Layer 2″ cryptocurrencies – those from projects built on top of “layer 1” blockchains, such as bitcoin and ethereum – have found new life after a year in the doldrums, buoyed by a rising crypto tide.
Anticipation of easing U.S. borrowing costs and a possible U.S. spot bitcoin exchange-traded fund have lifted crypto prices since the summer, with the market bitcoin up by about half since the end of August.
Tokens associated with Layer 2 projects – which typically aim to speed up transactions and reduce costs – have a combined market capitalization of about $14.3 billion, about a tenth of the total crypto market, according to data from CoinMaketCap.com.
Matic, the largest Layer 2 token with a market cap of $6.90 billion, has jumped 20% in the past 30 days to $0.74, according to CoinGecko. It’s used on Polygon, a platform that reduces congestion on the Ethereum network.
The next four largest coins – Immutable, Mantle, Arbitrum and Optimism – have jumped between 9% and 105% over the past month, trading between $0.5 and under $2 each.
However, all five tokens are down between 16% and 86% from their all-time highs of the past two years.
Ether, the layer 1 token linked to the Ethereum blockchain on which most layer 2 tokens are based, has jumped 13.8% in the past month to $2,028.80.
Layer 2 tokens, which have proliferated in recent years, can be a risky proposition. They are small and thinly traded, which means they can be highly volatile and unpredictable. Picking long-term winners is difficult.
“On average, the growth of these tokens is not sustainable … 100 tries and one wins,” said Matteo Greco, a research analyst at digital asset and fintech investment firm Fineqia International.
“There’s always a little bit of thin air behind the moves.”
Price performance is also uneven.
Matic is down about 3% in 2023, while gaming token immutable has more than tripled in price, compared to bitcoin’s 123% and ether’s 69% gains.
SPECULATIVE NATURE
Layer 2 tokens are a gauge of sentiment towards the projects they are linked to, but their extreme volatility also gives them a speculative character. They are often among the last to catch a bid when the broader crypto market rises, and among the first to sell when sentiment is shaken.
While Layer 2 tokens are tiny compared to big guns like bitcoin, their volatility makes them a favorite among active traders looking to capitalize on market momentum.
“They can be very attractive investments, even though they can be very speculative,” said Joshua Peck, chief investment officer at hedge fund TrueCode Capital, whose fund invests in matic. “For a token that’s down 97%, it doesn’t take a lot of capital inflow for it to triple, quadruple, quintuple in price.”
“Active trading is the right approach for these tokens because the market is moving so much,” Peck added.
The future of Layer 2 tokens is unclear.
Some analysts see the projects as critical to expanding the practical uses of blockchains like Ethereum, in areas ranging from finance to gaming.
But the market is crowded. Numerous projects and their tokens were launched as the crypto market boomed in 2020, before sinking in the crypto winter of 2022.
“The space feels ‘unserious’ right now … in terms of being able to point to an example of something you’d want to run your business or your family’s personal finances on,” said Alyse Killeen, managing partner at venture capital firm Stillmark.
Many investors agree that only projects with useful practical applications will survive.
“In these macro periods, the use cases are not really that important. The real difference between assets that have good use cases and assets that don’t is [in] the bear market,” says Fineqia International’s Greco.
“Assets that have good use cases are able to resist the downtrend, even if they get hit hard.”
