24
October
2023
Layer-2 Sequencing Demystified: A Lawyer’s Introduction
This article was written by DLx Law attorneys Tom Momberg & Angela Angelovska-Wilson (together with Arktouros PLLC attorney Mike Mosier) for Global Legal Insights (GLI), which originally included this article as a Chapter in its 2024 publication on Blockchain & Cryptocurrency Laws & Regulations.
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1. Introduction
The most popular “layer-1” blockchain networks, like Ethereum, have long suffered from limitations on scalability. In recent years, so-called “layer-2 rollups,” which are distinct blockchain networks that run protocols to bundle (or ‘roll up’) hundreds of separate individual “database transactions”[1] into a single entry on the layer-1 network (often called the “mainnet”), have emerged as the leading solution to these challenges.[2]
Rollups—by processing the majority of transactions on a separate “layer-2” blockchain network (i.e., off the mainnet) and only committing a concise summary of those database transactions to the layer-1 chain—significantly enhance the main network’s transactional throughput.[3] This ensures that the mainnet remains responsive and adaptable to increasing computational demands and growing network activity.[4]
Central to a rollup’s operation is the “sequencer,” a mechanism designed to determine the canonical order of database transactions.[5] A sequencer’s primary function is simply to decide the order of transactions, but this makes it essential for supporting web3 infrastructure’s reliability, efficiency, and consistency. Given the operational complexity of these functions, we attempt in this Chapter to distill the fundamentals, so as to help prevent misunderstandings and misapplication of wrongly ‘analogous’ legal constructs on neutral data and communications infrastructure by lawyers or policymakers.[6]
Crucially, a sequencer, like any other element of a layer-2 blockchain protocol, does not inherently introduce functionalities that could be broadly understood as providing regulatorily sensitive products or services. Rather, the sequencer is a technological component of a broader software-based framework that provides for greater and more efficient functionality on the underlying layer-1 blockchain.[7] A sequencer’s primary objective is to algorithmically interpret incoming transaction data and output ordered blocks, thereby optimizing a blockchain system’s throughput and efficiency.[8]
Although technically complex, the role of sequencer functionality is not particularly novel. Just like technology providers in traditional data infrastructures, sequencers are no more than an objective[9] software program being run to provide a purely technological service, with no intended ability to include independent discretion, judgment, or input.[10] This Chapter examines the intricacies of the technical solutions that sequencers seek to offer and calls for collaboration and understanding to assist both lawyers and developers seeking to understand and bolster the integrity of layer-2 blockchain systems.
2. Redefining data infrastructure: Bridging tech and legal frontiers
In contrast with open, blockchain-based networks, most current data infrastructures are generally opaque to the public, managed by dominant and concentrated data infrastructure providers.[11] These systems undergo significant downtime and rely on intermediaries, each, a single point of failure. Conventional data infrastructure is also prone to the influence of political aims and the powers of the largest providers of capital, which can favor or disfavor various economic sectors, geographies, or groups of persons or organizations.
Blockchain technology, including layer-2 rollup functionality, differs from the traditional approach because it offers a transparent, distributed ledger where publicly accessible data accompanies each transaction. This transparency and much higher level of decentralization mean that most of the potential risks or harms necessitating licensed intermediaries in traditional systems are inherently addressed.[12]
The architecture of traditional data systems is highly centralized, with few globally dominant data infrastructure providers wielding the vast majority of control over all data and systems.[13] This centralization can lead to its own inefficiencies and vulnerabilities, as well as a lack of transparency.[14] To the contrary, the decentralized nature of blockchain networks significantly reduces, if not eliminates, any opportunity for a single person or group to assume undue control over the network, promoting transparency, security, and efficiency. Database transactions made on blockchain networks are verifiable, irreversible (within the bounds of the protocol), and can be viewed by anyone. The order of transactions and state of the blockchain can also always be challenged, ensuring accountability and reducing the potential for many traditional forms of fraudulent activities.
As layer-2 rollup protocols evolve and become increasingly common, and as this allows the use of blockchain and digital assets to scale, this technology demands a comprehensive understanding—not just by the developers who are building with it, but also—by professionals in law, risk, compliance, and policy. It is no longer sufficient for lawyers, courts, policymakers, and other stakeholders to maintain a mere ‘general understanding’ of these technologies. Given blockchain technology’s continuing evolution and the increasing complexity of the solutions this technology entails, stakeholders must familiarize themselves with the nuances of these technologies and their practical implications before taking action that could substantially impact this area of innovation.[15] Only with a thorough grasp of the details can these professionals embark on a meaningful analysis or draw informed conclusions about layer-2 sequencing’s role in the blockchain ecosystem or any potentially regulated or controlled activities.
3. Technical foundations of layer-2 sequencing
Ethereum’s expanding user base has accentuated the network’s throughput capacity limitations, underscoring the urgency for scalable solutions. The essence of scalability lies in amplifying speed and throughput without sacrificing the pillars of decentralization or security.[16] On the Ethereum mainnet surges in demand at any given time can decelerate validation of pending database transactions and inflate gas[17] prices, emphasizing the need to bolster network capacity for Ethereum’s widespread adoption.[18]
Layer-2 rollups
Layer-2 rollups stand at the forefront of solutions addressing the scalability challenges inherent in blockchain networks, especially Ethereum.[19] These rollups leverage cryptographic and mechanism design techniques to allow transactions to be batched before being posted to the layer-1 blockchain, optimizing database transaction costs for blockchain users.[20]
Technically, a “rollup” is a function that is applied to input array data to produce reorganized and reformatted data in an output array on the layer-2 chain.[21] The key characteristic of a rollup is that all data necessary to derive a given output array can be determined at any time by using only the data from the input array.[22] Rollups typically store both the input array data and output array data on the layer-1 mainnet,[23] which acts as the “data availability layer” for the layer-2 protocol.[24]
By predominantly processing data off-chain and only relaying the underlying data and a summary of the computation results to the main chain, rollups drastically curtail gas expenses and amplify the database transaction processing rate.[25] Crucially, as data is embedded in blocks and consensus is attained on the layer-1 chain, rollups inherit the intrinsic security of the layer-1 chain.[26] Typically, layer 1, like Ethereum mainnet, is so widely used that there is widespread social consensus backing the protocol, which is why it is considered by most users to be virtually “immutable.”[27]
Sequencers
Sequencers are the linchpins in most layer-2 rollup architectures, shouldering the responsibility of deciding the order of transactions to be put into blocks on the layer-2 chain.[28] What is colloquially called a ‘sequencer’ is just one part of a larger rollup technology stack and is merely a combination of modular components of technology, which are generally under the control of a single person or entity.[29] Some of these components may overlap with other functions run by different, unaffiliated, uncoordinated third parties on the layer-2 network.[30] More specifically, a ‘sequencer’ is a software-based mechanism used in layer-2 protocols to append inputs (i.e., transaction data) to a rollup.[31]
In the same vein, ‘sequencing’ simply refers to the process by which the sequencer performs a computation based only on a specific, pre-established algorithm (i.e., code necessary to run a “rollup node”[32] and “execution engine”[33] based on a pre-agreed set of rules). This process is devoid of any discretion, other than the logic specified in the sequencer’s software implementation. The sequencer accepts every input in the input array as it is submitted by the “batch submitter” (or, as it is sometimes called, the “proposer”). Then, the sequencer applies its programmatically enforced algorithm to the input array, the output from which the sequencer determines strictly based on protocol rules and is otherwise unable to alter in any way under normal circumstances.[34] This ensures that the sequencer is unable to submit a malicious batch of inputs that violates protocol rules.[35] The only possible reason a sequencer would not act objectively and based solely on its algorithm is if the system or code on which the sequencer is run is hijacked, rewritten, or corrupted, but many layer-2 protocols include additional software-based mechanisms to eliminate the risk.[36]
A sequencer, in effect, has no discretion whatsoever. Most layer-2 sequencers currently order transactions on a first-in-first-out basis, unless other prioritization options are transparently built in, and this is executed algorithmically, mirroring how validators include transactions on Ethereum.[37]
In particularly unlikely circumstances given other controls in place,[38] the worst-case scenario for a rogue sequencer cannot possibly amount to a theft of assets (i.e., the sequencer inserting a transaction that moves an asset to an address controlled by a malicious actor rather than to an address controlled by the intended recipient). Instead, a more realistic concern is that a sequencer’s operator could delay or sensor transactions[39] or propose an invalid “state root,” causing the system to stall or to provide incorrect information to users.[40] To reduce or eliminate this risk, layer-2 protocols typically include multiple safeguards, such as waiting periods before withdrawals can be finalized and mechanisms for challenging and correcting invalid state roots.[41]
As a general matter, only the computer node running the sequencer is permissioned to write data to the rollup from the layer-2 chain.[42] This is with sole exception to the fact that, in many optimistic rollup systems,[43] users can bypass the sequencer and append inputs directly on the layer-1 network, which is essential for preserving censorship resistance, albeit being slower and more costly.[44] Sequencers often perform two fundamental functions:[45] (1) interpreting data on the layer-1 chain to help determine the final order of layer-2 transactions; and (2) following protocol rules to provide an overall technical service accessible via remote procedure call (“RPC”),[46] which, on many protocols, allows users to submit database transactions and opt to pay a priority fee to obtain preferential ordering.
Solutions for scalability
While the ethos of blockchain gravitates toward ‘decentralization,’ the imperatives of scaling solutions can create some tension with this principle with the adoption of what are largely centralized sequencing mechanisms. As with the implementation of most technologies, trade-offs need to be considered: sequencers, when operated under the control of a single party, can offer speed and cost-efficiency, attributes that will likely be instrumental to expanding uses for, and promoting broader adoption of, blockchain technology.[47]
The main advantage of sequencers lies in their batch-processing capability. Only the ‘root’ of these batches (i.e., a smaller data set, derived from the full data set of all transactions) is relayed to the layer-1 blockchain, leading to a substantial reduction in on-chain data.[48] Yet, this methodology is not devoid of challenges. The “data availability problem” introduces a risk where off-chain data might become inaccessible, rendering the system’s ability to revert to the main chain unfeasible.[49] Innovative solutions (like data sharding),[50] however, hold promise in alleviating this risk.[51]
Sequencers streamline data flow in the layer-2 ecosystem.[52] Users interface via RPC with sequencers, which subsequently process and sequence their transactions into blocks.[53] This data is then proposed, accepted, and incorporated into a block on the layer-1 chain.[54] The entire orchestration, spanning user interaction to block inclusion, is generally designed for maximum efficiency while also preserving many of blockchain’s core virtues like transparency and security.
Mechanisms for accountability
“Proof systems” underpin trust in layer-2 solutions and form the bedrock of accountability for layer 2.[55] They ensure that layer-2 validators and other blockchains can trust the accuracy of the provided data.[56] Among the leading proofing solutions are ‘optimistic’ and ‘zero-knowledge proof’ rollups.[57] “Zero-knowledge proof” rollups, harnessing cutting-edge cryptographic techniques, offer swift transaction confirmations and enhanced privacy.[58] This does, however, come with the trade-off of increased rollup design complexity and diminished adaptability when it comes to the execution of code in the form of any “smart contract.”[59] By contrast, “optimistic” rollups, which are more malleable in accommodating diverse smart contract logic, operate on a presumption of transaction validity.[60] This presumption introduces potential vulnerabilities, which layer-2 networks are able to mitigate using various challenge-response mechanisms.[61]
Sequencers, predominantly associated with optimistic rollups, play an indispensable role in layer-2 systems. The moniker ‘optimistic’ stems from the default assumption of validity.[62] If a block (or the data record within it) is perceived as fraudulent or invalid, it can subsequently be challenged.[63] A valid challenge results in the reversion of the errors, with the challenger receiving a reward.[64] The sequencer system in optimistic rollups minimizes the number of transactions or data entries that can be relayed directly to the layer-1 mainnet, thereby dramatically improving its capacity to scale.[65] While zero-knowledge proof rollups do not intrinsically necessitate a sequencer in the same vein as optimistic rollups, a sequencer can theoretically be employed to sequence and batch transactions prior to generating the zero-knowledge proof for on-chain validation.[66] This can further refine the system’s throughput and efficiency.[67]
As noted above, sequencers in optimistic rollups must be complemented with challenge-response mechanisms and other controls to ensure their accountability. The theoretical design of sequencers must be harmonized with practical oversight due to their pivotal role in transaction processing and sequencing.[68] The sequencer’s central role introduces potential vulnerabilities, necessitating robust, tailored measures to mitigate risks.[69]
Importantly, while efficient, the sequencer’s critical, often central role in layer-2 protocols introduces a potential single point of failure or manipulation.[70] Many layer-2 sequencer designs endeavor to implement controls that ensure credible neutrality, ensuring that no single entity can unduly influence the sequencer’s operations.[71] Future projects might contemplate regular audits, transparent reporting, or community-driven checks and balances to ensure that sequencers function as intended.[72] In the absence of these kinds of measures, trust in optimistic layer-2 solutions could wane, given the sequencer’s pivotal role.[73]
The role of verifiers
While sequencers play a pivotal role in processing and sequencing transaction data, “verifiers,” participants who run “verifier nodes” on the layer-2 blockchain, typically serve as the guardians of data integrity in rollup solutions.[74] Often, there are many verifier nodes running on a layer-2 chain, computing largely the same code as the sequencer (i.e., rollup node, execution engine, etc.).[75] This uniformity in code execution ensures consistency across the network. Depending on the specific layer-2 project, running a verifier node is typically permissionless, allowing for a distributed and trustless verification process.[76]
Verifiers are responsible for ensuring the correctness of all data submitted to the rollup.[77] They achieve this by verifying proofs and ascertaining the validity of state transitions on the layer-2 chain.[78] Unlike “validators,”[79] verifiers play only a passive role on layer 2, diligently checking the validity of data and replicating the outputs of the rollup computation.[80] This replication ensures that verifiers anticipate identical results as any other node operating solely based on the layer-1 blockchain’s data.[81] For example, in scenarios where a “proposer”[82]—a layer-2 rollup mechanism responsible for proposing new data or transaction batches—introduces an ‘error’,[83] the verifier’s node is typically equipped and incentivized to detect the discrepancy and raise an error by submitting a challenge.[84]
Layer-2 protocols are designed to prevent any identified errors from triggering on-chain repercussions. Some layer-2 projects, however, might one day explore the possibility of allowing a verifier node, or an entity running a node as a verifier, to submit a fault proof to rectify the error directly on-chain. Even in the current landscape, prevalent layer-2 protocols empower any layer-2 participant to run a node to verify the sequencer’s accuracy in real time.[85]
4. Diverse deployment scenarios: A technical review
Blockchain technology’s rapid progression has positioned layer-2 rollups as a promising solution to the scalability challenges of Ethereum and other blockchains.[86] As with any technological evolution, the journey toward widespread adoption is marked by a series of choices, each with its unique implications.
Developer choices
Layer-2 rollup technology, though nascent, provides layer-2 protocol developers with a range of options tailored to their specific requirements and goals.[87] These choices influence not just the technical architecture but also the security, scalability, and overall health of the ecosystem.[88] The processes and protocols governing how layer-2 rollup projects sequence and validate transactions can vary significantly[89] but, at least for optimistic rollups, broadly speaking, manifest in one of three different forms:
- Centrally controlled sequencing: Some developers opt for a centralized approach, where a single sequencing system and protocol processes data and orders transactions off-chain, sometimes even bypassing layer 2 altogether, and submit periodic summaries to the main (layer-1) blockchain.[90] While efficient, this model introduces potential vulnerabilities, including issues associated with a single, central point of failure.[91] Moreover, it may potentially be perceived as straying from the ‘decentralization’ ethos foundational to blockchain.[92]
- Shared sequencing: Many rollup projects champion a shared sequencer approach, distributing the transaction ordering process across multiple nodes or validators on the layer-2 blockchain,[93] thereby reducing potential bottlenecks or central points of failure.[94] This method, often touted as a beacon of ‘decentralization,’ aims to prevent power centralization and ensure that every network participant has a voice.[95]
- Hybrid approach: Striving for equilibrium, some rollups combine elements of both centralized and community-driven operational mechanisms.[96] This approach varies widely in practice and effect, but generally seeks to harness the efficiency of centralization while retaining the trust and security synonymous with shared sequencing.[97]
The three broadly defined categories represent a scalable range. Notions of ‘centralization’ and ‘decentralization’ are helpful in concept but fluid, broad, and ill-defined in meaning. While software components that do not live on a public blockchain are all inherently ‘centralized’ in some way, generally, various sequencer elements can often be distributed, decoupled from a single provider and run separately by different, unaffiliated, uncoordinated parties.[98] For example, some sequencers might run both the batch submitter protocol (i.e., submitting inputs to layer 1) and the output proposal submitter protocol (i.e., submitting outputs to layer 1), even though these are entirely independent software programs.[99] The output proposal process for most layer-2 projects could potentially be made permissionless, further limiting the adverse impact of an incapable or misbehaving sequencer.[100]
Importantly, decentralization is a spectrum, not an absolute state. Even today’s ‘centralized’ sequencers are not as centrally controlled as they may be perceived. Accountability systems and checks can provide assurances of a robust and transparent system. These might include mechanisms for providing real-time public visibility into the system’s integrity, allowing anyone to bypass the sequencer and transact directly on the rollup on layer 1, and controlling potential vulnerabilities, like with the use of challengers, proposers, guardians, and upgrade keys.[101]
Scalability vs security
The primary appeal of layer-2 rollups is scalability.[102] Scalability and security are intricately linked; however, enhancing one without due consideration to the other can introduce material vulnerabilities. Developers must tread this delicate balance to ensure that, as transaction speeds increase, the system’s integrity remains uncompromised.
For example, shared sequencers can offer enhanced transparency but also might introduce new challenges, like ensuring consistent data availability across the layer-2 network.[103] In a shared sequencing system, data must be readily accessible across various nodes or validators.[104] If any part of the data becomes unavailable or is delayed in its dissemination, it can cause system outages, leading to delays or failures.[105] To counteract these risks, optimistic rollups often mandate sequencers to post full transaction data when publishing to the layer-1 blockchain, ensuring continuity even if a sequencer goes offline.[106] This helps to ensure that, even if a sequencer goes offline, the sequencer (or another sequencer) can use the transaction data to reconstruct the state of the rollup and continue producing blocks on layer 2.[107]
User experience implications
The design and deployment choices of layer-2 solutions invariably affect the end user.[108] On the one hand, a solution that prioritizes rapid transaction confirmations might be well suited for platforms requiring real-time interactions.[109] On the other hand, a solution that emphasizes data availability and consistency might better cater to applications with high data retrieval demands.[110] The sequencing of transactions, whether centrally managed or in some way distributed, can also influence transaction costs, confirmation times, and overall user trust in the system.[111]
In a rollup protocol where transaction sequencing is controlled by a single entity or a select group, efficiencies in ordering and processing can allow reduced transaction fees.[112] Alternatively, this entity could also theoretically exploit its position to impose higher fees, especially if users have limited alternatives.[113] By contrast, depending on the incentive structures in place, a shared sequencing approach can potentially drive fees to more competitive rates where multiple nodes or validators participate in the ordering process.[114]
More centrally controlled sequencing systems might also offer faster confirmation times due to streamlined processing.[115] Shared sequencing systems, however, while benefiting from redundancy, might face longer confirmation times due to the need for consensus.
Choices made by layer-2 project teams can also have profound implications on user trust. In layer-2 networks with a centrally operated sequencer, trust hinges on the reputation and reliability of the operator. If the operator maintains a record of transparency, security, and fairness, users may be more likely to place significant confidence in the system.[116] Any missteps, however, such as perceived censorship or unfair fee structures, have the potential to erode that confidence much more rapidly than it was amassed.[117] Contrarily, shared sequencing systems distribute trust across multiple participants, potentially allowing users to feel more secure knowing that no single person or group has undue control over transaction ordering.[118]
5. The developer’s playbook: Merging tech with legal prudence
The fusion of technology and law, especially in the realm of blockchain, requires a careful and intelligent approach. As layer-2 solutions continue to evolve, developers must be both innovative and sensitive to a range of potential legal issues.
Overall, layer-2 rollup protocols require more than impeccable code; they must also embrace a broad spectrum of best practices. Rigorous testing is required to ensure that the system can handle real-world scenarios, and continuous monitoring should be used to detect and address potential vulnerabilities.[119] Moreover, by staying abreast of the latest research in blockchain, developers can integrate cutting-edge solutions, enhancing both efficiency and security. A hallmark of successful deployments is transparency, and this is no less true in sequencer operations.[120] By being open about their processes, developers can foster community trust and potentially mitigate any regulatory concerns that may arise.
Legal collaboration
Navigating the intricacies of layer-2 sequencing requires a keen understanding of both its technical and potential legal facets. The design choices, from sequencer control mechanisms to operational transparency, can have far-reaching legal implications. While sequencers play a pivotal role in the layer-2 ecosystem, they are only one part of a broader tableau. Developers seeking to establish a new layer-2 network must be cognizant of this bigger picture, recognizing that, depending on the choices they make, their project may potentially come under regulatory scrutiny. Importantly, the global legal landscape is dynamic and often not easily predictable: What might not be cause for legal concern to layer-2 developers today could very well be contentious tomorrow, however misplaced that future legal or regulatory anxiety might be.
While the underlying code of a layer-2 solution might be technically sound, its practical, real-world effects could potentially invite legal scrutiny. The level of influence and control a developer or any other entity wields over specific functions within the rollup can potentially be a focal point for regulators seeking to target blockchain-based projects and infrastructure. For instance, a rollup project that disproportionately influences transaction sequencing or inadvertently centralizes control over critical functions (like sequencing) without building in proper guardrails might attract regulatory attention, even if unintentional. If a single, definable entity has the power to dictate the order of transactions or blocks, validate data, or influence fees, then that entity could possibly be perceived as having some improper level of ‘control’ and potentially triggering scrutiny.
Engaging with legal experts early in the development phase is not just a precautionary measure, but a strategic imperative. Collaboration can illuminate potential pitfalls, allowing layer-2 project developers to make informed decisions that align with both their technological ambitions and the ever-evolving legal landscape. By understanding the potential legal ramifications of their design choices, developers can craft solutions that are not only innovative but also compliant with current and readily foreseeable regulatory frameworks.
“Future proofing” deployments
In the ever-developing world of blockchain, adaptability can be a key to success. Layer-2 solutions must be designed with an eye toward the future, capable of accommodating both technological innovations and potential shifts in regulatory paradigms across various jurisdictions. This might involve adopting modular design principles, championing open-source development, or conducting regular audits. By taking distributed ledger technology’s evolutionary trajectory into consideration early in the development of any layer-2 protocol, developers can better ensure their solutions remain relevant and robust and do not run afoul of potentially applicable restrictions.
One of the best ways to stay on top of developments is to stay engaged with the blockchain community, which is not just a user base, but a collaborative ecosystem composed of a community of individuals with a broad range of valuable insights and expertise. By actively seeking feedback, developers can refine their layer-2 solutions, helping to ensure that they meet the community’s needs and expectations while remaining cognizant of relevant developments in law, regulation, and best practices. This iterative approach is not only likely to enhance project efficacy but also to engender trust and foster a sense of shared purpose and vision.
6. Looking ahead: The future of layer-2 tech
The blockchain ecosystem is in a constant state of growth and transformation, with layer-2 rollup technology currently at the forefront, paving the way for novel applications and use cases.[121] As the demand for scalable and efficient blockchain solutions grows, so too does the drive for innovation in layer-2 rollup technology.
Prospective developments
One of the primary objectives of layer-2 rollups is to address the scalability challenges inherent in many blockchain networks.[122] Therefore, the most recent advancements have largely been focused on optimizing transaction throughput without compromising on security. This means that future layer-2 solutions might be able to safely handle a significantly higher number of transactions per second than current systems. With the growing concerns around data privacy and security, developers are also likely to push toward integrating advanced cryptographic techniques into layer-2 rollups. These techniques would likely not only ensure transaction privacy but also play a crucial role in enhancing the overall security of the system.
As the blockchain space becomes more fragmented with various chains serving different purposes, the need for these chains to communicate with each other becomes paramount. Future innovations in layer-2 rollups will likely focus on ensuring seamless interoperability between different blockchains, allowing for a more integrated and cohesive blockchain ecosystem.[123] As these technologies mature and are used to connect otherwise separate, siloed networks—laying the foundation for a more robust and cohesive web3—the potential applications and use cases for layer-2 rollups, and for blockchain more broadly, are theoretically infinite.
Key takeaways
Layer-2 rollups, while transformative, are but one component in the vast and diverse machinery of maturing blockchain technologies. Before jumping to any conclusions about how these technologies are being deployed, lawyers and policymakers would be wise to exercise restraint and take the time to understand granularly how each involved mechanism functions. As with any technology, the practical implications and real-world effects are what truly matter. Critically, like with any software component used by participants and intermediaries in traditional data networks and payments systems, sequencers and every other software component of layer-2 rollups are designed to be impartial, with no discretion to exclude data or transactions that they were not specifically programmed to include.[124]
The complexities of layer-2 sequencing technology underscore the importance of attorneys and regulators assuming a nuanced understanding and approach. Laws and regulations need not prescribe any requirements or limitations on blockchain development or any specific technological functions like sequencing. Likely no public policy that applies broadly to blockchain developers or participants would be adequately flexible and permissive, let alone necessary or appropriate. For instance, a layer-2 sequencer, while pivotal, is only one component of rollup systems and the evolving blockchain landscape. Rigidly prescribed rules or responsibility would likely only hinder a jurisdiction’s technological advances and set back the security, economy, and welfare of its people in an increasingly competitive global stage. Meanwhile, most regulators and enforcement authorities have existing frameworks to apply if a person or group’s activity raises concerns of willful fraud or consumer harm, without boxing every entity into a specifically financial regulatory framework.
The providers of data infrastructure, as a matter of best practices (and often compelled by independently applicable regulatory requirements),[125] must do their own due diligence before using any third-party software or participating in any network. The third-party software and infrastructure providers used by traditional intermediaries, however, are not—and need not be—subject to any direct regulatory requirements.[126] Therefore, similarly, it would be reasonable to conclude that those building out elements of web3 infrastructure should not be directly regulated as financial intermediaries just because their infrastructure might be indirectly utilized in financial transactions and should generally not bear responsibility for network participants, software users, or their applications of what is, in a controlled environment, completely neutral technology.[127]
Call to action
The future state of blockchain and the potential advancements it holds hinge on collaboration. Developers, users, legal experts, and policymakers must all engage in ongoing dialogue to foster innovation while ensuring a safe and resilient web3 ecosystem. By bridging the gap between technical innovation and legal prudence, we can pave the way for a future where technology and law coexist in synergy, driving progress while continuing to uphold principles of network neutrality, fairness, verifiable reliability, and security.
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Acknowledgment and disclaimer
The authors would like to thank Charles Lu of Espresso Systems, as well as DLx Law attorneys Lewis Cohen, Greg Strong, and Sarah Chen, for their valuable input and assistance in preparing this Chapter. The authors would also like to thank industry participants and the project teams building the layer-2 blockchains referenced in this Chapter, as well as general industry participants, who have greatly assisted them in their understanding of many of the underlying matters. Notably, layer-2 sequencing is still the focus of much ongoing research, so the discussion advanced in this Chapter and the views expressed by its authors should not be interpreted as unwavering or as attributable to other persons and organizations across the industry, including those who may have helped influence or support the production of this Chapter.
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[1] Notably, a “database transaction” is a technical term that does not necessarily have any financial implications. A database transaction is a unit of work in a database management system, treated consistently and reliably, separate from other transactions. It typically signifies a database modification. See Antonello Zanini, Database Transactions 101: The Essential Guide, Db Visualizer: theTable (Feb. 14, 2023), https://www.dbvis.com/thetable/database-transactions-101-the-essential-guide/; Carlos Garcia, What is a Database Transaction?, AppMaster: Blog (Jan. 18, 2023); What is a Transaction?, Microsoft Windows App Development: Documentation (Jan. 7, 2021), https://learn.microsoft.com/en-us/windows/win32/ktm/what-is-a-transaction?redirectedfrom=MSDN.
[2] See George Konstantopoulos, Almost Everything You Need to Know About Optimistic Rollups, Paradigm (Jan. 28, 2021), https://www.paradigm.xyz/2021/01/almost-everything-you-need-to-know-about-optimistic-rollup; Layer 2: Ethereum for Everyone, Ethereum, https://ethereum.org/en/layer-2 (last visited Aug. 24, 2023) (providing more detailed descriptions of layer-2 rollup networks, how they function, and how they interact with their related layer-1 network).
[3] See Vitalik Buterin, Proposed Milestones for Rollups Taking Off Training Wheels, Ethereum Magicians Forum (Nov. 3, 2022), https://ethereum-magicians.org/t/proposed-milestones-for-rollups-taking-off-training-wheels/11571; Kyle Charbonnet, An Introduction to Optimism’s Optimistic Rollup, Medium: Privacy & Scaling Explorations (Jul. 1, 2021), https://medium.com/privacy-scaling-explorations/an-introduction-to-optimisms-optimistic-rollup-8450f22629e8; How Do Optimistic Rollups Work: The Complete Guide, Alchemy: Overviews: Optimistic Rollups (rev. Mar. 14, 2023), https://www.alchemy.com/overviews/optimistic-rollups.
[4] See The Espresso Sequencer, Espresso Systems (HackMD) (rev. Mar. 20, 2023), https://hackmd.io/@EspressoSystems/EspressoSequencer; Layer-2 Scaling Solutions, Pontem Network: Pontem Blog, https://pontem.network/posts/layer-2-scaling-solutions-2 (last visited Aug. 24, 2023).
[5] See The Sequencer and Censorship Resistance, Arbitrum Docs: Sequencer (rev. Aug. 18, 2023), https://developer.arbitrum.io/sequencer.
[6] Like with other technologies, the degree of control exerted by sequencers, the transparency (or lack thereof) of their operations, and the choices made in their deployment could potentially draw scrutiny from regulators. It is worth noting that the legal landscape surrounding layer-2 sequencers remains largely uncharted; no sequencer deployment scenario has been rigorously tested or challenged under potentially applicable laws or regulations. See generally Angela Angelovska-Wilson et al., Decentralized Finance: The Revolution Continues, Current Regulations and Impacts of Cross-chain Bridge Solutions, Global Legal Insights, Blockchain & Cryptocurrency Laws and Regulations 2023 (Oct. 2022), https://www.globallegalinsights.com/practice-areas/blockchain-laws-and-regulations/05-decentralized-finance-the-revolution-continues-current-regulations-and-impacts-of-cross-chain-bridge-solutions.
[7] See Espresso Sequencer Architecture: System Overview, Espresso Docs, https://docs.espressosys.com/network/espresso-architecture/the-espresso-network (last visited Oct. 3, 2023); Sequencers, Metis Docs: Protocol in Detail (rev. Aug. 4, 2022), https://docs.metis.io/dev/the-architecture-of-the-metis-smart-l2/sequencers; The Sequencer and Censorship Resistance, Arbitrum Docs, supra note 5.
[8] See id.
[9] For the purposes of this Chapter, we presuppose that sequencers are programmed to follow an objective protocol as they largely are in the layer-2 iterations discussed by this Chapter. Notably, however, as with most software, sequencing software can be programmed differently depending on the functions it is designed to perform, including where a sequencer may be built with a different set of transaction ordering policies and priorities in mind.
[10] See Section 3 (under the subsection on “Sequencers”).
[11] See Shannon Wu, Bridging the Gap Between Traditional and Decentralized Finance, Forbes (Aug. 31, 2020), https://www.forbes.com/sites/forbestechcouncil/2020/08/31/bridging-the-gap-between-traditional-and-decentralized-finance; Angela Angelovska-Wilson et al., supra note 6.
[12] See Shannon Wu, supra note 11; Primavera De Filippi et al., The Alegality of Blockchain Technology, Oxford Academic: Policy & Society (Feb. 16, 2022), https://academic.oup.com/policyandsociety/article/41/3/358/6529327.
[13] See Jason Cohen, 4 Companies Control 67% of the World’s Cloud Infrastructure, PC Magazine: News: The Why Axis (Dec. 29, 2021), https://www.pcmag.com/news/four-companies-control-67-of-the-worlds-cloud-infrastructure; Felix Richter, Amazon Maintains Lead in the Cloud Market, Statista (Aug. 8, 2023), https://www.statista.com/chart/18819/worldwide-market-share-of-leading-cloud-infrastructure-service-providers/.
[14] See Clare Stouffer, 23 Cloud Security Risks, Threats, and Best Practices to Follow, Norton: Blog (Jul. 11, 2023), https://us.norton.com/blog/privacy/cloud-security-risks.
[15] See generally Primavera De Filippi et al., supra note 12.
[16] See Scaling Overview, Ethereum Docs: Scaling (rev. Apr. 7, 2023), https://ethereum.org/en/developers/docs/scaling.
[17] “Gas” are the transaction fees paid by network users, primarily to transaction validators.
[18] See Layer-2 Scaling Solutions, Pontem Network, supra note 4; Optimistic Rollups, Ethereum Docs: Scaling (rev. Jun. 28, 2023), https://ethereum.org/en/developers/docs/scaling/optimistic-rollups.
[19] See Scaling Overview, Ethereum Docs, supra note 16; Shared Sequencing: Defragmenting the L2 Rollup Ecosystem, Espresso Systems (HackMD) (rev. May 2, 2023), https://hackmd.io/@EspressoSystems/SharedSequencing.
[20] See How Do Optimistic Rollups Work: The Complete Guide, Alchemy, supra note 3.
[21] In simpler terms, consider the equation 2+2=4 as an example. Here, the input array consists of the numbers 2 and 2, and the output array is 4. The function, in this case, is basic arithmetic (i.e., addition).
[22] See Optimistic Rollups, Ethereum Docs, supra note 18 (discussing how all data necessary to reconstruct the rollup’s state is stored on-chain, ensuring that, even if the sequencer disappears, users can still retrieve their funds); see, e.g., Kyle Charbonnet, supra note 3 (highlighting the Optimism layer-2 protocol’s use of a modified version of the Ethereum Virtual Machine, or “EVM,” to ensure that layer-2 transactions are “replayable” on both layer-1 and layer-2 chains with consistent outcomes).
[23] The process can be illustrated, in reduced form, by three steps or three states: input array (layer 1) > function (rollup node software) > output array (layer 2).
[24] See Optimistic Rollups, Ethereum Docs, supra note 18.
[25] See id.
[26] In effect, the only way someone could change the established, historical state of the layer-2 blockchain is by changing the state of the Ethereum smart contract itself. This is only possible if the person can break Ethereum, a network renowned for decentralization and security. See id.
[27] See, e.g., Espresso Sequencer Architecture: System Overview, Espresso Docs , supra note 7 (emphasizing that the sequencer’s consistent communication with the layer-1 chain is designed to ensure trustless state checkpoints); OP Mainnet’s Security Model, Optimism Community Docs (rev. Aug. 23, 2023), https://community.optimism.io/docs/security-model (discussing how Optimism layer-2 blocks are stored on the Ethereum blockchain using a non-contract address to minimize layer-1 gas costs) (also discussing how, once submitted as call data on Ethereum, these blocks are immutable once included in a sufficiently attested layer-1 block).
[28] See Optimistic Rollups, Ethereum Docs, supra note 18.
[29] See Darren Kleine, Rollup Sequencers are Centralized: And That’s Fine, Blockworks (May 31, 2023), https://blockworks.co/news/rollup-sequencers-are-centralized; Overview: The Lifecycle of an Arbitrum Transaction, Arbitrum Docs: Tx Lifecycle (rev. Aug. 18, 2023), https://developer.arbitrum.io/tx-lifecycle.
[30] See Overview: The Lifecycle of an Arbitrum Transaction, Arbitrum Docs, supra note 29; Shared Sequencing: Defragmenting the L2 Rollup Ecosystem, Espresso Systems (HackMD), supra note 19.
[31] See Scaling Overview, Ethereum Docs: Scaling (rev. Apt. 7, 2023), https://ethereum.org/en/developers/docs/layer-2-scaling.
[32] A “rollup node” is a specialized node that the sequencer runs on the mainnet to submit batch transaction data.
[33] The “execution engine” is the component of the sequencer’s code that allows the sequencer to execute and process incoming transactions based on pre-agreed ordering rules.
[34] See Designing the Espresso Sequencer: Combining HotShot Consensus with Tiramisu DA, Espresso Systems (HackMD) (rev. Jul. 20, 2023), https://hackmd.io/@EspressoSystems/HotShot-and-Tiramisu; see generally Eric Rykwalder, The Math Behind the Bitcoin Protocol, CoinDesk (Oct. 19, 2014), https://www.coindesk.com/markets/2014/10/19/the-math-behind-the-bitcoin-protocol.
[35] See The Sequencer and Censorship Resistance, Arbitrum Docs, supra note 5; Darren Kleine, supra note 29.
[36] See Section 3 (under the subsection on “Mechanisms for accountability”) and Section 4 (under the subsection on “Developer choices”). Markedly, because various protocols could implement different ordering policies (e.g., first-come-first-serve, time enhancing, MEV maximizing), with differing use cases, aims, and risks, this may not always be true of all protocols. See also supra note 9.
[37] See Vitalik Buterin, What Would a Rollup-Centric Ethereum Roadmap Look Like?, Ethereum Magicians Forum (Oct. 2, 2020), https://ethereum-magicians.org/t/a-rollup-centric-ethereum-roadmap/4698; Overview: The Lifecycle of an Arbitrum Transaction, Arbitrum Docs, supra note 30; Optimistic Rollups, Ethereum Docs, supra note 18.
[38]> See Section 3 (under the subsection on “Mechanisms for accountability”) and Section 4 (under the subsection on “Developer choices”).
[39] These are some of the primary considerations compelling the use of decentralized sequencers. See Section 4 (under the subsection on “Developer choices”).
[40] See The Sequencer and Censorship Resistance, Arbitrum Docs, supra note 5; Optimistic Rollups, Ethereum Docs, supra note 18.
[41] See Optimistic Rollups, Ethereum Docs, supra note 18; L2 Output Root Proposals Specification, Github: Optimism: Specs (rev. Jun. 26, 2023), https://github.com/ethereum-optimism/optimism/blob/develop/specs/proposals.md.
[42] See Darren Kleine, supra note 29.
[43] Optimistic rollups are systems that operate on a presumption of transaction validity for all batch data submitted by the sequencer to the layer-1 chain. See Section 3 (under the subsection on “Mechanisms for accountability”).
[44] See Optimistic Rollups, Ethereum Docs: Scaling, supra note 18; see generally infra note 85 (discussing layer-2 rollup state challenge processes).
[45] See The Sequencer and Censorship Resistance, Arbitrum Docs: Sequencer, supra note 5; Espresso Sequencer Architecture: System Overview, Espresso Docs, supra note 7.
[46] A remote procedure call (or “RPC”) is a broader blockchain-related concept referring to the method by which users or applications communicate with a blockchain node. When working with layer-2 solutions like rollups, RPC endpoints can be crucial. They allow users and applications to send transactions, query balances, fetch data, and more, specifically for that layer-2 environment. As rollups and other layer-2 solutions have their own state and data separate from the main Ethereum chain, they often provide their own RPC endpoints for direct interaction. See Scaling Overview, Ethereum Docs, supra note 31; see generally What Is an RPC Node: A Comprehensive Guide, Blockchain Council: Understanding Blockchain, https://www.blockchain-council.org/blockchain/what-is-an-rpc-node (last visited Aug. 24, 2023) (providing a detailed overview of RPCs).
[47] See Darren Kleine, supra note 29; Optimistic Rollups, Ethereum Docs, supra note 18.
[48] See Optimistic Rollups, Ethereum Docs, supra note 18.
[49] See Kyle Charbonnet, supra note 3; Optimistic Rollups, Ethereum Docs, supra note 18.
[50] Sharding is a scaling solution for blockchains that increases the number of transactions a blockchain can process by splitting the network into smaller pieces, called shards. Each shard processes its own micro-blocks. Sharding can help address the data availability problem by ensuring that even if one shard becomes unavailable, the others remain operational. See Sharding FAQ, Github: Ethereum: Wiki (rev. May 24, 2022), https://github.com/ethereum/wiki/wiki/Sharding-FAQ.
[51] See id.; Ethereum 2.0 FAQ, Consensys: Knowledge Base, https://consensys.net/knowledge-base/ethereum-2/faq (last visited Aug. 24, 2023).
[52] See The Espresso Sequencer, Espresso Systems (HackMD), supra note 4; The Sequencer and Censorship Resistance, Arbitrum Docs, supra note 5; Espresso Sequencer Architecture: System Overview, Espresso Docs, supra note 7.
[53] See Overview: The Lifecycle of an Arbitrum Transaction, Arbitrum Docs, supra note 29; see also The Sequencer and Censorship Resistance, Arbitrum Docs, supra note 5 (discussing how the Arbitrum sequencer receives transactions directly from a client or via layer 1 through a “delayed inbox”).
[54] See The Sequencer and Censorship Resistance, Arbitrum Docs, supra note 5.
[55] See Introduction to zkSync for Developers, zkSync Docs (rev. Feb. 16, 2023), https://zksync.io/dev/tutorial.html; Optimistic Rollups, Ethereum Docs, supra note 18.
[56] See Introduction to Optimism, Optimism (Github): Specs (rev. Apr. 6, 2023), https://github.com/ethereum-optimism/optimism/blob/develop/specs/introduction.md; Alex Gluchowski, Optimistic vs. ZK Rollup: Deep Dive, Medium: Matter Labs Blog (Nov. 4, 2019), https://blog.matter-labs.io/optimistic-vs-zk-rollup-deep-dive-ea141e71e075; Rollups, Paradigm Research, https://research.paradigm.xyz/rollups (last visited Jul. 22, 2023); What’s the Difference Between Arbitrum Rollup and Arbitrum AnyTrust?, Arbitrum Docs: FAQs: Protocol (rev. Aug. 18, 2023), https://developer.arbitrum.io/faqs/protocol-faqs; see also Optimistic Rollups, Ethereum Docs, supra note 18 (emphasizing that security of optimistic rollups is based on the main Ethereum chain, thus ensuring trust in the provided data).
[57] See Alex Gluchowski, supra note 56.
[58] See Introduction to Optimism, Optimism (Github), supra note 56.
[59] See Alex Gluchowski, supra note 56.
[60] See id.; Introduction to Optimism, Optimism (Github), supra note 56; see also Optimistic Rollups, Ethereum Docs, supra note 18 (explaining that, because optimistic rollup protocols largely execute transactions off-chain, they must assume that all transactions are valid without proving transaction validity); Layer-2 Scaling Solutions, Pontem Network, supra note 4 (emphasizing that optimistic rollups assume that all transactions are valid without proving transaction validity).
[61] See Optimistic Rollups, Ethereum Docs, supra note 18; Introduction to Optimism, Optimism (Github): Specs, supra note 56.
[62] See Scaling Overview, Ethereum Docs, supra note 18.
[63] See How Do Optimistic Rollups Work: The Complete Guide, Alchemy, supra note 3; Optimistic Rollups, Ethereum Docs, supra note 18; Alex Gluchowski, supra note 56.
[64] See How Do Optimistic Rollups Work: The Complete Guide, Alchemy, supra note 3; Alex Gluchowski, supra note 56.
[65] See Scaling Overview, Ethereum Docs, supra note 18.
[66] See id.
[67] See id.; How Do Optimistic Rollups Work: The Complete Guide, Alchemy, supra note 3; Alex Gluchowski, supra note 56.
[68] See The Espresso Sequencer, Espresso Systems (HackMD), supra note 3; Darren Kleine, supra note 29.
[69] See The Espresso Sequencer, Espresso Systems (HackMD), supra note 3.
[70] This is often the case except with sequencers with some level of decentralization. See infra “Developer choices”; see, e.g., Shared Sequencing: Defragmenting the L2 Rollup Ecosystem, Espresso Systems (HackMD), supra note 19.
[71] See, e.g., The Espresso Sequencer, Espresso Systems (HackMD), supra note 3 (demonstrating how neutrality promotes accountability and allows for enhanced interoperability so that transactions can be processed in a manner that is consistent across various rollups).
[72] See Darren Kleine, supra note 29.
[73] See id.
[74] See Scaling Overview, Ethereum Docs, supra note 18.
[75] See id.
[76] See George Konstantopoulos, supra note 2; Optimistic Rollups, Ethereum Docs, supra note 18; What’s the Difference Between Arbitrum Rollup and Arbitrum AnyTrust?, Arbitrum Docs, supra note 56.
[77] See generally Introduction to Optimism, Optimism (Github), supra note 56.
[78] See id.
[79] “Verifiers” should not be confused with “validators” on a blockchain network. Verifiers do not produce blocks or participate in consensus like validators on a blockchain; instead, they only passively check the validity of data. See 2023 Metis L2 Roadmap, Metis Knowledge Base (rev. Apr. 5, 2023), https://metis.io/knowledge/2023-metis-l2-roadmap; Metis Andromeda (2beat): Scaling, https://l2beat.com/scaling/projects/metis (last visited Aug. 24, 2023); What’s the Difference Between Arbitrum Rollup and Arbitrum AnyTrust?, Arbitrum Docs, supra note 56.
[80] See What’s the Difference Between Arbitrum Rollup and Arbitrum AnyTrust?, Arbitrum Docs, supra note 56; Introduction to Optimism, Optimism (Github), supra note 56.
[81] See id.
[82] While sequencers often assume the same role as a “proposer” in many layer-2 systems, this association is not mandatory. For example, sequencers should not assume this role in systems that allow permissionless output proposals, because the role of a “proposer” mechanism in this instance becomes entirely unauthenticated.
[83] For instance, based on the simplified example in arithmetic from Section 3 (under the subsection on “Technical foundations of layer-2 sequencing”), an error might be providing “5” as the output for the inputs of “2+2.” See supra note 21.
[84] The verifier typically must submit any challenge as a transaction to the same smart contract on the mainnet. A successful challenge requires the verifier to specify the particular transaction or state transition that the verifier believes is invalid. In some cases, if there is a dispute that cannot be resolved on the rollup, the layer-2 protocol might have a mechanism to “fall back” to layer 1 for resolution, though typically more costly and time-consuming. This typically involves executing the challenged transaction on the mainnet to determine its validity. See Scaling Overview, Ethereum Docs, supra note 18.
[85] Participants can then take corrective actions, such as exiting the system through a direct layer-1 transaction or signaling to the broader community about potential issues with the sequencer’s operator. See Alex Gluchowski, supra note 56.
[86] See generally Primavera De Filippi et al., supra note 12.
[87] See generally id.; Layer 2 Scaling, Ethereum Docs: Scaling (rev. Apr. 7, 2023), https://ethereum.org/en/developers/docs/layer-2-scaling/#rollups; Scaling Overview, Ethereum Docs, supra note 18; see, e.g., Shared Sequencing: Defragmenting the L2 Rollup Ecosystem, Espresso Systems (HackMD), supra note 19 (highlighting choices available to developers between optimistic and zero-proof rollups); The Sequencer and Censorship Resistance, Arbitrum Docs, supra note 5 (discussing an array of options in setting up sequencer operations).
[88] See How Do Optimistic Rollups Work: The Complete Guide, Alchemy, supra note 3; Darren Kleine, supra note 29.
[89] See id.; The Sequencer and Censorship Resistance, Arbitrum Docs, supra note 5 (showcasing the variability in processes for sequencing and validating transactions).
[90] See generally Scaling Overview, Ethereum Docs, supra note 18; see, e.g., The Sequencer and Censorship Resistance, Arbitrum Docs, supra note 5 (detailing use of fully centrally controlled sequencer operations but contemplating more decentralized mechanisms for future iterations of the protocol, such as by involving a distributed committee of sequencers).
[91] See Shared Sequencing: Defragmenting the L2 Rollup Ecosystem, Espresso Systems (HackMD), supra note 19 (emphasizing the risks of having a single sequencer, which can become a single point of failure, leading to potential censorship and monopolistic behaviors); see generally Section 3 (under the subsection on “Mechanisms for accountability”).
[92] See Kyle Charbonnet, supra note 3 (acknowledging that relying on a single sequencer represents the departure from the aims of a fully decentralized model); Introduction to Boba Network for Developers, Boba Docs: For Developers, https://docs.boba.network/for-developers/developer-start (last visited Aug. 24, 2023) (underscoring how reliance on a sequencer could be seen as a move away from full decentralization); see also Espresso Sequencer Architecture: System Overview, Espresso Docs, supra note 7 (emphasizing the importance of credible neutrality and alignment with Ethereum’s ethos).
[93] See, e.g., Shared Sequencing: Defragmenting the L2 Rollup Ecosystem, Espresso Systems (HackMD), supra note 19 (suggesting that a shared sequencer can connect liquidity and applications between rollups, enhancing user experience, and increasing the utility of individual rollups).
[94] See id.
[95] See Radius (radius.xyz), Shared Sequencer for MEV Protection and Profitable Marketplace, EthResearch (Apr. 16, 2023), https://ethresear.ch/t/shared-sequencer-for-mev-protection-and-profitable-marketplace/15313; Darren Kleine, supra note 29.
[96] See, e.g., Introduction to Boba Network for Developers, Boba Docs: For Developers, supra note 92 (suggesting use of distributed checking mechanisms in combination with a centrally operated sequencer); Roderic Puah, Metis Andromeda: The Latest Layer 2 Protocol on Ethereum, Switcheo Research: Blog (Mar. 8, 2022), https://blog.switcheo.com/metis-andromeda (detailing use of multiple sequencers pooled into on-chain units called “decentralized autonomous companies”).
[97] See Peter Mell et al., Blockchain Technology Overview, Dep’t of Com., Nat. Inst. of Standards & Tech., NISTIR 8202 (Oct. 2018), https://nvlpubs.nist.gov/nistpubs/ir/2018/NIST.IR.8202.pdf; How Do Optimistic Rollups Work: The Complete Guide, Alchemy, supra note 5.
[98] See, e.g., Espresso Sequencer Architecture: System Overview, Espresso Docs, supra note 7.
[99] See, e.g., Batch Submitter, Optimism (Github): Specs (rev. Jan. 13, 2023), https://github.com/ethereum-optimism/optimism/blob/develop/specs/batcher.md; L2 Output Root Proposals Specification, Github: Optimism: Specs, supra note 41.
[100] See L2 Output Root Proposals Specification, Github: Optimism: Specs, supra note 41; Vitalik Buterin, supra note 37.
[101] See An Incomplete Guide to Rollups, Vitalik.ca (Jan. 5, 2021), https://vitalik.ca/general/2021/01/05/rollup.html
[102] See Scaling Overview, Ethereum Docs, supra note 18.
[103] See Layer 2 Scaling, Ethereum Docs: Scaling, supra note 87.
[104] See Espresso Sequencer Architecture: System Overview, Espresso Docs, supra note 7 (illustrating the flow of information throughout the system, starting from clients, passing through the sequencer, moving to integrated rollups, and culminating in certification and checkpointing on layer 1); see generally Shared Sequencing: Defragmenting the L2 Rollup Ecosystem, Espresso Systems (HackMD), supra note 19 (touting the sequencer as a tool for defragmenting the layer-2 landscape and connecting liquidity, applications, and shared data among different rollups).
[105] See George Konstantopoulos, supra note 21. Regardless of whether sequencing operations are centrally controlled or dispersed, there may always be a potential risk, however small, of a sequencer going rogue or even offline. See Shared Sequencing: Defragmenting the L2 Rollup Ecosystem, Espresso Systems (HackMD), supra note 19; see, e.g., Sage Young, Arbitrum Temporarily Stopped Processing Due to Software Bug, CoinDesk: Technology (Jun. 7, 2023), https://www.coindesk.com/tech/2023/06/07/arbitrum-temporarily-stopped-processing-due-to-software-bug (reporting how the Arbitrum layer 2 went out of service for several hours due to a bug in the sequencer and a resulting transaction backlog that stressed the network).
[106] See Optimistic Rollups, Ethereum Docs, supra note 18. While shared sequencers can reduce central points of failure and enhance transparency, they often require implementing additional mechanisms to ensure that data is consistently available and can be efficiently retrieved by all network participants. See Shared Sequencing: Defragmenting the L2 Rollup Ecosystem, Espresso Systems (HackMD), supra note 19.
[107] See Kyle Charbonnet, supra note 3; The Sequencer and Censorship Resistance, Arbitrum Docs, supra note 5.
[108] See Optimistic Rollups, Ethereum Docs, supra note 18 (highlighting the impact of various layer-2 features on the end user, such as the need for users to be online to challenge fraudulent transactions and any delays in withdrawals); see, e.g., Layer-2 Scaling Solutions, Pontem Network, supra note 3 (distinguishing between various layer-2 solutions and highlighting their unique features and impact on the end user).
[109] See George Konstantopoulos, supra note 1 (discussing how optimistic rollups achieve faster and cheaper transactions by executing most transactions off-chain and only submitting a summary to the main chain).
[110] See Optimistic Rollups, Ethereum Docs, supra note 18.
[111] See The Sequencer and Censorship Resistance, Arbitrum Docs, supra note 5; Shared Sequencing: Defragmenting the L2 Rollup Ecosystem, Espresso Systems (HackMD), supra note 19; What’s the Difference Between Arbitrum Rollup and Arbitrum AnyTrust?, Arbitrum Docs, supra note 56.
[112] See The Sequencer and Censorship Resistance, Arbitrum Docs, supra note 5; Shared Sequencing: Defragmenting the L2 Rollup Ecosystem, Espresso Systems (HackMD), supra note 19.
[113] See Kyle Charbonnet, supra note 3; Shared Sequencing: Defragmenting the L2 Rollup Ecosystem, Espresso Systems (HackMD), supra note 19 (emphasizing the challenges introduced by rollups, such as potential monopoly pricing, censorship, and fragmentation within the Ethereum ecosystem).
[114] See, e.g., Shared Sequencing: Defragmenting the L2 Rollup Ecosystem, Espresso Systems (HackMD), supra note 19 (discussing the benefits of shared sequencing, bridging between rollups, and atomic cross-rollup transactions).
[115] See Darren Kleine, supra note 29 (emphasizing that while blockchain technology aims for decentralization, developers often resort to centralized mechanisms for efficiency and speed).
[116] See The Sequencer and Censorship Resistance, Arbitrum Docs, supra note 5 (discussing how, despite the potential for sequencer misbehavior, rollup-2 protocols can be designed to ensure trustless security).
[117] See id. (emphasizing the challenges introduced by potential sequencer misbehavior, like monopoly pricing, censorship, and fragmentation within the Ethereum ecosystem); Kyle Charbonnet, supra note 3; Shared Sequencing: Defragmenting the L2 Rollup Ecosystem, Espresso Systems (HackMD), supra note 19 (“By relying on a single party for transaction ordering and inclusion in a rollup, they are prone to monopoly pricing and censorship.”); see, e.g., Sage Young, supra note 105 (reporting how the Arbitrum layer 2 went out of service for several hours due to a bug in the sequencer and a resulting transaction backlog that stressed the network).
[118] See Shared Sequencing: Defragmenting the L2 Rollup Ecosystem, Espresso Systems (HackMD), supra note 19 (discussing the challenges of potential monopoly pricing, censorship, and fragmentation, and proposing shared sequencing protocols as a solution); What’s the Difference Between Arbitrum Rollup and Arbitrum AnyTrust?, Arbitrum Docs, supra note 56 (demonstrating that regardless of the degree of centralization of sequencer operations, more crucial to maintaining the network’s “trustlessness” nature is the decentralization of validators); see also The Sequencer and Censorship Resistance, Arbitrum Docs, supra note 5 (elaborating on the potential risks of a centralized sequencer and describing how Arbitrum maintains its claim to censorship resistance even if the sequencer misbehaves). Importantly, notwithstanding, the complexity of shared or distributed sequencing systems can potentially make it challenging for average users to understand, potentially hindering their trust in the network.
[119] See Darren Kleine, supra note 29.
[120] Id.
[121] See George Konstantopoulos, supra note 2; Layer 2: Ethereum for Everyone, Ethereum, supra note 2.
[122] See Layer 2: Ethereum for Everyone, Ethereum, supra note 2.
[123] Notably, this is one of the primary objectives of the Cosmos network. See Cosmos Network, https://cosmos.network (last visited Aug. 24, 2023).
[124] For example, a sequencer might neutrally exclude transactions based on built-in mechanisms meant to address risks and vulnerabilities and follow established user incentives.
[125] See, e.g., Off. of the Comptroller of the Currency, Third-Party Relationships: Interagency Guidance on Risk Management, OCC Bulletin 2023-017 (Jun. 6, 2023), https://www.occ.gov/news-issuances/bulletins/2023/bulletin-2023-17.html (promulgating guidance to federally regulated depository institutions on best practices in managing relationships with and use of third-party technology service providers); see generally Carl White, Regulating Fintech: One Size Does Not Fit All, Fed. Res. Bank of St. Louis: On the Economy Blog (Feb. 24, 2021), https://www.stlouisfed.org/on-the-economy/2021/february/regulating-fintech-one-size-does-not-fit-all (discussing how, when third-party financial technology providers provide services to a bank or its customers, there may be third-party risk management guidelines to which banks must adhere, such as auditing and monitoring their providers).
[126] See Carl White, supra note 125 (emphasizing that the responsibility for meeting regulatory requirements for both in-house and outsourced technology needs falls on the banks that implement those technologies, not on the providers of those technologies).
[127] Note that there may be many various, nuanced legal issues and related liabilities (such as in intellectual property, tort, contract, etc.) that are potentially implicated by any given blockchain protocol or software-based mechanism (like a sequencer) protocols. This Chapter contemplates only broad legal principles and does not seek to address any particular legal or regulatory issues or classifications, under any theory, that may potentially be implicated by sequencers or other layer-2 rollup components.
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