May 26, 2021 · 6 min read
Deep dive into Polygon | Ethereum off-chain scaling solutions
Two weeks ago, we looked at ‘Ethereum Killer’ blockchains that have risen to prominence tackling Ethereum’s deep seated scalability issue. Vast numbers of users participating in DeFi transacting via Ethereum, has led to network congestion and rising gas fees.
This week, we look at what initiatives are taking place on the Ethereum blockchain itself to address the scalability issue. We focus on off-chain scaling solutions, or layer 2 solutions. We briefly go over different types of layer 2 solutions - rollups, sidechains, plasma state channels and validium. We will also take a deep dive into Polygon, the project that has established an extensive DeFi ecosystem.
Below we look at different types of Ethereum off-chain scaling solutions.
Rollups process transactions outside of layer 2, but post the finalized transaction data to layer 1. This means that rollup solutions derive the security from the Ethereum main chain. There are two types of rollups based on how they validate the transaction. Zero-Knowledge rollups (ZK rollups) use validity proofs. Here, transactions are computed off-chain and get bundled up to be posted to layer 1 with a validity proof. Similar to ZK rollups, Validium uses validity proofs, but does not post transaction data onto Ethereum layer 1. Optimistic rollups use fraud proofs. In this model, transactions are assumed to be valid by default, rolled up to be supplied to the main chain. Computations are run only when fraud is suspected.
Established DeFi protocols are working with rollups. Aave, Balancer and 1inch are exploring integrations with Zksync. Chainlink, Synthetix and Maker are working with Optimism. Dydx and Diversifi use Starkware’s roll-up solution.
State channels are created by locking a portion of blockchain state into a multisig contract which requires multiple signatures, or keys, to authorize a transaction. Then, the participants communicate quickly off-chain. Only the final transaction is broadcasted to the Ethereum main chain. This model is suitable for transactions that require a lot of state updates.
Sidechains run independently from Ethereum and have their own consensus mechanisms. The most established sidechain project is xDai. xDai created a healthy partnership ecosystem with DeFi projects on xDai spanning from an oracle Chainlink, decentralized derivatives exchange Perpetual Protocol, AMM DEX Sushiswap, yield protocol Akropolis, lending platform Unit Protocol and more.
Plasma could be seen as small copies of the Ethereum mainnet. Plasma chains can be created limitlessly using Merkle trees. In the following section, we delve into the most developed Plasma solution in the DeFi space, Polygon.
Before we move onto Polygon, we compare the Transactions Per Second (TPS) of different scaling projects below.
As shown above, Polygon’s 65000 TPS is 4000 times faster than Ethereum’s 15. Matter Labs, the team behind zkSync, is launching zkPorter with off-chain data availability that can process 20000 TPS. The expected launch date is August 2021.
Project Spotlight 💡
Polygon is a layer-2 scaling solution with side-chains for off-chain computational work while simultaneously obtaining asset security via the framework of Plasma along with a decentralized network of PoS validators. The project promises to offer scalable and rapid blockchain transactions at a minimal cost. By harnessing an adapted form of the Plasma framework, Polygon operates on PoS (Proof-of-Stake) checkpoints that are directly forwarded to Ethereum L1. Blocks developed or created by these producers are tethered to the checkpointing mechanism through the merkle block. This of course being the hash of all hashes, the Merkle root. It is here where the PoS validators approve random groups of blocks that are produced.
Polygon has created a favourable, multi-layered, decentralised ecosystem (shown below) with an impressive backing and performance in the market thus far. Below we map out Polygon’s DeFi ecosystem.
There is currently $5 billion locked in the protocols using Polygon. This number might look minuscule compared to Ethereum’s $61 billion, but Polygon is expanding at a faster pace than Ethereum. Polygon has shown a seven-fold increase in TVL over the past month, while that of Ethereum’s increased by 11%. Ethereum’s TVL had been hit hard by the recent crypto sell off, having lost more than 40% of its value in between 12nd and 24th of May.
The DeFi protocols that contribute the most to the Polygon blockchain are Aave, Quickswap and Sushiswap. DeFi lending giant Aave landed on Polygon in April. Since then, of its $16.6 billion TVL, $5.9 billion belongs to Aave Polygon already.
Now let’s have a look at Polygon’s native token MATIC. MATIC has shown a rapid growth over the past 30 day period with a 340% price increase. There has been a massive sell off movement in the broader crypto markets and MATIC was no exception. MATIC fell from $2.56 to $0.82 between 19th and 24th of May. MATIC is now trading around $1.60.
MATIC is also often featured in Momentum Pairs, our proprietary tool that tracks best liquidity pairs on Uniswap. The largest pool for MATIC on Uniswap V3 is MATIC-WETH with a 0.3% fee. The pool has added $3.6 million in liquidity in the past 24 hours, up 106%. The pool has $7.05 million in liquidity at the time of writing. The pool has generated $68K in fees in the past 24 hours, dividing that by the total liquidity gives 0.96% of 24h fees (this means fees average, so some will make NOTHING and others will be making a lot more).
MATIC is also traded frequently on Quickswap, a fork of Uniswap on Polygon itself. WMATIC-WETH pool on Quickswap boasts $111.4 million in liquidity, up 16% in the last 24 hours. Applying the same calculation used above, WMATIC-WETH pool on Quickswap gives 0.24% of 24h fees.
The Ethereum network has been facing some serious contenders such as Binance Smart Chain, Solana, and Polkadot eating up its pie. Keeping up with the trend, layer 2 scaling solutions sprang up, with Polygon leading the market. 1inch on Polygon facilitated $43 million in swaps with only $25 of gas. Since Aave’s launch on Polygon last month, only $158 has been spent on gas. It is early days of implementing the layer 2 solutions and it is expected that layer 2 solutions bring a dramatic change in the Ethereum ecosystem, and are well positioned to take the lead in the DeFi space leveraging the most established protocols on Ethereum.