How does Arbitrum reverse the token downturn?

Written by: BEN LILLY

Compiled by: Shenchao TechFlow

Back in March, I stated that the Arbitrum airdrop on March 23 would be the final blow to Arbitrum's decline.

Arbitrum is a Layer 2 protocol aimed at helping scale Ethereum. The "final blow" refers to the upcoming airdrop of the native token ARB.

Since then, ARB's price performance has not been optimistic. Although the entire market has been suffering this year, ARB has been particularly bleak. Last Monday, ARB hit an all-time low of about $0.74. Whales and market makers sold off tokens at a loss. Some market makers recently sold 21 million ARB for a loss of $8.15 million. Last week, ARB's main competitor, Optimism (OP), also surpassed ARB in market capitalization for the first time.

It should be clear that I am not blaming the drop in ARB on the airdrop. When you launch a new token in a bear market, you shouldn't expect it to magically rise.

Price isn't everything. The overall health of the network is equally important. However, this airdrop has indeed put pressure on the ecosystem, and if Arbitrum wants to survive when the bull market returns, it needs to find ways to innovate and attract demand. ARB is still struggling in this regard.

But I have some thoughts. First, let's explain why Arbitrum still has the potential to become the Layer 2 king in this bull-bear cycle.

Is Arbitrum Still a Contender for the L2 Crown?

Arbitrum has come a long way since its launch in August 2021.

In the first few months, it made almost no progress. Most DeFi projects from Ethereum chose to launch on Optimism instead of Arbitrum.

But over time, developers began to turn to Arbitrum. While there may be several reasons for this, one we can easily point out.

You see, most protocols on Ethereum, including Optimism, require developers to use a code called Solidity to write smart contracts.

But Arbitrum is different; it uses something called WebAssembly. WebAssembly is typically used in web browsers and allows you to compile multiple programming languages, such as Rust, C++, etc.

Therefore, developers are not limited to just using Solidity. They can use alternative programming languages to deploy smart contracts, which may be one reason they started flocking to Arbitrum.

As a result, Arbitrum's total value locked (TVL) grew from $0 at launch in August 2021 to $2.5 billion in November 2021. The rapid growth in just three months is astonishing.

Currently, Arbitrum's total value locked is $1.7 billion. In comparison, Optimism's is $650 million.

Arbitrum also has 450 protocols, more than double Optimism's 190.

But the key point to remember is not just Arbitrum's locked TVL, but its diversity. The diversity of TVL is crucial for the health of the ecosystem so that it does not rely on individual projects, which could threaten the entire project if they collapse.

Arbitrum has 27 projects with a TVL exceeding $10 million. While it is somewhat concentrated on the decentralized perpetual exchange GMX, which accounts for 25% of the total TVL, it is still a very diverse ecosystem.

Additionally, among all these protocols, there are about $1.5 billion in stablecoins on Arbitrum. This is significantly more than Optimism's $500 million and is comparable to the amount held by Solana, one of the most popular Layer 1 projects for stablecoin payments.

Moreover, Arbitrum has slightly more users than Optimism. Arbitrum has just over 107,000 users, while Optimism has about 85,000.

So, with so much activity even in a bear market, what can Arbitrum do to make itself an undeniable force in the next cycle?

It’s All About Adoption

To explain the next part, we need to look at the functionality of ETH itself.

ETH has many use cases. You can use it to pay for creating smart contracts or transaction fees. You can also use it as collateral for lending or to earn staking rewards, among other things.

These use cases not only make the token more versatile for holders. They also give the token higher "elasticity."

Thus, ETH has high elasticity because its use cases are not limited to just a way to send payments. This includes creating smart contracts and paying for computational fees, as well as higher-level uses such as a store of value, collateral, or yield-generating tools.

Now, what can you do with the ARB token?

…Got any ideas?

That's the problem. You don't even need ARB to pay for transactions on the network.

Tokens need to have a certain level of utility, even if it's basic. Once it has that, it can start unlocking higher-level uses similar to what we see with ETH.

The benefit of doing this is that it makes TVL very sticky. Then all liquidity can act as a reservoir to absorb supply changes. Right now, ARB does not serve this purpose. If a large unlock is coming or if a protocol on the network wants to sell the tokens it received from the airdrop, the ecosystem will not be able to absorb it.

The point is that I want to see more uses for the ARB token beyond just selling. Currently, if I had to grade ARB's economic model, it would get an F.

Fortunately, Arbitrum can improve this.

Remember, Arbitrum is a Rollup. It processes transactions off the Ethereum main chain, and once validated, it packages those transactions together and sends them back to the mainnet. This is faster and cheaper than validating each transaction on Ethereum.

To do this, the chain uses sequencers to order transactions and sends them back to the mainnet after validation.

The good news is that plans are being made to decentralize this process by requiring sequencers to stake ARB tokens. These sequencers can earn fees from validating transactions and helping the network run, similar to PoS networks. This provides a potential use case for ARB.

Looking Ahead

If ARB wants to remain competitive, it needs to start thinking about how to adjust incentive mechanisms with its token.

The following chart shows that over a million ETH (about $1.6 billion) is locked on Arbitrum. Although it has recently declined, it is still higher than at any time in 2022.

This shows the potential for Arbitrum to play a key role in the Ethereum ecosystem. But only when the team designs better use cases for the token can the price charts reflect this, which will greatly help its attractiveness as an asset once people start reducing their risk curve from Ethereum.