Ethereum Faces Recession as Layer-2 Networks Gain Ground and Threaten Its Future

• Ethereum’s fee revenue has dropped sharply after L2 networks gained more users.
• Fragmentation in ETH’s ecosystem disrupts its decentralised finance platforms.
• L2 networks might leave the token and become independent Layer-1 operating systems.

Ethereum is facing important challenges as Layer-2 (L2) technologies gain more traction. Justin Bons, founder of Cyber Capital, has raised concerns about ETH’s future. He states that Ethereum’s struggles with high transaction volumes and fees have pushed users towards L2 solutions. This shift, Bons argues, has created a “parasitic relationship” where L2 networks grow at Ethereum’s expense.

Fee Revenue Drops After EIP-4844

Since Ethereum Improvement Proposal (EIP) 4844 was introduced, the token’s billing income has dropped quickly. Bons believes this drop happened because L2 networks captured fees that the coin used to generate. This shift has also weakened Ethereum’s economic stability. The network now faces more inflation as revenue struggles to keep up.

2/9) Since EIP-4844 (Proto-Danksharding), fee revenue has collapsed!

That is why the fee burn can no longer catch up with inflation, as L2s are taking all the fees instead!

This is why inflation has risen over ETH ever since L2s took over, as ETH has outsourced all execution… pic.twitter.com/SNlV5cmqYA

— Justin Bons (@Justin_Bons) August 26, 2024

Bons points out that Ethereum’s reliance on L2 networks has made its financial foundation weaker. This decline raises questions about the coin’s long-term value, he says. As L2 solutions continue attracting users, Ethereum’s position in the market seems more uncertain.

Fragmentation and Centralisation Risks

Bons also highlights the fragmentation within Ethereum’s ecosystem caused by the growth of L2 networks. This fragmentation has split liquidity and composability among decentralized finance (DeFi) applications. This undermines the fluid interaction of DeFi platforms, which has been a key feature of Ethereum.

Additionally, Bons criticises Ethereum’s leadership for focussing on L2 development instead of expanding Ethereum’s Layer-1 (L1) capacity. He argues that this choice harms the network’s long-term health. The lack of on-chain voting mechanisms in Ethereum’s governance has allowed more centralised control to develop, which further complicates the issue.

Uncertain Future and Potential Impact

Bons also raises concerns about potential centralisation within L2 networks. He warns that many L2 platforms could censor transactions or seize user funds, which goes against Ethereum’s original vision of decentralisation. Bons suggests that Ethereum’s leadership might resist improving L1 scaling to protect L2 interests.

Bons predicts that L2 networks might eventually move away from Ethereum or become independent Layer-1 platforms. This shift could further fragment Ethereum’s ecosystem and weaken its position in the market. As a result, the growth of L2 networks poses significant risks to Ethereum’s future.

Source