What is Abritrum and how does it work?

Arbitrum ARB -5.56% operates as a Layer 2 scaling network on the Ethereum blockchain, aiming to improve scalability and security for decentralized applications through off-chain transaction processing. 

Its creator and core contributor is Offchain Labs, a research and development firm founded by Ed Felten, Steven Goldfeder, and Harry Kalodner. The firm released Arbitrum One, an optimistic rollup in 2021.

Arbitrum stands as the most widely used Layer 2 network on Ethereum, based on the number of active wallets. It also boasts the highest total value locked among Layer 2 solutions, at nearly $3.5 billion, and supports popular decentralized apps such as Uniswap, GMX and Aave.

How does it work?

Arbitrum uses “optimistic rollup” technology, executing transactions off the main Ethereum blockchain (Layer 1) and periodically submitting transaction data to it. 

Optimistic rollups are a form of Layer 2 solutions that operate dapps off-chain (or on a layer that’s separate from the main chain) while simultaneously securing dapps via the underlying L1 chain (in this case Ethereum) using a specific type of cryptographic proofs.

In other words, Arbitrum processes transactions off the main chain, submitting them to the main chain for verification in order to allow dapps to offer cheaper transactions.

The “optimistic” aspect assumes transactions are valid by default, verifying them only if challenged. This reduces the computational load on the main Ethereum chain, leading to faster transaction processing and lower fees.

A key aspect of Arbitrum’s operation is its compatibility with Ethereum’s existing ecosystem, allowing developers to deploy Ethereum-based smart contracts with minimal changes. This offers a seamless transition for existing Ethereum applications to leverage Arbitrum’s scalability benefits.

Two Arbitrum chains

Offchain Labs operates different Layer 2 networks on Ethereum, each their own ecosystem.

The first chain, Arbitrum One, serves as its flagship chain. Arbitrum One implements optimistic rollups to scale Ethereum apps, aggregating transactions on the secondary layer and publishing cryptographic proofs back on Ethereum for security.

The second Layer 2 chain, known as Arbitrum Nova, uses what's known as the AnyTrust protocol. This network is an off-chain data availability layer for storing transaction data and scaling apps. Nova offers developers lower fees with cheaper storage but a slightly more flexible security model than One.

In October, Offchain Labs released tooling for developers to launch their Layer 3 blockchains using the Orbit software stack. Orbit enables developers to create their chain settling on either Arbitrum One or Nova.

Arbitrum Orbit aims for faster optimistic rollup-based Layer 3s but with reduced security compared to Layer 2s. Optimistic L3s may involve longer withdrawal waiting periods due to optimistic rollups’ security assumptions. However, they also create opportunities for liquidity providers to facilitate bridging between chains.

The Arbitrum token

Arbitrum has a native governance token, ARB, that's used for collective decision-making, aligning network interests, and operating a decentralized autonomous organization (DAO). The token’s total supply is 10 billion, with over 42% allocated to the DAO treasury and about 26% to the core team (including Offchain Labs) and advisors.

The Arbitrum DAO’s responsibilities include voting on Arbitrum Improvement Proposals (AIPs) and electing and modifying the powers of the Arbitrum Security Council, a 12-member panel tasked with emergency actions, such as addressing vulnerabilities and other software issues in Arbitrum.