Arbitrum Explained - user adoption stats, the $2bil+ rewards for users and ecosystem projects

Every year there are few events that mark the important milestones in crypto, e.g. the merge of Ethereum’s execution and consensus layers in 2022. In 3 days time there will be an such event. On 23rd March 2023, the category leader in Ethereum L2 market, Arbitrum, will launch its token ARB by airdropping 12.75% of the total supply to early users and transition the governance of the network to a DAO.

Translation for those who may not be familiar with the term airdrop: Arbitrum is rewarding an estimated $2billion+ in value to its users as a thank you. What are the adoption stats of Arbitrum? How do we benchmark these and estimate the likely ARB token price? What are the Arbitrum projects that are showing traction? Let's dive in.

Ethereum and Rollups

If you are familiar with Arbitrum and what a rollup is, you can skip to the next section. Otherwise read on. I have filtered 2 hours of research into 2 mins of reading.

Blockchains work by adding new data to a chain of blocks containing transactions details. The speed at which you can add more blocks to a blockchain depends on its decentralization level and technological limitations. For example, it takes Bitcoin, the most decentralized blockchain, around 10mins to add and confirm a block of data.?It takes Ethereum around 12 seconds to include a block in its chain. And for each block of data, there is a max size limit on data that can be included.

Increasing this size limit means increasing the computational/hardware requirement for network nodes; this in turn leads to more centralized block production as only the biggest players can afford the technological requirements and it in turn lowers censorship resistance of a blockchain.

Due to the competition for inclusion, there is a cost for being able to include your transaction ahead of others. Practically this translates into a fee for every transaction you do on blockchain. And in the past year, this fee on Ethereum has ranged between?$2 and $50 per transaction. Obviously that is not scalable. Imagine having to wait 12 second and pay $5 every time you make a purchase on internet!

Enter Ethereum rollups or L2s.

A rollup is a blockchain. The term rollup/L2 refers to the blockchain being built on top of a parent chain called the L1. L2s/rollups have their input data imported from a parent chain and the output from the computation of transactions are ultimately posted back to parent chain’s blocks. If the rollup is an Ethereum L2, it means its input data is imported from Ethereum and that it relies on Ethereum’s?economic security guarantees?to ensure the provisioning of correct data.

The benefits of a rollup include:

1. faster transaction speed as the computation on an L2 is done by a single party or a few permitted parties as oppose to by thousands of Ethereum’s execution clients who can join the network freely. On L2s the transaction speed is not 12s but rather 0.000025s.
2. cheaper transaction cost as transactions are batched together and posted back to the parent chain in a single block. This spreads the $5 in the example above between hundreds if not thousands of people.

So instead of paying $5 everytime you make a purchase on Ethereum and having to wait 12 seconds, on an L2 you pay $0.01 every time you make a purchase and don’t have to wait at all. And for the $0.01 transaction fee you pay, you are ensured that your money is censorship resistant, i.e. no one can freeze it or confiscate it.

Arbitrum is an?optimistic?Ethereum L2 rollup. The word optimistic refers to the mechanism that ensures the data passed from Arbitrum back to Ethereum is valid and correct. If you are optimistic about something, you do the thing first and believe it will work out.

The transaction data on Arbitrum is bundled up and passed onto Ethereum with an optimistic view that these data are true and valid until someone disputes. If somebody spots that data is not valid after it is posted on Ethereum and can prove it using onchain data, then the person, called a sequencer, passing the data will be punished by the Arbitrum network’s incentive mechanism, leading to financial losses for the sequencer.

The other way to ensure all data are valid is still under development. It is based on zero knowledge fraud proofs that require Nobel prize level maths. If you want to stretch your brain, I have prepared a link just for you?here.

Arbitrum’s Adoption Stats Comparison

To understand how we can estimate the airdrop value we must first understand the adoption level and usage metrics of Arbitrum. We will look at 4 important metrics.

1. Total value locked (TVL)

Arbitrum currently commands a total of $1.78bil TVL on its chain, nearly double of the second placed Optimism’s $990mil.

Arbitrum and Optimism are by far the most active Ethereum L2s. You can see the evolution of their TVLs.

2. Number of transactions

Looking at data below, Arbitrum’s daily transaction has increased dramatically since 2022 and averaging around 1 million in the last month. While Optimism’s daily transaction number dropped off by 50%-60% since 2023 Jan after its airdrop incentive finished, it is still much higher than 2022 Jan when the general crypto market prices were much higher. Assuming Arbitrum’s transaction number follows a similar path and drops by approx 50% after its airdrop ends, we should see around 500k daily transactions on it.

To give more context, Ethereum is currently averaging about 1mil transactions a day. If number of transactions keeps rising on these Ethereum L2s and goes above that of Ethereum’s, then it would give further credence to the thesis that Ethereum L2s will onboard mass users as they offer cheaper and faster experience while Ethereum L1 serves as the censorship resistant security guarantee and data availability layer.

The recent?Coinbase announcement?of its Ethereum L2 called Base means they are onboard millions of its exchange users to their first blockchain experience in a way that is as performant as the internet today. For those who still remember the what it was like using EtherDelta - how far we have come!

3. Number of active wallets

Looking at data, there are currently around 100k daily active wallets on Arbitrum vs around the 50k on Optimism. Similar to TVL and transaction numbers, Arbitrum commands twice the number of active wallets as Optimism does.

To find out how these numbers compared with Ethereum’s own adoption number, I went and pulled up Ethereum’s daily active address data below.

Comparing the data on active wallets and transaction numbers of L2s and Ethereum:

1. Arbitrum and Optimism active wallets are making twice the number of transactions as the wallets on Ethereum. On average, L2 wallets make 5 transactions vs Ethereum wallets’ 2 transactions a day
2. This may be a result of L2’s much cheaper transaction cost and/or a result of the more crypto native user profile of L2 rollup chains. There is a much higher barrier to entry to interact with Arbitrum or Optimism apps than with the Ethereum blockchain. Most users of L2s are first proficient users of the Ethereum L1.

I would suggest monitoring the number of active wallet addresses is a better measure of broader user adoption while transaction numbers is likely to be a better measure of the stickiness between applications on the chain and its user.?You can read more about which crypto applications is likely to scale to 100mil users in my article here.

4. Number of applications building on top of Arbitrum

There are twice the number of applications building on Arbitrum (238) as there are on Optimism (116). This is very important as developers go where users are. The more people get onboarded, the more developers will take interest in building on that chain. And the more is built onchain, the more utilities the chain has to attract users.

Arbitrum has started a flywheel for user acquisition and developer onboarding.

Valuing the Arbitrum Airdrop

Right on cue. As if to celebrate the traction/success of the Arbitrum ecosystem so far, the Arbitrum Foundation announced the formation of Arbitrum DAO and the launch of ARB token with 12.75% to be airdropped on 23rd Mar 2023 to eligible users as of its snapshot taken on Feb 6th 2023.?Check if you are eligible.

A little digging shows there are 10bil ARB tokens in total supply. 1.275bil ARBs will be airdropped using the official number.

Benchmarking ARB

An obvious way to benchmark the ARB token’s valuation is to compare it to Optimism’s OP token that was also airdropped and is already trading on the market.

According to Coingecko, Optimism is currently valued at $11.8bil fully diluted with about 8% of the supply circulating. Given the adoption metrics above show that Arbitrum has roughly twice the Optimism’s user traction in terms of active wallets, daily transaction numbers, TVL and developer interest, it is reasonable to assume that Arbitrum will likely have a market cap that is 2x of what Optimism commands at approx $23bil.

This implies an estimated fully diluted ARB token price of $2.3 ($23bil/10bil ARB). Now crypto market is famous for its reflexivity. So it wouldn’t be surprising to see ARB bottoms out at a price lower as people rush to sell their airdropped ARBs initially and tops out at a higher number as people accumulate holdings of a fundamental building block of the Ethereum ecosystem.

ARB’s Longer Term Trajectory

Perhaps a more interesting question to ask is what is ARB’s long term trajectory after the airdrop? According to the study done by?cptn3mo, VP of Research at crypto VC Hashed, most airdropped tokens trade below their day 1 price by day 5 and by day 100, most has a median price that is 64% of the day 1 price.

However a notable exception is the Uniswap token. UNI is able to overcome that trend because Uniswap dominates the decentralized exchange market with over 70% of the market share.

While price volatility can dictates short term movements, product market fit is the key for long term project success. And Uniswap certainly enjoys lots of it.

We can monitor the adoption metrics data on L2s shown above to see whether Arbitrum can sustain the growth in its usage. But as I mentioned in my last?post, infrastructure can make the user experience better but the attraction for users come from the applications built on top.

So what are the Arbitrum projects that are demonstrating product-market-fit and are likely to grow?

Arbitrum Ecosystem Projects

While no one can predict the future, we can identify Arbitrum projects that are already attracting the most users and capital.

1.Projects with most active wallets

2. Projects with most transactions

3. Projects with the most transaction fees consumed

While a complete breakdown of all these projects is beyond the scope of this piece, I am happy to provide a more focused analysis in a future piece. Let me know which projects you find interesting. Leave a comment below and subscribe to the newsletter.

Excluding big Ethereum project names such as Uniswap, Sushi and Aave, that launched on Arbitrum as a part of their mutli-chain strategy, there are a few interesting native talents. I will provide a simple explanation of the most popular 5 projects and highlight any traction numbers.

1. GMX?is a decentralized perpetual exchange that allows users to trade BTC, ETH and others with up to 50x leverage and no price impact. It has done $100bil in trading volume and $170mil in fees. It is one of the two leading decentralized perpetual exchange in the whole of crypto.
2. Gains Network?is a decentralized perpetual exchange offering leveraged trading on crypto, forex, stocks, commodities and indices. It has done $32bil in trading volume and $17mil in fees.
3. Radiant Capital?is a lending protocol that allows you to deposit asset on one blockchain and borrow directly on another blockchain. It has done $300mil in loan volume and $4mil in fees.
4. Camelot?is a decentralized spot exchange that utilises Uniswap V2 and Curve AMMs for spot trading on Arbitrum. It is also a launchpad for smaller projects on Arbitrum.
5. Vela?is a decentralized perpetual exchange that is in beta. According this dashboard it has done $4bil in trading volume.

I plan to keep an eye on these names post the airdrop to see if they can sustainably have organic growth. This will be a tell-tale sign for the broader Arbitrum ecosystem.

Summary:

Arbitrum has seen huge growth in adoption stats recently with user activities, developer interests and capital locked on the chain at roughly twice the number of the second placed Optimism. This upcoming airdrop, estimated at more than $2bil, shall further announce and celebrate Arbitrum’s leadership position in Ethereum L2 rollup ecosystem. There are already projects showing significant tractions on Arbitrum. How well Arbitrum does longer term depends on how well it can further grow its ecosystem of projects providing utilities to users and how sticky these projects can make their user relationships to be. As always, feel free to drop any comments or questions below.

Disclaimer: This content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.