A Deep Dive Into Arbitrum - The Leading Layer 2 Solution for Ethereum

Arbitrum is a Layer 2 solution based on the Ethereum blockchain launched by Offchain Labs with the aim of improving the scalability and efficiency of Ethereum. Its founders are Ed Felten, Steven Goldfeder, and Harry Kalodner from Princeton University. Arbitrum went live in late August 2021 and now consists of two separate networks - Arbitrum One and Arbitrum Nova. According to the data from DefiLlama, Arbitrum has become the ecosystem with the largest Total Value Locked (TVL) among all Layer 2 solutions. As of March 27, 2023, Arbitrum’s TVL has reached $2.18 billion, indicating a promising future for projects based on the Arbitrum ecosystem. After the release of its airdrop on March 23, 2023, Arbitrum has created a lot of buzz in the entire blockchain community.

Source: https://defillama.com/

Why is Arbitrum needed?

The scalability of Ethereum is a key topic in the Web3 world. Doubts about the scalability of Ethereum become rather severe when the crypto market is booming or the Ethereum network bears high activities. For example, during important events, including the craze for the crypto market when CryptoKitties was launched in 2017, the DeFi summer in 2020, and the crypto bull market in 2021, the unprecedentedly strong demand for the Ethereum network has led to exorbitant gas fees. In order to address this problem, the scaling of Ethereum has become the top priority for the Ethereum developer community.

There are currently two solutions for scaling Ethereum or other public chains, including:

• Scaling the public chain itself (Layer 1 scaling)
• Building Layer 2 on top of Layer 1 to achieve scalability

Ethereum 2.0 is a classic example of scaling the blockchain itself. Through The Merge, Ethereum 2.0 completed its transition from Proof-of-Work to Proof-of-Stake and sharding. Sharding can effectively increase the throughput of the entire Ethereum network, especially when combined with rollups.

Regarding Layer 2 scaling, many different types of Layer 2 solutions have been developed, including state channels, sidechains, and rollups.

These are three of the most popular Layer 2 scaling solutions. Technically, state channels fully inherit the security guarantees of Ethereum but are only suitable for specific applications. Sidechains, on the other hand, are usually compatible with the Ethereum Virtual Machine (EVM) and can scale general-purpose applications, but have poor security as they do not rely on Ethereum’s security but use their own consensus models. Rollups aim to create a universal scaling solution while relying on the security of the Ethereum network.

Based on their verification methods, rollups come in two different forms - optimistic rollup and ZK-rollup. Arbitrum and Optimism are two typical examples of Optimistic Rollups, while zkSync, Starkware, and Loopring are representative projects using ZK-rollup technology.

Arbitrum One & Arbitrum Nova

As a Layer 2 solution based on the Ethereum blockchain, Arbitrum actually has two separate networks - Arbitrum One and Arbitrum Nova. These two networks run in parallel to support Arbitrum’s development as a whole. Arbitrum One uses optimistic rollup, while Arbitrum Nova uses AnyTrust technology, which is derived from the rollup technology. The biggest difference between the two lies in that Arbitrum One keeps all transaction data on Ethereum, while Nova sends them to the Data Availability Committee. Nova will only turn to put the data on-chain when the committee fails to complete its work. This greatly reduces costs, but it also indicates that Nova does not have the same level of security as One. In the future, it is possible that Nova would become the go-to solution for gaming and social applications, while Arbitrum One may continue to host more DeFi and NFT projects.

Technical details of Arbitrum One

Arbitrum One uses optimistic rollup technology to ensure that the data posted to Layer 1 is valid and secure. Before discussing the Optimistic Rollup technology on which Arbitrum One is based, let’s first explore what rollup is.

Understanding Rollups

Rollups are currently one of the most popular Layer 2 scaling solutions. On the sidechain, rollups bundle, compress and send thousands of transactions from the Layer 1 mainnet to the consensus layer for validation, and post a very small number of compressed, validated transactions to the mainnet. By validating multiple transactions at once, rollups could significantly improve efficiency and reduce costs. They allow Ethereum to process 15 to over 3,000 transactions per second (TPS) without compromising security. There are currently two types of rollups - optimistic rollups and zero-knowledge rollups. The main difference between the two lies in their different verification methods. OP-rollups verify the authenticity of transactions through fraud proofs, while ZK-rollups bundle a large number of transactions into batches that are executed off-chain and update the smart contract status by sending validity proofs to the mainnet. Therefore, only minimal data needs to be posted to the mainnet to verify transactions.

OP rollups

Optimistic rollups are considered “optimistic” because all transactions on OP-rollups are assumed to be true and valid. OP-rollups use cryptocurrency incentives and penalties to keep validators honest. Specifically, OP-rollups verify the authenticity of transactions through fraud proofs. After the transactions are compressed into a batch and submitted on Ethereum, there’s a challenge period, during which anyone can challenge the results of the batch by computing a fraud-proof. Although anyone can become a validator, optimistic rollup validators must provide a bond before producing blocks, which is much like the Proof of Stake mechanism. If the validator proposes an invalid block or attempts to fork maliciously, the bond can be slashed.

To enter OP-rollups, users need to deposit ETH, ERC-20 tokens, or other cryptocurrency assets into a cross-chain bridge. The contract of the cross-chain bridge will be connected to Layer 2, i.e. OP-rollups, and mint an equal amount of assets on that blockchain, and then send them to the user’s chosen address. However, exiting OP-rollups is more difficult. When users try to withdraw from OP-rollups, they must wait until the challenge period elapses, during which anyone can dispute a transaction. The withdrawal process itself is fairly straightforward but time-consuming, as it usually takes 1-2 weeks.

The advantage of OP-rollups is their good compatibility with the EVM, allowing teams that previously deployed contracts on Ethereum to deploy them on OP-rollups without having to modify a significant amount of code. This not only saves time but also enables development teams to continue to use familiar programming languages, testing tools, etc.

By using fraud proofs, Arbitrum One has a 7-day challenge period, during which validators and challengers continue to split the disputed transactions until the disputes are narrowed down to a certain part, and then execute the disputed transactions on Layer 1. By adopting this multi-round interactive proving, Arbitrum One addresses the disputes over data published to Layer 1 with low cost and high efficiency, thereby ensuring the security of transactions. Additionally, Arbitrum One is perfectly compatible with EVM. In a word, based on OP-rollups, Arbitrum One makes it easier to improve Ethereum’s efficiency, reduce costs, and maintain strong security.

The Arbitrum Nitro upgrade creates additional technical protection for Arbitrum One

In June 2022, the popular Odyssey event on Arbitrum One caused gas fees to soar due to the overwhelming number of on-chain transactions. To solve the cost problem caused by the huge number of on-chain transactions, the Arbitrum team announced the suspension of the Arbitrum One network and the iteration of Arbitrum One to Arbitrum Nitro before relaunching. On August 31, 2022, Arbitrum One was successfully migrated to Nitro, a technical stack upgrade for One instead of a network independent of One. The full name of the network after the upgrade remains Arbitrum One.

Nitro has several improvements over One that further strengthens the Arbitrum One network.

• 7 to 10 times increase in Nitro throughput compared to pre-Nitro
• Advanced calldata compression, which further drives down transaction costs on Arbitrum by reducing the amount of data published to L1
• Improved Ethereum L1 gas compatibility, which ensures that the pricing and accounting for Arbitrum EVM operations are consistent with Ethereum
• Additional L1 interoperability, including tighter synchronization with L1 block numbers and comprehensive support for all Ethereum L1 precompiles
• More secure retryables, which remove failure modes where retryable tickets cannot be created.
• Added Geth tracing for broader debugging support

The technical process of Arbitrum One

Generally, Arbitrum uses optimistic rollup to improve scalability by relaying most computations and transactions from the main Ethereum blockchain to a smaller, self-managed sidechain. In optimistic rollups, transactions are processed and validated on the sidechain, and then the computation results are submitted for final validation on the Ethereum main chain. This greatly reduces the workload of executing smart contracts on the Ethereum main chain, thereby increasing transaction throughput and reducing transaction fees.

There are two key components in Arbitrum One: Arbitrum Sequencer and Arbitrum Virtual Machine (AVM). The Arbitrum Sequencer is a trusted entity that monitors and manages the transfer of transactions between the sidechain and the main chain. The AVM is a system based on the Ethereum Virtual Machine that executes smart contracts on the sidechain. Transactions and computation results can be processed in the AVM and then transmitted by the Arbitrum Sequencer to the Ethereum main chain for validation and final confirmation.

Specifically, Arbitrum One operates as follows:

1. Deploy the contract: Firstly, a smart contract called Arbitrum Rollup is deployed on the Ethereum mainnet. The contract is responsible for processing all transactions and state updates on the Arbitrum sidechain.
2. Submit the transactions: When users execute transactions on the Arbitrum sidechain, these transactions are bundled into a batch and are submitted to the Arbitrum rollup smart contract.
3. Verify and execute transactions: Using Optimistic Rollup technology, the transaction batch is verified and executed within the Arbitrum rollup smart contract, thereby achieving high throughput and low transaction costs.
4. Submit the result: Once the transaction batch is verified and executed, the Arbitrum rollup smart contract submits the transaction results to the Ethereum mainnet, bundles them together with other transaction results into a block, and then submits it to the Ethereum blockchain.

In this way, Arbitrum is able to achieve efficient transaction processing while fully utilizing the decentralization and security of the Ethereum mainnet.

Source: https://www.blocktempo.com/10-mins-to-understanding-arbitrum/

The launch of Arbitrum Nova: Dual-network mechanism of Arbitrum to make it a significant player in rollups

In August 2022, Arbitrum Nova went live as a network independent of Arbitrum One. Based on the AnyTrust technology, Arbitrum Nova can achieve ultra-low transaction costs through a new security model supported by an external Data Availability Committee (DAC).

Arbitrum Nova largely differs from Arbitrum One in data availability. Specifically, One’s data availability is on-chain (Ethereum mainnet), while Nova’s data availability is off-chain (external Data Availability Committee).

As previously mentioned, the essence of rollup technology is to separate execution layers and execute complex computations after transferring them off-chain. One publishes the complete data set in the form of calldata to the Ethereum mainnet. Since calldata occupies some mainnet block space, the gas fee paid for this operation has the largest proportion of One’s cost.

Source: https://foresightnews.pro/article/detail/13471

Nova provides two data publishing methods, one is to publish full data in the form of calldata like Nitro, and the other is to publish DACert to prove the availability of data. Nova’s sequencer sends the complete data set to all DAC committee members simultaneously, and the committee signs and returns the signatures to the sequencer. When the sequencer collects enough signatures, it can aggregate them and create a valid data availability certificate (DACert), and then publish the DACert to the mainnet. If the sequencer fails to collect enough signatures, it will fall back to rollup (i.e. publishing the full data to the mainnet in the form of calldata).

Generally, Nova enjoys the following features:

• Ultra-low transaction costs
• Designed for high-capacity dApps
• Users have complete control over their assets
• Stronger EVM compatibility

To put it simply, Arbitrum One stores data executed off-chain on the Ethereum mainnet, while Nova stores data on the off-chain Data Availability Committee. Compared to One, Nova sacrifices some security to improve its performance, making it suitable for dApps such as gaming and social networks that require high-frequency interaction. Arbitrum One is highly expected to continue to be the home of DeFi and many NFT projects.

Stylus: Arbitrum’s next-generation programming environment

After the release of Nova, the Arbitrum development team Offchain Labs announced that it would launch Stylus, the next-generation programming environment for both Arbitrum One and Arbitrum Nova. Stylus utilizes WebAssembly smart contracts, allowing users to deploy applications using their favorite programming languages, including Rust, C, and C++, to run alongside EVM programs on Arbitrum. Stylus boasts speeds up to an order of magnitude faster and can reduce costs, and is fully interoperable with the Ethereum Virtual Machine (EVM). Stylus is referred to as EVM+ by Offchain Labs, but it does not replace EVM. It is believed that Stylus will further leverage the advantages of Arbitrum to augment and expand its ecosystem.

Popular Applications in the Arbitrum Ecosystem

Source: https://defillama.com/

Many on-chain applications have enhanced their utility by leveraging Arbitrum’s faster speed, lower cost, and higher scalability. According to data provided by DeFiLlama, as of March 27, 2023, there were 226 applications locked in the Arbitrum ecosystem, including decentralized exchanges, lending platforms, games, insurance, and yield farming, among others. The top 8 projects by total value locked (TVL) were GMX, Uniswap, Arbitrum exchange, Radiant, Sushi, Camelot, AAVE, and Curve.

GMX had the largest proportion of TVL in the Arbitrum ecosystem, accounting for 23.01%. It is a decentralized spot and perpetual cryptocurrency exchange built on Arbitrum and Avalanche, and supports low swap fees and zero price impact trades through its innovative GLP multi-asset liquidity pool and aggregated oracle price feeds. By staking GMX or GLP tokens, users can earn native cryptocurrency rewards from the network. Instead of a traditional Automated Market Maker (AMM) model, GMX adopted a unique multi-asset liquidity pool model, allowing users to deposit designated cryptocurrency assets to the liquidity pool to become liquidity providers. In this way, users can not only earn transaction fees, funding rates, and liquidation fees but eliminate the need for bearing the impermanent loss in AMM protocols.

Trading on GMX is completed by depositing and withdrawing assets from a liquidity pool called GLP. As long as there is liquidity in the GLP, the trade can be completed without facing the problem of being unable to match a counterparty. GLP is a multi-asset pool composed of different types of cryptocurrencies with different ratios. Currently, there are eight cryptocurrencies in the GLP on Arbitrum, including ETH, BTC, LINK, UNI, USDC, USDT, DAI, and FRAX, half of which are stablecoins pegged to the US dollar, while the GLP on Avalanche is composed of AVAX, ETH, BTC, and USDC. The GLP on different chains is not interconnected, but the proportion of stablecoins is similar, accounting for around 50% of the GLP pool.

This GMX protocol generated $33.9 million in revenue over the past year, making the GMX token one of the best-performing assets in the volatile year of 2022, with returns of 84.0% in USD and 428.5% in ETH.

In addition to GMX, DEXes such as Uniswap, Sushiswap, Curve, and Camelot accounted for the majority of the top 8 in Arbitrum‘s TVL. Camelot, as Arbitrum’s native DEX, completed its token sales in December 2022 and is essentially a conventional Uniswap V2 + Curve type of DEX, with additional features available, such as Launchpad, customizable transaction fees, the combination of LPs with NFTs, and the support of project parties’ incentive setting. In summary, Camelot has the following features:

• It is the same AMM DEX as Uniswap V2 with liquidity dispersed over the entire interval from zero to infinity.
• It has stablecoin trading pairs similar to Curve.
• It supports customizable, flexible transaction fee settings. Camelot allows project teams to set transaction fee ratios based on market conditions and specific protocol requirements.
• It provides revenue and incentives through NFTs. Users providing liquidity will receive spNFT representing staking positions.
• The protocol is permissionless, and project parties can set incentives through the incentive pool of Nitro Pools. These are additional reward pools.
• It has a Launchpad, enabling project teams to raise funds and guide liquidity.

Furthermore, there are many other applications using or planning to use Arbitrum to benefit from its faster speed, lower cost, and more scalability as an Ethereum Layer 2 scaling solution.

ARB Airdrop marks a more Decentralized DAO Governance Model

Airdrop Details

Source: https://defillama.com/

On March 16, 2023, the Arbitrum Foundation announced an upcoming airdrop of ARB tokens to the Arbitrum community members on March 23, 2023, marking the official transition of Arbitrum towards a DAO governance model. This means that ARB holders will have the power to vote on important decisions regarding the governance of the Arbitrum network. According to the Arbitrum Foundation, “the Arbitrum DAO will have the ability to control key decisions at the core protocol level, from how the chain’s technology is upgraded to how the revenue from the chain can be used to support the ecosystem.”

The total supply of ARB is 10 billion tokens, 56% of which are allocated to the Arbitrum community (1.13% to DAOs in the Arbitrum ecosystem, 11.62% to participants in the Arbitrum network, and 42.78% to the Arbitrum Treasury), 17.53% to the investors, and 26.94% to the developer team and advisors.

Arbitrum allocates 44.47% of its total supply to internal members (investors + developer team), which is much higher than that of its main competitor, Optimism (36%). Unlike ETH, which can be used to pay fees, ARB tokens can only be used for protocol governance. The governance process of the Arbitrum DAO will be executed automatically by smart contracts, meaning that voting can be directly used to change the core codes of Arbitrum. However, code changes may have time delays due to the need for auditing and other security considerations. Therefore, under the governance of the Arbitrum DAO, the Security Council composed of 12 community members will have the ability to act quickly in the event of security vulnerability.

The launch of the ARB token coincides with the launch of Arbitrum Obit. This will allow third-party applications and protocols to build a new “Layer 3” blockchain on top of Arbitrum’s low-cost infrastructure.

Arbitrum Website Suffers Downtime on the Airdrop Day

Almost an hour after the airdrop kicked off, the Arbitrum token claim site experienced downtime, which was because the frontend of the Arbitrum website was overloaded with server traffic. However, users were still able to claim the airdrop by directly interacting with the smart contract. Within the first hour of the airdrop, Arbitrum users claimed 42 million ARB tokens, most likely through direct interaction with the smart contract. According to Nansen, approximately 23,000 individual wallets applied for the airdrop, accounting for 3% of all eligible wallets. The total supply of ARB is 10 billion tokens. At the time of writing, the trading price of ARB is close to $1.37.

The impact of ARB airdrop on the Arbitrum ecosystem

Firstly, the airdrop of ARB tokens marks the transition of Arbitrum towards DAO governance, meaning that ARB holders will have the power to vote on important decisions regarding the governance of the Arbitrum network, thereby making it more decentralized.

Secondly, the release of ARB finally allows users to invest in the largest Ethereum Layer 2 network. Arbitrum serves as a powerful competitor for Ethereum to replace other Layer 1 platforms and take market share away from blockchains such as Solana, Polygon, and Avalanche. In addition, it may also bring more value to Ethereum since Arbitrum relies on the security of Ethereum. The more transactions performed on Arbitrum, the more transactions will be stored and verified on the Ethereum blockchain.

Finally, Arbitrum allocates 44.47% of its total supply to internal members (investors + developer teams), which is much higher than that of its main competitor, Optimism (36%). This may indicate that Arbitrum prefers to provide more incentives and rewards to its internal team to better support and develop the project. However, this may raise concerns among other investors and community members about the fairness of the token distribution process, the possibility of internal teams manipulating token prices, etc. Therefore, the project party needs to manage token distribution and the role of the internal team in a transparent and fair manner to ensure the development of the project and the trust of the community.

Arbitrum vs Optimism

Using the OP-rollup technology, Arbitrum has shown obvious advantages over Optimism in terms of its ecosystem.

Source: https://defillama.com/

According to DefiLlama’s data on March 27, 2023, Arbitrum’s TVL reached $2.21 billion, while Optimism only had $910 million, less than half of Arbitrum’s TVL. In terms of the number of ecosystem projects, there are 231 dApps built on Arbitrum’s ecosystem, while Optimism has only 102.

According to Nansen, as of March 29, 2023, Arbitrum’s highest daily trading volume reached $2.734 million, while Optimism had only $800,000; in terms of users, Arbitrum has 1.03 million users, while Optimism has only 644,000.

Source: https://www.nansen.ai/

Source:https://www.nansen.ai/

Although both Arbitrum and Optimism are classified as optimistic rollups, they do have some differences. Firstly, they use different dispute resolution processes to validate transactions. Optimism uses single-round fraud proofs executed on Layer 1, while Arbitrum uses multi-round fraud proofs executed off-chain. Arbitrum’s fraud proofing is more advanced as it requires lower transaction fees on-chain (i.e. on Ethereum). After several rounds of the dispute resolution process are completed, the small piece of code that the EVM ultimately processes requires much less gas than reprocessing the entire on-chain transactions (in most cases).

However, in the case of Arbitrum when processing a disputed transaction, the final confirmation of Ethereum is delayed longer than in the case of Optimism, as Optimism’s dispute resolution relies more on Ethereum Virtual Machine (EVM). When one submits a challenge on Optimism, the entire problematic transaction runs through the EVM.

Additionally, although Optimism and Arbitrum are EVM-compatible, Optimism uses Ethereum Virtual Machine (EVM), while Arbitrum runs its own Arbitrum Virtual Machine (AVM). As a result, Optimism has only a Solidity compiler, while Arbitrum supports all EVM-compiled languages (Vyper, Yul, etc.). This also makes Arbitrum more readily accepted and used by more dApps.

Arbitrum vs Other ZK-rollup Competitors

Compared with ZK-rollup technology, OP-rollups are more compatible with EVM and have higher levels of open-source availability, making them relatively easier to develop. This is why OP-rollups currently dominate the market share among various Layer 2 solutions.

On the other hand, OP-Rollups are inferior to ZK-Rollups in terms of security because they rely on fraud proofs instead of validity proofs. Besides, ZK-rollups have several advantages, including lower transaction fees, trust-free features, and faster transaction confirmation speeds.

However, ZK-rollups are developing slowly as they are difficult to be compatible with EVM and have various issues to be addressed, including low open-source availability, high technical difficulty, different approaches and mechanisms among various projects, etc.

Therefore, for the future development of rollups, it is widely accepted that OP-rollups are more promising in the short term, as they can effectively reduce Ethereum’s burden, while ZK-rollups are promising in the medium and long run for better security and scalability. Currently, major ZK-rollup players, such as ZK-Sync, Starkware, and Scroll, are mostly in the alpha or even pre-alpha phase (ZK-Sync just launched its mainnet on March 24, 2023). It may take a year or more to have well-developed mainnets available for use. Among OP-rollups, Arbitrum currently has an excellent first-mover advantage and strong ecosystem support, making it more likely to take the lead in Layer 2.

Conclusion

Arbitrum poised to continue to make waves in Layer 2

According to Alan Chiu, the founder of Layer2 Boba Network, with Ethereum’s Shanghai upgrade on April 12, 2023, Layer 2 will become even more efficient while maintaining its current advantages. Harold Hyatt, the product manager of TrustToken, commented that “Ethereum L2 solutions will also scale — if Optimism is currently 10x faster than L1, and Ethereum is 10x after (sharding), Optimism will 100x.” As adoption rates increase, the demand for networks like Ethereum will grow exponentially. It is believed that Layer 2 will play a prominent role in Ethereum’s future. Brian Fu, the co-founder of zkLend, is very bullish about the future of Layer 2.

As the leading project with the largest ecosystem in Layer 2, Arbitrum has a strong advantage over its competitor Optimism in terms of TVL, number of dApps, and existing number of users. Technically, Arbitrum uses multi-round fraud proofs that are executed off-chain. Its advantage in dispute resolution lies in its lower transaction fees on-chain (i.e. on Ethereum) compared to that of Optimism. Additionally, Optimism is limited to a Solidity compiler, while Arbitrum supports all EVM programming languages like Vyper, YUL, etc. This also makes Arbitrum more easily adopted and used by more dApps. Among all the OP-rollup solutions, Arbitrum is more promising to stand out than Optimism in the future.

Meanwhile, compared to their various competitors, ZK-rollups are difficult to get compatible with EVM and have many outstanding issues to be addressed, such as low open-source availability, different approaches and mechanisms among various projects, and high technical difficulty, which have slowed down its progress. Among OP-rollups, Arbitrum currently has first-mover advantages and strong ecosystem support, which is conducive to its rapid development. Coupled with Arbitrum’s transition to a more decentralized DAO governance, all of these factors suggest that Arbitrum may continue to make waves in the Layer 2 space.

At present, optimistic rollup is still criticized for being somewhat centralized due to the use of centralized sequencers in projects like Arbitrum, which uses whitelist proofs and upgradable contracts. Although there have been no security issues with these projects and user assets are well protected, users are still concerned about the risk of audits and fund losses. Therefore, the inevitable future for Arbitrum is to have decentralized sequencers and permissionless proofs. Regarding these issues, Offchain Labs provided a corresponding technical roadmap:

1. Continue to reduce costs and increase TPS
2. Decentralize the system
3. Decentralize the management and authorization of software
4. Decentralize validators
5. Decentralize the sequencer

Additionally, due to the excessive distribution of ARB tokens to the internal team, the project party is questioned whether the token distribution is fair and whether the team is manipulating token prices. Therefore, the project team needs to manage token distribution and the roles of internal team members in a transparent, fair way to ensure the smooth development of the project while gaining community trust.

Overall, Arbitrum may usher in continuous, explosive growth in 2023. Currently, Arbitrum places its focus mainly on DeFi and cross-chain applications. However, as the number of developers and users continues to grow, more new applications are expected to be deployed on Arbitrum One and Arbitrum Nova networks, with the most anticipated projects being social, NFT, and gaming projects based on the unique features of the two networks. In this ever-changing Web 3 world, let’s see whether Arbitrum can continue to lead the way in Layer 2.