What happens when your blockchain secures more assets (in $) than it’s native asset is worth? The ratio between L1 value (native asset) and L2 value (tokens, business value+), seems to be an important blockchain security metric.
What’s in this post?
- The L1L2 Ratio
- The Idea of Token Value and Blockchain Security Being Linked
- Layer 2+ of Public Blockchains
- Incentives and Blockchain Security
The L1L2 Ratio
The original idea was a $ETH to Token Ratio (twitter thread). To make it applicable to all public blockchains we’re calling it L1L2 Ratio. Layer 1 (L1) is the blockchain layer, of which the native asset ETH is a part. Layer 2 (L2) is tokens, assets and value build on top of that blockchain.
The Idea of Token Value and Blockchain Security Being Linked
The idea is that the layer1 value of a blockchain (value of all ETH/BTC), is a blockchain security parameter. The higher the L1 value, the harder it is to attack the blockchain.
To illustrate this, we gotta take a real quick look at the basics of blockchain security.
The most important public blockchains, Bitcoin and Ethereum, are secured by Proof-of-Work consensus algorithms. Proof-of-Work is done by computers solving a puzzle by brute force. This security is paid for in the native asset (L1) bitcoin and eth (block rewards + tx fees).
The value of L1 seems to be an important part of the blockchain security model as the higher the price of bitcoin, the more is invested into computers to secure bitcoin.
Layer 2+ of Public Blockchains
Bitcoin and Ethereum are protocols allowing permissionless innovation on top. On top of these protocols entrepreneurs build all kind of different businesses. You probably heard about the ICO mania in 2017? These ICOs resulted in tokens, or credits issued on top of public blockchains like Bitcoin and Ethereum. While the ICO is practically dead, we could see an explosion of tokens representing real world assets on top of Bitcoin and Ethereum in the years to come. Security offerings (STOs) is poised to be big.
Potential problem: Assets built on top of public blockchains does not contribute directly to the security model of the underlying blockchain.
A security, tokenized on Ethereum doesn’t directly add to the value of the underlying blockchain (at a minimum, there’s a lag). So there’s a seperation between value contribution to security (L1) and value secured (L2).
Incentives and Blockchain Security
At what point does the ratio between L1 and L2+ pose a security risk?
This is an interesting question. To illustrate its validity, imagine Country A trading all asset on Blockchain A. Maybe a good part of the stock market is traded on it too. Now imagine Country B, the arch enemy of Country A, investing X amount of dollars to attack Blockchain A. On PoW blockchains this could potentially be done with a 51% attack, allowing the attacker to alter the transaction history.
There must be a price at which this attack is viable. The likelihood of the attack being viable increases with the decrease in L1L2 ratio. As L2 becomes more and more valuable in relation to L1, the chances increases that it makes sense for Country B to attack.
The more value in L2 asset vs L1 assets, the more likely an attack become. Could we use the L1L2 ratio or similar, as part of a risk evaluation in choosing between blockchains to secure assets, smart contracts and more?
Published Dec 4, 2019