Arbitrum 101

Since the first launch of the Ethereum L2 network in December 2019, the total value locked (TVL) in all L2 networks has been steadily rising regardless of...

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Arbitrum 101

Disclaimer: This article is intended for general information purposes only and does not constitute legal, business, investment, or tax advice. It should not be used as a basis for making any investment decisions or relied upon for accounting, legal, or tax guidance. References to specific assets or securities are for illustrative purposes only and do not represent recommendations or endorsements. The opinions expressed in this article are those of the author and do not necessarily reflect the views of any affiliated institutions, organizations, or individuals. The opinions reflected herein are subject to change without being updated.


Key Takeaways
  • Arbitrum is a representative optimistic rollup in the Ethereum ecosystem, consistently maintaining the top spot in terms of TVL.
  • Arbitrum Nitro is the only existing rollup network with a fraud proof system implemented. Furthermore, it provides high scalability and EVM compatibility.
  • Arbitrum Nova is based on the Arbitrum AnyTrust protocol. Since it stores data through the Data Availability Committee (DAC) rather than the Ethereum network, it can provide higher scalability than Arbitrum Nitro.
  • Arbitrum Orbit is a framework that allows developers to easily develop L3 networks in the Arbitrum ecosystem, which is expected to enrich the Arbitrum ecosystem even further.

1. Introduction
1.1 Arbitrum, the Leading Competitor

Since the first launch of the Ethereum L2 network in December 2019, the total value locked (TVL) in all L2 networks has been steadily rising regardless of market conditions. A few years ago, there were very few L2 networks, but now there are 29 L2 networks, according to L2beat.

Among them, Arbitrum is a project that has consistently led overall network activity. As of Aug 1, 2023, Arbitrum's TVL is $5.94B, about twice as high as Optimism which is in second place. The number of unique addresses on Arbitrum is also about 1.5 times higher than Optimism, at 10,472,775.

1.2 Arbitrum Introduction

Arbitrum is an optimistic rollup network based on Ethereum. A rollup network is a blockchain that stores transaction data in the base layer and performs calculations itself, depending on the security of the base layer. Unlike zk-rollup, optimistic rollup processes users' transactions assuming that the computation result is valid. In case the results are not valid due to a malicious sequencer, a dispute window of about 1-2 weeks is set. If there are no challenges during this period, the result of the computation is considered valid and finalized.

Currently, there are Arbitrum One and Arbitrum Nova in the Arbitrum ecosystem. What's the difference between these two? The most significant difference is the way they handle transaction data. Because Arbitrum One stores transaction data directly in the Ethereum network, it can fully leverage the security of Ethereum, but there is a disadvantage of slightly lower scalability. On the other hand, because Arbitrum Nova manages transaction data by off-chain entities called the Data Availability Committee (DAC), it has the advantage of having much higher scalability in optimistic situations than Arbitrum One.

However, both only differ in their data storage methods, and it's the same in that all networks are fundamentally based on the Arbitrum Nitro stack.

2. Arbitrum Nitro
2.1 Arbitrum Classic vs. Nitro

(Source: Arbitrum Docs)

Arbitrum Nitro is an upgrade applied in August 2022. The previous Arbitrum Classic looks quite different from the current Arbitrum Nitro. Arbitrum Classic used the Arbitrum Virtual Machine (AVM), a self-built execution environment, not EVM. In contrast, nodes of Arbitrum Nitro do not use AVM, and as shown in the picture above, it consists of three layers.

The base layer has a geth core that can perform EVM operations, and most of the top layer has node software that came from geth. The ArbOS in the middle layer is custom software responsible for L2-related functions (e.g., L1-L2 bridging, L1 gas calculations, etc.).

2.2 Advantages of Arbitrum Nitro

Arbitrum Nitro, thanks to its new structure, has various advantages over Arbitrum Classic:

2.2.1 Separation of Execution and Proving

In Arbitrum Nitro, the execution and proving of transactions are performed separately. In Arbitrum Classic, high-level languages (e.g., Solidity, Vyper, …) were once compiled into EVM bytecode, and then this bytecode was transpiled to suit AVM for the fraud proof system.

However, in Arbitrum Nitro, in general cases, it is compiled targeting the native language, whereas, when a challenge comes in from the fraud proof system, it is compiled targeting Wasm bytecode suitable for generating fraud proof.

To put it another way, in Arbitrum Classic, all transactions were inefficiently compiled into fraud-proof code, even outside of dispute periods. In contrast, Arbitrum Nitro significantly improves efficiency by normally compiling into code specific to execution. However, it switches to compile into Wasm code used for fraud proof only during dispute periods.

2.2.2 Transaction Data Compression

As most of the costs incurred in rollup networks are gas fees for storing transaction data in the base layer, compressing transaction data is very important.

Since Arbitrum Classic's AVM was a custom virtual machine, it was challenging and technically risky to implement a new data compression algorithm. In contrast, Arbitrum Nitro only needs the VM to be compiled into Wasm, so not only geth but any Go code can be used. Since there are already many Go libraries related to transaction data compression, they can easily introduce algorithms to compress transaction data, which can reduce the transaction fees of the rollup network.

2.2.3 Ethereum Compatibility

The Classic AVM had subtle differences from EVM, such as different gas calculation logic, which was a disadvantage because developers had to modify the existing code slightly. However, Arbitrum Nitro has improved these things. Also, since the Arbitrum Nitro stack originally comes mostly from geth, it provides a much higher level of Ethereum compatibility.

3. Transaction Lifecycle
3.1 Lifecycle

The transaction lifecycle of Arbitrum is as follows:

  1. The sequencer receives transactions from users. Transactions can be received directly at L2 or through the Delayed Inbox contract at L1. Most transactions received from L1 are bridging, and if the sequencer censors, the user can forcibly include the transaction through the Delayed Inbox contract.
  2. The sequencer determines the order of transactions. Currently, Arbitrum uses a centralized sequencer, and transactions are processed on a first-come-first-served basis.
  3. The sequencer collects L2 transactions, creates a batch, and stores it on L1 as calldata.
  4. The rollup block is finalized (if there are no challenges) after a dispute period of one week through the fraud proof system.

3.2 Fraud Proof System

A fraud proof system is essential in optimistic rollups to ensure the validity of computations. An interesting fact is that among the existing optimistic rollups, the only networks that have introduced a fraud proof system are Arbitrum One and Arbitrum Nova. Note that only whitelisted validators can participate in Arbitrum's fraud proof system.

There are two main options in the fraud proof system: 'interactive proving' or 're-executing transactions'. Arbitrum adopts the former approach. Interactive proving refers to resolving disputes through interaction between the disputing parties. Arbitrum uses a method called dissection, in which the two parties interact to reduce N operations to → N/2 → N/4 → ... until one operation step remains, and the validity of this operation is judged.

4. Arbitrum Nova

Arbitrum Nova is a network based on the Arbitrum AnyTrust protocol, which is a slightly modified version of Nitro technology. Arbitrum Nitro basically stores transaction data on the Ethereum network as calldata, but Arbitrum AnyTrust relies on an off-chain party called the Data Availability Committee (DAC) for the storage of transaction data. Assuming that there are N members in the DAC, it is designed not to fail if at least two are honest (2-of-N). Typically, in BFT, more than 2/3 of honest actors are needed, but how can the Arbitrum AnyTrust system not fail with only two actors? This is because there is a 'fallback to rollup' function in case of system failure.

The Sequencer sends transaction data to the DAC, and the members of the DAC send signatures for storing the data back to the sequencer. If the sequencer cannot collect enough signatures within a certain time, it gives up using the DAC and operates in rollup mode. From then on, the transaction data is stored on Ethereum, not DAC. Therefore, the 2-of-N assumption of Arbitrum AnyTrust is not burdensome, and it can always be valid if N-1 out of N people signed it (assuming at least two are honest, at least one of N-1 must be honest).

As it is very cost-effective to store transaction data off-chain rather than on Ethereum, Arbitrum Nova is suitable for services where transactions occur frequently, such as games and social media. In fact, Reddit, the largest online community in the United States, applied Arbitrum Nova to its experimental service called Community Points, and MOON tokens, which are points on the r/CryptoCurrency subreddit, can also be traded on Arbitrum Nova.

5. Decentralization & Risk

Finally, let's look at the state of decentralization and risks of the Arbitrum network.

5.1 State of Decentralization

Like other rollups, Arbitrum has a roadmap for progressive decentralization. Arbitrum divides the components that need decentralization into four categories:

  • Chain ownership - It encompasses the decentralization of activities related to the chain, such as smart contract upgrades, parameter settings, and chain halt. Currently, it is governed by the Arbitrum DAO, made up of ARB token holders, and can be operated via multi-sig by the Security Council, composed of 12 members, in emergency situations.
  • Validator ownership - Validators are the participants in the fraud proof system, and currently, only whitelisted entities can participate. If all validators go offline, anyone can become a validator after about seven days, so there is no serious liveness issue.
  • Sequencer ownership - The Sequencer, which receives transactions from users and determines their order, is currently operated centrally by the Arbitrum Foundation.
  • DAC ownership - Arbitrum AnyTrust relies on the DAC, comprised of a few members. Currently, there are a total of seven members: Reddit, ConsenSys, QuickNode, P2P, Google Cloud, Offchain Labs, and Opensea.

5.2 Risks

The current risks existing in the Arbitrum network are as follows:

  • If the majority of the Security Council, comprised of a few trusted entities, acts maliciously, it can pose a significant threat to the network, such as arbitrarily upgrading smart contracts.
  • If there is not even a single honest validator, the safety of the network could be jeopardized.
  • The Sequencer can censor user transactions, which may cause liveness issues on L2, but users have the ability to force transactions through L1.
  • If more than six out of seven DAC members act maliciously, there could be safety issues with Arbitrum AnyTrust, but this can be defended by the 'fallback to rollup' mechanism.

6. Arbitrum Orbit

(Source: Arbitrum Docs)

Like other L2 projects, Arbitrum also provides a framework called Arbitrum Orbit, which allows developers to launch app-specific or general-purpose L3s easily. The L3 networks built with Arbitrum Orbit are based on the Arbitrum Nitro stack and can use Arbitrum One or Arbitrum Nova as the settlement layer.

L3 networks created with Arbitrum Orbit have a lot of freedom, as they can support Wasm-based smart contracts, enabling programming in languages like C, C++, and Rust, as well as adding account abstraction features such as fee subsidizing and providing a variety of features, including paying the gas fee with a different token.

Arbitrum Orbit is expected to greatly assist in growing the Arbitrum ecosystem by enabling numerous L3 networks.

7. Conclusion

Since the very beginning of the rollup ecosystem, Arbitrum has never lost its leading position in terms of TVL. How was this possible? The main difference compared to Optimism is the level of ecosystem activity.

In the early stage, Optimism had a whitelist preventing anyone from building dApps, while Arbitrum, launched in August 2021, had no whitelist, allowing anyone to build dApps. Thus, starting with simple DeFi protocols like ArbiNYAN, TVL of Arbitrum grew rapidly.

Subsequently, the emergence of innovative futures protocols like GMX and P2E platforms like TreasureDAO, which can attract many organic users, allowed the Arbitrum ecosystem to grow explosively. Additionally, airdrop events attracted a lot of attention, and Arbitrum maintains its top position in terms of TVL.

Beyond its thriving ecosystem, Arbitrum also stands out in the realm of technology. With the actual presence of a fraud proof system, the delivery of high performance and excellent EVM compatibility via Arbitrum Nitro, the provision of a more scalable solution known as Arbitrum AnyTrust, and the prospect of a multi-rollup ecosystem through Arbitrum Orbit, it's not only Arbitrum's present that commands attention, but its promising future as well.

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Four Pillars is a global crypto research firm based in Seoul, consisting of the most influential blockchain researchers in Korea. Through robust research and governance skills, it helps various market players easily onboard to the blockchain industry by offering high-quality research articles while supporting protocols in their expansion into Korean and global markets.

Writer: 100y (@100y_eth), Co-Founder and Publishing Lead at Four Pillars

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