What is a Layer 1 Blockchain?
Think of your favorite city: Perhaps it’s New York City, San Francisco, or Los Angeles. Regardless, each city differs geographically, geologically, and culturally, as well as in function: NYC is known for finance, LA for entertainment, SF for tech. City layout also differs significantly; vertical structures paint the NYC skyline and much of transportation occurs underground while in Los Angeles, large freeways connect disparate communities. Whether a resident, tourist, or real estate developer, each of these factors impacts the experience of people and their contribution to the functioning of the whole city.
Credit: Introducing New York and lacounty.gov
Figure 1
Source: Dragonfly Capital
In this report we’ll cover (1) Why Layer 1s matter and web2 alternatives, (2) The Blockchain Trilemma, and (3) An overview of smart contract blockchain design factors and resulting use-cases. In Part II of this report, we will focus on Layer 1 performance and user adoption between these different smart contract blockchains.
Why do Layer 1s Matter? What are Web2 Alternatives?
This brings us to the alternative offered by blockchains. Smart contracts can be viewed as a revolutionary application of the solution to the problem of centralized intermediaries, a concept originally implemented in Bitcoin. In his 2009 whitepaper, Satoshi Nakamoto envisioned a system of peer-to-peer value transfer that could bypass intermediaries, align user-platform interests and facilitate direct user ownership in a manner previously unseen.
FIGURE 2
Sources: Marvy Capital Research, a16z
However, with smart contract platforms, the power can shift back towards the users and the developers. In this open-source, permissionless environment, users retain control over their data and get to choose which decentralized apps (dApps) can access it. Developers, on the other hand, are not at the mercy of the platform; they cannot be unexpectedly kicked out, and they have more freedom to innovate.
FIGURE 3
Source: Franklin Templeton, For Illustrative Purposes Only
However, these Layer 1 smart contract platforms are more than just havens for developers. They’re beneficial for users at scale for various applications, from finance to social, gaming, and more. Users are not merely customers, but can be active contributors to the growth of a specific ecosystem as builders, users, investors, and even validators. We believe these platforms give rise to a novel dynamic where “your take rate is my opportunity,” as the ability to hard fork code and create a new chain allows for alternative options and naturally exerts downward pressure on pricing on fees that platforms charge users.
While these theoretical advantages seem enticing, it’s crucial to keep performance of the networks in mind. The upcoming discussion will offer an insight into the performance of Layer 1 platforms over the past five years, the important features to be considered, and some of the more notable smart contract platforms in the market.
Scaling Layer 1s and the Blockchain Trilemma
FIGURE 4
Source: Delphi Digital, For Illustrative Purposes Only
As new Layer 1s were introduced, new design philosophies were encoded into the architecture of different blockchains. For example, in contrast to the model of Ethereum, Solana’s design philosophy prioritizes scalability, performance, and ease of use. From a user perspective, Solana’s next-to-instant settlement time is palpable versus Ethereum and more reminiscent of web2 experiences like PayPal or Visa. Solana is able to achieve this level of speed in part due to its parallel processing mechanism, which enables efficient resource allocation to process transactions, versus sequential processing, a slower method of executing one task after another.
FIGURE 5
Source: Marvy Capital Research
Overview of Layer 1 Smart Contract Blockchains
In the following subsections, we’ll detail in depth how these design decisions and tradeoffs manifest in these protocols, starting with a focus on blockchain design, function, and technical performance, then moving on to adoption within each of these ecosystems.
Ethereum
In a philosophical retort to the centralized, transaction-heavy Solana, Ethereum supporters would probably echo the maxim, “If you want to go fast, go alone–if you want to go far, go together.” At around 27 transactions per second as of June, 1 2023, Ethereum exemplifies the “tortoise” rather than the “hare” among smart contract blockchains. Prohibitively high fees are often considered “a feature, not a bug.” This is possible for a few reasons. First, because transaction fees are given as rewards to validators, high fees directly incentivize demand to provide security to the network. Second, high fees push user and builder activity towards cheaper Layer 2 solutions built on top of Ethereum. Finally, part of fees goes towards burning the supply of ETH, which since the Merge last year has resulted in $9bn worth of ETH burn19 resulting in a current annualized inflation rate of negative 0.49%20; in other words fees result in supply deflation, essentially making ETH more scarce over time.
Solana
Polygon
Structurally, we believe Polygon is a great illustration of the long-term value prop of Ethereum–where high-throughput, low-fee chains batch their transactions and use Ethereum as a settlement layer. Because the two chains are connected, developers can easily build Polygon-based assets that users can interact with for lower fees while being portable and compatible with Ethereum28.
Avalanche
As can be seen in the graphic below, alternative Layer 1s such as Avalanche, Polkadot, and Cosmos involve variations of “app-chain” models, each enabling developers to customize their own blockchains within the context of a larger network and retain various degrees of sovereignty for builders as well as interoperability across chains.
Figure 7: App-chain models
Source: Burak Arikan, For illustrative purposes only
Conclusion
In the future, there could be a large opportunity for protocols that provide the best infrastructure for dApps serving high-opportunity emerging use cases. For example, Ethereum’s reliance on security has helped it become one of the most desirable options for DeFi while the customizability and low fees on Avalanche and Polkadot could make them attractive options for dApp developers. The same could be said in other areas such as DePIN and gaming for Solana and consumer brands for Polygon.
As New York City, Los Angeles, and San Francisco each compete for talent and offer different appealing elements to attract and retain potential residents, Layer 1s compete for users with the strategies we’ve explored in this piece. In the second part of this two-part report, we’ll compare progress and adoption across each of these chains.
- Dragonfly Capital
Non-Fungible Tokens (NFTs) are unique digital tokens that prove ownership of one-of-a-kind items or content, like art or collectibles, using blockchain technology.
The capability to copy underlying code and apply it to create a new chain.
Core elements or basic units in technology that are used as a foundation for creating more complex systems
- YCharts
Artemis.xyz
- Cryptoslate
- CertiK
Coinmarketcap as of June 2023
Ledger, as of December 2022
A method of validating and securing a blockchain network by holding and showing ownership of a certain amount of cryptocurrency
A way to record events in a digital system in a chronological and tamper-proof manner
“Market cap” label for represents market cap specifically on Ethereum network as of June 1, 2023
- Cryptoslate
Artemis.xyz
- Messari
- TechCrunch
- Cointelegraph
Polygonscan.com as of June 4, 2023
While Polygon is technically considered a Layer 1 “sidechain” for Ethereum at the moment, it is anticipating the full migration into an Ethereum Layer 2 in the future
