Five predictions for the Ethereum ecosystem in 2023

Our five predictions for the Ethereum ecosystem:

• The bear market is not over yet;

• EigenLayer will be the most important innovation of Ethereum;

• Blob transactions will not fix the scalability problem;

• ZK-Rollups will not see significant traction in 2023;

• Layer 3 will be the real competitor to Cosmos;

1. The bear market is not over yet

2022 is set to be a big year for crypto. The industry appears to be changing dramatically as institutional capital pours into crypto-focused projects, exciting new financial primitives are developed, and its legitimacy as an asset class grows globally. Unfortunately, these narratives have been overshadowed by the main story: a spate of financial misconduct, primarily at the hands of bad actors in positions of power. The revelation of this widespread fraud, combined with tightening monetary policy around the world, has led crypto markets into a relentless bear market comparable to 2018.

For crypto, 2022 is the year of the dominance of mercenary capital — entities acting as value extractors and players moving from one opportunity to another, seeking excess short-term profits but without any interest in participating in the community or building future infrastructure. This exists among most stakeholders in the crypto space, from end users to liquidity providers to crypto VCs — all of which have participated in various forms of rug pulls and dumps. However, these three implosions have left the industry in a state of distress:

Do Kwon’s Terra-Luna took an inherently flawed algorithmic stablecoin model and bribed people to use it to earn artificial collateral yields. The decoupling of the algorithmic stablecoin wiped out $60 billion in market value and emptied out the savings of retail investors around the world.

Three Arrows Capital (3 AC) was founded by Su Zhu and Kyle Davies as a foreign exchange arbitrage fund that financed its directional crypto bets through heavy borrowing. When the heavily over-leveraged firm collapsed in adverse market conditions, its billions of dollars in bad debts left a huge hole in the balance sheets of lenders throughout the crypto space.

Finally , the FTX exchange collapsed when SBF misappropriated customer deposits and lent them to his trading firm, Alameda Research, causing billions of dollars in losses as its FTT Token plummeted, and multiple lenders went bankrupt due to losses.

So, what does this mean for the crypto industry in 2023? First, we expect the FTX position liquidation and widespread bad debts to continue to negatively impact crypto markets throughout the next year. As bankruptcies and criminal proceedings proceed, liquidity issues and bankruptcies may continue to be seen in CeFi and DeFi services. Second, the breach of trust involved in this bankruptcy will severely hinder regulatory progress, investor activity, and consumer confidence.

Looking ahead

Despite the severe setbacks our industry has faced, we are optimistic about the prospects for crypto in 2023. While venal capital has taken its toll on our credibility, our industry is also filled with dedicated builders who are pouring a lot of sweat equity into this thriving world of Web3. These people are what we call “visionary capital”, and they are still building when most industry speculators have walked away. They are investing in the long-term and pushing Web3 to the cusp of irreversible entry into everyday life. We believe 2023 is the year of visionary capital and the year that crypto moves from a speculative investment to a core component of society built around Web3.

To some extent, this transformation is already underway. Between DeFi protocols integrating with traditional financial systems, DAO vaults accumulating real-world assets, and traditional gaming companies breaking into Web3, one of the emerging narratives today is that the line between decentralized solutions and the real world is blurring. This process will only continue, and 2023 may well be the year Web3 projects enter the mainstream.

Here are a few examples. In an age of pervasive data breaches, companies may begin to adopt decentralized identity technology that allows users to self-custody their data. Consumer-facing applications of blockchain technology will emerge in the media space, where marketing, storytelling, and gaming will merge to create immersive, interactive worlds. By building blockchain networks on top of existing power grids, utilities will be able to integrate distributed energy resources into new networks of new decentralized energy.

While none of this will be news to crypto natives, these examples represent the introduction of massive new user groups and suggest that the closed world we’ve seen over the past decade is preparing to go public. Behind these radical changes to our daily lives will be a wave of technological developments that will advance crypto’s capabilities and prepare it for its central place in the life of the metaverse. These events are unfolding in real time, and with our expectations summarized below, here are our predictions for how crypto and Web3 will take off in 2023.

2. EigenLayer will be the most important innovation of Ethereum

One of the most notable differences in blockchain development is the degree of permissionless activity possible between the infrastructure layer and the application layer. Infrastructure upgrades and changes lag behind the application layer because application deployment is permissionless, while core network upgrades are permissioned. Changes to the consensus, core, sharding, p2p, and middleware layers are based on democratic voting by designated parties, while applications are free to deploy and experiment on the core consensus logic.

Established and well-capitalized network systems require careful risk analysis before core upgrades or changes are made. This results in innovative solutions to consensus problems and core obstacles being limited or late to market. Once a system's sovereign trust network is established, the protocol becomes very rigid and less susceptible to innovative upgrades. When innovative consensus mechanisms or middleware layers (such as Snowman, Chainlink, or Nomad) emerge, it is impossible to use the existing trust layer to run the new network in a permissionless manner.

In addition, new networks are often constrained by inevitable capital boundaries. In order for decentralized networks to ensure the security of core consensus logic, the cost for malicious actors to self-implement changes or control assets needs to be prohibitively high. Therefore, it is not enough to have breakthrough technology alone, builders also need to find a large funding base for network security, which often becomes the biggest obstacle to infrastructure innovation.

Reward distribution further highlights the capitalization problem in network bootstrapping. In the Ethereum validator stack, 96% of total rewards are distributed to capital providers, while only 4% are distributed to node operators. Far from arbitrary, reward distribution reflects the implicit cost of capital in Proof of Stake (PoS) networks. The implicit risk of staking volatile assets for network security is fundamentally more expensive than running a general-purpose node that can be repurposed.

It is worth mentioning that the security of bootstrapping core infrastructure is the primary concern for a decentralized network. That being said, applications built on it are always limited by the most insecure denominator in their infrastructure stack. Applications that include middleware layers (such as cross-chain bridges and oracles) protected by their own sovereign trust network are reducing the overall security of the system to the least secure dependency.

To address the core divide in innovation from the infrastructure to the application layer, EigenLayer introduces a simple but extremely effective solution to the problem of high capital costs: re-staking.

EigenLayer Methods

EigenLayer is a smart contract layer on Ethereum that allows users to leverage existing trust networks by using heavy staking to protect other core infrastructure and middleware layers. At its core, heavy staking is about using the same staked ETH used for Ethereum network validation to protect other networks. This allows ETH stakers greater flexibility in staking capital while extending the trust layer to peripheral infrastructure such as sidechains, middleware, and even other non-Ethereum networks.

EigenLayer is introducing a two-sided market where ETH stakers can provide services to networks that require a trust layer. This enables new networks to reduce network security costs while gaining access to a huge pool of capital. In effect, this eliminates the most insecure denominator problem at the application layer. Oracles and cross-chain bridge networks will gain security and trust from the same infrastructure layer that the applications themselves are built on. EigenLayer allows trust to be consolidated, ultimately improving the security of all networks that interact with the layer. For example, a new entrant into the asset cross-chain bridge space can interact with EigenLayer and immediately gain access to a $18.7 billion security foundation.

Given that ETH stakers do not incur any marginal capital cost when validating other networks, re-staking greatly increases the range of possibilities for stakers. Of course, EigenLayer does present some leverage and slashing risk, as the underlying staked assets may be slashed across multiple security networks in the event of malicious behavior. Whenever the same funds are used to validate multiple networks, the asset base is inherently leveraged, opening the system to potential cascading.

Slashing risk is complex and can lead to slashing contagion. Losses due to malicious behavior or downtime inherently reduce the security considerations of all verified networks. If not controlled or limited, this contagion can have a detrimental impact on the system architecture. At launch, EigenLayer will introduce careful leverage guidelines and limits to ensure the stability of the trust system.

EigenLayer is also developing a data availability layer for Ethereum called EigenDA. This layer is similar to the current danksharding specification and includes features such as Data Availability Sampling (DAS) and proof of custody. However, EigenDA is an optional middleware and not a core component of the protocol. As a middleware layer, it can be stress-tested without the need for a hard fork, which provides several advantages: permissionless experimentation with the DA layer, and allowing validators to participate on an opt-in basis. If the implementation of pseudo-danksharding is successful on EigenDA, it may become the de facto DA layer for all optimistic and zk-rollups built on top of the Ethereum ecosystem, prior to the long process of Ethereum-level protocol changes.

During the prolonged 2022-2023 bear market, expect liquidity to continue to seek safety within Ethereum, further solidifying the network as a safe haven and central trust layer for crypto. The race to security will further stretch Ethereum’s capital base, widening the gap between alt-L1s and driving capital costs for new native validation networks to prohibitive levels.

Access to heavily staked ETH security will significantly reduce the cost of scaling middleware, sidechains, and the general decentralized technology stack. We believe Eigen will bring the most significant change to the way decentralized networks are built since it was first introduced on Ethereum in 2015.

3. Blob Transactions Won’t Solve Scalability Issues

Blob transactions will not be a magical fix for Ethereum scalability until modularity is achieved. And there will be considerable technical hurdles and delays in achieving modularity. The dramatic increase in on-chain data will also drive the need for state expiration to mitigate state bloat, and may even lead to changes in Ethereum's peer-to-peer structure. Blob transactions introduce a new data format for calldata (which rollups rely on) that contains a lot of additional data that is not accessible to EVM execution, but only to commitments.

As demand for Rollups and modular execution grows, this new data market will become increasingly competitive. This means we may see price competitiveness, just like we see competitive gas prices on Ethereum, we may see competitiveness around Data_gas, which is the new type of gas being implemented. There are still many issues to be resolved, such as whether gas should be time-based or slot-based, because if it is slot-based, it is possible to miss a slot without a blob transaction, which would make demand appear to increase, thus affecting gas prices.

https://www.eip4844.com/

There is also the issue of practical gossiping of blob transactions on a peer-to-peer (P2P) network, as the size of these blobs is much larger than anything that is currently gossiping. This requires further research, which is currently being explored by Paradigm. It will be interesting to see what happens with this, and whether the Ethereum network can handle this further state bloat and data. Regardless, state expiration will most likely be needed to limit the growth of the Ethereum state - which currently reaches an insane 1079 GB for a blockchain full sync, and is growing every day. State expiration will be achieved through state rent, so the state can be rented out to off-chain storage, or by deleting the state on a monthly or weekly basis and then storing it on archive nodes (which are unfortunately very centralized at this time).

https://ycharts.com/indicators/ethereum_chain_full_sync_data_size

As it becomes clear where Ethereum and many L1s will be positioned in the coming years, it becomes apparent that in order to remain decentralized and “keep up with the times,” they must move toward modularity.

4. ZK-Rollups Won’t See Significant Traction in 2023

ZK-Rollups will not gain significant traction in 2023 as they lack production readiness and fail to achieve sufficient decentralization. By production readiness we specifically mean their VM and proof-of-proof times.

Instead, we expect ZKPs to be widely used, especially in non-interactive state proofs. Projects such as Herodotus, Axiom, ETHStorage, and Lagrange will use them for a variety of data sharing purposes that require on-chain or cross-chain storage proofs.

It is expected that many cross-chain bridges will begin to use ZKPs for interoperability purposes, and some are already moving in this direction, including Wormhole, Polymer, and the ZKBridge collective.

These applications of ZKPs are almost ready and are expected to be verified on-chain at a reasonable price. These uses of ZKPs improve efficiency through recursion, which involves aggregating multiple proofs into a smaller proof. Most protocols have recognized the need for recursive ZKPs to reduce costs and improve efficiency, although some proof schemes are more efficient than others. However, it also comes with some caveats, as some proof schemes are more efficient than others.

https://ethresear.ch/t/reducing-the-verification-cost-of-a-snark-through-hierarchical-aggregation/5128

Many existing ZK schemes and algorithms with compact proof sizes incur high overhead during proof generation time (also known as attestation), which limits their efficiency and scalability. To address this, projects such as Supranational, Ingonyama, and DZK are working to improve the efficiency of proof generation. However, it is important to recognize that this hardware acceleration is only part of the reason for efficient attestation. Optimizations need to be made at the algorithmic level, the software level, and elsewhere. It is also important that the system remain sufficiently decentralized, which is difficult to achieve in practice.

https://eprint.iacr.org/2022/1010.pdf

Finally, proof times also increase with the complexity of the associated ZKP. Considering all the factors mentioned, it is undoubtedly difficult to build a sufficient ZKRollup to gain significant traction in 2023. Currently, the most effective use of ZKPs is in smaller-scale operations, such as the non-interactive state proofs and interoperability mentioned earlier.

5. Layer 3 will become a real competitor to Cosmos

Layer 2 (L2) improves Ethereum's scalability by reducing gas fees and increasing throughput. Due to these scalability factors, and the trade-offs that exist, L2 must choose to optimize for specific projects. Layer 3 (L3) is an application-specific blockchain built on L2, designed to mitigate these trade-offs and make more improvements. They are similar to application chain environments such as Cosmos, Avalanche, and Polkadot, but benefit from being built on a modular blockchain protocol stack rather than a monolithic chain protocol stack. Therefore, deploying a fully modular blockchain infrastructure stack, including a general-purpose L2 as well as customizable L3, will mark the end of the era of monolithic application chain ecosystems and the beginning of a new era of decentralized application development.

https://medium.com/1 kxnetwork/application-specific-blockchains-9 a 36511 c 832

Currently, monolithic application chains are the preferred choice for many applications because this allows them to freely create custom logic and smart contracts while achieving better execution. In addition, application chains have their own block space, so they do not have to compete with other chains for execution. But this is not as efficient as it could be. Using a monolithic blockchain architecture, such as application chains built on modular software (such as Cosmos) or as a completely monolithic application chain (such as Avax Subnet) limits their ability to reduce transaction costs and increase computational throughput.

In contrast, appchains built on fully modular blockchain protocols reduce unnecessary friction because they can leverage optimized blockchain layers built for specific functions. Imagine you compare an L3 built on top of zkSync (L2), which leverages Celestia for data availability and Ethereum for proof of settlement and consensus, to a monolithic appchain that combines all or some of the layers. In this case, the only way forward is to build modularly for better scalability while retaining decentralization.

It is worth noting that the measure of these benefits exceeds what a monolithic application chain can theoretically achieve. For example, L2 is 100 times less expensive than L1, and L3 is 10,000 times less expensive than L1. The zkPorter L3 that zkSync is building improves scalability by reducing fees by about 100 times, and a maximum TPS of 20,000+. L3 not only provides improved performance, but also has the ability to be customized for specific purposes. This includes adding privacy features when using ZKP, designing custom DA models, and enabling efficient interoperability solutions.

Almost every relevant EVM L2 has plans to develop a customizable L3 on top of its L2. In addition, opportunities will arise to build more modular blockchains using Celestia’s shared data availability base layer. However, an important thing to note about this prediction is that the future development of application chains will be as L3s on modular blockchain stacks, not monolithic chains. Combining the decentralization and security of the EVM with a scalable L3 makes a modular environment far superior to a monolithic application chain ecosystem. There are still important interoperability issues that need to be resolved, especially for cross-rollup transactions. However, progress is being made and L3 is expected to be launched by the end of 2023.

Therefore, if L3 can solve the interoperability problem, deploying application chains built on a modular blockchain technology stack will be a killer of the monolithic application chain theory. L3 will retain a certain degree of Ethereum security, improve speed and scalability, and allow dapps to be customized for specific use cases. Application chain ecosystems like Cosmos will continue to gain traction in 2023. However, as L3 is finally deployed in 2023, we will see the application chain narrative shift from a monolithic chain ecosystem to a modular ecosystem.