I remember a time when Ethereum fees were exorbitant. People were not willing to pay high fees. It has been said that people will migrate to Cardano and other platforms because it will be cheaper and transactions will be faster. That partially happened. However, some users migrated to many second layers (L2s) and remained in the Ethereum ecosystem. Does DeFi on Cardano stand a chance against the ever-growing number of L2s?
Second layers saved Ethereum
Low scalability is a problem for every blockchain and DeFi service, as fees can be high and unpredictable, and no one can be sure when their transaction will be settled. The network can only be used by the rich who are willing to pay for a place in the block. This hinders adoption, especially in poor regions.
It's still true that unless decentralized services are cheap, fast and reliable, we won't see mass adoption. To date, the Ethereum team has not resolved the low scalability issue of L1. However, it doesn't matter because the L2s saved the day.
People took their ETH and migrated to second layers that allowed them to use the same or similar services that were available on Ethereum. The user experience was amazing. Transactions were settled quickly and, above all, cheaply. Very quickly, many competing second layers began to appear. Today there are dozens of them and I bet you have never heard of many of them. However, the biggest ones are well-known to everyone. They have a large number of users and high TVL.
It is likely that if DeFi on Cardano had existed a year earlier, it would have more users and a larger TVL today. However, history cannot be changed. We have to think about whether the Cardano ecosystem can succeed in the competition of a large number of L2s.
Problems of L2s
L2s solve scalability but at the expense of decentralization and security. The reality is that most L2s do not (or only partially) inherit decentralization and security from the first layer. Users have exchanged user comfort for features that represent the meaning of the blockchain industry.
If you look at the list of L2s and start researching one by one, you'll run into problems you won't like. That is, if you think, like the author of the text, that decentralization and security are the characteristics that distinguish this sector from the traditional banking system.
Of course, the teams are aware of the problems and are trying to solve them. L2s may one day be more decentralized and secure.
The positive news is that no L2s are ready for mass adoption at this point. Solving decentralization at the second layer is a significantly more complex problem than scalability. I don't think L2s fundamentally threaten Cardano's success. In addition, even Cardano is not capable of processing thousands of transactions per second at the moment. I see it as the future is still open and no one is certain of success. Everything can fundamentally change within 5-10 years.
In the years to come, people will continue to migrate from one L2 to another. Many L2s will disappear because they will be overtaken by competition. It is somewhat reminiscent of the ICO mania when many projects were created, but today there are literally a few left.
L2s have several fundamental problems that are difficult to solve.
Decentralization must take place on the basis of an expensive resource. It can be either a hash rate or a coin. In theory, it could be other resources, like disk space, but let's leave that aside. L2s will likely have their own coins.
Decentralizing L2s based on ETH is probably impossible, since most of the ETH will be in different places (including ETH staking on L1) in the ecosystem, and a single L2 would only be protected by a small part of the total amount.
It is possible that successful L2s will tend to disengage from Ethereum and get rid of their dependence on it. Of course, it will depend on how they solve their own decentralization and security.
Ethereum is used as a well-secured data availability layer and execution layer. In simple terms, L2s basically perform some operations off-chain and use Ethereum as a layer that is more secure against attacks. However, in many cases, assets on L2s are not very well protected.
Another problem with L2 networks is that they split users and capital. Therefore, I think there won't be many L2s, but only a small number will survive. Their tokens can have such a value that it will be possible to build their own network of nodes and ensure security. However, we are still a long way from that.
Of course, it is possible that some models will be developed that will resemble the Polkadot or Cosmos ecosystem.
It is important to realize that there is a battle between L2s for users and capital. It's not that Ethereum is competing with Cardano, but that there is a battle going on in the Ethereum ecosystem between L2s. Cardano can be seen as another ecosystem that is competitive, but somehow outside of Ethereum. This can be an advantage.
The fight between L2s in the Ethereum ecosystem can be seen as chaos by some people. UX can turn many people off. When you add to this the other current risks associated with L2s, it may be a better choice to use DeFi on Cardano.
Personally, I think that a well-scaling L1 with a developed DeFi ecosystem is a better solution for users than an L1 with many L2 networks fighting each other for users and capital.
Users must be able to easily interact with each other through a single network or technology. This is the basis of building a large network effect. Splitting users into different subnets essentially degrades the building of the network effect.
Additionally, I think the fundamental difference between Cardano and Ethereum is the accounting model, i.e. UTxO vs. the account-based model. The accounting model has a major impact on the functioning of the Ethereum Virtual Machine (EVM) and the Plutus platform.
Personally, I lost faith not so much in Ethereum, but mainly in EVM, because the execution model is one of the reasons why there are so many hacks in the Ethereum ecosystem. Therefore, I think that the battle between platforms is not only on the level of scalability but also on the level of reliability and resistance to hacks.
Can secure L2s be built if they need EVMs to function? We don't know that yet.
I feel from L2 that they only temporarily solved the problem with high fees. Sending transactions and performing SC is done off-chain. However, off-chain operations are still dependent on the existence of L1. When you think about it from a wider perspective, you will find that it is just an effort to change the entire model of how Ethereum works. Ethereum is not completely done and neither is any L2. Teams across the ecosystem are looking for ways to achieve decentralization and high scalability. Essentially, the original network design is changing.
Instead of sharding, the team is moving to a new model. It is not at all certain that this is a good choice.
The IOG team builds something similar, with the difference that they put more thought into the design so that it doesn't have to be changed so often. Cardano will scale very well at L1 and there will be a large number of second layers at the same time. After all, they already exist today.
The goal is for Cardano to remain the centre of everything, as L1 is absolutely essential for the existence of L2s. L1s will be dependent on fees for their existence. L1 must be economically sustainable. L2s can be seen as competition for L1s.
Ethereum has historically been ahead and this is reflected in the number of users and TVL. In terms of technology and design, IOG leads the way in my opinion.
L2s have helped keep users in the Ethereum ecosystem so far, but that doesn't mean it's over. The Ethereum ecosystem has many problems with low decentralization of L2s and a large number of hacks. If this is not resolved, Cardano still has a great chance to succeed with those users who primarily require decentralization and the certainty that they will not lose money due to a large number of hacks. L2s are confusing and may not be trusted by newcomers. If DeFi on Cardano becomes available through a single wallet and financial operations become more transparent, Cardano can succeed, among other things, thanks to a clearer UX.
From a long-term perspective, it is necessary to think about the security budget. The success of L2 must not economically jeopardize L1. It may be economically beneficial for L2 to get rid of dependence on L1. In my view, L1 must remain technologically the best layer in the ecosystem.