wtf is settlement

Published: at 12:00 PM

Written by: lamby, krane (Asula)

Thanks to jim, rajiv, ibrahim, sylve and myles for their thoughtful feedback and comments.

Often modular blockchain systems are described as consisting of consensus, data availability, execution and settlement. Consensus, data availability and execution are mostly well-defined, but what does settlement actually mean? Almost all definitions of settlement seem to diverge at least slightly from each other so we thought we’d write this piece to figure out exactly wtf settlement is. To do this, let’s try to first jot down two commonly used definitions for settlement:

In the first definition, it seems like a settlement layer helps establish the source of truth for rollups. The second just seems to suggest a transaction is settled when all differences have been reconciled. The definition from traditional finance has a focus on asset settlement and Celestia’s definition has a focus on state resolution and verification. We could take a leap of faith and say that since rollups “settle” on their host chain, the final step in ascertaining whether transactions on a rollup have taken place correctly is the verification step on the host. Thus, the two definitions coincide in that all rollup asset transfers are verified by the host at settlement. But this leap of faith seems a bit over-extended. James Prestwich provided a very complete thread where he talked about the different lenses he sees folks refer to settlement from (these lenses somewhat coincide with the Celestia and traditional finance definition for settlement):

The blockchain with the validating bridge example corresponds closely to Celestia’s definition of a settlement layer; the ledger of record example maps more closely to the definition of settlement used in traditional finance due to its asset-specific nature.

For any transaction to have occurred in the view of a blockchain, all validators must have verified it and reached consensus on its inclusion in a block. For assets issued on Ethereum, a successful transfer transaction from one EOA to another would require consensus. Since Ethereum is the source of truth for the asset’s ownership (due to it being issued on Ethereum), a transfer verified by consensus “settles” the transaction. In the case of rollups, a large amount of the Total Value Locked (TVL) in the rollup comes from a “host chain.” For example, a large percentage of Arbitrum’s TVL is in ETH, whose ledger of record is Ethereum. Validation by the enshrined bridge between Ethereum and Arbitrum allows for all transactions on Arbitrum to be reconciled on Ethereum. This means that if Alice bought 10 ETH from Bob on Arbitrum, she could withdraw that ETH on Ethereum after the fraud-proving window, even if the Arbitrum sequencer was unable to process her transaction.

While we agree with Prestwich that settlement is subjective, and thus the ledger of record isn’t the only settlement layer for the asset, we do think the ledger of record for any asset is the final settlement layer for the asset. We can also use the subjectivity of settlement to say that settlement is multi-level; whether a specific “level of settlement” is sufficient depends completely upon the asset holder’s perspective. Every crypto asset has a base level of trust assumptions: we trust the entity that issues it and the blockchain it’s issued on. For example, for ETH, we trust the Ethereum protocol as the entity that issues ETH and the blockchain it’s issued on. For assets like MKR we trust the smart contract issuing MKR and the blockchain these contracts live on, Ethereum. The issuing entity is a point of trust in all cases where they have the capacity to mint new tokens and in cases where they don’t, there is some trust in the implementation of issuance. The native blockchain has to be secure enough to allow the movement of assets without the risk of censorship or double-spending. As these assets are transported to different domains, trust assumptions are added to the asset. We display this in the image below:

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In the example above:

As we can see, different domains have different trust assumptions. Rollups, in an idealized state, allow users holding assets to force exit to Ethereum without trusting any entity other than Ethereum itself. Centralized exchanges like Binance and Coinbase are fully trusted; there are no forced exits, but exchanges are governed by regulations and branding, which give them trust and recognition amongst users.

The final bookkeeping for ETH always happens on Ethereum. This does not, however, mean that users will always reconcile every transaction on Ethereum. For example, for most traders, when they trade spot ETH on Binance using the ETH/USDT market, they assume any buys and sells are final. This is despite the fact that, in the view of Ethereum, all assets are owned/held by Binance. Traders trust Binance’s internal ledger, and thus, billions of dollars of ETH settles on Binance each day.

Until now, we’ve mostly been looking at the settlement properties of purely digital crypto assets. Let’s also look at the case of USDC: USDC is issued by Circle to users’ addresses once these users deposit USD into Circle’s bank accounts. Even though USDC is minted on many blockchains, the ledger of record for USDC is the one Circle maintains and allows redemptions against. Even if an address holds USDC on Arbitrum, Circle could decide to freeze that USDC (NB: It is possible, however that if USDC is issued on a blockchain that gets compromised, an attacker can double-spend the USDC to trick unknowing buyers of the asset). USDC is a prime example of multi-level and subjective settlement. The final settlement layer for USDC is Circle’s ledger, but this doesn’t mean USDC doesn’t settle on other blockchains. Most users transacting with USDC, don’t actually have a Circle account and wouldn’t be able to redeem USD against their USDC. However, users transacting in USDC on Ethereum or Solana treat their transactions as final or settled.

In the above section, we tried to showcase how settlement is subjective and multi-level. We also noted that the ledger of record for an asset is the final settlement layer for the asset. Another definition for the final settlement layer for an asset could be the blockchain wherein the user has to make the least trust assumptions (or trust the least number of entities) to reconcile ownership.

Now, to understand what exactly people mean when they say “rollups settle on Ethereum” (or any other base layer). We previously described how the enshrined bridge validates the rollup’s state and allows assets to bridge back from the rollup to the host. In the previous section, we also defined the final settlement layer for an asset as the ledger of record for an asset. Now let’s imagine two users, Alice, who moves 300k USDC to zkRU (a zk rollup) and Bob, who moves 100E to zkRU. On zkRU, Alice and Bob reach a mutual agreement to trade their asset holdings with each other. Alice now holds 100E, and Bob holds 300k USDC. This state update is finalized on the rollup once the data is posted to the host and is included in a block. Rollup nodes can verify the block containing the transaction by reading from the host. But, Alice and Bob can’t move their assets back to Ethereum (even though the ETH and USDC were minted on Ethereum) until a proof of the zkRU’s state is posted to Ethereum and Ethereum nodes verify the proof. Before the proof is verified, Alice and Bob are trusting both Ethereum and the zkRU. Once the proof is verified, Alice and Bob can bridge back (including via forced exits) to Ethereum whenever they want. This process of verification allows the asset holdings of Alice and Bob to rely on as few parties as possible, reducing the trust assumptions of asset holdings to a minimum. Thus, for the final settlement of an asset, our definition of reducing the trust assumption to a minimum still holds. A large part of the appeal of blockchains is the minimization of trust in counter-parties and trusted intermediaries, so it makes sense that “settlement” in the context of rollups (which can be thought of as semi-trusted intermediaries) is the removal of the ephemeral trust we put in the rollup’s infrastructure.

Okay so let’s try to bring everything together: In general, settlement refers to the reconciliation of ownership of assets. Within the blockchain context, crypto assets have a ledger of record where the asset is issued. Any asset holder has to trust the ledger of record for the assets they hold. If users trade the asset on domains other than the ledger of record, they may be adding in temporary or permanent trust assumptions to their asset holdings. For an asset transaction to reach final settlement, a user’s ownership of the asset must be verified by the ledger of record for the asset. We could call the ledger of record the final settlement layer for the asset in such cases. However, settlement is subjective and can happen on domains other than the ledger of record. We can assign tiers or levels to the settlement based on how many entities or protocols the user is trusting to guarantee their asset ownership.

We believe everything we discussed in this piece is well-understood by most developers in the rollup-centric ecosystems. In fact, being able to force exit is the defining superpower of a rollup when compared to “sidechains”. Moreover, a clear corollary of our discussion is that since the large crypto assets have different issuing blockchains, it is unlikely that there will be one unifying settlement layer for all crypto assets. Despite this settlement or settlement layers were used as a catchall term that didn’t feel well-described or seemed to lack nuance. This piece is our attempt at bringing a bit more nuance to these topics as we understand them better ourselves.