What are Optimistic Rollups?

Ethereum was born as a smart contract platform where developers keen to launch their decentralised applications could build on top of it. Some perks of the Ethereum blockchain are its efficient data coordination system, network size, privacy, and rapid data deployment.

However, time has passed, and the DeFi and the cryptocurrency world are gaining popularity in mainstream markets. There's more capital flowing out from wealthy retail traders, institutional investors, and the massive expansion of DeFi. Non-Fungible Tokens (NFTs), Ethereum-based blockchain games, metaverses, and more DeFi apps building on Ethereum have caused severe network congestion —leading to increased gas fees, low throughput, and overall fatal performance compared to high-performance networks like Solana or Avalanche.

As a solution to these setbacks, sidechains were created to enhance Ethereum's network performance. With over $6 billion in TLV (Total Value Locked), Rollups are becoming a popular alternative for developers and users who seek cheaper gas fees and higher transaction speed.

TVL on Ethereum Rollups Reach New Heights

There's more than $6.90 billion in Total Value Locked (TVL) from Ethereum Layer 2 networks. On Nov. 23, the amount of TVL across multiple ETH L2 protocols soared over 15% from Aug. 24 to 21. Nov 2021. Optimistic and ZK Rollups are taking the lead, with Arbitrum, Boba Network, and dYdX sitting on the top 3.

Data from L2Beat shows the TVL has reached nearly $7 billion. With so much capital swirling, let's see what rollups are, the different types, and some of the most popular protocols out there.

What are Rollups

Rollups are scaling solutions in the form of Layer 2s —third party protocols that improve the speed and throughput of a blockchain network.

Rollups are fairly new technology currently under development but have shown to be quite successful in practice so far. They are considered the holy grail of scaling solutions as they inherit Ethereum's security properties without having to risk decentralisation.

Layer 2 vs Sidechains

Rollups are the combination between Layer 2s and sidechains. Layer 2 protocols, such as channels, are application-specific protocols that inherit Ethereum's security properties, while sidechains are EVM-compatible and rely on their own consensus models. Rollups create a general-purpose ecosystem that takes the best out of both worlds.

Let's get a bit more technical: rollups are a new form of Layer 2 protocols. They are independent blockchains that live outside of a major mainnet, specifically designed to alleviate the workload of a network, reducing gas fees and increasing transaction speed. Rollups emulate the state of a Virtual Machine (VM), in this case, the Ethereum Virtual Machine, to allow transactions to occur outside of the mainnet (off-chain) while keeping the transaction data on layer 1 (on-chain).

How do Rollups Work?

First, every rollup performs transactions outside of Layer 1 but post the transaction data on Layer 1. The transaction computation occurs off-chain, allowing to process more transactions as only a part of the data of the rollup transaction has to fit on the Ethereum block.

The rollup takes the transaction data and executes its computation on a separate chain that emulates a rollup-specific version of the EVM. Later, the rollup comprises all the transactions together and sends them back to the Ethereum mainnet. Data verification depends on the rollup type, but generally speaking, smart contracts on Layer 1 are in charge of verifying proof of data, which we'll see below.

Optimistic vs ZK Rollups

There are two kinds of rollups: Optimistic and Zero-Knowledge (ZK) rollups. When we study both models, we might think they are the same. However, while both technologies are very similar, they present different security models and benefits.

Optimistic Rollups use a rollup contract deployed on both Layer 1 and Layer 2 to communicate. They take the transaction of the mainnet and send it to the rollup contract, which then sends it to Layer 2. After the computation is done, it submits the result in batches to the mainnet.

ZK Rollups take bundles of transaction data backed by a smart contract on Layer 1 and post it on Layer 2. After all of the transactions are computed, the rollup wraps them all and sends them to Layer 1 in a whole batch, unlike Optimistic Rollups, which send several batches assuming the data is correct.

Proof of Data

While Optimistic Rollups generate proof of fraud, ZK Rollups generate validity proofs.

Optimistic Rollups will generate proof of data and post it on Layer 1, assuming it's correct, hence the name optimistic. Of course, this can be problematic. When the data is valid, the protocol doesn't have to do anything else with the transaction. But if it's invalid, the protocol needs to identify it and correct the state of the transaction, causing a delay in the system.

The cons with Optimistic Rollups is that Malicious actors can provide unreliable results, and a single party can significantly influence the transaction ordering of the rollup. If a user identifies a fraudulent transaction, the rollup executes a fraud-proof and runs the correct computation using the available state data and penalises the malicious actor. This process is also called dispute period.

When a validator wants to submit proof of data, he must provide a bond in ETH that can be slashed if the data turns out fraudulent.

ZK Rollups, on the other hand, generate a cryptographic proof for each bundle. This proof is called SNARK: Succinct non-interactive argument of knowledge. When the rollup sends the batches, they are rapidly verified by Layer 1, and invalid batches are immediately rejected.

ZK Rollups are generally faster than Optimistic Rollups since they don't rely on disputing periods. Instead, users' funds are available as soon as the batches are sent to Layer 1.

Validium

Validium rollups are similar to ZK rollups because they generate validity proof and have no dispute periods. But they do not store data on the mainnet. Validium rollups are the most recent type in circulation, and they're currently under heavy development. The results have shown a high throughput of over 10,000 transactions per second.

There are multiple protocols providing implementations of Validium for developers, yet it's worth knowing it's a much less battle-tested technology than ZK or Optimistic Rollups. Some setbacks are limited support for general smart contracts and the high computational power required to provide ZK proofs.

Arbitrum

Arbitrum is an optimistic rollup running on the Ethereum blockchain. Arbitrum has a set of smart contracts deployed on the ETH mainnet that enables the communication between Layer 1 and Layer 2.

Arbitrum takes the transaction data from the Ethereum mainnet, which is received by the rollup contracts and sends it to layer 2 —where the computation of that transaction takes place. The protocol then gets the results of the layer-2 computations and submits them to the Ethereum mainnet as "calldata" to ensure it's valid. This is how Arbitrum and Ethereum communicate with each other.

How Does Arbitrum Work?

Arbitrum relies on a series of validators and nodes and several core technologies.

Validators & Nodes on Arbitrum

Users on the Arbitrum protocol are free to decide if they want to be a sequencer or a regular validator.

Sequencers

Sequencers are responsible for computing transactions. These nodes periodically submit Merkle roots, a mathematical way to verify data blocks on a blockchain.

Sequencers can be penalised if they commit an offence, in which they'll see their funds slashed by adjudicators. If someone suspects fraud, they can alert adjudicators, and they'll review the transaction's state through the aforementioned fraud-proof process. Other nodes will be in charge of computing the correct state of the transaction while adjudicators take care of the faulty sequencer.

Validators

Arbitrum validators are divided as follows:

• Active validators: they stake their funds to participate in the protocol and propose new blocks.
• Defensive validators: these types of validators are the watchdogs of the protocol, supervising its performance. They eliminate a proposal with an incorrect block and submit a correct one to provide a reliable outcome. They don't usually stake when everything is working accordingly —they only stake when dishonest behaviour is detected.
• Watchtower validators work similarly to defensive validators. They do not stake nor participate in rollup block formation. They limit themselves to observing the rollup protocol's progress and alert adjudicators if they suspect fraud, whether if it's an incorrect block proposal or if the results of a transaction are untrustworthy.

Arbitrum Core Technology

EthBridge

Arbitrum operates on a set of ETH smart contracts called EthBridge, which is divided into three types of contracts: Inbox contract, Outbox Contract, and Rollup Contract.

• Inbox Contract: manages the Arbitrum inputs of the chain.
• Outbox Contract: handles the outputs of the chain, like messages requesting withdrawals.
• Rollup Contract: responsible for managing the entire rollup protocol by keeping track of the state of the chain, what rollup blocks have been proposed and which ones were accepted or not, and which people have staked recently

Arbitrum Token Bridge

The Arbitrum Token Bridge allows you to migrate your ETH and ERC-20 tokens to Arbitrum and use them on Arbitrum one.

AVM —Arbitrum Virtual Machine

The AVM is Arbitrum's virtual machine that acts as the interface between the Ethereum mainnet and the Arbitrum chains. The AVM runs above the EthBridge and allows the proper execution of Arbitrum smart contracts. Each chain is provided with a single AVM to compute transactions and storage data.

The idea is to efficiently execute programs compiled for the Ethereum Virtual Machine (EVM) —the reason why the AVM model is primarily based on it. This allows efficient execution of decentralised applications on the Arbitrum chain. Anything you do on Ethereum, you can do it with Arbitrum.

However, it's worth noting AVM has its differences from EVM. Arbitrum supports both executing —performing the computation of an order, done off-chain by Arbitrum— and proving —demonstrating the mainnet that the transaction outcome is correct— which is not yet supported by the EVM or similar infrastructures.

Arbitrum vs Optimistic

Arbitrum and Optimism are currently the most popular protocols battling to lead the space.

Both rollups are pretty similar. Arbitrum is an optimistic rollup designed to enhance the scalability of the Ethereum blockchain by improving the capabilities of Ethereum's smart contracts. The protocol was built atop the Ethereum blockchain, so it's compatible with the Ethereum Virtual Machine (EVM).

Arbitrum was created by the New York-based development firm Offchain Labs, spearheaded by co-founders Ed Felten, Harry Kalodner and Steven Goldefer. The three of them are blockchain and cryptocurrency experts. Their main goal was to tackle the shortcomings of Ethereum, especially the scalability issue. To achieve this, Arbitrum uses transaction rollups to bundle data transactions and send them to a faster and cheaper layer 2, also called a sidechain. This alleviates network congestion on layer-1, improves transaction speed and reduces gas fees.

Both Arbitrum and Optimism have smart contracts deployed on the Ethereum mainnet, meaning both rollups use ETH as currency. However, Arbitrum doesn't have a native token like Optimism, which uses Optimistic Ethereum (OETH) on Trust Wallet. Users have to pay for transaction costs with ETH.

The main difference relies on how both protocols generate proof of fraud and their throughput. Optimism relays transactions from the Ethereum mainnet and sends them to layer 2, and the sequencer will compute those transactions, wrap them up, and send them back to the mainnet as a single transaction.

On the other hand, Arbitrum executes small chunks of the layer-2 transactions until it finds a discrepancy. This method allows the protocol to check where the point of disagreement is over the transaction history. While this makes Arbitrum a more scalable solution than Optimism, it can also suffer delays as discrepancies will trigger dispute resolution periods.

Pros & Cons of Arbitrum

We can outline the pros and cons of Arbitrum as the same as optimistic rollups in general. Generally speaking:

Pros:

• Arbitrum is highly compatible with the Ethereum Virtual Machine (EVM), allowing developers to replicate any activity they would do in the Ethereum mainnet.
• Same security properties of the Ethereum mainnet
• High scalability —some estimates are that Optimistic Rollups can scale up to 1000x by 2022.

Cons:

• Malicious actors could provide unreliable transaction results, which opens a dispute period and causes a delay in transaction confirmation.
• A single operator can have an enormous influence on transaction ordering on layer 2, risking decentralisation.
• Limited throughput compared to other sidechain solutions like ZK rollups.

Other popular Protocols

• dYdX: a Layer 2 decentralised derivatives trading platform built on Ethereum. Supports perpetuals, margin trading, spot trading, and other financial products.
• Immutable X: a Layer 2 protocol that allows content collectors to trade Ethereum-based NFTs with high speed and low gas fees.
• Boba Network: L2 scaling protocol and a next-generation Ethereum blockchain