Layer 1

Scaling is one of the main technical issues that L1 chains face across the board, and it is also limited by the impossibly tight blockchain triangle (decentralization, scalability, security). Monolithic chains have tried to increase performance by changing the block size, but issues like on-chain congestion, a high gas cost, and over-centralization continue to be a pain.

Modularization

In the context of future development, modularization will continue to be a disruptive issue that cannot be avoided by any L1 chains. A complex system is divided into a number of modules that are mutually exclusive of one another throughout the process of modularization. Each module has its own separate logic and function, and when assembled as a whole, it may carry out all the functions of a complex system. The following benefits of modularization: Each module can be developed or outsourced simultaneously during the development phase to increase efficiency, and each module can operate independently to facilitate isolation in the event of problems. Additionally, each module is pluggable, allowing it to be combined with other modules to carry out additional tasks.

Blockchain architecture has gone through three stages of development. That is, after separating the execution and consensus layers (Layer 2), the typical monolithic blockchain, and now the layers for data availability (Celestia and Polygon). L1 chain development will inevitably lead to modularization. Two examples will help to illustrate this: 1. Monolithic chain's restrictions; 2. Blockchain's impossibly-shaped triangle. Monolithic chain's drawbacks are actually more surface-level, like in the case of Solana, which must finish underpinning infrastructure development, network security upkeep, and upper ecological building. The difficulty of ecological construction will increase if the L1 chain is not EVM compatible. Monolithic chains are also undesirable in terms of composability and cross-chain cost.

Source: Ethereum

A modularized L1 chain called Celestia, which is built on top of the aforementioned modular implementation mechanism, has a more creative design that focuses on addressing the data availability problems of other chains. Layer 2 is then built on top of Celestia as an execution layer. It is also being copied to construct independent data availability modes such as Polygon Avail and zkPorter.

The on-chain ecosystem and TVL of L1 chains only connected to modularization are rather weak, which is evident from technical implementation and on-chain statistics that these modularization technologies are still in their infancy. Rollup will serve as Ethereum's scaling solution for a while, at least until a number of concerns relating to sharding are resolved, including the cross-chain interaction and validation between the shards. Modularization will eventually have its day and space to develop.

Overall, modularized blockchains might offer more cross-chain options than just cross-chain assets. They might also make it simpler to attain ecological composability. However, the Terra incident could happen again. Sharding and Celestia are both still in the early stages of development, thus it won't be clear how they will affect the market until they are already in use. However, logical forecasts for L1 chains in the upcoming bull market could be made: When Evmos collaborates with Celestia, Rollup may end up serving as the execution layer for more than just Ethereum, becoming the infrastructure for the settlement and data layers of its ecosystem. Numerous situations will still work for Celestia even if sharding is successful. The L1 chain narrative's next major theme is still how to escape the impasse of the impossible triangle.

Creation of a network of multichain

The multi-chain network has undergone at least six years of technical development and is mostly based on the same development framework and modularization tools. The network now includes Cosmos, Polkadot, BNB Chain, Avalanche, Octopus, and may do so in the future with Polygon. All of these blockchains can offer tested modularization tools for their subnets, zones, and parallel chains, but they vary in terms of cross-chain functionality and shared security. A multi-chain network has the following benefits: 1. Developers can use modularization tools; 2. There is cross-chain security; 3. There is faster confirmation; and 4. Each sub-chain performs specialized execution and application, establishing a Dapp-specific chain that offers unbiased performance.

A new age for Cosmos begins

Cosmos is a multi-chain network's premier veteran L1 chain. The spark for Cosmos never runs out of heat thanks to the development of Evmos, the growth of multi-chain networks and modularization, and the Cosmoverse conference. Many projects have vowed to be a part of the Cosmos ecosystem because of the adaptability of Cosmos's modularization tools and the increased cross-chain capacity, and at the moment, there are over 263 projects deployed on Cosmos with a total market valuation of $11.7 billion. IBC cross-chain bridge connects 51 chains, and according to Map of Zones, the total volume of IBC transactions over a 24-hour period was $26.37 million (statistics as of October 24). There were 155,800 transactions in total. In terms of 24-hour IBC transaction volume and transaction amount, Cosmos is ranked top among popular cross-chain projects, exceeding Multichain, Stargate, Celer cBridge, etc. The cross-chain ecosystem is created by Cosmos' special cross-chain features, which have generated significantly greater demand than those of other projects.

Although Cosmos has excelled in multi-chain networks, it has been plagued by two issues: Inter-chain accounts and inter-chain security have been delayed because the technical upgrade is very sluggish and because Cosmos Hub's function in the ecosystem has always been ambiguous, which has a negative impact on $ATOM's ability to extract value. Regarding addresses on chain, Cosmos Hub has maintained a daily active address count above 10,000 since January of this year, whilst L1 networks like BSC, Ethereum, Solana, and Polygon are all above 300,000. The number of active addresses is not significantly different from that of Optimism when compared to significant Layer2 initiatives. With 175 active validator nodes, Cosmos Hub's network staking rate is currently almost kept at a safe 66%, $ATOM's annual inflation rate is 12.81%, and the overall staking annualized return is around 18.94%.

Parallelization: Aptos and Sui

Parallelization is a systematic approach adopted by the newest Layer 1s: Sui And Aptos.

To perform transactions, the newer L1 chains all use the Block-STM (Software Transactional Memory) parallel execution engine. To optimize parallelism, unrelated transactions are executed on separate cores on the same CPU at the same time by creating multiple command streams and multiple data streams for transactions. In terms of parallel processing, Aptos and Sui vary significantly. Sui, for example, classifies transaction objects using a combination of DAG and BFT consensus.

Parallelized computation is evident not just in increased TPS, since current smart contracts, such as AMM and NFT minting, are only appropriate for serial execution. To see the most of what parallel computing has to offer in the future, smart contracts must be more algorithmically aligned with parallel computing features. To reap the benefits of parallelized L1 chains, developers must adjust their thinking processes and create better ecological applications.

Aside from Diem's L1 chains, the most anticipated enhancement of L1 chains must be sharding, which is represented by ETH2.0, Polkadot, and Near. The three initiatives vary in the following ways:

Random shard validator and consensus method allocation
ETH2.0 employs homogeneous sharding, while Polkadot implements heterogeneous sharding
ETH2.0 utilizes proof of fraud or ZK-SNARK proofs to create stronger security for sharding node sampling.

The sharding technique has not made much progress this year, and it may take many years to develop owing to its difficulties. The whole industry is waiting to see whether further new technology will be used in L1 chains in the future.

Layer 2

Layer 2 with rollup is a potential off-chain scaling solution: the primary concept behind Rollup is that users perform transactions in Layer 2. The Layer 2 operator compresses and bundles the transactions before submitting the compressed transaction data and evidence of off-chain conversion to the chain. Finally, the data is validated by validators on the main Ethereum network. Rollup reduces the use of on-chain resources while maintaining data availability, that is, the Ethereum main network can filter and ensure that no one can interfere with off-chain transactions.

Rollup began in early 2022 and has experienced huge growth despite the dismal market conditions this year. According to L2beat data Rollup's entire TVL on January 1, 2022 was 1.56M ETH, which is about 4.5% of Ethereum's TVL. As of December 16, 2022, Rollup's TVL has increased to 3.5M ETH, representing roughly 7.5% of Ethereum's TVL. The general crypto market is quite depressing this year, with the price of ETH falling by 65% compared to the same time last year, making it difficult for Rollup to develop in such a climate.

It was originally argued that lowering the gas charge on the Ethereum mainnet would make Rollup less essential. However, despite the fact that the price of ETH and the average gas charge have both declined this year, and the gas fee of the Ethereum mainnet will decrease much more, Rollup continues to attract a huge number of project deployments. This demonstrates that many project teams are bullish about the future of Ethereum with Rollup, and a "Rollup-centric" Ethereum network is taking form.

Based on the projected number of addresses released by each Rollup's blockchain browser, Rollup now has 4M addresses, which has tripled since the beginning of the year. The core Ethereum network has 209M addresses, and the number of Rollup addresses currently accounts for around 2% rather than less than 1%. Despite significant progress, there is still a long way to go in terms of user acquisition.

Rollup's market share rise is mostly driven by technology. This year, Rollup has achieved significant progress in five areas: improving compatibility, decreasing data availability costs, lowering validation costs, increasing decentralization, and building zkEVM.

Enhancing compatibility

Because EVM compatibility makes deployment easier for all types of applications, OP Rollup's TVL accounts for more than 80% of the current Rollup. However, compatibility with EVM does not ensure error-free deployment; in other words, code changes must be done before deployment. As a consequence, OP Rollup has always prioritized enhancing EVM compatibility and removing differences with Ethereum.

Following an EVM equivalence update late last year, Optimism has implemented "Ethereum equivalence" this year. It will be implemented in Bedrock, a significant update scheduled for Q4 with the goal of minimizing incompatibilities with Ethereum so that Optimism and Ethereum may share and cooperate on the same core of technology. With improved compatibility, projects will be less expensive to deploy since more Ethereum-compatible tools will be available, and the network impact of the OP Rollup protocol will be maximized.

Lowering the cost of data availability

Rollup has two significant charges: the cost of data availability (DA) passed on to L1 and its own operating expenditures. Because Rollup is executed off-chain and the workload is often minimal, the operational cost accounts for a minor fraction of the total while the DA cost dominates.

Arbitrum has launched Nova, a new solution that decreases DA expenses to the bottom line. Nova is based on Arbitrum's Anytrust technology, which uses the Data Availability Committee (DAC) to store and distribute data off-chain, reverting back to Rollup mode only when the DAC is questioned by users. The DAC runs only when at least two honest members are present, which is a far less trust requirement and much easier to implement than the typical BFT-type consensus, which needs two-thirds of all nodes to be honest. Inherently, a little extra trust assumption is swapped for a reduced cost and quicker withdrawal time. Nova is ideal for gaming and social ventures, and around ten projects are already operating on it.

Reducing validation costs

OP Rollup settles disputes based on fraud evidence, which may be divided into two types: one-round interactive fraud-proof and multiple-round interactive fraud-proof. Arbitrum formerly employed multi-round interactive fraud proofs, but the OP Rollups based on the Optimism code use one-round interactive proofs. Multi-round interactive proof repeats the process of narrowing down the range of dispute off-chain until an execution of dispute is found, then it returns to the blockchain to re-execute and arbitrate, reducing the on-chain resources consumed to resolve the dispute at a lower cost than one-round interaction. Cannon, a multi-round interactive fraud-proof, is being developed by Optimism as a new generation of fraud-proof. Other OP Rollups are expected to follow Optimism's lead, lowering the total cost of OP Rollup dispute resolution in the future. More crucially, Cannon will employ MiniGeth (Optimism's reduced Geth client) as the EVM emulator, thereby separating Rollup from the main chain. On the one hand, MiniGeth could be upgraded to allow EVM upgrades; on the other hand, MiniGeth might be replaced with other tools to support additional virtual machines on the main chain in order to implement Rollup.

StarkNet enhances the recursive STARK proofs to increase validation performance. This improvement takes the use of STARK proofs' "logarithmic compression," which means that the time necessary to construct a proof is roughly linear in the time required to execute the statement. Meanwhile, the time needed to verify the evidence is roughly logarithmic in comparison to the time needed to construct the proof. After the update, the mother proposal is split into groups, subsidiary proofs are formed for each group, and these subsidiaries are then entered as propositions to build an accumulative ZKP2. Because of the logarithmic compression characteristic, verifying ZKP2 is substantially quicker than validating ZKP1, and requires much fewer computing resources from the chain. The generation of proofs is additionally sped up since several subsidiary proofs may be calculated concurrently.

CeFi

The 2022 institutional business portrait is significantly associated with the overall crypto market. According to CryptoCompare statistics, the amount of institutional business fell from almost US$70 billion at the end of last year to roughly US$22 billion from November 2021 to October 2022. It is good to observe a little comeback in October compared to September, a gain of approximately 1.76%, the first uptick since July, but still below the high in March. In terms of net inflows, they became positive in October, hitting $730K, up from a negative $9.2M in September. It displays a great connection with the institutional turmoil of April-June.

Competition in the custodial business/service landscape

The first institutional business to be formed is the trust business (crypto asset custody). More than 150 institutions will provide custody services by 2022. Among the most popular are Fireblocks, Coinbase, BitGo, ledger, and others. As seen in the graphic below, Fireblocks entered the crypto trust industry in 2018, supporting over 1,500 different kinds of assets in custody. Geographically, most of the top players are situated in the United States; the majority of the approaches are sole-proprietary (only one adopts hybrid custody). From a technological standpoint, MPC (multi-party computing) technology has progressively been merged into the previous single HSM technology.

CeFi Lending/Borrowing

The offering of crypto asset lending/borrowing services to institutional investors and consumers, including high net-worth people, is referred to as the institutional lending/borrowing business (including family offices). Borrowers are often quantitative trading firms, exchanges, mining pools, project teams, and so forth. Quant-trading institutions and exchanges often use institutional services for hedging or as part of operating capital, while mining pools use credit to pay power bills and acquire fixed assets like mining equipment. Similarly, lenders of institutional services, such as wealth management firms and family offices, are often long-term holders.

Copper, Hex, Matrixport, BitGo, and others will be prominent participants in CeFi lending/borrowing in 2022. The table below summarizes their key services and business methods.

Source: Copper

So far, the fastest and most convenient method to match trades is by email or WeChat (in Hex or Bitgo's model) using broker mode; the dealer mode of the fund pool is more difficult to build owing to compliance requirements.

Institutional upheaval statistics and consequences

Many investors have suffered significant losses as a result of Terra's demise. Three Arrows Capital and its investors were among the first to catch fire. Three Arrows Capital sustained terrible losses in the Terra event as a result of poor risk management; with so many investors involved, the tidal wave has generated a massive exposure of money in the cryptocurrency industry. As a consequence, institutions that had financial relations with Three Arrows Capital became ensnared. Three Arrows Capital's bankruptcy underscores the high risk of lending without collateral (credit lending) in the crypto industry, which has resulted in a string of institutional meltdowns. Following a spate of hazardous surges in the cryptocurrency market, many countries have opted to apply stricter rules to prevent such situations from occurring again.

The FTX incident is the other thunderstorm. All of this originates from Alameda, FTX's sister firm, borrowing monies from FTX for business purposes at the expense of mortgaging SOL and FTT; the amounts given out are all customer funds. CoinDesk published an article warning the general public about the risk on FTX's balance sheet, and CZ responded to this post with another post, claiming the plan of selling off all FTTs in his holdings; the market was thus in such a state of panic that the price of FTT plummeted, triggering a selling climax. FTT suffered from the selling climax, and liquidity was drained; meanwhile, the underlying FTT and SOL lost the bulwark of value, forcing FTX into insolvency, which eventually led to bankruptcy. Prior to all of this, FTX was the second biggest centralized exchange, after only Binance. Despite the fact that the FTX tragedy is already one of the financial world's disasters, it was hacked only hours after the declaration of bankruptcy, with assets worth over 600 million dollars stolen, and most consumers will never be able to withdraw their money again. It is a tsunami for the whole business, with some of the ramifications yet to come.

DeFi

Initially, the development of DeFi was mediocre: the kinds of protocols are quite restricted, and the majority of them are just replicas of conventional finance projected to blockchain infrastructures. It wasn't until 2020 that DeFi saw tremendous expansion, thanks to the advent of the Automated Market Maker (AMM) and liquidity mining. DeFi's Total Value Lock-in (TVL) hit a high of $182.16 billion by the end of 2021.

In 2022, DeFi has also been harmed by chain reactions of macroeconomic instability, cross-border tensions, black swan occurrences (Terra fall, 3AC, Celsius, and FTX incident), a surge in DeFi on-chain attacks and weaknesses, and a general crypto market decline. This chapter seeks to present the current state of the DeFi market on several aspects.

The DeFi's Current Situation in a Bear Market TVL

The TVL in DeFi protocols is present at $39 billion, down 78% from the all-time high of $182.16 billion, indicating a huge devaluation and outflow of money from the DeFi market. In terms of protocol categories, DEX and lending continue to be the primary battlegrounds in DeFi, accounting for around 68.1% of TVL, less than in 2021. Terra has the highest decline in TVL over the last year in the L1 chain category, mostly owing to the collapse of UST, which swept the value down to virtually nothing, and the Solana ecosystem is once again ravaged by the FTX disaster. The remainder of the large L1 chains reported a reduction in TVL as well, including BSC (down 45.1%) and Avalance (down 59.2%). According to Beosin's blockchain security assessment, over 30 hackings occurred in Q3 2022 in DeFi, over $400 million was stolen, and the whole sector pays the bill.

Source: DeFi Llama

DEX

DEX is such an important infrastructure in DeFi that its trade volume reflects market confidence and activity. The overall daily trading volume among the top ten DEXs dropped precipitously, from a high of $19.19 billion to as low as $740 million. The DEX sector, on the other hand, remains an oligopoly. According to Dune Analytics, Uniswap, DoDo, and Curve control roughly 90% of overall trade volume. With 67.5% of trade volume, Uniswap has a monopoly-like position in the business.

Source: Dune Analytics

While DEX has not received a substantial update in the same way as Uniswap V3 has in the last year, several modest updates have been accomplished by different DEX protocols in order to get through the crypto winter.

Integration with NFT trading is becoming more popular for DEX. On the one hand, Uniswap, the leading DEX, stated at the end of July that NFT trading would be enabled after the impending integration of the current NFT trading platform-Sudoswap, and users would be able to access on-chain liquidity offered by sudoAMM in the future. Other DEXs, such as PancakeSwap, have established and incorporated NFT trading markets on their own platforms, resulting in a 40% increase in income.

DEXs are diversifying their product offerings in order to give one-stop shopping. Many DEX protocols are no longer monotonic in swapping. However, cross-chain, lending/borrowing, staking, and wealth management are now offered as platform services to increase loyalty and attract new money. Furthermore, several AMM-based DEXs (SushiSwap, PancakeSwap, and others) have derived the classic limit order mode on the platform for a better trading experience.

Borrowing and lending

In terms of TVL, lending/borrowing is the second biggest in DeFi. Total DeFi borrowings declined from $28.4 billion to $16.2 billion at their lowest, while total deposits plummeted from $78.2 billion to 40.3 billion at their lowest. Lending agreement rates are also falling dramatically. The yield for stablecoin USDC and DAI lenders on prominent lending platforms like Compound, AAVE, and MakerDAO is only between 0% and 1.5%.

The bleak market has compelled numerous lending processes to aggressively seek alternatives in their operations. Using the popular loan application AAVE as an example, native stablecoin GHO will be beneficial in protecting the ecosystem by leveraging the large distribution of stablecoin and magnifying the platform's power. With the formal introduction of the ERC-4626 protocol, any interest-bearing certificates, such as Lido's stETH and cToken on Compound, may be simply included in different lending protocols using this interface. As new kinds of interest-bearing certificates are added to the list of supported assets for collateral and lending, the capital efficiency of funds will improve even more.

NFT

NFT is a new crypto sector that formed in 2021 and has gotten a lot of market interest since April 2021. It has been steadily heating up and entering the public eye since the second part of last year, reaching a peak at the beginning of 2022. However, in the middle of the crypto industry's gloomy environment, the performance exhibited weakness and a lack of impetus.

NFT overall market drop

Throughout 2022, NFT's overall market value fell from $31.14B in January to $21.73B in October, a 42% drop, and single-day closing fell from $842M in January to $48M in October, a 94% drop.

The number of active traders in the NFT market fell from 45,000 at the end of 2021 to 5,000 in 2022, with a proportionally huge drop in both buyers and sellers. Major transactions were seen in January, April, and June, followed by a relatively poor performance in the second half of the year. In comparison, the total number of NFT customers increased by 138% to 3,426,600 from 1,445,900 at the start of the year (the NFT market embarked in the second half of 2021). The rise in total users is followed by a fall in active trading users, suggesting an increase in price takers, with the bulk of users holding at a loss.

Source: NFTGO.io

NFTfi: Following a successful launch

NFT has grown from a pure PFP project to a more complex version mixed with games, metaverse, collateralized lending, and other features, producing a new paradigm of NFT + decentralized finance. However, being a non-fungible token, the indivisibility results in lower liquidity than FT, such as reduced trading accuracy, greater costs, and a lack of a price discovery mechanism.

To solve this, financial applications and tools for NFT asset problems have arisen in the market, with the goal of increasing liquidity and increasing certainty in NFT asset pricing. NFTFi improves the usage of money on NFT by combining NFT and finance to produce a better user experience in the NFT market, which we refer to collectively as NFTfi apps.

NFT lending/borrowing: a developing market.

NFT lending/borrowing is the most direct solution to solve the liquidity problem of NFT assets, as well as the most desired demand in the present NFT market. Prior to 2022, hardly any NFT lending/borrowing voices were heard, but it gradually began to surface in dialogues. The NFTfi protocol and the BendDAO protocol describe two dominant modalities for NFT lending/borrowing: P2P (peer to peer) and P2Pool (peer to the pool). They vary in terms of transaction frequency, trial scope, and price discovery efficacy, yet, the entire market remains limited in comparison to fungible tokens.

As noted previously in this article, the NFT market in 2022 is undeniably in decline, and so NFT lending/borrowing performs poorly. Current NFT lending/borrowing remains within the realm of blue-chip; for the time being, low-to-medium NFTs are not generally acknowledged in the market due to excessive price volatility and a lack of oracles.

Overall, although NFT lending/borrowing has witnessed considerable innovation in 2022, progress is still rather gradual, and the market size, let alone market value, is fairly minor in comparison to FT. At the bottom, the market will grow to include additional NFTs, as well as the realization of new financial derivatives and application scenarios based on the existing model.

The current state of NFT liquidity-providing solutions

In 2022, the whole crypto market contracted, and NFT liquidity solutions arrived just in time. Fractional NFT, fundraising protocols, and liquidity pool protocols are the most often used NFT liquidity solutions today.

Fractional NFT: By converting NFT into fungible tokens with improved transaction accuracy, it becomes suitable for numerous financial instruments like collateralization, staking, and leveraging of fungible tokens or equity.
Crowdfunding techniques carefully handle the market demand side's high requirement for users to hold an NFT, allowing players to pool their cash and co-manage an NFT in a multi-sig setting.
Liquidity pool methods collect NFTs at the floor price, allowing users to trade on a steady platform.

Overall, liquidity solutions developed one after the other in 2022, with certain initiatives (such as PartyBid) catching the attention of capital funds and investors. More innovative ventures are sprouting up.

The liquidity options discussed above are different, and all of them may increase financing efficiency to some degree. However, due to price issues, the liquidity of both long tail and unusual NFTs has never been successfully addressed. The NFT market would become more liquid than ever in the future as the accumulation of past trade prices progressively completed the NFT quote mechanism.

GameFi

GameFi is a new market category that emerged during the 2020 bull market. GameFi is a synthesis of gaming and finance: players play for enjoyment, while others earn from financial incentives; games are carefully financialized, and incremental traffic was introduced, revitalizing the industry. Amid last year's bull market, GameFi performed very well; yet, during the market slump, GameFi had a high positive association with the BTC index. Projects that depended on hype and unsustainable business models fared even worse in this year's down market.

According to Footprint's on-chain statistics, the growth of GameFi projects slowed substantially in May, with just 41 new projects launched throughout the month, many fewer than in Q1. After one year of growth in 2022, BSC now boasts the biggest gaming ecosystem, with approximately 582 GameFi projects.

Source: Footprint analytics

Axie Infinity was the most popular GameFi project last year, while StepN is the most popular this year. However, they are no longer in the top three in terms of average active users. They have fallen well behind the top three GameFi projects, showing that unsustainable gaming economics are not conducive to long-term project development. On the contrary, Alien Worlds and Splinterlands, two beyond the scope of GameFi, currently dominate the market. Even if the price of tokens has declined and the return on investment has diminished, they remain popular among gamers. This also implies that the playability of games may help to avoid asset inflation during a slump.

Disclaimer:
This article is intended for and only to be used for reference purposes only. No such information provided constitutes advice or a recommendation that any investment or trading strategy is suitable for any specific name.

Year-end Crypto Market Report: A Summary Of 2022: Part 2