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Abstract

Ethereum’s journey since its inception has been marked by unparalleled innovation in decentralized technologies, yet its inherent architectural limitations have posed significant scalability challenges. These limitations, primarily manifesting as high transaction fees, slow processing times, and constrained throughput, have historically hindered its widespread adoption, especially within the demanding operational frameworks of institutional finance. Layer-2 (L2) scaling solutions have emerged as a cornerstone strategy to circumvent these bottlenecks, facilitating the processing of transactions off the main Ethereum chain while diligently upholding its foundational security guarantees. This comprehensive report undertakes an in-depth analysis of the burgeoning landscape of Ethereum L2 scaling solutions, meticulously dissecting their diverse architectural paradigms, prominently including Optimistic Rollups and Zero-Knowledge Rollups. A central focus is placed on elucidating their transformative potential and direct relevance in enabling a plethora of institutional use cases. The recent, landmark migration of JPMorgan’s JPM Coin to Coinbase’s Base network serves as a compelling real-world exemplar, unequivocally demonstrating the practical applicability and profound implications of L2 solutions in bridging traditional finance with the efficiencies of public blockchain infrastructure. Through a rigorous examination of the technical underpinnings, multifarious benefits, and persistent challenges associated with L2s, this report endeavors to cultivate a deeper, nuanced understanding of their indispensable role in augmenting Ethereum’s scalability, enhancing its economic viability, and ultimately fostering broader, more robust institutional integration within the evolving digital asset ecosystem.

1. Introduction

Since its launch in 2015, Ethereum has revolutionized the digital landscape by pioneering smart contract functionality and enabling the development of a vast ecosystem of decentralized applications (dApps). Its innovative architecture provided the bedrock for decentralized finance (DeFi), non-fungible tokens (NFTs), and numerous other web3 paradigms, establishing itself as the leading programmable blockchain. However, this very success brought forth a critical challenge: scalability. As the network’s adoption soared, particularly during periods of intense activity such as the 2017 ICO boom or the 2020-2021 DeFi summer, the limitations of its monolithic design became glaringly apparent. High transaction fees, often referred to as ‘gas fees,’ and protracted transaction confirmation times became commonplace, impeding user experience and rendering the network economically unviable for certain types of applications and users.

These inherent scalability constraints pose a significant hurdle for institutional applications, which demand high throughput, predictable costs, stringent security, and robust reliability. Traditional financial systems are engineered for vast transaction volumes and instant finality, requirements that Ethereum’s mainnet, in its original form, struggled to meet. The ‘blockchain trilemma’ – the fundamental trade-off between decentralization, security, and scalability – posits that a blockchain can optimally achieve only two of these three properties simultaneously. Ethereum’s design prioritized decentralization and security, inherently sacrificing scalability at the base layer.

In response to these pressing challenges, Layer-2 (L2) solutions have emerged as a pivotal and sophisticated strategy. Rather than altering Ethereum’s core protocol, L2s operate as distinct protocols built atop the existing mainnet, processing transactions off-chain and periodically settling them on the main Ethereum chain. This architectural innovation aims to dramatically enhance transaction throughput and reduce associated costs without compromising the paramount security and decentralization inherent to Ethereum’s Layer-1 (L1). This paper delves into the intricate world of L2 scaling solutions, exploring their diverse architectural designs, underlying cryptographic principles, and their profound implications for institutional adoption. A particular emphasis is placed on analyzing the recent and highly significant integration of JPMorgan’s JPM Coin into Coinbase’s Base network, showcasing a tangible manifestation of L2s bridging the gap between traditional finance and public blockchain infrastructure.

2. Ethereum’s Scalability Challenges: A Deeper Dive

Ethereum’s mainnet, a foundational pillar of decentralized technology, has faced persistent scalability issues primarily due to its design choices that prioritize security and decentralization. The original Ethereum 1.0 architecture, based on a Proof-of-Work (PoW) consensus mechanism, processed transactions sequentially within fixed-size blocks. This monolithic design means that every node in the network must process and validate every transaction, which inherently limits throughput.

Specifically, the network’s throughput is constrained to approximately 15 to 30 transactions per second (TPS) on average. While sufficient for early-stage decentralized applications, this capacity pales in comparison to centralized payment systems like Visa, which can handle tens of thousands of TPS. During periods of peak network congestion, such as the CryptoKitties phenomenon in late 2017, or the rapid growth of DeFi during 2020-2021, the demand for block space far outstripped supply. This imbalance inevitably led to a competitive bidding market for transaction inclusion, driving up transaction fees (gas prices) dramatically. Instances where gas fees surged from typical values of $5 to $50, or even several hundred dollars for complex smart contract interactions, were not uncommon. Such exorbitant costs render the network inaccessible for microtransactions, significantly hinder the economic viability of decentralized finance (DeFi) applications that rely on frequent interactions, and fundamentally impede the ability to scale for enterprise-level use cases.

Furthermore, the concept of transaction finality on Ethereum 1.0 presented its own set of challenges. While a transaction is typically included in a block within seconds, achieving ‘cryptographic finality’ – the point at which it becomes practically irreversible – requires multiple subsequent blocks to be mined on top of it. This process could take anywhere from 12 to 15 minutes, or even longer depending on network conditions. For institutional applications, where real-time settlement, high-frequency trading, or instant payment confirmations are critical, this delay is unacceptable. Delays in finality introduce operational inefficiencies, increase counterparty risk in certain scenarios, and make integration with low-latency traditional financial systems extremely difficult.

Beyond throughput and finality, Ethereum’s existing architecture also presented challenges related to data availability and state bloat. As the network processed more transactions, the size of its blockchain grew, requiring more storage and computational resources for full nodes to operate. This centralization pressure on node operators posed a latent threat to the network’s decentralization in the long term. These multifaceted limitations underscored an urgent and fundamental need for scalable solutions that could accommodate the burgeoning demands of the Ethereum ecosystem without compromising its core tenets of security and decentralization.

3. Emergence of Layer-2 Solutions: Foundational Concepts

Layer-2 solutions represent a paradigm shift in how blockchain scalability is approached, moving beyond monolithic, single-layer designs. They are external protocols or frameworks built on top of the Ethereum mainnet (Layer-1), designed to handle a significant portion of transaction processing off-chain, thereby alleviating the load on the L1. The core principle behind L2s is to leverage the robust security and decentralization of Ethereum’s base layer for dispute resolution and final settlement, while conducting the bulk of the computational work and state transitions in a more efficient, off-chain environment.

This approach fundamentally changes the cost structure and throughput profile of transactions. Instead of every transaction incurring the full L1 gas cost and competing for limited block space, L2s batch multiple off-chain transactions into a single, highly compressed transaction that is then submitted to the L1. This ‘amortization’ of L1 gas costs across many L2 transactions dramatically reduces the per-transaction fee and significantly increases effective throughput.

The genesis of L2 solutions can be traced back to the early recognition of L1 limitations, leading to various architectural designs:

State Channels: Among the earliest proposed L2 solutions, state channels allow participants to conduct multiple transactions or state updates directly between themselves, off-chain. Only the initial ‘opening’ of the channel and the final ‘closing’ (or dispute resolution) are recorded on the main chain. During the channel’s lifetime, participants can execute countless transactions instantly and with minimal fees, without interacting with the L1. This approach is particularly effective for applications requiring frequent, low-value interactions between a limited set of participants, such as gaming, micropayments, or frequent trades between two parties. However, state channels typically require participants to lock up capital, need all participants to be online to close the channel safely, and are not well-suited for open, generalized computation or public broadcasting of state changes. Examples include Raiden Network for payments and Connext for generalized state channels.
Plasma: Introduced by Joseph Poon and Vitalik Buterin, Plasma aimed to create a hierarchy of ‘child chains’ that periodically commit cryptographic proofs of their state to the main Ethereum chain. These child chains could themselves have further child chains, creating a tree-like structure for massive scalability. Plasma used smart contracts and Merkle trees to manage off-chain transactions securely, relying on fraud proofs similar to Optimistic Rollups. While theoretically promising, Plasma faced significant design challenges, particularly regarding data availability and the ‘mass exit problem.’ In scenarios where a Plasma chain operator misbehaved or became unresponsive, users faced complex and potentially slow processes to withdraw their funds back to the mainnet, often requiring users to monitor the chain actively. This complexity ultimately limited its widespread adoption, though projects like OMG Network explored its potential.
Sidechains: While often grouped with L2s, sidechains operate differently. They are independent blockchains with their own consensus mechanisms and validators, connected to the Ethereum mainnet via a two-way peg. Unlike rollups, sidechains typically do not fully inherit the security guarantees of the Ethereum L1; their security relies on their own validator set. This means that if a sidechain’s validator set is compromised, the funds on the sidechain could be at risk, irrespective of the L1’s security. However, their independence allows for significant flexibility in design, consensus algorithms, and throughput. Polygon PoS Chain is a prominent example of a sidechain that has achieved considerable adoption due to its high throughput and low fees, though it relies on its own set of PoS validators for security, rather than Ethereum’s directly.
Rollups: In the contemporary landscape, rollups have emerged as the leading and most promising L2 scaling solution. They achieve scalability by executing transactions off-chain, bundling (or ‘rolling up’) hundreds or thousands of these transactions into a single batch, and then submitting a compressed representation of this batch along with a cryptographic proof to the Ethereum mainnet. The critical innovation of rollups is that they derive their security directly from the Ethereum L1. This means that if the rollup operator attempts to act maliciously, their actions can be detected and challenged (in Optimistic Rollups) or cryptographically proven invalid (in Zero-Knowledge Rollups) by the L1, ensuring the safety of user funds. This strong security inheritance is what differentiates rollups from sidechains and has positioned them at the forefront of Ethereum’s scaling strategy.

4. Architectural Approaches to Layer-2 Scaling: The Rollup Revolution

The dominance of rollups as the primary L2 scaling solution for Ethereum stems from their ability to offer substantial scalability improvements while retaining strong security guarantees derived from the Layer-1. These solutions are broadly categorized into two main types based on their dispute resolution and transaction validation mechanisms: Optimistic Rollups and Zero-Knowledge Rollups.

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4.1 Optimistic Rollups

Optimistic Rollups operate on an ‘innocent until proven guilty’ philosophy. They optimistically assume that all transactions processed off-chain are valid by default. This premise significantly reduces the computational load on the main Ethereum chain because L1 does not need to re-execute or cryptographically verify every transaction in a batch. Instead, the L1 only intervenes in the event of a dispute.

Mechanism in Detail:

Transaction Execution: Users submit transactions to an Optimistic Rollup network. A centralized or decentralized ‘sequencer’ node collects these transactions, executes them off-chain, and batches them together.
State Transition & Posting to L1: After executing a batch of transactions, the sequencer calculates the new state root (a cryptographic hash representing the entire state of the rollup after the transactions are applied). It then publishes this new state root, along with a compressed version of the transaction data (calldata), to a smart contract on the Ethereum mainnet.
Challenge Period (Fraud Proofs): Crucially, there is a designated ‘challenge period’ (typically 7 days) during which anyone observing the rollup’s state can submit a ‘fraud proof’ to the L1 if they detect an invalid state transition posted by the sequencer. A fraud proof involves re-executing the disputed transaction(s) on the L1 (or a specific part of it, in a ‘bisection game’ approach) to demonstrate the sequencer’s malicious or erroneous behavior. If a fraud is proven, the sequencer is penalized (e.g., their staked collateral is slashed), the invalid state transition is reverted, and the correct state is enforced.
Withdrawals: Due to this challenge period, withdrawing funds from an Optimistic Rollup back to the Ethereum mainnet typically incurs a delay equal to the challenge period (e.g., 7 days). This delay is necessary to ensure that any potential fraud can be detected and rectified before funds are released. ‘Fast withdrawals’ services have emerged to mitigate this by allowing users to pay a fee to a liquidity provider who front-runs the withdrawal and provides immediate liquidity, assuming the risk of fraud.

Economic Model and EVM Compatibility:
Optimistic Rollups achieve significant cost reductions by amortizing the L1 gas cost of publishing transaction data across many transactions. The actual computation happens off-chain, costing very little. They also generally offer excellent Ethereum Virtual Machine (EVM) compatibility, often achieving ‘EVM equivalence’ or ‘EVM compatibility.’ This means developers can port their existing Ethereum dApps and smart contracts to Optimistic Rollups with minimal or no code changes, significantly lowering the barrier to entry and fostering rapid ecosystem growth.

Leading Implementations:

Optimism: One of the earliest and most prominent Optimistic Rollups, Optimism utilizes the ‘OP Stack,’ a modular, open-source development framework for building L2s. It strives for EVM equivalence, making it exceptionally easy for developers to migrate. Optimism has fostered a vibrant ecosystem of dApps and protocols, offering significantly lower transaction fees and higher throughput compared to the Ethereum mainnet. The OP Stack is also being adopted by other projects, including Coinbase’s Base network.
Arbitrum: Developed by Offchain Labs, Arbitrum has also been a leader in the Optimistic Rollup space. It employs a custom Arbitrum Virtual Machine (AVM) that is EVM-compatible and utilizes a multi-round fraud proof system to efficiently pinpoint and resolve disputes on L1. Arbitrum offers multiple chains, including Arbitrum One (their flagship chain) and Arbitrum Nova, which uses AnyTrust technology for even lower transaction fees by relying on an external data availability committee for some data posting. Arbitrum has achieved impressive statistics, such as processing an average of 2.8 million daily transactions with an 85% reduction in transaction costs compared to L1 (dexola.com).

Trade-offs: The primary trade-off for Optimistic Rollups is the aforementioned challenge period, which introduces a delay for L1 withdrawals. While ‘fast bridges’ mitigate this, they introduce an additional layer of trust or cost. Furthermore, in their initial stages, many Optimistic Rollups rely on centralized sequencers, which can introduce some degree of censorship risk or downtime, though efforts are underway to decentralize these sequencers.

Many thanks to our sponsor Panxora who helped us prepare this research report.

4.2 Zero-Knowledge Rollups (zk-Rollups)

Zero-Knowledge Rollups take a fundamentally different approach to transaction validation, leveraging advanced cryptography to provide validity proofs. Instead of optimistically assuming correctness, zk-Rollups cryptographically prove that a batch of off-chain transactions is valid, submitting this proof to the Ethereum mainnet. This means that L1 nodes can verify the correctness of thousands of transactions in a batch by simply checking a single, succinct cryptographic proof, without re-executing any of the transactions themselves.

Mechanism in Detail:

Transaction Execution & Batching: Similar to Optimistic Rollups, a sequencer or prover gathers and executes transactions off-chain.
Proof Generation: After executing a batch, the zk-Rollup generates a ‘validity proof’ (specifically, a zero-knowledge succinct non-interactive argument of knowledge, or ZK-SNARK, or ZK-STARK). This proof cryptographically attests to the fact that all transactions in the batch are valid according to the rollup’s rules and that the new state root was correctly derived from the previous state root and the executed transactions.
Posting to L1: The sequencer posts the new state root, a compressed version of the transaction data (calldata), and the validity proof to a smart contract on the Ethereum mainnet.
Instant Finality on L1: Once the L1 smart contract verifies the validity proof, the batch of transactions is considered instantly finalized on the L1. There is no challenge period because the cryptographic proof itself guarantees correctness. This enables much faster withdrawals to the L1 compared to Optimistic Rollups.

Mathematical Foundations and Security Model:
zk-Rollups rely on complex mathematical constructions of zero-knowledge proofs. ZK-SNARKs (Succinct Non-interactive ARguments of Knowledge) are highly efficient in terms of proof size and verification time but often require a ‘trusted setup’ (though universal and updatable trusted setups exist). ZK-STARKs (Succinct Transparent ARguments of Knowledge) are typically larger and slower to verify but do not require a trusted setup and are theoretically quantum-resistant. The security of zk-Rollups is absolute, derived directly from the cryptographic strength of the validity proofs, meaning funds are secure even if the rollup operator acts maliciously or goes offline, as the L1 can always process valid withdrawals.

EVM Compatibility (zk-EVMs):
Developing a zk-Rollup that is fully compatible with the Ethereum Virtual Machine (EVM) – known as a ‘zk-EVM’ – is a significant technical challenge. This is because the EVM’s operations were not originally designed to be easily verifiable with zero-knowledge proofs. Different types of zk-EVMs exist, categorized by their degree of EVM equivalence, ranging from Type 1 (fully equivalent, minimal changes needed for dApps, but harder to build) to Type 4 (language-level compatibility, but requires dApps to be rewritten for the zk-Rollup’s specific VM). The ongoing advancements in zk-EVM technology are rapidly improving compatibility and developer experience.

Leading Implementations:

StarkNet (StarkWare): Utilizes ZK-STARKs and processes transactions in a custom virtual machine running its Cairo programming language. StarkNet focuses on general computation at scale and has seen significant development, claiming capabilities of processing up to 500 transactions per second with proof generation times under 15 minutes (dexola.com).
zkSync Era: Developed by Matter Labs, zkSync Era is a zk-EVM focused on providing a developer-friendly, EVM-compatible environment. It also pioneered Account Abstraction, allowing for more flexible wallet designs and user experiences.
Polygon zkEVM: An ambitious project by Polygon Labs to build a Type 2 zk-EVM, aiming for byte-code level compatibility with the EVM, allowing most dApps to migrate with minimal changes.
Scroll: Working in close collaboration with the Ethereum Foundation, Scroll is building another Type 2 zk-EVM, prioritizing full compatibility and leveraging extensive research into efficient proof generation.

Trade-offs: While offering superior security and faster finality, zk-Rollups are more computationally intensive to operate due to the complex proof generation process. This can lead to higher operational costs for the rollup provider and historically longer proof generation times. The technology is also more nascent and complex, presenting a steeper learning curve for developers. However, ongoing research and development are rapidly addressing these challenges, positioning zk-Rollups as the long-term scaling solution for Ethereum.

Many thanks to our sponsor Panxora who helped us prepare this research report.

4.3 Hybrid Approaches and Emerging Trends

The L2 landscape is continuously evolving. Hybrid solutions, like ‘ZK-optimistic rollups’ (e.g., Taiko), combine elements of both types, using optimistic assumptions but allowing validity proofs as an alternative. ‘Layer 3’ solutions are also being explored, building on top of L2s for application-specific scalability, often leveraging ZK-proofs for privacy and efficiency. The decentralization of sequencers and the development of shared sequencing networks are critical areas of research to enhance censorship resistance and network robustness for all rollup types.

5. Institutional Adoption of Layer-2 Solutions: A Paradigm Shift

The inherent scalability, efficiency, and cost-effectiveness offered by Layer-2 solutions have rendered them increasingly attractive, and indeed essential, for the burgeoning interest of institutional applications within the blockchain space. Traditional financial institutions operate under stringent regulatory frameworks, demand high transaction volumes, predictable costs, and robust security—requirements that Ethereum’s mainnet alone struggled to meet. L2s address many of these pain points, paving the way for real-time settlement, efficient cross-border payments, tokenized assets, and the development of complex financial instruments that were previously impractical on a public blockchain.

Many thanks to our sponsor Panxora who helped us prepare this research report.

Why L2s Appeal to Institutions

Cost Predictability and Reduction: Institutions handle high volumes of transactions. Volatile and high gas fees on L1 are prohibitive. L2s offer significantly lower and more predictable transaction costs, enabling economically viable enterprise-scale operations.
Increased Throughput and Speed: The ability to process thousands of transactions per second on an L2 means institutions can execute trades, settle payments, and manage digital assets with speeds approaching traditional financial systems, facilitating operations like high-frequency trading or instant cross-border transfers.
Enhanced Security through L1 Inheritance: Unlike sidechains, rollups inherit the robust security guarantees of the Ethereum mainnet. This provides a level of trust and finality that is crucial for institutional confidence, allowing them to leverage the security of a global, decentralized network.
EVM Compatibility and Developer Familiarity: The high degree of EVM compatibility in many L2s means that existing smart contracts and dApp logic can be seamlessly deployed. This reduces development costs and time-to-market for institutions looking to experiment with or deploy blockchain-based solutions.
Auditability and Transparency (Selective Privacy): Public L2s offer a degree of transparency that allows for easy auditing of transactions, which can aid in compliance. For use cases requiring privacy, advancements in zk-Rollups (e.g., private transactions, confidential computing) offer potential solutions without sacrificing verifiability.
Regulatory Fit: As regulators globally begin to understand and define digital assets, solutions built on established public blockchains with clear security models, like L2s, may offer clearer pathways for compliance and integration than proprietary, permissioned blockchains.

Many thanks to our sponsor Panxora who helped us prepare this research report.

The JPM Coin Case Study: JPMorgan’s Migration to Coinbase’s Base Network

Perhaps one of the most compelling and widely cited examples of institutional adoption of L2 technology is the integration of JPMorgan’s JPM Coin into Coinbase’s Base network. This move signifies a strategic pivot by a major global financial institution towards embracing public blockchain infrastructure for critical payment functions.

Background of JPM Coin and Onyx:
JPM Coin was initially launched in 2019 by JPMorgan’s blockchain and digital assets unit, Onyx. It is a permissioned, private blockchain-based system that represents dollar deposits held at JPMorgan. Its primary purpose has been to facilitate instant, wholesale payment settlements between institutional clients, enabling 24/7 transactions within JPMorgan’s ecosystem. Essentially, JPM Coin tokenizes clients’ fiat deposits, allowing them to move funds between accounts on a blockchain, significantly speeding up interbank and corporate settlements that would otherwise take days through traditional banking rails (e.g., SWIFT, ACH). This innovation aimed to reduce counterparty risk and operational costs for its institutional clients.

The Significance of Base Network Integration:
The recent migration of JPM Coin’s functionality to Coinbase’s Base network represents a pivotal expansion of its utility beyond JPMorgan’s proprietary ecosystem. Base is an Optimism-based Layer-2 solution, meaning it is built on the OP Stack and inherits the security of Ethereum. The choice of Base is strategic for several reasons:

EVM Compatibility: Base’s EVM compatibility makes it straightforward for JPMorgan to integrate its existing blockchain infrastructure and logic, as it can leverage familiar development environments.
Leveraging Public Infrastructure: By moving to a public L2, JPM Coin gains access to a broader, more decentralized network effect. While the JPM Coin itself remains permissioned (only eligible institutional clients can hold and transact with it), its underlying settlement layer benefits from the robustness, security, and potential for interoperability offered by the public Ethereum ecosystem.
Coinbase’s Regulatory Stance: Coinbase, as a publicly traded and regulated entity in the US, provides a trusted gateway for institutional participation in the crypto space. Its commitment to compliance and security aligns with the stringent requirements of a financial giant like JPMorgan.
Real-time, 24/7 Operations: L2s like Base enable near-instantaneous transactions around the clock, which is a significant improvement over traditional banking hours and settlement cycles. This facilitates immediate liquidity and reduces operational delays for institutional clients engaged in global commerce and financial markets.
Potential for DeFi Integration (Controlled): While JPM Coin’s use remains permissioned, its presence on a public L2 theoretically opens up possibilities for controlled, compliant interactions with broader DeFi rails. This could include things like tokenized asset issuance or programmable payments that leverage smart contract functionality, all while maintaining the necessary institutional controls and compliance layers.

Implications of the Migration:
This move by JPMorgan underscores several critical trends:

Validation of L2s: It provides strong validation for the viability and robustness of L2 scaling solutions, demonstrating their readiness for even the most demanding institutional use cases.
Bridging TradFi and DeFi: It serves as a tangible example of traditional finance (TradFi) actively exploring and integrating with public blockchain infrastructure, moving beyond purely private, permissioned networks for certain functionalities (coinlaw.io, cointrust.com).
Future of Wholesale Payments: The ability to settle wholesale payments instantly and securely on a public L2 could significantly disrupt existing correspondent banking networks and cross-border payment systems, reducing costs and increasing efficiency on a global scale.
Tokenization of Real-World Assets (RWAs): JPM Coin itself is a tokenized representation of a fiat deposit. Its deployment on Base signals a broader potential for tokenizing various real-world assets (securities, commodities, real estate) on public L2s, enabling fractional ownership, instant settlement, and new forms of liquidity.

Many thanks to our sponsor Panxora who helped us prepare this research report.

Other Institutional Examples and Interest

The JPM Coin case is not an isolated incident. Other financial institutions and enterprises are actively exploring or deploying solutions on L2s:

Tokenized Securities: Projects are emerging to tokenize traditional securities (stocks, bonds) on L2s, leveraging the efficiency for issuance, trading, and settlement while adhering to regulatory requirements.
Institutional DeFi: Efforts are underway to build ‘permissioned DeFi’ platforms on L2s, where institutional participants can access decentralized financial primitives (lending, borrowing, automated market making) while meeting KYC/AML and other compliance standards.
Cross-border Remittances: Companies are exploring L2s for faster, cheaper cross-border payment corridors, particularly for large-value transfers.

Many thanks to our sponsor Panxora who helped us prepare this research report.

Regulatory Landscape

While the technical capabilities of L2s are advancing rapidly, the regulatory landscape remains a critical factor for institutional adoption. Jurisdictions are gradually developing frameworks for digital assets, stablecoins, and blockchain technology. L2s, by virtue of their link to the highly regulated L1 Ethereum and their inherent transparency (for many rollup types), offer a more discernible path for compliance. Institutions will continue to demand regulatory clarity and legal certainty, which will undoubtedly shape the specific L2s and use cases that achieve mainstream adoption.

6. Comprehensive Analysis: Benefits and Challenges of Layer-2 Scaling Solutions

Layer-2 scaling solutions represent a crucial evolution for Ethereum, offering a powerful remedy to its scalability woes. However, like any complex technology, they come with their own set of advantages and inherent difficulties that must be meticulously considered, especially from an institutional perspective.

Many thanks to our sponsor Panxora who helped us prepare this research report.

6.1 Benefits in Detail

Enhanced Scalability and Throughput: The most immediate and significant benefit of L2s is the dramatic increase in transaction throughput. By processing transactions off-chain and only committing compressed data or proofs to L1, rollups can achieve orders of magnitude higher TPS than the Ethereum mainnet. For instance, Optimistic Rollups can theoretically reach 1,000-4,000 TPS, while zk-Rollups, with their superior data compression and proof mechanisms, aim for 10,000-100,000 TPS or even more in the future. This transforms Ethereum from a constrained settlement layer into a foundation capable of supporting global-scale applications and high-frequency institutional operations.
Substantially Reduced Transaction Costs: Offloading transaction execution from L1 significantly lowers gas fees. On L2s, the cost of processing a transaction is largely amortized across thousands of transactions within a single batch, drastically cutting the per-transaction expense. This makes microtransactions, frequent updates, and complex smart contract interactions economically viable, opening up new business models for institutions and individual users alike. Costs can be reduced by 90% or more compared to L1, making transactions affordable for a wider range of activities (yellow.com).
Improved Transaction Speed and Finality: L2s provide faster transaction confirmations. On Optimistic Rollups, transactions are confirmed almost instantly on the L2, though L1 finality requires waiting for the challenge period. zk-Rollups offer instant L1 finality once the validity proof is verified, providing a high degree of confidence and speed crucial for time-sensitive financial operations like trading and settlement. This reduces latency and improves the overall responsiveness of dApps, enhancing user experience.
Inherited Security and Decentralization from Ethereum L1: A cornerstone advantage of rollups is their direct inheritance of Ethereum’s security. User funds are secured by the L1 consensus mechanism, meaning that even if an L2 experiences a security breach or operator malfunction, funds can generally be recovered by interacting directly with the L1 rollup smart contract. This provides a robust security foundation that is highly attractive to institutions, as it leverages the proven security of a global, decentralized network rather than relying on a separate, potentially less secure, validator set.
Innovation and Ecosystem Growth: By removing the bottleneck of L1 scalability, L2s foster an explosion of innovation. Developers can build more complex, resource-intensive dApps that were previously infeasible due to cost or speed constraints. This enables the creation of novel financial products, sophisticated gaming ecosystems, and advanced enterprise solutions, driving the overall growth and utility of the Ethereum ecosystem.
EVM Compatibility and Developer Experience: Most prominent L2s are designed to be highly compatible with the Ethereum Virtual Machine (EVM). This ‘EVM equivalence’ or ‘EVM compatibility’ allows developers to seamlessly migrate existing smart contracts and dApps from L1 to L2s with minimal or no code changes. This reduces development costs, accelerates deployment, and leverages the vast existing developer toolset and talent pool of Ethereum, making L2s a natural extension for institutions already building on or considering Ethereum.

Many thanks to our sponsor Panxora who helped us prepare this research report.

6.2 Challenges in Detail

Complexity and Integration: Implementing and integrating L2 solutions requires a deep understanding of complex blockchain architectures, cryptographic proofs, and smart contract interactions. For institutions, this means investing in specialized technical expertise, navigating potentially nascent L2 documentation, and performing rigorous security audits. The integration process can be complex, requiring adjustments to existing financial workflows and compliance systems, which can be a significant barrier for entities accustomed to established, centralized systems.
Interoperability and Fragmented Liquidity: The proliferation of multiple L2 solutions (Arbitrum, Optimism, zkSync, StarkNet, Polygon zkEVM, Base, etc.) leads to a fragmented ecosystem. Moving assets and data between different L2s, or between an L2 and L1, requires bridging mechanisms. These bridges can be slow, costly, and in some cases, present security risks (as evidenced by several high-profile bridge hacks). This fragmentation also leads to splintered liquidity across various L2s, making it challenging for institutions to deploy capital efficiently across the entire Ethereum ecosystem and potentially hindering atomic composability between different protocols deployed on different L2s.
Security Risks and Centralization Concerns: While L2s inherit L1 security, vulnerabilities can exist within the L2 protocols themselves. Bugs in smart contracts, flaws in fraud proof mechanisms, or vulnerabilities in specific rollup implementations could expose user funds. Additionally, many L2s, especially in their early stages, rely on centralized sequencers or operators to order and batch transactions. This introduces a potential single point of failure, censorship risk, or downtime risk, which is a major concern for institutions demanding high uptime and censorship resistance. Efforts to decentralize sequencers are ongoing but remain a critical area of development.
User Experience and Onboarding: For new users, navigating the L1-L2 ecosystem can be confusing. Bridging funds, understanding gas fees on different layers, and managing assets across various networks add complexity. While strides are being made in user interfaces and wallet integrations, the friction remains higher than centralized alternatives, which can deter broad institutional and retail adoption.
Data Availability and Monitoring (Specific to Rollups): While rollups post transaction data to L1 calldata, ensuring this data is always available for fraud proofs (Optimistic) or state reconstruction (all rollups) is critical. For some designs, this can be a nuanced technical challenge, especially if the data is only available from specific entities for a limited time. Users or auditors must monitor the L2 to detect malicious activity, which adds a burden.
Regulatory Uncertainty: The regulatory landscape for L2s is still evolving. Regulators are grappling with how to classify and oversee these technologies, especially when they interact with traditional financial instruments or services. This lack of clear regulatory frameworks can create uncertainty and hesitation for institutions, who prioritize legal and compliance clarity before committing significant resources to new technologies.
Economic Sustainability of L2 Operators: The long-term economic model for L2 operators (sequencers, provers) needs to be sustainable. While they earn fees, the operational costs of running these sophisticated systems can be high. Ensuring a robust, competitive, and decentralized operator ecosystem is crucial for the long-term health and decentralization of L2s.

7. Future Outlook and Evolution of Ethereum Scaling

The trajectory of Ethereum’s scalability through L2 solutions is set to fundamentally reshape the blockchain landscape, accelerating its adoption across diverse sectors, particularly within institutional finance. The evolution of both Ethereum’s base layer and the L2 ecosystem itself will drive unprecedented efficiency and functionality.

Many thanks to our sponsor Panxora who helped us prepare this research report.

Ethereum’s L1 Evolution: Post-Merge and Data Availability

Ethereum’s foundational layer has already undergone a momentous transformation with the successful ‘Merge’ in September 2022, transitioning from Proof-of-Work (PoW) to Proof-of-Stake (PoS). This upgrade, now known as the consensus layer, significantly reduced Ethereum’s energy consumption and laid the groundwork for future scalability enhancements. While the Merge itself did not directly increase L1 throughput, it was a prerequisite for subsequent upgrades focused on data availability and sharding.

Proto-Danksharding (EIP-4844): A critical upcoming upgrade, Proto-Danksharding, slated for implementation in early 2024 (as part of the Dencun upgrade), introduces ‘data blobs’ (or ‘proto-shards’) to Ethereum blocks. These blobs provide a temporary, cheaper space for L2s to post transaction data. Unlike traditional calldata, blob data is not permanently stored on the execution layer, significantly reducing the cost for rollups to publish their transaction data to L1. This will directly translate into even lower transaction fees on L2s, making them vastly more cost-effective and competitive. EIP-4844 is specifically designed to reduce L2 transaction costs by making data availability cheaper, effectively serving as a ‘data availability layer’ for rollups.
Full Danksharding: Beyond EIP-4844, the long-term vision for Ethereum involves ‘Danksharding,’ which will dramatically increase the amount of data space available for blobs. This will enable truly massive throughput for L2s, potentially scaling the entire Ethereum ecosystem to hundreds of thousands or even millions of TPS. Danksharding will decentralize data availability further, enhancing the security and robustness of the entire L2 ecosystem.

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Advancements in L2 Technologies

zk-Rollup Maturation and Dominance: Zero-Knowledge Rollups are widely considered the long-term scaling solution due to their superior security model (validity proofs leading to instant L1 finality) and greater theoretical scalability. Ongoing research and development are rapidly improving zk-EVM compatibility, reducing proof generation costs and times, and making these complex technologies more accessible to developers. As zk-Rollups mature, they are expected to become the dominant L2 paradigm, offering enterprise-grade speed and security.
Decentralized Sequencers: The current reliance on centralized sequencers in many L2s is a temporary measure that introduces centralization risks (e.g., censorship, single point of failure). The future will see the implementation of decentralized sequencer networks, using various consensus mechanisms (e.g., PoS, DPoS) to ensure L2s are as censorship-resistant and robust as the L1, significantly enhancing their appeal to institutions.
Layer 3 Solutions (L3s): Building on the success of L2s, the concept of Layer 3s is emerging. L3s can be purpose-built, application-specific rollups designed for specific use cases (e.g., gaming, social media, enterprise supply chains), potentially offering even greater scalability or specialized features (like enhanced privacy or custom consensus mechanisms) while settling on an L2, which in turn settles on L1. This creates a fractal scaling architecture, allowing for hyper-specialized and efficient applications.
Cross-L2 Communication Protocols: As the L2 landscape becomes more diverse, seamless and secure communication between different L2s (and L1) is crucial. Advancements in native bridging protocols, shared state layers, and interoperability standards will aim to overcome liquidity fragmentation and enable atomic composability across the entire multi-rollup ecosystem, fostering a more unified user and developer experience.

Many thanks to our sponsor Panxora who helped us prepare this research report.

Convergence with Traditional Finance and Broader Adoption

The trajectory set by JPMorgan’s JPM Coin migration indicates a clear path toward deeper integration between public blockchain infrastructure and traditional finance (TradFi). This trend will only accelerate as L2s provide the necessary performance and cost efficiencies.

Tokenization of Real-World Assets (RWAs): The tokenization of various financial assets—from stocks and bonds to real estate and commodities—on L2s will become a significant growth area. L2s provide the infrastructure for fractional ownership, instant settlement, and enhanced liquidity for these assets, attracting institutional capital and unlocking new market efficiencies.
Institutional DeFi on L2s: Specialized, compliant DeFi protocols built on L2s will cater to institutional needs, offering regulated access to decentralized lending, borrowing, and trading platforms, complete with KYC/AML functionalities.
Enterprise Solutions: Beyond finance, L2s will power enterprise solutions in supply chain management, data provenance, intellectual property rights, and other areas requiring high transaction throughput and data integrity.

As these technologies mature and regulatory frameworks become clearer, they are poised to drive broader, more impactful adoption of Ethereum for a vast array of applications, cementing its role as the global settlement layer for the digital economy.

8. Conclusion

Layer-2 scaling solutions represent not merely an incremental improvement but a critical, foundational advancement in addressing Ethereum’s inherent scalability challenges. By intelligently offloading transaction processing from the congested Layer-1 while rigorously upholding its unparalleled security and decentralization, L2s have fundamentally transformed Ethereum’s capacity to support high-volume, cost-efficient, and secure transactions. This architectural innovation has been instrumental in unlocking Ethereum’s full potential, particularly for the demanding operational requirements of institutional use cases that were previously unattainable on the mainnet alone.

The strategic migration of JPMorgan’s JPM Coin to Coinbase’s Base network stands as a landmark testament to the practical viability and burgeoning acceptance of L2 solutions within mainstream finance. This move by a global financial titan signals a profound shift, demonstrating how L2s can bridge the gap between traditional banking infrastructure and the efficiencies of public blockchain technology, facilitating near-instantaneous, 24/7 wholesale payments with the security assurances derived from Ethereum’s base layer. This example, alongside the broader trend of financial institutions exploring tokenized assets and compliant DeFi protocols on L2s, underscores a clear trajectory towards deeper integration of digital assets into the global financial system.

While challenges persist—including technical complexity, interoperability hurdles, and the ongoing need to decentralize core L2 components like sequencers—the rapid pace of innovation is continuously addressing these concerns. Future developments on Ethereum’s Layer-1, such as Proto-Danksharding (EIP-4844) and full Danksharding, promise to further reduce L2 costs and dramatically increase data availability, creating an even more robust and scalable foundation. Simultaneously, the maturation of Zero-Knowledge Rollups, advancements in zk-EVM technology, and the emergence of Layer 3 solutions are set to redefine the boundaries of what is possible on decentralized networks.

In essence, L2 solutions are playing a pivotal, indispensable role in unlocking the full potential of blockchain technology for a diverse and ever-expanding array of applications. They are not just scaling Ethereum; they are evolving it into a multi-layered, high-performance ecosystem capable of serving as the global, programmable settlement layer for the digital economy, thereby ensuring its enduring relevance and transformative impact well into the future.