Investing in L2 VS Investing in ETH: Which strategy is more profitable?

Author: James Ho

Compiled by: DeepTech TechFlow

Investing in L2 vs ETH

In the past few years, Layer 2 (L2) solutions on Ethereum have made significant progress. Currently, the total value locked (TVL) in Ethereum L2 exceeds 40 billion US dollars, compared to only 10 billion US dollars a year ago. On @l2beat, you will find more than 50 L2 projects, but the top 5-10 projects account for over 90% of the TVL.

After the implementation of EIP-4844 proposal, the transaction fees have dropped significantly, and the transaction fees on platforms such as Base and Arbitrum are even lower than 0.01 US dollars.

Despite the significant progress in technology and adoption of L2, the performance of L2 tokens as a liquidity investment has been generally poor (although they have performed well as a speculative investment). You can find many jokes and anecdotes about the underperformance of L2 tokens compared to ETH.

We reviewed the valuations of major L2s relative to ETH. One notable observation is that despite the increasing number of listed L2s, the proportion of their total fully diluted valuation (FDV) to ETH remains unchanged.

Two years ago, the only L2s that were listed were Optimism and Polygon, which accounted for 8% of ETH’s FDV. Today, we have L2 projects such as Arbitrum, Starkware, zkSync, etc., which account for 9% of ETH’s FDV.

Every new L2 token listing actually dilutes the valuation of the L2 tokens listed before.

Investing in L2 tokens has resulted in significant underperformance compared to ETH. The 12-month return rates are as follows:

• ETH: +105%
• OP: +77%
• MATIC：-3%
• ARB：-12%

For a long time, the FDV of the major L2 tokens has been about 100 billion US dollars. To some extent, this is quite arbitrary, and market participants do not have a strong reason to explain why it is 10 billion US dollars instead of 20 billion US dollars or 30 billion US dollars. Ultimately, due to demand for liquidity and/or large-scale unlocking, there is significant supply pressure.

The above L2 generates monthly costs of 20 million to 30 million USD. Since the implementation of EIP-4844, the cost has decreased to 3 million to 4 million USD per month, with an annualized cost of approximately 40 million to 50 million USD.

Including: ptimism, arbitrum, polygon, starkware, zksync

Currently, the total FDV of the main L2 tokens is about $40 billion, with an annual fee of $40 million, and the valuation multiple is about 1000 times.

This is in stark contrast to large DeFi protocols, the latter’s valuation multiples usually ranging between 15-60 times (based on last month’s annualized fees):

• DYDX: 60 times
• SNX: 50 times
• PENDLE: 50x
• LDO: 40 times
• AAVE: 20 times
• GMX: 15 times

With the listing of more L2 projects, the FDV of L2 tokens may continue to face pressure and dilution. The oversupply in the market makes it difficult for the liquid market to provide easy support.

Conclusion

In the long run, L2 may generate substantial fee income. L2 generates $150 million in fees annually (including Base, Blast, Scroll), and this figure may rise significantly with the increase in L2 activities.

The above content is not specific to a particular L2 project, but a general observation of the entire category. It seems difficult to purchase a basket of L2 tokens with a FDV of approximately $40 billion and a cost of approximately $40 million (1000 times) and expect them to outperform ETH in the long term.

Obviously, there is no shortage of block space between L2, high-throughput chains (such as Solana, Sui, Aptos, etc.). The limiting factor is the use of these block spaces in applications. I hope that in the future, more attention will be paid to the application layer, and the market will reward the application layer rather than the infrastructure layer in the coming years.

In the previous cycle, it was more common for projects to be listed significantly ahead of schedule. MATIC was listed on the secondary market at an FDV of less than 50 million USD, and now it has exceeded 5 billion USD, rising more than 100 times. However, the situation of most L2 tokens such as $OP, $ARB, $STRK, $ZK, and others that may eventually be listed is not the same.