Since we announced layer2.finance, we have received more than a few requests for us to write an ELI5 (Explain like I am 5) article about the core concepts of layer2.finance, how it lowers the costs of accessing DeFi by 100X and if this additional layer makes it more complicated to use DeFi. We’ve heard our community loud and clear and so here is our explanation of layer2.finance using a fun analogy to help simplify the concepts and answer some of our community’s questions along the way.
DeFi City and Luxury Limo
One way to think about the entire DeFi ecosystem is to think of it as a city. In this city, your home is basically your cryptocurrency wallet. This DeFi city is pretty cool because it has all sorts of “money-making shops” that you can visit and “park” your money at to start earning 100X – 10,000X higher annualized yields compared to the traditional saving methods used by centralized banks. These “shops” are the DeFi protocols that we hear about all the time: like yEarn, Curve, Compound, Cream, Sushi Swap, Uniswap, AAVE, and Alchemix. In many cases, these shops have “partnerships” with each other and that’s really good for you: you can put your money in shop A, get back “parking validation” receipt (i.e. a proof paper) saying that you parked your money there and then take that receipt to shop B to get even more earnings! This “parking validation” is usually called LP (Liquidity Provider) tokens.
This all sounds super exciting but there is a small issue: the only way you can get around in this city is to hire some super expensive luxury limousine services. As an example: to get to a good old “PG13-rated” shop called Compound that gives you a 10% Annualized Percentage Yield (APY), it costs you about $250 per round-trip. This fee is the same no matter how much money you are taking with you to that shop.
This expensive limo fee is our analogy of the high smart contract transaction cost on Ethereum today.
For a multi-millionaire like Alice, who carries big bags of cash around the city, hiring the expensive limo service is not really a big deal: paying $250 on a million-dollar run is only a small 0.025% additional cost. For 10% APY, she can get that fee back in just a single day and start gaining profit on that sweet 10% APY in no time.
However, for Bob, a normal person like you or me, who may have somewhere around $2,000 to try “parking” in DeFi city,there is a big problem. Bob simply cannot afford the expensive limo service fee for chauffeuring him around. If Bob wants to “park” the $2,000 at the Compound shop like Alice, he will have to pay the $250 limo fee. Now, with the only $1750 left, he will only make $175 at 10% APY AFTER ONE FULL YEAR! That is a net loss of $75 for the whole year!
This is even more important for the people from underprivileged parts of the world who really need DeFi to help secure themselves from unstable financial systems.
How can we not be FURIOUS!? We moved all the way from “Traditional Finance Town” to DeFi City because it promised us “Open Finance for All with high APY” and to “Bank the unbanked.” Yet we find out that this is just another “rich-people-only town” with no place for us normal folk.
DeFi totally sucks.
Layer2.finance: The Public Transportation System of DeFi City
Before we give up on DeFi City, let’s calm down a bit and think about if DeFi City is indeed beyond redemption. Clearly all these Shops are not at fault: if you park your money there, they will faithfully provide the yield. The problem is clearly the limo-only transportation system of this city: the super-high layer-1 blockchain’s transaction fee. In real life, if we are looking for an economical solution to go from our home to shop A, it’s a no brainer that we should just create a public transportation system, like a subway!
This is exactly what layer2.finance is: the world’s first DeFi Public Transportation Service. You can think of layer2.finance is basically a subway network under DeFi City (the layer2 rollup scaling platform). Now, instead of being forced to hail the expensive limo service to get to these DeFi shops individually, multiple people can take our public transportation solution and drastically reduce their costs. Here is a simple step-by-step breakdown:
- Buy a “metro pass”: send one low-cost transaction to move your funds from layer1 blockchain to layer2.finance’s rollup chain. Note that in layer1, your funds are moved to a common fund pool.
- Get to the subway station and wait at the right platform: click a button to send a layer2 transaction saying that “I want to send $200 to the Compound protocol.”
- Board the subway with everyone else heading to the same shop and get to your yield-earning shop: layer2.finance will aggregate all the fund allocation demands together and send one single layer1 transaction to allocate funds in the shared funding pool. Everyone on that subway shares in the single layer1 transaction fee.
- When you want to move your funds to some other yield-earning shops, even ones with higher return and higher risk, you can simply repeat steps 2, 3, and 4.
You pay much cheaper DeFi costs because instead of paying one full transaction cost (the limo fee) for every single fund allocation demand, layer2.finance essentially splits the cost of one single layer1 fund allocation transaction across all the users on board the same layer2 subway train. If there are 100 people on the train, you can easily lower the cost by 100X. With this, it is possible to aggregate many smaller fund allocation demands to be just as strong as the millionaires using the layer1 blockchain.
But wait! How can we be sure that when we get on the subway, we won’t be kidnapped by some evil train operator? Is layer2.finance just a centralized entity holding custodianship over all of the users’ funds?
Rest assured! This is where the cool technology from Celer and layer-2 rollup, come into play. Without going into too much technical detail, this layer-2 scaling technology allows you to maintain 100% self-custodianship the entire time. There is just no way for the train operator to take your money and run. Theoretically, the worst case scenario is that the train may halt halfway and you’ll need to finish the journey yourselves, but that will not be something that happens since the “train operator” is not a single entity but the entire decentralized and reliable Celer State Guardian Network.
This seems to be too good to be true. So what’s the catch?
The public transportation system analogy continues to ring true here as well: just like taking the subway or train, you need to wait at a platform with other people. So instead of immediately injecting your funds to any DeFi protocol anytime you want, there is always a delay ranging from a few hours to a day in order to aggregate all of the users’ together and save on costs for everyone on the train. You can be lucky and get to the train station right before it comes or be unlucky and get there only to find out that the last train has just left. However, given the 100X cost saving potential and the alternative of not being able to use DeFi at all, this is a very reasonable tradeoff.
More importantly, just like in the real-world, as the layer2.finance public transportation system grows and as more and more people use it, the frequency of the subways and trains will increase accordingly. So the waiting time between them will become less and less, eventually they can be even faster than L1 transactions in certain cases! Think about New York City during their rush hour, would you rather take the $5 red line to cross town in 20mins or hail a $100 taxi and be stuck in traffic for 2 hours. There can even be a “rush-hour schedule” that dynamically adjusts the frequency of trains departing the station based on demand.
It also makes sense that modern, low-cost, and reliable public transportation is not only beneficial for the existing residents of the DeFi City, but will actually attract more people into the city and form a positive feedback loop of increased liquidity and efficiency for the entire DeFi ecosystem as a whole!
Expanding to a Global Transportation Network
Just like any public transportation system, you start by building a couple of “stations” and “routes” in the city, in this case: integration with existing L1 DeFi shops on Ethereum, and maybe simple strategies composing a couple of these DeFi shops together. As the number of users grow, more “stations” (i.e. integrations) can be added overtime.
Once the network effect is formed with a lot of users and liquidity in this system, new DeFi protocols will want to attract this valuable liquidity and will want to proactively build connectors to layer2.finance.
This public transportation is also not constrained to a single city (chain). With new layer2 chains, sidechains and other L1 chains popping up, layer2.finance can evolve into a cross-town and even global transportation network that connects to all DeFi protocol shops on different layer2 chains and layer1 chains via a single global network.
To sum it all up, layer2.finance serves as a robust DeFi Public Transportation System through which normal people can be united together into a force as mighty as any of the “big-whale players” in the ecosystem and enjoy the DeFi ecosystem in a simple and cost-efficient way.
Only through the People’s Power, we can truly achieve the vision of the People’s DeFi. Stay tuned for the boarding call!