Inspite of constant macro and regulatory headwinds and the imminent possibility of a recession in late 2023, we remain committed to DLT (Distributed Ledger Technology, or Blockchain) and Digital Assets as we have always been. We strongly believe that this asset class continues to present an opportunity of a lifetime.
Earlier last year, we published our detailed Investment thesis and talked about 3 megatrends that will propel the growth of Web 3.0 in this decade –
- Convergence – we anticipate further melting of physical borders facilitated by Web 3.0-based technological growth that will allow for greater convergence of cultures, communities, economies, and governance globally.
- Financialisation – we believe that DeFi has proven that financial architecture can be recreated without intermediaries. We anticipate an increased permeation of this promise into traditional use cases, under greater regulatory oversight, towards solving real-world problems.
- Virtualisation – we expect the chasm between real and virtual worlds to blur further and progress to shift from tokenomics to better experiences in such virtual worlds.
As a following step, our Research Team has put forth top ideas that we believe have a strong potential for bringing the next wave of growth in digital assets and onboarding a billion users in the years to come. Whether you’re a seasoned builder or just getting started in web3, these concepts can provide you a glimpse into what the web3 ecosystem may hold in the future.
Making the infrastructure and middleware layers of the Web 3.0 stack more uniform, secure, and quick is the main goal of convergence of technologies (vertical). It will allow smoother rails to be constructed between the Web 3.0 stack, the traditional stack (horizontal and vertical), and the developing technologies stack (newer or incremental paradigms) in order to create the most user-centric solutions.
As new chains and Layer-2 scaling solutions rapidly proliferate, they compete to bootstrap liquidity to attract new users and developers. Ironically, their success fragments liquidity across chains. In 2023, we expect to see the implementation of various multichain initiatives in Cosmos AppChains, Ethereum Rollups (Optimistic and ZK), Polygon Supernets, Avalanche Subnets, Polkadot Parachains, etc.
We strongly believe the success of a healthy DeFi ecosystem in all these hubs will require a specialised liquidity layer wherein all capital can be cumulated to create trading pools with the maximum possible liquidity depth to enable the lowest slippage swaps for users.
A primer for building such liquidity layers can be found in the following articles:
- Distributed AMM (dAMM) – A Cross-L2 AMM by StarkWare.
- Shared Liquidity AMM (SLAMM) – Using a coordinating AppChain “Hub”, virtual liquidity pools and “satellite” deployments on other chains, SLAMMs can theoretically optimise liquidity across isolated, cross-chain pools.
Game-Specific Chain Infrastructure
Top web3 games and gaming studios will at some point require their own customisable blockchain to manage the expectations of a smooth user experience and keep their operating expenses low. But this opens up entirely new design space for on-chain games, and their sovereign blockchains can have unique features like
- Unlocking the blockchain/game explorer only after progressing through a percentage of the game or completing a few tasks
- Replacing gas on traditional blockchains with new rate limits via in-game energy or mana
- Allowing new models for UGC by allowing creators to create smart contract-based recipes/scrolls
- On-chain guilds with built-in asset lending
- Private mempools to hide user moves from their opponent in a PvP game
- New forms of monetary systems, automation of grinding tasks, and many more experiments
We expect more scalable infrastructure to enable games to reach a new level of engagement and experience augmentation. A great project to be on the lookout for in the category is Argus Labs.
On-chain MEV Solutions
Cross-chain MEV requires strong guarantees of concurrent execution of transactions on multiple chains. One way to guarantee this concurrent execution is to allow MEV searchers and block builders to buy block inclusion rights on different chains beforehand. MEV searchers interested in capturing specific MEV opportunities will purchase the inclusion rights in all the relevant chains. This way, the searcher can guarantee the atomicity of execution of their cross-chain bundle on all the relevant chains.
A more general approach would look like SUAVE – the Single Unifying Auction for Value Expression. SUAVE unbundles the mempool and block builder role from existing blockchains and offers a highly specialised, credibly neutral and decentralised plug-and-play alternative. Sharing the same sequencing layer allows crypto to stay decentralised, block builders to capture cross-domain MEV, validators to maximise their revenue, and users to transact with the best execution while reducing the economic centralisation pressure on each domain.
Other on-chain solutions for MEV include but are not limited to –
- MEV Auctions (Optimism’s approach to MEV capture)
- Privacy-centric L1s/L2s using threshold encryption to make sure transactions are private until finalised. (Shutter Network, Osmosis)
- Protocol level Proposer builder separation (PBS in Ethereum roadmap)
Off-chain MEV Solutions
- Off-chain PBS (Proposer Builder Separation) systems like MEV-Boost are currently the most effective solution for permissionless, general-purpose smart contract platforms. The diversity of activity at the application layer results in many MEV opportunities.
- Frequent Batch Auctioning (FBA) allows protocols to batch transactions, not impacting the state of other transactions. All transactions in a batch are executed at the same price, thus making it impossible to capture MEV based on the order of the transactions. (Cowswap, Sei)
- MEV capture solutions that allow protocols and dApps to recoup a portion of the MEV generated and redistribute those profits to LPs, users, or fund the team’s operations. (Wallchain, Skip Protocol)
Read more about MEV Post-Merge and Cross-Chain Order Flow Auctions.
Consider a major web2 brand experimenting with web3 via an NFT sale on existing L1/L2 networks. In almost all cases, this will lead to the clogging of existing blockchains leading to poor execution for other users as well. We have had several instances of something similar with Otherside NFT Mint on Ethereum and Metaplex Candy Machine on Solana.
It would be great if developers, indicating a surge in demand, could initiate a temporary L2 – an app-specific chain. Once the activity is completed on the temporary layer, the resulting state can be committed to Ethereum (or any other L1). The flash layer is subsequently freed and taken down.
Teams like AltLayer and Solana Labs have been working on this problem. It would be very interesting if this idea could be expanded to a wider variety of applications in DeFi and Gaming.
After a US$ 1.6bn loss in digital assets due to bridge exploits in 2022, we expect the development of zero-knowledge proof systems (zk-SNARKs) to solve a large part of the current issues of scalability and security of cross-chain bridges.
To verify the state of one blockchain (the source chain) on another blockchain (the target chain) without shared security, we can use an on-chain light client for the source chain running on the target chain. A light client or light node is a piece of software that connects to full nodes to interact with the blockchain.
This allows us to verify the consensus of the source chain in the execution environment of the target chain without the need for additional trust assumptions beyond those required for the consensus of each chain. The target chain will then have some information about the source chain baked into its own consensus.
By using ZK-proof systems and specifically the “Succinctness” property of a SNARK, it is possible to perform this verification process using light clients efficiently. It is also possible to verify both state transitions and consensus on-chain for maximum security, similar to running a full node.
The roots for this technology have already been planted, and some of the teams working here include:
- Succinct Labs – have developed a system that allows for a trust-minimised connection between Gnosis and Ethereum.
- Electron Labs – is trying to create a connection between the Cosmos SDK ecosystem and Ethereum. Read more about Bringing IBC to Ethereum using ZK-SNARKs.
- zkBridge by BerkeleyRDI is a framework that allows for creating applications that can communicate between different blockchain networks.
- =nil‘s Trustless Data Accessibility uses state and query proofs for trustless bridging. Protocols will be able to use data retrieved from a protocol and a SNARK correctness proof to transfer data from different protocol databases to each other.
Layer-3s (L3s) will be application-specific blockchains built on L2s as L2s will fulfil the role of being a general-purpose execution environment with tradeoffs that will not be ideal for certain application types.
L3s will be similar to bespoke deployments on Cosmos, Avalanche, Polkadot, and Polygon but benefit from being built on a modular blockchain protocol stack instead of monolithic ones. Thus, deploying a fully modular blockchain infrastructure stack that includes a general-purpose L2 with customisable L3s will be the biggest challenge to the monolithic app-chain ecosystem era, and potentially start a new era in dApp development.
Some of the solutions in the ecosystem include:
- zkSync – their zkPorter L3 increases scalability with a ~100x fee reduction and 20k+ max TPS.
- Starkware – the team plans on using recursive STARK proofs to allow developers to build cheap and hyper-scalable L3 solutions. The team also believes this can be extended to L4s through fractal scaling.
Platforms that will allow easy deployment of L3s and allow them to be highly interoperable with each other on existing L2 solutions will be the monolithic app-chain thesis killer.
Open standards in the Account Abstraction (AA) space are being widely developed to leverage ERC 4337 to provide a cleaner user experience without introducing core protocol-level changes to Ethereum. AA has come a long way and offers a multitude of features such as social recovery, improved key management, batching transactions, and gasless transactions (native paymasters) that are being served by multiple wallets such as Argent and Biconomy. Going forward, innovation in the AA space will unlock possibilities such as:
- Transaction Guards – Front-end protection and monitoring.
- Arbitrary Authorisation Policy for Transactions – From ZK Proofs to Visa-style recurring payments.
- Immersive Apps with Session Keys – Applications like gaming suffer as repetitive prompts for signing transactions are sent to users. Session keys are temporary keys that can be used to send transactions for a limited amount of time with a limited scope of permissions.
- Wallets as NFTs – Trading accounts securely along with all assets owned by the account.
- Creation of Sub-accounts – With specific spending/transfer limits and special access permissions on an app-to-app basis.
- Easier Onboarding – Products like Transak One are using proxy contracts to make web3 onboarding easy with one-click actions; AA would augment this further.
Read more about Account Abstraction.
The open-source nature of DeFi has enabled extensive “experimentation” to recreate financial markets devoid of intermediaries. From decentralized exchanges to lending protocols to asset management to insurance products, as well as stablecoins to protocol native assets to real-world assets, the majority of these developments have occurred within the last several years. Yet, it is crucial that DeFi aims to develop end-to-end capability (earn, borrow, transact, insure, invest, and pay – all in digital assets) with a streamlined user experience for the industries that require such access the most.
Yield Rate Standardisation for Native Assets
At any given point, the yield for native assets like USDC, USDT, and DAI across various ecosystems and protocols is disproportionate. This yield disparity reflects the perceived risk for lenders across ecosystems – Ethereum, Avalanche, Moonbeam, Optimism, Arbitrum, etc. But considering that most lending protocols on these ecosystems are (modified) Compound Finance forks with similar risk parameters, the yield for native (non-wrapped assets) should be the same. We believe a protocol working as a cross-chain Yearn Finance should help us bring yield standardisation across the popular assets in DeFi.
Sports and eSports Betting
Mobile gaming consumer spending decreased by US$ 6.31bn in the last year as inflation, increased cost of living, and rate hikes took their toll on leisure spending across the globe. Despite these conditions, one of the categories with over 10% growth in in-app purchases (IAP) was Casino and Sports betting games. Geographies like India drove a large part of the increase in popularity.
Over the last decade, we have witnessed the success of companies like DraftKings, Bet365, Dream11, and many more. The target demographic for these games and the audience interacting with on-chain dApps is very similar, and providing access to these services with crypto rails can unlock the next wave of on-chain activity.
We also have early signs of eSports betting picking traction through BR1: INFINITE. Bet-to-Play (B2P) can be a new monetisation model that can combine with P2O (Play-to-Own) to amplify crypto gaming’s value proposition. It will allow developers to directly monetise game time spent and gamers to double down on competitive gameplay via wagering. B2P sits at the intersection of two large, growing markets: gaming and gambling.
For more insights into the opportunity, please read Prediction Markets, Sports Betting, and Blockchain, and Bet-to-Play: The Real 10x Paradigm Shift in Crypto Gaming | Messari.
The utility and prominence of NFTs in an on-chain world are growing, with use cases expanding into industries like the metaverse, gaming, ticketing, fashion, and DeFi. However, the illiquidity of NFTs is a significant obstacle to people wanting to unlock the value of their NFTs. NFT financialisation could potentially achieve greater liquidity.
- Fractionalisation: Splitting an NFT into smaller fungible and identical pieces (Fractional)
- Lending: Using NFTs as collateral for taking out loans (NFTfi, BendDAO)
- Feature Rental: Lenders lend their NFTs and receive income, while renters get to use specific utilities & benefits of owning these NFTs without actually owning them
- Pricing: This supports all liquidity solutions by trying to enable accurate and continuous pricing for NFTs (Abacus)
- Swapping: Using AMM-like bonding curves for the trading of NFTs (Sudoswap, CaviarAMM)
- NFT Perpetuals: These products allow trading and placing leveraged directional bets on the floor price of top NFT collections. Large holders of these collections can also utilise these to hedge their NFT position (NFTperp)
The NFT financialisation category has developed a lot over the past year, but the space still hasn’t had its breakthrough moment, which unlocks ease of onboarding, capital efficiency, and network effects. As the category and asset class mature, we will see structured products like active and passively traded index funds for NFTs. We are looking for teams building solutions to the above issues to propel NFTs into becoming the next major asset class.
DeFi has experienced siloed application development (Compound, Uniswap), followed by use case-specific aggregation (Paraswap, Yearn), then DeFi activity aggregation (Instadapp, Zapper), and most recently Meta-Aggregation (governance – IndexCoop, Fei, DEX – DeFi Llama Meta-Aggregator).
Even though the development of meta-aggregation in the above-mentioned parts of DeFi has brought about progress in the sector, we believe that the segment which will benefit the most from meta-aggregation is the Interoperability sector, supporting the multi-chain flow of liquidity. There are already more than a few teams working on this problem statement, including Bungee (powered by Socket) and Li.Fi. These solutions have already solved the problem of gas refuelling for users as they migrate from one chain to another.
With over 30+ cross-chain bridges (including Hyphen, Router, Synapse etc.) and current solutions, like Socket and Li.Fi, functioning more like aggregators there is a lot of development yet to come. We should see incumbents or new projects try to improve the routing logic to capture the maximum possible value for the customers in cross-chain swaps and provide opportunities for users to maximise their yield in a multichain environment, providing a seamless user experience at a dApp-specific level.
There are early indications that technologies such as IoT, VR/AR, and AI are beginning to interact in order to create centralized and walled metaverses. But, we believe that such individual worlds will be subject to the same data, privacy, and economic constraints as social media today. Therefore, it is essential that the future of social media and interaction be built on open technology such as blockchains, which allow ownership, transferability, and interoperability. We believe that NFTs will be the data and asset standard for virtualisation.
Fully On-chain Games
On-chain games are those where the entire game state (including in-game tokens) and game logic are written to the blockchain. Putting all states and logic on-chain can unlock the following:
- Smart Contract-based Players (SCPs) – SCPs play the game according to intelligent and constantly improving rules and strategy. SCPs not only compete with each other but also compete with human players.
- Trustless collaboration between players – Dark Forest, at launch, was a multiplayer game with only informal alliances that required a high degree of trust. A community developer deployed a smart contract to act as a combined and competing player. Instead of competing with each other, players were now incentivised to share resources and delegate them to the smart contract player (similar to how participating in Bitcoin mining pools increases your chance of mining a block). The players who contributed their points could share the prize pro rata.
- Game mods by Third-Party Developers – Game mods can be built without fear of getting de-platformed. Another Dark Forest player/creator developed a single-player spin-off of the multiplayer game using the same logic from the main contract. All that was changed was the map, the UX, and the scoring.
MatchboxDAO is a live example of such initiatives. Read more about Are We Building Web3 Games? and Thoughts on On-chain Gaming.
There are a plethora of no-code NFT generation tools, metaverse builders, and PFP generators out there in the market, and it is now easier than ever for anyone to mint their collection, generate a minting page, create whitelists, or even build custom marketplaces.
We now need more applications that allow people to use existing infrastructure in their day-to-day lives, not more infrastructure. Most sectors in web3 have gone through multiple phases of iterations to test out the infrastructure. Now, it is time to bring mass adoption.
Teams that can leverage existing technology around DeFi, NFTs, Gaming, Metaverses, Governance, etc., and can generate initial traction for network effects to kick in, will have serious business impacts and opportunities. Technology is ready, but business and community building need innovative methods to scale consumer applications.
Public Goods Development
Lastly, as a venture fund, there is limited opportunity to discuss the growth of public goods and their funding. But, we believe the growth of public goods is a critical component of our industry’s growth and development which we would like to see evolve even further in 2023. These can include:
- Open-source auditing and security tools (think tools like Foundry, but for aiding the auditing process, and automated static analysis and formal verification tools for new smart contracts).
- Aggregated RPC endpoint providers that serve custom performance and cost needs by combining the existing players (listed here).
- Reputation layers to promote good, active governance of protocols.
- Open-source client code for various blockchain networks that improve decentralisation and help with operator maintenance.
- Creation of Sybil resistance and user analytics toolkits for dApps.
- Education initiatives and guides for developers, cryptographers and home stakers in the community.
A larger list of open problems can be found here. Such opportunities need not require venture capital but can rely on community funding and grants through Gitcoin, Ethereum Foundation, Optimism PGF, 0xParc, etc.
There will be many benefits from the advances in Artificial intelligence and Zero-knowledge technology.
With the recent development in large language models and with the advent of AI, we believe this will improve the workflow for all developers and data analysts as they can use the assistance provided by these tools for quicker solidity, rust development, and use natural language to generate their SQL queries and sub-graphs.
The ZK development happening across the stack, including privacy, rollup validation, recursive compression, light clients, bridging, SDKs, high-level development frameworks, hardware accelerators, and proof of work in various decentralised networks like storage, indexing, and oracles, will also spillover into other technology domains and improve products in both the web2 and web3 world.
The information contained in this article is for educational purposes only and should not be considered as financial advice. The views expressed in this article are the author’s own and do not reflect the firm’s opinions. No representation or warranty, express or implied, is made as to the accuracy or completeness of the information contained in this article and the firm assumes no liability for any errors or omissions in this information or any failure to update the information. The information in this article should not be used as the sole basis for investment decisions, and investors should consult a financial advisor before making any investment decisions. Past performance is no guarantee of future results, and investing in any cryptocurrencies and digital assets is always involves risk.