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A Market Analysis of Layer 2 Blockchain Bridges

This research paper was my individual final assessment for my final-year applied finance project (FIN498).

Key Objectives

Overall Purpose:

To analyse the strategic relevance and market potential of a chosen DeFi technology / industry.

This can be split into 4 objectives:

1

Appraise a chosen DeFi industry - its incumbents and the problems they are tackling.

2

Analyse the uniqueness, business model, potential constraints, risks and challenges of a chosen DeFi project.

3

Provide a market analysis of the chosen DeFi industry and the relative positioning of your chosen project.

4

Assess why the chosen DeFi project will outperform its competitors OR help to build an ecosystem in the future.

Approach and Key Insights

The key difficulty of this project is its breadth - there are many topics we can choose, and I control the structure and content of the report.​

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Hence, I used the following steps to approach this project:

Process

1. Identify a DeFi technology and project of my interest

2. Research on L2 Bridges

  • What is it?

  • How and when was it developed?

  • What are the problems to be addressed?

  • What's the significance/importance of solving these problems?

3. Identify 2 key incumbents

  • What kind of protocols are they?

  • How do they work?

  • Key features, weakness, statistics

4. Research on Connext

  • What it is; its infrastructure

  • Key value proposition

  • Fees and economic incentives

  • Partnerships

  • Potential risks

5. Analyse the L2 bridges market

  • Identify industry methods for evaluating L2 bridges as basis

  • Identify supporting metrics and extract relevant data for analysis

6. Assess how Connext builds an ecosystem based on my analyses.

Decisions Made / Key Insights

Chosen Technology:

Layer 2 Blockchain (L2) Bridges

My group researched L2s in a prior project, so I decided to expand on that by looking at the bridging protocols connecting L2s.

Chosen Project:

Connext

Discovered Connext through the previous L2 project. It is an interoperability protocol, so my theory was that it aligns with building an ecosystem.

From my research, the key tenets of L2 bridges are:

#1:

Scalability and Interoperability

Pivotal challenges that L2 bridges aim to solve.

#2:

Security

Cross-chain bridge hacks are the top security risk in DeFi so security is of utmost importance.

Reasons for my choices:​

Incumbent #1:

Portal Bridge

  • Highest value locked with 1 proven hack

  • Illustrates security trade-offs in trusted bridges

Incumbent #2:

Across Bridge

  • Prioritises capital efficiency and liquidity - key consideration for L2 bridges

  • Shows the delicate balance in operational priorities for L2 bridges

Key

Insights

  • Unique position as a cross-chain app development and L2 bridging ecosystem

  • Trustless protocol that leverages the security of connected blockchains

  • Transaction fees are fixed at 0.05% with incentives to promote faster transfers

  • Potential risk of fund loss, censorship, and external blockchain exploits

Basis of Analysis:

4 Pillars of Bridges

  1. Capital Efficiency

  2. Security

3. Latency

4. Cost

To analyse latency and cost, I simulated transactions on various L2 bridges (1 ETH from Arbitrum to Optimism) and collected data on the transaction fees and estimated transaction time (minutes).

Considerations

  • How it stands out

  • Evaluate Connext using 4 Pillars of Bridges

  • Final conclusion

Compile information and write report

Skills Applied

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Critical Thinking, Interdisciplinary Thinking, and Curiosity

  • Genuine curiosity about L2 bridges led to comprehensive research where I used a funnel-like approach to understand the industry and protocols for better data collection and analysis

  • This topic was not covered in my course materials.

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Digital and Data Literacy

1

Data Processing and Analysis:

  • Used Excel's Power Query to load data from L2Beat and CoinMarketCap for analysis.

2

Use of Generative AI (ChatGPT) to:

  • Understand objectives and refine research scope

  • Ensure content coherency and flow

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Communication

  • Used a standardised design with Connext's branding for all collaterals created

  • Used typography, visual elements, and graphs to better convey key insights in the infographic

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Adaptability

Problem:

Lack of data to analyse latency and cost of L2 bridges

Solution:

Simulate transactions across different L2 bridges to collect data on cost and time taken per transaction.

"Send 1 ETH from Arbitrum to Optimism"

Reflection

How I would like to improve

Most Proud Of:

Creating the market analysis infographic using my skills in fintech, data analytics, and graphic design.

 

A culmination of almost everything I practiced in university. 

Main Struggle:

The L2 industry is quite novel as solutions only emerged around 2020.

 

There was a lack of established, academic research and the technicalities were very difficult to understand.

What I Want to Improve On:

Clarity: I believe my report content can be further refined to be more concise and easier to understand.

Time Management: The research process was laborious and intensive - I would like to explore how I can refine my research methods without compromising research depth.

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