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Source: Bankless - The state of Optimism
Author: Ben Giove

In the previous issue, we learned about Arbitrum, and now we turn our attention to its biggest competitor: Optimism.

Optimism is an optimistic rollup that, along with its competitor Arbitrum, forms the leading scaling solution for Ethereum.

L2 has been talked about for a while, but in the past few months, $OP as the first token launched on a rollup has gained attention.

OP is a token that has performed well at the start of 2023, with a 227% increase in OP/USD and a 135% increase in OP/ETH. Optimism currently has a fully diluted valuation (FDV) of $13 billion, which is comparable to L1 Solana.

This raises a series of questions - is Optimism's high valuation justified? Does the fundamentals support OP's outstanding performance? Does Optimism need to find its own development path in the L2 competition?

I will try to answer these questions from three perspectives.

1. KPI

2. Popular projects on Optimism

3. Potential growth and risk factors

1. KPI#

1.1 TVL#

Optimism currently has a Defi TVL of $786.8 million, ranking second among rollups and seventh among all chains. Optimism's TVL has grown rapidly over the past year, from an initial 0.2% to 1.2%, and its share in L2 has grown from 13.5% to 35.2%.

This growth seems to be accelerated by the release and airdrop of OP tokens. As the first layer 2 network to launch its own token among the four major L2s, this helped Optimism's strong growth last summer.

1.2 Active addresses#

The number of users on Optimism experienced rapid growth in 2022, with a 1768% increase in daily active addresses in Q4 compared to Q1. This growth partly comes from dapp users on the network and partly from ecosystem airdrop incentives. From the graph, we can see a 152.7% growth in Q3-Q4 at the end of the year, mainly due to Optimism Quests (similar to Odyssey on Arbitrum, earning NFTs by interacting with dapps). Now that this application has ended, we can see a significant decrease in active addresses on Optimism, with a 7.2% decline in Q1 2023 compared to Q4 2022.

Daily transactions#

Similar to the number of active addresses, Optimism's transaction volume has grown significantly in 2022, with a total volume increase of 851% in the fourth quarter compared to the first quarter. This growth peaked in the fourth quarter, with a 144.8% increase compared to the third quarter. While some of the transaction volume metrics can be attributed to dapp usage, this contribution should not be overstated. The decline in daily transaction volume since January 18th, when Quests ended, indicates that the speed of decline in Q1 is only 46.2% compared to the first quarter.

2. Popular projects#

Although not as diverse as projects on Arbitrum, the teams building dapps on the OP Stack are involved in various fields.

2.1 Velodrome#

Velodrome is the largest dapp on Optimism in terms of TVL, with a total locked value of $178.1 million. It gained popularity in July 2022 after the OP airdrop to veVELO lockers. Lockers are VELO holders who lock their tokens in exchange for NFTs that entitle them to a share of platform revenue.

Velodrome has identified market demand within the Optimism protocol (stablecoins and LSD issuers) and aims to control these channels through incentives and replenish the liquidity of its token. Currently, veVELO has provided lockers with an annualized return of over 52% for a four-year lock. Although the fixed AMM model has lost its competitiveness with the launch of Uniswap V3, Velodrome has captured the core community and opened up new niche markets for liquidity.

2.2 Synthetix Ecosystem#

Synthetix is not the only OG DeFi protocol, but it is the first to be deployed on L2. There are now over $192.5 million worth of SNX staked on Optimism, with over $48.2 million in sUSD borrowed and lent. Many protocols are built on top of Synthetix to leverage the liquidity of sUSD (e.g., Kwenta, Lyra, Thales).

Synthetix has had a tough few months, with a noticeable decrease in fee revenue. But there are several positive developments to look forward to, such as their V2 compatibility and the upcoming launch of Synthetix V3.

2.3 The Lattice Ecosystem#

Lattice is a team developing on-chain games based on the OP Stack. Lattice has developed two games: OPCraft, a Minecraft-like game, and Sky Strife, a combat game.

OPCraft currently only has a demo developed for two weeks, and it is scheduled to launch at the end of 2023, just like Sky Strife. Given the appeal of games to both crypto natives and the general public, Lattice's releases serve as important channels to bring users into the Optimism ecosystem.

3. Future Outlook#

3.1 Growth Catalysts#

Currently, Optimism is about to experience three major positive developments that should contribute to its growth in the coming months.

First, a 10 million OP airdrop is scheduled for February (worth $30 million at current prices). OP will be distributed to various stakeholders in the ecosystem through the Retrospective Public Goods Fund (RPGF), which will be decided by the members of Optimism's Citizen House. Citizen House is one of the two governance bodies within Optimism, and membership is passed through soulbound NFTs.

The OP allocated to projects through the RPGF can be seen as a reload of incentives and, if the market continues to rise, it can attract more users and liquidity to the network. In the long run, Optimism's use of RPGF and its experimental governance model can help attract idealistic, long-term-oriented developers to join the network.

Second, the Bedrock network upgrade. The upgrade aims to reduce transaction costs and improve transaction speed. Bedrock will also help improve the modularity of Optimism by making it easier for rollups to transition from optimistic rollup to zk-rollup. The proposal for the Bedrock upgrade is currently going through the L2's voting governance process.

Third, the increasing popularity of the OP Stack. Games like OPCraft are developed using the OP Stack framework, and other projects are starting to leverage this technology as well. One example is Aevo, a decentralized options exchange developed by Ribbon. Aevo is an order book-based options exchange and will launch its own custom L2 in the coming months.

3.2 Risks#

Optimism has undoubtedly carved out a niche market and is about to experience many positive catalysts. Its ecosystem is growing, but in the face of increasing competition, it is worth considering where Optimism is heading in the future. Optimism's incentives have proven successful in attracting users, liquidity, and dapps to the network, but we have reason to question whether they have distributed these incentives in a way that maximizes their ROI.

As of now, Optimism has distributed $69.9 million in incentives. However, since November 2022, Optimism's share of TVL in L2 has decreased from 46.6% to 35.5%. Its share has been almost entirely swallowed by Arbitrum, which has increased its market share from 49.8% to 62.1% during this period. Despite having a large arsenal in its treasury, it seems that Optimism has distributed a significant amount of tokens without new users and capital entering the network, without becoming the dominant L2 in DeFi.

With the launch and introduction of their own tokens on networks such as StarkNet, Fuel, Polygon's zkEVM, Scroll, and Arbitrum, the competition in the L2 space will intensify. The landscape in other areas is still uncertain, but we have reason to doubt whether Optimism will forever remain outside the top 8 in DeFi.

However, competition is not the biggest risk that Optimism faces today.

Like Arbitrum and other L2s, the biggest long-term threat to Optimism's success is network-level centralization factors. According to L2 beat, Optimism has several key centralization factors, such as the lack of fraud proofs, a centralized sequencer, the use of upgradable contracts, and the lack of a mechanism for block challenges in case of verification failure. Most L2s have appropriate safeguards in place to minimize the risk of user funds loss. Although they have been in use for several years, rollups are still a relatively new technology in the long history.

It is absolutely crucial for Optimism to achieve decentralization as soon as possible while ensuring network security because any malicious action by a centralization factor could have a catastrophic impact on the growth prospects of the network.

3.3 Conclusion#

Optimism's ecosystem is growing, and many upcoming catalysts can help it maintain growth for a period of time. With only about 5% of the OP supply released into circulation, its FDV is inflated in the short term, but in terms of usage, it seems to have maintained an equivalent valuation to other non-Ethereum L1 and L2 networks.

Undeniably, Optimism's lead can largely be attributed to token incentives, which have helped establish its clear leadership position alongside Arbitrum. However, with increasing competition, we have reason to question whether Optimism has used too much ammunition at the wrong time in order to attract the maximum number of users and liquidity.

Without considering the aforementioned perhaps unreasonable incentives and centralization issues, the breakthrough for Optimism may lie in the OP Stack. If the OP Stack becomes the standard for developing custom L3s, Optimism will benefit from all the different rollups using the framework.

Optimism may not be the leading L2, but there are still many reasons to be optimistic about its future growth prospects.