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Ember Nuggets #4

September 15, 2021

What are Ember Nuggets?

Ember Nuggets are a weekly update with commentary from the investment team on what’s happening within the crypto market - news, developments, market trends, and more.

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Nugget 1:  What is a consensus mechanism?

Blockchain technologies like Bitcoin and Ethereum are at a base level, distributed databases hosted by nodes. A consensus mechanism allows the distributed network of nodes to reach an agreement of the current state of the network, work together in sync and stay secure. For Ethereum and Bitcoin, the consensus mechanism is Proof of Work (PoW), where GPU-Miners compete to form new blocks with completed transactions that will be shared with the network and added to the chain. The winner is the fastest to solve complex math equations and is rewarded the underlying token of the network (i.e. ETH, BTC).

There are many consensus mechanisms, but the two most popular ones are Proof of Work and Proof of Stake.

Nugget 2: What are Layer 2 scaling solutions?

Before talking about Layer 2 (L2), we must give a brief overview of Layer 1 (L1). L1 blockchains are defined as the main chains like Ethereum, Solana, Avalanche, and Bitcoin to name a few. L2 is a solution that helps scale L1 blockchains by reducing the computational and storage burden on the main L1 chain. Most L2 solutions connect to an L1 solution and help increase transaction speeds and capacity by batching transactions. State channels and non-custodial side-chains (e.g. Plasma and Rollups) are the two main ways side-chains plan to help scale L1 chains like Ethereum.

When evaluating L1s and L2s, it's important to remember that all blockchains face the scalability trilemma.

Nugget 3: Introducing Arbitrum

Arbitrum is an L2 scaling solution built for Ethereum which utilizes optimistic rollups (OR) that leverage off-chain computation with on-chain data. Arbitrum went live on August 31, 2021 and over the past week it has seen tremendous growth hitting a total value locked (TVL) of $1.67B (as of 9/12/21). Arbitrum is the largest and fastest growing L2 solution today - with many liquidity mining rewards for early adopters.

Current chain ranking by TVL (descending order):

  1. Ethereum (L1)
  2. Binance (L1)
  3. Solana (L1)
  4. Terra (L1)
  5. Polygon (L2)
  6. Avalanche (L1)
  7. Arbitrum (L2)

So why does this matter? Arbitrum is one the main mechanisms that is supposed to help Ethereum scale by allowing more transactions per block at a faster processing rate, and most importantly, with lower transaction costs. If you have tried to do anything over the past few NFT craze weeks, you may have encountered $1K transaction fees for NFT minting. With PoS in ETH 2.0 and L2 mechanisms like Arbitrum - hopefully we can use the network in a more pragmatic way.

Thank you for reading!

Harsharn Singh
Investment Associate | Ember Fund

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