L3 Economic Dilemma: Unable to make a profit unless the monthly volume exceeds 50 million transactions

Original Author: Syndicate

Original text translation: DeepFlow TechFlow

As discussed earlier, L3s faces real challenges to economic sustainability.

Although Base only generated over $30 million in revenue through sequencers in the first quarter of 2024, the effective methods for a few L2s, such as Base, Arbitrum, OP Mainnet, and Polygon, do not apply to L3. Why is that?

Currently, L3 is becoming increasingly popular due to its ability to significantly reduce the costs for users and developers—which opens up the possibility of building new completely on-chain applications, games, and experiences. Similar to how cloud computing has reduced the cost and time of building web applications by thousands of times, L3 could potentially achieve the same effect for Web3, enabling the construction of the new world network at a thousand times the speed and cost. At least in theory.

However, the significant drop in fees by thousands of times also brings significant economic challenges to L3: the significant drop in fees means that they cannot rely on sequencer fees as their main source of income unless they have a volume similar to L2, which is unfeasible for almost all L3. In addition, to achieve a drop in fees by thousands of times, the operating costs of L3 still need to drop by 10 to 100 times from today's level. This will require a thorough transformation of the infrastructure of L3, rather than incremental improvements.

This has brought serious economic difficulties to L3. How does L3 hope to solve this problem?

L3 Profit and Loss Break-even Analysis

Through our collaboration with the emerging L3 ecosystem, the Syndicate team sees L3 attempting to address this challenge by increasing network fees to generate profits from its sequencer (or at least attempt to achieve break-even). So far, these efforts have not been profitable.

A few months ago, we conducted an economic scenario simulation for L3 - an analysis of their profit and loss balance and profit path relative to L2 under various on-chain activities and fee levels. The results were alarming.

If the cost of L3 is 10 times cheaper (or longer) than today's L2, L3 will never be profitable unless its monthly volume exceeds 50 million. This is equivalent to more than 50% of the Base activity or more than 75% of the Arbitrum activity.

Base and Arbitrum, the two most active L2s on Ethereum, typically see 50 to 100 million transactions per month. But these are the largest players. In the past 30 days, Zora has seen 3.8 million transactions, Mode has seen 3.8 million transactions, and Redstone has seen 1.1 million transactions.

To achieve a break-even point, an L3 with 500 million transactions per month needs to set its fees within 3 times that of L2. This is a significant challenge, especially if L3 relies mainly on lower fees for competition. Being only 3 times cheaper than L2 is not enough to attract users and developers to adopt the new network. Therefore, L3 must differentiate itself from L2 in other aspects, such as scalability, customizability, and community ownership.

In the past 30 days, only two L3s have had a volume of more than 5 million times, both of which focus on gaming: Xai (275 million transactions) and Proof of Play Apex (69 million transactions). Xai's network fees are nearly 200 times lower than L2, which means it may be running at a loss. On the other hand, Proof of Play Apex's network fees are 15 times higher than L2, which means it may be profitable, depending on who pays the fees.

But considering all of this, what are the ways in which L3 (and L2) can achieve sustainability and long-term value?

The current argument supporting L3s

Today, L3 can be seen as an 'operating cost' or 'cost center' with the aim of initiating the development of a new network and making it valuable over time. In addition, L3 provides operators with new economic tools through running sequencers, setting network fees, and using custom gas tokens, allowing them to dynamically manage their ecosystem, including users, developers, applications, and partners, through targeted gas subsidies and incentives.

For example, consider a fully on-chain game on L2, and pay Money Laundering for each on-chain operation. To improve the user experience, game developers may want to sponsor many (or all) transactions on behalf of users. As the game develops, this will be very expensive. Even on popular L2 platforms today, gas fees are very low, but if a game has 50,000 daily active users (DAU) and players make an average of 100 on-chain transactions per day, the total sponsored gas fees exceed $10,000 per day (or nearly $5 million per year). For many L2 platforms, this number could rise to $25-50 million per year! Therefore, building games on their own L3 can drop these variable costs close to zero, making many new mainstream social, gaming, and consumer applications - that is, on-chain applications - economically viable.

The future of on-chain gaming

"Completely on-chain" is also a major selling point for some games and applications. For example, Skyoneer is a completely on-chain game that exists on its L3 Gold focused on strategy games. Pirates Nation is another completely on-chain game that exists on the Proof of Play Apex L3, and it says, "When a game is on-chain, it means we don't run any servers. We can't shut down the game, it will exist forever... on-chain games... guarantee permanence, interoperability, and composability." Here, lower costs are not a direct selling point, but they are a necessary condition that enables other benefits of making the game completely on-chain.

Ultra-low fees also unlock new usage scenarios that users may not participate in. Consider Ham Chain recently significantly dropping the cost of each transaction, enabling new tipping and micro-transaction experiences on its L3.

Therefore, the main economic benefit of L3 is not in income generation, but in the value they provide to the applications built on top of them. By significantly dropping Transaction Cost, L3 makes it possible for new applications and business models that may not be economically feasible on more expensive L1 or L2 networks, and they allow applications to retain more long value at a lower cost.

Future Economic Opportunities for L3

While L3 may be seen as a cost center or negligible source of revenue today, our team has a clearer vision of how L3 can become more sustainable and valuable in the future. There are some new models on the horizon that will profoundly reshape the economics of L3, for both developers and users.

The most obvious example is priority fee. As more and more long applications, users, and transactions gradually migrate to L3, we may see the emergence of a priority fee market in popular L3s in the gaming, social, and financial fields. Of course, the priority fee market will only be open when the activity on L3 rises to a point where Block space is no longer as abundant as today's Ethereum L1 and popular L2s like Base.

However, we are already starting to see a more innovative model where L3 uses local gas or stakeToken. For example, Degen Chain uses $DEGEN as its local gas Token, creating additional utility for $DEGEN. The new L3 being developed not only plans to use its own custom gas Token, but also plans to use a custom stake mechanism to help protect or co-operate the network, giving its Token longer utility. By using local Tokens instead of just following the value created by the sequencer, L3 is exploring ways to create value through its local Tokens. In some cases, like Degen, this can be a greater value driver and opportunity than sequencer profits.

There will be even greater economic breakthroughs in the future. Our team has delved deep into the development and issues of L3, striving for rise and long-term sustainability. Through this work, we have identified significant issues (and opportunities) related to the design and operation of L3, ultimately limiting their economic autonomy and potential today. However, if you can fundamentally change the design and operation of L3 - you can unlock new income, new markets, and major structural advantages. This means that in the near future, L3 will not only be 1000 times cheaper, but will also be able to access new income and value generation opportunities that are currently impossible. We look forward to sharing our research and work in this area in the coming weeks.

Future Outlook

With the continuous development of L3, we will see many new experiments in the field of value creation and capture, whether from the perspective of chain operators, developers, or users.

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