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Arbitrum: what it is and how it works

June 16, 2023

10 min

Arbitrum: what it is and how it works

Let’s find out what Arbitrum is and how it works, being one of the most important players in the whole Ethereum ecosystem. In this article, we’re going to start by explaining in a simple way how its Layer-2 blockchain is structured and how it works on a technical level, and then delve into the context in which it was born and finally devote our attention to the ARB token and the practical use of the network. Let’s then immediately answer the question: what is Arbitrum and how does it work?

arbitrum token

Arbitrum: what is it and how does it work?

Ethereum is definitely the reference blockchain for the development of decentralised applications and blockchain programming in general. However, at the moment, its transaction execution process is still not very scalable and, also due to its wide adoption, implies high costs for users and transaction delays in times of high traffic. Development work to resolve these limitations has begun, but it may take a few years.

And it is precisely in the search for solutions that the answer to the question ‘what is Arbitrum’ comes in: a blockchain with the aim of offering fast and convenient transaction execution even in cases of high network traffic, without sacrificing security or decentralisation.

While some projects choose to build new blockchains from scratch (Layer-1), there are others that prefer to speed up development by relying on already existing protocols (Layer-2).

The latter is the case with Arbitrum, whose software is built on top of that of Ethereum, exploiting it mainly for transaction collection and security. So far, nothing new compared to other L2s. Let us then go deeper into defining the structure of this blockchain to understand technically what Arbitrum is and how it works.

The structure of the blockchain

You might wonder now where Ethereum ends and Arbitrum begins. Try to imagine the structure of the two chains as layers of software built on top of each other. In our case, these layers are:

  • The Ethereum blockchain
  • The EthBridge 
  • The Arbitrum Virtual Machine
  • ArbOS
  • The Arbitrum blockchain

The EthBridge is already part of the Arbitrum system, and contains the inbox and outbox of transactions. This means that it is responsible for handling incoming and outgoing requests. If you want to transfer funds from Ethereum to Arbitrum and vice versa, you will have to use the EthBridge.

The Arbitrum Virtual Machine, on the other hand, is the equivalent of the Ethereum Virtual Machine (EVM) and is highly compatible with it. It is, in short, the smart contract development and execution environment that reads inputs, processes them and produces outputs. The EVM acts as a gateway between Layer-1 and Layer-2.

ArbOS is the operating system of Arbitrum, the first component fully running on the Layer-2 that ensures the execution of EVM smart contracts, exactly as if they were executed on Ethereum.

This structure therefore results in a strong interconnection with the L1 and a solid EVM-compatible structure, which are key aspects for security and network adoption. We are now ready to unveil what distinguishes this solution from other L2s and what truly defines what Arbitrum is and how it works.

How do Arbitrum rollups work?

While Arbitrum bases much of its infrastructure on Ethereum, what it does autonomously is executing transactions requested by users and smart contracts. Therein lies its forte: optimistic rollups.

Arbitrum creates ‘batches’ (rollups) of requested transactions to the network, assuming them to be valid, then processes them without any distributed consensus procedure or verification. This is why the consensus mechanism is called optimistic

The only requirement for processing a transaction is that there is at least one honest validator in the network, which statistically is assumed to be true. In fact, to be a validator one has to stake ETH and in the event of malicious behaviour these are slashed, so validators have a vested interest in working benevolently. 

After execution, the protocol sends the transactions contained in the rollup back to Layer-1 for them to be recorded on the Ethereum blockchain. 

The system is optimistic, but it adopts an anti-fraud scheme that provides a fixed 7-day period within which network nodes can challenge the validity of the rollup. Essentially, they re-execute the transactions contained in the rollup, and if they come up with different results, the network reports this to Layer-1, which will make the necessary changes.

There are many differences between optimistic and zero-knowledge roll-ups, adopted for instance by Polygon, but in practice these are the main shortcomings of the two solutions:

  • ZKs require higher costs related to the hardware and processes necessary for cryptographic calculations
  • Optimistic transactions require a week for verification due to the anti-fraud system

Otherwise, they basically maintain an equally good compromise between security, decentralisation and scalability. 

To summarise what Arbitrum is and how it works, we could say, thus, that it is a Layer-2 solution that uses optimistic rollups to scale the execution of transactions on Ethereum.

Arbitrum: how did the crypto project come about?

Having now a definite idea of what Arbitrum is and how it works, it is good to have some information also on the history and the people behind it: fundamental aspects to consider in order to assess the soundness of a project before using its services.

The Arbitrum crypto project was created and developed by Offchain Labs, a company founded in 2018 by Ed Felten, Steven Goldfeder and Harry Kalodner. Names that may be little known, but of people who do not come out of nowhere. Ed Felten was no less than Deputy Chief Technology Officer of the United States in the Obama White House, as well as a professor of computer science and public affairs at Princeton University. Steven Goldfeder on the other hand holds a PhD also from Princeton University and together with Ed Felten wrote the book ‘Bitcoin and Cryptocurrency Technologies’.

While working at Princeton, the three co-founders designed the Arbitrum technology with the aim of solving Ethereum’s scalability problems, a solution they released with a paper in 2018

The Arbitrum One mainnet was then launched in August 2021. In the meantime, the project received solid funding thanks to a $120 million capital increase by major investors, including Lightspeed Venture Partners, Polychain Capital, Pantera Capital and Mark Cuban. The project had a great start, and soon Ethereum’s main DeFi protocols adopted it.

The platforms developments do not end here: we’ll go over the next milestones in the following paragraphs, exploring what Arbitrum ARB, the crypto project’s recent token, is and how it works.

The ARB token and governance

On 23 March 2023, the protocol governance token was introduced, together with the Arbitrum DAO, the decentralised autonomous organisation dedicated to project management. Let’s take a quick look at what Arbitrum (ARB) and the DAO are and how they work. The token is a classic ERC-20, initially distributed by airdrop to those who had previously used the Layer-2. Most of the supply, however, was allocated between the investors, the development team and to finance the DAO.

The ARB token is therefore strictly for governance purposes: holders can vote on decisions that, once approved, are automatically executed on the blockchain thanks to the DAO’s smart contracts. The voting process usually takes 21 to 37 days. By participating in governance, one can also elect the 12 members of the Arbitrum Security Council twice a year. This is a committee that holds the private keys of a multisig wallet used to perform emergency or routine operations such as updates and maintenance.

ARB owners can also delegate their vote by choosing a representative to replace them. In fact, participating in the governance of a project requires a significant commitment: to vote consciously and correctly one has to keep up with all the conversations, often even on a daily basis. Thus, if token holders do not have sufficient time to vote consciously, they can choose another member of the community whom they feel is prepared and delegate their voting rights to him or her.

In short, the introduction of this token is certainly a sign that the Arbitrum Foundation and Offchain Labs intend to continue on a path towards maximum decentralisation, and at the same time confirms that the cryptocurrency adopted for all other functionalities in the ecosystem remains ETH.

How to use Arbitrum?

So let’s get down to practicalities: if you like the answer to what Arbitrum is and how it works, you might want to use it. First, however, let’s look at what it offers. Fortunately, thanks to its high level of compatibility with Ethereum, it is particularly easy to bring a decentralised application (Dapp) to this L2 as well.

The network is consequently packed with both the most popular Ethereum applications such as Uniswap or Aave, and a few native services such as the decentralised exchange GMX or the lending platform Radiant. GMX especially has been very successful and is the main reason why the network boasts the highest TVL among Layer-2s (at the time of writing).

The main chain on which all these apps are based is Arbitrum One, but in 2022 Arbitrum Nova, a chain designed for social and gaming applications, was also launched. The latter in fact has a transaction execution mechanism that favours the speed of transaction processing, leveraging an alternative to rollups. Indeed, video games and social networks require immediacy and high transaction throughput, but usually few funds are deposited there. 

Arbitrum One, on the other hand, retains the basic operation of the protocol as written in the previous paragraphs, and is therefore used for DeFi applications such as DEXes or Yield Farming, which instead involve the handling of large numbers and simpler transactions.

So how to use all these services on Arbitrum? 

First, you need an Ethereum-compatible wallet, preferably a non-custodial one like Metamask. These wallets can easily connect to any blockchain application. In particular, to transfer ETH or ERC-20 tokens on Arbitrum you can use a bridge. Then, once you have funds on the network, simply connect your wallet to any Dapp that supports it to use the funds conveniently. And there you can finally test those famous fast and cheap transactions first hand.

Having said that, remember to always use decentralised applications with caution, by consulting trusted tutorials and plenty of calm. If you have read everything so far, however, you are surely ready to do at least one thing: explain to your friends what Arbitrum is and how it works.