In the first part of this series, we introduced the five foundational layers of the Web3 data stack: acquisition, storage, indexing/querying, analytics, and marketplaces, as illustrated below. Through real-world examples such as ORO, Arweave, and Ocean Protocol, this paper examines three critical layers (Data Acquisition, Decentralised Storage, and Data Marketplaces / Compute‑to‑Data) to show how capture turns into commerce.

1. Data Acquisition

Data acquisition refers to the process of capturing raw information, which could include on-chain activity ( e.g. wallet transactions or smart contract interactions) and off-chain inputs ( e.g. browsing behavior, personal data, and IoT signals). In an AI-driven world, the availability, quality, and verifiable provenance of proprietary data directly affect model performance, regulatory compliance, and defensibility.

Web2 platforms like Google and Meta rely on centralized data collection models, where user information is gathered passively and often without clear, ongoing consent. Users have little visibility or control, and receive no compensation. Web3 flips the model in two transformative ways:

(1) By introducing token incentives that reward users for contributing valuable data, and

(2) By embedding privacy-preserving technologies that protect user control and confidentiality.

Together, these innovations enable a participatory data economy where users are active stakeholders.

1.1 ORO: Turn Your Data into Digital Gold

AI systems like ChatGPT and Stable Diffusion have relied heavily on large, diverse public datasets. But this open data supply is dwindling. A 2022 paper, Will We Run Out of Data?, predicts that high-quality public text could be depleted by 2026, with even low-quality content exhausted by the 2040s. This looming shortage raises a critical question: where will the next generation of AI models get their data?

ORO is a decentralized platform launched in 2025 that empowers individuals to contribute private data to AI development while maintaining full control and privacy. As public data sources dry up, ORO supplies high-quality, permissioned datasets for next-gen AI models. Users are fairly rewarded, turning personal data into a valuable asset. Advanced cryptography ensures privacy, building trust in the data economy.

Shortly after launch, ORO has attracted over 500,000 users and unlocked more than 1.5 million connections across health, social, and finance applications. It has also generated thousands of hours of high-quality, net-new audio data, already being licensed by frontier labs and application-layer companies - demonstrating early evidence of strong latent demand for a privacy-preserving data marketplace.

1.1.1 ORO’s Model

At the heart of ORO is a two-layered system: a data sharing application and a privacy-preserving blockchain protocol. Users connect their accounts and complete quests that collect specific data needed by AI companies. The more users participate (by linking accounts, completing quests, and maintaining engagement) the more points and eventual tokens they accumulate. All contributions and rewards are transparently tracked and distributed via smart contracts on the blockchain, ensuring fairness and eliminating the need for a central authority.

Crucially, raw files never leave the contributor’s device or the protocol’s secure enclaves, maintaining scarcity and thus economic value.

1.1.2 Data Quality Assessment in ORO

1. On-Chain Validation and Scoring

ORO employs on-chain validation and scoring mechanisms to transparently track and assess every data contribution. This system ensures that all data submissions are recorded immutably and can be audited for quality and provenance. The scoring process is designed to be trustless, meaning it does not rely on a central authority but instead uses protocol-defined rules to evaluate contributions.

2. Data Quests and Structured Contributions

Data is contributed through structured “quests” or account linkages, which are designed to collect specific, high-value data types needed by AI companies. By defining clear requirements for each quest, ORO can set minimum quality standards for the data being collected (e.g., completeness, recency, relevance to the quest objective). This structure helps filter out low-quality or irrelevant data at the point of submission.

3. Automated and Cryptographic Validation

ORO’s privacy-preserving technology, including zero-knowledge cryptography (zkTLS) and Trusted Execution Environments (TEEs), not only protects user privacy but also ensures that data is processed and validated securely. These technologies can verify that data meets certain integrity and authenticity criteria without exposing the raw data, helping to prevent fraudulent or manipulated submissions.

4. Ongoing Scoring and Reward Adjustment

The protocol’s reward system is directly tied to the quality and utility of the data provided. Contributors earn ORO Points based on the value their data brings to AI model improvement. If data is found to be incomplete, outdated, or otherwise low quality, it may receive fewer points or be excluded from reward calculations. This incentivizes users to provide accurate, timely, and relevant data.

5. Community and Protocol Oversight

While much of the validation is automated, ORO also supports the creation of Data DAOs, where communities can collectively curate, review, and govern data pools. This allows for additional human oversight and the ability to flag or remove low-quality data through community governance mechanisms.

1.1.3 ORO’s Privacy Protection Architecture

Privacy is foundational to ORO. It combines cryptography, secure hardware, and on-chain permissions to ensure contributor data stays safe and user-controlled.

1. Trusted Execution Environments (TEEs)

ORO utilizes Trusted Execution Environments to ensure that all user data is encrypted and processed within secure hardware enclaves. When data is contributed, it is never exposed to any human or external system; instead, all AI model training and data analysis are performed entirely inside these secure vaults. This approach guarantees that raw data remains private and inaccessible throughout its lifecycle on the platform.

2. Zero-Knowledge Cryptography and Multi-Party Computation

To further enhance privacy, ORO employs advanced zero-knowledge cryptography (zkTLS). This technology enables the platform to validate and process data without revealing the underlying information, preserving privacy during both storage and computation. Additionally, ORO supports Multi-Party Computation (MPC), which allows distributed data processing across multiple nodes without reconstructing the original dataset, adding another layer of security for sensitive information.

3. Encryption, Access Controls, and User Consent

All data on ORO is encrypted both at rest and in transit, using industry-standard protocols such as AES-256 and TLS. Access to data is managed through granular, on-chain permissions, providing precise control over who can access information and for what purpose. Contributors retain the ability to decide what to share, adjust permissions at any time, and revoke access whenever necessary, ensuring ongoing user consent and control.

4. Cryptographic Attestations and Transparency

Every operation involving user data on ORO generates a cryptographic attestation—a tamper-proof, auditable receipt that verifies data was handled as specified. These attestations are publicly accessible, offering transparency and verifiability for all data handling activities. Combined with a decentralized architecture and adherence to global privacy standards, this approach minimizes the risk of data breaches and establishes a foundation of trust for all participants.

1.2 Risks and Regulations

1.2.1 Regulatory Compliance

Compared to conventional data collection models (where data is often resold without user consent), decentralized data acquisition frameworks may offer a more compliant and user-centric alternative. Regulations like the EU Data Act emphasize data portability, transparency, and user ownership, principles that are inherently embedded in many Web3-native approaches. Similarly, U.S. laws such as the CCPA and HIPAA enforce strict consent and access controls, which can be more seamlessly implemented in decentralized systems through mechanisms like self-sovereign identity (SSI), verifiable credentials, and on-chain permissions. By design, these models minimize data custody risks and return agency to users, potentially making compliance not only easier but native to the architecture.

1.2.2 Risks

Synthetic Data Could Undermine the Value Proposition

A growing number of AI companies are exploring synthetic data generation to sidestep the limitations of real-world datasets. Startups like Parallel Domain and Synthesis AI use simulated environments and generative models to produce artificial datasets for applications ranging from autonomous vehicles to facial recognition.

However, multiple recent studies provide strong empirical evidence that synthetic data, even when carefully constructed, still underperforms compared to real data for large language model (LLM) training.

Source: Long-context retrieval (2025), Machine translation (2024), Question answering (2024), Complex NLP tasks (2024)

In areas like behavioural science, product design, or sentiment analysis, synthetic data falls short. Here, authentic human data remains irreplaceable, reinforcing the long-term value of permissioned user datasets.

1.3 Where Startups/Investors can Win in Data Acquisition

While the foundational tooling for decentralized data acquisition is maturing, there remain clear white spaces where new startups can deliver significant value. In particular, we see two underexplored areas: (1) the user experience layer for individual data contributors, and (2) B2B infrastructure to unlock enterprise-grade datasets.

1.3.1 UX Layer for Individual Data Contributors

Most current systems assume a level of technical literacy that excludes mainstream users. Concepts like wallet connections, trusted execution environments, or zero-knowledge proofs remain foreign to the average internet user. As a result, participation is limited to crypto-native individuals, constraining the available data supply.

This creates an opportunity for a new class of consumer-facing data tools that embrace chain abstraction to minimize friction. Data contribution should feel as effortless as linking a Spotify or Gmail account (no wallets, no tokens, no technical setup). Platforms should handle everything behind the scenes: wallet creation, chain selection, data formatting, and transaction execution. The user’s role should be reduced to a single, clear action: granting consent.

By abstracting complexity, platforms can onboard the next wave of data contributors - people who care about privacy and agency but don’t speak Web3.

1.3.2 Infrastructure for B2B Data Contribution

While most of the attention in Web3 data acquisition has focused on individuals, enterprises and SaaS platforms collectively hold vast repositories of valuable, structured data. However, there is currently no standardized way for these organizations to contribute datasets to Web3-native marketplaces while preserving compliance and control.

We believe there is a meaningful opportunity for middleware infrastructure that enables enterprises to tokenize, permission, and stream datasets into ecosystems like ORO. This could take the form of API-based integrations with existing enterprise software, allowing organizations to monetize anonymized or aggregated data in a compliant and opt-in manner. By tapping into the long tail of enterprise data sources, such infrastructure could dramatically expand the breadth and depth of supply available to data buyers, particularly those building AI, analytics, or personalization systems.

2. Data Storage: Why Decentralization Matters

Decentralised storage networks guarantee data permanence and censorship resistance, decoupling storage cost from centralized vendor pricing.

Traditional Storage vs Decentralized Storage

Web2 stores data either locally (hard drives) or in the cloud (AWS, Google Cloud). Local storage offers control but is fragile. Cloud storage adds durability but at the cost of control - miss a payment or lose access, and your data’s gone.

Decentralized storage reimagines this. Unlike early peer-to-peer systems like BitTorrent, Web3 adds incentives and on-chain verification. Protocols like Arweave, Filecoin, and Storj pay nodes to store and serve data, backed by cryptographic proofs.

Source: ocularvc

These solutions generally follow one of two models:

• Pay-once, store-forever (e.g. Arweave)

• Pay-as-you-use (e.g. Storj, Filecoin)

In this piece, we’ll focus on Arweave, the pioneer of permanent storage.

2.1 Arweave

Arweave is best described as a global hard drive, one designed to store data permanently. Unlike traditional cloud storage platforms that rent space month-by-month, users pay once using the $AR token to store the data forever,

2.1.1 Proof of Access: The Economic Engine Behind the Network

When you upload a file (say, a PDF) to Arweave, you pay a one-time fee in the $AR token. This fee is pooled and used to incentivize a decentralized network of miners to store that file over the long term.

But unlike traditional blockchains where every node must store the full history, or other storage networks where data is split into encrypted shards, Arweave takes a different approach:

• Data is stored directly in blocks.

• Each miner chooses which blocks to store, creating a diverse and redundant distribution of data across the network.

What ensures this system works is Arweave’s novel consensus mechanism: Proof of Access (PoA). To mine a new block and earn rewards, a miner must prove they have access to a randomly selected previous block (the recall block). This mechanism:

• Incentivizes miners to store rare or less-replicated data,

• Penalizes those who can't produce the required proof,

• And naturally balances storage load across the network.

This design turns scarcity into a feature. The rarer the data a miner stores, the higher their chances of earning rewards. This creates an economic engine that sustains long-term, decentralized storage without central coordination.

2.1.2 The Blockweave (A Smarter Blockchain Structure)

Instead of a typical blockchain, Arweave uses a blockweave, a structure where each block references not just the previous block but a random prior block (“recall block”). This enforces replication and decentralization without full-chain validation.

Source: ocularvc

2.2 Advantages and Risks

Decentralized storage spans multiple architectures, each with different trade-offs. While Arweave focuses on permanence, projects like Filecoin and Storj offer dynamic, cost-efficient, and privacy-preserving models. This section looks at the broader opportunities and risks across decentralized storage, not just Arweave.

2.2.1 Advantages

1. Data Permanence as a Public Good

Today’s internet operates on fragile terms - websites can go offline, records may disappear, and historical context will be lost. Arweave changes that. Its economic model sustains permanent storage of critical public data like:

• Academic papers and scientific findings

• Legal documents, statutes, and governance records

• Historical media, journalism, and digital cultural artifacts

By aligning incentives for preservation, protocols like Arweave fill a gap that traditional cloud providers aren’t designed to address.

2. Lower Cost Through Market-Based Storage (Filecoin & Storj)

On the other end of the spectrum, protocols like Filecoin and Storj operate on pay-as-you-go models. This model isn’t designed for permanence, but it does outperform traditional cloud pricing in many cases.

As shown in the cost comparison table below, Storj has a significant cost advantage. For users or businesses with large datasets and less concern about long-term immutability, decentralized storage is already an economically superior option. The combination of lower costs, open access, and redundancy makes decentralized storage a compelling infrastructure primitive for the modern data economy.

Source: ocularvc

2.2.2 Risks

1. The Trilemma: Can’t Have Everything

Decentralized systems face trade-offs between permanence, privacy, and cost efficiency. No current solution delivers all three.

• Arweave offers unmatched permanence, but data is fully public unless encrypted by the user beforehand (through ArDrive). However, when using ArDrive, the cost becomes less competitive as seen in the table above.

• Filecoin and Storj prioritize privacy with very low costs, using sharding and erasure coding, but don’t offer guarantees of long-term persistence or immutability.

This reflects a broader Web3 trilemma: decentralization often comes with trade-offs that must be carefully considered depending on the use case.

2. Miner Attrition and Infrastructure Fragility

Like other decentralized networks, storage protocols rely on active global node operators. But the same group of miners is being courted by multiple protocols. If incentives weaken through low demand or token price drops, miners may leave, reducing network reliability.

This makes the long-term sustainability of each network tightly coupled to its economic model, user adoption, and developer engagement.

2.3 Where Startups/Investors can Win in Data Storage

While decentralized storage protocols like Arweave, Filecoin, and Storj have made great strides in availability, permanence, and cost-efficiency, they fall short in addressing a rapidly growing and distinct need: structured, AI-ready data pipelines.

We believe there’s an emerging need for a unified AI-native storage layer in Web3, one that abstracts away raw infrastructure and offers clean, modular APIs optimized for model builders.

Such a platform would:

• Build on top of existing protocols like Filecoin or Arweave

• Add indexing, versioning, and retrieval pipelines

• Support privacy-preserving permissions (e.g. via ZK proofs or DIDs)

• Provide vector-native lookup for inference-time embeddings

• Enable tokenized incentive systems for structured, high-quality contributions

This verticalized “data operating layer” could become foundational infrastructure for decentralized AI. In our view, AI-ready storage represents one of the most overlooked primitives in the current Web3 infra stack, a critical missing link between decentralized data availability and real-world model utility.

3. Data Marketplaces

Web2 data marketplaces like Snowflake, AWS Data Exchange, Databricks, and Oracle Marketplace serve as centralized hubs where enterprises list structured datasets (typically for B2B use cases) behind paywalls or APIs. These platforms offer access to business intelligence, demographic, financial, and scientific records.

But access is tightly controlled. The most valuable data (Google search logs, Meta user behavior, Amazon purchases) stays behind corporate firewalls. Even third-party vendors like FactSet or Acxiom operate on pricey subscriptions, leaving smaller players out of the loop.

Web3 reimagines this model by shifting data ownership from institutions to individuals. Instead of relying on centralized brokers, users can directly contribute and monetize their personal data through decentralized, privacy-preserving marketplaces. These platforms typically feature:

• Privacy-preserving access via zero-knowledge proofs or compute-to-data,

• Tokenized incentives to reward contributors and curators,

• Smart contract-based licensing and settlement,

• Decentralized governance that gives contributors a voice.

While the space is still nascent, with only a handful of established players, we now turn to one of its most developed examples: Ocean Protocol.

3.1 Ocean Protocol:

Ocean is a decentralized data exchange protocol that turns datasets into tradable, tokenized assets. Through Data NFTs and Datatokens, Ocean enables programmable, privacy-preserving data sharing for individuals and enterprises. In mid-2024, Ocean merged with Fetch.ai and SingularityNET under the Artificial Superintelligence (ASI) Alliance.

3.1.1 Data NFTs & Datatokens

Ocean uses two main primitives:

• Data NFTs (ERC721): Represent IP ownership of datasets

• Datatokens (ERC20): Grant access rights to datasets, each tied to specific licensing terms.

A single Data NFT can have multiple datatokens, one for 24-hour access and another for full-month usage. This gives data publishers fine-grained control over pricing and distribution. Licensing and payments are handled entirely through smart contracts.

3.1.2 Smart Contract Flow

To publish data, creators deploy a Data NFT, then mint one or more Datatokens linked to it. Each token can use different pricing models (fixed rate, free access, etc.). This setup makes data assets tradable via Ocean Market or DeFi platforms.

(A flowchart detailing the process of publishing dataset to datatoken being traded on marketplace), taken from Ocean Protocol docs

3.1.3 Compute-to-Data: Privacy-Preserving Access

One of Ocean Protocol’s most compelling innovations is Compute-to-Data (C2D), a privacy-preserving solution that enables data owners to monetize sensitive datasets without ever exposing the raw data. Instead of selling access to the data itself, owners can grant permission for specific algorithms to be executed on their dataset. Only the results of the computation are returned to the requester, while the data remains securely on-premise.

For example, a hospital might allow an algorithm to compute average patient age without revealing individual records. This privacy-preserving approach is ideal for sectors like healthcare, finance, or research where control and compliance are non-negotiable.

By separating compute from access, C2D unlocks value from sensitive data without compromising security.

Source: Ocean Protocol Docs

3.2 Advantages and Risks

3.2.1 Advantages

1. Discovery and Optionality

One of the core values of a marketplace is discovery. In today’s world, data demand often exists without clarity. Users may not even know what data they want until they see what’s available. A decentralized data marketplace surfaces new datasets, niche categories, and underutilized information. This enables a kind of “data browsing” experience and opens up novel use cases while encouraging experimentation. Much like eBay or OpenSea, users don’t always come in with a specific goal, sometimes the product finds the user.

2. Monetization and Distribution Infrastructure

Marketplaces unlock new distribution and monetization models that don’t exist in Web2. Through primitives like Datatokens, Data NFTs, and Compute-to-Data, data can be monetized not just as a static file, but as a programmable, access-controlled asset. Sellers can choose to:

• Sell access rights without giving up data ownership (via Datatokens),

• Sell the revenue stream (via the NFT),

• Or even allow usage-based monetization via smart contracts. (Different price schemas)

This flexibility enables businesses, researchers, and even individuals to treat data like an income-generating asset, severely expanding who can participate in the data economy and how.

3.2.2 Risks

Disintermediation and Quality Concerns

The marketplace model works best when there's a large, diverse pool of buyers and sellers. However, if the biggest, most resource-rich buyers go straight to the source, marketplaces may be left servicing only the long tail of the data economy.

We believe the white space lies in vertically integrated platforms that own both ends: acquisition and distribution. These platforms don't just list datasets, they own the entire pipeline: from consent-based data acquisition and validation, to licensing and monetization.

A strong marketplace must start by owning the supply side. Ultimately, data is gold and the marketplaces that succeed will be those that own the upstream gold mine, not just the storefront.

By treating data acquisition and marketplace distribution as a unified problem rather than two siloed layers, future platforms can build stronger network effects and deeper moats.

Conclusion

As the foundations of the decentralized data economy solidify, a new design space is emerging for how data is gathered, governed, and monetized. This shift is not just technical but philosophical, redefining trust, ownership, and value at the data layer.

At Ocular, we’re deeply excited about the potential of this space. We believe that the protocols being built today will serve as foundational infrastructure for tomorrow’s innovations.

Thoughts and takeaways:

• Decentralized data acquisition, storage, and marketplaces are rapidly maturing, with clear opportunities for new entrants in privacy, compliance, and programmable monetization.

• Key risks include synthetic data competition, incentive sustainability, and the Web3 trilemma → no single solution offers permanence, privacy, and cost efficiency.

• Protocols with robust privacy-preserving primitives and high-quality data curation are best positioned to capture value as the data economy evolves.

In the next installment of this series, we’ll dive into how data is accessed, queried, and transformed into insights. We will explore indexing protocols, analytics platforms, and emerging data rails powering the next generation of permissionless intelligence.

Stay tuned.

This three-part research series examines the growing intersection of Web3 and data infrastructure across five critical layers: data acquisition, storage, indexing & querying, analytics, and marketplaces. This first installment provides a high-level overview of the current landscape, identifying key players, technological developments, and emerging challenges. Subsequent pieces will delve deeper into each segment, assessing their technical architectures, economic models, and long-term viability.

As blockchain adoption expands beyond speculative trading into enterprise and institutional use cases, the efficiency and reliability of data infrastructure will play an increasingly pivotal role. This series aims to provide a structured framework for understanding how these systems operate today—and where they are headed next.

The Data Moment

In today’s digital age, data is often referred to as the new gold. It is easy to see why - data has become the foundation of decision-making, innovation, and economic growth. According to research from S&P Global, 90% of enterprise businesses reported that data is becoming increasingly important to their overall business. The global big data market size was valued at $327.3 billion in 2023, and it is projected to grow at a CAGR of 14.9%, to reach $862.3 billion by 2030.

Since 2022, the private equity industry has spent at least an estimated $170 billion acquiring or investing in over 450 data center companies. Looking at the breakdown by years below, we see that private deal activity for data centers grew exponentially in 2024, and blew past the $70 billion milestone.

As the value of data continues to grow, so does the increasing nexus between data and web3. The blockchain industry market size is estimated to reach $470 billion by 2030. With this growth comes greater demand for high-quality, fast and transparent data both on-chain and off-chain. The global, decentralized and composable nature of the blockchain technology combined with cryptographic incentives and zero-knowledge technology opens a new frontier for data generation, access and utilization.

According to Pitchbook data, Blockchain data infrastructure startups raised approximately $2.1 billion in H1 2024, a 40% increase YoY compared to H1 2023.

Key drivers for the increased investment volume include:

• Integration of AI with blockchain data (e.g., decentralized AI training datasets).

• Demand for institutional-grade compliance tools (e.g., FATF Travel Rule solutions).

• Growth of real-world asset (RWA) tokenization requiring reliable oracles and storage.

The blockchain data landscape has evolved into a complex ecosystem with distinct segments serving various stages of the data value chain. Our following framework of understanding the blockchain data stack aims to closely follow how data flows from its initial capture through processing, analysis, and ultimately monetization:

Anatomy of the Stack

1. Data Acquisition

Blockchain nodes and node operators are generally seen as the entry point of on-chain data extraction. However, the data acquisition we focus on here refers more to capturing both on-chain and off-chain (real-life) datasets, especially hard-to-access data. Traditionally, these data are scraped from online sources, through interactions with particular applications, which may be in the hands of large corporations such as social media platforms and banks. These data may often also be collected and shared without user consent.

Web3 improves data acquisition in two ways:

1. Incentivizing user-provided data. Token incentives and DePIN (Decentralized Physical Infrastructure Networks) enable users to share offline behaviors (e.g., habits, financial history), democratizing access.

2. Enhancing privacy. web3 technologies can give users greater control over their personal information. Through privacy-preserving technologies like zero-knowledge proofs (ZK-proofs) and multi-party computation (MPC), users are able to share specific insights without exposing raw data. This enables secure and trustless data sharing, addressing privacy concerns while still enabling data monetization. The examples mentioned below all tap on such technologies, to preserve user control and privacy over data access:

• Vana is a decentralized data marketplace that enables users to monetize their personal data while maintaining privacy. Its key differentiator is its focus on structured, user-owned datasets that can be directly integrated into AI models, making it a crucial bridge between web3 data economies and machine learning applications.

• Grass is similarly a web3 data acquisition network that collects browsing data. A web3-native data acquisition network that collects browsing data through a permissioned opt-in model. Unlike Vana, which focuses on structured datasets, Grass specializes in real-time, high-volume web traffic data, making it a valuable resource for AI models, ad-tech firms, and market intelligence platforms.

• ORO (@getoro_xyz) is a new data acquisition company that focuses on proprietary financial and health data. Its value-add lies in gaining access to proprietary data, to provide clients with new data sources and insights.

2. Data Storage

Data storage refers to the warehousing of acquired data. The current centralized model relies on large physical data centers, which can be costly and vulnerable to attacks since the risks are concentrated.

web3 mitigates these risks and concerns by offering a decentralized storage solution. web3 enables the rise of a distributed storage network, where data can be distributed across multiple nodes, improving redundancy and uptime. A distributed storage network mitigates single points of failure, enhances security, and reduces costs. By leveraging blockchain technology and peer-to-peer storage solutions, web3 platforms can create a more resilient and efficient data storage framework. It also promotes greater sustainability for the solution, as it will be easier to scale the network should there be increased demand, instead of having to put in place additional physical data centers.

Examples of web3 data storage projects include Arweave, Filecoin, and Storj:

• Arweave is a decentralized, permanent data storage network designed for long-term archiving. Unlike traditional cloud storage solutions, Arweave uses a “pay once, store forever” model, ensuring data remains accessible indefinitely without recurring costs. Its unique value lies in permanence and immutability, making it ideal for archiving important records and dApps.

• Filecoin is a decentralized storage marketplace that incentivizes users to rent out spare storage capacity. Unlike Arweave, which focuses on permanent storage, Filecoin operates more like a decentralized cloud storage system, allowing users to store and retrieve large datasets efficiently. Its competitive advantage is its scalable, cost-efficient marketplace that dynamically adjusts pricing based on supply and demand, making it suitable for enterprise-scale data storage.

• Storj is a decentralized cloud storage platform that distributes encrypted, sharded files across a global network of nodes, offering enterprise-grade security with end-to-end encryption, S3 compatibility, and pay-as-you-go pricing. Unlike Filecoin (auction-based long-term storage) or Arweave (permanent one-time payment), Storj focuses on fast, scalable storage for enterprises and Web3 apps, with no data egress fees and seamless AWS S3 integration. It aims to provide privacy-first, enterprise-ready decentralized storage focused on institutional clients.

3. Data Indexing and Querying

Data indexing and querying involve organizing and retrieving stored data. Many current systems rely on centralized providers. While a centralized approach gives the firm greater control over the entire process thereby ensuring greater stability and reliability in the data provided, the trade-off is that there will be some delays and requires high fixed costs. This is because the firm will have to sift through entire data catalog to obtain necessary information, leading to inefficiencies and latency issues.

With web3, data can be stored across multiple nodes, and this enables parallel querying, reducing retrieval times and computational demands. Additionally, decentralized indexing solutions can eliminate the need for intermediaries, allowing for more direct and transparent data access. This streamlines application development and fosters a more open data ecosystem.

Examples of web3 data indexing and querying protocols include The Graph, SonarX, SQD.AI and Space and Time:

• The Graph is a decentralized indexing protocol that enables efficient querying of blockchain data. Instead of relying on centralized APIs, The Graph allows developers to create and use subgraphs - specialized data feeds that make blockchain data easily searchable. It is a well-established solution that has gained widespread adoption across Ethereum and other chains, making it the backbone of data accessibility for web3 projects.

• SonarX is a blockchain data infrastructure platform that provides structured, indexed on-chain data from genesis to tip across 100+ chains. Designed for institutions, enterprises, and blockchain-based businesses, it consolidates fragmented data pipelines into a unified platform, delivering data via warehouses (Snowflake, Databricks, BigQuery), flat files (JSON, Parquet), Kafka streams, or direct S3 transfers. The platform supports historical analytics, real-time monitoring, reconciliation, staking rewards, transaction reporting, accounting, tax, and audit operations. SonarX is SOC II certified and GDPR compliant, meeting institutional security and regulatory standards. Its data quality framework, multi-chain coverage, and engineering expertise have made it the preferred provider for major enterprises, including FTSE/LSEG, AWS, and leading crypto analytics firms like Messari, Glassnode, and Kaiko.

• SQD.AI is a decentralized data lake and indexing protocol optimized for efficient querying and data access. It offers a toolkit that allow developers to create custom data pipelines, to obtain the necessary information at high speeds. It also supports local running and batch event processing, such that data requests can be broken down and processed in blocks if needed, making it cost-effective and scalable. Its unique composable approach opens up immense opportunities for decentralized projects and AI agents to leverage raw and structured on-chain data.

• Space and Time is a decentralized data indexing and querying solution. Its core value proposition lies in enabling verifiable and trustless query execution across both on-chain and off-chain data. It allows developers to run SQL-based analytics with cryptographic proofs, ensuring data integrity without relying on centralized databases.

4. Data Analytics

Data analytics transforms raw data into actionable intelligence. Today’s analytics tools primarily focus on off-chain data, often overlooking on-chain insights.

With web3, companies can gain access to on-chain data, to gain a deeper understanding of user behaviors, their social communities, and holistic financial transaction history and spending preferences. These insights can then be leveraged for risk assessment, trading strategies, and community engagement.

Many platforms are also now incorporating artificial intelligence to enhance predictive modeling and automate data-driven decision-making. This convergence of AI and web3 data analytics is unlocking new possibilities for forecasting trends and identifying opportunities.

Examples of web3 data analytics platforms include Nansen, Dune, and Chainalysis:

• Nansen is a blockchain analytics platform specializing in on-chain data intelligence and wallet tracking. Unlike general-purpose analytics tools, Nansen focuses on labeling and clustering blockchain addresses, allowing users to track fund movements, whale activity, and smart money trends.

• Dune is a community-driven data analytics platform that enables users to create and share SQL-based queries on blockchain data. Dune allows users to build their own custom dashboards and visualizations using raw blockchain data, enabling flexible blockchain data exploration.

• Chainalysis is a blockchain forensics and compliance platform focused on tracking illicit transactions and providing regulatory insights. Chainalysis serves law enforcement agencies, financial institutions, and governments by providing risk assessments and transaction monitoring tools. Its focus is on tracing suspicious activity across multiple chains, making it a crucial player in crypto compliance, anti-money laundering, and fraud detection.

5. Data Marketplaces

Data marketplaces enable businesses and individuals to monetize their data. Typically, buyers often struggle to discover datasets, negotiate access, and securely transfer data, creating friction in the data economy. In many cases, access to high-quality datasets is restricted to a few well-funded entities, limiting innovation and inclusivity.

With web3, datasets can be tokenized and listed on marketplaces to allow for easy discovery, seamless transactions, and secondary trading. It enables peer-to-peer data exchanges, creating more equitable access to information. The rise of data marketplaces also allows for users to monetize their personal data directly, shifting power away from centralized corporations and toward data owners themselves.

Examples of web3 data marketplaces include Ocean Protocol, Fetch.ai, and Datum:

• Ocean Protocol connects data providers and consumers through a decentralized marketplace. It helps to tokenize datasets into ERC-20 tokens, allowing data providers to monetize their data while maintaining control and privacy. Consumers can choose to purchase or rent these datasets, enabling secure and efficient data access.

• Fetch.ai is an AI-powered decentralized marketplace that facilitates autonomous data sharing and transactions using AI agents. Its infrastructure allows for the creation and deployment of AI agents that can interact with and process data across different platforms in real-time, allowing for autonomous workflows (including the discovery, acquisition and processing of datasets) without the need for direct human intervention.

• Datum is a blockchain-based marketplace focused on personal data monetization, allowing users to control and sell their own data directly to businesses and researchers. Datum prioritizes individual data sovereignty, and its key advantage lies in its privacy-centric model, where users retain ownership and earn rewards for sharing anonymized personal data.

The Future to Come

The blockchain data landscape is poised for significant evolution in the coming years, driven by a confluence of technological advancements, regulatory developments, and increasing institutional adoption. As blockchain technology matures, several key trends are emerging that will shape the future of data management, analysis, and monetization in this space.

1. The Rise of AI-Driven web3 Data Solutions

AI is becoming a key enabler in the web3 data space, enhancing data analysis, risk assessment, and automation. There are a few possible applications of AI-driven web3 solutions:

• Efficient request routing: web3 data indexing and querying solutions can use AI to more efficiently route queries across their nodes based on their typical response time and locations, allowing for faster and more accurate data retrieval. SQD.AI has already incorporated this in their data solutions.

• AI-powered smart contracts: decentralized data marketplaces can consider implementing such smart contracts to help automate the data monetization process, based on the demand and supply of specific datasets.

• Personalized insights: web3 data analytics platforms can integrate AI in their models, so that more personalized insights can be derived from the analysis, enabling more customizable and relevant data-driven applications to be created for users. Lens Protocol uses AI to analyze on-chain interactions and curate content feeds tailored to each user's interests and behaviors

2. Specialized Data Set Services

Specialized data set services are emerging as a critical component of the blockchain data landscape. They leverage blockchain's inherent properties like immutability, transparency, and security to improve compliance, reduce costs and enhance decision-making:

• Healthcare data management: companies like BurstIQ offer blockchain platforms that enable secure management of sensitive health information. Each smart contract gives users full data ownership, allowing them to decide how their data is used in personalized healthcare products, services, and marketplaces. This ensures privacy, security, and compliance with regulations like HIPAA.

• Financial services: blockchain data providers like Coin Metrics and Digital Asset Research offer specialized data sets for financial institutions. These include real-time market data, historical price data, and trading volumes, which are crucial for risk management, compliance, and market analysis.

• Supply chain and logistics: companies like Maersk and FedEx use blockchain for real-time visibility and data sharing across global logistics. Blockchain-based platforms ensure transparency, traceability, and reduce fraud by providing an immutable record of goods movement.

3. Cross-Chain Data Standardization

Blockchain data is still somewhat fragmented today. With the proliferation of decentralized data sources, standardization of data across chains is the key to interoperability.

• Data normalization: standardizing data formats across chains is essential for accurate analysis. This trend is already evident with companies like Covalent attempting to "standardize blockchain data under a single schema", though challenges remain with non-EVM chains requiring separate schemas.

• Data warehousing: aggregated data from multiple blockchains is often stored in a warehouse, where it's organized for query and analysis. SonarX is a blockchain data indexer with a data warehouse solution as well, enabling data to be ready for SQL-based analytics without additional processing.

4. Enhanced Privacy-Preserving Analytics

As regulatory scrutiny increases, technologies that enable analytics while preserving privacy will become more important for security and ethical considerations. The future of privacy-preserving blockchain data analytics will be shaped by a combination of advanced cryptographic techniques, regulatory compliance, user-centric controls, and innovative blockchain architectures:

• Privacy-focused blockchain architectures: layer 2 scaling solutions like sidechains or off-chain computation can enhance privacy by processing transactions or data off the main blockchain, reducing the visibility of sensitive information.

• View keys and selective disclosure: blockchain networks will increasingly support view keys or selective disclosure mechanisms, allowing users to control who can access their data. This empowers users to share information on a need-to-know basis, enhancing privacy.

• Confidential smart contracts: future smart contracts will incorporate privacy-preserving features, allowing for complex operations to be executed without revealing sensitive data. This could involve integrating ZKPs or homomorphic encryption into smart contract logic.

• Cross-chain privacy solutions: as blockchain interoperability becomes more important, privacy solutions that work across multiple blockchain networks will become increasingly valuable. This could involve standardized privacy protocols or cross-chain privacy oracles.

• Decentralized data marketplaces: these platforms will evolve to offer privacy-enhanced data trading, where data providers can monetize their information while ensuring that buyers receive only the insights they need without accessing raw data.

Stay Tuned

The convergence of Web3 and data represents one of the most dynamic frontiers in technology, driving unprecedented innovation across decentralized infrastructure, AI-powered analytics, and trustless data economies. Ocular is actively mapping this rapidly evolving landscape, engaging with the visionaries and builders who are redefining how data is owned, verified, and leveraged in an on-chain future.

In the next installments of this series, we’ll take a closer look at the key verticals and companies shaping decentralized data.

Stay tuned.

About Ocular:

Ocular is a Singapore-based web3 fund managed by Openspace Ventures. Ocular focuses on early stage token/equity investments globally. For more information please refer to www.ocular.vc.

Follow X @ocularvc

When people think of intelligence nowadays, the first thing that comes to mind is probably LLM models, i.e. GPT, Claude, Llama etc.

But actually, the market itself may be the best form of general intelligence, as it is essentially the synthesis of all actions. AI itself is trained on huge amounts of information generated by the masses. That said, AI is passive, it needs goals and instructions (at least before we reach a true agentic world). To better harness and express market intelligence, we need something that captures the ever evolving minds of the crowd, something that is forward looking.

Enter prediction markets. A prediction market is a platform where participants can buy and sell contracts based on their belief about the potential outcomes of future events. These events can range from politics (e.g. election outcomes) and economics (e.g. interest rate changes), to entertainment and sports (e.g. competition outcomes).

(Source: ocularvc)

This concept is not new - early forms of prediction markets were believed to have existed more than 500 years ago, primarily for forecasting political outcomes.

In the early 2000s, prediction markets like Intrade and Betfair started to gain prominence, particularly during the US presidential elections. However, these were centralized platforms that were often limited by geographical restrictions, regulatory constraints, and the need for trusted intermediaries to manage funds and settle bets. This affected their ability to grow and scale.

• For example, Intrade was forced to shut down in 2013. The US Commodity Trade Futures Commission had sued Intrade to stop Americans from using the site, saying that it was illegally selling futures contracts, and this led to a sharp drop in the number of users.

In the late 2010s, with the rise of blockchain technology, prediction markets resurfaced stronger than before. This time, platforms leverage blockchain to create decentralized and global platforms that offer several advantages over past centralized variants:

However, prediction markets were never mainstream. Not until this year. Thanks to the 2024 US Presidential Elections, there is renewed interest and attention on this new form of market intelligence. In this piece, we will deep-dive into the mechanics of web3 prediction markets, specifically covering 1) the use cases and current landscape of prediction markets; 2) a case study on Polymarket; and 3) future trends.

1) Use Cases and Current Landscape

Besides offering users an opportunity to profit from their views/predictions of the future, there are other use cases of prediction markets, as outlined below:

DeFiLlama estimates that the current total value locked (TVL) in web3 prediction markets is around $140 million. This is down from the pre-election highs, where the TVL was at $545 million.

In Oct 2024, the combined monthly revenue of all prediction markets was estimated to be around $750,000, or about $9 million on an annualised basis.

The key players in the space are Polymarket, Azuro; and Drift (BET). Across these three players, the total betting volume has risen by over 550% in Q3 2024 to reach $3.1 billion, up from just $463.3 million in Q2 2024 (see image below).

(Source: CoinGecko and ocularvc)

In Nov 2024, there were about 290,000 monthly active traders on Polymarket alone, and over 300,000 new accounts were created on the platform. Based on the all-time leaderboard for Polymarket, the most active trader on Polymarket has generated $397 million in transaction volume, and the most profitable trader has earned over $22 million.

2a) Polymarket - A Case Study

So how do prediction markets work? This can be broken down into three sub-categories, namely its features; charging model; and dispute resolution process. As Polymarket is the dominant player currently, we will make reference to their operating model.

Features

• Markets - Typically tied to real-world events. Polymarket features a wide range of markets, from politics and crypto to pop culture and weather outcomes, while others may choose to focus on a particular niche, such as sports betting.

• Outcomes - It can be:

  • Binary, e.g. “yes” or “no” to whether an event will occur;

  • Multi-outcome, e.g. predicting which candidate will win a multi-candidate race or which team will win a tournament; or

  • Continuous, i.e. predicting outcomes across a range of values (e.g. stock prices or percentage of votes).

    • Polymarket features mostly binary outcomes. There are some multi-outcome markets, but for each option (e.g. candidate), it will be a binary trade (see example below). There is a probability/price indicated for each side of the trade, and after the event happens, a share of the correct outcome can be redeemed for $1, while a share of wrong outcomes will be worth $0.

      

      (Source: Polymarket)

• Odds - There are two main ways that the prices/odds for the markets are decided:

  • One, through an order-book based system, similar to stock markets. Participants submit buy and sell orders; prices are determined by matching these orders.

  • Two, through an Automated Market Maker (AMM)-based system. In this system, every bid and ask is accepted. The price is determined and adjusted automatically based on an algorithm/mathematical formula that tracks the trading volumes.

    • Polymarket uses primarily an order-book based system.

    • When a market is created, there are initially zero shares and no pre-defined prices or odds. Those interested in buying “Yes” or “No” shares can place limit orders at the price they're willing to pay.

    • When offers for the “Yes” and “No” side equal $1.00, the order is "matched" and that $1.00 is converted into 1 “Yes” and 1 “No” share, each going to their respective buyers.

    • For example, if you place a limit order at $0.60 for “Yes”, that order is matched when someone places a “No” order at $0.40. This becomes the initial market price.

    • Subsequently, the prices displayed on Polymarket are the midpoint of the bid-ask spread in the order book — unless that spread is over $0.10, in which case the last traded price is used.

    • As seen with the market below, the probability/price of 37% is the midpoint between the 34¢ bid and 40¢ ask. If the bid-ask spread is wider than 10¢, the probability/price is shown as the last traded price.

      

      (Source: Polymarket)

• Payment - Polymarket runs on the Polygon blockchain and users use USDC to place their orders. Polymarket also recently collaborated with MoonPay to allows users to use fiat to purchase USDC.

• Orders - Polymarket offers market, limit and AMM orders. However, at this juncture, there is no leverage option. After you place an order, Polymarket allows users to trade the shares they own before the event described by the market actually transpires.

  • With reference to the example above, let’s say that we purchased “Yes” shares for Ethereum hitting $3,000 when the odds were at 37%. If the odds increased after we placed our bet, we could decide to sell our shares for a higher price and lock in profits before the actual event happens/deadline hits. Of course, there is also the option of selling the shares at a loss if the odds decreased after we made our bet.

Fees

There are two main fees that decentralized prediction markets can charge:

• Trading fees, i.e. the platform charges a small fee each time a trade is executed.

• Deposit/withdrawal fees, i.e. a small fee is charged each time fiat/cryptocurrency enters or leaves the platform.

Polymarket currently does not charge any trading fees. However, they do take a 2% fee on net earnings from winning bets. Polymarket doesn’t take home any of this fee as revenue; instead, it is used to reward liquidity providers (as part of their Liquidity Rewards Program), and to pay for gas fees. Polymarket also does not charge any deposit/withdrawal fees.

• When asked about its pricing strategy, Polymarket’s Founder Shayne Coplan said in Jul 2024 that “We're focused on growing the marketplace right now and providing the best user experience. We'll focus on monetization later.”

Disputes

To resolve markets after the event is over, platforms typically rely on a mix of 1) oracles; and 2) community voting.

• In Polymarket’s case, they rely on both strategies through Universal Market Access (UMA)’s Optimistic Oracle and Data Verification Mechanism (DVM). A simplified chart to illustrate the market resolution process can be found below:

  

  (Source: Polymarket and ocularvc)

  • On the four possible outcomes that can take place after the debate period, these are the implications of the outcomes:

    • Proposer wins - in this case the proposer receives their $750 bond back plus half the disputer’s bond as a bounty. This is to prevent people from merely challenging proposals for fun.

    • Disputer wins – in this case, the reverse occurs, where the disputer receives their $750 bond back plus half the proposer’s bond as a bounty.

    • Too early to tell – in this case, proposer will get punished for resolving the markets too early. So the disputer receives their $750 bond back plus half the proposer’s bond as a bounty.

    • 50-50 – if any of the first 3 options are not appropriate, then the market price may resolve to a split, where it is 50% yes; 50% no. In this case, the proposer is punished for resolving the markets inaccurately. So the disputer receives their $750 bond back plus half the proposer’s bond as a bounty.

2b) Risks and Limitations

Thus far, there are varying views on the effectiveness of Polymarket, and prediction markets as a whole, as a source of market intelligence. We have outlined these different views below.

(Source: ocularvc)

Ocular’s view is that there needs to be three conditions in place for prediction markets to be used as a source of intelligence:

• One, prediction markets work best when the three factors of incentive, ability and timing are aligned.

  • On incentive: The individuals that you are polling will need to have a vested interest in an issue. This could be because it affects their daily lives; their other investments; or it’s a trending topic on social media that they would like to be a part of. Point is they need to feel engaged/involved in this issue for them to participate in the markets.

  • On ability: The public will need to have the required information to formulate their views. It can’t be too niche a topic or a topic that requires deep technical expertise, because in this case, the public may not be any wiser and it is hard for the results to be credible.

  • On timing: While the markets can be launched instantaneously, you need time to collect the public’s views and for the markets to react to new information. So, this will not work for time-sensitive decisions.

• Two, there needs to be sufficient liquidity. Ultimately, prediction markets works best when they are truly able to tap on the wisdom of the crowd. What this means is that the markets need to be at a certain scale, both in terms of the number of relevant individuals involved as well as the betting volume, for it to make sense and be useful.

• Three, it should not be used in isolation. Oftentimes, prediction markets will be driven by what is publicly available, e.g. what is mentioned in the news or on social media. There may be others who have private sources of data that may not be fully reflected in the trades, so it may be useful to seek them out to get a different perspective.

3) Future Trends

We see a trend of the extension of use cases of prediction markets:

Prediction markets can potentially be applied to decision markets. Instead of what “will” the outcome be, users vote on what “should” the outcome be. Prediction markets, while providing valuable insight, is more passive. People vote and wait for the outcome to be revealed, often having little influence over it. Decision markets on the other hand, are more active and more applicable for governance.

Case study: MetaDAO ($META)

MetaDAO is a project founded in January 2023 and invested by Colosseum and Paradigm. Its core product is Futarchy, where governance proposals are put forward for votes, and 2 conditional trading markets are concurrently spun up:

• When the market thinks that the proposal would increase the value of the token above a certain threshold, they can bid up the “Pass” token. Conversely, they bid up the “Fail” token.

• When voting ends, if the TWAP price of the Pass token is 3% higher than the Fail token, the proposal passes and will be implemented. Conversely, the proposal fails and markets will be reverted.

  • For example, the proposal can be on hiring a new CEO for the company. If the decision markets indicate that the value of the company’s stock will increase significantly if the CEO is hired, then the proposal will pass and the CEO will be hired.

  • The broad idea of the futarchy is illustrated below, and the specifics can be found here.

    

    (Source: MetaDAO)

Futarchy was introduced in 2000 by economics Robin Hanson. He proposed it as a governance model combining prediction markets with traditional voting systems. In the Futarchy governance model, decisions are made based on predictions from decentralized markets. Instead of voting directly on policies, participants vote on measurable goals, such as economic growth. Prediction markets then forecast how proposed policies might affect those goals. The policy expected to achieve the best outcome, as determined by the market, is implemented. This approach leverages collective intelligence and financial incentives to guide decision-making.

Futarchy is better than Polymarket's binary betting model for scenarios where:

1. Decision-making is the goal, not just prediction.

2. Complex, long-term impacts must be considered.

3. Incentive structures need to align with societal or organizational objectives.

MetaDAO is currently working with six projects on decision-making, in addition to its own DAO governance. It has shown some early signs of success in decision-making, from preventing whales from purchasing $META at a deep discount, to directing firm resources away from new initiatives that the holders deem as distractions.

(Source: MetaDAO)

However, it is still early days for MetaDAO. There are several key constraints to MetaDAO’s model and it is to be seen whether this can work at scale:

• Oracle - Not every project has a token, and not every decision outcome can be measured precisely with metrics. It may also be difficult to tell impact on metrics by a relatively small decision.

• Liquidity - Concentration of users and wallets can lead to biased outcome. The UX may also be too technical for the broader population to get onboard with, and this may limit the pool of voters.

• Suitability - People in powerful positions may not want to transition decision making to markets. Participants also have to be an informed crowd. How do we ensure that users vote based on the long-term interests of the firm?

Other than MetaDAO, there are constant developments and innovation in prediction and decision markets:

• New markets - This year, there has been a lot of hype and chatter about prediction markets since it coincided with the Olympics and US Presidential Elections. The challenge for the sector will be to sustain interest in prediction markets, even after these cyclical events are over. Platforms can consider expanding beyond seasonal/one-off events, and explore different consumer base and categories, such as pop culture and social media, targeting female and youth participants.

• Advanced oracles - To establish new markets, new oracles may have to be built to scrape and fetch the relevant data to price new markets. Overlay is one such project that is looking to build oracles for unique markets, such as Counter-Strike skins and an AI index.

• Efficient arbitrage - Many of the platforms use an order-book based system (i.e buy and sell orders placed by users) to price their markets. As user behaviour and overall liquidity may vary across markets and platforms, there exists arbitrage opportunities both within and across platforms.

  • An example can be seen below with the odds for the US Presidential Election on Polymarket and Kalshi as of 28 Oct. A user could potentially purchase a contract for Kamala winning on Polymarket (at 33%) and a contract for Trump winning on Kalshi (at 62%), for a total cost of 95c. Given that the two events are mutually exclusive, the user will receive a payout of $1 regardless of the outcome, yielding a 5% arbitrage opportunity.

    

    (Source: Polymarket)

    

    (Source: Kalshi)

  • To efficiently capitalise on these arbitrage opportunities, platforms may wish to:

    • Ensure that there are no duplicate or similarly worded listings on the platform;

    • Factor in the odds found on other platforms in their own pricing models; and/or

    • Build a trading bot to capitalise on such opportunities and minimise the spread across platforms.

• Capital efficiency - Today, to execute a trade on most platforms, users will need to have the capital on hand and once the trade is executed, the capital will be locked in on the platform. To promote greater capital efficiency, platforms can consider:

  • Introducing leveraged products so that users will be able to make outsized bets;

  • Allowing for the use of yield-bearing stablecoins/tokens to execute trades;

  • Tokenising the user’s position and allowing that token to be traded on other platforms; and/or

  • Designing a lending protocol that allow users to borrow against their positions.

• Anti-manipulation - To address price manipulation, platforms could consider setting a bet limit or restricting the number of accounts that an individual can open. Using cross examination can also be effective in small markets with thin liquidity: for example, asking “what you believe and what you think others believe”, and comparing the results.

• AI participation - To enable the resolution process, particularly for straightforward markets, to be done more efficiently, platforms can consider tapping on AI/large language models to obtain and verify the necessary information to resolve the markets. AI agents can also be trained to more efficiently research on truth and participate in future voting.

Conclusion

Ocular is keeping a close watch on the prediction market sector and its developments.

Today, prediction markets are used to generate income; hedge positions; engage communities; and gauge market sentiments. Moving forward, it can be used for collective decision-making/governance and many more interesting areas:

• Predicting the replicability of scientific papers;

• Aggregating private information (within corporations);

• Predicting the success of drug trials;

• Getting estimates on subjective matters (product pre-launch testing); and

• Reinventing news media – reporters and analysts to have skin in the game.

While there are existing inefficiencies/constraints with the sector that needs to be addressed (e.g. inconsistent liquidity; regulatory uncertainty; and oracle issues), we remain optimistic about the sector in the long-term, especially with the overlaps with AI.

We look forward to connecting with those building in the space and/or have views on how this sector will continue to evolve - if this resonates with you, do feel free to reach out to us at crypto@ocular.vc.

In 2009, an anonymous entity known as Satoshi Nakamoto introduced Bitcoin, the world’s first decentralised cryptocurrency. It enabled peer-to-peer currency transfers without an intermediary, such as a bank. 

Due to its early origins, anonymous founding team, a vast network of miners, and absence of traditional fundraising, Bitcoin has become the most decentralised cryptocurrency. It is extremely difficult for a malicious actor to rewrite transactions on the Bitcoin network, as no single person controls it. Even if collusion occurs among multiple individuals, orchestrating an attack to compromise the network's accuracy is challenging due to its decentralisation. To understand how decentralised Bitcoin is, consider the Nakamoto coefficient, which represents decentralisation with a number. The coefficient represents the number of parties/node operators that, together, control more than a third of the entire network. Bitcoin’s Nakamoto coefficient is estimated to be around 7000. The second most decentralised network as per the Nakamoto coefficient at the time of writing is the Mina protocol at 151. Other notable names include Solana at 18 and BNB at 7. Bitcoin is unique because it is especially decentralised. 

Apart from decentralisation, Bitcoin is also special due to its fundamental characteristics. There is a limited supply of  21 million bitcoins/BTC, which makes it an attractive hedge against inflation and economic instability. This is why Bitcoin is often called “digital gold”. 

In summary, Bitcoin is:

1. Functionally simple – it enables peer-to-peer currency transfers

2. Decentralised – it is far ahead of every other cryptocurrency 

3. Secure – it remained immune to attacks and has been secure for over 15 years

These factors have led Bitcoin to receive the highest level of regulatory clarity. It has been classified as a commodity, which signals that institutions recognise its decentralised nature. It also had its ETFs approved in Jan 2024, which integrates Bitcoin into traditional financial markets. 

Here’s the base case: Bitcoin has established a baseline level of credibility, which continues to grow. If we can build applications on top of Bitcoin, they will benefit from second-order effects. 

However, this is easier said than done. Bitcoin was not originally intended to be a base layer for other applications. 

Firstly, transactions on Bitcoin are expensive and slow 

If I send 5 BTC to you, the transaction must be recorded on the Bitcoin network. More precisely, this transaction must be (1) included on the ledger and (2) the updated ledger must be distributed across thousands of computers. Including a transaction on a ledger entails numerous miners competing to solve cryptographic puzzles to validate and confirm transactions – it is resource-intensive and expensive. Ensuring the ledger is distributed also slows down how many transactions we can process per second. Computers run by the average person do not have unlimited storage capacities. Here we observe Bitcoin’s focus on decentralisation which leads to trade-offs in cost and speed. 

Secondly, Bitcoin is unfriendly towards smart contracts 

Assume that we want to do more complicated things beyond peer-to-peer money transfers. For example: we want to program a vending machine on top of the Bitcoin network. Depending on the value entered, the vending machine outputs a product, and the number of products left in the vending machine is continually tracked by the Bitcoin network. This vending machine is analogous to a smart contract: a set of processes that executes automatically based on a set of rules, given a certain trigger. 

Bitcoin does not directly support smart contracts, and this limitation arises from two intentional design choices.

1. Bitcoin employs a restricted, stack-based scripting language that is purposefully non-Turing complete, which lacks advanced features like loops and complex conditionals. In other words, it is difficult to code complex logic on Bitcoin. Only simple operations like digital signatures, time locks, etc. are supported. 

2. Bitcoin uses an Unspent Transaction Output (UTXO) model to track state – i.e., the current status of all information stored on the blockchain – which is efficient for tracking wallet balances but poor for tracking states for other kinds of transactions. 

These architectural decisions prioritise security and predictability at the cost of programmability. Hence, while Bitcoin excels at secure value transfer, it is very unfriendly towards supporting complex, state-dependent logic necessary for smart contract applications. Networks like Ethereum came later on as a solution to these limitations. 

Early attempts at overcoming these limitations

Segwit, Lightning Network, and Taproot 

The first major upgrade to Bitcoin was called Segwit, released in 2017. It allowed for Bitcoin transactions to occur more quickly. It also allowed for the modification of transaction IDs before confirmation on the blockchain. This allowed for the safe batching up of multiple transactions. Ultimately, multiple transactions that occurred off the blockchain could be condensed into 1 transaction that would then be stored on-chain. 

This brought about the first Bitcoin Layer 2 (L2), the Lightning Network, launched in 2018. An L2 is a protocol that settles on the underlying L1 (in this case, Bitcoin is the L1). 

Here’s a simplified illustration of what occurs in the Lightning Network: if I send 10 BTC to you, and you send 5 BTC back to me, there are usually 2 transaction entries. The Lightning Network creates a new mini-database, or ledger, between the two transacting parties. It settles the net result after a period (e.g., person A sent 5 BTC to person B), reducing the number of transaction entries on the main ledger from 2 to 1. The Lightning Network batches multiple transactions into one and records that single transaction on the Bitcoin blockchain. While there are trade-offs in decentralisation, the Lightning Network offers significant flexibility. For small transactions, users benefit from its speed and much lower transaction costs. Bitcoin’s transaction fees are about $1, while the Lightning Network's cost per transaction is $0.001.

The Lightning Network enables speed but not programmability or other fascinating use cases. With Lightning, I still cannot, say, send a stablecoin to you and have that transaction be secured by the Bitcoin network, much less program a smart contract on top of Bitcoin. 

The taproot upgrade, activated in 2021, laid the groundwork for programming smart contracts on Bitcoin. Essentially, it relaxed the limitations of the amount of arbitrary data that could be placed inside a Bitcoin transaction. 

Enter Ordinals 

Thanks to Taproot, users could now inscribe data directly onto individual satoshis (100mn satoshis equals 1 bitcoin). More precisely, a satoshi could (1) be assigned a specific number for future reference and (2) be inscribed with data such as text, images, or complex files. This process effectively transforms a fungible satoshi into a non-fungible one, creating what is commonly known as a non-fungible token (NFT). 

Ordinals have elicited mixed opinions. On one hand, Bitcoin ordinals can be considered superior to NFTs stored on other blockchains. Here’s why: when an NFT is stored on the Bitcoin network via inscription, the actual data – image, video, etc. – is stored on the blockchain. In contrast, non-ordinal NFTs generally store metadata/URL pointers on the blockchain as opposed to the actual data. So ordinals are less vulnerable to censorship, link rot, and data loss. 

On the other hand, many in the Bitcoin community believe that forcing Bitcoin nodes to download and store images is a waste of resources. Below is a famous ordinal collection, the Taproot Wizards collection. 

Some NFTs from the Taproot Wizards collection

And indeed, compared to a few months ago, ordinals are attracting less attention at the moment. From the graph below, we can see that fewer resources are being expended on creating ordinals and fewer ordinals are being created overall. 

Less effort towards the creation of Bitcoin ordinals over time (Source: Dune Analytics)

Concerns around ordinals deserving block space on the Bitcoin network are key drivers of this slow-down, but it is also worth zooming out and noting that this is not an ordinal-only phenomenon. Interest in NFTs has likely declined due to market oversaturation. 

The drop in hype is not Bitcoin-ordinal specific – it is downtime for NFTs across the space (Source: The Block)

A repeated theme throughout this piece thus far is Bitcoin’s emphasis on security and decentralisation which makes it less scalable. This is why ordinals are being critiqued – many believe that images are not worth additional congestion on the Bitcoin network. This brings us to Bitcoin L2s. 

Enter Layer 2s (L2s) 

Understanding L2s 

It’s worth gaining a general understanding of L2s before getting Bitcoin-specific. L2s can be confusing because different people have different definitions. In this piece, we will generalise L2s to consist of 2 main types: sidechains and rollups. At Ocular, we consider rollups to be true representations of L2s. 

Sidechains 

Sidechains are separate blockchains that do not settle their transactions on the main chain. In other words, not every transaction on the L2 can be verified directly on the L1. 

The Liquid Network is a good example of a Bitcoin sidechain. You can move BTC from the Bitcoin Network to the Liquid Network via a process called bridging. This entails BTC being sent to an address managed by a federation of “watchmen” – a pool of about 65 trusted members chosen by the community of exchanges, financial institutions, and bitcoin-focused companies. Then for every BTC transferred to this watchmen-managed address, the user receives a synthetic BTC called LBTC. It is a 2-way peg. 

As you can tell, the security of the Liquid Network depends on these watchmen and their consistent credibility; the Liquid Network is not inheriting security from the Bitcoin L1. If a majority of the watchmen collude or are compromised, the security of the sidechain can be jeopardised. The main benefit of the Liquid Network is that it helps parties that require fast and private transactions without fully leaving the Bitcoin environment – transaction speeds are faster, and you also can transact stablecoins and other tokens along with LBTC on the network.  

Rollups

We consider rollups as true L2s because every transaction is backed by a proof submitted to the L1; this proof may be verified directly on the L1. In rollups, a certain number of transactions gets rolled up into 1 transaction. This transaction is then submitted along with a validity proof to  the L1. The validity proof says: “Hey, I’ve checked these transactions and I can confirm they follow all the rules. You can check me and have cumulative certainty. You don’t need to check each one individually!”.

Illustrating the link from L1 to L2 (Source: Limitless Insights) 

Every transaction is secured by a proof that can be checked, so rollups inherit a high degree of security from the Bitcoin blockchain, and we can consider them to be genuine L2s. Rollups helping make Bitcoin more programmable include MerlinChain, BOB, BEVM, Bitlayer, and Botanix. 

Other approaches 

Stacks illustrates a non-rollup, non-sidechain approach that still inherits some degree of security from the Bitcoin L1.

How Stacks is intertwined with Bitcoin: Stackers receive BTC, Bitcoin miners receive STX, making these 2 blockchains intertwined (Source: Stacks Documentation)

Stacks is essentially a separate blockchain that calls on Bitcoin miners to validate its blocks in exchange for a reward. However, Stacks does not publish any proof or hash on the Bitcoin blockchain, so it is not tied to Bitcoin as directly as a rollup.

Other exciting attempts at programming on top of Bitcoin 

B² Network 

The B² Network is a good example of a genuine L2 which we can use to explore rollups in further detail. Transactions on B² are batched up and a verifiable proof stating that this batch is correct is generated. This  proof is then recorded on the L1 Bitcoin blockchain. 

The proofs employed by B² are called zero-knowledge (zk) proofs, and they are oftentimes considered the best implementation of proofs because they can allow for on-chain verification of the validity of the batch without revealing its contents. Simply put, zk proofs ensure privacy. The B² Network is also EVM-compatible, meaning that code written for Ethereum can run the same applications on B². This makes B² appealing to current developers. 

L2s like B² expand the Bitcoin ecosystem by enabling the development of user-facing platforms, such as Master Protocol. 

Master Protocol 

Master Protocol is a financial platform within the Bitcoin ecosystem, designed to facilitate interest rate swaps and yield farming for Liquid Staking Tokens (LSTs) and other yield-generating assets. 

Master Protocol improves liquidity in the Bitcoin ecosystem in several key ways:

1. Asset Aggregation: Asset Aggregation: Master Protocol functions as a user and asset aggregator, deeply integrated into the Bitcoin ecosystem. It consolidates various LSTs and yield-generating assets from different protocols and L2 solutions, creating a centralised hub for liquidity.

2. Yield Market Platform: Yield Market Platform: The Master Yield Market, a core product of Master Protocol, packages Bitcoin ecosystem assets into Master Yield Tokens (MSY), which are then split into Master Principal Tokens (MPT) and Master Yield Tokens (MYT). This allows users to trade these tokens, effectively creating a market for yield and improving overall liquidity.

3. Simplified Access: By aggregating multiple assets and protocols, Master Protocol simplifies interactions for users within the Bitcoin ecosystem. Users can access earning opportunities from various protocols without the need to constantly switch between them, thereby increasing engagement and liquidity across the ecosystem.

4. Liquid Staking and Restaking: Master Protocol allows users to stake Bitcoin on various Layer 2 networks and receive LSTs as staking certificates. These LSTs can be reinvested or further staked to earn Liquid Restake Tokens (LRTs), enhancing investment capabilities and asset liquidity without affecting the original stake.

5. Interest Rate Swaps: As an interest rate swap market, Master Protocol facilitates the trading of yield-bearing assets, which can help in managing liquidity risks and optimising capital efficiency.

6. Ecosystem Synergy: By serving as a one-stop Bitcoin ecosystem yield trading centre, Master Protocol not only improves its adoption but also directs traffic and users to multiple Bitcoin ecosystem protocols, fostering overall ecosystem liquidity.

7. Addressing Fragmentation: Master Protocol helps address the fragmentation caused by the growth of Bitcoin Layer 2 solutions, improving composability and operability within the Bitcoin ecosystem. This integration of various DeFi protocols and second-layer solutions enhances overall liquidity flow.

Master Protocol acts as a central hub connecting Bitcoin enthusiasts with various applications, supporting new app development, and enhancing the overall utility of Bitcoin's infrastructure. Additionally, it addresses the fragmentation caused by the growth of Bitcoin L2 solutions by improving composability and operability.

Babylon 

Babylon is an innovative project within the Bitcoin ecosystem designed to extend Bitcoin's unmatched security to various Proof-of-Stake (PoS) chains, especially those in the Cosmos network.

By leveraging Bitcoin's robust Proof-of-Work (PoW) consensus mechanism, Babylon enhances the security of PoS chains through a process known as "restaking." This involves locking Bitcoin on its network and using it to secure other PoS chains, thereby providing economic security and enabling Bitcoin holders to earn staking rewards. The protocol uses advanced cryptographic techniques and consensus innovations to facilitate this process without the need for complex smart contracts.

Babylon's architecture is built on the Cosmos SDK and is compatible with Inter-Blockchain Communication (IBC), allowing seamless data aggregation and communication between the Bitcoin chain and other Cosmos application chains. By integrating Bitcoin's security features with the flexibility of PoS networks, Babylon Protocol is poised to play a crucial role in the future of the Bitcoin ecosystem, fostering a more secure, scalable, and interconnected blockchain landscape. 

Next frontiers of Bitcoin programmability and areas we are watching

The Ocular team continues to intently follow the applications being built on Bitcoin and has identified the following areas to watch as innovation unfolds:

1. More L2 Solutions: Improved L2s are needed to improve transaction speeds and reduce costs while maintaining Bitcoin's security.

2. Smart Contract Platforms (remorachains): Initiatives like RSK (Rootstock) that enable Ethereum-like smart contract functionality on Bitcoin are becoming increasingly relevant. These platforms allow for the development of dApps and DeFi services on Bitcoin.

3. Cross-Chain Compatibility: Platforms that allow applications from other blockchains (e.g., Solana) to operate on Bitcoin, represent an exciting investment opportunity in the realm of blockchain interoperability.

4. DeFi on Bitcoin: As programmability increases, there's growing potential for a robust DeFi ecosystem on Bitcoin. Projects focusing on lending, borrowing, decentralised exchanges, and stablecoins built natively on Bitcoin could be interesting investment areas.

5. Bitcoin-Native Application Platforms: These platforms aim to enhance Bitcoin's programmability while maintaining its core principles of security and decentralisation.

6. ZK-Proof Technology: Projects implementing zero-knowledge proofs for Bitcoin could offer enhanced privacy and scalability features, making them attractive investment prospects.

7. Custody Solutions: As programmability increases, there will be a growing need for secure custody solutions that cater to Bitcoin's expanding functionality while maintaining the "not your keys, not your coins" ethos.

8. Developer Tools and Infrastructure: With the increasing focus on Bitcoin programmability, there's likely to be a surge in demand for developer tools, SDKs, and infrastructure to support this new wave of Bitcoin-based applications.

Conclusion

These areas represent the frontier of Bitcoin's evolution from a simple store of value to a more versatile and programmable platform. As the ecosystem develops, it's likely to attract more developers, users, and investors, potentially driving the next phase of growth in the Bitcoin and broader crypto market. As always, feel free to reach out to us at crypto@ocular.vc if you are building in the space. 

References:

1. NakaFlow. (n.d.). NakaFlow. Retrieved August 15, 2024, from https://nakaflow.io/

2. Komodo Platform. (n.d.). Bitcoin Script explained: Unlocking the power of Bitcoin's smart contracts. Komodo Platform Academy. Retrieved August 15, 2024, from https://komodoplatform.com/en/academy/bitcoin-script/

3. Transak. (2023, April 19). What are Bitcoin ordinals? Guide to create Bitcoin NFT. Transak Blog. Retrieved August 15, 2024, from https://transak.com/blog/what-are-bitcoin-ordinals-guide-to-create-bitcoin-nft

4. Reddit user. (2023, February 14). Speculation about the BTC Taproot Wizards NFT. Reddit. Retrieved August 15, 2024, from https://www.reddit.com/r/btc/comments/10wk9h1/speculation_about_the_btc_taproot_wizards_nft

5. Taproot Wizards. (n.d.). Taproot Wizards. Retrieved August 15, 2024, from https://taprootwizards.com/

6. DGTL Assets. (n.d.). Bitcoin ordinals analysis. Dune. Retrieved August 15, 2024, from https://dune.com/dgtl_assets/bitcoin-ordinals-analysis

7. The Block. (n.d.). NFT trade volume by chain. The Block. Retrieved August 15, 2024, from https://www.theblock.co/data/nft-non-fungible-tokens/nft-overview/nft-trade-volume-by-chain

8. Nervos. (n.d.). The ultimate guide to Bitcoin Layer 2: Part 1. Nervos Knowledge Base. Retrieved August 15, 2024, from https://www.nervos.org/knowledge-base/ultimate_guide_bitcoin_layer_two_part_1

9. XY Finance. (2023, April 11). Bitcoin Layer 2: A detailed introduction. XY Finance Blog. Retrieved August 15, 2024, from https://blog.xy.finance/bitcoin-layer-2-detailed-introduction/#:~:text=In%20summary%2C%20the%20benefits%20of,of%20sophisticated%20smart%20contract%20functionalities

10. Limitless Insights. (2023, March 10). Ethereum Layer 2s: ZK-Rollups vs. Optimistic Rollups. Medium. Retrieved August 15, 2024, from https://limitlessinsights.medium.com/ethereum-layer-2s-zk-rollups-vs-optimistic-rollups-82e0f4d3ffee

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Summary

• The current ZK landscape can be broadly classified based on two main criteria. The first criterion is whether it functions as an application or as infrastructure, and the second is whether it prioritizes privacy or focuses on better utility and scalability.

• Among them, ZK-applications (ZKApps) are applications that leverage zero-knowledge proofs to enhance privacy and utility. ZKApps can benefit our lives especially in areas like credentials, payments, and even biomedical engineering.

• Investing trends and on-chain data suggest a growing recognition of the burgeoning demand for Zero-Knowledge Proof (ZKP) usage, indicating that the retail side has begun to embrace relevant applications.

• ZKApps have become more practical and feasible thanks to technical advancements in cryptographic proof systems and decentralized proving infrastructures. These developments have lowered the barriers of ZKP generation and verification processes, enabling more people to use ZKApps.

1. Introduction

Why should we pay attention on ZKApps now?

The hype around Zero-Knowledge (ZK) technology in the Blockchain and Web3 industry has continued for several years and persists into the second half of 2024. As Vitalik Buterin stated, “While further infrastructure development and prover optimization will be needed, ZK will be the clear endgame within 10 years”, ZK is undoubtedly regarded by industry insiders as a promising technology for solving the blockchain trilemma, which involves balancing Security, Scalability, and Decentralization without sacrificing any one of them. 

Riding this wave of hype, many investors, irrespective of their technical expertise, have likely heard about terms such as SNARKs, STARKs, and KZG, which are technologically complex field and are being researched and developed particularly within the Ethereum community. However, from the consumer’s perspective, one fundamental question inevitably arises: “I understand that ZK is a impressive technology, but when can we actually use a cool product that leverages it? And is the technology mature enough to replace existing non-Web3 solutions?”.  

Even a few years ago, the answer to this question would have been, “Not yet, and we don’t know”. As Vitalik mentioned, the infrastructure and cryptographic proof technologies needed to practically run ZK-based applications (ZKApps) on the client-side were still lacking, making its development challenging. However, as of 2024, although there is still much room for improvement, significant technological advancements have been made, allowing the potential for ZKApps commercialization to take root. Therefore, we now need to shift our focus to identifying the fields where ZK technology is truly needed and contemplating how to leverage it to practically improve the quality of our lives. From an investor’s perspective, studying the categories of ZKApps that will be widely adopted in the future can also present promising new opportunities.

In this joint ZK research by Presto Research and Ocular VC, we provide an overview and outlook of the ZKApp industry, leveraging marketing trend analysis and cutting-edge technology insights from both research groups. In Section 2, we first cover the current ZK adoption landscape and highlight which ZK Infrastructures and ZKApps are gaining attention. Among them, Section 3 hones in on ZKApps’ development history, discussing their necessity and practical benefits. In the following Section 4, we examine the investment trends and on-chain data analysis in the ZK industry as of 2024, explaining why ZKApps are poised to become the next major trend. Lastly, in Section 5, we will discuss the on-going R&D efforts and technical achievements thus far in infrastructures to make ZKApps practical and a mainstream trend.

2. Current ZK Adoption Landscape

The current ZK adoption landscape can be categorized under many different criteria, but here we broadly bucket them based on the following: whether the service functions as an infrastructure or as an application, and whether it prioritizes privacy by leveraging the zero-knowledge property, or prioritizes utility by leveraging the succinctness property.

Figure 1: Current ZK Adoption Landscape

Source: Ocular VC

2.1. ZK Infrastructure

Type 1: Privacy-focused infrastructure

Services in this category primarily aim to address privacy issues in ZK systems, as many ZKP providers may still have the capability to inspect transactions, posing a risk of sensitive data exposure. In other words, privacy leakage often occurs during the process where clients submit their transactions to a ZKP provider to create a ZK proof. Thus, these privacy-focused infrastructure can be offered through both the prover layer (more explanations in Section 5.2) and the virtual machine (VM) component to enhance access control and ensure end-to-end data privacy. Representative examples include Ingonyama, Succinct, and Espresso. 

Type 2: Utility-focused infrastructure

ZK technology is not only useful for preserving privacy but also for enhancing the utility of ZKApps. One of the best examples of leveraging the utility of ZK is ZK L2 (i.e., ZK-rollups). It is now a well-known fact that among the ongoing ZK L2s, there are very few instances that actually guarantee end-to-end transaction privacy. Nevertheless, ZK L2 chains such as Taiko, zkSync, Intmax, and Zeko leverage the succinctness property of ZK technology to greatly enhance blockchain scalability by consolidating the validity of thousands of transactions into a single ZK proof and submitting it to L1. Another utility-focused use case is the prover layer. Prover layers are entities that provide computational power to help individuals with weak devices participate in the ZKP generation and verification process. Services such as RiscZero, Cysic, Irreducible, and Aligned Layer are currently operating in this space.

2.2. ZK Applications

Type 3: Privacy-focused applications

Privacy-focused applications are often the use case that first comes to mind when we think of “ZK Applications”. Services in this category are primarily applications that leverage the zero-knowledge property of ZK technology and prioritize privacy above other properties. This property is widely adopted in fields that handle sensitive personal information, such as KYC, verification, and credentials, for protecting clients’ privacy. Notable on-going projects include zkPass, Lumina, 0xKYC, and zkMe. This landscape is also expanding to areas such as secure wallets and emails, with examples like ZKSafe and zkEmail.

Type 4: Utility-focused applications

Utility-focused applications primarily operate on top of ZK L2s. Currently, DeFi-related applications such as DEXs and lending platforms dominate this space. Although ZK L2s do not guarantee privacy, these applications leverage the utility of ZK L2s in order to offer fast and low-cost transaction processing, which is crucial in the DeFi sector. Noteworthy applications currently in operation include zkFinance, ZKX, zkEra Finance, zkLend, and eZKalibur.

3. ZKApps: Origin and Evolution

3.1. The Roads to the Modern ZK Landscape

Zero-Knowledge Proofs (ZKPs) have emerged as a transformative technology within the blockchain industry, offering revolutionary advancements in privacy and scalability. Originating from cryptographic research, ZKPs have evolved from theoretical concepts into practical ZK applications (ZKApps), significantly shaping the landscape of decentralized finance (DeFi), cybersecurity, and beyond.

The Genesis of ZKPs

The concept of ZKPs was first introduced in 1985 by Shafi Goldwasser, Silvio Micali, and Charles Rackoff. Initially, it was a theoretical breakthrough in cryptography, demonstrating the ability to prove possession of certain knowledge without revealing that knowledge itself. ZKPs are particularly useful in authentication systems where passwords are involved, as they allow verification without exposing it. Notably, web infrastructure companies like Cloudflare have adopted ZKP mechanisms for secure web verification using vendor hardware.  

Transition to Blockchain Technology

The integration of ZKPs into blockchain technology marked a pivotal moment in its evolution. One of the early adopters was Zcash, which introduced the ZK concept into its payment system to ensure end-to-end transaction privacy. ZKPs allow transactions to be verified (i.e., the sender has enough amount of coin, and it is not double-spended) without revealing the sender, receiver, or transaction amount. This use case highlights the potential for integrating ZKPs directly within blockchain platforms, presenting an intriguing application.

The expansion of ZKP integration gained momentum with the initial deployment on Ethereum L2 solutions like zkSync and Starknet. These platforms utilize ZKPs as scaling solutions to address the low TPS rates that are a common bottleneck in blockchain systems. The successful implementation of ZKPs in these contexts has spurred further interest in developing more practical applications that leverage the existing infrastructure, enhancing both privacy and efficiency.

As the infrastructure has consolidated and matured in the recent years, people are starting to look at ZKApps. We talk about the details and benefits of ZKApps in the following section.

3.2. Definition and Benefits of ZKApps

As briefly introduced from Section 2, we define ZKApps as a application which utilizes ZKPs and ZK Infrastructures to generate transactions that primarily aim to 1) preserve user privacy and/or 2) increase efficiency. 

Focusing on the privacy aspect, applications which prefer not to store their transaction data (i.e., KYC procedures, gene testing, and confidential personal data) on public chains present compelling use cases. Leveraging ZKPs, these data can be safely stored in local database without revealed to the public, but can be verified (e.g., prove that Alice’s blood type is B, prove that Bob is over 20 years old) globally. This approach is particularly advantageous for privacy-sensitive applications where accountability and transparency are also required. Projects working on this topic include zkPass, nuAuth, and BioSnark.

Bhutan, a small Asian country situated between India and China, is a case in point. The country has been utilizing ZKPs nation-wide to build their digital identity infrastructure in recent years. This approach makes it easier for the government to manage data while ensuring that it can be verified across borders without conflicting with other countries' data privacy regulations. 

Interestingly, this use of ZKPs could be further implemented into credit loan systems and identity checking mechanisms, facilitating international cooperation and trust in shared digital services. For instance, USDT loans could utilize ZKPs to protect and verify off-chain credits. This approach could further facilitate the issuance of uncollateralized loans on chain using stablecoins. Such applications of ZKPs could revolutionize how credit is assessed and loans are issued, enhancing security and trust while expanding access to financial services.

There are still some underexplored fields, such as GambleFi, where this approach could be particularly beneficial. ZKPs enable fair and cheat-resistant gambling by cryptographically verifying outcomes and actions without exposing underlying data. An example can be creating betting pools where users’ contributions and winnings are kept anonymous, but the total pool size and distribution are verifiable. These benefits can hopefully attract more users to GambleFi by fostering trust and offering a more private and scalable gambling experience. 

The usage of ZKP is, of course, not limited to these examples. Beyond the mentioned use cases, ZKP can be introduced in social media to protect the anonymity of content creators, and top-ranked gamers who do not want to share their speedrun strategies may also welcome the adoption of this technology. As such, ongoing research explores how ZKP can offer more advanced services in various fields of our daily lives compared to existing methods, and more use cases will continue to be discovered in the future.

4. An Analysis: Why ZKApps Are the Next Trend

In this section, we provide a data-driven analysis of why the main trend in the ZK industry is shifting from infrastructure to applications. In Section 4.1, we explore why ZKApps are the next promising trend, based on the investment trends of 2024. And in Section 4.2, we examine how client demand for actual ZKApps has increased, using on-chain data as an evidence.

4.1. Investment Trends

When examining the investment history in the ZK industry, it’s evident that most substantial investments have been directed toward ZK infrastructures (i.e., ZK L1/L2s, Hardware acceleration), including projects like zkSync, Starknet, Aleo, and Cysics. Cumulative investments towards this market have surpassed $1 billion, with many projects gearing up to launch products in the coming quarters. This trend continues into 2024, as evidenced by the robust performance of the top 5 ZK-related fundraising deals (Figure 2), four of which received investments exceeding $15 million. Notably, four out of the top 5 deals were related to prover layers, while one was related to L2 solutions.

Why is the prover layer receiving so much attention? As explained in Section 3, the prover layer is a critical component that supports the growing demand for ZKPs by enabling individuals with weak devices to participate in the ZKP generation and verification process. This increased demand for prover layers indicates a significant rise in the demand for ZKPs, suggesting that more people want to generate transactions from using ZK L1/L2s. 

Figure 2: 2024 ZK Investing Trends

Source: Cointelegraph, The Block, Ocular VC

There are two possible interpretations for the increased demand for transactions on ZK L1/L2 chains. The first is that the demand for ZKApps has grown, leading to more transactions being submitted to the base ZK chain. The second is that the volume of transfers on ZK chains has significantly increased due to the mainnet launches of ZK L1/L2s over the past two years, resulting in a rise in number of transactions. Regardless of which interpretation is true, the outlook for ZKApps remains positive. In the former case, it signals that more people want to use ZKApps. In the latter case, it indicates that as more people use the base ZK chain and the ecosystem and infrastructure matures, an environment conducive to developing ZKApps is being established.

4.2. On-chain Data Analysis

Now, let’s directly confirm the increased demand for ZKApps through an on-chain data analysis.  One can observe that accumulated fees used in the ZKP verification process over the past 1.5 years, have exceeded $198 million, indicating a significant increase in demand for ZKPs compared to previous years. More importantly, most of the increase came from the growing demand for ZKApps. After breaking down the usage for ZKP verification fees into infrastructure and ZKApps, we found that the ZKApps’ share, which was 40% in the past, has risen to 70-80% in 2024. This data serves as evidence that the recent surge in demand for ZKPs has primarily come from ZKApps.

Figure 3: ZKPs Verification Fees Dynamics

Source: dune.xyz@nebra, Ocular VC

5. Technical Advancements Making ZKApps Practical

So far, we have explored what ZKApps are, identified key use cases to pay attention to, and discussed why the main trend in the ZK industry appears to be shifting from infrastructures to applications. The viability of these ZKApps, of course, hinges on technological advancements that make them practical and feasible. Previously, we noted that the ZK infrastructure has matured sufficiently, and ZKApps that appropriately leverage this technology will become mainstream in the Blockchain/Web3 industry in the coming years. So, what specific advancements have made this possible, and what’s more to come? 

5.1. ZK Proving Systems

First thing to discuss about is the progress in ZK proving systems. Given the complexity involved, to those without technical background, it is often opaque which process employ what types of cryptographic technologies and how their improvements have enhanced the ZK proving system. Thus, in this section, we highlight notable advancements in ZK proving systems along with easy-to-understand metaphors. In short, these advancements have brought two major benefits: “An increase in supported functionalities” and “Optimization of the computation process”.

*For readers who want to check the full details about the life cycle of ZK proving system and advancements in each particular process, please refer to Appendix.

Supporting more functionalities: Domain-Specific Languages (DSLs)

Domain-specific languages (DSLs) in ZK proving systems are specialized programming languages designed to handle specific tasks within the ZK ecosystem. These languages enriches the creation of ZKPs by providing tailored syntax and functionalities that are optimized for ZK operations. DSLs like Leo, Zinc, Cairo, Noir, and ZoKrates are currently being researched and developed to support more functionalities, such as mutable variables, if-statements, and arrays. 

This is analogous to a situation where Bob needs to prove Alice that he made a cake with a legitimate recipe, without revealing it. First thing Bob needs to do is make his recipe. The recipe should include all the high-level steps and ingredients needed to make the cake (e.g., make a batter with ingredients, then bake it). It will be great if Bob can use more trendy ingredients and cooking skills in his recipe (Figure 4)!

Figure 4: DSLs Support More Functionality for ZKPs

Source: DALL E, Presto Research

Optimizing the computation process: Arithmetization, Proof System (IOP+FCS) 

After writing a program with DSL, it undergoes process such as Arithmetization and Proof System (consists of Interactive Oracle Proof (IOP), and Functional Commitment Scheme (FCS)) to be converted into ZKPs. The common challenge in these processes is to minimize the computational overhead, in order to make the ZKP generation and verification process accessible to more people.

Among the efforts to reduce computational overhead, the most intuitively understandable is the reduction of field size in the Proof Systems. Here, the field size refers to the size of the mathematical field used in the ZKP generation process. In easy words, it represents the total number of possible values that can be used to create secret codes; larger field sizes make it harder for someone to guess the code but take longer to generate. Famous cryptographic proof systems like Groth16, Plonk, and Halo2, which even those unfamiliar with ZKPs might have heard of, use a field size of 256 bits. However, with advancements in technology, recent proof systems like Goldilocks and Plonky3 use field sizes of 31 to 64 bits without sacrificing security. The state-of-the-art proof system, Binius, has significantly increased computational speed by using only 1 bit (zeros and ones) as its field size.

5.2. Decentralized Proving Infrastructures

The second technological advancement to discuss is the development of decentralized proving infrastructures. While the advancements in ZK proving systems optimized and simplified the proof generation and verification process by reducing the amount of computation required, decentralized proving infrastructures allowed individuals to outsource intense computational power for generating ZKPs. 

Currently, there are two primary methods for implementing decentralized proving infrastructure in the ZK industry. The first method involves a ZK-based chain building its own in-house prover layer, and the second one is to operate an outsourced prover layer that can handle ZKP generation requests from various chains and applications.

In-house Prover Layer

For In-house prover layer method, the ZKP generation entities (i.e., the provers) are subordinate to specific chains. The biggest bottleneck of an in-house prover layer is the bootstrapping process: Since it is economically infeasible for chain developers to equip themselves with ZK proving devices to provide a seamless prover layer for all network users (this approach also negatively impacts the network’s safety and liveness), typically they deploy protocols that attract individuals or groups with computational power to participate in the prover layer by offering rewards in the form of native tokens. 

A representative example of a project operating an in-house prover layer is Aleo, a ZK Layer 1 blockchain. Similar to PoW in Bitcoin, Aleo requires provers to generate ZKPs that meet a certain threshold (i.e., “Proof Target”) for each block. If the sum of the accumulated proofs exceeds the “Coinbase Target”, the coinbase reward (Aleo token) is shared among the provers pro-rata based on their contributions. This proof-of-mining protocol can incentivize the development of faster software and hardware for ZKPs & decentralizing the prover ecosystem due to widespread distribution of prover rewards.

Outsourced Prover Layer

On the other hand, outsourced prover layers are located outside of the blockchain; and provides computational power upon request from various ZK-based chains and ZKApps. You can think of modular blockchains like Celestia, but with ZKP generation function. These outsourced prover layers are usually operated in a form of “prover market”: where clients submit their transactions requiring ZKP generation, while provers bid to offer their proving services, including their capacity and cost to generate ZKPs. 

Representative examples of projects currently operating outsourced prover layers include =nil, and Gevulot. =nil maintains an order book for each circuit with buy orders from users and sell orders from provers. The price discovery for generating a proof is managed through this orderbook mechanism. Gevulot operates in a PoS manner: it requires provers to deposit a stake and complete proof of workload tasks to join. Apart from the bidding system, the proof generation jobs are randomly allocated using a verifiable random function (VRF) to ensure fairness. 

Nevertheless, outsourced prover layer method also have major concern, which is the difficulty of preserving end-to-end-privacy since the transaction data included in the proof request is submitted to provers while unsealed. To address this issue, projects like Marlin and zkPass leverage enclaves (a secure, isolated execution environment that protect data integrity) to ensure there is no privacy leakage in the process of ZKP generation.

Figure 5: Overview of Decentralized Proving Infrastructures

Source: Presto Research

Conclusion

So far, we have examined the overall adoption landscape of the ZK industry, the benefits that ZKApps can bring us, the evidence for why the main trend in the ZK industry is shifting from infrastructure to ZKApps, and the technological advancements that will support the rise of ZKApps. The development of cryptographic proof systems and decentralized proving infrastructure has paved the way for ZKApps to be used more swiftly and affordably, bringing zero-knowledge technology closer to everyday life.

The Blockchain/Web3 industry often faces criticism for developing overhyped technologies aimed more at attracting investors with little consideration given to actual market demand. To overcome this criticism, developers must advance technology in ways that genuinely improve our lives; however, it is equally important for us, the users, to continually assess which fields this technology can be effectively applied to. We hope this article provides readers with a broad understanding of ZKP and ZKApps, and intrigue more DYORs towards this industry.

In the upcoming Presto Research & Ocular VC collaboration series, we will go over a list of cutting-edge ZK-related projects (i.e., privacy roll-ups, client-side proving, privacy-preserving prover layers) both on the infrastructure and application sides, that are set to launch based on technological advancements we have mentioned in this article. Stay tuned! 

Required Disclosures

Any expression of opinion (which may be subject to change without notice) is personal to the author and the author makes no guarantee of any sort regarding accuracy or completeness of any information or analysis supplied. The views and opinions expressed herein are those of the author(s) and do not necessarily reflect the views of Presto Labs or its affiliates. This material by itself, is not and should not be construed as an offer or a solicitation to deal in any investment product or to enter into any legal relations. This material is for informational purposes only and is only intended for sophisticated investors, and is not intended to provide accounting, legal, or tax advice, or investment recommendations, or an official statement of Presto Labs or its affiliates. Presto Labs, its affiliates and its employees make no representation and assume no liability to the accuracy or completeness of the information provided. Presto Labs, its affiliates and its employees also do not warrant that such information and publications are accurate, up to date or applicable to the circumstances of any particular case. Certain statements in this document provide predictions and there is no guarantee that such predictions are currently accurate or will ultimately be realized. Prior results that are presented here are not guaranteed and prior results do not guarantee future performance. Recipients should consult their advisors before making any investment decision. Presto Labs or its affiliates may have financial interests in, or relationships with, some of the assets, entities and/or publications discussed or otherwise referenced in the materials. Certain links that may be provided in the materials are provided for convenience and do not imply Presto Labs’ endorsement, or approval of any third-party websites or their content. Any use, review, retransmission, distribution, or reproduction of these materials, in whole or in part, is strictly prohibited in any form without the express written approval of Presto Labs. Presto Research and related logos are trademarks of Presto Labs, or its affiliates.

Introduction

One of the key themes in our recent piece ‘Charting the Web3 Horizon in 2024’ was the rise of Decentralized Physical Infrastructure Networks or DePIN. DePIN refers to capital-intensive infrastructure projects that use tokenization to coordinate and scale the bootstrapping phase of network development. DePIN offers a blockchain solution for real-world problems like overpriced or lagging digital infrastructure for wireless networks, computation, and energy. 

DePIN operates on the principle of distributing control, decision-making, and resources across a network of nodes rather than relying on a centralized authority. This model shifts the paradigm to promote community-driven innovation instead of corporate or government driven innovation. Each DePIN network consists of an ecosystem of nodes, which could be physical devices like sensors, devices, or even entire systems! Unlike their traditional centralized counterparts, DePIN promotes local community involvement in decision-making and management but also provides other benefits: network security / resilience, decentralized control, capital efficiency, and community empowerment. 

(The DePIN Flywheel, Source:@OcularVC)

Compared with centralized traditional infrastructure providers, DePIN demonstrates several advantages. Firstly,  by leveraging cryptographic incentives, DePIN presents a capital-efficient way to bootstrap essential infrastructure that is traditionally capital intensive and expensive to maintain. This could also bring reduced cost to consumers. Secondly, because DePIN networks are distributed across a network of nodes, redundancy is created and ensures that even if one node fails, the rest of the system stays operational. Lastly, the community-centric approach of DePIN networks can empower local communities to manage their own networks and improve network efficiency. When decisions regarding resource allocation and maintenance can be made at the grassroots level, infrastructure is viewed from a long-term holistic benefit perspective vs just profit. 

Over the past few months, we have seen DePIN network launches that have shown early signs of product-market-fit of the “sharing economy”. These projects are spread across various sectors within DePIN, each having different use cases. In this article, we will explore the state of DePIN, the issues DePIN projects are facing, and next steps for the sector to grow.

Current State of Play 

Summary:

Venture funding for all crypto projects has seen a resurgence this year, with $4bn of funding invested globally as of April 2024. DePIN is on the rise, with a total of 70 DePIN projects raising a combined $192m in the same period. Key deals to highlight include io.net, a Solana-based distributed GPU project that raised $20m for its Series A at a $1bn token valuation, and Aethir, a decentralized node provider for GPU compute that raised $65m in the first hour of its node sale. DePIN projects currently have a combined market cap of over $54b- projects across sectors currently generate over $18m of annual on-chain revenues, with the likes of Filecoin, Flux, Braintrust, and Helium leading the industry. Admittedly, valuations are still very rich at 3,000x FDV / Revenues but funding continues to come in anticipation of more robust product-market-fit. The entire ecosystem has grown to over 1,220 projects with over 600k active nodes.  

The DePIN ecosystem can be further broken down into 6 main categories: Compute, Wireless, Energy, AI, Services, and Sensors. 

(Source: EV3, Messari, Depin Ninja)

Compute

Under this category, we include the entire compute lifecycle which needs storage, the actual compute, and data retrieval infrastructure - we will dive into each briefly to discuss their differences. 

Storage

Decentralized storage infrastructure allows data to be stored across possibly thousands of different nodes vs having them all stored in web2 data center / cloud options like Amazon, Microsoft, and Google. Storage providers offer their extra space for a fee, akin to traditional data storage business models. Projects like Storj, Arweave and Sia  participate in storage, but Filecoin continues to lead the industry. 

(Filecoin Capacity, Source: Starboard Ventures)

The Actual Compute

Decentralized compute infrastructure is similar to data, but computational power is sold instead of storage space. This sector has taken off in recent months because of an increase in compute demand driven by AI projects. Unlike storage, the decentralized compute sector is constrained by a lack of supply. Aethir, a decentralized node provider for GPU compute, recently concluded its node sale and raised over $65m in the first hour alone. These nodes aim to provide compute capability for gaming and AI across both Web2 and Web3.

Data Retrieval

Data retrieval is concerned with pulling the stored data for ease of use. Data that is stored in a decentralized fashion requires robust content delivery networks to ease access, but the challenge is that the content delivery networks themselves are difficult to decentralize. Projects like Filecoin Saturn and Fleek are tackling this problem and have shown early signs of progress but none have seemed to crack the retrieval problem just yet.

Artificial Intelligence

The rise of AI companies has been rampant across all levels of society - DePIN provides a way for infrastructure to support the growth of AI but also a way for AI companies to monetize their models. Datasets that run computations privately can then be sold on decentralized marketplaces. SingularityNET looks to enable monetization of research and models in a decentralized fashion - its fully diluted market cap currently stands at $1.2bn. 

Energy

DePIN can enable peer-to-peer (P2P) energy trading in the energy distribution space. Instead of only distribution utilities companies trading energy, individuals and households with excess capacity can sell to neighboring homes or communities on a secure network. This network of houses can form a decentralized energy grid and bypass the need for a centralized grid provider. 

A clear use case would be to develop these decentralized grids in archipelagos where islands are far apart and disjointed (like the Philippines or Indonesia). The Southeast Asia region has immense potential for generating carbon credits, given the region’s rich biodiversity and potential for renewable energy projects in hydro, solar, and geothermal - Indonesia, Malaysia and the Philippines comprise three of the world’s 17 megadiverse nations. Southeast Asia holds almost 25%r of the world’s potential for natural climate solutions, with an estimated 58% of threatened forests (or about 114 million hectares) in the region being seen as financially viable carbon credit projects. We are seeing DePIN projects (like AllInfra or the Open Forest Protocol) tackling the carbon credit market as well with decentralized carbon credit tokens, opening new supply channels. 

Wireless

There is a large opportunity for DePIN to aid in the supply of data across mobile, fixed, and WiFi networks. Global data consumption across networks and devices are set to grow aggressively in the coming years, with the world needing differentiated solutions to satisfy this demand.

(Source: PwC, Omdia)

DePIN projects like Helium have launched to address connectivity issues by building a community-driven decentralized wireless network. Helium is one of the ‘OGs’ in the DePIN ecosystem - it was founded in 2013 to build a peer-to-peer wireless network for Internet-of-Things (IoT) devices. Helium then raised $111 million in a 2021 token sale led by a16z with participation from Ribbit Capital, Multicoin Capital, and now defunct trading firm Alameda Research. In February 2022 the project raised $200 million in a Series D round at a $1.2 billion valuation. Helium Mobile is now offering an outdoor Helium mobile hotspot for $499 and an indoor one for $249 - note that there are currently only 371k active hotspots on the Helium network. On the backend, the network incentivizes hotspot providers with the HNT token. Although valuation might be hefty compared to traction, Helium has demonstrated early product market fit for a novel attempt. Other projects like WiFi Map are launching similar efforts - the app helps users find publicly available hotspots, utilize global eSIMs, access offline maps, and much more. The project boasts 175m downloads, 15m active WiFi hotspots, and 5m monthly active users. 

Services

Blockchain has also aimed to tackle services that we use daily, like ridesharing and food delivery. By utilizing bootstrapped blockchain networks, restaurant owners can band together to create decentralized delivery systems and avoid paying the 15% to 25% cut to food delivery aggregators. Similarly, ridesharing networks are characterized by app duopolies and have no room for local / grassroots coordination. DePIN projects like Nosh and Teleport are aiming to give ownership (and power) back to local communities.

Sensors

To power the DePIN revolution, independent mobile devices will need to ‘sense’ what is going on around them. The Internet of Things will empower DePIN networks to add value as sensing machines. Projects today tackle problems from noise pollution to the lack of navigation / mapping for certain areas, all the way to counting how many steps a person’s walked for the day. Though our mobile phones are powerful, they still face the challenges of having to be ‘always on’, requiring users to ‘opt in’, and dealing with data privacy issues. 

Projects like Frodobots are looking to crowdsource real-world datasets with robotic gaming. Frodobots allows users to ‘play’ and operate real-life robots that gather location-based data as they traverse city streets. At the same time, users’ action labeling helps train the AI models behind the robot and can make users eligible for token rewards. 

DePIN’s current challenges

Despite hype and the vast amounts of capital pumped into DePIN projects, the sector is not without its challenges. We will discuss a few key issues that DePIN will need to solve before becoming completely viable. 

Technological Capabilities

DePIN will heavily rely on the integration of IoT devices and other tech to create a reliable decentralized network. As it stands, centralized solutions already encounter connectivity issues, especially in emerging markets, so it comes as no surprise that decentralized solutions that require existing infrastructure will also have a difficult time scaling. Reliability, data synchronization, and integration are problems that DePIN looks to address with its community-focused decentralized model that takes an ‘all hands on deck’ approach. 

Lack of Demand / Traction and Consumer Trust

Consumers and enterprises, regardless of location, will always need clear incentives to shift data infrastructure providers. Building out a reliable, cost-effective, and legal business model is paramount to building consumer confidence. If one of these facets fails, then consumers are less likely to shift to a decentralized provider vs sticking with incumbents. The lack of demand is evident in how DePIN projects are only generating ~$18m in revenue per year. Enterprises have more stringent processes to switch from their existing providers - suppliers need to be consistent and secure. DePIN needs to prove its reliability and security, despite being the cheaper solution - Filecoin costs $0.19 / TB / month while Amazon S3 costs ~$23 / month. As Filecoin’s network gets more secure, we see more consumers and enterprises moving towards the much cheaper solution. 

Economics

Because there is a lack of demand for DePIN projects, the incentive flywheels do not take off as intended. DePIN requires significant amounts of capital to kickstart its networks and bootstrap supply for the infrastructure it provides. The problem with the current market is that even after building supply, the lack of demand leads to a breakdown of the flywheel. The inherent volatility of crypto makes it hard to determine the long-term economic viability of bootstrapped DePIN projects but projects are looking to stabilize their networks to address inherent volatility. This is expected to improve when the ecosystem matures and usage increases. When projects are able to generate real revenues, the fundamentals will be able to support a more stable earn-out for network participants. 

Regulatory Issues

Telecommunications infrastructure is largely regulated across markets (developed and emerging alike), with government regulations evolving rapidly. Providers of digital infrastructure will need to remain nimble to address these regulatory challenges and at the same time have an open-line with government officials. Decentralized projects may have difficulty addressing government communications and foreign ownership issues that surround digital infrastructure at the moment. Global storage projects such as Filecoin should lead the way in terms of negotiations with governments to address this issue. 

Looking Ahead - Novel Crypto Primitives in DePIN

Despite the challenges mentioned above, DePIN has made significant progress in 2023. According to Messari, the industry added over 600k nodes over the past year alone. Underpinning this growth is a show of support from token holders: tokens locked as a % of total supply have increased for successful projects, giving teams more runway to incentivize supply or expansion into other markets. 

(Source: DePIN Ninja, EV3)

While traditional DePIN projects figure out sustainable incentive models, we believe new DePIN projects that tackle less complex and less critical infrastructure can take off. Projects like Hivemapper have created a decentralized way to map the world and have seen good initial traction. Users around the world using their own cameras to map the world. This is a new model where decentralized solutions (people on their phones / cameras) replace centralized ones (satellite imagery, governments) to help produce something better at a quicker rate. 

(Source: Hivemapper)

Less developed markets or areas of conflict with a lack of digital infrastructure like Africa and Southeast Asia stand to benefit from improved digital infrastructure. Africa has some of the most expensive internet prices in the world, with Nigeria ranked 3rd in cost / mb / s at $4.89. Centralized players find it hard to make a return on their investment without charging high rates - decentralized models have a window of opportunity to provide more competitive prices. Southeast Asia has two very large archipelago nations in the Philippines and Indonesia. Unsurprisingly, the Philippines and Indonesia rank 35th and 21st in the world in terms of internet cost. Markets like these where populations are young and tech savvy, stand to benefit from more advanced technological and economic solutions that DePIN has to offer. 

Looking ahead, we see more rooms of experimentation for DePIN projects, including Zero-Knowledge, memecoins and increasingly, AI. A latest report by EV3 and Messari also expects the next top-10 DePINs to come out of Asia in 2024 - 2025. 

Conclusion

The Ocular team has definitely put a pin in it and will explore trends in DePIN in subsequent posts, so do keep a lookout for them! We are excited to see how Web3 continues to evolve and improve infrastructure for corporates and consumers alike. As always, we would love to connect with anyone who is actively building in the space/shares a keen interest in discussing the latest trends in the DePIN sector - if this resonates with you, do feel free to reach out to us at crypto@ocular.vc.

There has been a renewed wave of optimism towards web3 in light of recent events, including the approval of the long-awaited spot Bitcoin ETF; and the surge in market activity in the early months of 2024.

On the regulatory front, we have seen the conclusion of several high-profile court cases and lawsuits, including some of the charges involving Ripple and Binance. Beyond the results of the rulings (which many argue are in favour/support of web3), the resolution of these cases in itself has provided greater clarity and stability to the ecosystem.

As these events set the stage for exciting times ahead, we at Ocular wanted to share the key trends and developments that we are watching in 2024.

Macro

Besides the events mentioned in the introduction, there are a few other macro catalysts that could significantly impact web3 this year.

First, the highly-anticipated Bitcoin halving scheduled for April 2024. This refers to the reward for Bitcoin mining being cut in half, reducing the supply of new coins issued by half.

Assuming demand for Bitcoin remains unchanged, this supply shock should lead to higher prices for Bitcoin. Historically, this has been the case. Past halving events in 2012, 2016 and 2020 have heralded the onset of bull cycles, culminating in Bitcoin hitting all-time highs. If this cyclical pattern continues, we may visit new all-time highs in 2024.

Second, the potential approval of a spot Ethereum ETF, which some speculate as early as May 2024. Following the success of the spot Bitcoin ETFs - which collectively have seen roughly $5 billion in net inflows in the first month of their launch - all eyes are shifting to a potential spot Ethereum ETF approval that market participants will look to front run. We would expect to see a new wave of retail and institutional investors participating in the space, and it would also significantly broaden Ethereum's accessibility, cementing its position as a cornerstone of the decentralised ecosystem.

Third, potential interest rate cuts by the Federal Reserve, which many expect to occur in the second half of 2024. A lower interest rate environment could steer capital away from traditional safe havens into riskier assets offering higher yields, including in web3. Today, we are already seeing certain crypto assets approach all-time highs, when interest rates are slightly above 5%.

Given points two and three, we could see greater institutional involvement and risk-taking in web3 this year. The notion of institutions investing/participating in the sector is increasingly normalised, with many institutions already invested in crypto assets and initiating/supporting strategic projects. Over the past few years, institutions might have hesitated to get involved in web3 given the high-interest rate environment where alternative assets could offer high yields with less considerable risks involved. However, this may change in 2024 and given greater regulatory clarity/mainstream acceptance of crypto as an asset class, the stage is set for a potential influx of institutional funds into web3.

We will also need to keep a close watch on the US presidential elections in November 2024. While election years are generally good for markets (e.g. the S&P 500 has averaged a 7% gain during U.S. presidential election years since 1952), it remains to be seen if the candidate elected will have a favourable view towards crypto and enact pro-crypto policies. Furthermore, depending on the composition of the House and the Senate post-elections, this may shape the regulatory frameworks that the US has governing crypto, and this could impact the sector given the prominent role that the US plays.

Themes

Having noted the favourable macro backdrop, let’s dive into the micro in search of alpha.

1. Next Chapter in Layer 1 Scalability War

Lots of popular Layer 1s (L1s) today (e.g. Solana, Avalanche, Aptos, Sei etc.) are monolithic (i.e. a single chain that ensures consensus before executing the transaction). The chain itself will also store the historical data of past transactions, giving the chain its immutable property. The downside of such an approach is the lack of customisability by use case and the greater centralisation risk at scale.

Alternatively, Ethereum is going down the modular blockchain route, scaling via an army of L2s. However, modularity does not stop simply with fractal scaling but seeks to provide efficiency and flexibility by breaking blockchains into their component parts: execution, settlement and data availability. A leading example is Celestia - a “lazy ledger” which looks to provide the cheapest possible data availability component, leaving other chains to compete primarily on execution. Modularity provides more flexibility, but also opens the door to competitors looking to carve out specific components within the stack.

Besides modular blockchains, we have also observed the advent of app-specific chains. This refers to chains that focus on a particular vertical or application to serve a specific function (e.g. dYdX Chain for decentralised derivative transactions on dYdX; Ronin for gaming; and DeSo for decentralised social applications). We expect these app-specific chains to continue to grow in popularity, as it gives projects/developers full autonomy over their underlying infrastructure and can be tailored to meet certain needs.

It remains to be seen which model of L1s will survive the test of time, but our view at Ocular is that all three models will continue to feature in the sector and can exist in parallel with each other. Nonetheless, there will be consolidation within each segment, e.g. we do not envisage the need for too many general-purpose monolithic L1s and it will be hard to sustain all of them given finite liquidity. In 2024, we could see liquidity and talents start aggregating around a select handful of ecosystems with break-away network effects.

2. Development of the Restaking Flywheel

Restaking on EVM refers to the process where staked ETH can be used as cryptoeconomic security for protocols other than Ethereum, in exchange for protocol fees and rewards. The concept of restaking was introduced when EigenLayer was launched, generating much excitement within the Ethereum community.

The hype around Eigenlayer is understandable given the advantages that it brings to protocols, validators/restakers and Ethereum itself, creating a win-win-win situation.

For protocols, EigenLayer eliminates the arduous task of having to bootstrap their own trust networks. By leveraging EigenLayer, protocols can focus on enhancing their core functionalities without being encumbered by the process of building out validation systems.

Validators/restakers stand to gain substantially from EigenLayer's inception too, as it presents an opportunity to generate additional yield from their staked ETH and enables greater capital efficiency.

A flywheel is thus formed, with two primary implications. One, it will popularise the concept of liquid staking (and restaking). More users would be attracted by the high yields and flexibility accorded by this concept and we could see more platforms similar to Eigenlayer being introduced. Two, this could solidify Ethereum's dominance as the primary L1. By consistently attracting users and liquidity to the chain, Ethereum will continue to grow in strength and will remain one of the main general-purpose chains that users and developers choose to use.

There are restaking protocols popping up for other chains such as Solana, Cosmos etc. However, it is unclear whether there is similar merit to ETH restaking, as the security level and underlying chain designs are different.

3. Rise of Use Cases to Attract Web2 Users - this could be in GambleFi and memecoins …

We shared previously as part of our Token2049 reflections that for web3 to achieve mass adoption, it is vital to educate and encourage web2 users to participate in the space. The sector will have to adopt a new mental model - shifting its focus from appealing solely to existing native web3 users, to promoting and making web3 understandable to a much wider audience.

One way to attract retail users to web3 is by creating apps that pique their interest and capture their attention. This could be in the GambleFi domain, be it in the form of a decentralised casino or prediction markets for any assets. For the latter, the concept is simple - one could issue/create assets of any kind and trade those assets easily. GambleFi is an area that is easy to understand and intuitive to users (given that we have similar concepts in web2). It is also highly social, in that users can interact/coordinate actions with other asset holders, enabling projects to tap on this community aspect to boost user retention rates.

GambleFi could be an easy access point for web2 users and there are existing examples to justify this claim. As of Dec 2023, Rollbit, a platform that offers an online casino and crypto futures, reported a year-to-date revenue of $355 million, making it the third-highest web3 protocol/platform in revenue generation, only behind Uniswap and Lido. Its user base also continues to grow - on 28 Jan 2023, it announced that it generated over $1.5 million in bets in just 24 hours, smashing its previous daily revenue record.

Another example of mainstream “gambling” that is increasingly popular will be memecoins. Memecoins can be defined as a subcategory of crypto centered around popular internet memes or pop-cultural references. Often, these coins do not have an underlying technology or support any particular use case, hence they do not have any fundamental value. The value of these coins will be driven by the attention they generate and whether the community finds the story behind the coins interesting and relatable. In recent months, the mania around memecoins has grown, and today memecoins have a market cap of more than $60 billion. Given the current price action of memecoins which will feed into its virality, we expect memecoins to continue to garner significant attention and could be the gateway for new users to enter web3.

The main headwind for GambleFI and memecoins will be regulations, as policymakers may wish to deter retail investors from overly risky speculative activities. Nonetheless, if projects in these domains could meet the regulatory framework and ensure that users gamble/invest responsibly, they could be sectors to watch.

4. … or decentralised social media experiences

The explosion of friend.tech last year reminds us of the potential that decentralised social media experiences have in generating mainstream attention and catalysing the next wave of growth for web3.

This year, we expect to see even more experiments in the decentralised social media space. Amid mounting concerns over data privacy and security, users are increasingly keen to take ownership of their data and be given the autonomy to decide which platform/who to share this information with. Aware of this pain point, projects will seek to address this desire and cater to the users’ preferences. This can be seen with farcaster.xyz, which has gained significant traction since its launch - today, it is estimated that there are nearly 25,000 daily active users on the Farcaster network.

Similar to what Farcaster does, we envisage that for future iterations of such decentralised social media experiences, it would be combined with NFTs. It would be a single platform where people can flaunt, exchange and discover collectables, before connecting with other like-minded enthusiasts. It would serve as a canvas for digital self-expression, enabling users to divulge more about themselves while actively pursuing their passions and interests.

5. Upcoming Solana DeFi Summer?

There has been a flurry of DeFi activity on Solana lately, evident in how its TVL has increased by over 55% from Jan to Feb 2024. This may be unsurprising given the scale of recent airdrops in the space, e.g. Jito, which handed out over $225 million worth of its tokens to users; and Jupiter, which distributed roughly $700 million worth of its tokens to nearly a million wallets. Other projects, such as MarginFi, Drift and Kamino are also rumoured to have an airdrop later this year, fueling growing interest in Solana DeFi protocols.

Besides the increased number of users and liquidity in the Solana DeFi space, what is interesting to us are the new DeFi models/innovations that tap on the powers of the Solana blockchain to offer faster, cheaper and more efficient transactions.

Take Jupiter for example - it is a decentralised exchange (DEX) aggregator that compares the prices of tokens across various DEXes, before offering the best price to users for trades. While there are many DEX aggregators in DeFI, Jupiter takes advantage of Solana’s speed and low cost to route the orders to as many DEX markets as possible, and at the same time, dynamically split the orders into multiple smaller trades if needed to get the best prices for them. On other platforms, routing these orders to this many DEXes and calculating all possible routes for transactions will severely inflate the transaction costs and take far too long, but it is possible on Jupiter, thanks to Solana.

Another example will be Central Limit Order Book (CLOB) DEXs, such as Phoenix. CLOB is an exchange model that aggregates limit orders and matches buyers with sellers. Compared to the more popular model of Automated Market Maker (AMM), CLOB offers tighter spreads, particularly for large orders on trading pairs with limited liquidity and does not run into the issue of impermanent loss. CLOB also offers greater flexibility in customising orders, with features such as limit orders, stop losses, trailing stops, options and leverage available.

To be clear, CLOB is a model that has been around in TradFi for a while now and may be familiar to readers. However, CLOB has not been used much in DeFi as it requires the execution of many transactions, which will make it inefficient and expensive on many existing L1s. Until now. With Solana, DEXes can afford to execute these transactions without having to pass on the costs to users, and CLOB becomes a viable model in DeFi.

Given the attention on Solana DeFi and the emergence of new technologies in the space that will benefit users, we expect Solana DeFi to become increasingly popular and could spark off the next DeFi summer.

6. There are existing sectors/technologies that we believe will continue to grow in prominence - first, zero-knowledge proofs …

To recap, a zero-knowledge proof is a cryptographic protocol that allows one party to prove to another party that a given statement is true without revealing the statement itself.

There are multiple applications for this technology, including in client-side privacy. Users may not wish to share their personal information with apps or with others, and they can potentially tap on this technology to develop zero-knowledge proof/identities for themselves. This way, their full details will no longer need to be revealed, but they will be verifiable and can authenticate that it is indeed them.

Zero-knowledge proofs are also useful for scaling solutions that move computation and state off-chain into off-chain networks for time and cost savings while storing transaction data on-chain on a L1 network. They can help prove that the off-chain computation was done correctly and build trust in the scaling solutions. This will encourage more users to adopt these scaling solutions, making their web3 transactions more efficient and affordable.

Another possible use of this technology will be in Artificial Intelligence (AI), with zero-knowledge machine learning (zkML). The idea behind zkML is that the party that generates an output using an AI model will be able to generate a cryptographic proof that proves that the right AI model (with the correct set of training data and parameters) was used in the computation process.

Why is this important? Today, we interface with many AI models and we tend to implicitly trust the outputs that these models generate. For example, when we key in a query on ChatGPT or Siri, we trust that these models have been trained by the right datasets and have conducted their inference correctly. So when these models recommend a restaurant for us to check out when we search for a place to eat, we are ok to go along with it. Even if the recommendation didn't turn out great, we may boil it down to our personal preferences, rather than any possible issues with the model.

But what if the stakes were higher and we could not afford to be wrong? Think about the case where there is a healthcare AI model that is used to determine if an individual has a disease. While the output may show that there is no disease, we may not be sure if the correct model has been run - this problem is neatly summarised in the picture below. This serves as the impetus for zkML, and it is an area that we think will continue to grow as AI models become increasingly prevalent.

(Source: https://twitter.com/daniel_d_kang/status/1582519854405255168)

7. … second, decentralised physical infrastructure (DePIN)

DePIN refers to capital-intensive infrastructure projects using tokenisation to coordinate and scale in the bootstrapping phase of network development. Individuals are tasked to help build the infrastructure in a decentralised manner, and they will be rewarded with tokens for their efforts.

In 2023, the DePIN sector continued to gain traction, particularly in the areas of decentralised storage, compute and wireless network. On the latter, we note that it is starting to serve mainstream users - the developers behind Helium Network announced in Dec 2023 that they would now be offering an unlimited data, talk and text phone plan for $20 per month in the US, in collaboration with T-Mobile. Overall, the DePIN ecosystem has grown to over 650 projects, with the combined market cap of DePINs with liquid tokens exceeding $20 billion.

We are of the view that there is further room for DePIN as a sector to grow, with Asia potentially being a bright spot for this new model. There are parts of Asia where there are large populations, but digital infrastructure may be lagging or overpriced. This sets the stage for the potential disruption by DePIN to reduce the costs of rolling out the next-generation infrastructure networks in a capital-efficient and bottoms-up manner. There are already examples of DePIN projects surfacing in Asia, including IoTeX; Starpower; and Huddle01.

Conclusion

We will elaborate further on these trends in subsequent posts, so do keep a lookout for them! As we think about the year ahead, we are excited to see how web3 continues to evolve and grow. As always, we would love to connect with anyone who is actively building in the space/shares a keen interest in discussing the latest trends in the sector - if this resonates with you, do feel free to reach out to us at crypto@ocular.vc.

In our 2023 thematic outlook, we highlighted that on-chain insurance is a DeFi sub-sector that remains underdeveloped.

Today, DeFi has largely covered the services offered by TradFi, such as payments, lending and exchanges; as well as central, commercial and investment banking services. There is also DeFi insurance (or more accurately termed as ‘DeFi cover,’ since the solutions provided are more discretionary than contractual; and may not be regulated), but presently it is not being offered as extensively as traditional insurance. For context, the global insurance market is estimated to be $6 trillion, while the TVL in DeFi cover is around $275 million, which is 0.5% of the total TVL in DeFi (at $55 billion).

This may come as a surprise to some, especially considering the series of unfortunate events that rocked web3 last year. A record of $3 billion was also lost to DeFi exploits last year, highlighting the need for more risk mitigation measures. In this article, we will discuss the state of DeFi cover, specifically covering the current landscape; the issues that consumers and DeFi cover providers are facing; and the next steps for the sector to continue to grow and address the risks of DeFi.

Current State of Play

Background

The concept of DeFi cover can be traced back to 2017 when Hugh Karp launched ‘Nexus Mutual’ and offered the very first cover products. Since then, many others have begun to offer similar products and there are currently around 24 active participants. Nexus Mutual remains the biggest player in the space, with a TVL of ~$200 million (or more than 70% of the total TVL for DeFi cover). Other notable players include Unslashed; Helmet; Ease.org; InsurAce; Sherlock; and Cozy Finance.

Historical data shows that there have been an all-time total of 19,839 covers sold, 552 claims and 379 payouts across leading on-chain DeFi cover providers so far. Given the events last year, 2022 marked the industry’s first large-scale stress test with $34.4 million in claims paid out (out of $36.9 million all-time tracked total, i.e. over 90% of all payouts occurred in the last 12 months). Notable payouts were for the UST depegging, with $22.5 million paid out; and the FTX collapse, with $4.7 million paid out.

Types of Cover

Currently, there are eight broad categories of covers offered in the market (see image below). Providers may choose to focus on a few categories instead of offering the entire sweep of products depending on their risk appetite and area of expertise, e.g. Nexus Mutual does not offer Stablecoin Depeg Cover, unlike InsurAce.

(Source: OpenCover)

Cover Mechanics

Each provider will also have their own terms and exclusions, pointing to a relatively nascent industry that has yet to embark on standardisation. They typically differentiate themselves across three dimensions: (1) risk assessment; (2) claims assessment process; and (3) underwriting capital.

(1) Risk Assessment

Each provider views the risk of certain events happening differently, influencing the selection of covers offered. The model used to price the risk of the incident happening may also vary and this will affect the cover pricing (i.e. the premiums to be collected from cover holders).

The broad parameters that providers tend to use to assess risk include TVL and historical protocol usage; quality and recency of smart contract audits; and team information.

(2) Claims Assessment Process

This refers to the process of determining the validity of the claims submitted. Broadly, there are five types:

• Community Vote - The community (typically involving DAO members who hold protocol governance tokens) will determine at their discretion if a submitted claim should be paid out based on the wording of the cover policy, akin to traditional discretionary mutuals. To ensure alignment of incentives to pay out valid claims, the protocol will typically reward participation in claim assessment while penalising voters who vote not to pay out claims determined valid by the majority.

• Parametric - When a claim is filed, the smart contract will check for the incident. Should it meet the predetermined on-chain condition, affected cover holders will be able to claim their payouts automatically. There will be no need to submit proof of loss or wait for the result of a vote. This is typically used for asset depegging covers since the incident can be measured objectively.

• Optimistic Oracle - This is a combination of community vote and parametric. In this semi-automatic approach, claims are accepted as valid unless disputed by any one party during a given timeline. If disputed, it will be assessed by the community via a vote. Once deemed valid, the payouts will be made automatically.

• Expert Panel - This relies on a predetermined group of experts to determine whether a claim is valid. The experts tend to include security and legal professionals; as well as core contributions and representatives from the protocol’s community. It tends to leverage a multi-signature contract which requires a majority vote to validate the claim.

• Hybrid - This can combine any element of the above four approaches. For example, a claim may first undergo a community vote, before being evaluated by an expert panel. Alternatively, it may first be evaluated by an expert panel, and should there be a dispute, it could be resolved by an optimistic oracle.

(3) Underwriting Capital

Underwriting capital refers to the funds available to pay out valid claims. There are various ways to build up this capital pool, such as (1) premiums paid by cover holders; (2) investments from institutional and retail investors, where they provide underwriting capital in exchange for a share of cover purchase fees; and (3) returns from investments of funds in underwriting capital pool.

The percentage reliance on each source of underwriting capital may vary across providers. Also, the ratio of the total amount covered by providers (i.e. total sum of all covers) to the underwriting capital may vary depending on the risk tolerance of the providers.

Issues Faced

Today, the growth of DeFi covers has been hindered partially by issues that consumers and cover providers face.

Consumers

For consumers, DeFi coverage is typically offered on a separate platform from the DeFi products, and is not well integrated with existing DeFi platforms. Users may not be aware of the availability of DeFi coverage for the specific protocols that they are interacting with. Even if they were aware, the multitude of options and the mechanics of each cover could be overwhelming. Unlike the traditional sector, where financial advisors and insurance agents can recommend suitable products, the UI/UX of getting DeFi coverage presents too much friction and lacks seamless integration.

Furthermore, much of the traditional insurance sector is well-regulated, which means purchasing insurance can be mandated by regulation for risk management purposes. The institutions also command high credibility when it comes to claim processes. Consumers are either required or are more comfortable with the idea of purchasing insurance to protect against risks.

The current cohort of web3 users tends to be risk-seeking early adopters who see themselves as partaking in an emerging asset class. In light of this mindset, purchasing DeFi coverage may just be an afterthought, as it adds extra costs when downside protection is not a top priority, and not mandated by law. Nonetheless, our view is that as web3 gains wider acceptance, particularly with the entry of more institutional investors, this culture will gradually diminish. Consequently, there will be a growing demand for DeFi coverage products over time.

Cover Providers

Besides the consumers, the providers themselves face their own set of challenges. Given the nascency of the sector, there are the following difficulties in firming up the optimal mechanism to supply these covers:

• Risk Assessment & Pricing - The truth is, nobody can confidently assess the risks inherent in DeFi, as this is a new field and protocols can break in unexpected ways. The best (or perhaps only) indication of safety may well be the Lindy Effect, in that the longer protocols survive with millions in TVL, the safer they are proven to be. This, however, can only be proven with time. It is also difficult to price the insurance given the difficulty in risk assessment, plus consumers’ willingness to pay for security is still low. Price elasticity is extremely difficult to estimate.

• Claims Assessment - There remain questions on who exactly should assess claims for loss events. Should it be policyholders, token holders, core team members, DAO members, or third parties; or should the protocol instead rely on parametric assessment tools? How do we align the incentives across the various stakeholders? A definitive answer remains elusive because no one has implemented a winning system yet.

• Underwriting Capital - Underwriter yield must compete with DeFi yield. Investors may favour participating directly in DeFi protocols instead of acting as an underwriter or participating in insurance markets, given the high returns that DeFi protocols offer. It is also difficult to build up an underwriting capital pool with alternative investments. Traditional insurance markets earn a majority of revenue from re-investing collateral into safe yield-generating products. In DeFi, what is considered a “safe” investment for pooled funds? Placing them back in DeFi protocols re-introduces some of the same risks they are meant to cover.

• Asset Management - If we were to push the concept of decentralised cover even further, we would need to consider who should be directly responsible for the crypto assets that are held by the cover providers. Should it be the DAO members or should it be a centralised team, given that the management of such assets requires a specific set of skills? If it is a centralised team, how do we ensure that this power and the funds under their charge are not misused?

What’s Next?

Here at Ocular, we have been keeping watch on DeFi cover and below are a few suggestions on how to address the existing issues with the space. They are by no means definitive answers, nor is this an exhaustive list, but we thought these are ideas worth exploring and discussing further.

For Consumers

• Make DeFi cover more accessible to all. DeFi cover providers can consider partnerships with other DApps such that each time a transaction is being executed, there will be an option to purchase a cover for it. This can include exchanges, wallets or other DeFi services.

  • The intent is to reduce the friction of purchasing these covers. Instead of requiring users to go to a separate platform, the DeFi cover option is readily available to them each time they make a transaction. This increases the likelihood of investors purchasing DeFi covers (and contributing to the underwriting capital pool), and helps the DApps’ image in promoting consumer safety and security.

• Create a DeFi cover agent to advise users. The goal is to develop an AI-driven agent that can emulate the role of a traditional financial advisor and guide users through the intricate landscape of DeFi cover products. By combining AI and on-chain data, the agent could first analyse the user’s historical interactions and transactions, before scouring the list of DeFi cover options available, to recommend the most suitable DeFi cover tailored to the user’s specific needs, preferences and risk tolerance. This will serve as an efficient and user-centric way of purchasing DeFi covers.

For Cover Providers

• Encourage participation of smart contract auditors and protocols. The goal is to promote skin in the game, where those best placed to assess the risks of a particular DeFi product/service will be asked to support their claims and put their money where their mouth is.

  • For the case of smart contract auditors, DeFi cover providers can consider requesting for these auditors to back up their assessment by committing part of the fees that they charge as underwriting capital. In return, part of the proceeds from the premiums can be given to them.

  • The same principle will apply to partnerships with protocols. Protocols can be asked to self-assess their inherent risks, and depending on their assessment, they will be asked to commit a portion of their treasuries to the underwriting capital pool. The higher the rating that they give for their self-assessment, the more money they will be asked to commit. Similarly, in return, they will get a portion of the premiums received.

  • Pushing for such arrangements will help build trust amongst investors, encouraging greater participation in the product/service, as well as the cover policy. It also promotes the growth of the underwriting capital pool, giving cover providers more liquidity to work with.

• Create an exploits oracle. The goal is to create an oracle that will serve as the source of truth for whether or not an exploit occurred. The oracle could classify the kind of exploit, which contracts were exploited, and what funds were affected. An oracle like this will benefit all DeFi cover providers, who can use it to verify the exploits that they cover and streamline the claims assessment process.

Conclusion

Insurance (and cover) options are a key piece of DeFi that may be lacking today. The maturation of this sector will help promote trust and the overall growth of the DeFi ecosystem.

Ocular continues to be on the lookout for projects/founders that are actively building in the DeFi cover space - if this resonates with you, do feel free to reach out to us at crypto@ocular.vc and we would love to connect!

In September 2023, Singapore hosted Token2049, one of the world's largest web3 conferences. More than 10,000 attendees from over 5,000 companies participated in Token2049, which featured over 450 side events.

The event was a resounding success (kudos to the organizers!), and Ocular was thrilled to be a part of it. We had the pleasure of engaging with brilliant minds in the space, and connecting with new and old friends in the community. Inspired by our learnings and interactions, we would like to share our key observations and takeaways from the event.

Getting Over the Hump of 2022

1) Greater regulatory clarity

We discussed this point in our Focal Point piece on regulations, but our interactions at Token2049 reinforced our views that we are making good progress on the regulatory front. The consensus at Token2049 was that these regulatory developments are positive for the industry - they not only provide clearer guidelines for projects to navigate the web3 space, but also foster trust in the system, encouraging users to be part of the community.

As with all other disruptive technologies, the developments in web3 have thus far outpaced the speed at which regulations are formulated. Think back to the early days of Uber and Airbnb, when it was uncertain if these apps would be permitted to operate. The concept of a sharing economy was relatively new and unfamiliar to most people (including policymakers), leading to questions on how to effectively oversee and regulate these peer-to-peer interactions. While not all concerns have been addressed, Uber and Airbnb have both worked closely with the authorities to establish their own industry and both apps have thrived in recent years. Similar parallels can be drawn for web3. We are still in the early stages, and there is much work to be done to achieve greater regulatory clarity. Nevertheless, we remain optimistic that once regulations catch up, there will be a surge in adoption rates, catalyzing the growth of the web3 ecosystem.

2) Asia is still a bright spot for web3 communities

Out of the 10,000+ attendees at Token2049, 80% came from outside Singapore and they represented over 120 countries. The scale, diversity and enthusiasm of Token2049 this year have cemented Singapore’s status as an epicentre for web3.

Many shared that despite the series of negative events in 2022, which mostly centered around Asia, the positive sentiment towards web3 and the community strength in the region remains unparalleled. It is arguably stronger than in Europe and the US, where regulation overhang has dampened enthusiasm. At Token2049, multiple self-organized NFT events took place with local communities, including those for Azuki, BAYC and Pudgy Penguin holders. While the NFT scene may not be as vibrant as before, there is still significant interest in the space, especially amongst the Asian communities. It is refreshing to see the continued community engagement and passion shown for NFTs, and this highlights Asia’s potential as a hub for future NFT consumers.

Singapore is not the only country in Asia that has established itself as a web3 hub. Prior to Token2049, Seoul organized Korea Blockchain Week to bring together the brightest minds in the industry to discuss, redefine, and celebrate the future of finance. Following Token2049, Tokyo will also host DCentral, the largest gathering of dedicated web3 builders and innovators in Japan.

Overall, we see this trend of web3 hubs emerging worldwide as a positive development for the ecosystem. It ensures the presence of physical support structures for community members, and promotes web3 in places that may be less familiar with it. It also presents an opportunity to develop web3 in accordance with local contexts and needs, ensuring that web3 is ultimately able to improve our lives and those around us.

Bringing the Next Billion Users - A New Mental Model

1) Building the bridge between web2 and web3

With the events in 2022 still fresh in our minds, it is easy to forget how far web3 has come along as an industry in just 5 years. In early 2017, the total crypto market cap was around $20 billion; today it exceeds $1 trillion. We started with Bitcoin as a reserve of value, to Ethereum as the world computer, and now we have sophisticated infrastructure (in L1s, L2s and middleware) which enables a wide range of applications from DeFi to NFTs to social platforms.

Many acknowledged the significant progress that web3 has made, but also emphasized that there is still plenty of room for growth. For web3 to achieve mass adoption, it is vital to educate and encourage web2 users to participate in the space. The sector will have to adopt a new mental model - shifting its focus from appealing solely to existing native web3 users, to promoting and making web3 understandable to a much wider audience.

There are ongoing efforts to bridge web2 and web3, and these efforts are gradually paying off. At Token2049, we learned about institutions embracing and promoting web3 development. For example, Starbucks is actively crafting their NFT strategy; Franklin Templeton has invested in a Bitcoin wallet (as part of their digital asset investment strategy) and has recently filed for a spot Bitcoin ETF; and Sony is partnering with web3 firms to set up incubation programs.

The converse is true as well, with many web3 projects looking to incorporate well-known consumer brands. This can be seen with Yuga Labs’ (creators of CryptoPunks) collaboration with Tiffany & Co, where CryptoPunks holders could purchase an NFT to see their pixelated characters transform into a real-life Tiffany’s necklace. The goal is to provide utility to the NFTs beyond just being a profile picture, and blending digital experiences with physical ones, also known as a ‘phygital’ experience.

More education is needed for users to fully embrace the web3 experience, but the bridge between web2 and web3 is progressively being built. We are excited to see more examples of web2 and web3 coming together and this will encourage more people to participate in the combined space.

2) Ongoing search for apps that can drive mass adoption

One way to attract retail users to web3 is by creating apps that can pique their interest and capture their attention. The sector is still in search of a ‘super-app’ that appeals to both web2 and web3 users, fostering mass adoption. At Token2049, discussions revolved around the essential elements required to develop this ‘super-app’, and we believe that it boils down to these three factors:

• A convenient and user-friendly interface;

• A reliable and trustworthy platform; and

• A use-case that addresses existing pain points.

On the user interface, the app should be seamlessly integrated with existing platforms that we are familiar with. The deployment process, whether it is opening the app or signing up for an account, should be as frictionless as possible. Furthermore, the app’s interface should be easy to navigate, responsive and intuitive to sustain user interest.

Unfortunately, the series of events last year shook users’ confidence in web3. Web3 apps should serve as a trusted platform that upholds the required standards of compliance and governance. It will need to act transparently and put in place adequate safeguards to protect consumers.

Lastly, to retain users, the app must consistently address a pain point they are facing. At Token2049, the popular use cases cited were DeFi, including liquid staking, stablecoins and tokenizing real-world assets (be it bonds, commodities, real estate or debt); as well as gaming/metaverse plays featuring interactive non-player characters and user-generated content. These themes were also discussed in our 2023 thematic outlook. Regardless of the specific use case, the app will need to demonstrate that its proposed solution can resolve the issues that users are facing.

Conclusion

Token2049 served as a timely reminder that (i) despite being in the early stages, web3 has made significant progress in the past few years; and (ii) there is more work to be done to foster the growth of the sector, and there are exciting future developments to look forward to.

Ocular continues to be on the lookout for projects that are actively building in the space. If this resonates with you or if we missed the opportunity to speak with you during Token2049, do feel free to reach out to us at crypto@ocular.vc and we would love to connect!

One of the key crypto themes in our 2023 thematic outlook is the rise of clearer and more robust regulations in the space. This is an understandable and timely development, given how incidents in 2022 revealed the shortcomings and loopholes in the ecosystem.

At Ocular, we have been closely monitoring updates on the regulatory front, in view of the potential impact that it could have on businesses and investors, as well as the public’s confidence towards the ecosystem.

This article summarises our research on the current crypto regulatory landscape across eight key countries/regions, namely the US; EU; UK; Singapore; Hong Kong; Thailand; Dubai; and Brazil, as of July 2023. These countries/regions were chosen as they have been very active in developing their regulatory regime. While these regulations may continue to evolve, we have observed a few trends thus far and we will be discussing our views in this article.

5 Key Takeaways

The specific regulations that each of the eight countries/regions have put in place can be found in the next section. We would like to start by sharing our key takeaways on the recent regulatory developments to provide the necessary context for understanding the details of the regulations.

1) Much progress has been made since end-2022

The first point that we would like to highlight is that policymakers worldwide are starting to pay more attention to crypto. This could be partly due to the series of unfortunate events last year that undermined public confidence in the space, but could also be due to the growth of the sector in recent years that makes it difficult for policymakers to ignore it further.

We are seeing more countries globally working on developing a regulatory framework. Besides the eight countries/regions that we will deep dive into, South Africa, South Korea and Taiwan have all announced plans to introduce new crypto regulations.

This is positive news for the sector and its development. With more eyes and scrutiny on the space, we can expect it to be less of a “Wild West”. There will be greater clarity, structure and stability in the space, which will encourage more people to be a part of it.

2) Regulators are trying to find a balance between innovation and consumer protection

Across all the countries that are planning to regulate the crypto sector, we see a common theme - ultimately, countries are trying to find the sweet spot between encouraging growth, innovation and competition in the space; and protecting consumer interests and discouraging criminal activities.

This is perhaps why we see many countries adopting a seemingly hot-and-cold approach towards crypto. On one hand, countries are regulating crypto exchanges and companies to promote consumer safety, but on the other hand, we also see them encouraging entrepreneurial crypto/web3 activities given the benefits it may bring to the financial sector and the broader economy. This is true in the West, as well as in Asia, making it difficult to argue that either side is more receptive towards Web3.

Take the US for example - we read about the lawsuits against crypto exchanges (as described in detail in the next section), but President Biden has pledged to support the responsible development of digital assets. In late June 2023, the SEC also approved the first leveraged Bitcoin Futures ETF. Recently, Blackrock has re-applied to the SEC for a spot Bitcoin ETF. Observers are optimistic that it will be approved given that (i) Blackrock has joined forces with other notable companies, including Coinbase, on the application; and (ii) Blackrock’s track record for ETF applications with the SEC has been stellar (575 approved vs. 1 rejected). If approved, it will be a significant milestone for the sector.

In Singapore, despite the regulations on the sector (as outlined in the next section), the Monetary Authority of Singapore (MAS) published a whitepaper in June 2023, proposing a common protocol to specify conditions for the use of digital money such as CBDCs, tokenised bank deposits, and stablecoins. The whitepaper was supported by the release of software prototypes that demonstrate the concept of Purpose Bound Money (PBM), which enables senders to specify conditions, such as validity period and types of shops, when making transfers in digital money across different systems. These initiatives seek to promote the ongoing development and learning of PBM, and to foster interoperability across different platforms.

Elsewhere in Asia, we see that Thailand's Securities and Exchange Commission also approved a joint venture between Binance and Gulf Energy Development to operate a digital asset exchange and brokerage, granting Binance its first license in Southeast Asia, in May 2023.

3) All eyes are on US’s regulatory regime, but there are uncertainties ahead

While countries might generally be willing to push forth crypto regulations, the specific contexts that each country is operating in might hinder the speed at which the regulations can be rolled out.

This is true even in the US, the largest market of traditional finance, with much attention on it. Today, there appears to be a deadlock as it is unclear whether crypto is a security or a commodity. This, in turn, affects which agency has the mandate to regulate the sector and the scope of regulations that could be implemented. This podcast by the Brookings Institution provides a good overview of how the US typically regulates security and commodities, and the challenges it faces in the context of crypto.

Many observers are looking to the SEC’s court case with Ripple Labs, the developer of the Ripple blockchain and the network’s XRP token, as an indication of the definition that the US plans to adopt for crypto. Recently, a judge ruled that XRP was not a security when it was listed and sold on public exchanges to retail investors; however, XRP was a security when it was sold directly to institutional investors. The main reasoning here is that institutional investors were more likely to be aware of XRP’s securities-like traits when being pitched by Ripple back then, but those who bought XRP directly on an exchange were not as clued-in.

It remains to be seen whether this ruling would provide greater clarity on the definition of crypto in the US. For starters, there is no clear outcome from this split ruling since it gives credence to the security-or-not debate on either side. The SEC has also hinted that they might file an appeal on the ruling, so this matter might not be resolved just yet. More crucially, the judge’s ruling appeared to be based on how well retail investors understood crypto in 2020 when the XRP token was listed. At that time, the market capitalisation of crypto was a fraction of what it is now and regulators were just starting to form their views of the space. This has certainly changed in recent years, so it remains to be seen if this ruling can be extrapolated to new cryptos that have been launched. Until there is a resolution on the definition of crypto, we believe that it will be challenging for the US to move significantly on any regulatory framework to govern the crypto sector.

4) The impact of regulations will vary depending on the sector but overall, it is a net positive for the ecosystem

The impact of regulations will vary depending on the sector that the business/project is in. Thus far, the bulk of the regulations have been on centralised networks and platforms, partially because it is a space that regulators may have more information on through existing reporting channels, and also because it is more easily regulated since there is a single point of contact. Decentralised projects have remained largely untouched at the moment, although that may change moving forward.

Nevertheless, as a whole, we find that clearer and more robust guidelines are a net positive for the ecosystem. A structured regulatory framework will provide clearer paths for companies to comply, and potentially act as a moat to increase adoption. This can be seen in how the US; Brazil; and Hong Kong have experienced the second, third and fifth largest increase in crypto adoption rates worldwide over the last 3 years respectively. In Singapore, 43% of the 1,500 Singaporean respondents in a 2023 Independent Reserve survey.) said they own some amount of cryptocurrencies, up 3% points from the 2022 results. For some countries, such as Dubai, regulations are an explicit part of their strategy to attract more businesses and talent. Dubai is aiming to attract 1,000 blockchain and metaverse companies and create 40,000 virtual jobs by 2030.

5) The crypto sector is a risk and an opportunity - geographic arbitrage is taking shape with ever-evolving regulation

At Ocular, we believe that we are only at the start of the journey to regulate the space. For the eight countries/regions highlighted below, there are likely to be further developments over the next few months. In the EU, there are plans to expand MiCA to DeFi; NFTs; and lending and borrowing of crypto assets. Singapore will require cryptocurrency exchanges to keep customer assets in a trust by the end of the year.

The increased attention that countries are placing on crypto regulations has proved that it is likely too late to put the genie back into the bottle. Crypto has its inherent risks as we witnessed last year, but it also represents a large opportunity with its growth and promise, for countries who want to gain a foothold in the potential future financial system and talent hub. There is a large amount of crypto innovation and wealth floating around looking for friendly grounds, and it is now up to each country to craft their own policies to capture part of the flow. The “Geographic Arbitrage” is taking shape.

Dubai and Hong Kong are great examples of places that have developed friendly crypto policies in the hopes of consolidating their statuses as global financial hubs. Other countries such as Malta was the first jurisdiction in 2018 to enact a comprehensive regulatory framework to allow the crypto sector to operate and proliferate, earning the title of being the world’s first blockchain island.

Countries without these regulations may soon start to feel that they are losing out. They will thus be incentivised to develop their own regulations to strengthen the inflow of businesses and talents. Over time, the benefits that the first-movers can reap may fade away as more and more countries get up to speed on regulations, but this will also mean that globally, there is a level playing field where regulations become the norm.

Current State of Play

Below is a summary of the recent regulatory developments (as of July 2023) in eight key countries/regions, namely the US; EU; UK; Singapore; Hong Kong; Thailand; Dubai; and Brazil.

US

The US has launched a series of lawsuits against crypto exchanges and companies, as elaborated below. This is in line with the roadmap that the Biden administration released in January 2023 to mitigate crypto risk, which had encouraged regulators to “ramp up enforcement” and for Congress to “expand regulators’ powers”.

• On June 6, SEC charged Coinbase with operating its crypto asset trading platform as an unregistered national securities exchange, broker, and clearing agency. The SEC also charged Coinbase for failing to register the offer and sale of its crypto asset staking-as-a-service program.

• On June 5, SEC filed 13 charges against Binance entities and Founder Changpeng Zhao for operating unregistered exchanges, broker-dealers, and clearing agencies; misrepresenting trading controls and oversight on the Binance.US platform; and the unregistered offer and sale of securities.

• It also recently fined crypto exchange Kraken $30 million for its staking service, and ordered it to halt staking in the US.

EU

The EU formally signed its landmark Markets in Crypto Assets (MiCA) regulations into law, and published it in the Official Journal of the European Union on June 9. Key highlights of MiCA include:

• A crypto-asset service provider (CASP), which is any business or person that provides crypto-related services on a professional basis, including exchanges and trading platforms, portfolio managers and custody providers, will have to adhere to strong requirements to protect consumer funds and become liable in case they lose investors’ assets. They should “act honestly, fairly and professionally”, and they should ensure their security protocols are up to scratch. They also need to have a minimum amount of their “own funds”, and may be subject to additional regulation depending on their activities.

• Issuers of any type of crypto-asset are required to produce a “white paper,” informing potential holders about the token. They have to be published before the asset is offered to the public, and function a little bit like the prospectus a company produces before offering its shares for sale to the public on a stock exchange. The white paper should cover information on the issuer or the entity offering the asset, as well as what project will be carried out with the capital raised, and any rights and obligations attached to the token.

• Investors should be able to redeem their crypto assets at any time. This means issuers of these assets (including stablecoins) will need to have reserves that match their liabilities to holders of the token, and it needs to be insulated from other funds.

• It also imposes more disclosure obligations for all crypto businesses and the implementation of anti-money laundering (AML) and data security procedures.

UK

The UK passed the Financial Services and Markets Bill (FSMB) into law after it received royal assent in end-June 2023. The Bill gives regulators more power over the UK financial system, following UK’s exit from the EU, and seeks to support the safe adoption of crypto assets in the UK.

The Bill includes a proposal to regulate stablecoins under the country’s payments rules; amendments to treat all crypto as a regulated activity; and measures to supervise crypto promotions. On the last aspect, firms marketing crypto assets to British investors will be required to introduce a 24-hour “cooling-off period” for first-time buyers. Under the new rules which will come into effect from October 8, 2023, first-time investors will be subject to a 24-hour delay between requesting to purchase cryptocurrency and completing the purchase.

Under the Bill, the UK Treasury, Financial Conduct Authority, Bank of England, and the Payments Systems Regulator will be able to introduce and enforce rules to regulate the sector. New specific rules for the crypto sector could come shortly.

Singapore

Singapore issued two consultation papers in October 2022 containing proposed regulatory measures relating to (a) Digital Payment Token Service Providers (DPTSP); and (b) certain types of stablecoin issuers, i.e. for stablecoins which are pegged to a single currency (SCS) where the value of SCS in circulation exceeds S$5 million.

For DPTSP, the proposed measures cover three broad areas:

• Consumer Access. DPT service providers will be required to provide relevant risk disclosures to enable retail consumers to make informed decisions regarding cryptocurrency trading. They must also disallow the use of credit facilities and leverage by retail consumers for cryptocurrency trading.

• Business Conduct. DPT service providers will be required to implement proper segregation of customers’ assets, mitigate any potential conflicts of interest which arise from the multiple roles they perform, and establish processes for complaints handling.

• Technology Risks. Similar to other financial institutions such as banks, DPT service providers will be required to maintain high availability and recoverability of their critical systems.

For stablecoin issuers, the key proposed issuer requirements relate to:

• Value Stability. SCS issuers must hold reserve assets in cash, cash equivalents or short-dated sovereign debt securities that are at least equivalent to 100% of the par value of the outstanding SCS in circulation, and these assets must be denominated in the same currency as the pegged currency. Requirements on audit and segregation of reserves, and timely redemption at par value will also apply.

• Reference Currency. All SCS issued in Singapore can be pegged only to the Singapore dollar or any Group of Ten (G10) currencies.

• Disclosures. Stablecoin issuers will be required to publish a white paper disclosing details of the SCS, including the redemption rights of stablecoin holders.

• Prudential Standards. SCS issuers must, at all times, meet a base capital requirement of the higher of S$1 million or 50% of annual operating expenses of the SCS issuer. They are also required to hold liquid assets which are valued at higher of 50% of annual operating expenses or an amount assessed by the SCS issuer to be needed to achieve recovery or an orderly wind-down.

Hong Kong

In June 2023, Hong Kong launched a new licensing regime for crypto service providers to legalise retail crypto trading. Selected rules under the regime include:

• All trading platforms and exchanges are to apply for a licence to sell and market to Hong Kong consumers, failing which would result in fines and jail terms. Operators should also perform client checks to ensure that retail traders from China, where crypto trading is banned, will not be accepted.

• Crypto exchanges are to maintain at all times no less than 5,000,000 Hong Kong dollars ($640,000) in capital, and at the end of each month, submit the platform's available and required liquid capital, a summary of bank loans, advances, credit facilities as well as a profit and loss analysis to Hong Kong’s Securities and Futures Commission (SFC).

• Exchanges must store private keys on shore, and 98% of customer funds must be kept in cold wallets, which are stored offline for security.

• All tokens listed on exchanges will need to go through due diligence procedures before being listed on exchanges even if they are already listed on another platform. They will have to go through smart contract audits by independent assessors. Approved tokens on regulated exchanges need a 12-month "track record”.

• The SFC said it will consult a separate review on allowing derivatives and stablecoins for retail trading.

Thailand

In January 2023, the Securities and Exchange Commission (SEC) of Thailand introduced new rules for crypto custody services/virtual asset service providers (VASP) to guarantee efficient custody of digital assets. The regulations include three major requirements:

• The provision of policy and guidelines for overseeing the risk management of digital wallets and private keys. The rules require VASPs to communicate with regulators regarding such policies and provide action plans to ensure compliance.

• Crypto custodians are to provide policies and procedures for designing, developing and managing digital wallets and keys.

• Crypto custodians are to establish a contingency plan in case of unforeseen events that may affect the wallet management system.

Dubai

Dubai established the Virtual Assets Regulatory Authority (VARA) in March 2022, to regulate all activities related to the virtual assets sector throughout the Emirate, including special development zones and free zones, but excluding the Dubai International Financial Centre.

In February 2023, VARA issued its Virtual Assets and Related Activities Regulations 2023, which would apply to all virtual assets service providers (VASPs).

• The Regulations cover seven licensed virtual asset activities, including advisory, broker-dealer, custody, exchange, lending and borrowing, payments and remittance, and virtual assets management and investment services.

• All VASPs operating in Dubai must be licensed by VARA. To secure a license from VARA, VASPs must meet several requirements including, but not limited to:

  • demonstrating that the VASP has adequate financial resources to operate its business;

  • implementing solid customer due diligence procedures;

  • establishing effective policies and procedures in order to manage potential risks associated with virtual assets;

  • establishing adequate systems in relation to anti-money laundering and terrorist financing;

  • establishing effective governance controls; and

  • ensuring that senior management and employees are fit to carry out their assigned roles.

• VASPs operating in Dubai are now subject to increased regulatory requirements. VARA will monitor all VASPs to ensure that they comply with the Regulations, and may conduct regular inspections and audits to assess VASP compliance.

• The Regulations provide that the issuance of anonymity-enhanced cryptocurrencies and all virtual asset activities related to them are prohibited in Dubai.

• In addition to the Regulations, VARA has released several rulebooks, including the (i) Company Rulebook; (ii) Compliance and Risk Management Rulebook; (iii) Technology and Information Rulebook; and (iv) Market Conduct Rulebook, (the “Rulebooks”). VASPs licensed by VARA must comply with the provisions of all the Rulebooks.

Brazil

Brazil published a law in December 2022 increasing regulation of the crypto market and adding penalties for non-compliance.

Under the new law, virtual asset service providers (VASPs), with virtual assets defined as “a digital representation of value that can be traded or transferred by electronic means and used to make payments or for investment purposes” may only operate in Brazil with prior authorisation from a federal public administration body or entity. It creates a “virtual service provider” license, which is to be requested by digital asset companies, including exchanges and trading intermediaries.

VASPs must operate within certain guidelines, including good governance practices, transparency in operations and a risk-based approach, provision of information security and protection of personal data. They must also be in line with international AML and counter-terrorist financing standards. Non-compliance with the law could result in a fine and between four and eight years of imprisonment. Repeat offences will see the original penalties of Brazil’s AML laws increased by a third.

Over the past few months, we have seen how ChatGPT has taken the world by storm. It is estimated that ChatGPT reached 100 million monthly active users in Jan 2023, just two months after launch, making it the fastest-growing consumer application in history.

The popularity of ChatGPT has reignited conversations on the potential of artificial intelligence (AI). According to ChatGPT itself, AI is defined as the development of computer systems that can perform tasks that normally require human intelligence, such as visual perception, speech recognition, decision-making and language translation.

The attention around AI has piqued investors’ interest in the space and they have placed big bets on AI-related projects. AI startups received over $50 billion in funding across around 3,400 venture capital funding deals in 2022. The sub-field of Generative AI - the technology that ChatGPT is based on - experienced a more than 70% increase in funding in 2022, compared to the previous year.

Here at Ocular, we believe in the power of technology and are excited to see how AI continues to shape our world. The full capabilities of AI have yet to be uncovered and web3 is a potential area that AI can play a big role in. In this article, we will highlight the significance of AI in web3 and how the two concepts have converged to transform many fields of work. Nonetheless, this only marks the start of the journey. In the future, we foresee many other use cases in which AI can be integrated with web3, and this will create new opportunities for businesses and consumers alike.

Current State of Play

AI Projects Leveraging Web3 Capabilities

We have observed the rise of AI-focused projects adopting web3 technologies to safely and securely store, trade and share information. These technologies can also be used to encourage buy-in and participation from users.

An example of this is DeepBrain Chain, which is an open-source, decentralized platform for AI computing. The platform aims to provide a cost-efficient and private way for companies and organizations to access the computing power they need to train and run their AI models. The network uses blockchain technology to create a decentralized marketplace for computing resources, where users can buy and sell computing power with the use of their token, $DBC.

Other decentralized AI marketplaces include SingularityNET - for anyone to create, share, and monetize AI services at scale; and Fetch.ai - for anyone to share or trade data to enable the creation of intelligent autonomous agents, which can interact with other agents and help perform tasks such as data analysis, prediction, and decision-making.

In finance, there is Numerai, which is an AI-based hedge fund built by a network of data scientists. The project uses its token, $NMR, to crowdsource new datasets and machine learning models that can help interpret and predict the stock market. Numerai then combines the best prediction models to form its in-house Stake-Weighted Meta Model and uses the Meta Model to construct and inform its portfolio.

Web3 Projects Incorporating AI Techniques

The converse is true as well - web3 projects are tapping on the power of AI techniques to optimize and improve existing processes. This is particularly prevalent in gaming and NFTs.

In gaming, Delysium is one of the first web3 open-world, player-owned games that use AI-generated content and characters as the foundation of its metaverse. In Delysium, AI-powered MetaBeing characters have a complete neural brain system that drives their lives in the virtual world. These MetaBeings are also able to hold assets and automatically participate in game modes to earn cryptocurrencies, as human players do.

In NFTs, Alethea AI proposes the concept of iNFT, which is an NFT that incorporates AI to give it unique personality characteristics and the ability to interact with users. Optic is also building an NFT verification protocol based on AI, focusing on NFT fraud analysis and NFT value discovery within the community. The Optic intelligent engine retrieves the collection of NFTs in the market by learning the real NFT series. Optic then returns a match score indicating how well the checked NFT matches the real NFT. This is aimed at helping the NFT market achieve higher authenticity and transparency.

Beyond gaming and NFTs, we are also seeing other infrastructure projects adopt AI. An example of this is Push Protocol, a web3 communications network that enables cross-chain notifications and messaging for dApps, wallets and services. It intends to integrate a ChatGPT-equivalent chatbot, to make messaging on the blockchain more user-friendly and accessible to a wider audience.

Future Use Cases

While the current use cases of AI and web3 are exciting, we believe that we are only just getting started in exploring the possible synergies between the two fields. We envision that AI could potentially be used to solve many web3-related challenges (or vice versa), and below are some potentially interesting areas:

Finance

AI can help with dynamic investment strategies, including the real-time optimization of on-chain trades. By reviewing past investment decisions, analyzing macroeconomic conditions and predicting price movements based on market sentiments, AI can provide investors with valuable insights that can help them make more informed decisions and achieve better outcomes in their investments. AI can also improve liquidation procedures on DeFi to provide better protection for debt positions.

In addition, AI could also assist with the efficient pricing of illiquid assets, such as NFTs. By making sense of past transaction data and predicting future demand for these assets, AI can help investors to better understand the value of these assets and construct their portfolios more efficiently.

Through analyzing on-chain activities, AI could also facilitate on-chain credit scoring to improve capital efficiency in DeFi lending.

Marketing & Recommendations

Web3 data comes from a variety of sources, and it is often unstructured and noisy. AI can be used to preprocess and analyse these on-chain data, to generate more detailed and complete profiles of web3 users. This can be combined with existing web2 data on the user’s behaviours and preferences, allowing marketers to better understand their audience. Armed with this information, marketers will be able to provide more personalized recommendations to users, e.g. an upcoming web3 game that is in line with a user’s interest or a DeFi project that matches the user’s risk-reward appetite.

Smart Contract Auditing & Tax

One of the biggest productivity gains from AI that we are already seeing (and will continue to see) is the shortening of time needed for programming. The process of writing and reviewing code will become more efficient with AI’s assistance. Smart contract auditing is a natural extension of this capability. By looking through past audits that were conducted, AI can be trained to assist with the auditing of smart contracts. This will reduce the time taken and manpower needed for smart contract audits (there is often a backlog of contracts to be audited due to capacity constraints), and may even be more accurate than existing methods.

AI can also help with populating and auditing tax filings based on the user’s on-chain transactions. This will minimize the risk of errors and streamline the entire process.

Tokenomics & Airdrop Optimization

Tokenomics is the key element of determining a project’s incentive scheme, both internally and externally. Once set, it is difficult to adjust later on after token generation. For games, the in-game tokenomics is akin to monetary policy, which has to be carefully designed and managed. Currently, a lot of web3 startups’ tokenomics appear to be designed arbitrarily. Allocation and vesting schedules are often based on prior examples, which may not have stood the test of time and have subsequently turned out to be flawed. AI can potentially help simulate token dynamics during the design and planning stage, and optimize for various scenarios and interest alignment across teams, investors, users and the wider ecosystem.

Airdrops are an important one-off event to incentivize the right users and grow the community. It is a marketing expense and is often dilutive to the existing token holders. By leveraging AI, teams can better allocate airdrop to the true supporters of the project that will continue to help in its growth.

Gameplay Simulation

As many reputable web2 gaming studios are now entering the web3 space, we expect more advanced and complex web3 games, combining web2 strategies and web3 digital ownership. With such complexity, it will be greatly beneficial to have AI-powered gameplay simulation, to achieve an optimal balance between fun and monetary incentives.

Security

AI can be used for fraud detection, e.g. identifying malicious entities on-chain by tracking their geographical and behavioural data. It can also be trained to bypass aliases and draw links between multiple wallets/accounts.

The other aspect of security that AI can help with is content moderation and monitoring. AI can review and flag false/abusive content on web3 platforms.

Authentication

AI’s ability to generate high-quality content is growing exponentially - from text to images to audio to video. It is already quite difficult to tell whether something is generated by AI or humans.

The famous deepfake video of Morgan Freeman generated by AI still confuses a lot of people:

This is a concerning trend given how much Internet content could sway people’s perceptions and views. Web3 could be the potential solution to solve this issue - by implementing digital on-chain signatures or using zero-knowledge proofs to authenticate the content. Similar to users using their private keys to sign off on transactions, creators can use their private keys as well to authenticate the content created. Several on-chain projects have already enabled linking cryptographic public addresses to signal the authenticity of content, e.g. Lens Protocol and Mirror.

Below is a summary of the current and possible future use cases for AI and web3, and how they can address both web2 and web3 issues:

Possible Challenges

The road to a full convergence of web3 and AI is not easy and does come with its fair share of challenges.

Technical Difficulties

The first is technical difficulties, as it is not always easy to integrate the two concepts. At this juncture, we have yet to see large-scale AI models being built onto the blockchain, as issues of interoperability, data privacy, and security must be addressed and resolved before a successful integration can be achieved.

In addition, existing AI models might require massive amounts of parameters, which could make it difficult to run on mobile devices or laptops that are mainly used for recreational purposes. To overcome these challenges, researchers are developing new algorithms and models that are more efficient and require fewer parameters. These new models could help with the seamless integration and operation of AI technologies on the blockchain, thus enhancing the user experience and expanding the reach of these technologies to a wider audience.

Regulatory Landscape

Italy previously imposed a temporary ban on ChatGPT, given concerns raised by data protection regulators. The ban was later lifted after the company made changes to comply with age verification requirements. However, other countries might follow suit and introduce similar restrictions.

Elon Musk and Steve Wozniak also recently signed an open letter with more than 2,600 industry leaders and researchers to halt further AI development for 6 months.

Given that this is a relatively new space, regulatory frameworks are not yet fully in place. As a result, it is difficult to predict how regulators will view the use of AI technologies in the future. This uncertainty can potentially affect the pace of developments in the AI <> web3 space.

AI-related Concerns

One of the key issues surrounding AI-generated content is the uncertainty and ambiguity around ownership and copyright structure. This includes the challenge of determining who is allowed to profit from such content. There are many factors to consider when it comes to ownership and copyright of AI-generated content. For example, who created the AI technology that generated the content? Was it an individual or a company? If it was a company, who owns the rights to the technology? Additionally, who provided the data that the AI technology used to generate the content? Was it a single individual or a group of individuals? There is currently no consensus to address these difficult questions, and this may deter projects from adopting AI-related content due to the risks it may pose to their business model.

Even if AI-generated content is adopted, there is a separate issue of bias in the AI models that analyse and process data that may affect the accuracy and fairness of the end results. AI algorithms are not immune to reflecting human biases. In fact, they can even amplify and reinforce them. This is because AI algorithms are trained on historical data that may contain inherent biases, such as gender or ethnicity. As a result, AI algorithms may create or reinforce gender biases, such as giving better credit scores to men than women, or discriminating against certain ethnicities. While there are ways to mitigate this issue, such as training AI algorithms on a diverse and representative dataset and using techniques including adversarial training or counterfactual analysis to detect and reduce biases in AI algorithms, it is important to recognise that AI models are not completely impartial and cannot be fully relied upon yet.

Conclusion

The convergence of AI and web3 is a rapidly evolving field with vast potential. At this point, we are just scratching the surface of what's possible. As technology continues to improve and regulations become better defined, the potential use cases for AI and web3 will only continue to grow. From the way we conduct business to the way we live our everyday lives, the impact of this technology could be significant.

At Ocular, we are committed to staying at the forefront of these developments and keeping a close eye on this space. If you're keen on delving deeper into these concepts or are currently working on a project related to these areas, we'd be thrilled to hear from you. Feel free to reach out and let's discuss the exciting possibilities of AI and web3!

Introduction

2022 was a challenging year for web3. We witnessed the collapse of TerraLUNA, the fall of FTX, and several notable insolvencies including Three Arrows Capital, Voyager, Celsius and BlockFi. These events deeply impacted the sector, with the crypto market losing over $2 trillion in market cap in 2022 and public perception of web3 turning sour. Many suspect we have yet to feel the full magnitude of the contagion effect of these events, as they are still ongoing (e.g. the FTX trial), and we could reach new lows. These events, coupled with the current macro environment of high interest rates and a heightened risk of recession, suggest that there could still be stormy times ahead.

Here at Ocular, we are keeping a close watch on these developments. Nonetheless, we remain cautiously optimistic in our outlook on web3. The sector continues to attract talented builders and founders which will only help to iterate and improve on the already robust technology. According to a report by Electric Capital, there are over 23,000 monthly crypto developers as of Dec 2022, which is a 5% increase from 2021, and almost a 300% increase from 2018.

We see big brands (e.g. Starbucks and Nike) and financial institutions (e.g. Bridgewater and JP Morgan) getting involved, highlighting growing adoption and acceptance of web3. The sector also remains well-resourced - in 2022, venture capitalists invested more than $30 billion into crypto and blockchain startups despite a very difficult year, nearly matching the $31 billion invested in 2021. With the funding provided by private investors, teams will have the means to grow and scale their projects.

In our first Focal Point post for 2023, we wanted to share the ten key areas in the web3 space that we are watching out for this year. This keeps us focused on the road ahead, and reminds us that while we may be in a down cycle, there are still many good opportunities to invest behind and the fundamentals of web3 continue to strengthen. Here’s our list, in no particular order of importance.

Key Web3 Trends in 2023 

1) Bigger and better Ethereum

We discussed Ethereum in detail in our previous post (check it out if you haven't), but to recap, we are at the start of an inflection point in Ethereum’s scaling roadmap. There are 6 distinct sections to the roadmap - The Merge, The Surge, The Scourge, The Verge, The Purge, and The Splurge:

Source: Vitalik.eth

We are particularly excited about:

1. The Merge with the Shanghai upgrade scheduled for now April 2023, as it will enable the withdrawal of staked ETH. This will result in more liquidity in the market, but could also increase interest in ETH staking without having to go through liquid staking protocols; and 

2. The Surge with Danksharding, as part of the EIP-4844 upgrade. It will improve the speed and scalability of Ethereum, which allows for more transactions to be conducted at a lower cost. As the blockchain matures, we can expect its appeal to grow and more apps and use cases to be built on it.

2) Scalability and privacy - continued development of Layer2s

Solving the scalability trilemma

We shared the landscape of Layer2s in a previous post. To recap, Layer2s are networks that operate and lie on top of existing Layer1 protocols. It increases the throughput and efficiency of the underlying blockchain without tampering with any of its original decentralization or security characteristics.

Layer2s exploded in popularity in recent months. Take Optimism for example -  in Jan 2023, the ecosystem logged over 800,000 transactions in a single day, which was 2x the network activity seen in November 2022, and over 10x since June 2022. Another example is Arbitrum, which has seen its TVL double from November 2022 to February 2023, to about $1.93 billion currently.

This is in part due to the roll out of several important upgrades for Layer2s, including Arbitrum’s Nitro upgrade and StarkWare’s introduction of recursive proofs (and upgrade to Cairo v1.0). 

With much faster speed and lower fees, we expect more applications and blockchain games to leverage Layer2s to improve UX and onboard even more users. 

Improving privacy

A prominent Layer2 solution is zero-knowledge rollups (ZK-rollups). ZK-rollups bundle or “roll up” multiple transactions together off-chain before submitting a summary of the changes to the main blockchain. In the process, a cryptographic proof is generated to validate all the transactions. With the proof, it allows operators to prove the correctness of the statements without revealing the statements themselves and avoids the need to re-execute all of the transactions on the main blockchain. 

There are multiple applications for this technology, including improving on-chain privacy, as the full details of the transactions will now no longer need to be revealed, reducing the time and cost involved in processing these transactions. Notable examples of ZK-rollups include Aztec, Nightfall (which was developed by Polygon in partnership with EY), ZkSync and Scroll. 

We are optimistic that these advancements will push us closer to resolving the scalability trilemma, and better position blockchain adoption for enterprises that value immutable transaction data but also require privacy protections. 

With Optimism’s airdrop early this year and rumored token launch of Arbitrum and Starkware, we think 2023 will be an eventful year for Layer2s. 

3) Easier onboarding and more secured self-custody

To onboard the next billion users, we are always looking out for innovative infrastructure solutions that make the web3 experience more seamless. Nick Grossman has a piece called The Butter Thesis, describing interactions & experiences that are just so smooth. Rich, easy, delicious. Unfortunately, this is nothing like today’s experience. 

The series of unfortunate events in 2022 was a stark reminder of the adage: “Not your keys, not your coins”, and the importance of self-custody. However, there remains some resistance to owning a non-custodial wallet, given the costs involved as well as the daunting task of having to remember/safeguard seed phrases, which could represent a simple point of failure.

Multi-party computation (MPC) wallets can help to address this issue. Broadly speaking, MPC tech enables a set of parties who do not trust each other to jointly compute a function over their inputs while keeping those inputs private. MPC wallets use a paradigm called Threshold Signature Scheme (TSS), which allows for the creation and distribution of shares of a private key such that no single person or machine controls the private key entirely — this process is called Distributed Key Generation (DKG). We can then jointly generate a public key by combining the shares without exposing shares between the parties (see image below; and this 1kx research piece for more details).

Source: 1kx

MPC tech can be used to help different parties jointly control and manage a cryptocurrency wallet. Individuals can now log in with their emails, and split their key between their own devices and a crypto service provider, effectively gaining access to a form of two-factor authentication.

Today, MPC-based solutions have primarily targeted institutional clients such as funds, family offices, exchanges and custodians, with the retail investor base largely dependent on private-key wallets. However, this is changing - companies such as Web3Auth have enabled this feature in the Binance Chain wallet; Coinbase and MetaMask are also looking to integrate MPC in their wallets. 

With these developments in MPC tech, we could be looking at a safer and more convenient way to manage our wallets. This could greatly encourage seamless onboarding for web3 social, gaming and creator-economy projects, where the users may not necessarily be crypto-native and would like to enjoy the in-app experience without having to deal with the hassle of managing a non-custodial wallet. 

Other than better key management and security, there are many things wallets can improve on to provide better UI/UX and capture more value. Being the touch point with users, we are interested to see how wallets play a larger role in MEV (maximum extractable value), recommendation/advertisement and the web3 social realm. Security guardrails and prompt are also important features to help users safeguard their assets.

4) Bringing real-world assets on-chain

This involves creating digital tokens representing real-world assets (RWA) that can be further financialized on the blockchain. Some of the more popular examples of RWAs are cash, metal, real estate, corporate debt, treasury notes etc. The advantages of tokenizing RWAs include reducing financial transaction costs by eliminating intermediaries, creating safe and immutable digital assets that cannot be tampered with, and allowing anyone with an internet connection to buy and sell these tokens, which democratizes markets and unlocks liquidity/utility of the RWAs.

RWAs are a great way to combine traditional institutions with DeFi liquidity. This can be seen with Project Guardian, an initiative by the Monetary Authority of Singapore with DBS Bank, JPMorgan and SBI Digital to test asset tokenization and DeFi for banks. The first phase of testing involved trades in tokenized Singapore government securities, Singapore dollars, Japanese government bonds and Japanese yen. It was conducted on Polygon, using Aave, the DeFi lending platform, and Uniswap, the decentralized exchange. Separately, MakerDAO, a leading DeFi lender, has invested $500 million in US Treasuries and corporate bonds and teamed with banks to lend using RWAs as collateral.

RWAs are expected to grow in the coming years. According to a recent report from Coinbase, RWA tokenisation could become a multi-billion TVL opportunity in the next 3-5 yrs. An earlier report by BCG also mentioned that the total size of tokenized illiquid assets, including real estate and natural resources, could reach US$16.1 trillion by 2030.

In this high interest rate environment, we expect to see more similar real-world yield and fixed-income assets grow on-chain, as real-world portfolio allocations seek safer instruments in this current climate. With RWAs, the lines between TradFi and DeFi will be increasingly blurred and will encourage more mainstream users to come onboard. This will also unlock more financialization opportunities (e.g. credit) with the power of smart contracts. 

5) DeFi: Decentralized brokerage, credit, insurance, trade optimization powered by AI

The advent of the FTX episode highlighted the need for decentralized brokerage platforms to conduct our transactions. Currently, there are segregated DeFi protocols that can fulfill a particular need, e.g. Automated Market Makers, options, lending, synthetics etc., but there is a lack of notable on-chain alternatives that provide holistic services of spot, future, perps, and also able to aggregate liquidity for cross-chain lending.  

We think that both retail and institutional investors are increasingly looking for such decentralized alternatives and the demand will be significant. We hope that in 2023, these platforms will emerge and establish themselves as credible options, to safeguard and enhance our DeFi experience. 

Lending in DeFi so far mostly requires close to full or over-collateralization through depositing on-chain assets. Platforms like Centrifuge and Maple do allow under-collateralization; however they mostly conduct underwriting off-chain, and therefore are opaque and subject to default risks. We feel there are opportunities for more capital-efficient on-chain loans underwriting based on past blockchain transactions, or future income secured under smart contracts. The scope will be further broadened by the introduction of RWA on-chain. 

On-chain Insurance is another sector that has some early contenders (e.g. Nexus Mutual, InsurAce), but still largely underdeveloped and inefficient. With the series of events taking place in 2022, we think there will be more demand for individuals, projects as well as institutions to seek protection from hacks, depegging and other risks. Protocols designed with sophisticated premium calculation mechanisms and efficient pay-out processes could benefit from the tail wind and see rapid adoption. 

With Artificial Intelligence (AI) models getting increasing sophisticated and commercially-competitive, we feel there is also huge potential in leveraging AI and Machine Learning (ML) in DeFi. By utilizing ML algorithms to analyze market data, AI can optimize trades, yield farming strategies, assess credit risks, and detect fraudulent transactions, ultimately enhancing the performance and security of DeFi platforms. Moreover, AI can also assist in automating compliance with regulatory requirements, improving efficiency and reducing costs.

6) Move to decentralized identity systems (DID) and web3 social

At the moment, our online identities are mostly centralized. Users would create an account with a new application and the data would be stored on the platform. It is siloed to a single application which fully owns the user’s data. We then transitioned to a federated identity system, where identity providers offer single sign-on and social logins for apps (e.g. google log-in). Users could sign up for new applications without having to create new accounts, but data would still be managed centrally by a few large tech firms, creating a power asymmetry between users and the parties that manage our identities and data. Users do not have full autonomy over their data and how it is disclosed to others, nor do they have control over situations where the platforms shut them down and all the data is no longer accessible. 

In recent years, the misuse of customer data and random censorship in large corporations has put decentralization at the heart of the next era of internet identity. Moving forward, we can expect a move towards a decentralized model of identity, where data and permission will be portable and fully owned by the users. There is currently a full suite of apps to support the creation of a decentralized digital identity (as seen in the image below), and we envision the ecosystem to continue to grow in 2023. 

Source: 1kx

Pushing the envelope on DID further, there has also been work done to explore the concept of non-transferable “soulbound” tokens (SBTs), which will represent our commitments, credentials and affiliations. It will be akin to having an extended resume on-chain, and these SBTs can be attested by other wallets. This new identity paradigm sets the basis for meaningful and trustworthy online relationships to be formed, creating a richer and more pluralistic ecosystem that some have termed “decentralized societies''. This could be particularly applicable to Asia where the population is young and spends much of their time on social media platforms. The usage of SBTs are still in the early days, with a lot of applications being novel rather than useful.

Additionally, AI-powered web3 solutions can play a crucial role in enhancing data security and privacy. Decentralized AI models enable users to run machine learning algorithms on their own devices, reducing reliance on centralized servers and ensuring that sensitive data remains private. Smart contracts can automate data-sharing agreements, allowing users to securely exchange information without intermediaries. This could potentially present great attractiveness of decentralized social vs. centralized.

We look forward to true innovations in this space in 2023, supercharging and democratizing social platforms with crypto rails. 

7) On-chain attribution and targeting

Currently, in the web2 world, our identity lives on individual apps and browsers based on our in-app activities and interactions. Through the collection of data such as session cookies, location check-ins, and how often/long we play with certain links or features, firms will try to construct a profile of us that can be served with advertisements and other campaigns. However, this data is difficult to obtain and generally controlled by a few very large centralized tech platforms (e.g. Google, Meta, Bytedance), which do not share information with each other. 

Web3 and on-chain data is open, portable and precise. It contains a lot of information that defines our digital identity. Through our on-chain activities, we are able to identify financial or social information (think about NFT ownership and digital memberships); our opinions (when we participate in a governance vote); and our interests (when we mint a POAP). 

We feel marketing and ads based on on-chain data could be a trend to explore. Surprisingly, there still isn’t much on-chain recommendation or sophisticated targeting, which could have huge potential. It would be even more interesting to map web2 and web3 data sets, attributing user web2 activities with on-chain wallets and profiles, enabling cross-targeting in web2 and web3 spheres. 

The whole process of predictive analysis, sentiment analysis and smart ad placement can be further enhanced by AI, providing much more efficiency accuracy in insight generation, improving conversion and enhancing user experience.

For individual users and businesses, one could imagine how on-chain data could be used to prove the financial credibility of an individual, given their holdings, transaction history, as well as future income streams from staking/payment smart contracts. This could help create some form of on-chain credit scoring that will determine the credit limit for an individual or business or the amount of collateral they would have to post when requesting a loan.

In 2023, we look forward to projects that could leverage on-chain data to generate recommendations. This is especially important considering web3 applications will move towards mobile as well, with limited screen space and shorter attention spans from users. Projects that are able to aggregate cross-chain data and attribute accurately to users could discover the holy grail of on-chain ads and targeting, which historically has been an extremely lucrative sector.

8) Growth and maturity of blockchain games

GameFi continues to grow at a rapid pace. There are now 398 active blockchain games, defined as having at least one active wallet in the past 24 hours within the game, and this is a 92% increase from a year ago. In terms of users, the number of daily unique wallets interacting with game-related smart contracts surged to 1.3 million last year, a 46-fold increase over the 28,000 at the end of 2020. In 2022, VCs and angels invested over $3.4 billion in GameFi, and it is the top investment-based trend going into 2023.

GameFi remains a sector to watch in 2023. With so many resources and attention focused on the sector, we foresee high-quality blockchain games being produced, enticing mainstream gamers to come onboard, prioritizing the gaming experience rather than purely on the monetary incentives.

New game models with improved tokenomics

2021 and 2022 saw the rise of the play-to-earn model, which propelled the virality of several game tokens. With liquidity and prices coming down, these models generally find it difficult to sustain the same rate of growth, given reduced financial attractiveness. We feel 2023 will see innovative tokenomics models for blockchain games, for e.g. with tiered earning capabilities, where only good players can earn free tokens/items and the rest have to pay; and more creative in-game-taxation to truly accrue value to the platform. There are also play-to-own games popularized by Upland, as well as the recent bet-to-play category proposed by Messari. First and foremost, the games have to demonstrate strong communities and provide entertainment value. Additionally, with crypto rails, there is the potential to earn or own digital assets to trade across platforms and chains, allowing more efficient price discovery for these assets on and off-chain.

A game we are particularly excited about is Mighty Action Heroes by Mighty Bear Games. We spoke previously of our regard for the Mighty Bear Team (check it out here) and we can’t wait to see how they (alongside other gaming studios) seek to achieve the right balance between gameplay and financialisation.

Full on-chain (FOC) games

This refers to games where the entire game state and logic (not just in-game assets like currencies and NFTs.) are written to the blockchain.

Putting all states and logic on-chain unlocks all sorts of novel behaviors, including:

• Trustless collaboration between players via smart contracts. For multiplayer games that require players to form alliances and work on the basis that they would not betray each other, this is a game-changer (no pun intended). Through smart contracts, players can come together with the assurance that transactions/interactions are tracked and it would be executed flawlessly. No player will be able to tweak the design of the smart contract to cheat and gain an unfair advantage.

• The rise of smart contract-based players (as opposed to human players) that play the game optimally and can adapt to constantly evolving rules. It could add a new layer of difficulty and sophistication to the game, where players not only compete with each other, but also the different smart contract-based players.

• Third-party developers can spin off new games, given the code and logic of on-chain games will be made available which could spark a new wave of innovation in the gaming sector. Developers can also help each other improve their existing games by suggesting new features or optimising game processes.

While exciting, FOC game is still a novel concept. We expect general blockchain infrastructure to level up before these games can build sufficiently good in-game experiences to differentiate from traditional games. 

9) Decentralized Physical Infrastructure (DePIN)

DePIN refers to capital-intensive infrastructure projects using tokenization to coordinate and scale in the bootstrapping phase of network development. Individuals are tasked to help build the infrastructure in a decentralized manner, and they will be rewarded with tokens for their efforts. 

This marks a shift from the existing business model for infrastructure projects. Traditionally, corporations will invest significant amounts of time, energy and money to build and maintain the required physical infrastructure for their projects. Through DePIN, companies are trying to outsource this process to individuals, and they will monetise their project subsequently, when the infrastructure base has been built and there are more users onboard. This is the proposed economic flywheel of DePIN: 

Source: Messari

To be clear, this is not entirely a new concept. We have seen this used for data storage projects, such as Filecoin and Arweave, as well as for 5G networks, such as Helium. Some projects have had more success than others - ultimately, it depends on the utility that the service provides and whether users are attracted to the platform, rather than how the infrastructure is built. 

Nonetheless, we still see potential in DePIN as a new model that could reduce the barriers of entry for infrastructure projects. It reduces the initial CAPEX and friction with token incentivization. DePIN is also a useful way to decrease the OPEX involved in maintaining the system and can bring people from different communities together. 

It might take some time for DePIN projects to ramp up supply and demand, especially where existing infrastructure is good and affordable. However, in geographies where infrastructure is less developed and dominated by a few large monopolies with little incentive to make it cheaper, better or more accessible (including parts of Southeast Asia), there is an opportunity for DePIN projects to catch on, and we feel this is a sector in which the token economy has an advantage. 

10) Regulations tightening - Asia as a bright spot? 

We can’t end this post without talking about regulations. 2022 revealed the failings and gaps of crypto, and served as a harsh reminder for more robust and clearer regulations. In the US, the Treasury Department added sanctions against Tornado Cash, a decentralized crypto-mixing service for Ethereum. The SEC has an ongoing case against XRP creator Ripple Labs, whom it alleged sells XRP in unregistered securities sales. The SEC is also looking closely at the stablecoin market - it has issued a notice to Paxos for the issuance of Binance USD (or BUSD) and sued Terraform Labs for terraUSD (UST). In both instances, the SEC is asserting that BUSD and UST are securities, and should be registered under federal securities laws. It has also recently fined crypto exchange Kraken $30 million for its staking service. 

Policymakers are also mulling new laws to govern the sector, aiming to prevent another FTX-style implosion. In the UK, the deputy governor of the Bank of England called on Britain to “continue to bring these activities and entities within regulation.” In the US, Treasury Secretary Janet Yellen has called for customer funds to be segregated from company assets. There is also the Senate Agriculture Committee’s Digital Commodities Consumer Protection Act (DCCPA), which seeks to set strict rules on customers’ assets.

Most notably, the European Union is looking to push through the Markets in Crypto-Assets (MiCA) Regulation, which has been described as one of the first attempts globally at comprehensive regulation of cryptocurrency markets.

In Asia, regulators continue to keep a close eye on the sector, and are trying to find a sweet spot balancing consumer safety and innovation. Singapore has proposed measures to reduce risks to consumers from cryptocurrency trading, but has also supported the development of stablecoins as a medium of exchange after acknowledging it is not feasible to ban cryptocurrency given its role in the digital asset ecosystem. Hong Kong has gone a step further in proposing rules that would let retail investors trade certain “large-cap tokens” on licensed exchanges, as they signal their intention to be a leading cryptocurrency hub. 

In 2023, we are actively monitoring updates on the regulatory front. Regulation will potentially impact the existence of many businesses in crypto, especially in the DeFi and CeFi space. On the flipside, it will also allow others to create clear moats and become winners in their own domains. This is the technology forefront, and having clear but nuanced regulation frameworks sooner will inspire greater confidence amongst the public and institutions towards web3, which is essential for the growth of the ecosystem.

Conclusion

We will deep dive into many of these developments and trends in subsequent posts. After the dark clouds of 2022, we remain excited and passionate about the future of the web3 sector. We continue to be on the lookout for projects/founders that are actively building in the space - if this resonates with you, do feel free to reach out to us at crypto@ocular.vc and we would love to connect!

— Twitter @notdegenamy

Background

The much anticipated Ethereum Merge is upon us - on September 15 UTC, Ethereum mainnet will be merging with the proof-of-stake consensus layer, the Beacon Chain. The Beacon Chain was created on December 1, 2020, and has since existed as a separate blockchain to Mainnet, running in parallel.

This will be one of the most significant upgrades in Ethereum’s history, and took years of research and development.

The Merge will transition Ethereum into a more “green” protocol with much lower energy consumption. The Merge is the first step of a series of upgrades towards higher throughput and scalability. As outlined in Vitalik Buterin’s updated Ethereum roadmap, other upgrades include the Surge, Verge, Purge and Splurge.

Read till the end to find out what they mean.

Source: Ethereum Foundation

What are proof-of-work (PoW) and proof-of-stake (PoS)?

Since its launch in July 2015, Ethereum has used PoW consensus mechanism, similar to Bitcoin, where miners have to purchase expensive computing equipment (such as ASICs mining machines) to solve complicated mathematical problems and earn rewards for securing the chain. In essence, miners prove they have capital at risk by expending energy. Under PoS, validators explicitly stake their capital (ETH) into a smart contract on Ethereum, which acts as collateral that can be “slashed” if the validator behaves dishonestly or lazily. The validator is then responsible for checking that new blocks propagated over the network are valid and occasionally creating and propagating new blocks themselves.

Post merge, a full node will comprise of an execution node and a consensus node, with an engine API in the middle responsible for communication.

Why the change?

Ethereum is moving off of PoW to PoS because it is more secure, less energy-intensive, and better for implementing new scaling solutions.

When is the ETH Merge taking place?

After multiple rounds of tests performed on shadow forks and testnets (Ropsten, Sepolia and Goerli), the ETH Merge will take place at Mainnet Block Height 15,540,293 when Ethereum Mainnet hits the Terminal Total Difficulty (TTD) value of 58750000000000000000000.

The Merge will occur in two steps, Bellatrix consensus layer upgrade and Paris execution layer upgrade:

• Consensus Layer Upgrade (Bellatrix): 19:34 on 6 September, 2022 (GMT+8) >>>Completed

• Implementation Layer Upgrade (Paris): countdown here

What do users and dApps have to do?

The Merge will not cause any downtime, users do not have to do anything additional to secure their funds.

It will have minimal impact on smart contract and dApp developers, but the Merge does come with changes to consensus and certain changes to the application layer, which devs should pay attention to:

• block structure

• slot/block timing

• opcode changes

• sources of on-chain randomness

• concept of safe head and finalized blocks

Key changes after switching to PoS

Energy consumption

As there is no longer a need to operate electricity-consuming equipment to solve mathematical problems, energy consumption in PoS will reduce by 99.95% compared to PoW. With PoS enabled, the energy cost for Ethereum is just running a node—about 2.6 MWh per year. This makes Ethereum a significantly more environmentally friendly chain, and positions ETH well for ESG-sensitive institutional investors.

Issuance of new ETH

Currently under PoW, new ETH is issued from two sources:

1. Mining rewards on the execution layer (i.e. Mainnet): ~13,500 ETH/day (about 2.08 ETH per block of 13.3s)

2. Staking rewards on the consensus layer (i.e. Beacon Chain): ~1,700 ETH/day with about 14m ETH staked

After The Merge, issuance from the execution layer (#1) will go to zero, as validators do not have to purchase expensive hardware and pay high electricity costs, reducing the monetary incentive needed to secure the network. This means the issuance will reduce by ~90%, the amount of issuance reduction Bitcoin can only reach after 3 halving events. Therefore, PoS is often considered “the triple halving” event for ETH as shown in the below table. Additionally, PoS validators do not have as much pressure to sell block rewards to cover operating costs.

• Current # of ETH supply: 120.5m

On August 5 2021, EIP-1559 was passed: instead of paying the entire transaction fees to the miners, the base fee would be burnt. At gas of 17 Gwei and above, the burn could exceed issuance and therefore resulting in ETH supply being deflationary, which is extremely bullish for the ETH price.

• Assumed average gas: 17 Gwei

Gas fees & speed

The ETH Merge is a change of consensus mechanism, not an expansion of network capacity, and will not result in significantly lower gas fees.

Post the Merge, block times will reduce from 13.3 seconds to 12 seconds, translating into 10% increase in speed and reduction in fees. Users are unlikely to notice any significant differences.

Most of the speed improvement and fee reduction will be achieved on rollups and Layer 2s, not yet on Layer 1 till sharding is in effect sometime in 2023.

Staking rewards

Current ETH stakers receive ~4.1% APY. Post merger, this APY is estimated by J.P. Morgan to increase to ~8.5% as stakers start to also collect transaction fees previously captured by miners. Yield earned on staked ETH does not compound, but stakers can choose to stake the rewards back into the pool.

Withdrawals

To ensure network stability, it is not possible for stakers to immediately withdraw their ETH after the Merge goes through successfully. Withdrawals are planned for the Shanghai upgrade, the next major upgrade 6-12 months following the Merge. This means that newly issued ETH, though accumulating on the Beacon Chain, will remain locked and illiquid for at least 6-12 months following The Merge. That being said, validators will have immediate access to fee tips/Miner Extractible Value (MEV), which are not newly issued ETH.

There is also a withdrawal/deposit queue that allows a maximum of 43,200 ETH unlocked per day. This is to prevent an exodus or an attacker being able to withdraw their stake quickly, acting as another layer of protection for the network.

Network security: 51% attack

A 51% attack is a type of attack on a decentralized network where a group gains control of the majority of nodes. This would allow them to defraud the blockchain by reversing transactions and double spending the native token. In PoW, once miners command 51% of the mining capacity, they can perform a 51% attack until more mining power comes onboard, which generally takes time due to the physical setup requirements. It could also be difficult to identify the exact attacker. In PoS, there will be more transparency as the network will know the address of the attacking validator. The community could fork the chain and remove the attacking validator from the system, effectively burning their stake and reducing the ETH supply.

The incentive for attacking PoS is much lower than PoW. PoW attacks require a high amount of computation power, and after the attack they can direct the computing power somewhere else, or can attack the network over and over again till they lose 51%. If a large malicious party wants to do that, it is possible, and there is less skin in the game. For PoS, the attacker has to put up a significant amount of capital to buy out 51% of staked ETH and control 51% of validator nodes, and be prepared to lose everything after the network is attacked as price will likely plummet.

However, in PoW no one can be forked out of their own chain, PoS validators can theoretically collude and fork someone else out.

Maximum extractable value (MEV) after POS

The process of determining which transactions and what order is known as “block building”. Under PoW, “block building” - proposing and confirming a block - are all handled by the miners. Because mining requires specialized tools and knowledge, a small set of mining pool operators are responsible for the vast majority of block construction on PoW Ethereum, therefore extracting value for themselves through the process.

Flashbots estimates that over $670m MEV has been capture since beginning of 2020 on Ethereum.

Post Merge, a new set of actors is created - Block Builders. These Block Builders are specialist providers that will compete in a real-time marketplace to perform block construction on behalf of validators. This mean there will be separation between Block Builders and Proposers, and this will be codified in the network under what is known as the Proposer/Builder Separation (PBS).

This means that value will accrue more to validators and stakers. There is also possibility that wallets get paid by Block Builders to route transactions exclusively, in turn wallets pay users to use their wallets.

Future upgrades

The Merge is just part of the roadmap of a series of Ethereum upgrades, according to Vitalik Buterin’s “What Happens after the Merge”. The other key phases include the Surge, Verge, Purge and Splurge, together scaling Ethereum towards ~100,000 transactions per second.

Source: @vitalik.eth

Note that these are not stages but all happening in parallel.

Surge - Danksharding + rollups

Sharding will be an important scaling solution after the Merge. With sharding, validators will no longer be required to store all of this data themselves, but instead can use data techniques to confirm that the data has been made available by the network as a whole. This drastically reduces the cost of storing data on Layer 1 by reducing hardware requirements.

The 1st version of shard chains will only be responsible for data availability, but will not handle transactions. The 2nd version of shard chains will be able to also execute code and incorporate smart contracts. At the initial stage, throughput will be significantly increased with the launch of Proto-Danksharding (PDS) via EIP-4844. This is an interim step towards full Danksharding, which will increase throughput by additional orders of magnitude.

The Surge will concurrently focus on increasing scalability through Layer 2 rollups. Shard blocks will have big ‘blobs’ of data used by the Layer 2s to drive significantly greater scalable throughput, with Ethereum Layer 1 providing security.

Source: Dankrad Feist, Ethereum Foundation (Ethereum Research)

Verge

The Verge converts from Merkle Trees to Verkle Trees, which will allow for more simple validation of blocks and blockchain. This will optimize storage and reduce node size, ultimately increasing scalability.

Purge

The Purge reduces the hard drive space needed for validators. This eliminates historical data and bad debt, streamlines storage, which in turn reduces network congestion.

Splurge

These are miscellaneous upgrades that should simplify the use of Ethereum and make it more accessible to an average user.

Risks

Potential PoW fork (ETHW)

After the Merge, existing Ethereum miners will have to either switch to being validators or shut down. To put their expensive equipment to productive use, some of them have already switched to mining ETC (Ethereum Classic) instead, as seen from the drop of ETH hashrate, and significant increase of ETC hashrate:

Source: Coinwarz

Although most of the existing projects on Ethereum have indicated support of the PoS chain, Chandler Guo, one of the most prominent crypto miners, has proposed that miners continue to validate and add blocks to the current PoW Ethereum chain post-Merge.

This so-called contentious hard fork would keep the current Ethereum PoW chain alive, which Guo and supporters have termed EthereumPoW, with its native token being $ETHW. Holders of ETH ahead of the Merge will receive 1:1 ETHW after the potential fork. Binance has already expressed support for the potential ETHW airdrop and listed the ETHW future ahead of the Merge.

It is to be seen how much support EthereumPoW will gather. And the Ethereum foundation and the large community’s interest is for there to be a single chain where all the activities take place - PoS. Ethereum will seek to implement the Difficulty Bomb: a mechanism intended to incentivize the network to move away from proof of work by exponentially increasing the difficulty level of puzzles required for mining - making continued mining unviable.

Concentration of validators

To participate as a validator under PoS, a user will need to lock up 32 ETH, run commands on validator software, generate and manage their own private keys. For users who are not able to meet the minimum requirements to run their own validator nodes, staking-as-a-service is available via several platforms, which aggregate stakes and take a percentage of the yield.

According to a recent report by Nansen, top 5 staking services control 64% of staked ETH.

Lido has emerged as the largest staking platform for ETH. There are currently 14.4m ETH staked in total, and Lido accounts for ~31% according to Dune Analytics and Nansen’s report. This number could increase over time, which causes concerns over concentration of Ethereum validators, and Ethereum’s ability to resist censorship.

“Attending” the Merge

🥳 Ethereum Merge Viewing Party - Ethereum Foundation

Thursday, September 15 @ 11am Singapore Time

Gartner Hype Cycle (Source: Wikipedia)

Crypto gaming experienced its rise to the first Peak of Inflated Expectations in the past 18 months. Since we first started working on and observing crypto gaming back in 2017 up until 2020, crypto gaming was still a relatively niche segment within either gaming or crypto. It served mainly 2 groups of users: (1) gamblers who wanted an unregulated channel to gamble (that’s why there is a gambling vertical tracked by Dappradar for the longest time) and (2) true crypto-gamers. Guess what, there were not that many in the second category, but those guys were hard-core believers who were in it for fun or somewhat religious fun.

No. of blockchain game users and transaction volume in 2H2020 (Source: DAppRadar)

In 2021, crypto gaming caught up significantly when the DeFi hype was subsiding, and companies started infusing finance into gaming as a way to attract “mining”. Hence the GameFi concept was popularized in early 2021 with Axie Infinity holding the torch, marching from one high to another. The game indeed brought millions of non crypto native folks into a new paradigm where they could make a living. Some argued Play-to-Earn (P2E) a true innovation, while skeptics pointed out various similarities to pyramid schemes. Some praised P2E for creating jobs and banking the unbanked; while critics are pointing to the exact opposite as Axie fell into its own Trough of Disillusionment. Each side has its own merits, but we pick up several lessons learnt along the way.

Axie Infinity’s Market Cap and Revenue (Source: token terminal_)

While the current version of crypto gaming is not perfect, many of its components are anything from subtle to true innovation. Those components include (1) the application of NFT to tokenize in-game assets, giving true ownership of digital assets to gamers regardless of the faith of the game developers, (2) the use of tokenomics & NFT sales to bootstrap project development and ramp up user growth, and (3) most importantly, the introduction of a new gaming value chain where gaming distributors do not hold the ultimate power, something similar to what DeFi promises to TradFi. Perhaps the last point is also a dilemma playing out at some incumbent game makers / distributors. E.g. Steam and Minecraft are not fond of the idea so much since their metrics are often about competitive moat, retention and LTV which tend to be drained away when their ecosystems are opened up.

The rise and fall of Axie Infinity and the second generation of crypto games in the past 18 months could be a bug but could also be a feature of the last cycle that will inspire the next generation crypto game developers to keep working on and refining crypto gameplay. The number of GameFi projects continues growing (though not as fast as it used to be). Investors’ appetite remains relatively strong with c. US$4.1 billion of capital pouring into GameFi in 1H2022. New and ever larger gaming funds were launched, e.g. a16z launched a US$600 million gaming-focused fund in May, Immutable launched a US$500 million web3.0 gaming venture fund in June.

No. of crypto gaming projects launched (Source: Footprint Analytics (@KikiSmith), Binance Research)

GameFi funds raised (Source: Footprint Analytics (@KikiSmith), Binance Research)

Pleasantly, we feel that many traditional gaming companies are heading the crypto way. NCSoft Corp announced in Nov 2021 that it will unveil NFT-based, play-to-earn games in 2022. Square Enix sold US$300 million worth of valuable IP to fund its blockchain initiatives in May 2022; Epic Games raised US$2 billion to develop its metaverse efforts in April 2022. Ubisoft, EA, and Tencent have also entered the blockchain gaming space, albeit to different extents. These traditional companies are more likely to take relatively more measured approach toward blockchain uses, but will definitely bring in lots of game development experience to drive the next phase of the market.

Adoption S-curve illustrating various generations of NFT games (Source: Nansen)

At Ocular, we believe that the next generation of crypto games must achieve the right balance between gameplay and financialization, (vs. having tokenomics and earning at the center of the gameplay like today). Games need to be designed in a non-extractive spirit, i.e. they need to be fun and enjoyable first while earning is a component supplementing such purpose. Unfortunately, there is no exact formula to achieve that and the process will require a lot of testing. After all, creating a good and fun game is no easy task (see gaming’s very steep power law curve), let alone fixing a new category of gaming. As such, instead of backing strong crypto native teams doing games for the first time, we want to support strong studios which have experience making good games, the conviction in crypto gaming and the courage to stay and solve the existing problems despite another winter coming.

With this thesis, we found Mighty Bear (actually, some of us have known Simon and his team for over 4 years). They are definitely one of the strongest studios in SEA that we know, comprising of industry veterans with experience at the likes of King, Ubisoft, Lucasarts, Disney and Gameloft. The team has a proven track record of developing highly engaging games that appeal to universal audiences. And guess what! Despite having a good web2 gaming business, the Mighty Bear team form their conviction around how crypto gaming will be the future and transition themselves into a 100% crypto gaming studio.

As part of this pivot, the company also raised US$10 million funding led by Framework Ventures with participation of several gaming and crypto native funds including Ocular. Last week, Mighty Bear unveiled the first of its crypto battle royale game series: Mighty Action Heroes. We don’t want to go too much into the game details but if you are interested, do watch out for more updates here: @playmightyhero. (The game is still in development but will be launched very soon). We wish the Mighty Bear team a successful game launch and more fruits to come as they embark on the Web3.0 journey.

Best,

Ocular Team

We aim to post every one to two weeks. We hope you will enjoy this newsletter and provide us with valuable feedback. Do sign up below to receive the latest updates directly in your inbox!

Disclaimer: All write-ups in this substack channel are Ocular Ventures’ own opinions, and should not be misconstrued as investment advice or recommendations. Ocular Ventures does not hold positions in the projects discussed in this channel, unless otherwise stated. This content is intended for informational purposes only.

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Hi everyone,

It has been a few weeks since our last post. Hope everyone had a good Christmas / New Year holiday and is geared up for 2022. As you may know, the market has retreated significantly from its all-time highs in early-Nov 2021. Perhaps this is the much-needed cooldown that inspires crypto enthusiasts to reflect where we are in the market cycle and where we should go from here.

Our theses of various subsectors within the crypto market remain the same and we continue to be bullish about the long-term future of blockchain / web3.0 applications. In this piece, we will continue our discussion of Decentralized Finance (DeFi) that we started last month. Our discussion will revolve around DeFi’s current use cases, trends and existing shortcomings.

Recap

In the first piece of the DeFi Series, we discussed the history of Fintech, our expectations of where Fintech is heading, and how DeFi is converging with the latest Fintech trend. In short, while Fintech 1.0 was mostly about implementing software to modernize banking infrastructure; Fintech 2.0 runs deeper into the tech stack, unbundling the existing banking infrastructure into various ‘As-a-service’ layers and allowing non-banking actors to rebundle and offer various financial services. Fintech 3.0 runs even deeper, breaking down banking infra layers into primitives, making them composable and open-source and allowing for much faster, cheaper and better rebundling. With similar characteristics, we argued that DeFi could already fulfil the promises of Fintech 3.0.

As described earlier, the DeFi stack consists of 6 layers - each of which is permissionless, open-source, composable, interoperable, and interchangeable (as long as they are sitting on the same chain). For a team to build an application, they don’t need to reinvent the wheel. They just have to pick and choose the required Lego bricks and plug them together. This reduces the cost to build, time to market, and cost to operate, which collectively improves user experience and promotes financial inclusion.

To illustrate how the DeFi stack comes together, we will map it against the example of UniSwap, a DEX.

The DeFi stack can be illustrated through another example - this time, we take a look at Aave, the lending and borrowing platform.

Major DeFi Use Cases

The use cases of DeFi can be broken down into a few categories:

Decentralized Exchanges (DEXs)

Decentralized exchanges, or DEXs, are digital asset trading platforms that allow users to buy, sell and exchange their crypto assets without having to go through an intermediary or custodian.

Unlike centralized exchanges (CEXs), users of DEXs are not required to comply with KYC requirements and do not need to give up their personal data. In addition, users retain complete control over their assets at all times, as they hold custody over their private keys instead of having to entrust them to a third party. DEXs are also lauded for being more secure, as it shelters users from the risk of hacking and theft on CEXs, as well as the possibility of CEXs shutting down or pulling an exit scam.

There are various types of DEXs. Some of the earlier ones such as 0x, EtherDelta and StellarTerm rely on the traditional order book model where buyers are matched with sellers. While it is a model that is familiar to many investors and allows for greater transparency on the bid-ask spread, it runs the risk of price manipulation and it will be difficult to execute trades for illiquid markets.

Since 2020, a popular model known as Automated Market Makers (AMMs) has emerged, where the price of the crypto asset is determined algorithmically based on how much liquidity there is and how much the user wants to buy. The exact mathematical formula varies across AMMs, but a classic example will be x * y = k, where x is the amount of one token in the liquidity pool, and y is the amount of the other. In this formula, k is a fixed constant, meaning the pool’s total liquidity always has to remain the same. In addition, instead of having to rely on a counterparty to make a trade, users can interact directly with the liquidity pool through a smart contract and execute their trades. AMMs include Uniswap, SushiSwap and Balancer.

While AMMs have several advantages, many have realised that there are a few issues with the model. This includes high slippage for large orders especially for trading pairs with a smaller liquidity pool and impermanent loss for liquidity providers, which happens when the price ratio of deposited tokens changes after it is deposited in the pool, and users may have been better off holding on to the tokens instead of adding them to a pool.

To address the above concerns, some DEXs have adopted a hybrid model to tap on the advantages of both AMMs and on-chain order books. This allows for uninterrupted trading as market orders will be matched with the AMM as well as order book prices to find the best price for processing. Notable examples of DEXs that use the hybrid model include Raydium and OneSwap.

Due to the proliferation of DEXs, there are now also aggregators that combine and connect the liquidity of many sources, offering users the best price for their trades. Aggregators include 1inch, Slingshot and Paraswap.

Lending/Borrowing

A popular use case of DeFi relates to lending and borrowing, and it operates in a similar fashion to traditional money markets. Users who want to earn interest/yield can deposit (lend) their funds into a pool of liquidity, while borrowers can tap into this pool of liquidity and take out loans. The interest rates depend on the utilization rate of the pool, i.e. how much of the deposits have been borrowed.

The pool is highly liquid. Lenders can withdraw their funds at any time as it is not locked in, and borrowers can pay their loans back at their convenience. In addition, these protocols are borderless and permissionless - anyone from all over the world can participate in them. Given the supply and demand forces at play, the interest rates are variable and will be updated regularly.

To ensure credit-worthiness and protect the lenders, borrowers typically need to deposit collateral worth substantially more than the loan amount and maintain this collateral above a certain value threshold. For example, if a user wants to borrow $5k of USDC, they may need to deposit $10k of BTC or ETH. If the value of the collateral falls below a certain amount due to price volatility and the borrower does not add on, the collateral will usually be liquidated to repay the lender.

Given the overcollateralized nature of the loans and the repayment mechanisms in place, there is a minimal risk of defaults in DeFi lending/borrowing protocols. Prominent protocols include Maker, Aave, InstaDApp and Compound.

Staking

From a user’s standpoint, staking in DeFi is analogous to an interest-bearing savings account. Users receive interest (rewards) for participating in the network governance of Proof-of-Stake (POS) blockchains. This is done by either delegating digital assets to a validator node or by simply holding these digital assets in a compatible wallet. For their efforts in helping to secure the blockchain, users earn rewards that are automatically delivered by the network.

Some of the more popular POS assets that can be staked include Solana, Tezos, Cosmos, Avalanche and Cardano. Users can stake on applications such as Lido, Marinade Finance and Ankr or through wallets that support staking including Phantom, Atomic Wallet and Trust Wallet.

Yield Farming

Another popular way for users to generate passive income with their crypto assets is by engaging in yield farming, which is the practice of lending crypto assets to DeFi protocols in exchange for rewards. The assets which are lent out are used in liquidity pools to facilitate trades in DEXs as well as lending and borrowing. The incentives that lenders (or farmers) receive can be a percentage of the transaction fees, interest from borrowers or a governance token from the protocol (a process which is also known as liquidity mining).

Users can engage in yield farming on DeFi applications such as Curve Finance and Convex Finance. Farmers can contribute their assets for as long as they choose, which can be as short as a few days or as long as 1-2 years. The longer the duration, the greater the rewards.

Given the liquid nature of yield farming pools, yield rates often fluctuate and this incentivizes farmers to move platforms regularly in search of the best returns. However, farmers will incur gas fees each time they leave or enter a liquidity pool. To address this issue, projects such as Yearn Finance has implemented automatic yield farming tactics. The farmer’s assets will be deposited into a vault, which will constantly rebalance its assets among all of the liquidity pools to partake in the best yield farming possibilities.

Derivatives

Similar to the offerings in traditional finance, investors can invest in derivatives based on the crypto asset class, be it options, futures or perpetual contracts. Derivatives trading is growing increasingly popular. In Jun 2021, the total derivatives trading volumes for crypto totalled $3.2 trillion (c. $100 billion per day), which was higher than the total spot volumes at $2.7 trillion, giving it a market share of 53.8%.

There are several derivatives platforms on DeFi, including Synthetix, dYdX, Injective Protocol and Perpetual Protocol. On these applications, users can also engage in leveraged trading, up to 25x the original collateral.

Asset Management

In DeFi, retail users tend to be the custodians and managers of their own crypto assets, as the intent is to eliminate the need for intermediaries. To aid users in the process of investing, projects like TokenSets, Enzyme Finance and Symmetry have created crypto index funds, where there is a predetermined portfolio and investors can gain exposure to a wide range of assets at once. Users simply have to buy the token for the index, and the protocols will execute the trades on their behalf. An automatic rebalancing feature is also available.

For more active investors, these platforms also allow users to create and customise their own portfolios based on their risk-reward preferences and interests in the crypto market. Users can track and benchmark the past and present performance of their portfolios against the market, and make the necessary adjustments.

From a security perspective, to prevent unauthorised usage of crypto assets, there are also applications such as Gnosis Safe, BitGo and Electrum that offer users multi-signature wallets. Users can protect their wallets against any single point of failure by requiring multiple keys or logins to various devices to assess their funds.

How Has DeFi Evolved in the Past Few Years?

Through our interactions with the DeFi space, we have noticed a few key trends about DeFi:

Growth of DeFi

DeFi has experienced exponential growth in the past few years and is gaining mainstream popularity. As of Jan 2022, the total value locked (TVL) in DeFi is around $200 billion, up from around $230 million in Jan 2019. Dune Analytics also estimates that there are around 4.4 million DeFi users currently, and this is more than 3.5x the 1.2 million DeFi users at the start of 2021.

Breaking DeFi down into its various verticals, we see that lending and DEXs are most popular with users, as they currently command the majority of the TVL at $40.6 billion and $30.4 billion respectively. This is followed by asset management, which has a TVL of $16.9 billion.  

Looking ahead, we expect DeFi to gain further traction as developers work on improving the UI/UX, accessibility and security features of DeFi primitives for mass adoption.

There is significant funding in this sector to support these efforts and sustain the momentum. According to CB Insights, crypto exchanges captured the most funding of any other blockchain/crypto category in the third quarter of 2021, raising nearly $2 billion. This translates to a 22.4x increase from the $84M raised in the third quarter of 2020. Some expect DeFi, as a whole, to explode soon and could become an $800 billion industry by the end of this year. 

Rise of DeFi on Other Layer-1 Protocols

Over the past year, we have observed the rise of DeFi primitives being built on other layer-1 protocols, including Binance Smart Chain, Terra, Avalanche, Solana and Fantom. While the majority of DeFi primitives are still built on Ethereum today, the percentage share of TVL on Ethereum has dropped significantly since Jan 2021 (see below).  

Source: DeFi Llama

We believe that this trend can be explained by the following reasons:

High Gas Fees on Ethereum

As seen in the chart below, the average transaction cost on Ethereum has largely been above $20 in 2021 and it reached a high of around $70 at the end of May 2021.

Source: Twitter

Gas fees were costly both for users as well as developers. By the end of 2021, developers had to spend an average of over $300k to deploy their smart contracts on Ethereum (see chart below).

Source: Twitter

In light of the cost increases in interacting with Ethereum, it is unsurprising that users and developers started looking for cheaper alternatives in other layer-1 protocols to conduct their transactions. Chains like Solana and Terra offer much lower gas fees, with transaction fees being less than $1 on average.

Better Scalability on Other Layer-1 Protocols

Referencing a table that we had previously produced for the ‘Understanding Fantom’ piece, we note that besides lower gas fees, protocols such as Fantom, Solana, Terra and Avalanche all offer faster speeds and can manage a higher transaction throughput than Ethereum. As a result, these alternative layer-1 protocols are able to scale at a much faster pace, making it more suitable for DeFi which has high trading volumes.

Developer Incentive Mechanisms

Other layer-1 protocols have also rolled out several incentive mechanisms to attract developers and users to be a part of their ecosystem. With more rewards to be gained on these protocols, more have decided to embrace them.

Fantom, for example, announced a 370 million $FTM incentive program in Aug 2021 to encourage more projects to be built on the platform. In the same month, Avalanche also announced a $180 million liquidity mining incentive program to introduce more applications and assets to its DeFi ecosystem. Part of the incentives was also used to bring Aave and Curve to launch on Avalanche.

Ease of Developing Projects

Besides the incentives (and hence desire) given to developers to participate in other layer-1 protocols, developers have the ability to easily crossover to different protocols with the presence of Ethereum Virtual Machine (EVM) - the runtime environment for the Ethereum blockchain. Protocols such as Binance Smart Chain, Fantom and Avalanche are EVM-compatible, which means that projects on these protocols are interoperable with those on Ethereum and developers can tap on Ethereum’s tools and applications. Crypto developers will be familiar with the technology needed to build projects on these protocols, and this enables new projects to be surfaced and scaled up quickly.

Notable Community Leaders

The growth of alternative layer-1 protocols has been supported by many institutions and influential individuals. Binance Smart Chain, for example, is backed by Binance, which is one of the world’s largest centralized exchanges with over 28.6 million users as of October 2021. Fantom has Andre Cronje, who is acting as the project’s DeFi Architect. Andre is a prolific DeFi developer that founded Yearn Finance. For his contributions to the DeFi space, he was named the “DeFi Person of the Year” in 2020 by DeFi Prime. The endorsement of several well-regarded personnel has drawn significant mainstream attention towards these protocols and catalysed their growth. 

Symbiotic Relationship Between DeFi and GameFi

Over the past year, we have witnessed the meteoric rise of play-to-earn games, where gamers can truly own and trade their in-game assets for financial rewards. As of Jan 2022, the market cap for all play-to-earn games has exceeded $15 billion. It is estimated that there are currently over 2.5 million players in the blockchain-based gaming space, and experts believe that we could see 100 million players in the sector in the next few years.

As play-to-earn games become increasingly popular, gamers will also start turning their attention to DeFi primitives as they will have to interact with them to buy, sell, or exchange their tokens. Given the fun and easily accessible nature of GameFi, we can expect the mainstream population to first try out these play-to-earn games at the start of their crypto journey, before transitioning to DeFi as they become better acquainted with the ecosystem. GameFi will serve as a conduit to onboard more users to DeFi and enable mass adoption.

At a project-specific level, we are also starting to see the confluence of DeFi and GameFi. There are projects like DeFi Land (see images on gameplay below) on Solana that seeks to gamify DeFi, and educate gamers on how to interact with various DeFi protocols. In Sep 2021, DeFi Land raised $4.1 million in its Series A funding round from investors such as Alameda Research, Jump Capital and FTX.

Source: DeFi Land

BitSport, a blockchain-based eSports platform, also has a unique way of encouraging DeFi users to be part of the GameFi space. BitSport hosts four seasonal tournaments each year, and it is designed to bring together competitive gamers and eSports enthusiasts around the world. BitSport has enabled anyone to sponsor a tournament to earn passive returns. Users can stake stablecoins (DAI, USDT, USDC) to farm BFI token rewards (BitSport’s own token), which can be claimed at any time. Stakeholders can even pool their collective funds to sponsor their favourite BitSport gamer, allowing access to liquidity, while winning profits are distributed at a predetermined ratio amongst sponsorship pool participants and the gamer. By increasing interoperability and access to various digital currencies, BitSport aims to grow its ecosystem and increase synergies between DeFi token users and gamers.

Existing Shortcomings with ‘DeFi 1.0’

While DeFi holds great promise and potential, we acknowledge that it is still relatively nascent and will have to overcome a few shortcomings before we can fully leverage its advantages in Fintech 3.0. The concerns surrounding DeFi can be grouped into two categories: macro and micro, i.e. at the project level.  

Macro

At the macro level, the top issue on the agenda will be regulations. As DeFi is a recent development in the Fintech space, governments and key financial institutions around the world have yet to develop a robust regulatory framework to govern DeFi, but that is slowly changing. The Bank for International Settlements, an umbrella group for central banks, recently urged greater regulations on DeFi platforms as they are concerned that DeFi may not be as decentralized as advertised and may hurt the interests of users. In Sep 2021, the Securities and Exchange Commission (SEC) had also launched an investigation into Uniswap Labs, the developers behind Uniswap, to understand its workings and how Uniswap is marketed.

Stablecoins, a key unit of value in DeFi, have also experienced greater scrutiny from regulators lately. In Nov 2021, the Biden administration released a report stating that while stablecoins are a compelling payment option, they will need to be regulated and urged Congress to pass legislation to limit stablecoin issuance to insured banks. In Oct 2021, the Commodity Futures Trading Commission (CFTC) had also cracked down on Tether and ordered it to pay $41 million in fines for its false claims that the Tether stablecoin was fully backed by US dollars from 2016 to 2018.

At Ocular, we believe that greater regulations may not necessarily be a bad thing as it ensures a safer environment for users to participate in. Nonetheless, regulations may alter the way things operate in the DeFi space, and in light of this headwind, major DeFi labs will have to work closely with regulators and other stakeholders to balance all of the varied interests.

Micro

Projects also have to work through a few issues:

Scalability and Interoperability

As shared above, the majority of DeFi primitives are currently built on Ethereum, but Ethereum users are suffering from the high gas fees and long waiting times for transactions to be completed. This restricts the scalability of DeFi as Ethereum (in its present form before the ETH 2.0 upgrade) may not be the most suitable platform for high trading volumes, especially if the trades are coming in at quick succession.

While there are layer-2 scaling solutions being deployed on Ethereum and alternative layer-1 solutions have also started building their DeFi ecosystem, we note that the DeFi primitives may not be interoperable across blockchains. Users will have to conduct several transfers to bridge their assets from one protocol to another, and this will be costly and time-consuming.

Liquidity

DeFi primitives often require deep liquidity to ensure smooth operations. For example, DEXs will need liquidity for trades to be executed at the best price, while lending/borrowing protocols will need liquidity to offer loans at an attractive rate. However, one of the biggest issues that DeFi projects face is how to attract long-lasting liquidity sustainably.

To bootstrap themselves, what most DeFi projects do is allocate a significant chunk of their native tokens into the liquidity mining incentives. They offer users a high annual percentage yield (APY) to onboard users and rent the users’ liquidity. While this may help attract huge capital inflows at the start, the problem is that the vast majority of liquidity is not loyal and will move to the next project if it offers better incentives. Users will be driven by prices and should they pull out of a project, it will create huge selling pressure for the native token, which can then make or break a project. In addition, the process of sustaining liquidity in the project will incur perpetual variable costs as there is a need to continuously pay out the expected APY.

Capital Efficiency

Although the DeFi sector has seen rapid growth in its TVL, much of the capital that is in the ecosystem is not efficiently allocated, resulting in many assets remaining static and unused. In lending/borrowing primitives, for example, loans are often overcollateralized, which means borrowers have to lock up a significant portion of their base capital as collateral and this collateral does not generate any yields. Furthermore, these projects may have a low utilization ratio, where they may be more lenders than borrowers, resulting in large amounts of untapped capital.

Capital inefficiency is also an issue for staking or yield farming. Users will deposit their assets in a liquidity pool, and may receive a liquidity provider (LP) or aggregator token. These tokens represent the user’s share of the pool and will be used to redeem the underlying asset that has been contributed. However, at times, these tokens may not have other use cases, and they will sit idle in wallets before the users are ready to unstake.

In addition, users may not choose the optimal liquidity pool to maximise their rewards or may be reluctant to switch from primitives to primitives due to the perceived barriers of entry (e.g. multiple transactions with high fees and needing to re-learn how things work) and a status quo bias.

Security Risks

While DeFi eliminates the need for intermediaries and significantly reduces counterparty risks, there are other security risks that are present when interacting with DeFi primitives. Overall, security concerns about DeFi are rising, as the total number of hacking incidents on the blockchain and the total monetary losses have increased significantly over the past few years (see chart below). While it is in tandem with the increase in TVL in DeFi, it highlights that more needs to be done on the security front to protect users.

Source: Cointelegraph

The first security risk is flash loan attacks due to primitives relying on their reserves as the sole price oracle. Chainlink describes this process at a deeper level here, and below is a pictorial representation.

Source: Chainlink

To summarise, malicious actors with large amounts of funds due to flash loans (step 1) can manipulate the price of various tokens on a primitive with large trades (step 2), since some projects only use a single oracle that does not offer adequate market coverage. Given so, these actors are able to raise the reported value of the token used as collateral and lower the reported value of the token used as debt. This allows the attacker to borrow more funds than they should have been able to (step 3), and upon paying back the flash loan (step 4), they will be able to get away with a sizable profit. Flash loan attacks are not uncommon in DeFi - in 2021, victims included PancakeBunny who saw $200 million drained from its platform; Cream Finance who experienced a $130 million exploit; and Yearn Finance who lost $11 million.

The second risk is smart contract vulnerabilities. Smart contracts are driven by code and there are often cross-contract interactions. Through these exchanges, there may be flaws and bugs in the code that can be exploited. A common type of security attack is the reentrancy attack, and this happens when a contract calls an external contract before updating its own state. Malicious actors may take control of the external contract and potentially drain the main contract of its crypto assets. In 2020, we saw reentrancy attacks on Lendf.me and Uniswap, with about $25 million stolen from both protocols.

Another common exploit on smart contracts is to gain privileged access control. Many DeFi smart contracts include privileged functions, which are designed to only be called by the owner of the contract and have access controls in place to enforce this. In some cases, these access controls are missing or implemented in a way that allows an attacker to bypass them and drain value from the contract. The most notable example of this exploit happened to Poly Network in Aug 2021, with hackers stealing more than $600 million in assets before returning nearly all of it 48 hours later.

While some vulnerabilities in DeFi are complex, this is not always the case and a small coding error in smart contracts could sometimes lead to assets being compromised. An example of this can be seen with the Value DeFi hack in May 2021, which led to $11 million being lost. The line “initialized = true” was missing from the code, which meant that anyone could re-initialize the pool and set themselves as the operator of the contract. The attacker took advantage of the situation, re-initialized the pool and used a simple function to drain the staked tokens from the contract.

The third risk is leaked or stolen private keys, which serve as PIN codes to access blockchain accounts. By gaining hold of the private keys, malicious actors can control the transactions from the account. This happened to the EasyFi Defi protocol in Apr 2021 and the attacker got away with over $80 million. From what we understand, the attacker had gained access to the private keys to EasyFi’s admin account by hacking into the CEO’s computer and compromising the MetaMask wallet.

UI/UX

As DeFi primitives are relatively new, the UI/UX of the apps may not be as sophisticated as those in TradFi. In addition, as they are offering new financial products in a new asset class without the help of mainstream media to explain and educate them to the public, their products may not be easily understood. In several cases where DeFi applications require users to move assets across chains, new users might be discouraged by the number of execution steps needed and could lose interest in the products or make mistakes along the way (which might result in money loss). To achieve mass adoption, DeFi projects will need to simplify their apps’ UI/UX, abstract away as many technical steps as possible, and enable easier onboarding of new users.

Final Remarks

The DeFi community is cognizant of the above issues surrounding their ecosystem, and have taken steps to address them. In the next part of the DeFi series, we will discuss their efforts in greater detail and write about this new wave of DeFi innovation, also known as ‘DeFi 2.0’. In addition, we will seek the views of key players and experts in the DeFi space on what may lie ahead for the sector. It promises to be a great time of learning and sharing, and we cannot wait to write about our findings! Stay tuned for the next part to read more about it!  

In previous posts, we have written about specific L1/L2 projects, as well as the history and state of NFTs. By popular demand, in the next few editions, we will do a deep dive series into DeFi (Decentralized Finance).

Welcome again to the journey of Web 3 with us. Enjoy reading. Get in touch: crypto@ocular.vc

Disclaimer: All write-ups in this substack channel are Ocular Ventures’ own opinions, and should not be misconstrued as investment advice or recommendations. Ocular Ventures does not hold positions in the projects discussed in this channel, unless otherwise stated. This content is intended for informational purposes only.

Introduction

Have you ever heard the phrase: “Every company will be a Fintech company”? It was a term coined by Angela Strange at Andreessen Horowitz, who outlines her views in this video. To most people, this could be a controversial topic. Those at the forefront of Fintech and Crypto development may agree with this notion, which is based on the promise of ‘Embedded Finance’ (another concept that means non-financial companies could embed financial services into its offering from a third-party financial service provider). On the other hand, those who have been dealing with the legacy of traditional finance (‘TradFi’) may find it unrealistic based on their real-life pains dealing with TradFi providers.

(Source: Scott Adams)

As a group of venture capitalists who have studied the global Fintech space for many years, we gear more towards the former view and remain bullish on the accelerating development of Fintech. At the same time, we keep asking ourselves how Fintech development and adoption could progress even faster than its current pace; and how we as investors could help trigger such progress. The answer probably came in 2018 but it became a lot more obvious since the summer of 2020 when the financial use cases of crypto, collectively called Decentralized Finance (‘DeFi’), saw phenomenal growth in adoption and capital flow.

(Source: WaitButWhy)

Today, DeFi is the new Fintech that is merging with traditional Fintech and could potentially be the centre of the next Fintech wave. In this piece of writing, we will attempt to explain our thinking on where Fintech is headed and why DeFi will play a critical role in this development. This piece is also the first part of our three-part series on DeFi - the second piece will discuss the main verticals of DeFi and the trends we are observing, and the third piece will discuss the next steps for DeFi.

To understand where we are today, it’s always good to start with a walk through the history of Fintech and review where we are in the current cycle.

Past - Fintech 1.0: When the ‘Fin’ met the ‘Tech’ for the first time

Many moons ago, financial services were synonymous with banks, asset managers and to a certain extent, insurance providers. They were the primary actors of any economy handling deposits, lending and investment activities. Assets were kept physically in concrete or marble buildings, and operations were pretty much handled by pen and paper. For a long time, these financial institutions represent the trust that consumers and investors have in the financial system of a country. The bigger the building, the higher the trust.

(Source: Pinterest)

Then the mainframes and COBOL came in the 1960s and totally changed the industry. In the next half a century, financial institutions started spending money developing software and leveraging the Internet to enhance existing services or enable new services. Banks were able to interconnect, wire money across each other and even across countries electronically, allowing users to access products remotely via the Internet or ATMs.

We call this period the Fintech 1.0 era which is characterized by:

• Growing adoption of software by traditional financial institutions from electronic payment / clearing systems to core banking / software-enabled front offices.

• Software was mostly functionality-/ product-centric, monolithic, developed in-silos, sitting on-premises, making it hard to upgrade and replace. Even today, the cost of upgrading and replacing core banking is very expensive.

• Financial institutions’ mindset was all about value capturing and value extraction, resulting in walled-garden ecosystems. Banks considered their technologies, systems or databases, etc. their competitive moat and refused to let non-approved actors access their back-end. Fintech players were mostly limited to tech-enabled traditional actors or software vendors to those actors.

• Consumers conducted low-value activities virtually (e.g. checking account balance, making small transfers, repaying credit card loans) but needed to go to physical branches for high-value activities (e.g. opening a bank account, taking a loan, making a large cash transfer or withdrawal, signing a contract) because of the large trust gap of doing things virtually vs. physically and the high cost of reconciliation across various siloed systems.

Present - Fintech 2.0: Unbundling and re-bundling of financial services

In the 2000s, the cloud infrastructure industry took a great leap and enabled software (application) adoption to hit an inflexion point. In July 2002, Amazon created subsidiary Amazon Web Services, and in March and August 2006, Amazon introduced its Simple Storage Service (S3) and Elastic Compute Cloud (EC2) respectively. These products pioneered the usage of server virtualization to deliver Infrastructure-as-a-Service (IaaS) at a cheaper and on-demand pricing basis. In April 2008, Google released Google App Engine, a Platform-as-a-Service (PaaS – the first of its kind) proving fully maintained infrastructure and a deployment platform for users to create web applications using common languages such as Python, Node.js and PHP. In February 2010, Microsoft released Microsoft Azure.

The advancement of cloud infrastructure and the abstraction of software deployment and scalability challenges enabled Fintech to transition to its second era where financial institutions (especially banks) started moving their software to the cloud, systems became more modular and Software-as-a-Service (SaaS) made it easier to rebuild, buy and sell existing financial products.

(Source: a16z)

This trend is marked by the banking infrastructure stack being broken down into various layers and tech companies offering those individual layers as a service to other companies like Uber, Shopify, Earnin, etc. to offer financial services. There are many more existing examples in developed markets like the US or Europe, as illustrated by a16z here.

To summarize, the Fintech 2.0 era is characterized by:

• Unbundling banking infrastructure into various as-a-service layers which help non-financial companies easily re-bundle and build their own financial service offerings, shortening time to market and lowering development costs.

• Greater number of companies offering financial products. Greater number of consumers have access to financial products, thus increasing financial inclusivity.

• Consumers comfortably conducting a growing number of use cases online. Physical branches are becoming less important. Digital-only / neobanks are winning market shares from traditional physical banks especially in the younger/ more tech-savvy consumer segments.

• While traditional financial institutions’ mindset is still about value capturing and value extraction, their ecosystems are getting more open (e.g. in Europe, regulators even mandated open banking infrastructure). For tech companies offering financial services, the initial mindset has been about financially enabling more unbanked/underbanked consumers and ‘stealing’ existing consumers from traditional financial institutions. It’s about value growing first and value capturing later.

• Although the majority of fintech companies rely on more modern infrastructure, it is nearly impossible to avoid interacting with legacy tech because more than 40% of banks’ code is built on COBOL. This is still a big pain point for developers, and worse, they are also finding themselves building the same infrastructure again and again.

Outstanding issues with TradFi

While TradFi has made significant progress with the advent of the various Fintech waves, there remain a few issues with the industry that has yet to be resolved:

Inaccessible to the masses

Today, there are around 2 billion unbanked individuals globally. Some of the key reasons provided for why individuals do not have a bank account include not having sufficient money, long distances to the nearest bank and the lack of required documents. This is understandable, considering that many banks require individuals to have a minimum sum of money before processing their transactions as well as some form of identity documents and assurance of their credit history before onboarding them as customers. Given the need to perform verification checks, banks may also require individuals to register for an account in-person, creating an additional barrier to account ownership.

While it is important to carry out the necessary due diligence on consumers, the current process adopted by the traditional banking sector has led to certain individuals being excluded from the system. A recent study by the British research platform Merchant Machine revealed that Morocco, Vietnam, Egypt, Philippines and Mexico top the list of the most unbanked countries in the world with more than 60% of their population unbanked. In fact, the developed regions are not perfect role models either – around 21% of individuals in North America are unbanked. More can be done to promote greater financial inclusion.

Wavering public trust

The 2021 Edelman Trust Barometer, which surveyed 33,000+ respondents across 28 countries, showed that most individuals still do not have a high level of trust in the financial services sector. While trust levels in the sector have increased by 8% over the last decade, it remains in neutral territory with a score of 52 and it is behind many other industries, including entertainment, automotive and telecommunications.

While consumers would like banks to be reliable, approachable and supportive, many tend to have negative experiences that affect their trust levels in these institutions. This could include financial products that are often riddled with convoluted terms and conditions and an overall lack of transparency on fees; a lack of support and real-time updates on their financial standing which makes them feel unheard or unimportant; and privacy concerns where they may have been a data leak, resulting in consumers feeling that their money or personal information is at risk.

Banks need to build the trust imperative as it affects the overall effectiveness of the financial system. A high degree of confidence in banks will lead to increased contributions to the pooling of savings and expansion of credit by banks. Trust is also essential for the stability of the financial system, as it reduces the danger and intensity of bank runs.

Trust can also affect the bottom lines of banks. A 2018 Accenture study of 900 companies found that for the 54% of companies that experienced a drop in trustworthiness, it cost them about $180 billion in total revenue over just two years. While the percentage decline in revenue will vary by industry, it appears that the banking sector will be severely affected. Revenue growth for companies in the banking sector is projected to decrease by 21.8% should there be a drop in trust, highlighting the material importance of maintaining a high degree of public trust. 

Influenced by legacy

The above two issues that have been highlighted calls for the financial sector to undertake a closer look at their processes and potentially implement widespread changes in the industry. Nonetheless, the financial sector may find it difficult to push the envelope, given that it faces its own set of constraints and will likely be hampered by legacy issues.

While financial institutions themselves have long sought to expand their pool of consumers and include as many individuals as possible, the current KYC methods have proven effective in minimising default rates and there is little incentive to modify the process. In addition, financial institutions have a bottom line to meet and it may not be cost-effective to process transactions of significantly low value.

On the second issue of public trust, we understand that trust in banks has fallen sharply since the global financial crisis in 2008 and these events are likely to be embedded in a society’s memory and personal perceptions. The effects of a loss in trust are long-lasting and despite the best efforts of banks, it will likely take a while for public trust to be rebuilt. 

Given the challenges faced by banks today, it is clear that there is a need for a new model to revolutionize and galvanize the financial sector. It calls for a system that is permissionless and accessible to all; open-source and transparent to build public trust; and more importantly, not burdened by past experiences such that it can be easily adapted, unbundled and recomposed to meet the needs of consumers. Can you guess where we are heading towards?

Future - Fintech 3.0 and the open-source lego bricks

Before we reveal the answer, it is important to outline some key objectives of the next wave of transformation in the financial sector. Fintech 2.0 was pretty much about unbundling and re-bundling existing applications and infrastructure to create new services or enable non-financial companies to offer financial services. Does the question then become what’s next from here? What if you can slice the above mentioned “as a service” layers even further to the most basic primitives, thus creating a lot more lego bricks and enabling an even great number of possible combinations? What if these lego bricks are composable and interoperable, allowing companies to select and assemble them in any combination to meet specific user requirements? Even greater, what if we open-source all these lego bricks so others in the community can help make them better?

The logic here is that if the current Fintech 2.0 trend continues or runs deeper, we should see primitive, composable and open-source to be the themes of the coming decades. With the traditional financial services moving away from being service-centric to being tech-enabled, we believe that the next wave of Fintech will be tech-centric or driven by developers who see the opportunities to offer financial services in a faster, better and cheaper manner. As long as the incentives are aligned, good developers globally will join forces and accelerate the next wave.

Primitive

Primitive means the most basic, or in this context means components not developed nor derived from anything else, each component has been broken down as far as possible.

(Source: a16z)

As described earlier, Banking as a service (BaaS) companies typically choose a layer of the banking stack (e.g., compliance, core systems or payments), and provide that layer “as a service”. They help other companies launch new financial services in a faster and cheaper manner; and will provide tremendous value to the Fintech wannabes. But developers globally probably won’t sit still and be satisfied with this outcome yet. The world needs a programmable inventory of every type of lego bricks that could be combined in any permutation. We are only halfway there, and we have reasons to believe that such a vision is feasible since the same transformation actually has taken place in cloud computing. The introduction and application of programmatic and open-source building blocks such as microservices of applications or infrastructure as a service for computing resources are providing developers with maximum flexibility in building modern applications. With more lego bricks to assemble, developers can conduct thousands of re-bundling experiments and enable new services and new experiences.

Composable

Slicing banking infra down to financial primitives won’t be useful if we cannot assemble them seamlessly. This comes to the concept of composability. Composability means existing resources can be used as building blocks and programmed into higher-order applications. Composability allows developers to reuse someone else’s work, resulting in more rapid and compounding innovation. To paraphrase Chris Dixon’s tweet, compounding interest is money building on itself, while composability is software building on other software.

The challenge with composability is gauging its impact because, by nature, humans intuitively underestimate exponential growth. There is even a term for this phenomenon called the exponential growth bias. If compound interest is easy to quantify but difficult to feel, and software composability is even harder to quantify and to intuit. As such, historically, there has always been a trade-off between open vs close platform and self-build vs outsourcing vs off the shelf software. The ultimate consideration here is control:

• Control over end-user experience (how a company must ensure its products work all the time to meet user experience requirements); as well as

• Control over the economics of the supply-side resources (how a company must ensure its economics works especially when its products scale up significantly to serve a broader user base)

Cloud infrastructure is the solution to the high cost of scale and to a certain extent, the high friction of inter-application communication, as it technically abstracts away the hardware constraint and enables a new standard for software build to be more interoperable. More still needs to be done but things are progressing well. It is the trust factor that is difficult to resolve and we think that a trustless mechanism will be the ultimate piece of the puzzle needed to unlock composability. It will enable developers to build atop shared infrastructure without fear of lower-level dependencies.

Open-source

Open-source is source code that is made freely available for modification and redistribution. The idea of sharing source code on the Internet is not new and dated back to the days when the Internet was quite primitive with software distributed via UUCP, Usenet, IRC, and Gopher. Today the open-source movement often refers to a decentralized software development model that encourages open community cooperation. These communities consist of individual developers as well as large companies. Most notable projects in the tech world include Linux, Git, MySQL, Node.js, Docker, Hadoop, Spark, MongoDB, etc.

In the financial service industry, the open-source model is already making a tremendous impact in several ways:

• First, many countries (UK, Europe, Brazil, etc.) are implementing open banking regulations which mandate local banks to open up back-end infrastructure (payment, database, etc.). Open-source libraries (like The Open Banking Project) help banks cut short this process without redoing the same work that other banks have done as well as provide code / API for third parties to interact with legacy core banking.

• Second, many projects are going beyond just opening up but also creating the new standard for specific use cases. Moov uses open-source primitives to help developers embed payment into their software. Mifos is providing open-source core banking for any microfinance business. Red Hat is standardizing the API request process and data flow. Standardization makes the global financial system more connected and accessible.

• Last but not least, the open-source model is reducing the cost of and the barrier to banking software access, which in turn is powering thousands of fintech companies to offer financial services at cheaper costs and thus driving financial inclusion. Fintech companies unencumbered by legacy banking tech could enjoy lower costs to serve their customers and thus would be willing to lower their service fees.

Why do we need an open-source ecosystem for Fintech 3.0? Because innovation happens faster when the best and brightest all contribute to the common “knowledge goods”. Cost to build will be significantly reduced, hence incentivizing developers globally to develop whatever makes economic sense to them. The community mindset of open-source, in contrast with the control mindset described earlier, will go hand in hand with the other two components of Fintech 3.0 to complete a feedback loop of accelerated innovation.

DeFi at the centre of Fintech 3.0

With the above considerations in mind, we have high conviction that the next wave of Fintech development (aka Fintech 3.0) will be built on top of permissionless, trustless, composable and open-source primitives that are unencumbered by legacy issues. While we can wait many years for this wave to take shape, a solution already exists. It’s called DeFi (or Decentralized Finance).

DeFi is an umbrella term encompassing the vision of a financial system that functions without any intermediaries, such as banks, insurances or clearinghouses, and is operated by smart contracts. No specific institution or individual is needed for the functioning of DeFi, and users can rely solely on the mechanics of the smart contracts, which is open-source and available to all, to process their transactions.  Current DeFi development has already covered the key services that have been typically offered by TradFi, such as payments, lending, insurance, exchanges, money as well as central, commercial and investment banking services.

(Source: Consensys)

So how does DeFi work? According to Multicoin Capital, DeFi can be viewed as a stack of 6 distinct levels. The levels are distinct yet composable and can be built on each other. We will provide a brief summary of each layer below, but do check out their article for a detailed breakdown.

(Source: Multicoin Capital)

• Level 1: Units of Value. There is a need for assets to serve as collateral for derivatives, loans and leverage. In DeFi, these atomic units of value can be ETH, money market tokens or stablecoins, such as USDT and USDC.

• Level 2: Transaction Layer. With the atomic units of value in hand, users must be able to make transactions on-chain for DeFi to work. For this, it requires a layer-1 or layer-2 protocol with sufficient capacity to process the transactions. Examples of protocols include Solana (which we had covered previously), Ethereum, Avalanche, etc.

• Level 3: Oracles. Secure and verifiable inputs of market data are critical to the functioning of DeFi protocols. Price oracles serve to provide financial primitives with accurate data and enable them to trigger certain events, such as liquidations. The most popular oracles today include Chainlink, Band, Nest and Coinbase.

Levels 1, 2, and 3 comprise the core infrastructure of DeFi. Developers then build on these levels to create sophisticated and interoperable financial primitives, which will form levels 4-6.

• Level 4: DeFi Primitives. This is a level that many will be familiar with, as it refers to the DeFi applications that users interact with. It includes lending protocols, trading pools, order book exchanges, derivatives networks and asset management platforms. The primitives can also be thought of as a network, as each primitive can be used independently or in conjunction with other primitives to meet the needs of the users. Notable examples include Compound, Aave, Curve, Serum, dYdX and Set.

• Level 5: Aggregators. Aggregators live on top of primitives, and there are both supply-side and demand-side aggregators. Aggregators do not custody collateral assets – instead, they often provide smart contract instructions that enable users to interact with other DeFi applications. Aggregators include Yearn Finance, 1inch and Paraswap.

• Level 6: Wallets / Front Ends. The final level is wallets and other front ends (including relayers), which users rely on to store their units of value and engage DeFi Primitives. Notable examples include MetaMask, Phantom, Coinbase and Ledger.

Advantages of DeFi

We will discuss the use cases of DeFi (i.e. Level 4-6) in greater detail in Part 2 of this series, so stay tuned! In the meantime, with the workings of DeFi stack in mind, we would like to understand how DeFi measures up to TradFi. The table below summarises the features of both systems.

Summary

As seen above, DeFi has the potential to fulfil the promise of Fintech 3.0 and address the issues that TradFi currently faces. Given the advantages that DeFi brings, it is a model that financial systems around the world may move towards in the future, though their trajectories may be slightly different. In developed regions such as the US and Europe, they are currently in the midst of a transition from Fintech 2.0 to Fintech 3.0, where DeFi features prominently in the movement. Adoption of DeFi primitives may thus come slightly more seamlessly for these regions and we expect it to gain mainstream popularity soon.

On the other hand, for developing regions including Southeast Asia, we note that Fintech 2.0 has only just started to take shape, as the ecosystem is less mature. Nonetheless, given the high crypto adoption rates in the region, we may observe the region leapfrog into Fintech 3.0 directly, instead of waiting for the Fintech 2.0 wave to run its course. It is a scenario that could mirror that of e-payments previously – while developed countries had transitioned from cash to debit/credit cards to contactless payment (e.g. use of QR codes), some developing countries jumped straight to contactless payment from cash, bypassing debit/credit cards.

While we recognise the merits of DeFi, DeFi is not without its issues as well. In the next part of this DeFi series, we will cover the main verticals of DeFi as well as dive deeper into the key trends and concerns surrounding the sector. For Part 3 of the series, we will discuss the views of the DeFi community on what lies ahead for the sector, and their proposed solutions to address the issues that we had raised above. There will be interviews, exciting new ideas and more in-depth analysis of DeFi, so be sure to check out the articles when they are released!

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Introduction

Welcome back to part 2 of the NFT series. In this article we will be going through Gaming NFTs and wrapping up the section with overall thoughts on NFTs before a special interview section in part 3. Before we dive into Gaming NFTs, we should spend a bit of time on gaming in general and how it has evolved to provide a foundation for NFTs to proliferate.

The concept of paying for digital gaming assets is not a novel one. Players have been buying items or characters since the early 2000s, either through 3rd party platforms or on official stores that allowed companies to cash in on the lucrative market.

In 2007, a character on World of Warcraft was sold for ~$10,000 because he had one of the most rare items in the game. In the same year, an online version of Amsterdam was sold on eBay for $50,000 for the game Second Life.

Picture of Amsterdam in Second Life

More recently, gaming studios have set up their own cash shops to monetize player bases. World of Warcraft sells cosmetic in game items to players, while Valve allows players to buy and sell items and item skins on their auction platform. Recently, a player bought a CS:GO sniper rifle skin for $61,000 via the platform.

It’s not surprising that gaming would be a huge part of the NFT market given its characteristics, and the psyche of gamers. NFTs allow ownership of digital assets, provide a seamless way to buy and sell these assets, and with the right structure, allow owners to utilize and monetize said assets.

Picture of the $61,000 CS:GO sniper rifle skin

All it needed was the NFT ecosystem to blossom, and for creative minds to start putting their heads together to build out gaming ecosystems for NFTs to thrive in.

Axie Infinity – the new standard for “play to earn”?

Axie Infinity is a “play-to-earn” pet training game and virtual world built on the Ethereum blockchain founded by Trung Nruyen. In the game, players can collect, breed, battle and trade in-game pets called Axies.

Axies battling it out

According to their white paper, the founding team wanted to remedy a fundamental flaw in the Web2 gaming model: value generated in games like Fornite accrued solely to the platform owners and disempowered users. Axie Infinity was a way for users to gain control of their digital assets and swap the economics back in favor to the users.

How is this “Play-to-earn” (P2E) and why it is so powerful

In Axie Infinity, players can earn through the following ways:

1. Farming Smooth Love Potion (SLP) tokens and converting them into fiat. SLP is the foundation element of the Axie Infinity economy as it is the reward when a player completes daily quests or wins an Axie match. Depending on experience, time input, and level of the Axies used to battle, an average player can expect to earn around 200-400 SLP a day, and top players with powerful Axies can earn ~600 SLP a day.

   

   (Data source: Coinmarketcap)

2. Breeding and selling Axies to other players. Like Pokemon, Axies can be bred with one another to produce children. This requires a combination of SLP and AXS tokens (AXS is the native Axie Infinity governance token).

   Axie Breeding – note the SLP token requirement and breeding fee of 1 AXS

   

3. Starting an Axie Scholarship. Each playe requires a team of 3 Axies to enter a match. While many people are interested to play and earn in the games, they may not have the staring capital quired to purchase their Axies upfront (which will cost approximately US$1,000 and more). These people then can become scholars. These Scholars are run by managers who have lots of Axies but lack time to play. The earnings in the form of SLP tokens are divided on an agreed upon percenrage, usually in the range of 70/30 or 60/40 tilted towards the Scholars.

4. Investing in Lunacia Land. Lunacia is the homeland of Axies and is divided into tokenized plots which can be upgraded over time using resources. Land can spawn resources (AXS and other in game materials) that can benefit players. These lands can also be sold off for in game currency.

Given the recent covid job market, many people in developing countries have suffered from loss or reduce of income, Axie Infinity remains a lucrative way for players to utilize their free time to earn something extra on the side. 200 – 400 SLP tokens per day of grinding out on Axie Infinity equates to roughly $14 – $28 per day, which comes up to between $5,000 - $10,000 a year. For example, the year earnings is significantly above the average salary of $3,218 per year in the Philippines.

There is a huge pull factor for players from developing nations as playing Axie could easily double their annual income. Given more time, Axie could come up with ways to incentive players further – especially since they recently raised a $152 million Series B from a16z, Accel and Paradigm. Proceeds will be used to expand its team and build its own distribution platform to support game developers.

Axie Infinity’s diverse diverse ecosystem is a shining example for other game developers to refer to while trying to build out their own gaming ecosystems. An interesting phenomenon is the rise of guilds like Yield Guild Games, a Philippines startup that bridges the real world with the metaverse. The startup brings together Axie Infinity players and lends Axies to these players, which helps to remove one of the barriers to entry – the expensive amount of capital needed to build out a players’ first Axie team.

In essence this is an Axie scholarship, just scaled up multiple times with their own token which provides autonomy to design and reward the startup founders. Players within Yield Guild Games are incentivized through Axie tokens, SLP tokens and the native YGG tokens which creates a powerful feedback loop for the startup. These guilds are not only looking to launch on Axie, but across other NFT games such as Animoca Brand’s Sandbox, Parallel Life, League of Kingdoms, and others.

An overview of the Axie Infinity ecosystem

(Data source: Twitter)

There are other play-to-earn models that are being built which mirror Web2 games – Gods Unchained is very similar to Hearthstone, while Parallel Life is similar to Magic the Gathering: Arena. The space feels like the early days of web2.0, where creators were referring to web1.0 concepts and building duplicates of them. However, like what we saw in web2.0 – we believe that given enough time, new concepts and new ideas would start to bear fruit and become the gold standard or AAA rated games of the future.

We believe that that this is a big innovation in gaming, evolving from a service model to an ownership model. GameFi (an intersection between Gaming and Finance) has also become an important channel to attract users into the decentralized world of finance. Users can now enjoy earning monetary rewards while playing different games, all of which culminates to learning how to use DeFi applications to cash out or swap their rewards. We expect a lot of the P2E games to start popping up soon, and eventually these games will start to incorporate NFTs to retain users on their platform.

Loot – A decentralized way to build games?

Loot is a collection of 8,000 unique NFTs which represents bags of adventurer gear. The NFT collection was launched by Dom Hofmann (co-creator of Vine) and was intended to be a side project where users could claim the NFT by just paying gas. Dom intended the project to be an unfiltered, uncensored building block for stories, experiences, games that would be empower the community to build out for themselves. Putting it another way, it would be a completely decentralized way of building a metaverse.

Dom’s inaugural post for Loot

(Data source: Twitter)

Hoffman’s bet on a decentralized gaming metaverse paid off – in 5 days, Loot bags were resold for $46 million and had a market cap of $180 million. Sure, Hoffman’s fame might have played a part in building hype and curiosity around the NFT mint. But Loot’s success was built upon the community which came together and started iterating on the building blocks which Hoffman provided.

Loot’s discord started to rapidly fill up, with Loot holders and non-Loot holders who were keen on contributing to the Loot metaverse. Guilds, the foundation of every game, started popping up and attracting like minded followers to join their cause and to build adventures around Loot. A financial ecosystem called Lootmart was built to accommodate players who were seeking individual items to upgrade their adventurer in the Loot universe.

Lootmart on Twitter

(Data source: Twitter)

But at the end of the day, Loot was envisioned as the building blocks for the community to build games on top of it. Dom never built a game for players to participate in. And build the community did. Games such as Loot Infinity, On Chain World Boss started to manifest itself on the community boards. Artists started rendering Loot characters for owners of Loot bags. All of which pointed to signs of a healthy ecosystem which could continue to push the community forward and create more utility and ultimately create value for Loot holders.

Loot character based on Loot #1 NFT

(Data source: Twitter)

The question that some might have is – what is driving and sustaining the value of Loot? Ultimately, it’s 8000 randomly generated words on a screen. How does one ascribe value to it?

Our take on it is this. Right now, player agency is key – the capacity of individuals to act independently and make free choices is a driving force in today’s world. Bandersnatch, the “choose your adventure” episode of Black Mirror received huge fanfare and garnered two Primetime Emmy Awards. Until Dawn, The Wolf Among Us and Undertale are some games that have the “choose your adventure” element. Avichal Garg at Electric Capital likens Loot to a deck of playing cards, where on its own its just sturdy paper with drawings on it. But with some imagination, it becomes the base for Solitaire, Poker and other games. The player agency which Loot provides is the true value of the underlying Loot itself. The NFT is only as valuable as the ecosystem and utility it brings. Given enough time and imagination, the games on which Loot is the foundation will provide value for Loot holders.

But the opportunity for Loot is also its biggest challenge. Can Loot’s community continue to build and iterate? Can a decentralized community come together and create value for themselves and others? This utility could come in the form of strategy games like Axie Infinity where Loot items are used in turn-based combat games. Where the art is built on what has already been created by the community. At the end of the day, it all comes back to how players and users utilize the agency provided by Dom Hoffman.

The end, or the beginning?

There’s a common theme of value creation being driven from utility and community across both NFT articles. This feeds back into the larger theme around cryptocurrencies – value ascribed to tokens are driven from the utility derived from owning the token, and the community that can create hype around it. Which is like startup companies in the real world – the value of the startup is derived from the utility it provides to the users, and the ecosystem it creates for its users.

Can NFTs continue to hold the value currently ascribed to them? Would they hold up in a bear market? Only time would tell, but one should look at NFTs the same way as investing into alt coins – find ones that have strong staying power, if not, make sure you’re ok holding them throughout the cycle

There are three main comments that we’ll leave with users as we move on to the next part of this series of articles on NFTs – pricing, use cases and getting to mainstream.

Pricing

They say beauty is in the eye of the beholder (beHODLer even). And it applies to NFTs as well. NFT pricing is fluid because no one really knows how much a digital asset is worth, let alone a digital asset promising some utility in the future. Plus, NFTs are priced in the base currency – it is easier for someone to spend 0.03ETH on a JPEG, than to shell out $112 on the same thing. Even though 0.03ETH = ~$112, our human brains are numbed to a smaller number and not converting it to real currency before clicking the purchase button.

The analogy to draw here is between the art world and the NFT world. Art pricing is subjective. No one can explain why one would value a Van Gogh at $30 million instead of $10 million. To the collectors and the people in the art world, there is meaning behind the purchase. However, to the people looking from outside the fishbowl, they can’t comprehend it. Similarly, dropping 100ETH for a Cryptopunk or 50ETH for a Bored Ape Yacht Club is a no brainer for people in the ecosystem, but blows the minds of people outside of it.

Use cases

Currently, NFTs are generally used in a basic manner – rewards for participating in activities like gaming or being traded on platforms like Opensea. But underlying this basic layer is a strong use case which has started to disintermediate traditional industries like the art world. As mentioned in Part 1, NFTs have empowered artists to directly interact with their audience without middlemen, or constraints of geography. Royalty collection becomes fair as every transaction is locked onto the blockchain. Instead of selling creations to a platform or an agency, they can now own and earn from their own pieces.

We believe the next step is for the music industry as it shares similar characteristics with the art world. 3LAU and other musicians are pioneers in this space, and we look forward to more musicians embracing NFTs soon. Another industry that could soon embrace fungibility is the real estate industry, and we have started to see early entrants like CitiDAO try to tokenize real estate.

Getting to mainstream

The question front and center on people’s minds is – when do NFTs become mainstream? For one, the steps that the community has taken is a great first step:

1. Get celebrities like Steph Curry, Tom Bradley, Renee Witherspoon, Mike Tyson, Snoop Dogg on board and get them to preach the good word to their followers

2. Get recognition from “pillars of the community” such as Sotheby’s and Christie’s through auctioning pieces of NFTs

3. Create massive hype through transacted volumes and news articles

4. Create accessibility to NFT games such as Ronin as an on-ramp tool for Axie Infinity. This allows non crypto natives to be able to find their way onto NFT game metaverses with ease

But what else can be done to elevate NFTs to the next level?

1. Collectibles in the form of NFL x Dapperlabs

2. Fantasy sports in the form of Sorare’s platform

3. Pokemon in the form of Axie Infinity’s ecosystem

4. Trading card games like Hearthstone or Magic the Gathering in the form of Parallel Life or Gods Unchained

5. Comics in the form of DC Comics NFT

6. Create interoperable NFTs across multiple alternative chains (Tezos, Fantom, Solana). A true metaverse means that assets on the Ethereum blockchain can be traded for assets on another blockchain. Right now, we see walled gardens within each chain, but we believe that with time, we will be moving to a single metaverse for NFT games.

It’s only a matter of time that other web2 or traditional assets start to JPEG-ify. Once an incumbent in a particular space (Visa, Budweiser, NFL) starts to move, the rest of their competitors will start to move to.

While traditional gaming platforms such as Steam have banned blockchain games and assets, other platforms such as Epic Games has embraced it. Ubisoft also recently invested into Animoca Brands, strengthening strategic ties with the NFT ecosystem. SEGA has also announced that it will start selling NFTs related to its classic IP after partnering up with Double Jump Tokyo.

Right now, we’re in between the second and third generation of NFT games. Moving forward, we can expect more traditional gaming companies to get involved (i.e. fourth generation and beyond).

(Data source: Nansen)

We believe that gaming companies still feel that the addressable market of crypto-native players is relatively small given the target audience they are focused on (male, 20 – 40 years old). It makes sense that gaming companies that have built walled gardens through their cash shops will continue to double down on them. However, as crypto starts to become mainstream, we expect these walled gardens to be slowly worn down. Once Epic Games launches its first successful NFT based game, we believe that other gaming companies will start to take note and build, partner or acquire their own.

My guess, the next product that will have NFTs attached to it will be sneakers, given that hype and community go hand in hand with the sneakerhead community. Till then, crypto natives and NFT natives can only wonder when, and outsiders can only wonder why.

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Introduction

In our past few posts, we wrote extensively about cryptocurrency tokens and protocols, including Solana, Polygon and Fantom. We hope that you managed to read them! This week, we would like to shift gears slightly and discuss another area in the blockchain space that is growing increasingly popular – Non-Fungible Tokens (NFTs).

NFTs can be thought of as unique digital assets that serve as certificates of ownership for virtual or physical objects, such as art, music, collectibles or even real estate. It is non-fungible in that it cannot be interchanged for another asset of the same type. Each NFT can only have one official owner at a time and it is secured by the underlying blockchain. This means that no one can modify the record of ownership or recreate an existing NFT.

Demand for NFTs has been heating up. In the first half of 2021, NFTs generated over $2.5 billion in sales, up from just $13.7 million in the first half of 2020. In March 2021, Beeple’s NFTs titled “Everydays – The First 5000 days” also sold for a record $69.3 million, cementing Beeple’s position as one of the top three most valuable living artists. With many rushing in to purchase NFTs, it leads us to question what the hype over NFTs is really about.

This post seeks to explain NFTs in greater detail - we will discuss the history of NFTs, the different types of NFTs available and how to navigate the different platforms that offer exposure to NFTs. This will be Part 1 of a three-part series on NFTs. In Part 2 and Part 3, we will share more on gaming NFTs and the views of various NFT artists respectively, so be sure to stay tuned for it!

Background of NFTs

The concept of NFTs first started in 2012 with the inception of Coloured Coins. Coloured Coins were used to represent real-world assets ranging from subscriptions to digital collectibles on the Bitcoin blockchain and were made up of small denominations of a Bitcoin, known as Satoshis. While Coloured Coins marked a leap in the usage of Bitcoin’s blockchain, it was not as efficient as originally hoped for as Bitcoin’s scripting language was not designed to support NFTs.

In 2014, with the limitations of Bitcoin in mind, Robert Dermody, Adam Krellenstein, and Evan Wagner founded Counterparty. It was a peer-to-peer financial platform and distributed, open-source Internet protocol built on top of the Bitcoin blockchain, and allowed for the creation and issuance of assets. 

Many projects subsequently began to take tap on the Counterparty platform to launch their NFT-like assets. This included Spells of Genesis in April 2015 with their in-game currency called BitCrystals, and Force of Will in April 2016, which placed their popular trading cards on the blockchain. By October 2016, memes such as the recognizable green frog Rare Pepes were issued on Counterparty.

This is what Rare Pepe looks like

With Ethereum gaining prominence in early 2017, Rare Pepes soon made its way onto Ethereum as well. Nonetheless, the first NFT project on Ethereum came in 2017 with CryptoPunks, which was founded by John Watkinson and Matt Hall. CryptoPunks consists of 10,000 unique generated characters and it is arguably the project that has inspired the modern CryptoArt movement.

This is what CryptoPunks look like

Interestingly, it is worth noting that CryptoPunks used the ERC-20 Ethereum token since ERC-721 had not yet been developed. While ERC-20 tokens are useful, they are not best suited for creating unique tokens as they were created as standardized tokens that can be fungibly shared or exchanged for other tokens.

With the emergence of NFT projects on Ethereum, Dieter Shirley (alongside William Entriken, Jacob Evans and Nastassia Sachs) proposed the ERC-721 standard [AZ1] for Ethereum tokens, which stores unique identities to track the ownership and movements of individuals tokens. The ERC-721 token was then used by Dieter himself in 2017 to co-create CryptoKitties, a blockchain game that allows players to purchase, collect, breed and sell virtual cats.

Image of CryptoKitties

CryptoKitties took the world by storm as its launch coincided with the cryptocurrency bull market in 2017. Roughly a month into its launch on November 28, 2017, its daily transaction count shot up 111% and the average transaction fee rose by 1,165%. CryptoKitties has been described as the first NFT project to gain mainstream popularity, and the rest ever since then is history.

According to NonFungible, the total monthly sales on NFTs (as of 1 Oct 2021) exceeds $1.5 billion, and this is significantly higher than $33.8 million in sales done on 1 Jan 2018 (see chart below). In the same time period, the total number of active unique wallets which have bought or sold an NFT has also increased from 56,000 to over 150,000.

(Data source: NonFungible)

General public interest in NFTs has also spiked in recent years. Based on Google Trends, the term ‘NFT’ was searched most often in early September 2021, and the current search interest for the term stands at a relative score of 63, as compared to 1 a year ago in October 2020 (as depicted below). In terms of popularity by region, China, Singapore and Hong Kong have shown the greatest interest in NFTs, with Australia and the United States coming in at 7th and 8th respectively.

(Data source: Google Trends)

To summarise this section, below is a timeline summary of the key milestones for NFTs.

Where to buy NFTs

NFTs can be purchased on a peer-to-peer marketplace, which allows users to trade their NFTs. DappRadar has mapped out the top 10 most popular NFT marketplace of all-time based on trading volume on the platforms (as seen below). Some are generic marketplaces, e.g. Opensea, Rarible and Foundation, while others are targeted towards a specific type of NFT, e.g. CryptoPunks and NBA Top Shot or game, e.g. Axie Infinity and Aavegotchi.

Top 10 Marketplaces on dAppRadar

As seen with the above list, most of the marketplaces and NFTs on the platforms are built on ETH. This is unsurprising considering that Ethereum was one of the first blockchains to be established and it has created a robust ecosystem of projects and developers. In fact, Ethereum may benefit from the Lindy Effect, where we can expect it to continue to remain relevant in the future as it reaps its network effects.

While ETH is the main chain for NFTs, other chains such as Solana, BSC and Tezos are also getting into the NFT space and starting out their own marketplaces. As mentioned in our last post, Fantom also recently launched a new NFT marketplace called Artion on its blockchain. Depending on the popularity of the underlying blockchain, these marketplaces may see greater adoption over time.

Categorizing NFTs: How we like to break it down

In the wide world of NFTs, we can think about it in two key parameters – how original an NFT is, and how much utility it has to the owner. Originality ranges from super common pieces such as generative profile pictures which can range from 1,000s to 10,000s of somewhat similar pictures, to original digital art which is called “1/1s” (one of one). Whereas utility ranges from purely a JPEG to display on your social media or an online gallery, to providing utility to the owner – be it through dividends, special invites, access to other projects or more.

Non-exhaustive map of NFTs

Despite the multiple categories out there in the NFT-verse, we will be focusing on three different types of NFTs: (1) Generative Profile Pictures; (2) Original “1/1” Art; (3) Gaming. We will try to take you through the intricacies of each type, and also personal stories of participating in and buying some of these NFTs.

Generative Profile Pictures (PFPs): You think you’re unique but you aren’t

Some of the first NFTs made were profile pictures to be used on social media as avatars, and amongst the first of that category were CryptoPunks. As introduced above, this NFT came in a set of 10,000 generative profile pictures that was fed through an algorithm which created mostly common traits, but with one or two that were zombies or aliens. When it was first introduced in 2017, the NFTs were given away for free (anyone with an ETH wallet could claim one). This was back in the early days, where there were only a handful of NFTs that existed.

Fast forward to 2021, where Opensea recorded over $3.4 billion in transactions over 1.67 million NFTs. Ledger Insights reports that the makeup of transactions over this period was mostly avatar-like NFTs that hoped to emulate CryptoPunks. Given the ease at which creators can produce these generative art pieces, it’s no wonder that they would gravitate towards this category. Plus, buying generative art pieces feels like buying lootboxes on gaming sites – it’s cheap, generally 0.01 eth to 0.03 eth to mint, and there’s a sense of FOMO when you see NFTs being flipped for 10x – 100x on social sites.

There are plenty of famous PFPs that are currently trading at mind blowing prices. Just see the top 10 places on the Opensea transaction leaderboard for the past 30 days. Out of these, CryptoPunks, Bored Ape Yacht Club, Mutant Ape Yacht Club, CrypToadz, Cool Cats, Sneaky Vampire Syndicates are all PFPs that have seen huge success. Sneaky Vampire Syndicate (ranked #9), has seen transaction volumes of ~$51m over the last 30 days. What’s crazier is that it was only dropped in the middle of September which means that it has only really had 2 weeks of trading action!

Opensea top 10 NFTs by volume over last 30 days

PFPs are also very easy to get into, and don’t require a lot of research before buying them. There are even celebrities (athletes, rappers) that had PFPs as their first purchase. On August 31, basketball superstar Steph Curry shelled out 55 ETH (~$180,000) for a Bored Ape Yacht Club NFT. BAYC #7990 to be precise about which NFT he bought. 

Steph Curry’s Twitter profile

Snoop Dogg, also known as @CozomoMedici, bought a CryptoPunk zombie (considered ultra rare) for 850 ETH (~$2.8 million) alongside other NFTs. To date, his collection stands at over $20 million with multiple rare pieces. He has also partnered up with The Sandbox, an upcoming multiverse game within the Ethereum blockchain, housed under the Amonica Brands family of multiverse games.

Snoop Dogg ousts himself as CozomoMedici, a whale in the NFT space

Even Mike Tyson, one of the greatest heavyweight champions of all time, is no stranger to the NFT space. He recently bought a Cool Cat NFT and has it as his Twitter profile picture.

Mike Tyson’s Twitter profile

As it stands, PFPs are a very easy way for non-crypto natives, or even non-NFT natives to get into the industry. The seemingly flippant nature of profile pictures and the excitable community existing on twitter and discord makes purchasing these NFTs fun and enjoyable.

Original “1/1” Art: You’re unique, but its slow

Unlike generative art which can be churned out at a mind-blowing speed, original “1/1” art takes slightly, if not a lot longer to produce given that each individual piece is unique. Each piece of work also is more expensive, given the amount of labor and effort going into produce one. As a result, original “1/1” art usually has a smaller set of consumers, and a higher entry price.

Another reason for the smaller consumer base is due to the lack of visibility on both social channels such as Twitter, as well as ranking sites such as Opensea’s “Stats” ranking page. If you were to scroll through Opensea’s ranking, you’d find the first original art at #20 with TIMEPiece Community, which is built by a group of artists that were inspired from the prompt “Building a better future” by TIME magazine.

Opensea stats ranking by volume over the last 30 days

The next original art on the list would be Gary Vaynerchuck’s VeeFriends, which is a collection of hand drawn pieces with alliterative titles. Something interesting to note here is that while the art can be considered simple, what’s driving volume and adoption (~$26 million total transacted value over the last 30 days) are two things:

1)      Gary’s star power as an internet personality and CEO of VaynerMedia which has clients such as Shell, Pepsico, Unilever, Mondelez, KraftHeinz, Diageo;

2)      The utility that owning a VeeFriend gives to the user. A post on the VeeFriends discord points out that each individual NFT provides the user different levels of access and activities through the smart contract attached. The NFT token is the key that unlocks the user into Gary’s world.

Gary Vaynerchuck’s VeeFriends Opensea listings

Utility and community play a very important role in the NFT space, and more important than in the PFP space given. This is because the NFTs are slowly released to the community, unlike in a PFP where 10,000 of NFTs can be claimed over a span of a few minutes. Therefore, the artist must consistently nurture and build up their community.

I will paraphrase an example that our main fund’s managing partner likes to use: The community is like the organs; they must be strong to have a healthy body. The utility is like the blood; it must continue to be present and circulate to have healthy organs. The means of engaging the community (games, giveaways, engagement managers) is like the glucose; it must be present to give boosts to the organs from time to time.

Having been in multiple discord channels, I’ve seen firsthand how communities get hyped for a project only for it to die 1-2 days after because there wasn’t enough community engagement. Like sales in the real world, a lack of after sales support kills retention.

But I’ve also seen vibrant communities that have continued to flourish as the artist builds out the NFT collection. Artists that employ contests like the Lxveless’ drawing contests or Bull Market Girlfriend’s giveaway contests continue to build up their community and keep them engaged as they take their time to produce their art. These contests allow new members to receive free NFT drops which ultimately would keep them engaged, while continuing to build the hype with others for a chance to win a free NFT in the future.

Lxveless quick draw contests held every 3 days

Bull Market Girlfriend’s daily raffle

An interesting point about the original “1/1” NFT projects is that they build staying power through providing utility for the owners. Owners of the NFTs are usually entitled to pre-sales, deals, and other giveaways. This creates hype around the project and usually increases the value of the NFTs over time as more consumers are made aware of the projects, while the pace of release of the NFTs is kept constant. 

An example of this is the Lxveless project. The project first launched the series “Five Lxve Languages” which featured 30 pieces of each Lxve Language. Owners of the project could collect each Lxve Language, which entitled them to a special giveaway in the future. This pushed up the secondary price of the NFT as collectors were busy bidding up NFTs. The Lxveless then released “Ancient Lxves” which was 40 pieces of each type of Lxve. Again, collecting each piece of the set enabled owners to a special giveaway. Owners could also combine Lxve NFTs to receive unique pieces which enabled them to other giveaways.

As a result, the price of the NFTs has been kept consistently high, hovering around 0.5ETH – 1ETH. This is significantly above the 0.05ETH mint price which owners mint these NFTs with (minting refers to the price at which the owner buys the NFT from the artist at). Unlike PFPs which usually have floor prices (floor refers to the lowest price in the open market) similar or lower to mint prices, original “1/1” NFTs tend to have significantly higher floor prices.

Lxveless’ utility roadmap

Stay tuned to part 2 of this article, where we will continue with a dive into gaming NFTs and add some concluding remarks to this space. Part 3 of the article will focus on interviews with NFT artists to round up Ocular’s segment of the NFT space!

We started this newsletter to share our knowledge of the latest blockchain technologies, including infrastructure protocols, DeFi, NFTs, and other dApps which are going to reinvent how things work in web2.0. We hope you will enjoy this newsletter and provide us with valuable feedback.

We aim to post every one to two weeks. Do sign up below to receive the latest updates directly in your inbox!

Disclaimer: All write-ups in this substack channel are Ocular Ventures’ own opinions, and should not be misconstrued as investment advice or recommendations. Ocular Ventures does not hold positions in the projects discussed in this channel, unless otherwise stated. This content is intended for informational purposes only.

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Introduction

The recent bull run in the cryptocurrency markets has driven up the prices of a few popular layer-1 and layer-2 tokens. In the past six weeks, Bitcoin’s dominance as a percentage of the total market cap has decreased from 45% to about 42% currently. The total market cap for cryptocurrencies (excluding Bitcoin) has also increased by about $100 billion.

In our previous two posts, we shared a layer-1 and layer-2 project, Solana and Polygon respectively, both of which have gained significant traction this year. This week, we would like to introduce a lesser-known project, outside of the top 40 cryptocurrencies by market cap. This project has also been making moves in the market and could be an exciting pick. It is none other than Fantom.

Fantom’s token is $FTM, and $FTM’s YTD ROI stands at a staggering ~10,000%. In this piece, we will discuss what Fantom is, the reasons for its extraordinary price hike in 2021 and its future plans. 

Background of Fantom

Fantom was founded in 2018 by Ahn Byung Ik, a South Korean computer scientist, who previously served as President of the Korea Food-Tech Association and co-founded a food-tech platform called SikSin.

Ahn left Fantom in 2019 and the project is now led by the Fantom Foundation, which is helmed by Micheal Kong and comprises a team of 27 members. A notable name within the team is Andre Cronje, who is acting as the project’s DeFi Architect. Andre is a prolific DeFi developer that founded Yearn Finance. For his contributions to the DeFi space, he was named the “DeFi Person of the Year” in 2020 by DeFi Prime.

Fantom is a Layer-1 platform that is compatible with the Ethereum Virtual Machine (EVM) - the runtime environment for the Ethereum blockchain. This means that projects on Fantom are interoperable with those on Ethereum, and developers on Fantom can benefit from Ethereum’s tools and applications.

Fantom promises to overcome the limitations of previous generations of blockchains and resolve the scalability trilemma of scalability, security and decentralization. Fantom aims to overcome these challenges through its high-speed consensus mechanism, Lachesis. Lachesis uses a different variant of distributed ledger technology known as directed acyclic graphs (DAGs) and has the below features:

• Asynchronous. Participants can process commands at different times and not all information will need to be conveyed to all participants.

• Leaderless. No participant plays a “special role” or has added abilities to manipulate the blockchain in their favor.

• Byzantine Fault-Tolerant. Refers to the ability of a distributed network to achieve consensus, therefore to continue to operate, despite incorrect information or malicious participants within the network. Fantom supports up to one-third of faulty nodes, including malicious behavior.

• Final. Lachesis’ output can be used immediately. There is no need to wait for block confirmations; transactions are confirmed in seconds.

A quick summary of the milestones that the Fantom project has reached since its inception can be found below.

(Source: ICObench)

Fantom’s Technology

Diving deeper into Fantom’s technology, we observe that Fantom was built with the considerations of speed, security and scalability in mind.

• Speed. The DAG-based Lachesis is able to capture the past relationship between events and calculate the exact final order of events (and hence transactions) independently of each node. Given so, there is no need for nodes to send finalized blocks to one another.

  Validators on the network do not vote on the concrete state of the network; instead, they periodically exchange observed transactions and events with peers to build consensus. Lachesis also uses new events to vote for the order of the past events. As the same event may be used in various elections simultaneously, this creates fewer consensus messages and helps to reduce latency.

• Security. Fantom uses a leaderless Proof-of-Stake (PoS) protocol for its network. By removing leaders, the network security is not dependent on a small set of actors, unlike leader-based or delegated PoS systems.

  In addition, Fantom’s asynchronous Byzantine Fault-Tolerant (aBFT) consensus algorithm ensures that it can continue to function and provide reliable information even when there is an attack, so long as less than 1/3 of the nodes are malicious.

  While the usual practical Byzantine Fault-Tolerant (pBFT) mechanism will provide similar security features, it is worth noting that pFBT reaches a consensus about a decision by passing messages amongst all nodes and requiring nodes to stay in constant communication. This communication overhead increases exponentially each time a new node joins the network, and for large networks, there will be a time lag in reaching finality unlike the almost instantaneous confirmation with Fantom.  

• Scalability. Lachesis is modular in nature, as it represents one layer of the Fantom stack. It may be plugged into any distributed ledger, and developers may port any existing Ethereum-based decentralized applications onto Fantom in minutes. Besides providing users with greater flexibility and a better UI/UX experience, this also means that each project built on Fantom is independent of the others and is customizable.

  Because of the Lachesis design, the performance and stability of each project will be unaffected by traffic and projects can build on each other. As described on the Fantom website, Fantom is a network of networks. If we think of Ethereum as a decentralized computer, Fantom is a network made of a potentially infinite number of decentralized computers. Nonetheless, each project will share the same software logic and can communicate with one another.  

The table below summarizes the key attributes of Fantom. Compared to other layer-1 solutions such as Solana, Terra and Avalanche on these fronts, it can be seen that Fantom is on par with its peers in terms of speed and scalability, but performs slightly better on security.

While Fantom may have many advantages over its peers, we would like to caution that it may not be as decentralized as hoped for. Fantom currently only has 47 active validators and has high entry requirements to be a new validator. This resulted in network failures previously, which will discuss in the risks/threats section later on. Referencing the scalability trilemma, it appears that Fantom may have prioritized security and scalability over decentralization.  

Nonetheless, we believe that overall, Fantom’s technology remains robust and their DAG-based model may be the blueprint adopted by other emerging protocols moving forward. Besides Fantom’s technology, we would also like to highlight that 1) Fantom has high adoption rates, both at the retail/individual and institutional level, and 2) it has a reasonable valuation with strong fundamentals, which are likely to be strengthened in the future with its exciting plans in the pipeline.

Adoption Rates

Adoption rates for Fantom have been on a steady increase in the last year. This can be seen at the retail/individual level as well as at the institutional level.

• Retail/individual level. In terms of usage, the number of daily transactions and unique addresses on Fantom has risen significantly in the last month. This is in part due to a 370 million $FTM incentive program that Fantom had rolled out on Aug 30, 2021, to encourage more projects to be built on the platform.

  

  (Data Source: $FTMScan)

  As for retail investing, $FTM is now listed on major CeFi exchanges such as Binance, Gemini, Bitfinex and Crypto.com. $FTM can also be found on DeFi platforms such as 1inch, Uniswap and Sushiswap. $FTM’s price has doubled in the last month and reached its all-time high in early Sep 2021 (as seen below). $FTM was also the 3rd most popular search on CoinGecko from Sep 6, 2021 - Sep 13, 2021.

  

  (Data Source: CoinMarketCap. Price stated per day is based on close price, i.e. latest data in range – UTC time)

• Institutional level. Fantom has been adopted by several government agencies across various sectors, including the Afghanistan Ministry of Health, Pakistan Punjab Prisons Department, Ministry of Industry of New Technologies of Tajikistan and AG Mentors Group, which will incorporate Fantom in the Uzbekistan Government’s IT infrastructure.

  It is worth pointing out that developing countries have often been the preferred test-beds for blockchain technologies, as they aim to promote greater inclusion, address inefficiencies in existing processes and raise trust in government management. Nonetheless, only a few protocols have proven popular with governments worldwide – besides Fantom, other protocols that have been adopted include Stellar, Cardano and Algorand.

  In terms of use cases in the blockchain ecosystem, Fantom is used by Travala, a blockchain-based travel booking platform and SuperFarm, a cross-chain DeFi protocol designed to turn any token into an NFT farm with no code required. The Atari Chain team also recently announced their plans to tap on Fantom to allow users to trade, stake and play games using Atari’s tokens.

  Last Sunday on Sep 26, 2021, Andre himself launched a new NFT marketplace called Artion on the Fantom blockchain. It promises zero platform fees and low transaction fees of a few cents to allow users to create and trade many NFTs easily. To date, there are about 50,000 NFTs on Artion.

  In 2018, Fantom had received over $40 million in funding for its venture round, and investors included Obsidian Capital and HyperChain Capital. In Apr 2021, HyperChain Capital announced that it bought an added $15 million stake in Fantom. This is on top of the $35 million and $20 million stakes that Alameda Research and BlockTower Capital had acquired in Fantom respectively.

  Earlier this month, Fireblocks also shared that it has added support for Fantom, making the $FTM token available to 500+ banks, hedge funds, lending desks and other financial institutions using its platform. With the establishment of this partnership, we may expect further investments to flow into Fantom in the future.

Reasonable Valuation

Fantom is currently the 7th largest chain by TVL with $1.25 billion, ahead of others like Klaytn ($928.3 million), Celo ($861.7 million) and Optimism ($129.9 million).

(Data source: DeFi Llama)

Based on the above numbers, Fantom appears to be reasonably priced, as its market cap/TVL ratio is a lot lower (or better) than other projects (including those with a higher TVL). Fantom’s ratio stands at 1.49, as compared to Ethereum (2.81), Avalanche (4.04) and Solana (4.62).

Fantom’s fundamentals are likely to be strengthened in the future, as they are undertaking a series of efforts to develop the community and build the ecosystem. As shared above, Fantom had announced an incentive program to encourage developers to build on and grow its network. Fantom will also be holding its first Fantom Developer Conference in end-Oct 2021 to bring together its users.

In terms of use cases, Fantom is currently researching and developing Central Bank Digital Currency (CBDC) solutions. According to Fantom, a CBDC is a Central Bank-issued and controlled digital currency that functions like regular banknotes. CBDCs can be used by individuals or small businesses to pay each other – retail CBDC – or by financial institutions interacting to settle interbank transfers or securities transactions – wholesale CBDC.

In Mar 2021, Fantom had presented its CDBC case to the United Nations and its connected stakeholders. Fantom’s ties with several government agencies worldwide will stand it in good stead and should Fantom’s CDBC solutions prove successful, we will see more central banks and enterprises onboarded onto Fantom’s network.

Tokenomics

The $FTM coin was launched in a Jun 2018 ICO. The total supply of $FTM coins is capped at 3.175 billion, and there are currently about 2.55 billion $FTM coins in circulation.

Fantom made 40% of the total token supply available for sale at the ICO in mid-2018. The rest are reserved: 30% for staking rewards, 15% for advisors and contributors, and 15% for Fantom project team members and founders.

Risks and Threats

While there are reasons to be optimistic about Fantom, Fantom may also face a few risks and threats.

• Alternative layer-1 and layer-2 solutions. There are currently other protocols, including Solana, Terra, Polygon and Avalanche, which are more popular than Fantom, in terms of the number of projects, TVL, number of daily transactions and revenue generated. With a greater number of use cases and stronger network effects to tap on, these protocols may be more likely to be adopted by users.

  

  While we acknowledge that other protocols may be more prominent than Fantom at the moment, we believe that the future will be a co-existence of multiple solutions. It is unlikely that there will be a winner-take-all scenario. When users find that gas fees on Ethereum are too high, they will naturally look for cheaper and faster layer-1 and layer-2 solutions, with Fantom being one of them. Should Fantom be able to continue the momentum of attracting developers and projects, it could keep gaining traction with its robust technology, and emerge as an important player in the blockchain ecosystem.

• Centralization. In Feb 2021, the Fantom Opera mainnet experienced a temporary outage and new block confirmations were halted for seven hours. The outage was caused by the fact that two validators represented more than 1/3 worth of stake and they were unable to keep up with the block production process.

  This episode highlights the centralized nature of the network. It also shows that Fantom is a work-in-progress and has yet to fully figure out how to scale the network for mass adoption. There may be further hiccups along the way and there is no guarantee that it can eventually fulfil its objectives.

  Fantom is cognizant that much of the staking power is concentrated amongst a few nodes and are taking steps to address this. They are defining the parameters of their proposals, but are likely to lower the minimum amount of $FTM required to run a node and put a cap on the node size. We will continue to keep a close watch on their plans to decentralize and upkeep its technology.

• Price volatility. As Fantom is still in its developmental phase, $FTM’s price may experience significant fluctuations depending on the news surrounding it. In addition, as it is one of the smaller tokens, its trading volume is not high and prices are subject to speculative pressures. For context, the trading volume on $FTM was around 540 million on Sep 29, 2021, and this was around 1.8% of the trading volume on Bitcoin, which was over $29.8 billion.

  $FTM’s price may also be influenced by the sentiments towards cryptocurrencies in general and is often aligned with changes to Bitcoin’s price. In recent weeks, with China’s ban on cryptocurrency trading and the SEC sounding signals on the need for greater cryptocurrency regulations, the cryptocurrency markets have taken a tumble and $FTM, alongside the other cryptocurrencies including Bitcoin, have all experienced a dip in prices.

  Nonetheless, the above considerations are not unique to $FTM and will apply to most small tokens. Investors are encouraged to manage their risks accordingly.

Conclusion

Here at Ocular, we believe that the Fantom project is promising. We are not the only ones that see its value. Individual and institutional adoption rates of Fantom have been on the rise, with many government agencies, enterprises and blockchain projects incorporating Fantom as part of their solutions across a variety of sectors.

Despite Fantom’s meteoric rise since the start of the year, Fantom remains reasonably priced and is flying under the radar. While there are risks and threats that Fantom will have to manage, the future looks bright for Fantom especially with the exciting slew of projects and partnerships coming up. Through its incentive program and events targeted at developers, Fantom has also built a vibrant community that will be well-placed to support its growth.

We started this newsletter to share our knowledge of the latest blockchain technologies, including infrastructure protocols, DeFi, NFTs, and other dApps which are going to reinvent how things work in web2.0. We hope you will enjoy this newsletter and provide us with valuable feedback.

We aim to post every one to two weeks. Do sign up below to receive the latest updates directly in your inbox!

Disclaimer: All write-ups in this substack channel are Ocular Ventures’ own opinions, and should not be misconstrued as investment advice or recommendations. Ocular Ventures does not hold positions in the projects discussed in this channel, unless otherwise stated. This content is intended for informational purposes only.

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Introduction

In our previous post (check it out here if you missed it), we wrote about Solana and how it provides a more scalable solution compared to the other layer-1 protocols, particularly ETH 1.0. Since then, Solana’s price has soared by over 144% to reach a new all-time high of $214.96. We hope that you managed to get in on the action!

While Solana and other layer-1 solutions are gaining popularity, ETH 1.0 remains the dominant blockchain. According to State of the DApps and Coin98 Analytics, around 78% of dApps are currently built on ETH 1.0 and ETH 1.0 has over 200,000 validators in its ecosystem (as compared to 2,000+ on Cardano and 900+ on Solana).

Nonetheless, the issues surrounding ETH 1.0 have yet to be resolved. ETH 1.0’s processing speed is still around 15 TPS and its fees are high, with gas prices being around 150 Gwei. Cognizant of the limitations of ETH 1.0 (and other layer-1 protocols), the blockchain community have devised a few methods to improve their scalability.

The most prominent method is known as a layer-2 solution, which refers to a network that operates and lies on top of existing layer-1 protocols. It increases the throughput and efficiency of the underlying blockchain without tampering with any of its original decentralization or security characteristics. This is done by handling transactions off the main infrastructure.

For this week’s post, we will dive deeper into the concept of layer-2 solutions and analyze some key projects. We will also address the question of whether layer-2 solutions will remain relevant after ETH 2.0 is rolled out.

Landscape of Layer-2 Solutions

There are five main types of layer-2 solutions:

• Sidechains. A Sidechain is an independent blockchain that operates on its own consensus mechanism and security properties. It acts as an interoperable sister chain alongside the main chain, and assets can be moved between chains to handle various transactions.

  Given the above definition, some have commented that Sidechains are not really a layer-2 solution, and rightly so. We have included this in, as we view it as a useful hybrid between a layer-1 and layer-2 solution and it was one of the first few scaling technologies introduced. Examples of public sidechains include xDai and SKALE, and some apps use their own private sidechains like Axie Infinity with Ronin.

• State Channels. A State Channel is a two-way communication channel between participants that allows them to make multiple transactions off-chain and submit only two transactions to the underlying blockchain.

  To use a State Channel, a portion of the blockchain is first sealed off via a multi-signature smart contract that is pre-agreed by the participants. The participants can then directly interact with each other off the main chain. It is only when the entire transaction set is over that the final state of the channel is added to the blockchain. Bitcoin’s Lightning Network and Ethereum’s Raiden Network are examples of state channels.

• Commit-Chains (or Plasma specifically). Plasma leverages the power of Merkle Trees and smart contracts to create unlimited smaller versions of the underlying blockchain. These smaller chains are called child chains or Plasma chains, and they can be built on top of each other to form a tree-like structure. The child chains work together to offload bandwidth from the main blockchain, also known as the parent chain. Each child chain has its own block validation mechanism, but the child chains periodically interact with the parent chain to settle disputes and report dishonest nodes. OMG Network and Gazelle are protocols that use Plasma.

• Zero-Knowledge Rollups (ZK-Rollups). ZK-rollups bundle or “roll up” multiple transactions together off-chain before generating a cryptographic proof called a SNARK (Succinct Non-interactive ARguments of Knowledge). To validate all of the transactions, only the SNARK will need to be submitted to the main blockchain and it will be used to update the state of the layer-1 protocol. Notable examples of ZK-rollups include Loopring, zkSync and StarkNet.

• Optimistic Rollups. Optimistic rollups are similar to ZK-rollups in that it aggregates multiple transactions before committing them to the main blockchain. The key difference is that for Optimistic rollups, no computations are done and aggregators will only need to publish the minimum information required onto the blockchain with no proofs. Optimistic rollups assume that the transactions are legitimate by default. It is only when someone reports a fraudulent transaction that the Optimistic rollups will execute a fraud-proof to verify the transactions. Optimistic rollups are currently developed by Optimism and Offchain Labs’ Arbitrum rollup.

Using Eth1.0 as the base layer for context, each layer-2 solution type has its pros and cons.

As seen in the above table, sidechains are useful as quick fixes to the scalability issues faced by ETH 1.0 but compromise security. On the other hand, state channels and plasma are scalable and secure, but they deprioritize the speed and scope of transactions.

Both ZK-rollups and Optimistic rollups seek to address the inherent trade-offs that sidechains, state channels and plasma face. Rollups, in general, will improve the scalability of ETH 1.0, but at the same time, not neglect the security, speed and scope of transactions that can be done on the blockchain. Given its superior technology, many believe that the future of layer-2 solutions will revolve around rollup projects. Vitalik Buterin, the co-founder of Ethereum, himself envisions a rollup-centric Ethereum future.

Introducing Polygon

While many projects are working on layer-2 solutions, we would like to highlight Polygon, as it has attracted significant attention from developers and retail investors since the beginning of 2021. In fact, Polygon’s YTD ROI has exceeded 8,000%.

Polygon was started in 2017 by four software engineers – Jaynti Kanani, Sandeep Nailwal, Anurag Arjun, and Mihailo Bjelic – and it was originally called the MATIC network. It aims to address the pain points associated with layer-1 solutions, including high gas fees and slow speeds, without sacrificing security. At first, Polygon (or the MATIC network) offered scaling solutions for Ethereum through its own Proof-of-Stake (PoS) chain and Plasma framework. This is also known as the Polygon Commit Chain, which is built on the Ethereum network, as seen below. For a more detailed description of the workings of the Polygon Commit Chain, do refer to this video.

(Source: Stacked Crypto)

Subsequently, in Feb 2021, MATIC underwent a rebranding and renamed itself as Polygon, in tandem with a shift in vision. Polygon now wants to be an aggregator of all scalable solutions on Ethereum and provide a framework for developers to build and connect all Ethereum-compatible blockchain networks. We will expand more on Polygon’s products in the subsequent sections.  

Polygon’s native token is still called MATIC. At the time of writing, MATIC is priced at $1.42, giving it a market cap of $9.4 billion. There is a circulating supply of 6.65 billion MATIC, out of a total supply of 10 billion MATIC. The chart below provides the breakdown of MATIC token supply distribution.  

(Data Source: Binance Research)

Polygon has three key advantages:

1. Polygon supports a variety of layer-2 solution types, giving users the flexibility to decide on the right tool for them without having to compromise speed or cost.

2. There are multiple use cases on Polygon, highlighting its relevance to a wide variety of sectors and creating new expansion opportunities.

3. Polygon has experienced growing adoption over time, resulting in the development of a robust ecosystem and equipping Polygon with network effects that it can tap on.

Aggregator of Layer-2 Solution Types

What if we told you that all five layer-2 solution types introduced above can be found in a single project and you can pick and choose the ideal solution type based on your demands? Well, that is what Polygon is promising.

In line with the term ‘poly’ in Polygon’s name, Polygon is looking to present a suite of solutions to Ethereum’s scalability issues. While it still deals primarily with sidechain connectivity and taps on the Plasma framework, it plans to expand its toolbox to include other layer-2 solutions. Currently, it has incorporated ZK-rollups (through the acquisition of Hermez) and will be adding on Optimistic rollups, Validum chains, application-specific chains, enterprise chains and interchain communication protocols shortly. Given so, Polygon has described itself as a Swiss Army knife of Ethereum scaling and infrastructure development. These solutions are packaged in a modular format, so users can plug and play depending on their needs.

With Polygon, projects will be able to build blockchains that combines the best features of standalone blockchains (sovereignty, scalability and flexibility) and Ethereum (security and developer experience). It promises to resolve the scalability trilemma that has hampered Ethereum. In addition, Polygon is compatible with Ethereum, allowing these blockchains to tap on existing Ethereum tools and communicate with each other as well as with Ethereum.

Thus far, Polygon has proven useful in scaling Ethereum through its increased throughput. Polygon can do up to 65,000 TPS on its chain, which is significantly higher than the 15 TPS that ETH 1.0 currently achieves. Polygon has also reduced the high transaction fees associated with ETH 1.0, as seen below (figures are correct as of 10 Sep 2021).

(Source: Polygon)

Moving forward, Polygon hopes to expand beyond Ethereum and enable other blockchains to adopt its solutions. This means that we could see other layer-1 protocols using Polygon and there will be interoperability between chains, allowing for a scalable multi-chain ecosystem. 

Use Cases

Multiple projects spanning various sectors have embraced Polygon. There are over 500 dApps using Polygon’s scaling solutions, accounting for over $500 million in transactions. This graphic summarizes all the projects on Polygon and provides the breakdown by key sectors.

Some of the top projects on Polygon include Curve, the largest DEX by TVL at $12.8 billion and Aave, the largest lending DeFi platform by TVL at $14.1 billion. Other notable examples in the DeFi space include SushiSwap, QuickSwap and Zapper.

Popular games like REVV Racing, PolyBlades and Meeb Master are on Polygon. Polygon has also partnered and invested in Decentral Games to inspire the next wave of “play-to-earn” games on the platform, such as Axie Infinity. As for NFTs, Polygon currently powers OpenSea and Aavegotchi. On 27 Aug, Dolce & Gabbana announced that they will be producing and releasing a nine-piece NFT fashion collection. The drop will take place on UNXD, a curated marketplace for digital luxury and culture, which (as you may have guessed) runs on Polygon.  

Growing Adoption

There is an increasing number of developers and users adopting Polygon, as seen with the total number of addresses and transactions on Polygon as well as TVL of the chain.

• Number of addresses. As of end-Aug 2021, the total number of addresses on Polygon has passed 50 million. While Polygon still lags BSC by about 40 million addresses, it is growing at a much faster pace and is likely to catch up soon. As seen with the chart below, there are about 550,000 new addresses per day on Polygon as compared to 200,000 and 102,000 new addresses per day on BSC and Ethereum respectively.

  

  (Source: Coin98 Analytics)

• Number of transactions. Over the past 3 months, Polygon has consistently amassed about 6.5 million transactions per day. This is significantly higher than Ethereum’s average throughput of 1.2 million transactions per day and is comparable with BSC’s average throughput of 7.9 million transactions per day (although BSC’s numbers fluctuate wildly and at times, Polygon have exceeded BSC in transactions).

  Using the number of addresses and transactions, we note that Polygon’s daily transaction ratio per address is significantly higher than that of Ethereum and BSC since Polygon has fewer addresses, and this indicates more active participants on Polygon’s network.

  

  (Source: Coin98 Analytics)

• TVL. Polygon is currently the 5th largest chain by TVL. Its TVL exceeds that of Avalanche ($2.13 billion) and Fantom ($1.71 billion), correct as of 10 Sep 2021.

  

  (Data source: DeFi Llama)

In line with Polygon’s popularity, the price of Polygon’s token has been steadily on the rise in the last two months. It reached its all-time high in May 2021 and while there has been a slight dip since then, it has grown by about 20% in the last month.

(Data Source: CoinMarketCap. Price stated per day is based on close price, i.e. latest data in range – UTC time)

Polygon has also garnered significant institutional interest and is backed by Binance and Coinbase. In Jun 2021, the Polygon ecosystem received a major funding boost, as it announced a $21 million joint venture fund with blockchain venture capitalist AU21 capital. The funds will be used to build new projects on Polygon and to support developers.

Risks and Threats

We have identified four main risks and threats that Polygon will have to manage, should they wish to remain relevant in the future.

• Development of ETH 2.0. Ethereum, as we are aware, is undergoing a series of upgrades to improve its scalability, security and sustainability. The first phase of ETH 2.0, the Beacon Chain, was launched in Dec 2020 and the third and last phase of ETH 2.0, the Shard chains, is expected to be ready in 2022. With the Shard chains in place, Eth 2.0 is set to become 64 times more scalable than ETH 1.0, and this has led to questions on the future of layer-2 solutions.

  Some have argued that ETH 2.0 may render layer-2 solutions redundant, especially since layer-2 solutions currently face issues of limited composability, liquidity and onboarding and offboarding friction. While these issues may be fixed, users may prefer the convenience of sticking with a single platform, i.e. ETH 2.0, instead of having to shuffle through various layer-2 solutions.

  Here at Ocular, we take a more moderated view of the situation. We note that the full implementation of ETH 2.0 will take time and the endeavor of transitioning a large established protocol like ETH is risky in itself, without any guarantees of success. In the meantime, the scalability issues of ETH 1.0 will need to be addressed and layer-2 solutions will help to plug the gap.

  In addition, once ETH 2.0 is rolled out, it may not fully address its scalability issues. While ETH 2.0’s throughput may increase by 64x, demand is likely to increase exponentially as well as more users move to web3.0, and ETH 2.0 may not be able to cope with the increased traffic. The magnitude and complexity of the scalability trilemma call for a multi-pronged approach, rather than a single situation. Given so, we believe that there is enough space in the ecosystem for both ETH 2.0 and layer-2 solutions to co-exist and complement each other.

• Rollups. As shared earlier, rollups (both ZK-rollups and Optimistic rollups) are at the forefront of layer-2 solutions. Due to its superior technology, rollups may be the most popular layer-2 solution amongst users.

  While we are cognizant of this risk and acknowledge rollups’ potential, we see them as developing technologies without much traction yet. For Optimistic rollups, Optimism and Offchain Labs’ Arbitrum had only recently published their solutions on the mainnet in Jul 2021 and Aug 2021 respectively. For ZK-rollups, zkSync 2.0 had only made available its public testnet in Jun 2021, and it is not on the mainnet yet.

  In terms of usage, Optimism and Arbitrum has a TVL of $127.6 million and $22.9 million respectively, which lags behind Polygon ($4.7 billion). Optimism and Arbitrum also currently process about 50,000 and 15,000 daily transactions respectively, which is much lower than Polygon (6.5 million). Given the infancy of these rollup projects, it is uncertain whether they will be able to live up to their billings and be widely adopted.

  In any case, we note that Polygon will also be adopting rollups in their toolkit and are well-positioned to tap on and benefit from any developments in this area. Furthermore, Polygon’s key strength is that it is an aggregator of layer-2 solutions, which provides users with the flexibility to choose the right solution for their needs. Users may prefer the options that a generic project like Polygon offers, instead of having to pick and stick with a particular solution type.

• Other layer-1 solutions. Ethereum’s scalability issues have led to the rise of many layer-1 alternatives. These options promise faster transactions without compromising on security, and users may choose to utilize these chains instead. Some of the more popular Ethereum-compatible chains which may pose a threat to layer-2 solutions include Solana, Terra, Avalanche and Polkadot.

  While the layer-1 alternatives have gained traction lately, we see as of 10 Sep 2021 that the number of projects and daily transactions on Polygon exceeds most of the other chains due to its exceptionally high TPS. The cost per transaction on Polygon is slightly higher than its peers but remains low. Consequently, Polygon is generating a healthy annualized revenue. Polygon seems to have built up a defensible technology and has managed to reap some network effects.

  

• Centralization. Currently, over 55% of staked MATIC are owned by three entities, with Binance owning about 28%. This has led to concerns that Polygon may be overly centralized and possess a higher security risk, given that the three entities could come together to launch a 51% attack on the network.

  Here at Ocular, we will continue to keep a close watch on Polygon’s staking numbers. As more users adopt Polygon, the breakdown of the staked MATIC may change as well. More importantly, we believe that it is unlikely for the three entities to collude and sabotage the network, as their investments will also be undermined should anything happen to Polygon. In addition, Binance is a well-known entity in the blockchain ecosystem and any undesirable actions on their part will adversely impact their reputation and standing in the community.

Conclusion

Taking all of the above into consideration, we are of the view that layer-2 solutions are here to stay even with the introduction of ETH 2.0. As Vitalik writes, “it seems very plausible to me that when phase 2 (of Ethereum) finally comes, essentially no one will care about it.”

In particular, rollups appear to be the most suitable solution to address Ethereum’s scalability issues. Vitalik himself admitted that in the near future, “everyone will have already adapted to a rollup-centric world whether we like it or not, and by that point it will be easier to continue down that path than to try to bring everyone back to the base chain for no clear benefit and a 20-100x reduction in scalability.”

While there are projects that focus solely on rollups such as zkSync, Optimism and Offchain Labs’ Arbitrum, we believe that users may prefer a versatile solution like Polygon which offers a wide range of options, including rollups. Polygon can also be used in a variety of sectors (as seen with its use cases) and adoption rates have been on a steady increase, making it a promising pick out of all layer-2 projects.

Furthermore, despite its meteoric rise since the start of 2021, Polygon seems to remain reasonably priced. Its market cap to TVL ratio stands at 1.84, which is significantly lower (or better) than its peers such as BSC (3.82), Solana (6.40) and Avalanche (4.65). While not without execution risks and challenges, we believe that there is room for Polygon to continue to grow and scale, and we are bullish about its prospects.