Investing in Layer 2 (L2) tokens on Ethereum has seen significant progress in recent years. The total value locked (TVL) in Ethereum L2 now exceeds $40 billion, compared to just $10 billion a year ago. While there are over 50 L2 projects on platforms like l2beat, the top 5-10 projects account for over 90% of the TVL.
With the implementation of the EIP-4844 proposal, transaction fees have significantly decreased, with fees on platforms like Base and Arbitrum even lower than $0.01.
Despite the significant technological advancements and usage of L2, the performance of L2 tokens as investment vehicles has been generally poor (although they have performed well as venture investments). There are many jokes and anecdotes about the underperformance of L2 tokens compared to ETH.
We analyzed the valuations of major L2 tokens relative to ETH. One notable observation is that while the number of listed L2 tokens has increased, their fully diluted valuations (FDV) as a proportion of ETH have remained unchanged.
Two years ago, the only listed L2 tokens were Optimism and Polygon, with their FDV accounting for 8% of ETH. Today, we have Arbitrum, Starkware, zkSync, and other L2 projects, with their FDV accounting for 9% of ETH.
Each new L2 token listing actually dilutes the valuations of previously listed L2 tokens.
The result of investing in L2 tokens has been a significant underperformance relative to ETH. The returns over the past 12 months are as follows:
ETH: +105%
OP: +77%
MATIC: -3%
ARB: -12%
The FDV of major L2 tokens has been around $10 billion in the long term. To some extent, this valuation seems arbitrary, as market participants do not have a strong rationale for why it is $10 billion instead of $20 billion or $3 billion. Ultimately, there is significant supply pressure due to demand for liquidity and/or large unlocks.
The aforementioned L2 tokens generate monthly fees ranging from $20 million to $30 million. Since the implementation of EIP-4844, fees have decreased to $3 million to $4 million per month, with an annualized cost of $40 million to $50 million.
Including Optimism, Arbitrum, Polygon, Starkware, and zkSync, the total FDV of major L2 tokens is currently around $40 billion, with annualized fees of $40 million and a valuation multiple of approximately 1000x.
This is in stark contrast to large DeFi protocols, whose valuation multiples typically range from 15-60x (based on last month’s annualized fees):
DYDX: 60x
SNX: 50x
PENDLE: 50x
LDO: 40x
AAVE: 20x
MKR: 15x
GMX: 15x
As more L2 projects are listed, the FDV of L2 tokens may continue to face pressure and dilution. The market is oversaturated, making it challenging for the liquidity market to support them easily.
In the long run, L2 may generate significant fee income. L2 generates $150 million in fees per year (including Base, Blast, and Scroll), and this number may increase significantly with the growth of L2 activity.
The above content is not specific to any particular L2 project but rather a broad observation of the entire category. It seems difficult to buy a basket of L2 tokens with a $40 billion FDV and $40 million fees (1000x) and expect them to outperform ETH in the long term.
Clearly, there is no shortage of block space between L2 and high-throughput chains like Solana, Sui, and Aptos. The limiting factor lies in the applications using this block space. I hope that in the future, more focus will be placed on the application layer, and the liquidity 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 list significantly earlier. MATIC listed with an FDV of less than $50 million in the liquidity market and now exceeds $5 billion, a growth of over 100x. However, this is not the case for recent L2 tokens like $OP, $ARB, $STRK, $ZK, and most other L2 tokens that may eventually list.