We got an overwhelming response last year on our 2022 Tech trend view and based on that we have decided to publicly share our internal thoughts as we look forward to 2023. Our fund was created to be tech first, an early strategic partner in projects that go on to build, and be the leaders in the decentralized ecosystem of the future.
As we looked back on our 2022 predictions, most of which still hold we realized there are few sub-products/streams which have become predominant and deserve their own focus. On a broader note, with multiple chains coming into the ecosystem we still believe that there will be a sector specific chain ecosystem supported by the top execution layer based on the product sector with multiple underlying L1s/L2s for users to easily support their multi chain transactions.
With that in mind As we enter 2023 we wanted to share with you insights into the trends that we have identified, analyzed and continue to focus on and invest in.
Trend #1: Secure and Decentralized Cross-chain Communication
ZK & Optimistic Bridges
Cross chain asset transfers are carried out by interchain bridges. With bridge hacks being the major crypto hacks, we need increased innovation on secure cross chain communication protocols. This year itself hackers stole $1.3 billion by targeting cross-chain bridges . According to Chainalysis cross chain bridge hacks account for 69% of the funds stolen across crypto projects in 2022.
We believe one of the major trends of 2023 will be the transition from centralized bridges to more secure decentralized bridges. Native ZK and Optimistic bridges will gain adoption. Native ZK/Optimistic bridges depend on the security of the chain itself rather than introducing a new attack surface. Hence, they are theoretically more secure than any other type of bridge.
Optimistic bridges work to improve the security of transactions, the tradeoff being transaction latency.
Like traditional bridges, data is posted to a smart contract on the origin chain, that data is signed by an updater who stakes funds that are slashed in case of fraud, and the data is then posted on the target chain. Once this is done, any of the watchers (nodes watching the target chain) have a time window in which they can submit a fraud proof in case of an invalid transaction, if this proof is correct the updater’s funds are slashed and the transaction is invalidated, if not the transaction is finalized. Optimistic bridges, like optimistic rollups depend on a set of watchers to watch the chain, this is different from having a group of external verifiers that validate bridging transactions. In the case of external verifiers, m out of n have to sign the transaction for it to go through and hackers have been able to compromise m validators, in the case of optimistic bridges the transaction is assumed true and only 1 out of the n watchers is required to submit a proof. Thus to take control of an optimistic bridge the hackers have to compromise all of the bridge watchers. Taking control of all bridge watchers is significantly harder than controlling 51% of them, thus making optimistic bridges more secure. The tradeoff here is the wait period in which watchers submit fraud proof before a transaction can be finalized. Though this is still not 100% hack proof. Nomad bridge was a notable optimistic bridge, it was hacked for $190 million in August 2022, however, the reason for the hack was due to a vulnerability in the smart contract (our Tech trend #3 stresses on the importance of smart contract auditing), not the optimistic nature of the bridge.
Though we definitely see more products on ZK snarks and optimistic bridging, a strong school of thought is that comfort with existing systems with more rounds of smart contract auditings will delay the full adoption over the next couple of years. Irrespective, some shape or form of decentralized bridges will take over the centralized game soon.
Trend #2: Actionable Cross Chain Analytics, Monitoring and Observability Tools
The global data analytics market size was ~$40 billion in 2022, with companies like Forrester Research and Gartner being worth billions of dollars. By comparison the blockchain analytics space is in the very early stages and we expect companies that can gather transaction and user data across multiple blockchains and present that data in an easy to understand and actionable way will see great growth in 2023.
Cross chain monitoring tools will also grow, especially as more emphasis is laid on maintaining regulatory compliance and preventing crypto frauds. We will see growth in observability tools like Elliptic’s Holistic Screening, that can track many different crypto assets across multiple chains. These monitoring tools provide services like automatically tracking stolen funds/funds involved in fraudulent transactions across multiple chains.
The current common practice for multichain products is to usually launch multiple native products on each chain like AAve on Ethereum and then Polygon etc. This is usually done from a security and simplicity perspective but with more secure bridges enabling cross chain transactions we hope to see one product transacting across chains, but this will take a couple of years for it to become a mainstream practice.
Trend #3: Increased focus on smart contract auditing, AML and KYC infrastructure
In addition to KYC and AML infrastructure, security infrastructure for digital asset custody, auditing of smart contracts and real-time smart contract monitoring will be a major trend to look out for. For example, Fireblocks raised $550 million in 2022 at an $8 billion valuation to become the highest valued digital asset infrastructure provider.
The crypto industry lost $3 billion in various hacks last year, real-time monitoring solutions and formal verification based audits will be critical to prevent such hacks. Looking back at the $615 million Ronin hack, the largest crypto hack of 2022, it took the team six entire days to become aware of the hack , that too only when a user complained that they were unable to withdraw funds. Real-time monitoring tools could have detected a hack almost instantly after an initial large, suspicious transaction. Companies like Valid Network, Cyver, and Forta are offering such real-time network monitoring solutions.
Forta uses machine learning to detect threats and anomalies in real-time, it allows developers to create bots that monitor smart contracts, when the bot detects threats it alerts the developers. Companies using machine learning techniques train their algorithms on patterns of past hacks and exploits’ as well as on normal chain behavior so that they can flag anomalous behavior. As blockchain usage and the number of transactions/contracts on-chain increase, we will get larger datasets to train the algorithms on, this will lead to improved ML prediction performance. Though machine learning has been used in credit card fraud detection for a while, its use in blockchain monitoring is innovative and we will continue to see techniques from other industries being applied to blockchain.
The focus on security will also provide a boost to firms like Hexens, a Delta portfolio company that provide security solutions like smart contract and wallet audits, penetration testing and compliance services. The $320 million Wormhole hack, was due to a vulnerability in the contract, this could have been prevented by timely smart contract audits.
Trend #4: Adoption of Custodians and DEX’s over Centralized exchanges
Due to the collapse of major centralized exchanges and hedge funds like FTX, 3AC, Celsius, Voyager and BlockFi users are finding it more favorable to control their own funds and use open source decentralized exchanges rather than trusting centralized exchanges with their funds.
Users lost $8 billion in the FTX scandal, which has been accused of misusing customer funds. This mistrust of centralized exchanges led to the daily DEX volume on the Ethereum blockchain surging 730% to $2.3 billion on November 10, up from $278 million just a few days earlier, following the collapse of FTX. On Nov 14th 2022, Uniswap the largest DEX by trading volume and number of users, surpassed Coinbase in daily volume for the ether/U.S. dollar trading pair .
The combination of misconduct by centralized exchanges and the continuous improvements in DeFi protocols means in 2023 we will see:
- People will move away from using CEX as custodians and instead do self custody or use regulated custodians like Fire Blockscrypto or regulated exchanges with transparency and accountability. Institutional funds will move more towards custodian solutions like Anchorage and FireBlocks both for custody.
- Native users migrating away from centralized exchanges and toward self custody and DeFi.
Trend #5: Rise of Regulated, Hybrid blockchains and App specific chains
As governments dive deeper into adopting blockchain based solutions, “regulated” blockchains will come to the forefront. In 2022 the International Monetary Fund published a document on creating a framework for “ Regulating the Crypto Ecosystem “. They called for a globally accepted regulatory framework that covers the key entities in the crypto value chain from fiat-to-crypto on/off-ramps and exchanges. They propose only allowing authorized and licensed service providers. In addition to this they propose introducing requirements on the actual economic functions of crypto assets in addition to just their technical design and governance.
Protocols that will have the support of such institutions will be ‘regulated protocols’ that carry out KYC/AML checks on-chain with decentralized identities. They will then allow users to access the services without compromising their privacy while also ensuring that the transactions are safe and within the realm of regulations.
Another way to see the future is to imagine hybrid blockchains that have both permissioned and permissionless aspects. Data that needs to be private or securely stored can be done on top of a permissioned chain thereby only key users can access it, while the actual proof of the data can be stored on a public or permissionless blockchain. Zero-Knowledge is one of the key technologies being used by many projects to build these permissionless solutions.
The Cosmos SDK is one such software enabling developers to create app specific chains. Cosmos allows developers to build out the exact application layer they need to update their state, while providing them with the customizable Cosmos consensus protocol (Tendermint). Instead of building a dApp on Ethereum, developers may move to building their own chain from the ground up so that they can optimize the chain performance and enable the chain to be best suited for their particular application.
Though a very important component of regulated chains will be clear directions from the government entities and the institutional adoption both of which can take far longer than just a year to adopt, however we will still see a lot of product building and conversations regarding regulated and hybrid chains this year.
Trend #6: Rapid institutional adoption and the rise of blockchain products as a service
This massive level of institutional adoption will also spur the growth of Blockchain-As-A-Service (BaaS) providers that can help both large institutions make their move into Web3 and help startups focus on their domain expertise by providing them with the support to build and maintain their blockchain systems.
Our portfolio company Nahmii, a layer 2 scaling solution for Ethereum, is working closely with Norges Bank on a pilot project for CBDC. Many startups like Nahmii can help existing players with faster rollout and testing of blockchain solutions. Cloud providers including AWS, Microsoft Azure and Alibaba Cloud have already started offering blockchain as a service solutions to their existing suite of clients.
As more businesses adopt blockchains to solve their problems we will continue to see end-to-end tailored blockchain development and maintenance solutions. This can be seen with companies like Blaize, that develop blockchains for businesses based on their specific business needs and also provide them with node infrastructure, dApp development and cross chain bridges.
Trend #7 — ZK Rollups & zkEVM’s for improved Scalability and Privacy
Zero knowledge or “ZK” rollups use mathematics & computer science to confirm that transactions posted to layer 1 chains are true and valid. Optimistic rollups use a dispute method to ensure the transaction’s truthfulness. Optimistic rollups are relatively easy to deploy, but despite being complex, ZK is catching up.
ZK verifies the transaction by constructing so-called “zk-SNARKs” — a kind of cryptographic message that proves a statement is true without requiring you to walk through it yourself. Proving that transactions are valid in ZK is more fool-proof than trusting people to reject malicious transactions within a certain time window, usually seven days, as is required with Optimistic rollups.
The two major areas that we see ZK being used in 2023 are scalability and privacy.
Trend #8: Decentralized Social Media Apps will see increased adoption
The advantages offered by decentralized social media apps are; giving users ownership over their content, improved monetization power for creators, preventing the sale of user data as well as preventing a central power from making arbitrary censorship and policy changes. These advantages will fuel their growth in 2023. Proving identity while maintaining privacy will be the new direction of social media where hateful bots are redefining the social behaviors.
In addition to the advantages of non blockchain based decentralized social media apps, where blockchain based decentralized social media apps shine is that users can directly reward creators using crypto tokens, and creators can directly monetize their digital content in the form of NFTs. Some popular blockchain based decentralized social media apps are Peepeth and BitClout which are blockchain-powered social network alternatives to Twitter, Pixelfield a decentralized alternative to Instagram.
Decentralized social networks will also lead to the need for a robust trust and reputation system. On traditional social networks we have a centralized authority that monitors users’ reputations and bans them in case of misconduct. While this has led to increased censorship on traditional social networks, the lack of any reputation system in Web3 native platforms is also harmful. The lack of reputation and identity based services have led to many rug-pulls and scams, since the perpetrators can get away without revealing their identity. In 2022 alone there were more than 188,000 rugpulls across different blockchains, this has caused users to lose $3.5 billion .
One such protocol aiming to solve this problem is the EigenTrust Protocol, a decentralized reputation protocol for Web3. Herein, quantifiable reputation scores are calculated based on a weighted peer review method, resulting in a standard global trust value of an individual or corporate. Such a reputation protocol can have far reaching use cases like trusted creator scores for NFT artists, filtering users out for airdrops, creating a community participation ranking and rewarding active users. These are a few cases amongst many more. By creating and tracking identity scores on the blockchain these protocols can also help tackle negative aspects of social media, something that traditional social media companies have been unable to tackle over all these years. Thus we see very clear and pressing use cases for such reputation protocols and will see major developments in this space in the coming year.
Trend #9 Improved focus on User and Developer Experience
In order to bring crypto products to the mainstream they have to be easy to use and easy to build. Compared to Web2, Web3 companies are still in the early stages of building out their infrastructure, we will continue to see Web3 companies work to improve user experience so that their products can be used by less technically savvy users. Ledger wallet recently announced their new wallet, Stax, equipped with a E-ink touchscreen, making it easier than ever to hold crypto and NFTs assets in self custody and easily sign transactions. To abstract away some of the tedious aspects of crypto development we are seeing companies like Axel, that provide API integrations across multiple lending, borrowing and staking protocols. Our portfolio company Hatchfi provides developers with seamless integration to exchanges like Binance, Gemini and Coinbase as well as chains such as Ethereum, Optimism and Polygon so that they can access data in human readable and easy to use forms. No-code solutions for crypto will also grow in popularity, our portfolio companies Airstack provide users no-code solutions for querying historical data from the blockchain and Esprezzo provides users with real-time alerts for custom web3 events. Thus applications that serve as blockchain middleware and make it easy for developers to build more complicated blockchain based solutions will be one of the defining technologies of 2023.
Finally we would like to conclude by stating that there is still unmatched development going on in the crypto ecosystem, developers are still flocking to the crypto space at a rapid rate with the number of monthly verified smart contracts up 2.6x YoY and the number of downloads for web3 libraries like web3.js and ether.js up 3x over the past year .
Though we saw lots of historical jaw dropping low moments in the crypto world in 2022 , the tech adoption both at the individual and institutional level continued to increase. We believe that it is the influx of talent that will lead to a new wave of innovative products and services in the coming years. We are bullish on the technology and strongly believe that tech will get its recognition and pay off the space in the next crypto summer!