Scaling Smart Contracts via Layer-2 Technologies: Some Empirical Evidence

Blockchain-based smart contracts can potentially replace certain traditional contracts through decentralized enforcement and reduced transaction costs. However, scalability is a key bottleneck hindering their broader application and adoption, often leading to concentrated or exclusive networks. To avoid falling short of the original promise of the technology, firms actively explore “layer-2” methods for scaling. We provide some initial evidence on the economic implications of a layer-2 scaling solution, which moves information aggregation from on-chain to off-chain peer-to-peer networks. A parallel-system experiment allows clean identification because we observe the same unit in the treatment and control systems at the same time. We find that this scaling solution reduces operating costs by 76%, and importantly, leads to decentralization with lower market concentration and more participation, which in turn improves data accuracy. The findings provide insights on how blockchain and smart contracting technologies evolve toward achieving decentralized and scalable trust. This paper was accepted by David Simchi-Levi, information systems. Funding: W. Cong received funding from Ripple’s university blockchain research initiative (UBRI). Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2023.00281 .