Author: BTX Research Source: medium Compilation: Jinse Finance, Shan Ouba

Summary

1. The Arbitrum project is supported by a strong academic team with a deep understanding of the theory and practice of blockchain technology. This knowledge and experience uniquely positions them to address the scalability challenges faced by Ethereum and other blockchain platforms.
2. The Arbitrum ecosystem is growing rapidly, especially in the fields of DeFi, DEX and GameFi. Notable projects include Camelot, Pendle Finance, Radiant Finance, and GMX in the DeFi and DEX space, and Treasure Dao in the GameFi space.
3. Major Ethereum upgrades, such as the upcoming Cancun upgrade, are major events in the Web3 space. These upgrades typically trigger a wave of interest and development in the Ethereum ecosystem, and Arbitrum, as a Layer 2 solution for Ethereum, will benefit from these advancements.
4. Using the Mcap/TVL ratio as an indicator, we estimated the token price for the upcoming release and during the Cancun upgrade, with a potential future price range of $1.59 to $11.08.

1. Introduction to Arbitrum

1.1 Background

Arbitrum is an innovative Layer 2 (L2) scalability solution developed by Offchain Labs, which proposes a unique solution to enhance the performance of the Ethereum network. This is achieved using Optimistic Rollup technology, supported by a novel multi-round interactive challenge protocol. Currently, there are two different Arbitrum chains on the Ethereum mainnet: Arbitrum One, which is based on Optimistic Rollup, and Arbitrum Nova, which operates according to the AnyTrust principle. Both of these mechanisms aim to reduce dispute resolution costs on Layer 1 (L1) chains by segmenting the fraud-proof process.

Equivalent to the Ethereum Virtual Machine (EVM), Arbitrum is built on top of Geth, a highly flexible virtual machine capable of executing any Ethereum bytecode. Arbitrum also does a similar calculation for Gas costs, similar to Ethereum.

Arbitrum's architecture adds an additional level of validation by requiring validators to stake on proposed new states and propose blocks. More specifically, the validator is responsible for retrieving transaction data from the sequencerInbox contract, running the transaction on the local WebAssembly Virtual Machine (WAVM), and then updating the local L2 state. Thereafter, validators stake the new state, propose a new block and enter a 7-day challenge period before finally confirming the block.

The distinguishing feature of Arbitrum is its anti-fraud mechanism. While many systems, such as Optimism, require comprehensive execution traces to prove fraud, Arbitrum advocates a more granular approach. The concern is that a full interaction could lead to fraud prevention containing a large number of transactions and exceeding the gas limit. As a solution, Arbitrum argues that a single incorrect instruction execution can initiate fraud prevention without executing all instructions. This allowed Arbitrum to break down fraud prevention into several steps, allowing the system to provide evidence of misbehavior by the sorter and save costs simply by proving that the sorter was wrong to execute a specific order.

1.2 Team Background

The Arbitrum project is developed by Offchain Labs, a team led by experienced academics and professionals in the field of computer science.

The co-founder team consists of former White House deputy chief technology officer Ed Felten, a professor of computer science at Princeton University. In addition to Felten, the team includes Steven Goldfeder and Harry Kalodner, both Ph.D. Arbitrum was founded as a computer science student at Princeton University.

The strong academic background and professional knowledge enable the Offchain Labs team to have a deep understanding of the theory and practice of blockchain technology. This combination of knowledge and experience uniquely positions them to address the scalability challenges of Ethereum and other blockchain platforms.

1.3 Decision Making Timeline

August 2018: Arbitrum introduced the Arbitrum Virtual Machine (AVM) at the Usenix Security Conference, proposing to execute transactions off-chain.

August 2021: Mainnet launch of Arbitrum One, a complete Optimistic Rollup solution.

September 2021: Arbitrum Sequencer experienced a brief offline period due to transaction overload.

October 2021: The team proposes Arbitrum Nitro, an upgraded version of Arbitrum One, plans to convert AVM to Web Assembly (WASM), and replace the EVM simulator with Geth for better performance and EVM compatibility.

March 2022: AnyTrust Chain was proposed to store transaction data outside the chain to reduce transaction fees and achieve faster speed, mainly targeting the gaming industry.

August 2022: Arbitrum Nova mainnet launch based on AnyTrust technology.

August 31, 2022: Arbitrum Nitro mainnet goes live, offering lower transaction fees and better EVM compatibility.

February 2023: The development team announces that a new programming language, Stylus, will be coming later this year for Arbitrum One and Arbitrum Nova.

March 2023: $ARB token listed on most CEXs and DEXs.

1.4 Fundraising Information

2. Decision Ecosystem

From the chart, we can observe that DeFi, DEX, and GameFi on Arbitrum are developing extremely rapidly

2.1 Decentralized Finance

2.1.1 Camelot

Camelot is an ecosystem-focused, community-driven decentralized exchange (DEX) that allows liquidity pool builders and users to leverage its customizable infrastructure to achieve deep, sustainable and adaptable custom liquidity . Camelot supports the launch of new protocols on Arbitrum, providing tools to initiate, bootstrap and sustain growing liquidity.

2.1.2 Pendle Finance

Pendle Finance is an innovative, permissionless DeFi yield trading protocol that enables users to efficiently manage their yield. It allows users to fork off and buy the yield generated by staking ETH at a discount. Pendle uniquely converts Yield Tokens into Standardized Yield Tokens (SY) and splits them into two distinct types: Principal Tokens (PT) and Yield Tokens (YT). These tokens can be traded using a custom V2 Automated Market Maker (AMM). In this system, PT operates like a zero-coupon bond, and YT functions like a coupon payment, providing a unique approach to yield management in the DeFi space.

2.1.3 Radiation Finance

Radiant Finance is a groundbreaking lending protocol built on top of the LayerZero architecture. Originated from Arbitrum, it has now been extended to the BSC public chain to create a cross-chain lending agreement. This allows users to deposit on the Arbitrum public chain as well as borrow and withdraw assets on other public chains such as Polygon, ETH, and BSC. Previously, such complex operations required the simultaneous use of multiple lending protocols and cross-chain bridges. Radiant Finance simplifies this process by providing a one-click solution.

As we move towards the future of multi-chain coexistence, we need to solve the problem of liquidity fragmentation between different public chains. Radiant Finance solves this problem by allowing users to move freely between public chains. This feature sets Radiant Finance apart from mainstream lending protocols like Aave and Compound, which currently do not offer this feature.

2.1.4 GMX

GMX is a decentralized exchange (DEX) that specializes in spot and perpetual contract trading, especially derivatives trading. GMX was initially launched as Gambit on the BSC chain, and later transitioned to Arbitrum and extended its support to the Avalanche (AVAX) chain. Unlike platforms such as dYdX and Perpetual Protocol that utilize order book or AMM models, GMX uses a global liquidity model. This model allows users to provide liquidity not by providing two tokens (such as ETH/USDT) at a ratio of 1:1, but by directly purchasing and pledging the liquidity token GLP issued by GMX to provide liquidity. By staking GLP, users effectively participate in the market making of GMX.

2.2 GameFi

2.2.1 Treasure Dao

Treasure aims to create a "decentralized wonderland" consisting of a series of on-chain games. These games are connected to each other through the interoperability of in-game assets and using Treasure's native token MAGIC as a shared currency. The platform hosts a variety of popular games, including strategy games like Bridgeworld, role-playing games like The Beacon and Smolverse, and resource management and strategy games like Realm.

3. Potential Hot Narrative

3.1 Cancun upgrade

A major Ethereum upgrade is always a noteworthy event in the Web3 space. The Shanghai upgrade in the first half of this year triggered a wave of LSD Summer. At ACDE#163 3, the scope of the Cancun upgrade was finalized. Cancun upgrades include EIP 4844, EIP 1153, EIP 4788, EIP 5656, and EIP 6780 (a list of included EIPs can be found in cancun.md 87), most notably the scaling-focused proposal EIP-4844

3.1.1 Data availability is the key bottleneck of scalability

In aggregated transactions, costs are divided into execution, storage/state, and data availability. The first two costs occur on the Rollup network and are only a small fraction of the total cost. A significant bottleneck is the cost of data availability, which involves publishing data to Layer 1 (L1).

Data availability is critical because it allows anyone to reconstruct the state without permission. The scalability provided by Layer 2 (L2) is achieved by separating execution checks and data security. This separation allows us to synchronize and fetch data to verify state without being directly affected by the sequencer.

Currently, rollups upload data to L1 as calldata, which is expensive and inefficient. Therefore, methods such as calldata compression and EIP-4488 were introduced to reduce the cost of calldata from 16 gas per non-zero byte to 3 gas.

However, using calldata is not sustainable because it imposes unnecessary legacy costs on L2. The EIP-4844 proposal allows us to prune data, because according to the proposal, data only needs to be available long enough for an honest network participant to reconstruct the full state and challenge the sequencer.

**3.1.2 What is EIP 4844? **

EIP-4844, also known as Proto-Danksharding, is a proposal that aims to lay the foundation for a complete Danksharding specification without any immediate implementation of sharding. Under this model, all validators and users are still responsible for directly verifying the availability of all data.

Blob carry transactions: The main innovation introduced by Proto-Danksharding is a new type of transaction, the Blob carry transaction. Similar to regular transactions, transactions that carry blobs carry additional data called blobs. These blobs are large in size (~125 kB) and are more cost-effective than an equivalent amount of call data. However, the Ethereum Virtual Machine (EVM) can only observe commitments to blobs, not the blob data itself.

Blob carrying transaction operation process

During this process, the Sequencer initially provides the data, which is then hardened on Layer 1 (L1). Next, the blob sidecar is extracted from the blob transaction, and the execution within the blob transaction is carried out in the execution load. Subsequently, the data required for aggregate status verification is relocated into a separate database. This allows Layer 2 (L2) validators to access, download, and sync these sidecars with L2, ensuring seamless operation of the network.

Two salient features of blob carry transactions

• They cannot be used for contract reading.
• The value contained in the blob is set to be deleted by the consensus layer nodes after one month. Traditionally, transactions consume block space. However, with the advent of Layer 2 (L2), Layer 1 (L1) becomes the data layer that acts as L2, causing Calldata to take up more block space. Timed deletion of blob data provides an effective solution to the L1 state inflation problem.

**3.1.3 How does the original Danksharding (EIP-4844) compare to EIP-4488? **

EIP-4488 is an earlier and simpler attempt to solve the same average-case/worst-case load mismatch problem. EIP-4488 does this with two simple rules:

• Calldata Gas cost reduced from 16 Gas per byte to 3 Gas per byte
• There is a limit of 1 MB per block, plus an additional 300 bytes per transaction (theoretical max: ~1.4 MB)

Raw sharding is a way to create a unique transaction type capable of holding cheaper, large, fixed-size chunks of data. The number of blobs per block is limited, and these blobs are not accessible from the EVM, but only their promises. The consensus layer (the beacon chain) rather than the execution layer stores these blobs.

The main practical difference between EIP-4488 and original sharding is the degree of change they induce. EIP-4488 seeks to minimize immediate changes, while the original shard now implements more changes to limit future modifications required to upgrade to a full shard.

Although implementing full sharding is complex, even with raw darksharding, this complexity is limited to the consensus layer. After the original danks sharding is implemented, no further work is required by the executive layer client team, rollup developers, and users to complete the transition to full sharding. Also, proto-danksharding separates blob data from calldata, making it easier for clients to store blob data in less time.

3.1.4 Main Benefits of EIP-4844

• Dedicated block space for data availability
• Reduced cost of layer 2 rollup
• Introduce full Danksharding forward compatibility
• ZK proof experiment

**3.1.5 What opportunities are worthy of attention? **

Rollup and Danksharding are Ethereum's only trustless scaling solutions for the foreseeable future, possibly indefinitely. Obviously, this will greatly benefit the entire Layer2 Rollup landscape. It is worth noting that Arbitrum, the topic we discuss today, also occupies an important position in the Layer2 field.

4. Layer2 competitor analysis

4.1 TVL

The graph above shows the trend of Arbitrum Total Value Locked (TVL) year-to-date. Since the beginning of the year, we have observed a consistent growth trend. Arbitrum's TVL has grown from $978.92 million at the beginning of the year to $2.198 billion today, an impressive 125% growth rate. This represents a very rapid growth trajectory.

Comparing Arbitrum's data in the entire Layer2 Rollup ecosystem, whether it is the number of agreements or the total value locked (TVL), Arbitrum maintains a leading position, significantly ahead of the second-ranked Optimism.

From the perspective of the total value locked (TVL) market share in the Layer2 Rollup ecosystem, Arbitrum occupies a dominant position with a market share of 66.3%, significantly ahead of the second place Optimism at 25.6%. Another key on-chain metric to consider is the Mcap/TVL ratio. Currently, Arbitrum's Mcap/TVL is only 0.68, the lowest among all token-issuing Layer 2 Rollup ecosystems.

4.2 Users on the second layer chain are more active

Arbitrum’s on-chain active user data has consistently outperformed Optimism’s since the token launch. At times, it even surpassed the on-chain active users metrics of Ethereum and Polygon.

4.3 Compare on-chain transactions

From the graph, we can see that Arbitrum’s on-chain transaction volume has been overwhelming Optimism’s for nearly three months, sometimes even approaching Polygon’s transaction volume.

L2 Activity Sheet

When we compare the transaction volume of the entire Layer 2 ecosystem with the transaction volume on the Ethereum chain, we can observe that although the transaction volume on the Ethereum chain is still the highest, many Layer 2 are already close to Ethereum’s level. We can see that Arbitrum has a maximum daily transaction volume (TPS) of 31.64, ranking second in the top 10. Its transaction volume in the past 30 days reached 24.76 million, ranking first in the second-tier field.

4.4 What is the most profitable L2?

Profitability is also a key metric for evaluating projects. In this case, considering our already issued Layer 2 tokens, namely Arbitrum and Optimism, the L2 profit comparison graph shows that Arbitrum's revenue most often outperforms Optimism. In March 2023, when Arbitrum launched, its revenue peaked at 1,506 ETH. At least from the current data, Arbitrum is still the most profitable Layer 2.

Another point that cannot be ignored is that a large number of different types of projects are currently being developed on Arbitrum, enriching the ecosystem of Arbitrum. This has the potential to increase Arbitrum's trading volume and revenue. In addition, due to its potential promotional effect on Layers, the Cancun upgrade may promote the development of Arbitrum’s ecology to a certain extent, amplifying the growth of Arbitrum’s transaction volume and revenue.

4.5 Token Issuance Plan with Greater Investment Potential

Arbitrary Token Issuance Schedule

As shown in the provided chart, the Aritrum token issuance schedule shows that no new ARB tokens will be introduced into circulation between now and March 2024. It is highly anticipated that the Cancun upgrade will be completed by the end of 2023. This suggests that no new ARB tokens will be released while the entire narrative is developed and the Cancun upgrade is complete, removing any potential selling pressure. This condition creates a favorable environment for a healthy appreciation of the ARB token price.

Optimism Token Release Schedule

The chart above shows Optimism’s token launch schedule. We can see that between now and March 2024, approximately 251 million OP tokens will be released, representing 39% of the current token supply and 5.8% of the total issued token supply. The newly issued tokens are mainly composed of core contributors and investors.

Given the volume, the OP token will still face significant potential selling pressure from the massive token release during the Cancun upgrade. But fortunately, these tokens are not released all at once, but gradually over time, providing an opportunity for the market to gradually absorb the selling pressure. Therefore, there may not be significant price fluctuations during this period. However, before each token launch, there is still a certain opportunity for short selling.

5. $ARB token data analysis

5.1 Analysis of giant whales on the chain

$ARB Top 100 Traders Data

We did an in-depth analysis of the on-chain data of the top 100 traders of $ARB, details can be found in the attached link. Based on our statistical analysis of this data, it is clear that these significant on-chain entities have an average cost basis of $1.29 and an average return of -12.51%.

When disaggregating the earnings of the top 100 traders, we found that only 7% of these major on-chain traders were profitable, while 82% faced losses. However, despite widespread negative returns among these major holders, none of them have shown any signs of paring their positions over the past seven days. In fact, only 3 holders have reduced their stake in the past 30 days. This pattern of firm holding by the majority of traders despite the current market downturn indicates a general confidence in the value of the $ARB token.

We should also note that 35 of the top 100 traders (35%) chose to increase existing positions or open new ones in the past 30 days. We further examined the subset of traders who accumulated the most. For example, a trader identified as 0x3737 started consistently buying additional $ARB tokens after a significant price drop. The average cost of these additional purchases was approximately $1.07. Importantly, this trader added to his position without any evidence of selling or profit taking. Likewise, a trader named 0x83ee has an average acquisition cost of around $1.15, and these acquisitions account for 98.3% of its current holdings. Even during the price drop, the trader did not take any stop losses.

There are exceptions to these primary holders. For example, a holder identified as 0x92fe who sold some tokens on June 10, 2023 to reduce risk during a sharp price drop does not look like a committed holder. However, the trader continues to reaccumulate on June 30, 2023 at a price of approximately $1.14. The average acquisition cost for other major holders is between $1.00 and $1.15. These traders have not been prompted to sell their holdings due to falling prices. Quite the contrary, many have taken advantage of these lower prices to add to their positions, reducing the average cost basis.

5.2 Valuation

Project Key Indicators

Currently, the only function of ARB and OP tokens is governance, enabling holders to vote on the future direction of the project. However, past proposals have caused confusion and undermined the certainty of voting rights. From a revenue perspective, this only confirms that the Arbitrum protocol and project has some earning potential, but the ARB token has yet to demonstrate any value capture in this regard.

We currently lack robust valuation models for such governance tokens. Therefore, in this study, we use the Mcap/TVL (Market Cap to Total Value Locked) ratio, a key metric, for ARB's valuation. Also note that using the Mcap/TVL ratio for ARB valuation is only valid until the next $ARB token sale. As we highlighted before, a large release of tokens will occur during the next unlock period, which may trigger large fluctuations in the Mcap/TVL valuation, rendering the current valuation invalid.

$ARB valuation based on Mcap/TVL

Using the Mcap/TVL ratio as an indicator, we estimated the token price for the upcoming launch and during the Cancun upgrade, with a potential future price range of $1.59 to $11.08. Combined with our previous whale analysis, which found that whales had an average cost basis of around $1.29, and considering that typical accumulations by major holders during previous price crashes ranged from $1.00 to $1.15, it appears that even at conservative prices According to calculations, the estimated price is US$1.59, and major shareholders still have room for profit in the future.

For retail investors with less available capital, a viable strategy may be to purchase $ARB tokens at prices below or within the range of accumulation by major holders on average. This approach may result in a more favorable risk-reward ratio for retail investors.

Six, conclusion

In conclusion, Arbitrum represents a major advancement in Layer 2 scalability solutions for the Ethereum network. Its unique use of Optimistic Rollup techniques and a multi-round interactive challenge protocol demonstrates a novel approach to enhancing network performance and reducing dispute resolution costs.

The strong academic and professional background of the Offchain Labs team behind Arbitrum ensures a deep understanding of blockchain technology theory and practice. This knowledge and experience uniquely positions them to address the scalability challenges faced by Ethereum and other blockchain platforms.

The rapid growth of the Arbitrum ecosystem, especially in the DeFi, DEX and GameFi space, highlights the potential of the platform to foster innovation and growth in the blockchain space. Notable projects like Camelot, Pendle Finance, Radiant Finance, GMX, and Treasure Dao have demonstrated that it is possible to build a variety of applications on Arbitrum.

Major Ethereum upgrades such as the upcoming Cancun upgrade may further stimulate the development of the Ethereum ecosystem. As a layer 2 solution for Ethereum, Arbitrum has greatly benefited from these advancements. It is therefore crucial that stakeholders keep a close eye on the progress of Arbitrum and its ecosystem, as it is expected to play a pivotal role in the future of Ethereum and the wider blockchain space.