Investing in L2 VS Investing in ETH: Which strategy is more profitable?

Written by: James Ho

Compiled by: Deep Wave TechFlow

Investment in L2 vs ETH

In the past few years, Layer 2 (L2) solutions on Ethereum Significant progress has been made. Ethereum L2 currently has more than $40 billion in total locked volume (TVL), up from just $10 billion a year ago. On @l2beat you will find over 50 L2 projects, but the top 5-10 projects account for over 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 advances in technology and usage, L2 tokens have generally performed poorly as a liquid investment (although as a venture capital investment, they Outstanding). You can find many jokes and jokes about the L2 token’s poor performance relative to ETH.

We review the primary L2 valuation situation relative to ETH. One notable observation is this: while 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 L2s listed were Optimism and Polygon, whose FDV accounted for 8% of ETH. Today, we have L2 projects like Arbitrum, Starkware, zkSync, etc. whose FDV accounts for 9% of ETH.

Every new L2 token that is listed 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 rationale 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 unlocking.

The aforementioned L2 generates $20 million to $30 million in monthly fees. Since the implementation of EIP-4844, costs have dropped to $3 million to $4 million per month, for an annualized cost of approximately $40 million to $50 million.

Includes: ptimism, arbitrum, polygon, starkware, zksync

Currently, the total FDV of major L2 tokens is approximately US$40 billion, annualized The 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 : 15x
• GMX: 15x

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

Conclusion

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.

The above is not specific to L2 projects, but rather a broad observation of the category as a whole. It seems difficult to buy a basket of L2 tokens with ~$40B FDV and ~$40M in fees (1000x) and expect them to outperform ETH in the long term.

Apparently, there is no shortage of block space between L2, high-throughput chains (such as Solana, Sui, Aptos, etc.). The limiting factor is 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.

In the last cycle, it was more common for projects to be listed significantly ahead of schedule. MATIC was listed on the liquid market with an FDV of less than $50 million and is now over $5 billion, a growth of over 100x. 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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