A trend has emerged as Layer 2 tokens, intricately tied to projects riding on the back of Layer 1 blockchains like Bitcoin and Ethereum, experience a revival. This resurgence comes against the backdrop of heightened expectations surrounding the easing of U.S. borrowing costs and the potential approval of a U.S. Spot Bitcoin ETF, contributing to a substantial upward trajectory in crypto prices, with Bitcoin alone witnessing a 50% surge since the close of August.
As the crypto tide rises, tokens associated with layer 2 projects, designed to enhance transaction speed, and reduce costs, have amassed a combined market cap of approximately $14.3 billion, constituting about a tenth of the total crypto market, according to data from CoinMarketCap.com. Leading the pack is Matic, the largest layer 2 token with a market cap of $6.90 billion, experiencing a commendable 20% increase to $0.74 over the past 30 days. Matic operates on Polygon, a platform dedicated to alleviating congestion on the Ethereum network.
The next four prominent layer 2 tokens—immutable, mantle, arbitrum, and optimism—have demonstrated impressive growth rates ranging from 9% to an impressive 105% over the past month, trading within the affordable range of $0.5 to just under $2 each. However, it should be noted that despite recent surges, all five tokens still linger between 16% and 86% below their all-time highs recorded over the last two years.
Ether, the layer 1 token linked to the Ethereum blockchain, the foundation upon which most layer 2 tokens are built, has experienced a notable uptick, surging 13.8% to $2,028.80 in the past month.
Layer 2 tokens have witnessed a proliferation in recent years, offering solutions to scalability issues associated with layer 1 blockchains. However, investing in these tokens is not without its risks. Characterised by their smaller size and lower liquidity, layer 2 tokens can be highly volatile and unpredictable, making it challenging to identify long-term winners.
Matteo Greco, a research analyst at digital asset and fintech investment firm Fineqia International, emphasises the speculative nature of layer 2 tokens, stating, “On average, the growth is not sustainable for those tokens… 100 try and one wins. There’s always a bit of thin air behind the moves.”
While Matic has experienced a marginal 3% decline in 2023, other tokens such as immutable have defied the odds, more than tripling in price. This divergent performance underscores the speculative character of layer 2 tokens, acting as both a sentiment gauge for associated projects and a favourite among active traders capitalising on market momentum.
The future trajectory of layer 2 tokens remains uncertain, with analysts offering varying perspectives on their importance in enhancing the practical applications of blockchains like Ethereum. Despite their potential, the market for layer 2 tokens is crowded, with numerous projects and their tokens launched during the crypto boom of 2020, only to face challenges during the crypto winter of 2022.
Alyse Killeen, managing partner at venture capital firm Stillmark, reflects on the current state of the space, stating, “The space feels ‘unserious’ right now… in terms of being able to point to an example of something you’d like to run your business or family’s personal finances on.”
Many investors concur that only projects demonstrating useful practical applications will survive in this competitive landscape. Matteo Greco of Fineqia International asserts, “In these macro phases, the use cases are not really so important. The real difference between assets that have decent use cases and assets that don’t is (in) the bear market. Assets that have good use cases are able to resist the downtrend even though they get hit hard.”
Layer 2, in the realm of blockchain technology, refers to a set of off-chain solutions or separate blockchains constructed on top of layer 1s. This strategic approach addresses bottlenecks related to scaling and data. Notably, Ethereum, among other blockchains, employs secondary blockchains known as layer 2s to enhance scalability and speed.
To tackle issues of scalability and speed, layer 2 extends Ethereum as a separate blockchain above the layer 1 network. These layer 2s effectively communicate and alleviate the heavy burden of transactions from the mainnet through smart contracts that integrate and benefit from Ethereum’s robust decentralised security model. In essence, Layer 1 manages security, data availability, and decentralisation, while layer 2s focus on scaling transactions, unlocking the potential for more efficient and streamlined blockchain operations.
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