basic fee when the chain is less active. When the chain is busier, each Rollups will charge a congestion fee (often rising exponentially) based on the degree of congestion. Since Rollups' L2 overhead is extremely low (only off-chain engineering and operation and maintenance costs), and the execution costs collected are highly autonomous, almost all users' income for paying L2 fees will become the profit of the protocol. Due to the centralized operation of the Sequencer, Rollups have control over the basic fee floor, congestion fees, and priority fees. Therefore, the L2 execution fee will be a "parameter" game for the protocol. As long as the ecosystem is relatively prosperous and the price does not arouse user disgust, the amount of execution fees can be designed at will.
1.2.2 MEV Income MEV transactions are divided into malicious MEV and non-malicious MEV. Malicious MEV is a front-running transaction similar to a sandwich attack, which is more about robbing the user's transaction value. For example, in a sandwich attack, the attacker inserts his own transaction before the user's transaction, causing the user to buy at a higher price or sell at a lower price, which is called "being sandwiched". Non-malicious MEV is a back-running transaction such as arbitrage and liquidation. Arbitrage can balance prices between different exchanges and improve market efficiency; liquidation can remove bad leverage and reduce systemic risk, which is considered a beneficial MEV behavior.
Unlike Ethereum, Rollups does not provide a public mempool. Only the sorter can see transactions before they are finalized. Therefore, only the sorter has the ability to initiate MEVs on the L2 chain. Since most L2s are centralized sorters, malicious MEVs are unlikely to exist for the time being. Therefore, the current MEV income will need to consider arbitrage and liquidation types.
According to the research of Christof Ferreira Torres and others, they replayed the transactions on Rollups and concluded that Arbitrum, Optimism, and Zksync have non-malicious MEV behaviors on the chain. The three chains currently generate a total of $580m in MEV value, which is enough to serve as a source of income worthy of attention.
1.2.3 L1-related costs This part is the fee that Rollups charges users to cover L1-related costs. The specific cost structure will be discussed later. Different Rollups charge differently. In addition to predicting L1 gas to cover the cost of L1 data, Rollups will also incur additional fees as a reserve fund to deal with future gas volatility risks, which is essentially an income for Rollups. For example, Arbitrum will add a "Dynamic" fee, and OP stack will multiply the fee by the "Dynamic Overhead" coefficient. Before the EIP4844 upgrade, this part of the fee was estimated to be about 1/10 of the DA fee. 1.2.4 Profit Sharing Base is relatively special because it uses OP stack. There is a profit sharing. Base promises to contribute 2.5% of the total revenue/15% of the profit after deducting the cost of submitting data to L1 in L2 transactions. The higher of the two will be given to OP stack. In return, Base will participate in the on-chain governance of OP Stack and Superchain, and receive up to 2.75% of the OP token supply. According to recent data, Base contributes 5 ETH/day to Superchain's revenue. We can see that Base provides a considerable proportion of revenue for Optimism. In addition to cash flow, the healthy network effect also makes the OP Stack ecosystem more attractive in the eyes of users and the market. Although some of Arbitrum's performance, such as TVL or stablecoin market value, is higher than Base + Optimism, it is currently unable to exceed the latter's trading volume and revenue. This can also be seen from the P/S ratio of the two-after considering Base's revenue, $OP's PS ratios are 16% higher than $ARB, reflecting the additional value that the ecosystem brings to $OP.
1.3 Rollups Cost 1.3.1 Ethereum L1 Data Cost The specific cost structure of each chain is different, but the major categories can be basically divided into communication cost, DA cost, and verification cost unique to ZK Rollups. Communication cost: mainly includes state updates between L1 and L2, cross-chain interactions, etc. DA cost: includes publishing compressed transaction data, state roots, ZK proofs, etc. to the DA layer. Before EIP4844, the main cost of L1 came from DA cost (more than 95% for Arbitrum and Base, more than 75% for zkSync, and more than 80% for Starknet). After EIP4844, DA cost dropped significantly, and due to different L2 mechanisms, the degree of DA cost reduction is also different, with a cost reduction of about 50%-99%. 1.3.2 Verification cost Mainly used by ZK Rollup to verify the reliability of Rollups transactions through ZK means. 1.3.3 Other costs Mainly include off-chain engineering and operation and maintenance costs. Due to the current operation mode of Rollups, the running cost of the node is close to the cost of the cloud server, which is relatively small (close to the cost of the enterprise AWS server) 1.4 Comparison of L2 profit and other L1 data At this point, we have a general understanding of the overall income-expenditure structure of Rollup L2, and we can make a comparison with Alt L1. Here Rollups chooses Arbitrum, Base, zkSync, and Stakrnet weekly average data as the data source.
It can be seen that the overall profit margin of Rollups is relatively close to that of Solana, and it has obvious advantages over BSC, reflecting the excellent performance of Rollups' business model in terms of profitability and cost management. 2. Horizontal comparison of Rollups 2.1 Overview The fundamental performance of Rollups varies significantly at different stages of development. For example, when there is an expectation of currency issuance in a transaction, Rollups will experience a significant increase in transaction volume, and the subsequent fee income and expenses will also increase significantly. The vast majority of Rollups are still in their early stages, and absolute profitability is not that important to them. What is more important is ensuring balance of payments and long-term development. This is also the concept that Starknet has always announced that it hopes to achieve profit by not charging additional fees to users. But since mid-March, Starknet has been operating with negative returns and continues to this day. Its on-chain activity performance is indeed poor, but what is the root cause of negative returns, and will it continue in the long term? Let’s go deeper with this question. In fact, the revenue structure of Rollups is relatively similar, but the marginal cost structure brought about by the Rollup mechanism of each chain is different, and different calculation mechanisms such as data compression methods also bring about cost differences.
We hope to compare the costs in Rollups to help us compare the characteristics of different Rollups horizontally. 2.2 Cost structure of different types of L2 ZK Rollup ZK Rollups mainly differ in verification costs, which can often be regarded as their fixed costs. It is difficult to collect them through amortized handling fees, which is also the root cause of Rollups' inability to make ends meet. This article mainly discusses two relatively mature ZK Rollups with transaction volume. Starknet Starknet uses its own shared verification service SHARP. After transaction sorting, confirmation, and block generation, the batches are constructed through SHARP to build transaction proofs, which are sent to the L1 contract for verification. After passing, the proofs are sent to the Core contract. The fixed costs of verification and DA in Starknet come from blocks and batches respectively. The variable costs in Starknet increase with the number of transactions, mainly DA costs, which theoretically do not incur additional expenses. In fact, it is even the opposite - Starknet's transaction fees are charged per write, but its DA cost depends only on the number of updated memory cells, not the number of updates per cell. Therefore, Starknet previously charged too high a DA fee. There is a time difference between the collection of transaction fees and the payment of operating costs, which may lead to partial losses or profits. Therefore, we see that as long as transactions are still being generated, Starknet needs to continue to produce blocks and pay the fixed costs of blocks and batches. At the same time, the more transactions there are, the more variable costs need to be paid. Fixed costs do not significantly increase marginal costs. Since Starknet has a computing resource limit for each block (Cairo Steps), its gas fee calculation method is based on the computing resources and the amount of data, covering the fixed costs and variable costs respectively. Since the cost of producing blocks/batches is difficult to allocate to each transaction, but since each block is closed after reaching a certain computing resource (fixed costs are triggered), part of the fixed cost can be calculated and charged through the dimension of computing resources. However, due to the limitation of block time, if the transaction volume is insufficient (insufficient computing power in a single block), the computing resources cannot measure the amortized price well, so the fixed cost still cannot be fully covered.At the same time, the "limitation of computing resources" will be affected by the upgrade of Starknet network parameters. This is reflected in the huge losses in short-term operations after EIP4844. The losses were not alleviated until the computing resource parameters in the fees charged were adjusted. Starknet's charging model cannot effectively cover the fixed costs in every transaction, so when the Starknet mainnet is updated and the transaction volume is extremely low, negative income will occur. zkSync (zkSync Era) zkSync era switched from block verification to batch verification and storage state differences after the Boojum upgrade, effectively reducing verification and DA costs. The process is basically similar to Starknet. The Sequencer submits the batch to the Executor contract (state difference and DA commitment), the proof node submits the verification (ZK proof and DA commitment), and the batch is executed after the verification is passed (once every 45 batches); the difference is that Starknet has verification costs for both blocks and batches, while zkSync only has batch verification costs. Cost comparison between zkSync and Starknet Starknet batch size is much larger than zkSync Era, which has a limit of 750 or 1,000 transactions per batch, while Starknet has no transaction limit. In this way, Starknet has stronger scale capabilities. Since each block has computational resource constraints, the ability to process more transactions and batches in a single block makes it better in high-frequency transactions and scenarios where a large number of simple operations need to be processed, but there will be problems with high fixed costs when the transaction volume is small. zkSync's compression efficiency and flexible block resources make it more advantageous when it needs to flexibly respond to L1 gas price fluctuations and lack of on-chain activity, but there will be limitations in terms of block speed. For users, Starknet's fee model will be more user-friendly, less correlated with L1, and have stronger scale effects. zksync's fees are more efficient but will fluctuate more with L1. For the protocol, in the low activity stage, Starknet's high fixed costs will lead to more losses, and zkSync will be more suitable for this scenario. In high-activity phases, Starknet is more suitable for conducting large-scale high-frequency transactions and controlling costs, and zkSync's current mechanism may perform slightly worse in high transaction volumes.2.3 Optimistic rollup The cost structure of Optimistic Rollup is relatively simple. In the absence of verification costs, users only need to pay the computing cost of L2 and the DA cost of publishing data to L1. Among them, the publication of the state root is more of a fixed cost because it is related to block production, while the upload of compressed transactions is a variable cost that is easy to estimate and easy to amortize.
Compared with Zk Rollup, it has lower fixed costs and is more suitable for scenarios with appropriate transaction volumes. However, since each transaction needs to include a signature, the variable cost of DA will be higher, and the marginal cost advantage in the large-scale adoption stage will be relatively smaller. Based on the current scale of adoption, the fixed cost of ZK Rollup may lead to a higher fee floor for unsubsidized transactions, which will bring costs to users compared to OP Rollups, but ZK's advantage lies in scale: high transaction volume and proof aggregation will share the verification cost, and eventually the marginal cost saved by L1 will exceed Optimism Rollups; running Validiums/Volitions and DAs that only require state differences, faster withdrawal speeds, etc. will be more suitable for scale-based economic needs and RaaS ecology. 2.3 Data Comparison Income Rollups charges users gas fees. It can be seen that Base has higher income, Starknet has lower income, Arbitrum and zkSync are on par, and the difference in transaction volume leads to horizontal and vertical gaps, so we calculate the revenue per transaction. It can be found that before the EIP4844 upgrade, Arbitrum's per-transaction revenue was higher, and after the upgrade, Base's per-transaction revenue was higher.
Cost From the perspective of the cost of each transaction, before EIP4844, Base had high transaction costs due to high DA costs, and was actually in a situation of high marginal costs. The cost advantage due to the scale effect was not reflected. After EIP4844, with the significant reduction in DA costs, Base's transaction cost per transaction plummeted, and it is currently the lowest transaction cost among all Rollups. Compared with OP and ZK, it can be seen that OP Rollups is a greater beneficiary of the upgrade. The actual cost of StarkNet's L1 DA can be reduced by about 4 to 10 times, which is slightly less than OP Rollups by an order of magnitude. This is also consistent with theoretical inferences: in the EIP-4844 upgrade, the benefits of ZK Rollups are not as great as those of OP Rollups. The fee performance of ZK Rollup after the upgrade also reflects the impact of fixed costs on it.
Judging from the profit data, Base has the highest gross profit due to the scale effect, far exceeding Arbitrum, which is also Optimistic. Starknet, which is also a ZK Rollup, has a negative transaction gross profit due to its low transaction volume and inability to cover fixed costs. zkSync has a positive gross profit but is also limited by fixed costs and is lower than OP Rollup. The EIP4844 upgrade did not bring direct help to the profit margin - the main beneficiaries will be users, whose fee costs will be greatly reduced.
3. Summary 3.1 Cost side At present, it seems that most Rollups are still in the first half of their Margin curve. As the transaction volume increases, the marginal cost gradually decreases, and the average fixed cost will also decrease significantly. However, after the Ethereum L1 or L2 ecological transaction volume rises in the future, the increase in average transaction costs affected by the capacity of the network will lead to a gradual upward trend in marginal costs (as can be seen from the performance of Base3-May). This is something that cannot be ignored in the long-term development of Rollup. question. While focusing on cost changes due to short-term adoption, we also need to pay attention to Rollups' efforts on the long-term cost curve. In the short term, for Rollups, reducing marginal costs more effectively is the best way to establish barriers, and adjusting revenue and cost models according to market conditions is a better solution. 3.2 Income side In order to maintain long-term competitiveness, the protocol charges no additional fees to users as much as possible, and even rebates fees to keep user expenditures as low and stable as possible, as we see now with Starknet. Priority fees will certainly bring more revenue, but the prerequisite is that the chain must be sufficiently active. After EIP4844, the revenue of some Rollups has dropped significantly (such as Arbitrum). This is due to the fact that part of the source of profit difference-the hidden income of DA data fees has been almost wiped out. The revenue model of Rollups will become relatively single, mainly derived from L2 fees. As transaction volume increases, the priority fees and congestion fees generated will become important revenue components. At the same time, in terms of active income, MEV extraction through Sequencer will also be one of the important sources of income for Rollups in the future. Overall, Rollups’ business model does have the advantage of economies of scale, especially ZK Rollups. The current market conditions are not suitable for Rollups to take advantage of them, and they need to wait for a Base moment like March-May this year. The diversity of business models and the adaptability of different Rollups in different market conditions also allow us to see the far-reaching considerations of the Ethereum L2 Rollups ecosystem. References https://community.starknet.io/t/starknet-costs-and-fees/113853 https://medium.com/nethermind-eth/starknet-and-zksync-a-comparative-analysis-d4648786256b https:/ /blog.quarkslab.com/zksync-transaction-workflow.html https://www.alexbeckett.xyz/the-economics-for-rollup-fees/ https://davidecrapis.notion.site/Rollup-are-Real-Rollup-Economics-2-0-2516079f62a745b598133a101ba5a3de https://arxiv.org/pdf/2405.00138 https://blog.kroma.network/l2-scaling-landscape-fees-and-max-tps-fe6087d3f690 https://forum.arbitrum.foundation/t/rfc-arbitrum-gas-fees-sequencer-revenue/24730 https://mirror.xyz/filarm.eth/aZwXFN-tfuZKrMjzT9rXchlY15HGuYJGGj_5FPtPZ88 https://x.com/ryanberckmans/status/1768290443425366273 https://mirror.xyz/lxdao.eth/CnZFjWYHbR1Vu9Z4UPa7JKDceLtVtNf1EfsQ98Zq7JI
