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Amid all the excitement surrounding The Merge last year, the fortunes of Ethereum (ETH 1.34%) and Polygon (MATIC 0.93%) appeared to be inextricably linked. After all, Polygon was the most popular Layer 2 scaling solution for Ethereum, so any future growth in the Ethereum ecosystem implied future growth in the Polygon ecosystem. But fast forward to 2023, and it looks like the paths of these two cryptocurrencies are starting to diverge.

While both cryptos are up about 50% for the year, it's their performance over the past 30 days that's the most troubling. During that time, Ethereum was up about 10%, while Polygon was down 17%. Is this a short-term mispricing in the marketplace or a sign for investors that Polygon's future growth prospects are coming under pressure?

On the surface, the growth story for Polygon remains in place. It's arguably still the most popular Layer 2 in the Ethereum ecosystem and has some of the best technology out there for making Ethereum run faster, better, and more efficiently.

Moreover, there are still plenty of top brands and companies utilizing Polygon for new Web3 initiatives.As a result, Polygon has a market capitalization of $9.8 billion, making it one of the top 10 cryptos in the world.

Image source: Getty Images.

However, look beneath the surface, and the picture gets a bit murkier because there's been a steep falloff in growth at Polygon since December.

For example, consider the number of new Polygon addresses being created on a daily basis. These are down 32% from mid-February levels, a warning sign that developers and users could be looking elsewhere when deciding to build on top of Ethereum. Even more troubling, Polygon recently said it was cutting of 20% of its team.

What's going on here? The problems at Polygon could be linked to the emergence of new competition.

Polygon isn't the only Layer 2 option that developers have, and it's starting to become very evident now. For example, Optimism (OP 2.57%) seemingly exploded out of nowhere this year to become a super-popular Layer 2 scaling solution. For the year, it's up more than 170%.

Optimism recently made headlines as the result of a high-profile partnership with crypto exchange operator Coinbase Global. If you look at key blockchain metrics such as total value locked (TVL), Optimism appears to be narrowing the gap with Polygon.

Moreover, there are other Layer 2 names out there that are generating buzz. Another top Layer 2 solution is Immutable X (IMX 3.91%), which is up more than 200% this year. It now has a market cap of over $1 billion, making it the No. 53 crypto in the world.

But the name that everyone is talking about now is Arbitrum, which is about to get its own crypto token soon.According to some traders, the price of Polygon could sink as much as 15% as soon as the new Arbitrum token starts trading.

Meanwhile, Ethereum has shown little-to-no impact from the recent spate of bank failures and bank runs and is now being mentioned as a potential safe haven for investors thinking about moving their money into crypto. According to Cathie Wood of Ark Invest, Ethereum has not "skipped a beat" during the recent market upheaval, and that should be very reassuring to investors.

Ultimately, the choice of whether to invest in Ethereum or Polygon comes down to a single question: Do you feel more comfortable investing in a Layer 1 or a Layer 2 blockchain? While there's a lot of exciting activity happening at the Layer 2 level, the field is getting so crowded now that investing in a Layer 1 looks a lot more appealing.

Finally, keep in mind track records. Ethereum has a proven track record dating back to 2015 and managed to pull off The Merge in 2022 amid one of the worst crypto meltdowns ever. If you're looking for a crypto to ride out the gathering financial storm, the clear choice now is Ethereum.

Dominic Basulto has positions in Ethereum and Polygon. The Motley Fool has positions in and recommends Coinbase Global, Ethereum, Immutable X, and Polygon. The Motley Fool has a disclosure policy.

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Better Buy: Ethereum or Polygon? - The Motley Fool