The Blockchain Trilemma & Layer 1 - #WFM 200
How can the blockchain trilemma be solved? Is there any real "Eth-killer?"
We’re going to dive into 1 blockchains this week, and explore Layer 2 blockchains next week. Both L1s and L2s have an abundance of unique mechanisms, use-cases, and supporters.
SXSW UPDATE
Elliot will be at SXSW, so if you’re planning to be in Austin, please reply to this email (or elliot@futurenftmints.com) so that he can say hi.
ALSO, Elliot is scheduled to speak on a panel about Web3 Branding. Sat, Mar 11 @ 1pm. Location hasn’t been shared yet, so we’ll share that in next week’s newsletter.
Other Blockchains and Use Cases
By Harrison Smith, Head of Research @ Future Mints
Since its creation in 2015, Ethereum has built the foundation for almost every major blockchain used today. Ethereum, similar to Bitcoin, is a layer 1 blockchain.
Although layer 1 blockchains are obviously super powerful tools, they struggle with a concept that Vitalik describes as the blockchain trilemma.
“The blockchain trilemma refers to the idea that it’s hard for blockchains to achieve optimal levels of [decentralization, security, and scalability] simultaneously. Increasing one usually leads to a weakening of another.”
Bitcoin and Ethereum both prioritize decentralization and security, and consequentially struggle with scalability. This leads to high transaction fees and long wait times.
In general, there is far more development on Ethereum than Bitcoin, largely due to the difference in stated purposes. Bitcoin’s purpose is being a store-of-value, while Ethereum’s purpose is simply being useful. The primary deterrent (currently) to Ethereum’s usability comes from its inability to scale.
Of course, there are direct solutions to the scalability issue. Bitcoin’s Taproot upgrade unlocked the ability for multiple signatures and transactions to be batched together. Ethereum has completed the Merge and has Sharding on the way which will enable 100K+ transactions per second vs ~30 today.
But some developers opt to search for other solutions to the blockchain trilemma. Some believe the best way to solve scalability is by using an entirely different layer 1 chain. Others believe the solution is augmenting Ethereum through layer 2 blockchains, sidechains and rollups.
Layer 1 blockchains are direct rivals to Ethereum, while layer 2 blockchains often work to supplement Ethereum.
Layer 1 Blockchains
Layer 1 blockchains (L1), often called “mainnets,” are simply the base level of a blockchain network. L1 blockchains host their own native token, which is used to cover transaction costs, or gas fees, and oftentimes they offer a uniquely distinct consensus mechanism.
Bitcoin and Ethereum are by far the biggest layer 1 blockchains. But a handful of other layer 1 blockchains have made impactful developments within the blockchain ecosystem.
A common factor of layer 1 blockchains outside of Bitcoin and Ethereum is the goal to solve scalability. Turning back to the blockchain trilemma, this often comes at the cost of decentralization. Let’s look at a few examples.
Solana is a layer 1 blockchain that created its first block in 2020. The network touts $0.00025 average cost per transaction, and over the past few years, has rapidly ascended into a nearly $10B market cap. Solana operates on a Proof of History system. The blockchain creates a chain of transactions by hashing the output of one transaction and using it as the input of the next transaction, validating the order in which transactions occur based on cryptographically-enforced timestamps.
Between semi-frequent outages and an assortment of VC ties, Solana is often criticized for its lack of decentralization. 50% of the original Solana allocation was distributed between Solana Labs, VC investors, and developers. The small concentration of ownership could lead to an abuse of power, and takes away from the overall decentralization of the chain.
Remember NBA Topshot? In early 2020, an officially licensed digital collectible platform was launched by Dapper Labs. Dapper would go on to release more official sports collectible platforms, like NFL All Day and UFC Strike.
All of these Dapper Lab products have something in common: the Flow Blockchain. Flow is a layer 1 blockchain - it is entirely its own network, and has its own network token ($FLOW). Flow, similarly to Solana, has low fees and is highly scalable. But concerns about Flow’s centralization are even worse than Solana, since it is operated by a single entity that has ultimate decision making power.
Dapper Labs has often been criticized for their strategic direction, or rather lack thereof, and their ability to individually manipulate a multi-billion dollar market. The lack of decentralization and lack of transparency behind the organization has constantly led to frustration, and even legal action. Dapper Labs was recently named in a class-action lawsuit, and the judge in the case determined that the interconnection with the Flow blockchain may even make the digital collectibles securities.
Speaking of lawsuits and layer 1 blockchains, Binance has recently come under regulatory fire within the United States for their token.
BNB was first created as an ERC-20 (a technical standard for Ethereum-based tokens) by Binance, and launched on Ethereum in 2017. By 2020, Binance had migrated the token to their own layer 1 blockchain, the Binance Smart Chain (BSC). To date, “Binance has invested more than $1 billion in the BSC ecosystem to support its ongoing and intensifying rivalry with the Ethereum network and other layer 1 blockchain systems.” BNB can be used to reduce Binance exchange trading fees, pay for transaction fees made on chain, and purchase goods and services.
Binance continued to flesh out their layer 1 ecosystem by implementing their own BUSD stablecoin, created by the U.S. based Paxos Trust Company.
This is exactly where regulatory issues arose - Binance’s regulatory status in the U.S. has always been iffy, and a United States company issuing Binance’s stablecoin was a hard no. The U.S. Securities and Exchange Commission (SEC) deemed BUSD to be an unregistered security.
Despite local legal scrutiny, BUSD is still a massive ecosystem worldwide, and BNB is currently the 11th biggest token by market cap (roughly $10B).
Stepping back for a second…
Stablecoins are a vital part of layer 1 ecosystems - they allow users to hold funds in crypto yet stay detached from market speculation (though sometimes this is only in theory). Stablecoins are supposed to be pegged 1:1 with a matching fiat currency, and ideally, a stablecoin provider should be ultra-transparent about their holdings. Stablecoins can be multi-chain, serving the same purpose across multiple layer 1 blockchains.
Tether is the world’s biggest stablecoin; with a $71B market cap, the stablecoin ranks #3 only behind Bitcoin and Ethereum. USDT (not to be confused with UST), has had its fair share of criticisms. Last year, speculators who feared Tether did not have sufficient funds to cover their token issuances tried to short Tether, while dumping large quantities of USDT. The price shortly wavered by 5%, but quickly regained its $1.00 price. Tether now publishes a breakdown of their holdings on their website.
Right behind USDT in market cap is USDC, issued by the US-based tech company Circle. USDC is perhaps the most utilized stablecoin within the United States, with holders including many top-tier financial institutions such as Blackrock.
In addition to USDT and USDC, there are tons more stablecoins worth covering. We plan to talk more about stablecoins and algo-stablecoins in a few weeks.
Okay, back to L1s.
Another super popular layer 1 blockchain is Avalanche. Avalanche tries to solve the blockchain trilemma by using a combination of interoperable blockchains.
To do this, Ava Labs designed three chains:
The Exchange Chain (X-Chain) is employed to create and exchange the native AVAX tokens and other assets. Similar to the ERC-20 standard on Ethereum, these tokens follow a set of standardized rules. It uses the Avalanche consensus mechanism.
The Contract Chain (C-Chain) hosts smart contracts and decentralized applications. It has its own Avalanche Virtual Machine, similar to the Ethereum Virtual Machine, allowing developers to fork EVM-compatible DApps. It uses the Snowman consensus mechanism.
The Platform Chain (P-Chain) coordinates network validators, tracks active subnets and enables the creation of new subnets. It also uses the Snowman consensus mechanism.
The Avalanche network’s security is not free from criticism. Polkadot founder Gavin Wood argues that a network is only as secure as its least-secure subnet. The fear is that messages from less-secure subnets may be transmitted to a more secure subnet, potentially compromising security.
Then again, Polkadot (DOT) is another layer 1 blockchain. All of these chains are competing not only against ETH, but against other layer 1s.
Over the past few years, there has been an explosion in layer 1 blockchains. Here’s a few other popular or high market cap L1s:
Cardano (ADA) - a proof-of-stake blockchain based on the Ouroboros consensus mechanism
Algorand (ALGO) - a pure proof-of-stake (PPoS) algorithm built on a Byzantine agreement
Evmos (EVMOS) - a blockchain deployed on Cosmos built for cross-chain connectivity
Near (NEAR) - a proof-of-stake blockchain that solves scalability through sharding
We’re going to end things here, partly because we couldn’t cover every L1 blockchain within a year, even if we published 2 newsletters everyday. And new layer 1 networks continue to be developed all the time.
All of these layer 1 blockchains try to provide what Bitcoin and Ethereum lack: scalability. This almost always comes at a cost, paid in either security or decentralization.
We’ll pick up with L2s, sidechains, and rollups next week.
News of the Week
Lawmakers and Binance continue to clash - a letter was delivered Wednesday to CEO Changpeng Zhao requesting details of the company's balance sheets, internal procedures and any communications regarding efforts to limit compliance.
Polygon ID is Polygon’s new identity infrastructure. Polygon ID's open-source, ZK-based solution hopes to verify off-chain data on-chain. Learn more in a thread from Polygon here.
TwelveFold is a 300-piece Ordinals generative art collection by Yuga Labs. Yuga plans to offer more details about timing and the auction mechanics in the coming week.
Metamask announced Hyperplay, a game launcher that brings MetaMask into native games. Metamask hops to allow players to carry their wallet across the entire decentralized web and into every game.