Layer 2 solutions made to scale Ethereum have raised billions in funding and showed massive adoption. Even with this expansion, these networks are hit by critical challenges surrounding value capture and token utility. Networks such as Arbitrum and Optimism have eaten their lunch and acquired most of that market share. Their native tokens rarely represent what’s actually taking place economically on these platforms.

As it stands today, Arbitrum has around $3 billion in total value locked (TVL). Though after an early 2023 spike, its TVL has flattened the last year and a half. For context, Optimism currently has roughly $350 million in TVL. Today, Arbitrum sees more transactions than Ethereum itself and is home to a massive decentralized finance (DeFi) ecosystem. Supply chain governance Optimism sets itself apart from its governance innovation and its “Superchain” vision.

A more fundamental problem with most Layer 2 solutions is that their tokens have probably all been designed around governance utility. That’s because they fail to directly charge for value created consistent with the benefits derived from network usage. Users pay transaction fees on these networks using ETH rather than the native tokens. This mechanism decreases the amount of revenue that gets distributed back to token holders.

With a very lucrative airdrop, Arbitrum’s ARB token was launched in March 2023. Its price reached an all-time high of $2.40 in early June 2023, but today it is trading around $0.45. Yet this sharp decline is indicative of the ongoing struggle of Layer 2 tokens to make a value proposition stick.

Layer 2 solutions function by grouping hundreds of transactions off Ethereum mainnet and then submitting compressed proofs of the transactions back to Ethereum’s mainnet. Optimistic rollups, such as Arbitrum and Optimism, assume transactions are valid unless challenged, which necessitates a withdrawal period of up to seven days. Technical vulnerabilities have posed considerable threats, with bridge exploits resulting in millions in lost funds.

The Layer 2 landscape is quickly consolidating around a few key Layer 2s, with each playing different strategies to capture market share.