Chainalysis Report: New Layer 1 Blockchains Are Expanding The DeFi Ecosystem
The second phase of the Chainalysis report reveals that new Layer 1 blockchains perceived to solve Ethereum’s problems have been billed as “eth killers” primed to replace the second-most popular cryptocurrency as the go-to for web3 and DeFi, but so far, none have been able to do it.
Nearly all cryptocurrency tokens fall into one of two categories: Layer 1s and Layer 2s. Layer 1s are tokens with their own blockchains, while Layer 2s are built on top of Layer 1 blockchains, usually through smart contract technology. Layer 2s can be new tokens, or more complex projects known as decentralized apps, or dApps. However, there are also Layer 2 projects that don’t utilize smart contracts, such as Bitcoin’s Lightning Network, which is designed to facilitate faster and cheaper Bitcoin payments through transaction batching.
Different Layer 1 blockchains are designed and optimized for different goals. Bitcoin is designed to be a currency for simple, trustless transactions with enforced scarcity to preserve its value. However, its relatively simple structure limits what can be built on top of it. Ethereum was the first mainstream blockchain to incorporate smart contracts, and it hosted the first wave of dApps and tokens that ushered in DeFi and web3.
But, while Ethereum has become the most prominent blockchain for Layer 2 project development, its Proof of Work (PoW) mining system and high gas fees have proven an impediment to transaction speed and scalability within its DeFi ecosystem. Many, if not most, of the smart contract-enabled Layer 1 blockchains developed since were created to address those problems. Solana and Algorand, for instance, leverage a Proof of History (PoH) and Proof of Stake (PoS) consensus mechanism, respectively, in order to provide lower fees and faster transaction times. Other Layer 1 blockchains, such as Avalanche, are built more for interoperability with other chains. We’ll explore each Layer 1 chain’s unique goals and characteristics in more detail later in the section.
Comparing Layer 1s: Bitcoin vs. Ethereum vs. Algorand
Using blockchain analysis, we can compare three prominent L1s — Bitcoin, Ethereum, and Algorand — to see how their usage trends differ.
Bitcoin appears to have led in unique users until March 2020, at which point it was overtaken by Ethereum. This coincides roughly with DeFi growth, which makes sense, as the rise of DeFi fostered the creation of many services that accept Ethereum and other tokens built on its blockchain. Algorand, on the other hand, has yet to achieve comparable adoption, with a one-week high in active wallets of 103,000, compared to 1.7 million for Ethereum and 916,000 for Bitcoin.
Investor profiles
We can approximate the types of investors who tend to use each of the three coins based on transaction sizes. We categorize transactions the following way:
- Small retail (<$1K)
- Large retail ($1K$10K)
- Professional ($10K$1M)
- Institutional ($1M$10M)
- Large institutional (>$10M)
Below, we can see the share of total transaction volume by transaction size for the three currencies.
Ethereum stands out as the cryptocurrency with the most institutional dominance. 40% of its total transaction volume comes from large institutional transactions, compared to just 30% for Bitcoin and 29% for Algorand. If we group institutional-sized transactions with large institutions, that figure becomes 66% for Ethereum and 64% for Bitcoin. Algorand, on the other hand, sees just 49% of transaction volume made up of institutional and large institutional transactions. On the other end of the spectrum, 10% of Algorand’s transaction volume comes from retail or large retail transactions, compared to 5% for Bitcoin and 8% for Ethereum. Again, this likely reflects Algorand’s status as a relatively new blockchain. It may also signify that Algorand is succeeding in its goal of enabling a high volume of smaller transactions.
The problem with Ethereum
Ethereum, however, isn’t perfect despite these successes. Due to its PoW consensus mechanism, Ethereum can only handle roughly 15 transactions per second, compared to 1500 for non-cryptocurrency solutions such as the Visa network. Gas fees, which act as another source of compensation for miners and as a mechanism for preventing an overload of transactions, also harm Ethereum’s scalability. This is especially true for smaller transactions.
What’s next for Layer 1s?
Several new Layer 1 blockchains have emerged to stake out their own place in the growing web3 ecosystem, largely driven by a demand to address Ethereum’s problems with scalability, speed, and fees. While many of them have attracted substantial investment and user bases, questions remain.
For instance, will any of them surpass Ethereum in adoption? Many new Layer 1 blockchains perceived to solve Ethereum’s problems have been billed as “eth killers” primed to replace the second-most popular cryptocurrency as the go-to for web3 and DeFi, but so far, none have been able to do it. Ethereum is still far ahead in transaction volume, especially in popular areas of web3 like NFTs, and the Ethereum Foundation is working with miners to implement changes to address its issues, such as its upcoming switch to a PoS consensus mechanism. If its entrenched status as the number two blockchain behind Bitcoin is already allowing Ethereum to fend off competitors, it seems especially unlikely that another smart contract-enabled blockchain will challenge it should those issues be solved.
