Summary Optimism is a popular layer 2 scaling solution on Ethereum. The chain's governance token has been one of the best performers in crypto - up 200% YTD. Tokenomics are less than ideal and the network activity has fallen dramatically since a recent growth campaign wrapped up. Optimism ( OP-USD ) is one of the most popular layer two scaling chains built on Ethereum ( ETH-USD ). Optimism has integration with dozens of DeFi protocols and is home to some of the more popular applications in crypto; Synthetix ( SNX-USD ), for instance. OP has been one of the best performing crypto assets in 2023, now up roughly 200% year to date: YTD (Seeking Alpha) As we'll explore in this article, OP's performance seems to be more of a news-related move than a fundamental one. It appears the biggest catalyst that is likely creating the current price surge in OP is the impending vote for Optimism's 'Bedrock' upgrade that is expected take place on the Optimism Mainnet in the coming weeks. Bedrock has successfully been implemented on the Goerli Testnet and when finished on Mainnet will bring significant techincal improvements in the L2 chain according to the team working on the upgrade: The Bedrock release enables performance improvements across the board, including transaction costs, throughput characteristics, and sync speeds. According to the chain's developers, the successful implementation of Bedrock on the Optimism's Mainnet will position the ecosystem as a leader in Ethereum scaling. OP Tokenomics In the past, Optimism has operated without a native coin. However, last year OP was launched as a pure governance token rather than as a traditional utility token. This means Optimism users don't pay gas fees with OP. From a token supply standpoint, there is a lot of potential dilution coming - this data is according to CoinMarketCap: Total Token Supply: 4.3 billion Circulating Supply: 235 million (5.4%) Token Price: $3.01 Market capitalization: $707 million Fully diluted cap: $12.8 billion Market Cap Rank: 69 The first thing that probably jumps out from those metrics is the circulating supply. At 5.4%, that circulating supply is preposterously low. This has two fairly large impacts on the coin. First, with less supply in circulation there is a greater chance for volatility. This is what explains the 200% surge in a little over a month. Second, if tokens that come out of lockup end up entering the market too quickly, it could drastically deflate the price of OP tokens. Though just 5% of supply is in circulation from the airdrop at launch, over 30% is actually out of lockup since we're currently in Year 0. Unlock Schedule (Optimism) Later in 2023, we'll see the release schedule add some of the tokens from early investors and core contributors. This is where OP investors today could possibly see price deflation if the early money looks to get out of the investment after such a marvelous increase in price. In total, 17% of the tokens went to early investors (or "Sugar Xaddies") and 19% went to core contributors. Token Allocation (Optimism) 19% is for airdrops and the rest is for building the ecosystem and public goods funding. Which are tokens that are apparently being held for distribution to developers and startup builders who help grow the ecosystem after they have created something meaningful for the public good of the chain rather than before. Which in my view is actually a smarter way to release funds that are similar to grants. Network Adoption? OP was already moving very nicely in January but it was actually the February 1st announcement that the community will be voting on the Bedrock upgrade that really sent the token skyward from $2 up over $3 in a matter of just a few days. But from where I sit, it really looks like speculation is what is driving this price increase in OP rather than actual chain usage. In fact, daily transactions on Optimism have actually declined by about 75% since mid-January's 800k high: Dune Analytics/Blockworks We can see Arbitrum taking the L2 lead back from Optimism in daily transactions again in the middle of January. The drop off in transactions on Optimism is particularly notable because it appears to coincide with the conclusion of a "quest" program that the Optimism team had been running since September of last year to facilitate adoption of the chain. The program awarded users with NFTs for exploring the ecosystem. One could certainly argue then that the activity on-chain had been inorganic and may not ultimately return without another similar program. Optimism TVL (DeFi Llama) Despite that, Optimism does still command a top 10 TVL with just under $790 million in total value locked. Furthermore, the DeFi trend on Optimism is actually pretty good having increased from $500 million on January 1st to $715 on February 1st. That 43% TVL growth was the strongest of any top 10 smart contract chain by percentage over that time. What is also a positive sign is the low protocol dominance from Velodrome at just under 21%. This insinuates a DeFi ecosystem that is more diverse than peers. However, it does stand to reason that many of Optimism's DeFi users could be simply engaging with the chain to position themselves for future token airdrops from the OP airdrop fund. Summary The growth of Optimism's network over the last several months has been terrific. This is particularly impressive because we've been in crypto winter and the ecosystem has grown in spite of. I like that a lot. But it is definitely concerning how fast daily transactions on Optimism fell back to pre-Quest levels. That doesn't mean a similar activity level can't ultimately come back and growth initiatives like Optimism's Quest campaign aren't uncommon. Fundamentally, Bedrock is an interesting potential catalyst as it would enable a modular approach to the chain that will allow for transaction batching - they say this would lower fees and improve chain speed dramatically. That would be great for users of the network as speed and reduced fees are the entire point of layer 2s. All this said, from a straight investment perspective, pure play governance coins aren't generally my favorite crypto investments, though I have made exceptions in the past. For OP specifically, I think there is still so much dilution remaining in the coin that it just makes more sense to buy ETH instead if you want to enjoy the fruits of Optimism's future success.