Modular Blockchains and Rollups: The Future of Ethereum and Beyond

Introduction to Modular Blockchains 

Before we jump in, it’s important to grasp why blockchain modularity and rollups are even sometimes discussed together. The main idea here is that both concepts focus on separating different blockchain functions to boost performance. You’ll get it, just hang around a little longer. 

Let’s start with monolithic blockchains, like the early versions of Ethereum. These blockchains manage all key components—consensus, smart contracts, data availability, transaction execution, and settlement—within a single-layer architecture. But while this integrated structure is effective, it also leads to scalability limitations since all tasks  are processed within a single layer, relying on the same set of nodes, which can create bottlenecks. 

Now, contrast that with modern modular blockchains. They take a different approach by breaking down core functions into specialized layers, where different tasks are executed on different nodes. For instance, Settlement Layer finalizes transaction results, establishing a trust-minimized ledger, often in conjunction with execution on rollups. Its primary role is to provide proof verification and dispute resolution for rollups. Data Availability Layer and Consensus Layer guarantee that transaction data remains accessible for off-chain processing and validation, because this is crucial for the network to agree on the current state of the blockchain. Smart Contracts are applications that operate on the execution layer, which handles transaction processing for dApps. And Execution Layer is responsible for processing transactions and smart contracts, ensuring that all computational tasks are efficiently carried out. Rollups are a scaling solution that executes transactions off-chain and posts data to an on-chain execution layer. 

That said, rollups, such as Arbitrum and Optimism, emerged as scaling solutions to support monolithic blockchains like Ethereum by handling execution off-chain. However, they've become essential in this modular approach, often serving as a separate layer that processes transactions and publishes data back to Layer 1. This close relationship between rollups and modular architecture is why they’re frequently discussed together when exploring the future of blockchain scalability. We’ll delve deeper into this topic in the following sections! Stay tuned. 

Monolithic vs Modular Blockchains 

So, now you already know how monolithic blockchains and modular blockchains represent two different architectural approaches to blockchain design, each bringing its own set of strengths and challenges. But instead of talking just theory, let’s illustrate the differences and compare some real-life modular blockchains with monolithic ones.  

Starting with monolithic blockchains like Ethereum before the Ethereum 2.0 upgrades, the Ethereum network faced scalability issues due to high gas fees and slower transaction speeds as a result of network congestion. As Ethereum grew, congestion became a significant issue, because in monolithic structures, each node processes and stores all transactions, limiting throughput and increasing difficulty in scaling. Since then, many improvements have been made to address these challenges. The transition to Ethereum 2.0 introduced the proof-of-stake (PoS) consensus mechanism, we’ve seen a surge in Layer 2 scaling solutions like Optimism, Arbitrum, and zkSync, however, the modular blockchain paradigm is relatively new and one of the latest developments as of 2024. A modular blockchain, like Celestia, separates blockchain functionality into layers, such as execution and consensus & data availability. This means that not every node now needs to handle all tasks anymore. Instead, nodes can specialize in a single layer, reducing the overall load on the network. 

Understanding Rollups 

Rollups often present a robust scaling solution, while still maintaining a connection to the main blockchain for security and data availability. Essentially, they "roll up" multiple transactions into a single batch, reducing the operational burden on the base layer responsible for consensus and data availability. 

How Rollups Work 

If you're only sending small amounts of cryptocurrency and don't mind waiting for a few minutes or hours for your transaction to be confirmed, you might not need to use a rollup. However, if you're dealing with larger transactions, require faster confirmation times, or need to process a high volume of transactions, rollups can be a significant advantage. 

As of October 7, 2024, gas fees on such Ethereum rollups like Optimism, Arbitrum, and zkSync were typically between 0.001 and 0.02 ETH, 0.0015 and 0.015 ETH, and 0.001 and 0.005 ETH, respectively. So, if you've got assets on Ethereum and want to save on fees or time, using a rollup is a solid choice. Here's how it usually goes down: You log into your wallet, like MetaMask or WalletConnect, and if your assets are on Ethereum mainnet, you bridge them to a rollup, such as zkSync. After that, you can send transactions directly from one zkSync address to another. Simple and efficient! 

But how does everything work under the hood of a rollup?

1. Off-Chain Processing: If we’re talking about modular blockchains like Celestia, most of the off-chain computational tasks, like transaction execution and smart contract processing, occur on the rollup layer, easing main chain congestion. Instead of executing every transaction directly on the main blockchain, rollups aggregate a large number of transactions into a single batch, reducing the computational load. 

2. Batch Submission: Once the transactions are processed off-chain, they are bundled into a single batch and submitted to the main blockchain. This submission is minimal in size and only contains enough data for verification, which is significantly smaller than running each transaction on the base chain individually.

3. On-Chain Data Availability: Although execution happens off-chain, data must still be accessible for verification and consensus purposes. Rollups   post compact data proofs, either Validity or Fraud Proofs, to ensure transparent transaction verification on the main chain. There are two types of rollup proofs: Validity Proofs (used by ZK-Rollups) and Fraud Proofs (used by Optimistic Rollups). 

4. Layer 1 Security Dependency: Rollups still rely on the security and consensus of the Layer 1 chain. If the rollup is optimistic, anyone can challenge the validity of transactions via fraud proofs. In ZK-rollups, the validity proof ensures that only valid transactions are accepted. We’ll get to that in just a second, hang tight!

5. Transaction Finality: Once the batch of transactions is confirmed on the Layer 1 blockchain, the transactions in that batch are considered final. Depending on whether the rollup is optimistic or ZK-based, finality can happen almost immediately. 

Now, time to talk about different types of rollups, because you probably have questions.

Optimistic Rollups Explained 

Optimism and Arbitrum are well-known implementations of optimistic rollups, but other noteworthy solutions include Base, Metis, and Cartesi. Other noteworthy solutions include Base, Metis, and Cartesi. Optimistic rollups are a type of Layer 2 scaling solution designed to enhance Ethereum's throughput by processing transactions off-chain. Optimistic rollups assume transaction validity by default, hence the term “optimistic” to denote this verification approach. Instead of verifying every transaction on-chain, optimistic rollups submit a transaction batch summary to Ethereum Layer 1, minimizing Layer 1 computational load and storage, reducing the computational and storage burden on Layer 1. This is quite different from zk-rollups, which rely on cryptographic proofs to confirm transaction validity. 

The key to the security model of optimistic rollups lies in fraud proofs, which allow users to challenge invalid transactions during a set dispute period. After transactions are processed off-chain, a window of time—typically a week or more—is provided during which anyone can challenge a suspicious transaction by submitting a fraud proof. If fraud is detected, the system re-executes the transaction to check its validity. This system balances scalability and security by allowing most transactions to proceed without immediate verification, while maintaining the ability to revert malicious actions. 

Optimistic rollups like Arbitrum and Optimism offer scalability benefits by reducing gas fees and increasing transaction throughput, making them  viable for dApps focused on reducing gas fees and enhancing transaction throughput. However, the downside is the longer finality time due to the challenge period, making it less ideal for time-sensitive operations.

ZK Rollups: A Deep Dive

Zero-Knowledge (ZK) rollups offer an advanced scaling solution, leveraging cryptographic proofs for transaction validation and efficiency, particularly in the context of Ethereum. Unlike optimistic rollups, which assume transactions are valid until proven otherwise, ZK rollups use cryptographic proofs to ensure that all transactions in a batch are indeed valid.  The use of cryptographic proofs positions ZK rollups as a secure choice, especially for applications where immediacy and high-trust finality are essential. 

The operation of ZK rollups involves several key stages. First, similar to optimistic rollups, ZK rollups handle transactions off-chain. However, the main difference lies in their approach to validating these transactions: ZK rollups generate validity proofs (zk-SNARKs) for transaction batches, ensuring verified integrity before main chain submission.

Next, for every batch of transactions, ZK rollups create a compact cryptographic proof known as a zk-SNARK (Zero-Knowledge Succinct Non-Interactive Argument of Knowledge). This proof verifies the validity of all transactions in the batch without disclosing any underlying data or requiring the main blockchain to execute each transaction. 

After generating the zk-SNARK, only this proof and a small amount of batch-related data need to be sent to the main blockchain. This significantly reduces the data load and the gas fees involved in processing transactions. Once submitted, the main blockchain verifies the zk-SNARK proof against the provided data. If the proof checks out, the entire batch is deemed valid without further examination, resulting in near-instant finality. This quick verification process greatly enhances the user experience, particularly for applications where timing is crucial.

In terms of security and trust, ZK rollups benefit from the underlying security of the Layer 1 blockchain (like Ethereum) and maintain a high level of confidence in transaction validity due to the cryptographic proofs involved. This approach mitigates the risk of fraud that may occur during the challenge period associated with optimistic rollups.

The benefits of ZK rollups are notable. They significantly boost scalability by increasing transaction throughput while lowering gas fees, as they efficiently compress multiple transactions into a single proof. With zk-SNARKs facilitating near-instant finality, they are particularly suitable for applications requiring immediate transaction confirmation, such as payments and trading. Additionally, ZK rollups enhance user privacy, as the specifics of individual transactions remain hidden in the proofs submitted to the main blockchain, making them ideal for applications demanding confidentiality.

Prominent ZK rollup solutions, including zkSync and StarkWare, have become integral to the Ethereum ecosystem due to their efficiency. These solutions have gained traction in the Ethereum ecosystem for their efficiency and innovative use of zero-knowledge technology. As of October 2024, gas fees for zk-rollups like zkSync range from 0.001 to 0.005 ETH, making them an attractive option for users looking to minimize costs while enjoying faster transaction speeds.

The Concept of L2-MEV 

MEV, or Maximum Extractable Value, refers to the profits obtained by manipulating transaction ordering within blockchain networks. Since it was formally defined in the “Flash Boys 2.0” paper in 2019, MEV has become a pressing concern, particularly with the rise of L2 solutions, such as rollups. Arbitrage bots aim to capture MEV in DEX trades, while miners and validators may exploit transaction ordering for profit.

The sequencer plays a central role in MEV extraction within rollups, managing transaction ordering and block submission to Layer 1. And the problem is that currently most Ethereum L2 rollups have a single, centralized sequencer that controls transaction ordering. This centralized  sequencer holds considerable influence over MEV extraction, affecting transaction ordering and potential profits. 

However, the potential for MEV extraction varies across different rollups based on their sequencing mechanisms. For instance, in Arbitrum’s First Come, First Served model, transaction sequencing follows the order of receipt, limiting MEV manipulation opportunities. In contrast, Optimism’s sequencer has more discretion over the order of transactions, providing more room for potential MEV extraction. That said, Optimism has safeguards, such as time windows for including transactions, which restrict the sequencer’s ability to fully exploit this power. 

Given Ethereum’s rollup-centric roadmap, which envisions that 99% of all activity will eventually occur on L2s as rollups mature, designing rollups with mechanisms to mitigate the MEV extraction race will be crucial for ensuring fairness and efficiency across the network.

Impact of L2-MEV on Ethereum 

Layer 2 adoption has reshaped the Ethereum ecosystem, especially concerning Maximum Extractable Value (MEV) dynamics. As Ethereum continues to scale through rollups, the dynamics of transaction sequencing and MEV extraction shift to these L2 networks, where sequencers—centralized or decentralized—play a pivotal role in determining the order of transactions. This has several implications for Ethereum as a whole:

1. Scalability with Trade-Offs
   L2 solutions like Optimism and Arbitrum significantly enhance Ethereum’s scalability by reducing the load on the Layer 1 blockchain. However, the centralization of sequencers creates a bottleneck where the potential for MEV extraction can increase. While Ethereum’s rollup-centric roadmap promises greater scalability, the challenge lies in balancing this with fair transaction sequencing. Unchecked centralized sequencers may exploit transaction ordering, undermining Ethereum’s decentralization ideals, potentially driving up costs or favoring specific transactions—undermining the decentralized ethos of Ethereum.

2. Decentralization of Sequencers
   One of the ongoing efforts to mitigate MEV extraction involves decentralizing the role of sequencers. Introducing decentralized sequencing methods or competitive sequencer systems can mitigate MEV risks and align with Ethereum’s decentralization goals, rollups can reduce the likelihood of MEV abuse. This is especially critical as Ethereum moves toward greater adoption of L2 solutions. Such decentralization would align with Ethereum’s long-term goal of decentralization and improve the network’s overall security.

3. Economic Incentives and MEV Auctions
   As MEV becomes an increasingly recognized issue, some L2s are exploring the implementation of MEV auctions, where the profits from MEV extraction are distributed to validators or back to users rather than captured solely by the sequencer. This mechanism could realign economic incentives to reduce MEV’s negative impact, ensuring that value flows back to the broader Ethereum ecosystem rather than being concentrated in the hands of a few.

4. User Experience and Gas Fees
   L2-MEV extraction may lead to higher transaction fees and delayed finality, particularly on rollups with centralized sequencers manipulating transaction order, particularly on rollups with centralized sequencers that can manipulate transaction ordering for profit. Conversely, more decentralized or well-designed rollups that minimize MEV extraction can offer a smoother, cheaper, and more secure experience. Lower gas fees on L2s could also help Ethereum achieve broader adoption, but the challenge remains in ensuring fairness in transaction ordering across these solutions.

5. Security Considerations
   As more transactions move to Layer 2,  Ethereum’s security will increasingly hinge on the MEV management approaches within Layer 2 rollups. Poorly designed rollups that allow excessive MEV extraction could erode trust in the network, while  Rollups with fraud/validity proofs, decentralized sequencers, and MEV limitations will bolster Ethereum’s security and decentralization.

That is,  while L2 solutions like rollups present a powerful path forward for Ethereum’s scalability, they introduce new challenges related to Ethereum L2-MEV. The success of Ethereum’s rollup-centric future hinges on addressing these challenges through decentralization, transparency, and economic realignment, ensuring that Ethereum remains both scalable and fair.