Investing in L2 VS Investing in ETH: Which has a brighter future?

Author: James Ho

Compiled by: Deep Wave TechFlow

Investing in L2 vs ETH

Layer 2 (L2) solutions on Ethereum have made significant progress over the past few years. Currently, the total locked volume (TVL) of Ethereum L2 exceeds $40 billion, compared with only $10 billion a year ago. On @l2beat, you will find more than 50 L2 projects, but the top 5-10 projects account for more than 90% of the TVL.

After the implementation of the EIP-4844 proposal, transaction fees have been significantly reduced, and transaction fees on platforms such as Base and Arbitrum are even less than $0.01.

Despite L2’s huge advancements in technology and usage, the L2 token has generally performed poorly as a liquid investment ( Although as venture capital investments they perform very well). You can find many jokes and jokes about the L2 token’s poor performance relative to ETH.

We reviewed the valuation of major L2 relative to ETH. One notable observation is: Although the number of L2s listed has increased, their total fully diluted valuation (FDV) as a proportion of ETH has remained the same.

Two years ago, the only listed L2s were Optimism and Polygon, whose FDV accounted for 8% of ETH. Today, we have L2 projects such as Arbitrum, Starkware, zkSync, etc., and their FDV accounts for 9% of ETH.

Every time a new L2 token is listed, it actually dilutes the valuation of the previously listed L2 token.

The result of investing in L2 tokens is significant underperformance relative to ETH. Returns over the past 12 months are as follows:

• ETH: +105%

• OP: +77%

• MATIC: -3%

• ARB: -12%

The FDV of major L2 tokens has long been around $10 billion. To a certain extent, this is quite arbitrary, and market participants do not have a strong reason for why it is $1 billion and not $2 billion or $300 million. Ultimately, there is significant supply pressure due to demand liquidity and/or massive unlocks.

The above-mentioned L2 generates monthly expenses of US$20 million to US$30 million. Since the implementation of EIP-4844, costs have dropped to $3 million to $4 million per month, with annualized costs of approximately $40 million to $50 million.

Includes: ptimism, arbitrum, polygon, starkware, zksync

Currently, the main L2 generation The total FDV of the currency is approximately US$40 billion, the annualized fee is US$40 million, and the valuation multiple is approximately 1,000 times.

This is in stark contrast to large DeFi protocols, which typically trade at valuation multiples between 15-60x (based on last month’s annualized fees):

• DYDX: 60 times

• SNX: 50 times

• PENDLE: 50 times

• LDO: 40 times

• AAVE: 20 times

• MKR: 15 times

• ##GMX: 15 times

As more L2 projects come to market, the FDV of L2 tokens may continue to come under pressure and dilution. There is too much supply in the market and liquid markets cannot easily support it.

Conclusion

1. # In the long run, L2 may generate significant fee income.

   L2 generates $150 million in annual fees (including Base, Blast, Scroll), and this number is likely to grow significantly as L2 activity increases.

2. The above is not specific to L2 projects, but rather a broad observation of the entire category.

   It seems difficult to buy a basket of L2 tokens with ~$40 billion FDV and ~$40 million in fees (1000x) and expect them to outperform ETH in the long term.

3. Clearly, there is no shortage of block space between L2, high-throughput chains (such as Solana, Sui, Aptos, etc.).

   The limiting factor lies in the applications that use these block spaces. I hope that more focus will be placed on the application layer in the future, and that the liquidity market will reward the application layer over the infrastructure layer in the next few years.

4. In the last cycle, it was more common for projects to be launched significantly ahead of schedule.

   MATIC was listed on the liquid market with an FDV of less than $50 million and has now exceeded $5 billion, an increase of more than 100 times. However, this has not been the case recently with $OP, $ARB, $STRK, $ZK, and most other L2 tokens that may eventually be listed.

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