Ocular: 2023 Thematic Outlook
10 Trends to Watch in 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:
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
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!