1. Introduction

1. 1. Ethereum Scaling Solution, Rollups

Rollups launched to enhance Ethereum's scalability. They achieved their initial goal: reducing gas fees and accelerating transaction execution through off-chain computation. Arbitrum and Optimism account for 65% of the TVL across all rollups. They recorded transaction fees approximately 10 to 20 times lower than Ethereum. Consequently, user costs decreased by over 90% compared to Ethereum.

User cost reduction due to rollups, source: Dune

The significant reduction in transaction costs attracted users and developers. They struggled with Ethereum's high fees. Rollup TVL grew remarkably. It increased approximately 74 times from $460 million in March 2021 to$34.5 billion by March 2024, according to L2Beat. This growth established rollups as a core pillar within the blockchain industry. They boast a daily transaction volume 8 to 10 times higher than Ethereum. This attracts substantial capital and user engagement.

1. 2. Cambrian Explosion of Rollups

As of early March 2024, 45 rollups launched. An additional 34 projects prepare for launch. Arbitrum and Optimism hold market shares of 42% and 24%, respectively. Starknet, Base, and zkSync follow behind. The development landscape became more accessible due to Data Availability (DA) layers like Celestia. Open-source frameworks like OP Stack, Orbit, and Polygon CDK also contributed. This trend lowered technical barriers to rollup development. It led to the launch of numerous new rollups.

Furthermore, anticipation for token airdrops spurred active capital inflow into new rollups. Notably, Blast, Manta, and Mode launched mainnets on February 29, 2024, September 12, 2023, and January 31, 2024. They now rank 3rd, 4th, and 15th in terms of TVL.

Top 5 Rollups by TVL, source: L2Beat

1. 3. Arbitrum, Consolidating its Lead

Despite nearly 90 rollups and continuous competition, Arbitrum stands out. Its performance is notable compared to other layer 2 solutions. As mentioned earlier, Arbitrum holds over 42% of the TVL in rollups. It secures the top spot. The number of dApps onboarded is 560. This is about 2.5 times more than Base, the second-ranked platform.

Arbitrum maintains a dominant place in dApp TVL. It holds approximately $3.4 billion. This is more than three times that of Optimism. The ecosystem hosts a range of projects. This includes DeFi OGs like Aave and Uniswap. It also includes recent projects like Pendle, Hyperliquid, and Vertex.

Regarding revenue, Arbitrum demonstrates superior performance. Examining onchain revenue from February 2023 to February 2024: Arbitrum revenue rose for four consecutive months. This lasted from September 2023 to January 2024. It surpassed zkSync Era. It established itself as the top revenue-earning chain among the five listed.

In this competitive landscape, we highlight the reasons for Arbitrum's success. We also explain why we expect continued high performance.

2. What is Arbitrum?

Before diving deeper, let us examine the Arbitrum network and its native token, ARB. Arbitrum is an Ethereum layer 2 solution developed by Offchain Labs. It utilizes Optimistic Rollup technology. Optimistic rollup refers to a layer 2 technology. It assumes transaction results processed on layer 2 and stored on the mainnet are valid. To prevent malicious attacks, it includes a dispute period of one to two weeks. During this period, the validity of transaction execution can be contested.

2. 1. Arbitrum One

Arbitrum One is the main rollup solution provided by Arbitrum. We commonly refer to it as the "Arbitrum network." As an Optimistic rollup, a sequencer batches transaction data. It is stored on the Ethereum network. This process allows Arbitrum One to fully inherit Ethereum's high level of security.

The implementation of Arbitrum Nitro in August 2022 marked significant development. It distinguishes the period before as Arbitrum Classic and after as Arbitrum Nitro. Nitro represents the latest phase in Arbitrum's technology evolution. With Nitro, Arbitrum One achieved lower fees and higher EVM compatibility. The previously discussed metrics include high TVL, dApp quantity, and onchain revenue. These are attributes of Arbitrum One.

Furthermore, the chart shows an upward trend. Since 2024, active users and transaction counts increased. TVL consistently increased. It maintains steady performance.

Weekly trends in Arbitrum One active users and transaction counts. source: Token terminal

2. 2. Arbitrum Nova

Arbitrum Nova is another network in the Arbitrum ecosystem. It is established on AnyTrust technology, a modified version of Nitro. This network emphasizes gaming and social applications. It leads with high scalability and usability. Arbitrum Nova differs from Arbitrum One in how it stores transaction data. It leverages this difference to assert security enhancements while reducing costs.

Arbitrum One saves transaction data on the Ethereum mainnet in calldata. Arbitrum Nova takes a different approach. It stores this data with an external Data Availability Committee (DAC). The DAC consists of N members. AnyTrust assumes at least two members are honest. When the sequencer sends transaction data to the DAC, members sign it. They return it to the sequencer.

If the sequencer fails to gather enough signatures within a few minutes, it shifts from the DAC storage method to a standard rollup approach. This "fallback to rollup" strategy ensures that, assuming at least two honest DAC members exist, the validity of signatures from up to N-1 members remains verifiable. Arbitrum Nova suits gaming or social projects requiring frequent transactions. By replacing the high cost of submitting transaction data to the mainnet with an external DAC, Arbitrum Nova reduces operational expenses. This cost structure makes it practical for high-frequency transaction environments. Notable examples include Reddit's community point tokens, MOON and BRICK, launching on the Arbitrum Nova network. MOON is a token distributed based on Karma, a point earned by posting, commenting, or recommending content on Reddit’s "r/CryptoCurrency" subreddit. Similarly, BRICK is a community token allocated based on Karma earned in the "r/FortNiteBR" subreddit, associated with Fortnite: Battle Royale. Holders gain access to exclusive services like badges, GIFs in comments, and custom emojis. Additionally, BRICK serves a dual purpose: it acts as a governance token and a tipping mechanism within its subreddit.

2. 3. Native Token, ARB. ARB, an ERC-20 native token of the Arbitrum network, primarily serves governance purposes and provides grants to dApps within the ecosystem. ARB holders have the right to vote on significant ecosystem changes, including grant programs, committee selections, and network upgrades. The Arbitrum Foundation disburses ARB as grants according to community rules. This mechanism assists dApps in acquiring users and funds to support ecosystem growth and sustainability. We explore the details and impact of these grants in the section titled "5. Expanding the Ecosystem Through Grants." Optimism, a traditional rival of Arbitrum, launched its native token in March 2021, three months after its mainnet launch. In contrast, Arbitrum released its native token roughly eighteen months after its mainnet launch in August 2021. The Arbitrum Foundation announced an ARB airdrop for ecosystem participants on March 16, 2023. It subsequently distributed over 1 billion ARB tokens to more than 500,000 wallets on March 23. The effort to qualify for the airdrop and the subsequent spike in daily transactions after claiming ARB demonstrate the high anticipation surrounding the token release.

3. Cost Reduction Following EIP-4844. The Dencun Upgrade, specifically the implementation of EIP-4844, represents a significant change within the Ethereum ecosystem. Rollup solutions like Arbitrum awaited this update. Following successful tests on Goerli, Sepolia, and Holesky in January and February, the Dencun Upgrade deployed to the Ethereum mainnet on March 13.

4. 1. EIP-4844, the Core of the Dencun Upgrade. Known as Proto-Danksharding, EIP-4844 is a key component among the nine EIPs in the Dencun Upgrade. It is the main reason Ethereum rollups anticipated this upgrade. The core function of EIP-4844 is to introduce "blobs." This aims to reduce costs for rollups by lowering gas fees. This seeks to enhance the scalability of Ethereum's layer 2, improving efficiency and cost-effectiveness. A blob is a new type of data storage stored exclusively in the Ethereum consensus layer. Before EIP-4844, rollup solutions used sequencers to bundle transaction outcomes. They submitted these batches to the Ethereum mainnet execution layer as calldata. This process incurred high gas fees, accounting for up to 90% of total operational costs for layer 2 solutions. This led to higher transaction fees for users. The introduction of blobs addresses the scalability limitations caused by these costs. By creating a separate data storage space distinct from calldata, the upgrade frees up space on the Ethereum mainnet and significantly reduces data submission costs (DA costs).
5. 2. Cost Changes with the Introduction of Blobs. Monthly batch submission cost per rollup, source: Dune. The referenced chart shows monthly costs for various rollups transmitting batches to the Ethereum mainnet. Arbitrum paid approximately 24,617 ETH in these fees over 2023. The high operational costs stem from batch submission. This is attributed to the high cost of calldata, which is 16 gas per byte. In contrast, the official Ethereum GitHub states blobs cost 1 gas per byte. This makes blobs 16 times cheaper than calldata. Blob pricing operates in a market separate from calldata fees. This means blob costs remain unaffected by surges in calldata demand. This separation stabilizes blob storage costs. It provides a more predictable and scalable cost structure for rollups on Ethereum. The introduction of blobs and the resulting reduction in rollup costs impact users, primarily by lowering transaction fees. Since the majority of rollup expenses are tied to batch submission fees to the Ethereum mainnet, a reduction in these costs should lower the fees rollups charge users. Examining the gas fee formula on Arbitrum makes this relationship evident.

Arbitrum Transaction Fee = L1 Cost + L2 Cost = (Calldata size * Cost per byte) + (Gas demand * base fee). Arbitrum transaction fees divide into two main categories: the cost of storing calldata on the Ethereum mainnet (L1 cost) and the cost of executing contracts on Arbitrum (L2 cost).

The L1 cost is determined by multiplying the size of the calldata stored on Ethereum by the cost per byte. The L2 cost is calculated by multiplying the gas required for contract execution by the base gas fee. The introduction of blobs directly impacts L1 cost by reducing the cost per byte for data storage. Therefore, mathematically, overall fees for Arbitrum users decrease with blob implementation.

IntoTheBlock projects changes in rollup gas costs after the Dencun Upgrade (Source: IntoTheBlock).

Arbitrum implemented blobs later than other chains. Now that implementation is complete, the average gas fee dropped to $0.01. This is roughly 20 times lower than before. However, the current situation can change quickly. For example, Base saw a sudden rise in L2 costs after a surge in memecoin trading. Initially, blobs reduced gas fees to$0.0005—over 100 times lower. But increased activity raised costs again. Arbitrum may face similar increases. A spike in transaction processing could raise L2 costs. Increased demand for blobs could also raise L1 costs.

Rollup gas cost comparison (Source: growthepie).

4. Expanding the Ecosystem Through Technical Upgrade

Beyond EIP-4844, Arbitrum is making active efforts to expand its own ecosystem. We categorize these efforts into two types: expansion through technical development and expansion through grants. In this chapter, we explore examples of expansion via technical development.

As noted, the rollup space is crowded. Many existing and upcoming rollups compete for users, developers, and projects. Despite leading in TVL, throughput, and projects, Arbitrum actively develops its tech stack for flexible growth. Key initiatives include Arbitrum Orbit for vertical expansion and Arbitrum Stylus for horizontal expansion. These upgrades aim to attract projects and developers, easing their transition into the ecosystem.

4.1. Arbitrum Orbit

Arbitrum Orbit is a permissionless service using Arbitrum Nitro. It allows users to create Layer 2 or Layer 3 solutions based on their needs. Optimism's OP Stack is a comparable service. With Orbit, users can choose between Arbitrum rollup (Arbitrum One) and AnyTrust (Arbitrum Nova). They can create a custom chain tailored to their application.

To date, about 20 projects plan to create chains using Arbitrum Orbit. Five have already launched mainnets. Prominent examples include Xai, TreasureDAO, and Yuga Labs. Notably, Yuga Labs selected Arbitrum Orbit for ApeChain via a community vote. This choice beat out Optimism, Polygon, and zkSync in the voting.

Beyond onboarding projects via Orbit, Arbitrum collaborates with infrastructure providers like Caldera, Conduit, Altlayer, and Gelato. It also works with data availability protocols like Celestia and EigenDA. This enhances influence within the modular blockchain ecosystem. These partnerships offer clients more options for chain development. This provides a foundation to gain an advantage in the competitive rollup market. For instance, users can choose optimal services based on their needs. They might use Arbitrum Orbit as a rollup framework, Base for settlement via Conduit, and Celestia for data availability.

4.2. Arbitrum Stylus

Arbitrum Stylus is a technical upgrade from Nitro. It aims to attract more developers alongside Orbit. A key improvement is adding a WASM VM alongside the EVM on Arbitrum One and Nova. This enables deployment of contracts written in Rust, C, and C++. It goes beyond EVM equivalence to achieve "EVM+".

Some in the community anticipate Stylus will enhance scalability as much as, or more than, the Dencun Upgrade. Stylus is expected to have two major effects. First, by supporting languages like Rust and C++, which have a broader base than Solidity, it secures a wider pool of developers. According to Statista 2023 data, only 1.33% of developers used Solidity. In contrast, 13.05% used Rust, 19.34% used C, and 22.42% used C++.

Second, WASM can reduce gas fees and increase execution speed. Arbitrum states that leveraging Nitro's fraud-proof tech could make WASM execution over ten times faster. It could also cost 100 to 500 times less.

5. Expanding the Ecosystem Through Grants

In this chapter, we explore Arbitrum's efforts to expand its ecosystem through grants like STIP, LTIPP, and GCP. While Orbit and Stylus lower technical barriers, programs like STIP and GCP increase on-chain activity and attract users.

5.1. STIP and LTIPP

5.1.1. STIP

The Short Term Incentive Program (STIP) is a grant program. It distributes 50 million ARB to 30 projects selected by community voting. The goal is to distribute ARB to projects within Arbitrum. This provides a foundation to design incentive structures that attract users and funds sustainably. STIP was proposed in October 2023 and passed in December 2023 with 99% approval. The proposal attracted over 100 applications within a week. This highlights the community's high interest.

Of the 50 million ARB distributed, about 44% was allocated to perp DEX protocols, with GMX receiving the largest grant of 12 million ARB. Decentralized exchanges followed, receiving 12% of the total grant allocation. STIP allocation per project, source: The Castle Chronicle

Additionally, Arbitrum proposed the Backfund program in November, extending an additional support of 21.4 million ARB to 26 projects that did not receive a grant from STIP. In this program, the Perp DEX protocol Gains Network received the largest allocation of 4.5 million ARB. Unlike STIP, this round included bridge protocols such as Stargate, Synapse, and Wormhole, which were not part of the original STIP allocations.

Projects selected for the STIP and Backfund programs must complete the distribution of ARB incentives to users by March 29, 2024. The original deadline for incentive distribution was January 31, 2024, but it was extended to March 15 for the Arbitrum Foundation's ARB distribution and March 29 for projects to distribute ARB incentives to their users. This extension facilitates the design of effective incentive structures, especially for Backfund projects.

Moreover, projects which received ARB incentives are required to update their progress biweekly on the Arbitrum forum. Updates must include the amount of ARB received from the foundation, the amount used, incentive details, trends in TVL and transaction increases, and plans for the next two weeks.

Approximately four months after the initiation of STIP, 82.1% of the total allocated 62.68 million ARB has been distributed to the projects. Of that distributed amount, 75.47% has been used for user incentives. It has been observed that the majority of the top 20 projects by ARB allocation—where over 90% of ARB distribution has been completed—have seen an increase in TVL since the start of STIP.

Notably, the Perp DEX protocol Vertex, which received an allocation of 3 million ARB, experienced a TVL increase from 6,000 ETH to 22,000 ETH during the incentive program period. This represents a roughly 3.67-fold increase, demonstrating significant fund inflows beyond mere ETH price appreciation.

Vertex TVL trend, source: DefiLlama

Vertex launched its native token, VRTX, concurrently with the start of STIP and announced a VRTX and ARB incentive program. This program was designed to enable users to earn ARB and VRTX rewards through trading and staking in liquidity pools. The aim is to increase the number of transactions executed, boost the protocol's revenue, and secure long-term user liquidity within the protocol.

The rapid success of Vertex can be considered a prime example of effectively utilizing the anticipation of a protocol token airdrop. By designing an incentive structure that benefits the protocol, its users, and the Arbitrum ecosystem, it fulfills the objectives of the grant program most effectively.

5.1.2. LTIPP

The Long Term Incentive Pilot Program (LTIPP) is a 12-week test program. It bridges the gap between STIP and LTIP with a total support of 45 million ARB, approved on January 17th. According to the Arbitrum DAO, STIP identified three major issues. Arbitrum aims to address these problems within LTIPP, using the solutions as a foundation to enhance the outcomes of future grant programs.

The Issues and Solutions for STIP

1. Issue 1: The challenge of reviewing and voting on over 100 project proposals through direct elections. Solution 1: Transition to an indirect voting method by electing 5 council members.
2. Issue 2: Lack of appropriate feedback for projects that were not selected. Solution 2: Introduction of Application Advisors to provide guidance and feedback.
3. Issue 3: Strict limitations on ARB incentive structure design led to a scarcity of innovative examples. Solution 3: Relaxation of restrictions through the introduction of Application Advisors.

The election for the 5 council members was completed on January 24th, selecting GFX Labs, 404 DAO, Wintermute, GMX, and Karel Vuong. The application period for LTIPP ended on March 17th at 23:59 EST. This is followed by a two-week feedback period, one week of council evaluation, and one week of voting. After this process, the selected projects will participate in LTIPP for 12 weeks. Projects that applied for LTIPP can be found on the Arbitrum forum.

5.2. Gaming Catalyze Program

The Gaming Catalyze Program (GCP) is a grant program designed to expand the Arbitrum gaming ecosystem with an allocation of 200 million ARB tokens. Unlike the STIP and LTIPP, which focus on DeFi projects that leverage Arbitrum's strengths, the GCP targets Web3 gaming projects. This sector was previously considered a weakness within the Arbitrum ecosystem.

As the largest and longest initiative of its kind, spanning two years, Arbitrum aims for the successful implementation of the GCP. This will be achieved through rigorous vetting by the Arbitrum Foundation, a 5-member council, and a Venture Team. The council, elected through community voting similar to the LTIPP process, will oversee the hiring and firing of the Venture Team members. The Venture Team is a subsidiary of the Arbitrum Foundation. The council will also manage the whitelisting of projects wishing to participate in the GCP.

Out of the total 200 million ARB allocated to the GCP, 160 million ARB will be used for builder onboarding and development. The remaining 40 million ARB will be distributed for the construction of infrastructure to support game development.

• Builder Onboarding and Development Funds (160 million ARB): These funds are allocated to onboard promising projects onto Arbitrum, aiming to facilitate their development within the ecosystem.
• Infrastructure Development (40 million ARB): This portion of the funds is dedicated to the development of technology and infrastructure crucial for game development, such as account abstraction, game engine SDKs, and more.

Through the strategic use of these funds, GCP aims to onboard between 200 to 300 gaming applications and launch over 25 Orbit chains. This initiative is projected to secure over 20% market share of the total gaming projects, positioning Arbitrum to gain a competitive edge over other layer 2 solutions.

The proposal for GCP was introduced on the Arbitrum forum on March 11. It passed a governance vote with approximately 99% approval on March 23. Following this, the GCP council elections and the formation of the Venture Team are scheduled to be completed between April and May. The program will start to receive project applications soon after.

Despite only completing the community vote phase, the GCP has already attracted significant interest within the Arbitrum community. This attention is due not only to the program's unprecedented scale and long-term vision, but also its timely introduction amidst growing efforts to energize the gaming ecosystem, such as the Arbitrum Arcade launch. Furthermore, the GCP proposal was authored by Karel Vuong, a co-founder of TreasureDAO and a member of the LTIPP committee. This highlights the strategic involvement of key figures within the Arbitrum ecosystem. Vuong's involvement, along with expressed enthusiasm from various notable community members, underscores the GCP's potential to drive significant growth and innovation within the Arbitrum gaming sector from its early stages.

6. Conclusion

We have examined the background that could allow Arbitrum to maintain its lead in the intensifying competition among layer 2 solutions. We focused on aspects such as gas fee reduction following the Dencun upgrade, the development of technology upgrades including Orbit and Stylus, and the implementation of grant programs like STIP and GCP. However, while the decrease in gas fees due to the Dencun upgrade is a necessary condition for the revival of the rollup ecosystem, it is not sufficient on its own. Even if the absolute cost for users to operate on the network decreases significantly, a lack of appealing services or applications to attract users means that the reduction in fees could fail to be beneficial. It could also negatively impact revenue due to decreased earnings.

Arbitrum revenue estimates under EIP-4844, source: Arbitrum forum

From its launch, Arbitrum has onboarded numerous dApps, particularly DeFi projects. This established it as the network with the highest TVL and a significant number of transactions among rollup solutions. Furthermore, the steady release and migration of emerging DeFi dApps to Arbitrum highlight its dominant position in the DeFi sector. With the introduction of GCP, Arbitrum is also making concerted efforts to expand into the gaming sector. It aims to solidify its presence and attract a broader user base.

Top 5 rollup by TVL, source: DefiLlama

Despite the rich ecosystem of Arbitrum, ongoing concerns about the limited utility of its native token, ARB, remain a challenge that Arbitrum needs to address. Like most Ethereum rollup solutions, the primary use case for ARB is governance. Gas fees are still paid in ETH. This results in a lack of opportunities for ARB's continual utilization within the ecosystem. Furthermore, a significant unlock event occurred on March 16, with 1.11 billion ARB being released in the largest unlock since ARB's launch. This will be followed by monthly unlocks of 926 million ARB targeted at teams and investors until March 2027. Therefore, to leverage the increased liquidity from these unlocks as a driving force for ecosystem activation rather than a downward pressure on price, Arbitrum must diversify the use cases for ARB.

ARB unlock schedule, source: TokenUnlocks

Having addressed the issue of comparatively high gas fees with the Dencun upgrade, Arbitrum is strengthening its existing advantages. It is also striving to arm itself with new tools, such as gaming and L3 expansion. As liquidity continues to flow into layer 2 solutions and the technical barriers to network launches are reduced, it will be important to observe whether Arbitrum can solidify its leading position.

References

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