Ethereum has become one of the most – if not the most – popular blockchain in the crypto ecosystem to develop decentralised apps, with over 2,800 apps currently running on the blockchain according to data from on-chain research firm State of the DApps.
This eye-popping increase in the number of DApps built on Ethereum has caused gas fees, which represent the cost of making transactions within the network, to surge significantly alongside an increase in the price of the ETH token.
The chart above, provided by Etherscan, shows how average transaction fees in USD have in some cases reached as much as $70 per transaction – a situation that pushes the cost of running DApps within the Ethereum network to a point that is considered too expensive.
The widespread adoption has, therefore, unveiled one of the Achilles heels of this popular blockchain and developers have been working hard to find solutions to the scalability issue, which leads us to the introduction of Arbitrum.
What is Arbitrum?
The Arbitrum protocol is a layer 2 functionality developed by the New York-based company Offchain Labs that seeks to solve the congestion that the Ethereum network has been experiencing by improving how smart contracts are validated.
The platform leverages on the security provided by the Ethereum mainnet but allows smart contracts to run on a separate layer to reduce congestion within the network. This technique is called ‘transaction rollups’ (explained in some detail by the developers here) and consists of batches of transactions and records that are validated on the lower layer to then be moved to layer 1’s mainnet – in this case, the Ethereum mainnet.
Arbitrum compensates nodes that actively validate the smart contracts powered by the Arbitrum chain (known as aggregators) with ETH and they are responsible for adding the blocks to the first layer – the Ethereum mainnet.
As the chart above shows, the volume of daily transactions processed by the Ethereum network has been growing steadily since the beginning of 2019, moving from a low of 381,000 transactions processed on 10 February 2019 to around 1.75 million on 9 May this year.
Alongside this surge in daily transaction volumes, the amount of daily gas used has also climbed steadily, reflecting the widespread adoption of ETH as one of the favourite blockchains on which developers currently build DApps, including popular DeFi protocols such as Uniswap (UNI), Chainlink (LINK), and MakerDAO (MKR).
How does Arbitrum work?
On 29 May 2021, Arbitrum launched its beta version and quickly attracted the interest of DeFi app developers, constantly seeking to reduce the fees that users incur for using the Ethereum network at peak times.
The beta version of Arbitrum was called Arbitrum One and developers can request access to start building test versions of their DApps on this lower layer of the ETH mainnet.
According to a blog post from developor Offchain Labs, as many as 250 teams of developers have already requested access to the protocol and One is now considered Arbitrum’s mainnet.
Just to clarify, this doesn’t mean that Arbitrum will now run separately from the Ethereum blockchain. The Arbitrum One ecosystem is a layer 2 mainnet that powers smart contracts that will be later on validated by the Ethereum network (layer 1).
Fees charged by Arbitrum will be paid in ETH and the developing team expects a reduction of around 50 times the usual fees paid per transaction on layer 1. This means that it should be cheaper to run Arbitrum smart contracts than running them in the ETH mainnet directly.
What makes Arbitrum unique?
Many networks have been introduced with the promise of solving Ethereum’s issues. Some of these networks include Polkadot (DOT), Cardano (ADA) and EOS (EOS), which are separate blockchains powered by proof-of-stake (PoS) protocols that promise to solve the scalability issues of the Ethereum network.
Different from these solutions, Arbitrum operates as a separate layer of the network to relieve the ETH mainnet from excess transactions by facilitating the validation of smart contracts through the introduction of optimistic Arbitrum rollups.
Although other protocols also aim to achieve similar improvements, the Arbitrum network currently stands out for its EVM (earned value management) compatibility, meaning that developers don’t have to learn a new coding language to be able to build their DApps within the Arbitrum mainnet.
Meanwhile, Arbitrum One also seeks to reduce fees by allowing smart contracts to be validated in batches while at the same time providing compensation to validators for their effort.
Moreover, the developing team’s decision not to give priority to a small group of developers for testing the beta version of the mainnet has been seen with positive eyes by the crypto community as it evokes the essence and spirit of a decentralised ecosystem – one that aims to be transparent, fair and equitable.
Is there an Arbitrum coin?
No, there is no Arbitrum token. Arbitrum operates as a layer of the Ethereum network, which means that transactions will eventually be recorded within the top layer (Ethereum). The developing team has stated that they don’t plan to launch a separate Arbitrum token, which means that all transaction fees will be paid in ETH even if they are completed within the Arbitrum One mainnet.
That said, this doesn’t mean that investors cannot benefit from the widespread adoption of Arbitrum. Since the primary goal of this layer 2 protocol is to improve the efficiency of the Ethereum network, a reduction in congestion levels within the network could result in an increased adoption of the Ethereum blockchain as the infrastructure on which more decentralised apps will be built.
As a result, demand for the ETH token might increase as users will have to buy ETH to pay for transaction fees, which could increase the value of the ETH token. This shouldn’t be considered as a linear forecast of what will happen but rather as a possible scenario that could result from the success of Arbitrum as a solution to help the Ethereum network in scaling.
The price of ethereum in US dollars appears to have emerged from a bear trap recently, as the price action broke below the long-dated trendline support shown in the chart above to then quickly climb above it today – which results in short-sellers being trapped and forced to cover their positions to avoid further losses.
The trap seems to have accomplished its mission so far, as the price of ETH has surged for five days in a row since bouncing off the $1,700 level, as increased buying volumes have fuelled the rally. This has resulted in the formation of a potential double-bottom setup, a bullish pattern that typically results in a short-term spike in the price of the instrument.
This view is reinforced by a buy signal provided by the MACD (moving average convergence divergence) while the RSI (relative strength index) seems to have bottomed near oversold levels on 26 June 2021.
That said, although these patterns indicate a bullish outlook for ethereum, technical analysis only seeks to identify potential trading opportunities based on past performance. There are no assurances that these patterns will play out as expected as the price could turn around at any given point.
Trade Ethereum to US Dollar - ETH/USD CFD
How to invest in Arbitrum?
Even though you cannot invest in Arbitrum directly, a significant improvement in the efficiency of the Ethereum network as a result of the widespread adoption of Arbitrum could result in a higher price for the ETH token, as developers will continue to build and launch more ETH-powered DApps – therefore attracting more demand to the token.
However, this statement should not be taken as a forecast since there are no assurances that the solution proposed by Arbitrum will work as expected.