UCL Institute of Finance & Technology

Layer 2 and BRC20 etc.

IFTE0007 Decentralised Finance and Blockchain
Dr. Hui Gong ([email protected])
Contents
• From the Dencun Update
- What is Dencun Update? and Why we need it?
- Layer 2 Solutions
• ZK/ZKP
• Verifiable Random Function (VRF)
• Cross-Chain and Bridge
Ethereum Cancun-Deneb
(Dencun) upgrade, explained
Dencun, an amalgamation of two separate upgrades — Deneb and Cancun —
tackles both Ethereum’s consensus and execution layers in a single upgrade.
Technically a hard fork in blockchain terminology, the upgrade rolled out at
Ethereum epoch 269,568 at 1:55 pm UTC and finalized at 2:10 pm 13 March 2024.
The upgrade is set to significantly slash the transaction fees of layer-2 solutions and
boost the scalability of Ethereum.

Dencun unveils proto-danksharding,

which will benefit L2 networks such as
Polygon, Arbitrum and Optimism,
among others.
What is EIP-4844 (proto-danksharding)
Proto-danksharding, which has introduced data blobs via Ethereum improvement
proposal (EIP)-4844, is the most notable feature of the upgrade.
Data blobs are a novel solution intended to improve the efficacy of L2
transaction data storage. Currently, L2 solutions use transaction calldata, which
the upgrade will replace with blob data. Calldata stores limited transaction data on-
chain, which needs to be retained by the nodes forever, significantly increasing the
burden on validators.
Proto-danksharding is a novel technique that removes the limitations of the
present on-chain data storage system, opening up a vastly more effective data
management system. By utilizing data blobs specifically designed to manage large
volumes of data outside the Ethereum blockchain, rollups benefit from more
scalable data storage.
Proto-danksharding vs. danksharding
It reduces
network
congestion
and optimizes
network size
for better
performance.
Additionally,
lower gas
prices will
increase the
usability and
efficacy of L2
applications.
Expanding Horizons with Layer 2
Solutions
Layer 2 solutions on the Ethereum network are
essential because they address the blockchain Scalability
trilemma of decentralization, scalability, and security.
The blockchain trilemma posits that it is challenging
to achieve all three properties simultaneously;
typically, a blockchain can only excel at two out of
the three. Ethereum, like other Layer 1 blockchains,
is decentralized and secure but has struggled with
scalability, especially as the network has grown and
the demand for block space has increased. This
results in high transaction fees and slower Security Decentralization
processing times during periods of congestion.
Layer 2 solutions
Layer 2 solutions, such as Rollups, aim to alleviate these issues by handling transactions off the main
chain, thus increasing throughput and reducing costs without compromising on the network's
decentralization or security. Rollups work by grouping or "rolling up" multiple transactions into a single
one, and then submitting this to the main Ethereum chain. This process helps in relieving congestion
on the network and makes transactions faster and less expensive.
There are two main types of Rollups:
• Optimistic Rollups: Optimistic Rollups assume transactions are valid by default and only run
computations in the event of a challenge
• ZK-Rollups: ZK-Rollups use zero-knowledge proofs to verify transactions’ validity without revealing
their contents
Both have their own set of advantages and trade-offs. ZK-Rollups, for instance, offer faster transaction
speeds and lower fees but require a more complex setup that can lead to centralization. Optimistic
Rollups, on the other hand, are easier to implement but have a challenge period that can delay
withdrawals.
Optimistic Rollups vs. ZK-Rollups
Feature Optimistic Rollups ZK-Rollups Example
Example
EVM Arbitrum, Optimism Polygon zkEVM, Scroll
Compatibility zkEVM
Transaction Lower due to minimal data Potentially higher due to
Costs on-chain proof generation
Security Based on economic Based on cryptographic
incentives and fraud proofs proofs
Use Cases DeFi applications, Identity verification, private
decentralized exchanges crypto trading
What Is a Zero-Knowledge Proof?
Zero-knowledge proofs (ZKPs) are a cryptographic method used to prove knowledge
about a piece of data, without revealing the data itself.
While the inherent transparency of blockchains provides an advantage in many
situations, there are also a number of smart contract use cases that require privacy
due to various business or legal reasons, such as using proprietary data as inputs to
trigger a smart contract’s execution. An increasingly common way privacy is
achieved on public blockchain networks is through zero-knowledge proofs (ZKPs)—a
method for one party to cryptographically prove to another that they possess
knowledge about a piece of information without revealing the actual underlying
information. In the context of blockchain networks, the only information revealed on-
chain by a ZKP is that some piece of hidden information is valid and known by the
prover with a high degree of certainty.
How Do Zero-Knowledge Proofs Work
The three fundamental characteristics that
define a ZKP include:
• Completeness: If a statement is true, then an
honest verifier can be convinced by an honest
prover that they possess knowledge about the
correct input.
• Soundness: If a statement is false, then no
dishonest prover can unilaterally convince an
honest verifier that they possess knowledge
about the correct input.
• Zero-knowledge: If the state is true, then the
verifier learns nothing more from the prover
other than the statement is true.
Zero-Knowledge Proof Use Cases
Zero-knowledge proofs unlock exciting use cases across Web3, enhancing security, protecting user
privacy, and supporting scaling with layer 2s.
• Private Transactions: ZKPs have been used by blockchains such as Zcash to allow users to
create privacy-preserving transactions that keep the monetary amount, sender, and receiver
addresses private.
• Verifiable Computations: Decentralized oracle networks, which provide smart contracts with
access to off-chain data and computation, can also leverage ZKPs to prove some fact about an off-
chain data point, without revealing the underlying data on-chain.
• Highly Scalable and Secure Layer 2s: Verifiable computations through methods such as zk-
Rollups, Validiums, and Volitions enable highly secure and scalable layer 2s. Using layer 1s such
as Ethereum as a settlement layer, they can provide dApps and users with faster and more efficient
transactions.
• Decentralized Identity and Authentication: ZKPs can underpin identity management systems
that enable users to validate their identity, while protecting their personal information. For example,
a ZKP-based identity solution could enable a person to verify that they’re a citizen of a country
without having to provide their passport details.
Zero-Knowledge Proof Use Cases
Voting Systems
Zero-knowledge proofs can be used to create highly secure and verifiable voting mechanisms that
enable individuals to cast votes without compromising their identity or revealing who they voted for.
Internet of Things (IoT)
Verifiable Random Function (VRF)
A verifiable random function (VRF) is a cryptographic function that takes a series of inputs, computes
them, and produces a pseudorandom output and proof of authenticity that can be verified by anyone.
In cryptography, a verifiable random function (VRF) is a random number generator (RNG) that
generates an output that can be cryptographically verified as random. Verifiable randomness is
essential to many blockchain applications because its tamper-proof unpredictability enables exciting
gameplay, rare NFTs, and unbiased outcomes.
As the name suggests, a verifiable random function is defined by its core features:
• Verifiable — Anyone can verify that the random number generated by a VRF is valid.
• Random — The output of a VRF is entirely unpredictable (uniformly distributed) to anyone who
doesn’t know the seed or private key and follows no pattern.
• Function — VRFs rely on a mathematical algorithm to produce both the random number and a
proof that verifies its authenticity.
VRF Use Cases
Most RNGs don’t produce a random number that can be cryptographically verified, leaving
them vulnerable to manipulation and thereby limiting their use cases. By guaranteeing the
security of a random number, VRFs unlock a number of important use cases such as:
• Internet security — VRF is used to help secure domain name system (DNS) messages.
• Zero-knowledge technology — VRF is used in the protocol design for zero-knowledge
proofs and zero-knowledge databases.
• Non-interactive lottery systems — VRF enables provably fair and efficient outcomes for
lotteries.
• Verifiable transaction escrow schemes — VRF can help support automated escrow
services that preserve user anonymity.
• Blockchains and smart contracts — VRF has become an important part of decentralized
protocols and applications.
What Is Cross-Chain?
Cross-chain technology refers to the ability to transfer data and tokens between
different blockchains.
The Web3 landscape is increasingly becoming multi-chain, with the DApp
ecosystem existing across hundreds of blockchains, layer-2 networks, and
appchains. However, blockchains don’t have the native ability to communicate with
external systems or APIs. This limitation not only prevents blockchains from
communicating with existing web infrastructure but also with other blockchains.
Given the wide variety of blockchain ecosystems, it’s critical that these distinct on-
chain environments are able to interoperate and communicate with each other.
Cross-chain interoperability protocols are a critical piece of infrastructure for
exchanging data and tokens between different blockchains.
Why Is Cross-Chain Communication
Important?
Cross-chain interoperability is critical for a more integrated Web3 ecosystem as well as for building
bridges between existing Web2 infrastructure and Web3 services. By enabling cross-chain smart
contracts, cross-chain interoperability solutions reduce fragmentation in the ecosystem and unlock
higher capital efficiency and better liquidity conditions.
DeFi’s permissionless composability has given rise to increasingly complex applications that allow
developers to combine distinct DApps into a structure that can achieve more than the sum of its parts.
However, composability is significantly hindered with hundreds of different networks, as a smart
contract can only natively compose with other contracts on the same network. If an application wants
to follow the users and remain competitive in a rapidly changing multi-chain environment, it has to be
deployed on multiple platforms, leading to fragmented liquidity and a degraded user experience.
Furthermore, individual DApp deployments take up precious development resources that could
otherwise be spent improving the business logic of the application.
Why Is Cross-Chain Communication
Important?
Why Is Cross-Chain Communication
Important?
How Does Cross-Chain Technology Work?
Cross-chain solutions typically involve validating the state of the source blockchain and relaying
the subsequent transaction to the destination blockchain. Both of these functions are required to
complete most cross-chain interactions.
One key piece of infrastructure is a cross-chain bridge that enables tokens to be transferred from a
source blockchain to a destination blockchain. A cross-chain bridge typically involves locking or
burning tokens on the source chain through a smart contract and unlocking or minting them through
another smart contract on the destination chain. In effect, a cross-chain bridge is a cross-chain
messaging protocol applied to a very narrow use case—transferring tokens between different
blockchains. As such, cross-chain bridges are often application-specific services between two
blockchains.
Cross-chain bridges are only one simple application serving cross-chain functionality. Programmable
token bridges enable more complex cross-chain interactions, such as swapping, lending, staking, or
depositing tokens in a smart contract in the same transaction that the bridging function is executed,
while arbitrary data messaging protocols provide more generalized cross-chain functionality, which
can support the creation of more complex dApps such as cross-chain decentralized exchanges
(DEXs), cross-chain money markets, cross-chain NFTs, cross-chain games, and much more.
Types of Cross-Chain Bridges
A cross-chain bridge is a type of decentralized application that enables the transfer of assets from one
blockchain to another. Cross-chain bridges increase token utility by facilitating cross-chain liquidity
between distinct blockchains. A cross-chain bridge typically involves locking or burning tokens on the
source chain through a smart contract and unlocking or minting tokens through another smart
contract on the destination chain.
Cross-chain bridges are powered by three main mechanism types:
• Lock and mint — A user locks tokens in a smart contract on the source chain, then wrapped
versions of those locked tokens are minted on the destination chain as a form of IOU. In the reverse
direction, the wrapped tokens on the destination chain are burned to unlock the original coins on the
source chain.
• Burn and mint — A user burns tokens on the source chain, then the same native tokens are re-
issued (minted) on the destination chain.
• Lock and unlock — A user locks tokens on the source chain, then unlocks the same native tokens
from a liquidity pool on the destination chain. These types of cross-chain bridges usually attract
liquidity on both sides of the bridge through economic incentives such as revenue sharing.