Blockworks: Summary of the development of Ethereum, Cosmos and competing public chains in 2022

Key Points

• The 2022 crypto market crash began with Terra and spread to major CeFi players such as 3AC, BlockFi, Celsius, FTX/Alameda, and most recently DCG.

• Ethereum’s successful transition to PoS consensus, “The Merge,” is arguably one of the biggest events in the cryptocurrency’s nascent lifecycle.

• Ethereum Layer 2 achieves widespread adoption in the second half of 2022; we expect this trend to continue into 2023.

• Transactions on “Layer-1 competing public chains” faced significant headwinds in Q3 and Q4 due to CeFi bankruptcies, a large amount of block space coupled with falling demand, and the rise of the Ethereum L2 community.

• With the release of the ATOM 2.0 whitepaper, the launch of Circle Chain, and the upcoming migration of dYdX from StarkEX to Cosmos, the Cosmos “application blockchain” thesis has become even stronger.

• Infrastructure is an area ripe for innovation in crypto, competition in the oracle space is minimal, and bridge hacks are still commonplace.

In November 2021, the total cryptocurrency market capitalization reached an all-time high of $2.9 trillion. Since then, the market has declined significantly, falling 65% year-to-date (YTD) from $2.2 trillion to the current level of $770.5 billion. DeFi TVL has experienced a similar decline, plummeting 76% YTD from $170 billion to $40 billion. This decline is not unexpected, as DeFi TVL is mainly composed of non-stable cryptocurrencies. In terms of ETH, TVL is only down 8.6% YTD, which means that the decline in TVL is driven by price declines rather than users withdrawing funds from DeFi protocols. However, DeFi yields have contracted significantly since the DeFi Summer and are now generally less attractive than the risk-free yield of US Treasuries.

This year has been challenging for many companies in the industry, with several notable bankruptcies, including FTX, Alameda, BlockFi, Celsius, Voyager, and Three Arrows Capital. In addition, many Bitcoin miners, funds, and other cryptocurrency companies have been struggling to stay afloat. Many "Layer-1 competing public chains" such as Solana, Avalanche, Terra, and Near have seen significant losses since the beginning of the year, with most experiencing declines of around 90%. Due to UST's death spiral, Terra's LUNA lost 99.99% of its value during the same period. "Contagion" has been a theme throughout 2022, with Terra's collapse acting like the first domino to fall, triggering a massive deleveraging this year. We hope that the worst is over, but with uncertainty surrounding DCG/Genesis' solvency, it remains to be seen whether the last domino has fallen.

Despite the negative sentiment, builders continue to forge ahead. Ethereum successfully merged to the Proof-of-Stake Beacon Chain, Layer-2 gained full adoption, and the Cosmos “application blockchain” theory continued to gain momentum.

Ethereum

The most significant event in the crypto space over the past year was certainly the “merge,” in which Ethereum transitioned from Proof-of-Work to Proof-of-Stake consensus on September 15th. Many have likened this transition to “changing an airplane engine mid-flight,” demonstrating how difficult this feat is and why it takes several years to achieve. While there is some debate as to whether PoW or PoS offers stronger security, the most significant impact of this change is the new supply dynamics for ETH. After the merge, the ETH supply increased by only 3,800 ETH, while inflation of 1.2 million ETH would have occurred if the network was still operating under PoW consensus. The chart below visualizes the USD value of inflation (or deflation) under PoW and PoS, assuming a PoW block subsidy issuance rate of 13,500 ETH per day and an ETH price of $1,250.

In other words, in less than four months, more than $ 1.5 billion of selling pressure was removed from the market due to the merger. In addition, miners under the PoW network must sell some newly mined tokens to pay for operating expenses, and they do not lock up the chain's native assets because there is no need for a penalty mechanism. The amount of staked ETH continues to climb at a steady pace, and about 13% of the total ETH supply is locked in staking contracts to earn a yield of around 5-6%.

In addition to activating staking withdrawals, the next major upgrade on the Ethereum roadmap is the inclusion of EIP-4844, also known as Proto-Danksharding, which is a step towards full Danksharding, where L2 sends "blobs" instead of call data to Ethereum to reduce gas costs. Other notable EIPs that may receive more attention include EIP-4488, an alternative to Proto-Danksharding that reduces the cost of publishing call data; EIP-4337, which allows account abstraction at the L1 level; and EIP-1135, which reduces gas costs on L1 and has been heavily lobbied by the Uniswap team, who are developing their V4 product with the EIP-1135 upgrade in mind.

Ethereum Layer 2

As of 2022, Layer 2 on Ethereum continues to see greater adoption as different ecosystems and communities begin to form, along with significantly lower transaction fees compared to Ethereum L1. The percentage of total Ethereum gas consumed by L2 has steadily increased over the past year, with Optimism and Arbitrum taking the majority of the share.

Arbitrum

Arbitrum One remains the most dominant L2, accounting for more than 65% of all rollup TVL at $1.1 billion despite having no tokens as rewards. The biggest highlight of Arbitrum as a network is the upgrade to Nitro, which improves performance and costs in many aspects, such as compressing call data and providing better interoperability and gas compatibility, thereby significantly reducing transaction fees.

Arbitrum's DeFi ecosystem has experienced rapid growth, with many unique applications originating from Arbitrum, with Arbitrum as its main outpost. This includes a large number of perpetual contract futures exchanges such as GMX, Mycelium, and Rage Trade, as well as options protocols such as Dopex and Premia. Arbitrum also hosts TreasureDAO, a set of blockchain P2E games that combines DeFi and NFT elements that have gained attention this year. Trader Joe's announced its move to Arbitrum in December of this year, indicating that rollups are becoming a popular destination for applications. Offchain Labs, the team behind Arbitrum, also launched Arbitrum Nova in the second half of 2022. Nova is tailored for applications that require high transaction throughput and low fees by publishing transaction-related data to an off-chain data availability committee.

Optimism

The second most adopted general purpose L2 is Optimism, another optimistic rollup on Ethereum that has garnered $650M in TVL, representing 32% of the market share of all rollups. Optimism is also home to a growing ecosystem of DeFi protocols, including Synthetix and related applications such as Kwenta for perpetual futures, Lyra for options, and Overtime for sports betting. Optimism also hosts Velodrome, an automated market maker heavily influenced by Curve, as its primary venue for liquidity and spot trading. The biggest development for Optimism this year was the release of OP Stack, allowing anyone to create their own rollup leveraging their modular design and codebase. There are many rollups under this umbrella, which creates a vision of a “superchain” where using the same development stack means direct composability across all OP Stack chains. The first of these OP Stack chains were OPCraft, a Minecraft imitator where all elements of the game are recorded on-chain, and Optimistic Game Boy, a Game Boy emulator where all actions are recorded on-chain. In 2023, we can expect more projects including the Aevo Options Exchange built on Ribbon Finance, leveraging tailored solutions and direct composability with other OP Stack chains.

On April 26th, Optimism released the OP token and the first airdrop allocation. 25% of the token allocation will go to the ecosystem fund, which has been allocated to applications, 20% will go to retroactive public goods funding, and a total of 19% will be used for airdrops. Shortly after the launch, the team discovered a code error and they actually emitted 20% of the supply instead of 2%. This was quickly resolved, but the OP supply is definitely larger than initially estimated. The first airdrop only provided 5% of the 19%, so we can expect a further 14% of the supply to be left for further airdrops, with some of this additional allocation going to active users in 2023.

zkEVM

One of the more interesting areas of development on layer 2 is zkEVM, where zero-knowledge rollups attempt to maintain a level of equivalence or compatibility with the EVM, combining the massive scalability of the former with the network effects of the latter. The three major players in this space are Polygon, Scroll, and zkSync, with others like ConsenSys and Taiko also experimenting with the model. None of these solutions are live on a fully open and permissionless mainnet; zkSync is currently in the “baby alpha” stage, Polygon is in the final stages of testnet, and Scroll is on a pre-alpha testnet. This will likely be one of the main narratives of 2023 as these products begin to open up to users developing EVM-based applications, and whether these solutions begin to take market share away from Arbitrum and Optimism. There are also other general-purpose zk rollups that execute using different virtual machines, such as StarkNet.

Cosmos Ecosystem

There are now 53 IBC-enabled chains in the Cosmos ecosystem, with a combined market cap of $9.7 billion. In the past 30 days, users have transferred $745 million in value via IBC, with the majority of volume flowing through Osmosis, the largest DEX in Cosmos.

After the Terra crash, the TVL of chains based on the Cosmos SDK plummeted by 93%. However, the crash was an unintentional stress test for the Cosmos technology stack. On May 11, Terra executed a record 1.2 million transactions, more than double the daily average, while Osmosis processed a record $500 million in transaction volume, more than double the previous high. All blockchains based on the Cosmos SDK and Tendermint remain operational, and IBC works as expected.

In June, dYdX announced plans to launch dYdX Chain as an application-specific blockchain (appchain) in the Cosmos ecosystem. The dYdX team is well-respected and has been building their product since 2017, so the decision to leave the Ethereum ecosystem is groundbreaking. The current version of dYdX is based on Ethereum L2 (StarkEx), but the team said that the move to the Cosmos ecosystem paves a shorter path to decentralization. The next iteration of dYdX will feature a fully decentralized, off-chain order book run by a validator set. Each validator will store and maintain their version of the order book locally, creating a scalable and decentralized perpetual contract exchange. While this system has some tradeoffs, leveraging validator memory can fully decentralize the order book - a stated priority for the dYdX team. This concept pushes the current boundaries of the validator design space, so if dYdX is successful, the value proposition of building an appchain becomes even stronger.

In late October, Circle announced the release of USDC on Cosmos through Circle Chain. Circle Chain is an asset issuance that mints USDC into the Cosmos ecosystem, allowing users to send native USDC to any IBC-connected chain. It is likely to become the consumer chain for Interchain Security of the Cosmos Hub. Stablecoins play an integral role in DeFi, and there is currently no dominant stablecoin in the Cosmos ecosystem. On Osmosis, there is only $430,000 on IST, a CDP stablecoin backed by ATOM and built on the Agoric protocol (Cosmos native). There is also about $17 million in wrapped stablecoins on Osmosis, including USDC, USDT, BUSD, and DAI, but 2022 has shown us that wrapped assets bring unnecessary risks. While there is room for more decentralized options, USDC has the ability to launch DeFi in the Cosmos ecosystem and become the dominant Cosmos native stablecoin.

Cosmso Hub

Cosmos Hub was responsible for the birth of the Cosmos ecosystem. The protocol funded the creation of the core technology used by today’s Cosmos application chains. However, it now finds itself with outdated token economics and no meaningful revenue stream. In addition, Osmosis threatens its position at the top of the Interchain. While Cosmos Hub stagnated, Osmosis continued to improve its “hub-like” qualities. The DEX has more liquidity, IBC volume, and active addresses than Cosmos Hub. ATOM is listed on most centralized exchanges, so one of its main use cases is to onboard users to the Cosmos ecosystem. Let’s say a user wants to buy Cosmos ecosystem tokens. In that case, the process would look similar to buying ATOM on a CEX, transferring it to a self-custodial wallet, IBCing the ATOM to Osmosis, and then using Osmosis to exchange it for the desired asset. However, Binance recently listed OSMO, which shortens the above process by eliminating the need to buy ATOM and connect to/from the Cosmos Hub.

The Cosmo Hub needs to reevaluate its position in the ecosystem, move towards sustainable revenue generation, and upgrade its first-generation token economic model. The ATOM 2.0 proposal aims to do this by transforming the Cosmos Hub into a new role, placing it at the center of ecosystem expansion and bringing value back to the protocol. ATOM 2.0 aims to leverage Interchain Security to onboard new application chains to the ecosystem, generating revenue for ATOM validators and stakers. New revenue streams will offset the reduction in ATOM issuance, enhancing the sustainability of the protocol while taking into account the impact on validator revenue. Strengthening monetary policy will also better position ATOM as the de facto reserve currency of the Cosmos ecosystem. The proposal also introduces a new economic engine, the Scheduler and the Allocator, which will create additional protocol revenue streams for the protocol. The proposal went live in November, but 37.4% of the "no" votes resulted in the proposal not being passed. The opposition believed that the proposal was too broad and believed that it should be divided into a series of smaller proposals.

The ATOM 2.0 vision depends on the successful implementation and adoption of Interchain Security, which is expected to be ready in Q1 2023. While governance approval is required for the launch of Interchain Security, there is already a list of potential consumer chains. Consumer chains pay fees to the Cosmos Hub to secure their chains, so it is important to pay attention to where these revenues go. Ideally, it follows the ATOM 2.0 vision and flows to validators and stakers, minus taxes that flow to the community pool. A recent proposal would increase the community pool tax to 10% to increase funding for the protocol.

L1 competitive public chain

Solana

After the FTX crash, the TVL and activity of the Solana ecosystem dropped significantly. TVL fell from $12 billion to below $500 million year-to-date, a 96% plunge. The Solana Foundation announced that it has $1 million in cash equivalents, 3.24 million FTX shares, 3.43 million FTT tokens, and 134.54 million SRM tokens locked on FTX. In addition, Alameda and FTX purchased 50.5 million SOL tokens from the foundation, with a linear unlocking schedule that lasts until 2028.

After FTX withdrawals were frozen, malicious parties exploited FTX security and compromised its exchange wallets. Solana’s main central limit order book (CLOB) Serum has been largely defunct. It turns out that the Serum program update key is not controlled by the SRM DAO, but by a private key connected to FTX. As a result, Serum developers cannot update any code on their own, and the protocol is vulnerable to malicious code. The Solana community chose to fork Serum in a new CLOB called OpenBook. DEXs such as Raydium and Jupiter have already implemented OpenBook.

The Solana network itself suffered several performance-related outages as the ecosystem declined catastrophically throughout the second half of 2022. Due to Solana’s original base fee design, the network was a haven for bots, which could exploit the lack of priority fees to overload the network with transactions, halt DeFi liquidations, and even force the network out of consensus. However, on June 1, validators chose to hard fork the network. Soon after, a new base fee mechanism was introduced that dynamically adjusts the base fee based on the network’s target load. This new mechanism also accounts for priority fees, significantly reducing the risk of DoS attacks on the network.

With most of Solana DeFi shifting dramatically from VC-driven to community-led, the future of the Solana ecosystem looks bleak, but there are some beacons of hope. Plans for the upcoming Saga phone will continue to move forward. Saga will use the xNFT Backpack to enable users to run a large number of dApps directly from their mobile operating systems. Additionally, Jump Crypto has been steadfast in its launch of Firedancer - an open source validator that will improve the reliability, throughput, and scalability of the entire Solana network. With Saga and Firedancer, Solana's strategy remains highly focused on attracting the next wave of users to cryptocurrency, no matter what obstacles the community faces.

Avalanche

The Avalanche ecosystem experienced a period of relative stagnation in the second half of 2022. The collapse of 3AC in June, a major backer of projects on the Avalanche network, led to a reduction in investment in the Avalanche ecosystem. TVL fell from $12 billion to $1 billion. Avalanche's TVL fell 92%, and the AVAX price fell 89% during the same period.

Despite 3AC being exposed as an over-leveraged fraudster, some developers continue to release updates. Trader Joe’s made significant progress in the form of its NFT marketplace Joepegs and its centralized liquidity AMM: Liquidity Ledger. As mentioned earlier, Trader Joe’s announced that it would deploy on Arbitrum Ethereum L2, although the team still appears to be considering Avalanche as their primary focus. Cross-chain exchange network THORChain completed its integration with AVAX in Q4. Crypto game developers have flocked to the ecosystem with notable developments and announcements from Shrapnel and Ascenders, both of which are moving towards full launch. DeFi Kingdom and Crabada launched subnets, helping set an example that projects can develop on the Avalanche C-chain and, once mature enough, create custom subnets.

Avalanche successfully implemented the Banff upgrade on October 18, a big step towards subnet-to-subnet communication called Avalanche Warp Messaging. With subnet interoperability, the network could become a more serious competitor to Cosmos. Avalanche launched its native BTC bridge, BTC.b, in June, which saw widespread adoption in the last six months of 2022.

Aptos

Libra, centered around Diem, is a blockchain and cryptocurrency announced by Facebook (Meta) in 2019. Diem failed to launch following internal controversy, regulatory scrutiny, strategic pivots, and lost partnerships. A large portion of the engineering and research team went on to create Aptos, a layer 1 blockchain that hopes to realize the original vision of Libra and the MOVE smart contract language.

After raising $475 million at a valuation of over $1 billion throughout 2022, the team finally launched the token and network in October. Much to the dismay of investors and Crypto Twitter, the project has seen little user adoption or developer interest. The token quickly fell from $13 to $4 and currently has a market cap of around $500 million and an FDV of around $4 billion. Early investors can mark their investment as green, while anyone who purchased the token on the open market will lose their principal. Aptos is a perfect example of a “VC chain”: retail investors may want to stay away from this token fundraising model in the future. Despite these headwinds, the Aptos chain is performing as intended; with the team’s connections in Silicon Valley and the power of the MOVE language, it is possible that Aptos will see more dApps and adoption in the future.

Network Infrastructure

Oracle

By the end of the year, one of the most notable developments in blockchain infrastructure was the launch of Chainlink’s staking mechanism. LINK holders can now stake their tokens to increase network security and earn LINK rewards. This marks a fundamental shift for oracle providers and further decentralizes the protocol. However, LINK staking should not be confused with the typical PoS consensus mechanism associated with other blockchain networks. Instead, this mechanism is more akin to a service guarantee around the reliability of Oracle data. If a node operator fails to meet their service agreement obligations, a portion of the staked LINK can be punished and reallocated to more reliable node operators.

Chainlink provides an on-chain source of truth for the DeFi lending market, so enhancing the security of its oracles is critical to the continued success of DeFi. The protocol has implemented an initial staking pool cap of 25 million LINK. This protected launch will help the protocol to gradually upgrade in a protected manner. In its early days, staking will be incentivized through LINK emissions, but over time these will be phased out and user service fees will become the primary source of incentives. In addition, Chainlink will launch a partner growth program where various protocols and DAOs can provide incentives to staking participants in exchange for price/data servicing. While other oracles exist, Chainlink has by far the most adoption and battle-tested. With the launch of staking, the future of Chainlink remains bright.

Throughout 2022, upcoming oracle solution Pyth continues to announce new partnerships and integrations. Pyth differs from Chainlink in its “pull” model for price updates. Typically, oracles “push” price updates to the blockchain, but Pyth aims to improve latency and scalability through a pull model, where users request price updates only when they need them. Pyth is currently live on 13 blockchains, including Ethereum, Solana, Avalanche, and Polygon. So far, Synthetix, Ribbon, Lido, and several other protocols have committed to using Pyth feeds to update applicable data in real time. While the Pyth token is not yet live, the protocol could pose a significant threat to Chainlink’s oracle dominance in 2023.

bridge

Bridges saw a significant drop in activity in the second half of the year, primarily due to an overall drop in on-chain activity. Another contributing factor may have been the large number of hacks that occurred throughout the year, totaling at least $2.1 billion.

Bridges remain critical infrastructure for a multi-chain future, but security needs to be drastically improved to mitigate the risk of loss for liquidity providers and end users. If anything, 2022 demonstrated that we still have a long way to go before we can jump between chains without worry. We’re still waiting for Synapse and Stargate to deploy their own “Layer zero” chains, which could greatly improve the user experience of multi-chain for everything. As we head into 2023, we can expect successful deployments of the Synapse Network or Layer 0 to help solve the siloed liquidity problem, where dApps compete to maintain liquidity across multiple networks, rather than having all deployments use one liquidity layer. The chart below shows the TVL of six notable bridges on their native networks.

While overall bridge TVL declined significantly and bridge volume stagnated, bridge activity in and out of L2s such as Optimism and Arbitrum showed substantial growth in the second half of the year. Combined with the metrics discussed above regarding L2 utilization, these ecosystems show promise. Specifically, the increase in Arbitrum inflows can be attributed to GMX. Airdrop hunters and participants seeking to use Velodrome, Lyra, and Synthetix likely saw a surge in Optimism inflows.

Final Thoughts

While the massive drop in asset prices has caused TVL to drop across the board, there have been many positive developments this year. Ethereum was able to successfully migrate from PoW to PoS and reduce selling pressure by $1.5 billion in less than four months. Adoption rates for Optimism and Arbitrum continue to climb, indicating demand for the EVM and Ethereum L2. Cosmos has made great progress in increasing the presence and value accumulation of the Cosmos Hub, while providing a sufficiently attractive developer environment to attract developers from StarkEx to dYdX. Although "Layer-1 competing public chains" such as Solana and Avalanche have taken a huge hit in TVL, developer share, and VC capital this year, developers remain as ambitious as ever, unwavering in creating the best experience for developers, and remain committed to bringing the next billion users into the crypto space. While bridges have been the subject of many hacks this year, the security of these networks continues to strengthen, especially with the development of Stargate and LayerZero, Circle's cross-chain transfer protocol, and atomic composability of zk rollups. The next year holds promise as we continue to see developments on the Ethereum roadmap, with the rollout of zk rollups, zkEVM, and L3, the release of Solana’s Saga Phone, exciting new Cosmos appchains like dYdX, and more.