Governance Decides Where Ethereum Transacts: The L2 Governanceย Race

This article is written by @m0xandrew in collaboration with @contentguildxyz.

State of Layer 2โ€™s

The leading rollups, Arbitrum and Optimism, are fairly undifferentiated. EVM equivalence abstracts away many differences by design. This means transactions generally look the same for users between both. There are areas where they can distinguish themselves though. Effective governance will be the biggest factor. It is the vehicle for making critical decisions that impact how the L2s grow. This understanding will be important for competitors, investors, users, and builders that need to know the viability and expected growth of the top rollups, particularly in comparison to each other.

L2 Power Structures

Governance will impact growth and market share in three ways. First, leadership will pick investments. The leadership structure will fully determine the next two factors: investments in technology and investments in marketing. These investments will create the developer and user experience, the most important goals for a growing rollup. The chain with the best governance will draw the largest user base by having the best user experience and richest app ecosystem.

The ability to allocate the right amount of investments to the right projects is the sole lever under networks' control to influence their growth. Networks do not make decisions autonomously, though. They rely on their leadership to make these choices. This means leadership and governance are the most important factors in understanding Arbitrum and Optimism's trajectories. There are subfactors that are both under their control and not. Arbitrum and Optimism can no longer choose their ownership. This was decided by their governance token distribution and will develop based on investor demand. Special councils and houses may offer the promise of separation of powers and checks and balances, but are currently extensions of the existing power dynamic. This said, network owners have the opportunity here for enlightened self-interest in the area they control.

Effective advocacy for meaningful investment in governance structures will prove to be the deciding factor in the L2 race. Better governance structures that have checks and balances and more credibly share power with users will benefit from the trust of the userbase and be in a position to make better decisions for the networkโ€™s future. Every major economy enjoys the benefits of independent bodies like central banks and judiciaries. Leaders must be put in place that have the will and ability to invest in governance research and development. The values of decentralization, representation, and equal opportunity are not just important philosophically, but also economically. Having better leaders and decision-making structures will directly enable leading rollups to grow by more efficiently investing in their technology and marketing.

Investing in Technology

Technological investment will take three forms: developer experience, novel applications, and infrastructural advantages. DevEx will enable more developers to create better applications more quickly. This should be a top goal for any rollup, as they exist to be rails for these experiences. Much of the success of the first PlayStation is attributable to the ease of development on it. More and better games brought more players. More apps will bring rollups more users. Areas for improving developer experience include documentation, integrations with popular developer tools, and, particularly for zk-rollups, EVM equivalence, so developers are not required to know and use anything new for porting or developing.

Relatedly, just as PlayStation expects to sell less consoles without exclusive, first-party content, Arbitrum and Optimism should expect to sell less blockspace if they do not have novel applications. Both have existing structures for investment. Still, the willingness to invest in the breadth and scope of projects must be expanded. Uniswap exists because of a grant from the Ethereum Foundation and Ethereum has benefited from it since. The amount of treasury funds earmarked for this purpose and the lack of any clear killer app arising from this funding shows existing governance structures are insufficiently equipped to foster these opportunities. The network leaders are too conservative and should be given tools to better identify useful, homegrown applications, or should be replaced by new leaders who are able to.

Lastly, core infrastructure upgrades will benefit both users and developers. Network upgrades like Bedrock objectively improved Optimism by improving efficiency, lowering fees, and simplifying the codebase. This drives usage and development. Future developments like L3s, Superchains, and decentralized sequencers will take these improvements further. Zk infrastructure also has the potential to dramatically reshape the rollup landscape. Arbitrum and Optimism are in a position to be able to adopt this technology, but this migration process will test the ability of their governance structures to recognize this and make the appropriate preparations and investments. Each of these technological investments will prove vital to the L2 race moving forward, and will be entirely decided by the strength of leadership and governance of each network.

Investing in Marketing

Marketing investment will also be extremely important. The blockchain space is plagued by solutions in search of problems. Marketing is the channel through which rollups learn who their users are, what they want, and how to communicate their solutions to these people. Marketing offers multiple pathways for differentiation, pulling more users towards a particular network. Optimism, with its Optimistic Vision and Citizensโ€™ House, targets more ideological users than the more hands-off Arbitrum which was earlier to open the network and is more fully controlled by token governance. Understanding the audience of different rollups will enable these networks to identify useful new applications for their technology. An example of this is the since discontinued Arbitrum/Reddit Community Points collaboration. Polygon also generated attention with their similarly limited Starbucks Odyssey partnership. There is evidence exclusivity drives usage on networks. Arbitrum's largest app by TVL and revenue is GMX, which can only also be found on Avalanche. Similarly, Optimism's top two apps by TVL, Synthetix and Velodrome, are Optimism-exclusive.

Finally, marketing can also extend to promotions in the form of discounts. Arbitrum and Optimism would do well to consider gas subsidies and rebates using treasury funds. Optimism currently does this with OP rebates when bridging onto its network using Hop Protocol. These funds can provide another level of incentives for using a particular chain over another. Critically, this would serve as a pro-growth investment where the added usage will beget more usage. Understanding what users are looking for, how to convert that into brands, values, and services, and how to communicate those developments to users will be just as critical to growing rollups as underlying technology. This responsibility is put to the leaders of the networks. This critical responsibility, further highlights the importance of effective governance in producing high-quality outcomes for networks.

Governance is the Key

Ultimately, the single largest factor that networks can control in influencing their own growth is improving the quality of their governance structures. This will lead to quality, balanced leadership that will make sufficiently large investments targeted at the right projects in service of the right goals. Leaders must pay special attention to investments in technology and marketing. Delivering on espoused values like decentralization will lead to substantial growth and financially benefit the investor-owners of these platforms. Failing to do so, however, will create openings for competitors that are willing and able to replace them.


This article is written by @m0xandrew in collaboration with @contentguildxyz.

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