The hidden war between L2 and L1, who can be the winner of dApp revenue?

Original title: The L2 vs L1 Battle that Nobody is Talking About

Original article by 0x taetaehoho, Chief Security Officer, EclipseFND

Original compilation: zhouzhou, BlockBeats

Editor's note: L2 has an operational cost advantage over L1 because L2 only pays for a single sequencer, while L1 pays for the security of all validators. L2 is uniquely positioned for speed and MEV reduction, and enables innovative economic models to maximize dApp revenue. Although L2 cannot compete with L1 in terms of liquidity, its potential in the dApp economy will drive the crypto industry's transformation from infrastructure to a profit-driven, long-term business model.

The following is the original content (the original content has been edited for ease of reading and comprehension):

The following is a decision matrix from a dApp perspective that analyzes whether to deploy to L1 or L2 in the current environment, assuming that both support similar types of applications (i.e., L1/L2 is not tailored for a specific application type).

Aside from the relatively low MEV (Maximum Extractable Value) due to the centralization of block producers, L2 has not yet taken full advantage of other benefits. For example, despite the potential for lower transaction costs and faster throughput, Solana is still ahead of L2 in the EVM ecosystem in terms of performance and transaction costs.

As Solana continues to increase throughput and advance MEV tax regimes such as ASS and MCP, L2 will need to explore new ways to help dApps maximize revenue and reduce costs. My current view is that L2 is structurally superior to L1 and can execute dApp revenue maximization strategies more quickly.

One of the key roles of the execution layer in maximizing application revenue is how fees/MEV are allocated.

Currently, MEV tax or fee sharing is only possible with "honest block proposers", i.e., proposers who are willing to follow prioritization rules, or share revenue with the app according to preset rules. Another way is to allocate a portion of the base fee of EIP 1559 to the dApp that the user interacts with, a mechanism that Canto CSR and EVMOS seem to employ. At the very least, this will allow dApps to increase their ability to bid on their own MEV yields, making them more competitive in the deal inclusion market.

In the L2 ecosystem, if a block proposer is run by a team (i.e., a single block proposer), then it is inherently "honest" and can guarantee the transparency of the block construction algorithm through reputation mechanisms or TEE (Trusted Execution Environment) technology. Currently, there are two L2s that have adopted fee sharing and prioritization block construction, and Flashbots Builder is able to provide similar functionality to the OP-Stack ecosystem with minor changes.

In the SVM (Solana Virtual Machine) ecosystem, Jito-like infrastructure can redistribute MEV revenue to dApps on a pro-rata basis (e.g., in terms of CUs, Blast uses a similar mechanism).

This means that L2 can enable these features sooner while L1 is still working on MCP and built-in ASS options (which Solana may be working on, but there are no CSR-like renaissance plans in the EVM ecosystem). Because L2 can rely on trusted block producers or TEE technology, there is no need to enforce OCAproof, so the MRMC (Revenue, Cost, MEV Competition) model of the dApp can be adjusted more quickly.

But the advantage of L2 is not just the speed of development or the ability to redistribute fees, they are also subject to fewer structural constraints.

The conditions for survival of the L1 ecosystem (i.e., the conditions under which the validator network is maintained) can be described by the following equation: total number of validators × validator operating costs + staking capital requirements × capital costs < TEV（通胀 + 网络总费用 + MEV 小费）

From a single validator's perspective: validator operating costs + staking capital requirements × cost of capital > inflation gains + transaction fees + MEV yields

In other words, there's a hard constraint on L1s wanting to lower inflation or reduce fees (by sharing with dApps) – validators must remain profitable!

This limitation will be more pronounced if validator operating costs are high. For example, Helius points out in his SIMD 228 related article that if inflation is reduced according to the proposed issuance curve, at 70% stake, 3.4% of current validators may exit due to declining profitability (assuming REV maintains volatility levels in 2024).

REV (MEV Share in Staking Yield) is extremely volatile: On the day of the TRUMP event, the REV share was as high as 66% · On November 19, 2024, the REV share is 50% Currently, (at the time of writing), the REV share is only 14.4%

This means that L2 is not subject to a ceiling on reducing inflation or adjusting fee allocation due to validator monetization pressure, allowing L2 to explore strategies to optimize dApp revenue more freely.

OLANA validators are currently facing higher operating costs, which directly limits the "shareable profit margins", especially as inflation falls. If Solana validators have to rely on REV (MEV share in staking yield) to remain profitable, then the total percentage that can be distributed to dApps will be severely limited.

This presents an interesting trade-off: the higher the operating cost of validators, the higher the overall take-rate of the network must be.

From a network-wide perspective, the following formula must be met: Total network operating costs (including capital costs)< 网络总 REV + 发行量

The situation is similar for Ethereum, but it is less affected. Currently, the APR (Annualized Yield) of ETH staking is between 2.9% -3.6%, with about 20% coming from REV. This also means that Ethereum's ability to optimize dApp monetization is also subject to validator monetization requirements.

This is where L2 comes in in a natural way. On L2, the total cost of operation of the entire network is only the cost of operating a sequencer, and there is no capital cost because there is no staking capital requirement.

Compared to L1, which has a large number of validators, L2 requires a very small profit margin to maintain breakeven. This means that while maintaining the same profit margin, L2 can allocate more value to the dApp ecosystem, which can greatly increase the revenue margin of dApps.

L2's network cost will always be lower than L1's size because L2 only needs to "borrow" L1's security (taking up part of L1's block space) on a regular basis, and L1 must bear the security cost of all of its block space.

L1 vs L2 Battle: Who Will Dominate the dApp Economy?

By definition, L2 cannot compete with L1 in terms of liquidity, and since the user base is still largely concentrated in L1, L2 has struggled to directly compete with L1 at the user level (although Base is changing this trend).

But so far, very few L2s have truly played to their unique strengths as L2s – the characteristics that come with the centralization of block production.

On the surface, the most discussed advantages of L2 are:
Mitigate malicious MEV
Increase transaction throughput (some L2s are exploring this direction)

But more importantly, the next major battleground in the L1 vs L2 battle will be the dApp economic model.

Advantages of L2: Non-OCAproof TFM (Non-Composable TFM)

Advantages of L1: CSR (Contract Self-Operated Income) or MCP (Minimum Consensus Protocol) + MEV Tax

This competition is the best thing for the crypto industry

Because it directly brings:

• Maximize the benefits of dApps and minimize costs, which in turn incentivizes developers to build better dApps.

• Changing the incentives in the crypto industry from the infrastructure token premium (L(x) premium) of the past, to a long-term crypto business driven by profits.

• Combined with the clarity of DeFi regulation, token value capture at the protocol layer, and the entry of institutional capital, the crypto market has entered an era with "actual business models" as the core.

Just as we've seen an influx of money into infrastructure over the past few years, driving innovation in areas such as applied cryptography, performance engineering, consensus mechanisms, and more, today's competition between chains will bring about a massive shift in the industry's incentive structure and attract the brightest minds to the crypto application layer.

Now, it's the real starting point for the massive adoption of crypto!

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