Adoption of DeFi, ZK Tech, NFTs and More Will Continue to Increase in 2023
The crises of the past year obscured genuine advancement in promising crypto industries, writes Pantera Capital General Partner Paul Veradittakit. Here's where a leading investor sees growth in the coming year.
This year has certainly been a series of highs and lows for the crypto industry. After the 2021 bull run, we kicked off 2022 with a correction as bitcoin (BTC) and ether (ETH) dropped around 20% and 31%, respectively, in January alone. Macro factors, such as the U.S. Federal Reserve’s interest rate hikes, high inflation, layoffs and generally slowing economic growth have led to much uncertainty. Rough market conditions largely became the standard for much of the year, but that didn’t stop crypto from many incredible technological achievements.
Improvements in the decentralized finance (DeFi) sector like the protocol Compound’s version (v)3 and the march of the zero-knowledge (ZK) ecosystem continued regardless. Institutional adoption of crypto has also occurred at a rapid pace, with Disney, Starbucks, Adidas and many other household brands quietly embracing blockchain. Large banks have also shown increasing interest in the sector: Fidelity launched a crypto service for investors, BlackRock partnered with Coinbase to bring its institutional clients crypto access and Goldman Sachs is creating a crypto data service.
One industry highlight this year was the Ethereum Merge in September, where the blockchain transitioned from proof-of-work to proof-of-stake, reducing Ethereum’s energy usage by an incredible 99.9%. Secondly, many amazing engineers continued to build through this bear market, and some of the strongest projects came out of it. Another benefit for the industry, though rough in the moment, was the lessons learned from each of the disasters that 2022 brought. Many projects – and even entire categories in crypto – have shown their resiliency in light of these events. If crypto has proven anything through its existence, though, it has proven that it can survive unfavorable times. Because of this, the industry will enter 2023 with a level of strength and durability that 2022 has given it.
Paul Veradittakit is a general partner at investment firm Pantera Capital. This story is part of CoinDesk's Crypto 2023 outlook.
Here are my top predictions for the crypto industry in 2023:
DeFi will continue to grow while CeFi consolidates: This past year exposed many of the problems of centralized finance (CeFi), while DeFi at large functioned flawlessly. In light of 2022’s many CeFi collapses, I expect the industry to consolidate into highly regulated players such as Coinbase and Bitstamp.
In the period following the FTX collapse, DeFi transactions have already spiked, with volumes up 68% (to $97 billion) from October to November. Events like these prove the case for DeFi: governing assets via secure smart contracts enables users to better understand liquidity flows and have more control over their investments.
Come 2023, I believe we’ll see more complex and interesting applications of DeFi increase. A few exciting examples are GMX, a decentralized perpetual exchange, and 1inch Pro, a regulatory-compliant platform that connects traditional finance (TradFi) to DeFi. Next year will also likely bring more traction for use cases like self-custody wallets, synthetic assets, and prediction markets.
Despite market conditions, the sector’s true strengths lie in its foundational infrastructure that powers transactions in a trustless and efficient way. These properties will greatly accelerate DeFi’s adoption and growth in 2023, especially in light of CeFi’s struggles this year.
We will see tremendous ZK adoption and use cases: As the question of privacy comes to the forefront of the crypto industry, zero-knowledge technology has been particularly notable this year. ZK technology essentially uses a prover, a verifier and mathematical algorithms to prove something without revealing underlying information about the proof. Because blockchains are inherently transparent, this application is huge for the industry and allows many more interactions to take place on-chain in a private way. ZK proofs are also extremely lightweight, making on-chain interactions much more scalable and efficient.
With projects such as Succinct Labs, Risczero and Espresso Systems emerging, we’ve seen use cases for ZK proofs, VMs and rollups explode. ZK technology has particularly beneficial applications for identity as a crypto vertical. With ZK proofs, users are able to prove their identity on-chain without having to reveal sensitive data. Ethereum co-founder Vitalik Buterin also noted in a recent piece how huge ZK technology is for solving the on-chain information problem – but that the category is “something that will actually need to be worked on.”
ZK technology is also valuable for bridges, which are able to transmit messages and tokens while guaranteeing security and correctness via succinct proofs. There are also exciting applications for TradFi systems like credit scores and taxes.
Institutions will increasingly tokenize financial assets: Real-world assets (RWA) are financial primitives that represent a claim on an underlying asset and often produce yield for that asset. The emergence of the category has unlocked huge amounts of liquidity and utility so far, and 2023 will likely bring more assets represented on-chain in an accessible manner.
Stablecoins are arguably the most popular application of a RWA in today’s market, with the category constituting three of the top seven tokens by market capitalization. Circle’s USDC and Maker’s DAI have been top-tier stablecoins and have both seen almost no volatility throughout the bear market.
On-chain communities have demonstrated demand for RWAs: for example, MakerDAO decided in mid-2022 to invest $500 million worth of DAI into U.S. treasuries and corporate bonds. Goldfinch, a company that provides loans that are collateralized off-chain, currently has an active loan value of ~$100 million. Jia allows business owners to take out blockchain-based loans and generates substantial yields for liquidity providers backed by real-world businesses and assets. I expect 2023 to bring the growth of interesting applications of RWAs, such as flash loans and real estate. In-line with the real world asset trend, I also expect to see a surge of startups focused on bringing TradFi institutions into crypto in a regulatory-compliant way.
More companies will emerge to leverage blockchain data: Arguably, rich and open-source data is one of the blockchain’s best features, as it allows for deep analysis of on-chain activity. Leveraging this data in an efficient and responsible way is integral to the expansion of blockchain dapps and their use cases. Data reveals a massive amount about how blockchains are used, emerging trends, user behavior, and on-chain money flows.
Blockchain analytics platforms like Nansen will continue to be critical for understanding on-chain analytics through wallet activity. Companies such as nxyz are also tackling blockchain indexing by providing data APIs with no rate limits. Definitive emerged in 2022 to provide user acquisition tooling and insights for both on-chain and off-chain activity. Even with the growth of these companies, blockchain data is still largely untapped and I expect to see significant developments in the sector during 2023. To understand where crypto is going next, we need to get granular with our level of data analysis of the state of the industry as it is right now.
The developer tooling stack will continue to grow as blockchain engineers increasingly seek easy and efficient ways to deploy Web3 projects: Developer tooling eliminates many repetitive and tedious parts of the job and encourages more engineers to experiment with creating on-chain protocols. Companies including Alchemy and Tenderly have been particularly critical players in the sector this past year.
Despite the bear market, developers have experimented with on-chain applications more than ever. Alchemy recently stated that it saw the number of engineers using its platform soar three times since the start of the year. In September 2022, monthly verified smart contracts were up 2.6 times, year over year. Impressively, 2022 also saw 36% of total smart contracts ever deployed and verified.
As a greater number of Web3 developers get involved in the ecosystem, it is critical to provide them with sturdy tooling as they begin to build. Cross-chain tooling is particularly relevant, as it provides composable software that makes launching projects on multiple chains easy. By serving as the backbone for many crypto projects, developer tooling will continue to grow in 2023 as more crypto use cases arise and an increasing number of engineers seek to enter the industry.
Non-fungible tokens that provide some kind of value to their holder, such as gaming NFTs and identity NFTs, will expand: Utility NFTs, such as in-game NFTs, identity tokens, and token-gated communities, software, and events will expand in 2023. This year, we’ve seen the sector start to develop technologically and creatively, but the space is nowhere near mainstream adoption. While the digital (pure) art industry is undoubtedly a massive vertical, using NFTs to permit specific privileges has the potential to disrupt many incumbent sectors.
We’ve seen some exciting applications and developments of these ideas so far. Proof Collective allows its NFT holders to access future Proof drops (one of which was the popular Moonbirds NFT project) and access to Proof community initiatives, such as in-person events and a private Discord. Ethereum co-founder Vitalik Buterin also released a formative paper on soulbound tokens (NFTs that hold on-chain identity information), which some projects have already adopted. Gaming transactions also skyrocketed in 2022, at one point composing over half of all blockchain activity. Further, NFTs are starting to be explored in the context of entertainment, specifically for fan engagement.
Traditional companies have been exploring adoption of NFTs at an increasingly rapid pace. A few highlights: Tiffany’s released a collection of pendants for CryptoPunk holders, Instagram announced that it will incorporate NFTs into its platform and Nike acquired metaverse fashion company RTFKT. Royal has redefined music revenue streams and ownership by allowing fans to invest directly into songs. In addition, sports players including Cristiano Ronaldo have dropped NFT collections to drive up fan engagement and potentially give access to other future perks.
In 2023, I’m excited to see industry disruption and ideas for utility NFTs fleshed out even further. Cryptonative applications, as well as traditional companies, will likely start to experiment more with using NFTs to bring something valuable to their owners.
How were my predictions for 2022?
At the end of 2021, I made predictions about the growth of six sectors listed below. Here’s how I score myself on accuracy, with 1 being the least accurate and 5 being the most accurate.
Layer 2s and Rollups, both ZK and optimistic, will continue to expand in the coming year
Layer 2s have seen incredible growth this year. Though Ethereum underwent the Merge, its gas fees were essentially unchanged, meaning layer 2s are still critical for decreasing the financial barrier to entry to interact on-chain.
Layer 2s account for an impressive 30%-40% of Ethereum transactions, and around $250 million flows into layer 2s monthly. Arbitrum and Optimism have been particularly dominant players – both of the networks saw their TVL surpass Solana’s this year. Arbitrum also had an incredible 516% growth in active developer teams since January. Further, cumulative volume traded on all StarkEx platforms has skyrocketed to $775 billion since launch. However, the sector wasn’t completely immune from the effects of the bear: total value locked on layer 2s on Ethereum was down 30%+, from ~$7.3 billion in January to ~$5 billion in late October.
Non-Ethereum/Bitcoin chains will become larger players in DeFi, gaming, and more
Ethereum’s share of TVL versus alternative layer 1 chains (altchains) has mostly stayed flat between ~50% and ~58% throughout 2022. 2021 saw explosive growth of alternative chains, with Ethereum’s share of TVL dropping ~20%. 2022 has been flatter, with Ethereum retaining around the same share for the year versus competing altchains. Part of this may be due to the Ethereum Merge, where the network switched from proof-of-work to proof-of-stake and subsequently made the chain a more attractive option.
Though Ethereum maintained its TVL share, many layer 1s did emerge in 2022, promising higher transaction fees and lower gas fees. Two notable examples are Sui and Aptos, both founded by ex-Meta developers (specifically Diem). The projects collectively raised $450 million+ in funding in 2022 and have seen huge amounts of attention and ecosystem growth since launch.
I noted last year that Ethereum virtual machine (EVM) platforms have allowed Ethereum dapps to seamlessly launch on other EVM-compatible chains. This technology continues to show its strength, as it essentially eliminates the need to rebuild a dapp from the ground up to ensure that it is compatible with a given layer 1’s tech stack. In 2022, EVM has driven efficiency and interoperability on the development side as well as improved functionality and more seamless liquidity flows for users. Recent data also shows that EVM-compatible chains experienced more activity than non-EVM compatible chains.
Composability and Web3 will continue to gain traction as crypto’s use cases grow
Last year, I speculated on the growth of the Web3 sector, which in general is a blanket term which refers to blockchain and crypto-enabled technologies. This prediction was largely accurate as we saw composability/interoperability popularize massively in 2022. Projects like Succinct have done a fantastic job reducing friction by allowing for seamless communication between protocols.
Web3 also made huge strides as companies including CreatorDAO, Arpeggi Labs, and Arkive redefined ownership, collaboration mechanisms, and monetization streams. Developers are continually experimenting with fresh use cases for crypto: Ethers.js was downloaded ~948,000 times so far in 2022, a 212% increase since 2021, and web3.js was downloaded ~587,000 times, a 137% increase since 2021. In addition, powerful new revenue streams for creators, financial mechanisms like co-ownership, and identity and social tools were brought to the market in 2022. Companies including Farcaster and Lens Protocol made Web3 social a less complex and more palatable sector by providing users better UI/UX and offering unique, crypto-enabled ways to interact.
Expansion of NFTs will be a dominant trend in 2022
NFTs were definitely all the buzz in 2021, but the sector didn’t fare quite as well in 2022. From the fourth quarter of 2021 to the first quarter of 2022, the total number of NFT sales was down ~46%, from ~14 million to 7 million. Another notable stat reveals that NFT trading volumes have decreased 97% from all-time highs. Additionally, in Sept. 2022, OpenSea saw trade volume decrease 99% since May highs. Many metaverse NFT companies have been struggling as well; for example, digital fashion giant RTFKT saw sales decrease from roughly 14,000 ETH in February to 154 ETH in November.
However, the year definitely did see expansion in utility, gaming, and music NFTs, as well as creative new applications for utility NFTs, such as soulbound tokens, token-gated communities and events, and co-ownership mechanisms. In addition, 2022 saw the launch of Sudoswap, a novel and permissionless NFT exchange for trading NFTs via an AMM design. The royalty-free platform saw more than 7,000 transactions in one day at its peak in August, representing over $3 million. Uniswap also recently introduced NFTs on their platform with an aggregator that supports OpenSea, Sudoswap, and X2Y2, among others. Overall, the year brought many creative new takes on how NFTs can be used, despite the category’s sluggish transaction volume.
The DAO space will continue to see growth in complexity and use cases
Both the number of decentralized autonomous organizations (DAO) – and the number of companies tackling DAO tooling – have grown significantly in 2022. The total number of DAOs skyrocketed from 700 in May of 2021 to more than 6,000 in June of this year, and companies such as Utopia Labs, Coordinape, and Layer3, among others, have made it easy to deploy and manage a DAO.
The total market cap of all DAO tokens was roughly $21 billion in Jan. 2022, with the top five DAO tokens constituting $13.2 billion of that number – revealing that value is largely concentrated in only a few quality DAOs. Uniswap, the leading DAO in terms of treasury size, saw its treasury decrease from $2.9 billion at the end of 2021 to $2.3 billion in late Nov. 2022. Most DAO treasuries have followed suit during the bear market, but the sector has shown resilience. Analytics reveal that more than 2,850 DAOs began governance activities from May to Oct. 2022, and in general, more DAOs were created this year than last (on a month-by-month basis). Because incentive structures, use cases, and governance look different for every DAO, the sector is still evolving rapidly and we’re continually seeing fresh takes on what it means to operate as a DAO.
Security will be integral for strengthening the DeFi ecosystem
The Ronin bridge hack in March 2022, where attackers stole $625 million, constituted a higher amount than the roughly $610 million stolen in malicious DeFi exploits in all of 2021. In total, 2022 saw more than $3 billion worth of digital assets stolen, as of Nov. 1. The sheer number of DeFi security companies has certainly increased in 2022, and their tech stacks have improved; however, explosive DeFi growth led to more targeted hacks than ever as the industry expanded.
We’ve undoubtedly seen more innovation in the sector as companies such as Quantstamp, CertiK, and OtterSec continually secure the industry via mechanisms such as formal verification, smart contract auditing tooling, and white-hat hacking.
However, the spotlight remains on crypto security. In the midst of continued exploits, the FBI cautioned investors of potential platform hacks and asked DeFi platforms to improve security measures. Crypto cannot go totally mainstream unless it becomes secure; 2022 was largely disappointing in terms of hacks, but we did see more companies emerging and strengthening to tackle the issue.
My final takeaway from 2022
Despite some painful hacks and CeFi crashes, the crypto industry as a whole made huge technological strides in 2022. Even through the harsh crypto winter, Web3 has reached an incredible amount of individuals – and the technology is clearly here to stay. Our job as an industry is to make that technology accessible, reliable and safe for users around the world in order to usher in an era of financial transparency, dependability, and autonomy. Web3 continues to redefine how we think about money, ownership (of both physical and digital assets), identity, and community. I’m very excited to see what 2023 brings as we continue to accelerate the adoption of an economic layer to the internet.
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