Ethereum Layer 2 Ecosystem in Consolidation Phase

The Ethereum layer 2 (L2) ecosystem has been experiencing a significant shift in recent times. A growing number of L2s have been shutting down or struggling to maintain liquidity, leading to concerns about the viability of general-purpose chains.

According to industry participants, this is not because the technology behind L2s has failed, but rather due to a lack of sustained demand. Ben Fisch, co-founder and CEO of Espresso Systems, noted that 'anywhere where somebody would be running a smart contract on an existing blockchain, someone could equally run a layer two.' This means that L2s can still be viable if they focus on specific applications or use cases.

One of the key issues facing L2s is the concentration of activity among a handful of networks. Base and Arbitrum account for more than 80% of layer-2 DeFi total value locked (TVL), according to DefiLlama data. This has led some experts, like Alice Hou, former research analyst at Messari, to suggest that only a few L2s with clear financial demand will be able to sustain themselves over time.

The economics of launching an L2 have never looked better, thanks to Ethereum's Dencun upgrade in 2024. However, the real challenge lies in generating enough sustained demand to make the network worth operating. This has led to a shift in focus from infrastructure to applications, with many teams recognizing that simply offering another Ethereum-compatible chain is no longer enough.