How to Launch a Layer 2 Network Focused on Real-World Assets in DeFi?

The DeFi space is rapidly evolving, with a notable trend towards the integration of real-world assets (RWA) into blockchain ecosystems. This shift is driven by the desire to bridge traditional financial systems with the innovative, permissionless nature of DeFi. In 2024, the total value locked (TVL) in DeFi protocols reached approximately $70 billion, a significant portion of which is now tied to RWAs. The market for tokenized RWAs alone is expected to exceed $16 trillion by 2030, as more traditional financial institutions and investors recognize the potential of blockchain technology to unlock new liquidity sources and enhance financial accessibility.

Amidst this trend, the development and launch of a Layer 2 network focused on RWAs within DeFi ecosystems have become a hot topic. Such networks offer a blend of scalability, security, and compliance, making them attractive for developers, financial institutions, and users alike. This article delves into the intricacies of launching a Layer 2 network tailored for RWAs, exploring the technical, regulatory, and economic considerations involved.

Understanding Layer 2 Networks in the Context of DeFi and RWAs

What Are Layer 2 Networks?

Layer 2 networks are secondary frameworks or protocols built on top of an existing blockchain, primarily designed to enhance the scalability and efficiency of the underlying Layer 1 blockchain, such as Ethereum. By offloading certain operations to Layer 2, these networks alleviate congestion on the main chain, reduce transaction fees, and improve transaction speeds. This makes them particularly suitable for applications requiring high throughput, such as DeFi protocols dealing with RWAs.

The Role of Real-World Assets in DeFi

Real-world assets in the context of DeFi refer to physical or tangible assets — like real estate, commodities, or government bonds — that have been tokenized and brought onto the blockchain. Tokenization allows these assets to be traded, collateralized, and leveraged within DeFi ecosystems, thus merging traditional finance with the innovative benefits of blockchain technology.

Key Considerations for Launching a Layer 2 Network Focused on RWAs

Launching a Layer 2 network focused on RWA within DeFi is a complex endeavor requiring a deep understanding of both blockchain technology and traditional financial systems. Below are the key considerations that need to be addressed:

1. Technical Infrastructure and Scalability

One of the most critical aspects of launching a Layer 2 network is the underlying technical infrastructure. The choice of technology stack will determine the network’s scalability, security, and interoperability with other DeFi protocols.

• Choosing the Right Tech Stack: To achieve optimal performance, the Layer 2 network should be built on a proven tech stack that supports high transaction throughput and low latency. For example, the OP Stack, a modular framework designed by Optimism, is a popular choice for Layer 2 networks. This framework not only ensures scalability but also facilitates integration with Ethereum’s existing ecosystem, which is crucial for DeFi applications.
• Leveraging Rollup Technology: Rollups, which bundle multiple transactions into a single transaction on the Layer 1 blockchain, are essential for scaling DeFi applications. Two primary types of rollups exist: Optimistic Rollups and ZK-Rollups. While Optimistic Rollups assume transactions are valid and only run fraud proofs if challenged, ZK-Rollups use zero-knowledge proofs to ensure all transactions are valid. The choice between these depends on the specific needs of the network, with ZK-Rollups offering stronger security guarantees at the cost of increased computational complexity.
• Interoperability and Cross-Chain Compatibility: Given the increasing fragmentation of the blockchain space, ensuring that the Layer 2 network can seamlessly interact with other blockchains and Layer 1 networks is crucial. Cross-chain compatibility allows for the transfer of assets and data between different blockchains, enabling a more fluid and integrated DeFi ecosystem.

2. Regulatory Compliance and Governance

Regulatory compliance is a significant consideration, especially when dealing with real-world assets, which are subject to existing legal frameworks and financial regulations. Integrating RWAs into a Layer 2 network requires careful planning to ensure that the network adheres to relevant laws while maintaining the decentralized ethos of DeFi.

• Optional Compliance Layers: An innovative approach to regulatory compliance is the use of an optional compliance layer. This allows users and protocols to opt into compliance mechanisms, such as Know Your Customer (KYC) and Anti-Money Laundering (AML) checks, without mandating it across the entire network. This model offers flexibility, enabling permissionless participation while allowing regulated entities to meet legal requirements.
• Decentralized Identity (DID) Systems: A decentralized identity system is crucial for managing compliance on a Layer 2 network. DID systems enable users to prove their identity and comply with regulatory requirements without compromising their privacy. In the context of RWAs, this could involve issuing Decentralized ID tokens linked to user addresses that store KYC data, which protocols can then use to meet their specific regulatory needs.
• Governance Models: The governance structure of the network must balance decentralization with effective decision-making. Decentralized Autonomous Organizations (DAOs) are often used in Layer 2 networks to govern protocol upgrades, compliance mechanisms, and other critical aspects of network management. Token-based voting, where participants use governance tokens to vote on proposals, ensures that the community has a say in the network’s direction.

3. Economic Incentives and Native Tokens

The economic model of a Layer 2 network is central to its success. This involves creating incentives for participants to use and secure the network, as well as establishing mechanisms to maintain the value of native tokens.

• Native Stablecoin and Yield Mechanisms: Launching a native stablecoin backed by real-world assets, such as U.S. treasury bills, can provide a stable value store within the network. This stablecoin can be further leveraged by offering a native yield mechanism, where users earn interest by locking their assets for a set period. For instance, a six-month lockup could yield an annual interest of 5.35%, creating a strong incentive for users to participate in the network’s economy.
• RWA Liquidity Layer: A dedicated RWA liquidity layer can enhance the utility of the network by providing a unified basket of assets for lending, collateral, and trading purposes. This layer could include tokenized treasury assets and leading cryptocurrencies, which are rebalanced periodically to maintain liquidity and stability. Participants can stake these assets to earn additional rewards, further driving engagement.
• Token Economics and Staking Rewards: The native token of the network, such as CPOOL in the context of Clearpool’s Ozean, plays a crucial role in securing the network and incentivizing participants. Staking mechanisms can be designed to reward users for participating in consensus (e.g., through sequencing and blockspace fees) and maintaining the stability of the network’s stablecoin. Additionally, a buy-back-and-burn mechanism funded by protocol revenue can help maintain the token’s value by reducing supply over time.

4. User Experience and Accessibility

For a Layer 2 network focused on RWAs to gain widespread adoption, it must offer a seamless and intuitive user experience, minimizing the barriers to entry for both retail and institutional users.

• Fiat On-Ramps and Off-Ramps: To attract users from traditional finance, it’s essential to integrate fiat on-ramps and off-ramps that allow users to easily convert fiat currency into stablecoins or other crypto assets on the network. These on-ramps should support a wide range of payment methods, including credit/debit cards, bank transfers, and possibly even local payment options in different regions. By simplifying the process of moving funds into and out of the blockchain ecosystem, the network can appeal to a broader audience, including those less familiar with cryptocurrency.
• Custodial Wallet Services: While self-custody is a core principle of DeFi, it can be intimidating for new users due to the complexities of managing private keys. Offering a native custodial wallet service can help mitigate these frictions by providing a user-friendly interface that abstracts away the complexities of key management. These wallets can be designed to offer both security and ease of use, allowing users to interact with the Layer 2 network without needing extensive technical knowledge. Such services are particularly valuable for onboarding users from traditional finance who may be unfamiliar with non-custodial wallets.
• Gasless Transactions and User-Friendly Interfaces: One of the main pain points in using blockchain networks is the need to pay gas fees for every transaction. Implementing gasless transactions on the Layer 2 network can significantly improve user experience by eliminating the need for users to hold the native token just to pay for transaction fees. Additionally, developing user-friendly interfaces and dashboards that allow users to easily manage their assets, track yields, and interact with different DeFi protocols will be crucial for widespread adoption.
• Developer Tools and Ecosystem Support: For the network to thrive, it needs a robust developer ecosystem. Providing comprehensive developer tools, such as APIs, SDKs, and documentation, can encourage developers to build on the Layer 2 network. This, in turn, leads to a richer ecosystem of applications and services, driving further adoption. Ecosystem grants and incentives for developers can also play a role in fostering innovation and ensuring the network remains at the cutting edge of DeFi development.

5. Security and Risk Management

Security is paramount in any blockchain network, particularly when dealing with real-world assets where the stakes are high. Ensuring the safety of users’ funds and data is crucial for building trust and achieving long-term success.

• Smart Contract Audits and Bug Bounties: All smart contracts deployed on the Layer 2 network should undergo thorough audits by reputable security firms to identify and mitigate potential vulnerabilities. Additionally, launching a bug bounty program can incentivize white-hat hackers to discover and report vulnerabilities before they can be exploited by malicious actors.
• Insurance and Risk Mitigation: Offering insurance products to cover potential losses due to smart contract failures, hacks, or other unforeseen events can provide an additional layer of security for users. Insurance protocols within the DeFi space, such as Nexus Mutual, could be integrated into the Layer 2 network to offer coverage options for users. Moreover, risk mitigation strategies, such as diversified collateral pools and automated liquidation mechanisms, can help protect the network from systemic risks.
• Compliance with Security Standards: The network should comply with industry security standards, including those set by organizations like the International Organization for Standardization (ISO) and the Blockchain Security Standardization Group (BSSG). Adhering to these standards can help ensure that the network’s security practices are aligned with global best practices.

Steps to Launching a Layer 2 Network for RWAs

With the key considerations outlined, let’s explore the step-by-step process for launching a Layer 2 network focused on RWAs within the DeFi ecosystem.

Step 1: Define the Network’s Vision and Objectives

The first step in launching a Layer 2 network is to clearly define its vision and objectives. This involves identifying the specific problems the network aims to solve, the target audience, and the unique value proposition it offers. For a network focused on RWAs, the primary objective might be to bridge the gap between traditional finance and DeFi by enabling seamless integration of tokenized real-world assets.

Step 2: Assemble a Skilled Development Team

Building a Layer 2 network requires a team with expertise in blockchain development, smart contract programming, cryptography, and financial systems. Assembling a team with diverse skill sets is essential to tackle the various technical and regulatory challenges that will arise during development. This team will be responsible for designing the network architecture, developing smart contracts, and ensuring the network’s security.

Step 3: Choose the Tech Stack and Develop the Core Protocol

Selecting the right tech stack is critical for the network’s performance and scalability. This includes deciding whether to use Optimistic Rollups, ZK-Rollups, or a hybrid approach, as well as selecting the appropriate framework (e.g., OP Stack). The development team should then focus on building the core protocol, including the consensus mechanism, smart contracts, and essential components like the compliance layer, native stablecoin, and RWA liquidity layer.

• Developing the Compliance Layer: The compliance layer should be designed to allow flexible regulatory adherence. This involves integrating mechanisms for KYC/AML compliance and implementing decentralized identity (DID) systems. The compliance module should be modular and configurable, enabling protocols to set their own KYC requirements while allowing users to maintain their privacy.
• Creating the Native Stablecoin: The development of a native stablecoin involves designing and implementing mechanisms for its issuance, redemption, and backing. For instance, if the stablecoin is backed by U.S. treasury bills or equivalent assets, smart contracts must ensure that the backing assets are securely held and that the stablecoin maintains its peg to the dollar.
• Implementing the RWA Liquidity Layer: The RWA liquidity layer, such as the Oxygen layer mentioned, should facilitate the integration of tokenized RWAs and ensure liquidity. This involves creating mechanisms for asset tokenization, rebalancing, and staking. The liquidity layer should support a wide range of assets, including tokenized treasuries and cryptocurrencies, and provide tools for lending and trading.

Step 4: Conduct Security Audits and Testing

Before launching the network, rigorous testing and security audits are essential to ensure its robustness and reliability. This includes:

• Smart Contract Audits: Engage reputable security firms to audit the smart contracts for vulnerabilities and ensure they function as intended. Audits should cover all aspects of the smart contracts, including compliance mechanisms, stablecoin operations, and liquidity management.
• Testnet Launch: Deploy the network on a testnet to simulate real-world conditions and gather feedback from developers and users. This phase allows for identifying and addressing issues before the mainnet launch.
• Stress Testing: Perform stress testing to assess the network’s performance under high transaction volumes and various scenarios. This helps to identify potential bottlenecks and ensure that the network can handle the anticipated load.

Step 5: Launch and Promote the Network

Once the development and testing phases are complete, it’s time to launch the Layer 2 network and promote it to potential users and developers.

• Mainnet Launch: Deploy the network on the main Ethereum blockchain. Ensure that all components, including the compliance layer, stablecoin, and liquidity layer, are fully operational.
• Community Engagement: Build and engage with a community of users and developers. This involves hosting webinars, participating in industry events, and creating educational content to inform potential users about the network’s features and benefits.
• Partnerships and Integrations: Form strategic partnerships with DeFi protocols, financial institutions, and other stakeholders. Integration with existing DeFi platforms and services can drive adoption and enhance the network’s utility.
• Incentives and Rewards: Launch incentive programs to encourage early adoption and participation. This can include staking rewards, liquidity mining programs, and other promotional activities designed to attract users and developers.

Step 6: Monitor and Evolve

Post-launch, continuous monitoring and evolution are crucial for the network’s success.

• Performance Monitoring: Track the network’s performance, including transaction speeds, fees, and user activity. Utilize analytics tools to gather insights and identify areas for improvement.
• Community Feedback: Collect feedback from users and developers to understand their needs and preferences. Regularly update the network based on this feedback to enhance its functionality and user experience.
• Protocol Upgrades: Implement protocol upgrades and improvements based on evolving industry standards, technological advancements, and regulatory changes. This ensures that the network remains competitive and aligned with the latest developments in DeFi and blockchain technology.

Conclusion

Launching a Layer 2 network focused on real-world assets represents a significant step forward in bridging traditional finance with decentralized finance. By addressing key considerations such as technical infrastructure, regulatory compliance, economic incentives, user experience, and security, developers can create a robust and scalable network that meets the needs of both users and financial institutions. With the right approach, this network can unlock new opportunities for integrating RWAs into the DeFi ecosystem, driving growth and innovation in the financial sector. The success of such a venture will depend on careful planning, execution, and ongoing adaptation to the evolving landscape of blockchain technology and financial regulation.

How to Launch a Layer 2 Network Focused on Real-World Assets in DeFi? was originally published in Coinmonks on Medium, where people are continuing the conversation by highlighting and responding to this story.