In this week’s edition of ‘The Cortex Connection,’ we dig into the Arbitrum network, highlight its benefits and challenges, how it compares to other Layer 2 (L2) solutions, and look at some of the projects that are building and migrating to it.
What is Arbitrum?
Launched in May 2021 by Offchain Labs, a New York-based development company founded by former Princeton University researchers Ed Felten, Steven Goldfeder, and Harry Kalodner, Arbitrum is an L2 scaling solution for Ethereum that aims to provide fast, secure, and low-cost transactions. They embarked on this project to solve the problem of Ethereum’s congestion and high transaction costs using a technique called Optimistic Rollup, which allows transactions to be executed on a sidechain and periodically submitted to the main Ethereum chain. This reduces the congestion and fees on the main chain, while still inheriting its security and decentralization.
How Arbitrum Works
Arbitrum is based on the idea of Optimistic Rollup, which is a type of L2 scaling solution that relies on fraud proofs. Fraud proofs are a way of ensuring that the transactions on the sidechain are valid and consistent with the main chain (Ethereum). If someone tries to submit an invalid transaction or state update to the main chain, anyone can challenge it by providing ‘proof’ that it is fraudulent. The challenger and the submitter then enter a dispute resolution process, where an arbitrator (in this case, Arbitrum— get it?) verifies the validity of the transaction or state update. If the challenge is successful, the submitter loses their stake and pays a penalty to the challenger. If the challenge is unsuccessful, the challenger loses their stake and pays a penalty to the submitter.
Source: Finematics
This process ensures that only valid transactions and state updates are finalized on the main chain, while invalid ones are reverted. However, this process also introduces a delay between when a transaction is executed on the sidechain and when it is confirmed on the main chain. This delay is called the ‘challenge period’, and it can vary depending on the network conditions and the security parameters. Arbitrum claims that its challenge period can be as low as 10 minutes, which is much faster than other optimistic rollup solutions.
At inception, Arbitrum used a technique called ‘virtual machine (VM) abstraction’ to improve the scalability and compatibility of its sidechain. VM abstraction means that Arbitrum does not require developers to write smart contracts in a specific language or format but instead allows them to use any Ethereum-compatible tooling and framework. Arbitrum then compiles these smart contracts into bytecode that can run on its own VM, which is optimized for L2 execution. This way, Arbitrum can support any Ethereum smart contract without requiring any changes or modifications from the developers.
Arbitrum has recently upgraded from VM abstraction to Nitro, which uses many of the same principles as VM abstraction, but simplifies the process allowing direct usage of native Ethereum implementations.
For gas, the costs of executing transactions on a blockchain network, Arbitrum uses Ether ($ETH) - the native token of the Ethereum network. Additionally, on March 23, 2023 Arbitrum began issuing their native token $ARB initially through an airdrop to early adopters and investors. The $ARB token is used for governing the Arbitrum DAO allowing holders to vote on things like fund allocations, technical changes, and who will be on the Arbitrum Security Council.
Benefits and Challenges
Arbitrum offers several benefits for Ethereum users and developers:
Fast
Can process thousands of transactions per second (TPS), with low latency and high throughput v Ethereum’s 20-40 TPS.
Cheap
Reduces the gas fees by up to 100x compared to Ethereum.
Secure
Inherits the security and decentralization of Ethereum, as any invalid transaction or state update can be challenged and reverted by anyone.
Compatible
Supports any Ethereum smart contract without requiring any changes or modifications from the developers.
Flexible
Allows developers to customize their own sidechain parameters, such as block size, gas limit, gas price, etc.
However, Arbitrum also faces some challenges and trade-offs:
Delayed Finality
Transactions are not finalized until they pass the challenge period, which can introduce some uncertainty and risk for users and developers.
Limited Liquidity
Users need to deposit and withdraw their funds between the main chain and the sidechain using a bridge, which can incur some costs and delays. Moreover, Arbitrum users may face limited liquidity and interoperability with other L1 or L2 platforms as adoption continues to grow.
User Experience
Arbitrum users need to install a browser extension or use a compatible wallet to interact with the sidechain, which may not be very user-friendly or intuitive for some users. This, however, is common in the industry as it exists today and is not exclusive to Arbitrum.
Adoption
Despite being the 4th largest chain by TVL - $2.1B as of July 2023 - Arbitrum is still a relatively new project that needs to attract more users and developers to its ecosystem and retain them, which has been a challenge for many L2s. It also needs to compete with other L2 solutions that may offer different features or advantages.
How Arbitrum Compares to Other L2 Solutions
Arbitrum is not the only L2 scaling solution for Ethereum. There are other projects that use different techniques or approaches to achieve similar goals. Some of the most notable ones are:
Polygon PoS & Polygon zkEVM
Polygon PoS (Proof of Stake) is an L2 scaling solution that uses a hybrid approach of Plasma and proof-of-stake. Plasma is a technique that allows transactions to be executed on a sidechain and periodically submitted to the main chain as a compressed proof. Proof-of-stake is a consensus mechanism that allows validators to stake their tokens and secure the sidechain. The Polygon team has also proposed an upgrade of Polygon PoS to incorporate ZK (zero-knowledge) security features, similar to their other sidechain Polygon zkEVM. Polygon solutions can offer high scalability and low gas fees, but they also introduce some trade-offs in terms of security and decentralization.
ZK-Rollups
ZK-Rollup is another type of L2 scaling solution that relies on zero-knowledge proofs instead of fraud proofs. Zero-knowledge proofs are a way of verifying the validity of transactions or state updates without revealing any information about them. ZK-Rollup solutions can offer faster finality and lower gas fees than Optimistic Rollup solutions, but they can also require more complex code and computations. Polygon zkEVM (as mentioned above) and zkSync Era are the most well-known chains that incorporate ZK-Rollup processes.
Optimism
Optimism, similar to Arbitrum, is an Optimistic Roll-up solution that uses a technique called optimistic virtual machine (OVM) to improve the compatibility and performance of its sidechain. OVM is a replica of the Ethereum virtual machine (EVM) that can run any Ethereum smart contract without requiring any changes or modifications from the developers. Optimism solutions can offer high scalability and compatibility, but they also face some challenges in terms of finality and liquidity.
Who Is Building On Arbitrum?
Arbitrum has attracted a lot of attention and interest from the Ethereum community, and many projects have announced their plans to launch or integrate with Arbitrum.
Some of the most prominent ones are:
Uniswap
Uniswap is a decentralized exchange (DEX) that allows users to swap any ERC-20 tokens without intermediaries or fees. Uniswap has launched its alpha version on Arbitrum, which aims to offer faster and cheaper transactions for its users and boasts over $300 million* in TVL on the Arbitrum network.
GMX
GMX is a decentralized spot and perpetual exchange that supports low swap fees and zero-price impact trades. Users can swap between different assets or open perpetual futures contracts up to 50x leverage. GMX exchange is powered by two tokens: GMX, which is used for governance and utility, and GLP, which is used for liquidity provision. GMX has the largest TVL in the Arbitrum system with over $525 million*.
Aave
Aave is a decentralized lending platform that allows users to borrow and lend various crypto assets. Aave has deployed its protocol on Arbitrum, which offers lower borrowing and lending rates for its users with $159 million* in TVL.
Curve
Curve Finance is a decentralized exchange platform that allows users to trade stablecoins and earn interest on their deposits. It uses an algorithm that adjusts the exchange rate based on the supply and demand of the coins, resulting in low slippage and high liquidity. Curve was one of the first native Ethereum platforms to launch on Arbitrum and maintains a TVL of nearly $80 million*.
*As of July 2023 ~ Source: DeFi Llama
How to Get Started with Arbitrum
If you are interested in using or developing on Arbitrum, you can follow the official steps provided by the Arbitrum Foundation here. As mentioned above, this isn’t exactly the most user-friendly yet, but the steps are pretty straightforward. The ecosystem is improving — “we are still early“.
Note that you will be provided an option to choose between Arbitrum One and Arbitrum Nova. Arbitrum One is designed for the more common DeFi use cases like the notable dApps we’ve listed above, whereas Arbitrum Nova will be the solution of choice for gaming and social applications. As such, Arbitrum One is where we recommend starting.
Additional Arbitrum Resources
Here are some official resources to dig in and learn more about Arbitrum as well as follow updates on future progress:
So there you have it! We hope you enjoyed this deep dive and look forward to more in-depth coverage of protocols and projects in the future. As always, if you have any suggestions for future editions of ‘The Cortex Connection’, please visit our Discord channel to let us know!