IOSG founder: Layer 2 competition in the eyes of investors, ecological growth dilemma and solution

IOSG Ventures

2023-11-03 10:29

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Original source: Jocy, founder of IOSG

L2 summer or dilemma?

I recently heard several friends who work in speculative studios complain to me that many studios have invested huge resources and transaction flows in zkSync and Linea in the past, but in the end they found that they had nothing to show for it. Instead, they helped several major L2s to contribute tens of millions of dollars in transaction fees. Therefore, when these studios saw the new L2 go online, they began to be less active in creating transactions.

We originally expected a prosperous L2 Summer that did not require studios, but now we find that as the studios gradually fade out, the transaction volume and TVL of several major zkEVMs have not met expectations. When speculators on the market no longer participate in L2 and no longer create vitality and vitality for the ecosystem, the dilemma of weak growth and shrinking ecosystem emerges.

L2 competition in the eyes of investors

From the perspective of investors, the investment logic of deploying L2 infrastructure is that we believe that these teams will launch ecological competition in different dimensions with sufficient capital support, and encourage the flourishing of applications within the ecosystem. However, most of the current L2 arms races do not focus on ecological construction, and still spend a lot of money on high-priced recruitment of ZK and technical experts from PSE (of course, from a strategic point of view, L2's investment in technology research and development and talent competition is understandable), but I think that high-concurrency compatible Rollup without applications has little value and will only be castles in the air.

L2 Ecosystem Growth Dilemma

Waiting for the natural growth of the ecosystem will be a long process. If this arms race cannot help Ethereum usher in the blowout growth of the application ecosystem, and it is still over-investing and repeatedly investing in share sequencers/Bytecode underlying design/and other underlying technologies, then we will not be able to see the emergence of a prosperous ecosystem.

At present, the competition in L2 ecological applications is very fierce. If an application is bound to an L2 chain, it will be extremely difficult to obtain the support of other L2s. The application dare not easily migrate to other L2 chains at this stage, because once migrated, it will mean that it will be more difficult for them to get the Grant of the original bound L2.

Therefore, choosing the right partner has become a difficult problem that applications need to face. For this reason, each L2 wants to have an exclusive application, and then the application will have a separatist war in different L2s. Of course, after the application becomes larger, there will be application chains or multi-L2 deployments. The problem lies here with L2. When they can't figure out whether the application will stay in their own L2 in the future, they don't want to invest too much for the time being.

We often see that some L2 applications that have not grown up cannot get Grants or incentives on some L2s, which leads them to wander around different L2s to seek financial support to survive. So which L2s have not yet made their own ecological Grant plans public?

Solution 1: Head L2 projects take the initiative to take on the responsibility of ecological construction

Of course, we don’t want to see the situation where L2 stands on its own, which has caused the relative fragmentation of the Ethereum ecosystem. Perhaps this is a product of the competitive market, but in our opinion, it is necessary for the entire L2 ecosystem to incubate and support the emergence of more diversified application products with the help of the L2 application combination solution, and finally to have applications that are bound and of a certain scale.

Unicorn companies with a value of more than one billion US dollars should fully shoulder the responsibility of ecological construction, which is very important. There are many ways to build an ecosystem. For example, Starkware and Optimisim have focused on supporting Dojo and Mud engines in FOG games. Arbitrum Grant incentives have done a great job in supporting ecosystem investment. In a short period of time, the transaction scale and user experience of GMX exclusively launched by Arbitrum are comparable to dydx, and they have also co-invested with IOSG in TreasureDAO's game platform (known as 4399 on the chain). Optimism and Coinbase launched the Base chain based on Opstack, and the Base chain can produce phenomenal applications such as http://Friend.tech. In less than two months, the protocol revenue has exceeded 20 million US dollars, and the TVL is as high as 20m. The above...

What they do is very simple. They attract developers within the ecosystem based on the network effect, and use various methods of protocol tokens to incentivize more diversified innovation and investment. Of course, I recently discussed with some zkEVM L2s that many founding teams believe that giving airdrops and incentive expectations, including how to internally support ecological projects, cannot encourage innovation. They prefer to let things take their own course and let projects within the ecosystem compete naturally. At this level, I believe that if we do not invest heavily in funds and tokens to build the ecosystem, more aggressive strategies will create advantages in future market capacity and positioning, and platforms that do not implement a certain level of investment will also encounter development bottlenecks.

Solution 2: Competition should focus on the art of alliance

In theory, L2 competition is different from L1. Ethereum emphasizes equal rights and open cooperation. Everyone has different technical routes and challenges different technical implementation difficulties. All expansion protocols are helping Ethereum build a stronger network effect.

After Ethereum transitioned from the ETH2.0 roadmap to Rollup, the ecological technology task fell on L2. The industry's prospects lie in super applications and large-scale users. Capital always executes Ethereum's roadmap at the first time. Should L2, which has received capital support, launch an arms race based on ecological application construction? With a valuation of tens of billions of dollars and a capital investment of more than 5 billion US dollars, how should it be transmitted to the downstream of the industry's user-oriented application innovation?

I think that in addition to allowing capital to continue to invest heavily and support the application ecosystem, zkEVM represents the hope of the industry's innovation power, and should shoulder the industry's mission to reposition the development plan of the ecosystem. L2 should learn from DeFi Lego. Entrepreneurs and developers should not just repeatedly build similar technical service stacks, but should explore different ideas to generate more new perspectives and directions, and try more creativity and possibilities. In some open source technology protocols and directions, the same standard should be used as much as possible to reduce the repeated waste of resource investment. In terms of competition, a kind of vertical and horizontal alliance should be emphasized, and more financial resources should be deployed in breakthrough applications. In the pioneering application track, at all costs, we should strive to support applications like GMX/Friend.tech on each platform.

The end of the ecosystem with a hundred flowers blooming- L3 and application chains begin to grow

The industry is currently in a staged and tortuous innovation process. We have witnessed too many sighing moments in the bear market. Many founders who started their first business encountered various difficulties. To get out of the predicament, L2 project founders need to truly understand their importance in the industry. In such a difficult time, we should not only consider competition, but should have more cooperation to encourage and support the flourishing of the Ethereum ecosystem.

Mainstream VC and L2 projects can do some construction for the developer environment and developer ecology. The industry should dare to support some projects that do not list coins, but the key is to provide values to other projects, build up the open source community, build up the developer experience, build up the application front end, and build up developer Education Training. I firmly believe that L2 Summer based on the outbreak of applications can lead us out of the bear market!

After dydx chose to leave Starkware, they decided to deploy application chains on Cosmos. More and more application projects began to break away from the mainstream L2 and rebuild their own valuation logic and product architecture for infra+ applications. At the same time, we saw the large-scale emergence of Rollup as a Service projects such as Conduit/Caldera/Gelato based on opStack deployment, and increased support for game and application ecosystems.

For example, Caldera helps protocols and games build small temporary functions. Each function takes 2 to 5 engineering days, providing high-touch and tailored application functions (monthly and functional payment options), and Gelato helps Astar complete the issuance of zkEVM on the Polygon chain, and charges monthly according to Raas. There are also emerging projects such as Arbitrum Orbit/Risc0/Nil foundation, etc., which are competing and building ecological protocols under this new Raas pattern.

In the past year, IOSG's investment strategy has reduced the proportion of infra investment from 80% to the current 60%, and the proportion of investment in application has also increased to more than 40%. We are very optimistic about the innovation of Asian teams in tracks such as product user interaction/AI-driven applications/social games. We will also support these application teams to cooperate with various L2s to obtain broader ecological support.

This article only represents personal opinions and does not constitute any investment advice. Thanks to Jiawei/Weikeng for their modification suggestions. Based on the disclosure of relevant interests, IOSG is currently an investor in most L2 protocols (including but not limited to Arbitrum/Optimisim/Starkware/zkSync/Aztec/Scroll/Risc0/Linea/Taiko, etc.).