A beginner's guide to understanding all the core concepts of encryption in one article

Cryptocurrency is heating up with the recent approval of a US Bitcoin spot ETF, the rise of Solana, new experiments around blockchain architecture, and innovations in the Bitcoin ecosystem. Therefore, GSR Digital provides an overview of various digital asset themes and sub-sectors as a reference for experienced people and a beginner’s guide for those new to the circle.

Blockchain-related concepts Bridges Different blockchains have different rules, consensus mechanisms, and token standards, so tokens cannot simply be sent from one blockchain to another. Bridges can transfer tokens and data from a source chain to a destination chain, and must perform three main tasks in the process: data transfer, verification, and interpretation. Bridges can be built in a variety of ways, with different tradeoffs between trustlessness (whether the bridge inherits the security of the connected chain), scalability (is it easy to connect multiple chains or does each path require a custom implementation), and versatility (can the bridge send arbitrary data/messages, or can it only perform cross-chain exchanges). Bridges also represent a huge attack vector, and their security is usually assessed by the number of chains supported, daily active users, and total value locked. The three main ways bridges perform cross-chain transactions are: Locking and minting: These bridges lock native tokens in a smart contract on the original chain and then issue an equal amount of wrapped tokens to users on the destination chain. Wrapped tokens act as IOUs and can be burned later to get the original tokens back on the original chain. Such bridges have advantages in staking efficiency, as they do not require additional staking or liquidity, but they disperse liquidity on the destination chain, produce multiple wrapped versions of assets, and pose systemic risk to the destination chain if attacked. Cross-chain liquidity: These bridges act as cross-chain automated market makers by letting liquidity providers (LPs) provide liquidity to facilitate low-slippage swaps. They are inefficient in liquidity, but only deal in native tokens, so the risk is limited to LPs. Burning and minting: These bridges destroy native tokens on the origin chain and mint an equal amount of tokens on the destination chain. Since they do not wrap tokens or use AMMs, they do not disperse liquidity or introduce slippage. However, the bridge must have the right to mint native tokens on multiple chains, which is generally only applicable to real-world assets (Circle's CCTP is an example).

Before minting on the destination chain, the bridge must reach consensus that the assets on the origin chain have been locked or destroyed. This is done in three ways: Local Validation: The bridge runs a light client of the origin chain as a smart contract on the destination chain to verify. This inherits the security of the connected chain, but the light client must be custom built for each one-way bridge. External Validation: The bridge reaches consensus using its own set of validators, which may be a centralized entity, a multisig, or a decentralized group of stakers (usually using a PoA or PoS mechanism). These bridges are less secure and are essentially blockchains themselves, but without social consensus. Local Validation: Locally validated bridges act as a P2P matching platform based on a centralized limit order book, involving two parties interacting to cryptographically verify the counterparty. They are secure and easy to set up between multiple chains, but can only exchange assets. Optimistic Validation: A hybrid of the above methods, similar to optimistic rollup, it assumes that the block headers submitted on the destination chain are valid unless proven otherwise during a challenge.

Cryptography Cryptography is the study of techniques for securing communications and data in the presence of adversaries. It is part of the larger discipline of cryptography, along with cryptanalysis. Cryptography uses various encryption algorithms (called ciphers) to secure communications, where a password and a key transform input data (called plaintext) into an encrypted output (called ciphertext). Cryptography can be divided into symmetric cryptography, asymmetric cryptography, and cryptographic hash functions. Symmetric cryptography uses the same key for encryption of plaintext and decryption of ciphertext. It is generally simpler and less computationally intensive than asymmetric cryptography, but requires a way to securely share keys, and a separate key is required for each pair of users in the network. Examples include various ciphers (e.g., the Caesar cipher) and the Data Encryption Standard (DES). Asymmetric cryptography (also known as public key cryptography): The use of mathematically related public and private keys eliminates the need for shared keys and is therefore more suitable for large/expanding/active networks. Public keys can be freely shared and are created from private keys, they act as a single-factor authentication mechanism and should be kept strictly confidential. The public and private keys are mathematically related, and while it is easy to calculate the public key from the private key, the reverse is almost impossible. This provides a way to prove knowledge of a private key without revealing it, and allows a message to be encrypted to the recipient's public key, which can then only be decrypted by the recipient's private key (providing encryption), and the sender's public key can be used to verify that the sender is the holder of the private key without revealing the private key (providing authentication). Examples include DH, RSA, and elliptic curve cryptography, the latter of which is used by Bitcoin, Ethereum, etc. Cryptographic hash functions create a digital fingerprint for any amount of data by splitting the data into pieces and performing multiple rounds of local operations on them, losing information, and ultimately converting the data into a fixed-length string of digits. Hash functions are one-way (the input cannot be deduced from the output) and deterministic (return the same output for a given input). Bitcoin uses the SHA-256 hash function in the protocol.

Custodians store and protect the owner's cryptographic private keys, enabling holders to sign digital asset transactions. Keys are stored in crypto wallets, which can be hot wallets (connected to the internet; sacrifices security in exchange for speed, liquidity, automation) or cold wallets (not connected to the internet; more secure but slower and requires manual work). Custodians hold keys on behalf of users, while custody technology providers provide technology solutions that enable end users to self-custody securely and efficiently. Custodians take on more risk, are subject to more regulation, and provide higher customer service, but offer fewer assets/functionality, introduce counterparty risk, and are slower to respond. Core custody technology solutions include: Hardware Security Module (HSM): is a tamper-proof, government-certified physical device that protects the encryption process and is not connected to the internet. HSMs are difficult to crack, but they create a single point of failure. Multi-signature: Multiple keys are required to authorize digital asset transactions, typically requiring a majority of the keys associated with the asset to sign the transaction (e.g., 3 out of 5). Multi-signature mitigates the single point of failure problem of HSMs, but may not be supported by all blockchains, can result in higher transaction fees or reduced privacy, and introduce smart contract risks.

Multi-party computation (MPC): is a process whereby a private key is split into key shares and distributed across multiple devices. MPC is flexible, can enable complex signing rules, signature shares can be changed or revoked later, allows for a mix of hot and cold wallets, and generates standard signatures, but is a newer, less tested technology that cannot be used with HSMs. Custodial solutions are managed by a variety of providers (e.g., dedicated crypto-native providers, traditional financial institutions, cryptocurrency exchanges, prime brokers), may focus on retail or institutional investors, and often offer additional services such as trading, lending, staking, governance participation, and/or secure customer networks.

Decentralized Autonomous Organizations Decentralized Autonomous Organizations (DAOs) are blockchain-based organizations governed by a set of automatically enforceable rules that allow bottom-up decision-making and organizing communities around common goals. DAOs are collectively managed and owned by their members, have no hierarchical structure, and their governance is encoded in smart contracts. DAOs are essentially coordination mechanisms that provide trustless management and organizational transparency, participatory decision-making and borderless cooperation, as well as novel funding methods and ownership mechanisms. They are used to manage protocols, fund grants, distribute creative works, guide investments, unite community members, and serve other DAOs. Membership in a DAO is usually determined by ownership of the DAO token, which is usually available for free and allows any holder to propose and vote on governance proposals (such as how to use treasury funds). In addition, a number of DAO frameworks have emerged to automate DAO creation, including Aragon, DAOstack, Moloch, and Colony. The most famous DAO is The DAO, a community-directed venture capital fund established in 2016 that invests its funds based on member votes. The DAO, which at the time gathered 14% of all circulating ETH, had $60 million stolen from its treasury, and disagreements over whether to restore the funds led to the network splitting into Ethereum and Ethereum Classic (ETC). DAOs are widely relied upon in the governance of DeFi protocols such as Uniswap, Compound, and Aave. More recently, DAOs have been set up as art collectives (PleasrDAO), social communities (Friends With Benefits), and for purchasing items (ConstitutionDAO). The largest DAOs include Optimism, Arbitrum, Mantle, and Uniswap.

DAOs have the potential to improve civic engagement, streamline business creation and fundraising, pave the way for shared financial and social capital, make work unconstrained and customizable, better match products/services with demand, and improve meritocracy, contribution-driven ownership and rewards. However, to date, DAOs have fallen short of their original expectations and goals, and are often criticized for low voter participation, potential for coercion, lack of privacy, and excessive influence by large token holders.

Decentralized Finance Decentralized Finance (DeFi) is a form of finance that uses blockchain technology, smart contracts, and decentralized applications to provide traditional financial services such as lending, trading, and investing in an open and transparent manner without intermediaries. Protocol developers typically release their DApps as smart contract code deployed to a blockchain such as Ethereum. DApps usually start out centralized, but typically become decentralized over time and ultimately controlled by a decentralized autonomous organization (DAO). DApps typically issue tokens to coordinate and incentivize user behavior and reward value contributions. By leveraging smart contract code deployed to a decentralized public blockchain and creating a peer-to-peer network, DeFi is both trustless (because the program executes automatically) and rent-free (because there is no centralized intermediary). DeFi also inherits the properties of blockchains such as transparency, openness, and immutability, and introduces new paradigms about ownership, governance, and incentives. DeFi activity can be measured by the number of active users, the number of DApps, or the total value locked (TVL), which refers to the total amount of assets locked in DeFi smart contracts over a specific period of time. Most DeFi activity occurs on Ethereum or its second-layer network due to large network effects, however other blockchains such as Solana and Avalanche also have active DeFi ecosystems and offer advantages over Ethereum in terms of speed/scalability. Popular DApps include Uniswap (spot DEX), dYdX (perpetual DEX), Aave/Compound (lending), Lido (liquidity staking), and Maker (collateralized debt positions/DAI stablecoin). DeFi began to flourish in the summer of 2020, known as DeFi Summer, when lending platform Compound began to incentivize activity on its DApp through its COMP governance token, a process known as liquidity mining.

Derivatives A derivative is a financial contract whose value depends on an underlying asset or portfolio of assets and is used to hedge risk or for speculative purposes. The price of a derivative fluctuates based on changes in the underlying asset and can be traded on exchanges with standardized terms or bilaterally in over-the-counter markets with more customized terms. While derivatives in traditional finance also include forwards and swaps, the most common derivatives in the crypto space include calendar futures, perpetual futures, and options. Futures Contracts: (Delivery) Futures are a financial contract that requires the buyer to buy an underlying asset and the seller to sell the underlying asset at an agreed price on an agreed date in the future. Futures contracts are standardized, traded on exchanges, and can be settled physically or in cash. Standard cryptocurrency futures are primarily made up of CME's futures products, with perpetual contracts accounting for less than 5% of all futures trading if they are included (i.e., most futures trading is done through perpetual contracts). Perpetual Contracts: Perpetual contracts are similar to futures contracts, but they do not have an expiration date. As futures contracts approach expiration, their price converges to the spot price, while perpetual contracts use a funding mechanism to connect the contract to its underlying spot price. Specifically, when the perpetual contract price is above the spot price, the funding rate is positive, and longs pay funds to shorts, and vice versa (the funding rate is also based on the size of the gap between the perpetual contract and the underlying price to incentivize traders to balance demand and connect the perpetual contract price to the spot price). Perpetual contracts improve market efficiency by pooling liquidity from various expiration dates into instruments traded on a single exchange. Binance dominates the perpetual contract market share, and OKX and Bybit are the main perpetual contract exchanges. Only 2% of perpetual contract trading volume occurs on-chain, with dYdX standing out in this regard.

Options: Options give the holder the right, but not the obligation, to buy (call options) or sell (put options) an asset at a specific price (called the strike price) and to be exercised before or on a predetermined future date. The price of an option is determined by the price of the underlying asset, the strike price, the time to expiration, the volatility of the underlying asset, and interest rates. Options traders typically focus on risk metrics called Greeks, which measure the response of the option price to changes in underlying variables, such as the price of the underlying asset (called Delta), the change in Delta due to changes in the underlying asset (Gamma), the change in volatility (Vega), and the change in time remaining (Theta). Compared to perpetual contracts and liquid options markets, crypto options have limited adoption. Deribit controls 80-90% of crypto options trading volume, while Paradigm is an OTC communication/quote network that accounts for about a third of Deribit's trading volume. Decentralized exchanges (DEXs) account for only 1% of total options trading volume, with Ribbon/Aevo, Lyra, and Dopex being the main DEX options trading platforms.

Market Makers Market making is the act of providing two-way bid and ask quotes and bid sizes for an asset on an exchange. It increases liquidity for buyers and sellers who might otherwise see worse pricing and lower market depth. Market makers use proprietary software, called engines or robots, to display two-way quotes on the market, and these engines constantly adjust bid and ask quotes based on price changes and changing volume dynamics. Traditionally, market makers earn profits by charging the bid-ask spread (e.g., buy at $100, sell at $101), and they take on the risk that global price movements go against them when they hold an asset, i.e., price risk. Given the high prevalence of trending markets and one-way order flow, market making work in the cryptocurrency market is usually done through a lending + options or margin model. Differences between market makers include the liquidity provided, technology and software, history and experience, transparency and reporting, reputation, exchange integrations, ability to provide liquidity on centralized and decentralized exchanges, and value-added services.

Specific key performance indicators for market makers include bid-ask spread, percentage of volume, percentage of best bid/ask (i.e. percentage of best bid/ask prices), and uptime. Market makers provide many benefits to projects and exchanges, such as better liquidity and market depth, reduced price volatility, improved price discovery, and significantly reduced slippage. Perhaps most importantly, tokens play a large role in decentralized applications, so liquidity is a key factor in making the technology work.

Market Structure Market Structure: Crypto market structure has many unique characteristics compared to traditional finance, including 24/7 trading, the ability to self-custody, centralized exchanges playing multiple roles such as broker/exchange/custodian, instant settlement, hybrid regulatory oversight, stablecoins as underlying assets, a growing derivatives market, the ability to trade both on-chain and off-chain, and enhanced transparency (for on-chain activities). Crypto markets offer many key advantages over traditional finance, including fewer intermediaries, instant settlement, lower costs, higher efficiency, and greater access. Crypto market structure presents several key challenges and risks. First, there is a patchwork of legal and regulatory oversight, with many regulatory regimes still under development. Second, there are heightened risks associated with security (smart contract risks, hacks, scams), custody (lost keys, poor access controls), and counterparties (misappropriation, anonymous teams). Finally, capital efficiency is generally low due to the fragmentation of liquidity across different trading venues and on/off-chain, the lack of full-service crypto prime brokers, limited cross margin, and the required pre-funding of trades. Trading can be conducted on centralized or decentralized exchanges or through over-the-counter markets. While some spot trading is conducted through decentralized exchanges (about 15% of total trading volume), derivatives trading rarely occurs on-chain (about 2-3%). Perpetual contracts are the most popular trading instrument, followed by spot trading, with relatively few options or futures trading.

Despite low correlations with traditional assets, cryptocurrencies exhibit high volatility due to their nascent and structural nature. Bitcoin is highly correlated to the increase or decrease of global liquidity and tends to move in the short term with macro and crypto-specific catalysts and risks. In the long term, we expect Bitcoin's price to change with changes in fundamentals, including adoption, usage, development, talent, and capital.

Maximum Extractable Value Maximum Extractable Value (MEV) is a measure of the profit that a miner or validator extracts from block production, in addition to block rewards and transaction fees, by including, excluding, and changing the order of transactions in a block. Transaction information, including the transaction's base fee and priority fee (Gas), is typically broadcast to the blockchain network and placed in a queue of pending transactions called the txpool or mempool. Miners/validators can choose which transactions to include in their proposed blocks and in what order, and historically, they have selected transactions with the highest gas prices from the mempool and sorted them by gas expenditure. However, pending transaction information can be used maliciously, as bots attempting to snap up transactions ahead of pending transactions quickly realize that ordering transactions based on priority fees is not a profit-maximizing strategy relative to more complex sorting strategies. For example, miners or independent third parties called searches may use complex, bot-based trading strategies to arbitrage price differences between DEXs, wrap pending DEX transactions with their own buy and sell orders (known as a sandwich attack), or perform liquidations for decentralized lending protocols. While validators are in the best position to exploit such transactions, as they control what transactions are included in blocks and in what order, the vast majority of MEV is extracted by highly sophisticated independent parties (although the majority goes to validators). The Ethereum validator role is designed to be as simple as possible without specialization, but maximizing transaction fees in this MEV paradigm is very complex and computationally challenging compared to the early days when miners simply ordered transactions based on the fees paid. As a result, validators now typically no longer construct their own blocks (although they can still do so), but instead typically receive blocks from mutually trusted relayers who relay between block generators and block proposers (validators). Flashbot's MEV-Boost software facilitates this handoff. In this setup, block production is outsourced to a market of professional block generators who aim to maximize MEV, and these generators bid block proposers (validators) to propose their blocks to the network.The role of the validator becomes very simple, just selecting the block with the highest bid. Due to the competitive nature of this bidding process, the majority of MEV revenue is paid by builders/searchers, which goes back to the validators who actually have the ability to propose the blocks that harvest it.

While some types of MEV, such as CEX/DEX arbitrage to ensure users pay the same global market price and exchange clearing to ensure loans are returned, are beneficial, MEV creates a number of negative externalities. These include worse execution and higher prices for squeezed traders, and broader concerns about network centralization due to the specialization required to compete. Two very important vectors of MEV competition include private order flow and latency. All else being equal, more trades are always better from a searcher’s perspective, so any searcher/generator that receives private order flow, rather than trading through the mempool, will be in an advantageous position. Additionally, CEX/DEX arbitrage is currently the largest form of MEV, and since prices on most DEXs only adjust between blocks (12 seconds), while prices on CEXs fluctuate constantly, it is advantageous to have the lowest latency to submit the most competitive bid before the auction ends. This is particularly notable when the true market price of an asset moves dramatically over a 12 second period, enabling the lowest latency participant to submit the most competitive bid before the auction ends.

There are various companies and strategies to reduce the negative externalities of MEV, the most notable of which is Flashbots, a research organization that aims to reveal and democratize access to MEV. After successfully launching products such as Flashbots Auction and MEV-Boost, Flashbots is now developing its SUAVE solution to decentralize block generation itself.

Mining The Bitcoin blockchain is a network of unrelated computer nodes that use cryptography and consensus mechanisms to reach agreement and record valid transactions. Special nodes are called miners, who organize pending transactions into blocks and compete to be the first to solve the mining puzzle, add their block to the blockchain, and receive a block reward (and associated transaction fees). By requiring miners to spend something valuable (in this case, computing and energy resources) to solve the mining puzzle, Bitcoin encourages miners to participate honestly, despite the potential risk of bad actors. Miners organize pending transactions into a proposal block and include a random number called a nonce, hashing their proposal block so that the hash output is below a target value (a hash function is a deterministic, one-way algorithm that converts any amount of input data into a fixed-length digital output). If the hash value is below the target value, the miner broadcasts the winning block to the network, which is verified and added to the blockchain by other miners, and the winning miner receives the block reward and block transaction fees. If a miner does not solve the mining puzzle, it changes the nonce (and/or the transaction) and hashes it again, repeating the process until it or another miner solves the puzzle, and the process starts over again. Miners typically use mining rigs with specialized circuitry, and each model of mining rig has its own hash rate (hash rate refers to how many hash operations a device can do per second. For example, a Bitmain S19J Pro can do about 100 TH/s, or 10^14 hashes per second) and efficiency (the power required for each hash). Bitcoin has a maximum supply of 21 million bitcoins, which is achieved by halving the block reward every four years (the current block reward is 6.25 BTC, which will be halved in April 2024). In addition, the network adjusts the mining puzzle target approximately every two weeks so that it takes the network (and its hash rate at the time) approximately ten minutes to solve the mining puzzle. Therefore, the Bitcoin network produces a new block approximately every ten minutes, which, combined with the block reward of 6.25 BTC, means that the network distributes 900 new BTC per day (6.25 BTC block reward * 6 blocks per hour * 24 hours per day).

Any one miner's chance of solving a mining puzzle is proportional to their hashrate market share (the miner's hashrate relative to the network's hashrate). For example, if a miner produces 4 EH/s (4 * 10^18 hashes/second) and the total network hashrate is 400 EH/s, then that miner would have a 1% hashrate market share and would be expected to receive 1% of all Bitcoin block rewards, or 9 BTC per day. This setup encourages hashrate competition between miners. Also, note that to smooth income and reduce the effect of luck, miners join mining pools, which bundle hashrate together and split block rewards in proportion to the hashrate contributed in exchange for a small fee). Mining occurs all over the world, but miners flock to geographies with strong rule of law and low electricity costs. China was the leading geography due to its cheap hydroelectricity until mining was banned in May 2021, and now the United States is the leading geography for mining. It is important to note that Bitcoin mining is often criticized for its high electricity consumption, and while opponents often conflate usage with emissions (mining often over-relies on renewable energy because it is often the cheapest source of power), mining can actually drive renewable energy development by providing flexible baseload for otherwise uneconomic renewable energy projects. The largest miners include Marathon (26 EH/s), Core Scientific (16 EH/s), CleanSpark (10 EH/s), RIOT (9 EH/s), Bitdeer (8 EH/s), and Cipher (7 EH/s).

Modular blockchains have four basic functions: execution, consensus, settlement, and data availability. Traditionally, all four of these functions are performed by the first layer of the blockchain, which is known as a monolithic structure. However, this leads to the trade-off of the blockchain trilemma, which states that it is impossible for a blockchain to simultaneously balance decentralization, security, and scalability (e.g., a blockchain can increase the block size to increase speed, but this will cause the blockchain to become larger, making it impossible for some nodes to keep a complete copy, ultimately reducing decentralization). However, a new type of protocol is separating and optimizing each function, allowing each component of the modular stack to be optimized to achieve a more decentralized, more secure, and faster blockchain. This concept is known as modular blockchain or modular architecture. In more detail, the four functions of a blockchain are:Execution: Performing computations. This involves starting from an initial state, running transactions, and transitioning to an end state.Consensus: The process of reaching agreement on transactions and their ordering.Settlement: Validating transactions and providing finality guarantees. For modular chains, this includes verifying/arbitrating proofs and coordinating cross-chain messaging.Data availability: Ensuring that transaction data has been published so that anyone can recreate the state.

Examples include: Ethereum has chosen to improve scalability by outsourcing execution to a second layer network. While Ethereum can still operate as a monolith, it is moving towards executing consensus, settlement, and data availability while leveraging second layer scaling solutions for off-chain execution. Celestia is another example, using data availability sampling and erasure coding to provide transaction ordering and data availability to prove that enough data is available to replicate the state of the blockchain and allow other modular components to connect to Celestia's network to quickly create interoperable, customizable, high-performance blockchains. Other examples include Fuel (modular execution layer), Tezos (first layer with rollup capabilities), Avail, and EigenDA (data availability layer). Different building blocks can be used to design modular chains, and different solutions can be used for different functions. For example, Solana performs all four blockchain functions and is a monolithic blockchain. In contrast, smart contract rollups use Ethereum for consensus, settlement, and data availability, and smart contract rollups for execution. Validium (a scaling solution) can use Ethereum for consensus and settlement, off-chain data availability through the Data Availability Committee (DAC), and execution on validium. While sovereign rollups can use Ethereum for data availability and consensus, execution and settlement occur on the sovereign rollup. There are many challenges with modular chains, such as their development is still a work in progress, rollup sequencers are still centralized (i.e. each rollup currently determines its transactions/transaction ordering and may be subject to censorship), and liquidity is fragmented between different execution layers.

Non-fungible tokensFungibility is when two items are identical and interchangeable, such as dollars or airline points, while non-fungibility is when an item is unique and therefore not freely interchangeable, such as an original painting or land. NFTs are non-fungible (completely unique) digital assets stored on a blockchain and can be thought of as blockchain-based digital representations of ownership. Note that for cost reasons, an ID number is stored on-chain instead, which points to a URL to a JSON metadata file (Autoglyphs is one of the few counterexamples). Also note that blockchains have standards for defining fungible tokens, such as Ethereum's ERC-20, and non-fungibles, such as Ethereum's ERC-721. NFTs have typical cryptocurrency benefits, such as immutability, provable scarcity and provenance, standardization and interoperability, and programmability, and they make digital assets as real and permanent as items in the physical world. NFTs can represent ownership of unique and valuable items such as digital art, domain names, intellectual property, and event tickets, and can be used for a variety of use cases such as collectibles, gaming, media, music, and finance. Notable examples of NFTs include: colored coins on Bitcoin in 2012; CryptoPunks in 2017 (the first NFT on Ethereum); CryptoKitties in 2017 (a digital cat NFT collection and breeding game); Beeple’s Everydays NFT auction (sold for a record $69 million); and NBA Top Shot (digital NBA cards) in 2021. NFTs have historically been traded on various NFT marketplaces, some specializing in specific areas, until the boom market in late 2021, when OpenSea captured 95% of the market. However, Blur recently replaced OpenSea as the dominant marketplace by using token incentives and enhancing trading capabilities. Overall, NFT trading volume, many of which are “PFP” (avatar NFT) transactions, has fallen by about 95%, and prices have fallen by more than 80% from their peak.

Despite severe declines in trading volumes and prices, many believe that the importance of NFTs cannot be underestimated and that they will eventually become ubiquitous as new features (such as improved programmability and composability), new use cases (such as tokenization and continued development of gaming), new ownership and business model paradigms emerge, and the world becomes increasingly digital.

Blockchains consist of blocks of transactions that are created and validated according to pre-defined, coded rules. However, since participants can be malicious, blockchains require block producers to stake a certain value to prevent bad behavior. Proof-of-Stake (PoS)-based blockchains like Ethereum do this by requiring block producers (called validators in PoS systems) to lock cryptocurrency in smart contracts, a process called staking. In addition to additional balancing mechanisms, validators are randomly selected to produce a block based on their stake ratio and receive staking rewards from transaction fees and protocol issuance to compensate them for the work they perform, such as proposing and validating blocks. However, if validators perform their duties poorly, either intentionally or unintentionally, a portion of their stake may be slashed. Staking is therefore essential to the proof-of-stake process and is a means of protecting the network. To stake, individuals can run a validator node or delegate tokens to a validator in exchange for a small portion of the staking rewards. Staking rewards vary based on protocol design, stake participation rate, network activity, lockup period, and selected validators (for token delegators). Risks include the unwinding of the staking period, as the staked tokens are often not allowed to be withdrawn immediately, the possibility of being slashed in the event of poor performance, and opportunity costs, as the staked tokens cannot be used for other activities. To circumvent high opportunity costs, many staking service providers distribute derivative assets called Liquidity Staking Tokens (LSTs), which not only represent the staked tokens, but also generate interest and can be used in DeFi protocols, such as as loan collateral or to provide liquidity on decentralized exchanges. Lido Staked Ether (stETH) is the largest example.

Many decentralized applications and centralized digital asset service providers offer staking services, where users deposit tokens into smart contracts or centralized modules to earn rewards/increase rewards, gain governance rights, etc. Although this is also called staking, it is very different from staking in the consensus protocol of the blockchain, and it is more commonly used to reduce token supply, increase token demand, and reward users.

Real World Assets (RWA) Overview: Tokenization is the process of bringing off-chain assets (often referred to as real-world assets or RWA) onto the chain to enable on-chain tracking, trading, programming and management. Many different types of assets can be tokenized, such as commodities, collectibles, financial instruments, intellectual property and real estate. Due to the benefits and improvements it brings, enterprises, crypto OGs and regulators have shown great interest in it. According to The Block, the global tokenization market is expected to reach $16 trillion by 2030. Benefits: The benefits of tokenization include: Asset Management and Administration: Streamlining operations, reducing administrative burdens, automation and transparent recordkeeping Market Efficiency and Liquidity: Improving asset efficiency through composability by reducing administrative costs and decentralization, improving standardization, shortening settlement times, reducing reliance on middlemen Inclusive Finance: Lowering minimum investment restrictions and access to more sources of capital Economic Growth: Improving access to capital and financing through a wider and more diverse range of participants Process: Real-world assets are brought to the chain through the tokenization process. According to The Block, the process includes: Identification: Selecting real-world assets to be put on the chain Verification: Confirming the ownership and value of assets through legal documents or appraisals. A trusted third party, such as a lawyer or auditor, can verify authenticity, ownership, and valuation

Tokenization: Create a digital token or set of tokens to represent an asset on a blockchain. Each token typically represents fractional ownership or a specific claim on an asset, and smart contracts can be used to define the properties and functionality of the token. Issuance: Verified asset information and created tokens are recorded on the blockchain, and token issuance is done through an ICO, STO, or direct listing. Custody/management: Asset management and custody ensure the safekeeping of physical assets and the management of their on-chain representation, typically involving traditional asset custodians and blockchain-based custody solutions.

Examples: Stablecoins are the most well-known example of tokenization, which are typically tokenized USD, but also include other assets such as gold (e.g. KAU, PAXG, XAUT). The US Treasury tokenization market has grown rapidly, with leaders including Franklin Templeton ($300 million), Ondo's OUSG ($130 million), and Matrixdock's STBT ($85 million). In addition to Treasuries, other debt instruments are also being tokenized, such as private credit (by Defyca), structured debt (Intain), debt securities (Obligate). In addition, some protocols are also tokenizing or acting as markets for less liquid tokenized products, such as Centrifuge, Goldfinch, Maple, RealT, BSOS, and Re, while others are tokenizing stocks and indices, such as Backed and Swarm. Finally, tokenization has also expanded to carbon credits (Ecowatt, Flowcarbon), physical collectibles (Collector, Tangible) and even data indexes (The Graph), KYC (Shyft Network), and work marketplaces (Human Protocol), although the latter is generally not included in the current tokenization/RWA narrative. Challenges: Despite these benefits, tokenization/RWAs must first overcome various challenges before they can realize their full potential. First, a robust and clear legal and regulatory framework must be established. Second, standardization is needed in terms of asset representation, ownership determination, and user identity. Third, interoperability needs to be improved to consolidate users and liquidity between chains and applications. Finally, data, custody, and audit processes need to be improved.

TokenomicsTokenomics is the economics of a protocol’s tokens, covering various supply and demand characteristics. Tokens play an important role in decentralized entities by coordinating and incentivizing behavior, rewarding value contributions, and facilitating exchange. As such, strong tokenomics are likely to support protocol goals, create/enhance sustainable economic models, and accelerate long-term protocol growth and value creation. Token economics design starts with the goals of the protocol and then examines how the tokens contribute to achieving those goals. Rather than increasing the price by reducing the supply, tokenomics is more about matching supply and demand. There are many tokenomics frameworks, but studying supply and demand is probably the most popular. Supply: Token supply is typically coded in smart contracts and is more formulaic than demand. Some important things to know about token supply include: Supply Definitions: There are various definitions of token supply, including that circulating supply is the number of tokens currently in circulation and immediately available for sale; total supply is the number of tokens created minus the number of tokens destroyed (including tokens locked in smart contracts); and maximum supply is a hard-coded limit on total tokens, indicating the total number of tokens that will exist in the future, indicating remaining inflation. Supply Metrics: The current and future supply of a token is affected by many different components. These include issuance schedules (many protocols have built-in mechanisms to increase circulating supply to incentivize and reward activity), allocation (tokens may be created and distributed through a fair launch or pre-mine), lock-up (pre-mined tokens may be subject to a lock-up schedule to prevent large amounts of supply from entering the market all at once), and distribution (who currently holds tokens and in what quantities, with the risk of a few large holders).

Generally speaking, a token that has a majority of its maximum supply spent, has stable, predictable inflation to encourage its use, has a fair launch or pre-mine, has a gradual, long-term vesting schedule, has a high rate of community token distribution, and is well-distributed with no outsized holders, will generally do well to steadily absorb demand over time. Demand: Token demand is driven by the benefits provided by the token based on fundamental and speculative characteristics. Demand Creation Mechanisms: Token demand can come from a variety of sources, such as use within the protocol (e.g., value exchange, governance, access discounts, etc.), sharing protocol revenue or potential revenue with token holders, monetary properties, and speculative demand. Demand drivers are not all equal. Governance rights are generally less valuable because voter participation is low. Speculative demand works both ways, and can help or hurt token prices. Sharing revenue with token holders is a strong potential benefit and demand driver, but is difficult to achieve in the current regulatory environment. In summary, protocols should focus on providing and growing real use cases/utility for their tokens to drive demand for their tokens, and then meet that demand to match supply.

Zero-Knowledge Proofs A zero-knowledge proof (ZKP) is a method that allows one party (called the prover) to prove to another party (the verifier) ​​that a statement is true, without revealing any other information. To illustrate, suppose your friend is wearing a blindfold and holding a green ball and a red ball. You want to prove to your friend that the two balls are different colors, without revealing any information about the two balls or anything else. You ask your friend to put the balls behind his back, either switch hands or not, and then show them to you again, at which point you can tell him if he switched the balls. With one round and one correct answer, your friend might start to believe you, but not completely, because you had a 50% chance of guessing right. But with each round and correct answer, you are only moving the probability of guessing towards zero, and your friend will eventually believe that the two balls are different colors, without you revealing any information about the two balls or anything else. Zero-knowledge proofs are used primarily in blockchains for privacy and scaling purposes. Examples of the former include hiding transaction information and minimizing information sharing, while examples of the latter include zero-knowledge rollups, which are implemented by processing transactions outside the Ethereum mainchain and then batching, compressing, and publishing state data to a layer, while providing a zero-knowledge proof (called a validity proof) that proves that the computation was performed correctly. Future use cases include verifiable outsourced computation at cloud scale, open third-party analysis of anonymized data, and enhanced trust, privacy, and remuneration for decentralized identities. Zero-knowledge proofs utilize arithmetic circuits to prove the validity of a statement, are probabilistic (cannot be determined, only stated with a high degree of confidence), can be interactive (as in the example above) or non-interactive (which is the approach used by blockchains), and in the crypto space often exist in the form of zk-SNARKs. Zero-knowledge proofs have only recently moved from theory to practice, and are rapidly improving in key areas such as proof time, proof size, verification time, and trusted setup.

The downsides of zero-knowledge proofs are that they are in early stages of development, are probabilistic rather than deterministic, require multiple interactions or a lot of computation, and usually have some minimal trust assumptions in a trusted setup, which is the process of generating standard parameters for proof systems (although some ZKP implementations do not require a trusted setup). Zero-knowledge proofs are similar to other technologies such as multi-party computation (enabling multiple parties to share data for computational tasks without revealing each other's data) and fully homomorphic encryption (enabling computation on encrypted data without first decrypting it). Popular protocols that employ zero-knowledge proofs include Aleo, Anoma, Mina, Tornado Cash, Iron Fish, Manta Network, Aztec, Argent, Starknet, zkSync, and Penumbra, among others.

Blockchain Sub-Sectors Blockchain Games Games are increasingly leveraging blockchain technology to incorporate cryptocurrency-based payments, rewards, and ownership into games. This includes everything from facilitating in-game transactions to creating in-game digital assets such as NFTs to verifying and recording all blockchain transactions that occur in the game. Blockchain-based games offer many benefits, including: Decentralization/Trustless: Games are more secure, transparent, trustless, and traceable. Ownership: Users truly own their assets in the form of self-custodied NFTs, turning in-game purchases from expenses into assets. Enhanced functionality: Users can resell their assets to others. Composability could potentially enable users to transfer assets between games or enable developers to build on top of existing games. Greater reach: Blockchain-based games could feature user-generated content or DAO-based community governance, where users can create worlds/in-game assets, enact storylines, or improve the game’s economic model. Incentives: Token incentives could reward users for contributions to the game, such as completing quests, producing popular content, or onboarding new users. New revenue streams: Developers can now oversee dynamic virtual economies where they can take a cut of all commerce transactions.

Blockchain-based games first emerged in late 2017 with the launch of CryptoKitties. CryptoKitties enabled users to collect and breed digital cats based on a smart contract-based breeding algorithm that determined the cat’s attributes, and was so popular that it clogged up Ethereum. The next hot blockchain-based game was Axie Infinity, which launched in 2021, a digital pet universe game that allowed players to collect, breed, and battle NFT-based Axie characters through gameplay, earning tokens from the game. At its peak, Axie had nearly 3 million daily active users, many of whom had quit their day jobs to rely on gaming for income. Other popular games include Ember Sword, Star Atlas, Splinterlands, The Sandbox, and Sorare, among others. Gamers are generally skeptical of blockchain-based games, viewing them as money traps for developers, and GameFi has been criticized for relying on a growing player base and potentially collapsing as quickly as it grew. In addition, blockchain-based games face many other challenges, such as regulation, security, scalability, UI/UX, and general poor gameplay/graphics. However, developers are now focusing on the games themselves and the unique benefits that blockchain technology brings, while avoiding volatility incentives. In addition, given the long development cycles, we are finally approaching the first true AAA blockchain-based games, such as Illuvium, Shrapnel, and Otherside.

In addition to the games themselves, there are other players in the blockchain gaming ecosystem, including development studios (such as Sky Mavis, Blockade, Mythical, Dapper, Wax), marketplaces (Immutable, Rarible, OpenSea), blockchain/scaling solutions (Immutable, Ronin, Polygon, Flow, Wax, Hive, Safa, Oasys), infrastructure/tools (Enjin, Ronin, Forte), and gaming guilds (Yield Guild Games, Avocado DAO, Merit Circle).

Lending protocols Lending markets, such as Aave and Compound, are the backbone of DeFi, allowing users to borrow or lend crypto assets permissionlessly through smart contracts to obtain leverage, short the market, or earn additional yield. Smart contracts enable these services to conduct non-custodial transactions without the need for intermediaries. Often referred to as peer-to-pool lending, borrowers lend their crypto assets to a liquidity pool from which borrowers can borrow. Interest rates are usually variable and determined algorithmically based on supply and demand (i.e., pool utilization). Increased demand for borrowing drives up interest rates, providing lenders with higher returns, and vice versa. Lenders typically receive receipt tokens corresponding to their lending margin, similar to the design of liquid staking tokens. Lending returns are either credited to the balance of receipt tokens (aTokens) or to the price of receipt tokens (cTokens). Given the peer-to-peer lending model, borrowers can only recover their loans when they have idle capacity, and when the lending pool is fully utilized (i.e., all deposits have been borrowed), borrowers may not be able to redeem their loans. However, since interest rates are typically floating and rise with usage, one would expect some borrowers to return their loans in such circumstances, allowing lenders to reclaim their collateral from the pool. Additionally, since receipt tokens are provided in correspondence with loans, borrowers can sell their loan positions on secondary markets through decentralized exchanges if liquidity is urgently needed.

Lending often requires overcollateralization to help reduce the risk of the protocol accumulating bad debt. Borrowers are exposed to liquidation risk, and if the value of the borrowed asset rises dramatically or the value of the collateralized asset falls, most protocols charge additional fees when liquidating a position, so the borrower's loan health factor should be closely monitored. Borrowing/loaning assets are usually only supported on a permissioned basis, as risk is often shared, so supporting smaller/riskier assets increases the risk of the protocol accumulating bad debt. As a result, only large tokens are usually supported, but protocols like Euler have taken the approach of isolating the lending market and allowing lending markets to form without permission. The lending/loaning market has also introduced a whole new ecosystem of financial primitives that do not exist in traditional markets, the most prominent example of which is probably flash loans. Flash loans allow borrowers to borrow any available amount of an asset without posting any collateral, as long as the liquidity is returned to the protocol within the same block (i.e., imagine if ETH on Uniswap is more expensive than Sushiswap, you can borrow USDT to buy ETH on Sushi and then sell it to Uni within the same block, thereby cutting the spread before repaying the loan). If the loan is not repaid within the same block, the entire flash loan transaction will fail (i.e., the capital will not leave the lending pool).

Central Bank Digital Currency Central bank digital currencies (CBDCs) are widely available digital forms of a country's legal tender issued by a central bank. As CBDCs are liabilities of the central bank itself, they have no credit or liquidity risk. The central bank's goal is to ensure that CBDCs do not undermine monetary and financial stability, coexist and complement other payment mechanisms and forms of money, and support efficiency and innovation. There are two main types of CBDCs: retail CBDCs are used by the public for everyday payments, while wholesale CBDCs are used as a settlement instrument between financial institutions. CBDCs can improve payments and payment infrastructure, support policies and enhance economic growth, promote global commerce and improve remittances, support financial inclusion and combat inequality. Risks of CBDCs include potential impacts on financial system stability, monetary policy, credit costs/availability, and privacy. There are many design options for CBDCs, covering interest rates, household limits, structure, payment verification, functionality, access, and governance. For example, the architecture can be centralized or decentralized, transfers can be made through a central intermediary or peer-to-peer, system and payment access/verification can be identity/account-based or token-based, ledgers can contain simple liability data or more complex payment information, and ledger access can be relatively open or more restricted. In addition, the central bank must also determine what responsibilities it will provide in addition to issuance, such as distribution, system management, and device management. Currently, 11 CBDCs have been launched, 21 are being tested, 33 are under development, and 46 are in the research stage.

Centralized Exchanges Centralized cryptocurrency exchanges (CEXs) are intermediary platforms that connect token buyers and sellers and enable digital asset transactions. Unlike traditional finance, most CEXs have a wider range of roles, acting as brokers, exchanges, and custodians. CEXs create user virtual balances after receiving fiat/token deposits, and only conduct on-chain transactions when withdrawing funds. This increases speed and reduces costs, but introduces a lot of trust assumptions on the exchange that custody user deposits. CEXs use a centralized limit order book (CLOB), where different currency pairs have bids (the amount willing to pay for an asset) and asks (the amount willing to sell an asset at a certain price). The exchange matches bids and asks based on the price-time priority principle, and market participants can see the order book depth, which means they can see bids and asks in addition to the best bid and ask. Orders can be market maker orders, which provide liquidity and are added to the order book (i.e. limit orders), or taker orders, which are immediately executed at the best bid or ask price (i.e. market orders) and reduce liquidity. Market maker orders often have significantly lower or even negative transaction fees in some cases, while taker orders are usually much more expensive. Additionally, exchanges often offer trading fee discounts at higher volume tiers.

Different CEXs offer trading in different crypto assets and products, such as spot, perpetual futures, and options. Exchanges also often offer their own tokens, which may grant holders discounts on trading fees, access to launchpad listings, and can be used as gas on the blockchain associated with the exchange. The largest exchanges include Binance, Upbit, OKX, and Coinbase (for spot trading), Binance, OKX, and Bybit (for perpetual futures), and Deribit (for options). CEXs account for 85% of total spot trading volume (compared to DEXs) and 97% of derivatives trading volume.

Distributed Cloud (Computing and Storage) Decentralized cloud protocols use blockchain technology to provide storage and computing services: Cloud storage: provides space to store data, but is stored offline on cloud servers over the Internet. Cloud storage is used for web hosting, file sharing, virtual desktop hosting, automatic data backup, etc., allowing users to protect data from disasters, secure sensitive data, supplement storage space and reduce operating costs. Cloud computing: is any Internet-based service that conducts computing processes or runs applications. It is used for cloud-based communication platforms (such as email), SaaS, remote data analysis, website content and management systems (such as CRM, CMS, ERP), it promotes easier collaboration, enables remote work, improves business flexibility and integrates important files and applications. Decentralized cloud companies provide these services through a P2P network of service providers who either utilize idle infrastructure (such as renting unused computer hard drive space through Filecoin) or purchase custom hardware and run the network from scratch in exchange for token rewards (such as Flux miners purchase and run Flux nodes in exchange for Flux rewards). Decentralized cloud providers compete with oligopolistic tech giants like Amazon AWS, Google Cloud Platform, and Microsoft Azure, offering lower prices, higher elasticity, better privacy, and censorship resistance.

Decentralized storage: Decentralized storage solutions store data distributed across multiple nodes or computers, eliminating the need for a central server and achieving data permanence and censorship resistance. They act as a market that allows anyone, from individuals to large cloud companies, to rent unused hard drive space in exchange for a fee, and attempt to coordinate and secure the process (including encryption, storage, retrieval, contract management, storage auditing, etc.). Typically, users encrypt their data, which is then split into smaller parts called shards, which are usually replicated for redundancy purposes and stored by nodes on the network. Nodes communicate with each other through a P2P protocol, receive token incentives that guarantee storage availability and reliability, and retrieve and share data when requested by users, all in a transparent and tamper-proof manner. Some decentralized storage solutions include Filecoin, Storj, Arweave, and Sia. Filecoin is built on IPFS and uses a content-based addressing rather than a location-based addressing system to store files (this method assigns a unique cryptographic hash to each data file, acting as a fingerprint of the file, called a CID), which makes it easier to share files without worrying about their location and ensures that the files cannot be tampered with. Filecoin sits on top of IPFS, providing a P2P market for storage services, incentivizing storage and retrieval providers, and ensuring that the process proceeds smoothly (miners post slashable collateral and submit proof that they are storing data, called proof of replication, and proof that they continue to store data, called proof of time-space). Other storage solutions offer similar services, but may differ. For example, Storj uses error correction coding and parallel file transfers to improve performance and availability, rather than relying on a single host for file transfers like IPFS does. Arweave is another example that, unlike IPFS, is not permanent and requires the use of a fixed service to achieve this, allowing you to store files permanently for a one-time fee.

Decentralized computing: Decentralized computing protocols use geographically distributed computing resources to provide computing, data processing, and data interaction services, which are usually provided together with data storage. Most protocols provide CPU, RAM, and GPU (newer options) and allow computing on anything that can be put into a Docker container. In addition, many computing protocols provide enterprise-grade service-level agreements and may be compatible with existing centralized providers (such as Amazon S3) for easy integration. For example: Flux incentivizes miners to purchase specialized node hardware, provides computing resources, and provides distributed storage (Flux Drive) and distributed wallet/identity solutions (Zelcore). Akash is a decentralized cloud market based on Cosmos that connects users and providers of computing and storage services. Personal or company servers can bid for work through unused capacity, which can save users up to 90% compared to AWS. Internet Computer uses data centers and high-end node hardware to replace the traditional technology stack, directly provide web content to users, act as a public computing platform, and expand, decentralize, and enhance the web. It should be noted that other protocols copy smaller components of the current Internet stack, such as Fleek, a decentralized edge network/CDN (similar to CloudFlare).

Companies are increasingly turning to hybrid cloud models with multiple providers because traditional cloud costs have roughly doubled in the past two years and it doesn’t handle new technologies like artificial intelligence well. In addition, companies are adding local servers to put computing tasks close to the data source (known as edge computing) to reduce latency and save bandwidth costs. This hybrid infrastructure reduces dependence on and lock-in to large tech providers, making it easier for companies to adopt decentralized solutions.

Decentralized Exchanges A decentralized exchange (DEX) is a decentralized application that acts as a peer-to-peer marketplace that allows cryptocurrency trading to take place directly between users. DEXs inherit the positive characteristics of cryptocurrencies (decentralization, permissionless, trustless, censorship-free, immutable, etc.), with two of the more notable features being the elimination of rent-extracting intermediaries and the ability to achieve self-custody. Given the speed and cost limitations of the underlying blockchains they are built on, DEXs typically use a deterministic pricing algorithm called an automated market maker (AMM) instead of a central limit order book. AMMs utilize a pool of tokens locked in a smart contract, allowing anyone (called a liquidity provider or LP) to deposit tokens into the liquidity pool. The price of tokens in the pool follows a formula such as the constant product market maker algorithm (x*y=k, where x and y are the number of two tokens in the pool and k is a constant), resulting in the ratio of tokens in the pool determining the price, slippage being determined by the ratio of the transaction size to the pool size, and liquidity always being available regardless of the transaction size. The price is then pegged to the global market price by arbitrageurs, who buy and sell tokens in the liquidity pool, pushing it back when it deviates from the global market price. Liquidity providers receive trading fees in the liquidity pool in proportion to the liquidity they provide. In addition, protocols often incentivize the provision of liquidity by providing liquidity providers with protocol tokens, which is called liquidity mining. Liquidity providers are exposed to the risk of impermanent loss, where there is a significant difference in the movement of one of the two assets provided to the pool compared to the other, resulting in the liquidity provider earning a better return by directly holding both assets rather than providing liquidity. Decentralized exchanges account for approximately 15% of total spot trading volume and approximately 2-3% of total derivatives trading volume.

Uniswap is the best-known and most widely used DEX, with v2 implementations that allow permissionless pool creation (anyone can create a pool), v3 that allows for pooled liquidity (liquidity providers can provide liquidity within a specific range to improve capital efficiency), and the upcoming v4 that provides hooks (for improved pool customization). In addition to Uniswap, various protocols have iterated on the basic AMM model or introduced new models to provide performance improvements for highly correlated tokens (Curve), multi-asset liquidity pools (Balancer), and have also extended to virtual AMMs such as the DeFi perpetual contract protocol.

Decentralized Identity With over a billion people unable to prove their identity, the average internet user having 100 passwords, and identity fraud costing billions of dollars each year, there are many problems with current identity verification systems. Digital identity initially took the form of users creating individual accounts on each website (centralized model), later users logged in through Google or Facebook (federated model, sacrificing privacy for convenience and security), and more recently has shifted to a new decentralized paradigm called self-sovereign identity (SSI) or decentralized identity, where users own and control their personally identifiable information (PII) and data without relying on centralized entities. Instead of having PII stored and controlled by centralized institutions that could abuse their power, decentralized identity allows individuals to keep their own data. To do this, users create decentralized identifiers (DIDs), which are then granted verifiable credentials (VCs) by the issuer, and users can use cryptography to prove ownership of the DID and make claims that can be verified by verifiers. Decentralized identity brings improved experience (login with your wallet and bring your data to the site), enables users to monetize their own data (get paid for sharing data or viewing ads), enhances digital reputation (provides low-collateral loans), increases privacy (selectively disclose information), and reduces risk (self-custody of data). Use cases range from identity verification to compliance, access control, Sybil resistance, governance, employee management, medical records, supply chain, and more.

There are several challenges facing decentralized identity systems. First, the solution set is highly fragmented across use cases and blockchains, with little interoperability (there are more than 90 DID method specifications across more than 80 blockchains), and entities like the World Wide Web Consortium (W3C) face a huge task in developing standards. In addition, most users still have difficulty managing keys and having a good user experience. In addition, it will take a long time for user behavior to change and decentralized identity to break the strong network effects of current digital identity construction. Issuers will have to adapt to new management and issuance frameworks, and enterprises and validators will need to adopt verification technologies to promote the acceptance of these credentials. There are many decentralized identity and certificate issuance protocols, some are built on general-purpose blockchains like Ethereum (POAP and ENS, issuing proof-of-presence NFTs and name-to-address resolution, respectively), while others are built as blockchains optimized for decentralized ID management (such as Sovrin, Veres One, and Ontology). There are also protocols that provide certificates as a service, enabling other Dapps to easily issue certificates, such as Galaxe and Gateway.

Decentralized Physical Infrastructure Networks Due to the billions of dollars of investment required to build and maintain large physical infrastructure and hardware networks, many technology sectors have been characterized by oligopolies that are impervious to new competitors. However, blockchain technology challenges this model by allowing projects to bootstrap and coordinate these networks through user-contributed infrastructure and token incentives. This decentralized physical infrastructure network or DePIN (also known as token-incentivized physical infrastructure network TIPIN or proof of physical work PoPW) incentivizes users to contribute to and operate devices on the network that could potentially scale to rival existing networks. DePINs have several key differences. First, it bootstraps the network by crowdsourcing hardware. Second, it enables the network to be owned and operated by users rather than by large companies extracting rents. Third, they democratize access to the network because anyone can run a node or use its services. Finally, they are decentralized and censorship-resistant. In theory, DePINs can achieve a flywheel where supply-side participants are incentivized to deploy infrastructure through token rewards. As the infrastructure network grows, developers create products and end users increase demand. As demand increases, the fees generated from end users attract more hardware providers, and the cycle repeats. Actually, DePINs perform well in bootstrapping hardware networks, but they do not always meet the corresponding needs of users.

DePIN networks are created with user-contributed hardware, which can be new or existing but idle. The former involves users purchasing and operating nodes/hotspots in exchange for protocol tokens, while the latter involves users contributing already existing but idle resources, also in exchange for token payments. For example, Helium is the first project to create a large-scale network of new hardware contributed by users, and it/third-party manufacturers sell plug-and-play Helium hotspots to users to power IoT devices (hotspots both build/protect the network by mining HNT and provide connectivity to nearby devices in exchange for HNT rewards). Although Helium built the world's largest LoRaWAN network, demand did not emerge as expected, and Helium is now more focused on rolling out 5G cellular networks. Other protocols such as Filecoin and Arweave allow users to rent or purchase unused hard drive space on other people's machines in exchange for FIL or AR tokens, making use of excess storage space, while also increasing data durability and censorship resistance because files are stored on multiple machines. DePIN is being applied in various infrastructure sub-fields, including: Storage networks: Filecoin, Arweave, Sia, Storj Databases: Ceramic, Tableland CDN networks: Fleek, Meson VPN networks: Boring, Deeper, Orchid Computing networks: Akash, Flux, Render, Livepeer, Gensyn 5G networks: Helium, Pollen, XNET

LoRAWan network: Helium, ChirpWiFi: WiCrypt, Wifi DabbaSensor network: Hivemapper, DIMO, Planetwatch, WeatherXMEnergy network: React, Arkreen

Liquid Staking Tokens Liquid staking is an innovation in the Proof of Stake (PoS) blockchain ecosystem that enables stakers to maintain liquidity while simultaneously earning staking rewards. In exchange for depositing assets with a liquidity staking provider, users receive Liquidity Staking Tokens (LST), which serve as proof of deposit and provide liquidity, fungibility, and rewarding claims on otherwise illiquid staked assets. In addition to maintaining liquidity, LST can also be freely used for other DeFi purposes, such as borrowing as collateral or providing liquidity in a DEX. Overall, LST improves capital efficiency and increases flexibility while earning staking rewards in exchange for a small fee priced as a percentage of rewards. Rewards are typically accumulated into LST in one of two ways. First, rewards may accumulate into the price of LST, so that as rewards are earned, LST becomes more valuable than the underlying asset. Alternatively, rewards may accumulate into the token balance of LST, increasing the supply of LST (e.g., new LST tokens are minted in proportion to the value of accrued rewards). While the latter model allows the price of LST to track 1:1 with the underlying token, there may be negative tax implications in certain jurisdictions.

Variables to consider include: Is the LST battle-tested? How long has the provider been on mainnet? How much stake does the provider control? Who manages the staked assets? Is it one entity? Multiple entities? Can anyone be an administrator of the staked assets (no permission required for node operators), or is a whitelisting feature required? How much liquidity does the LST have? Are there multiple uses besides buying and selling liquidity? Is there widespread DeFi integration? What is the fee structure? Are there any governance issues? Does the underlying PoS blockchain employ strict stake-based governance, or is it more like soft governance similar to Ethereum? Does the LST provider have its own token with governance powers, like Lido’s LDO?

How is LST structured? Liquid staking has flourished on Ethereum, particularly because the network does not allow native delegated staking, so the vast majority of Ethereum’s ETH stakers stake indirectly through staking service providers, which typically offer liquid staking. In contrast, ecosystems such as Cosmos, Solana, Avalanche, and Polkadot all allow native delegated staking, so delegators can delegate stake directly through the protocol without having to find a third-party liquid staking provider. The most well-known liquid staking token is Lido’s Staked ETH (stETH), which represents ether staked 1:1 through the Lido platform. There are also many smaller competing liquid staking providers on Ethereum. Outside of Ethereum, the liquid staking ecosystem is smaller, but most other blockchains have at least one liquid staking provider. For example, Solana has Jito and Marinade, Cosmos has Stride, which supports liquid staking for all IBC-compatible chains, Avalanche has Benqi, and Polkadot has Acala. While liquid staking provides more utility and flexibility for stakers, it also introduces new risks and considerations. The value of liquid staking tokens can be somewhat decoupled from the underlying asset, as the underlying asset cannot be redeemed immediately (e.g., the time to unlock varies widely, ranging from days to months or even years). In addition, smart contracts involved in liquid staking increase technical risks, including potential vulnerabilities or bugs. Liquid staking may also introduce risks that were not considered in the original protocol design (e.g., new attack vectors may emerge if all stake is delegated to unbonded node operators).

Meme coins are crypto assets that originate from internet memes or have humorous or quirky characteristics. Such tokens gain popularity and value primarily through community and social media hype, influencer endorsements, and viral internet trends, rather than fundamental value or technological innovation. More specifically, meme coins may gain value by evoking certain emotions and psychological contexts, such as being part of a community or believing that others will pay more for the token in the future. This kind of pleasurable value is difficult to quantify, especially given its behavioral nature. The success of community tokens is primarily driven by their community and cultural appeal. These communities often coordinate efforts to promote the token, creating a sense of belonging and fun. In addition, community tokens are also often created in real time based on real-world events. Finally, community tokens also tend to have unit bias, using extremely low prices in decimals and very large supplies, which have a psychological advantage for some people. Dogecoin (DOGE) is one of the earliest, most valuable, and most well-known meme coins. Doge was created in 2013 based on the "Doge" meme, featuring a Shiba Inu dog. Dogecoin is a simple successor to Bitcoin (a fork of Bitcoin), which is just a joke, not an innovation. Other examples include: Shiba Inu, Pepe, Bonk, SafeMoon, Dogelon Mars, and many more. Community tokens are known for their extreme volatility and speculative nature. Their value can quickly soar or plummet based on social media trends, celebrity tweets, or community hype, making them a high-risk investment option. In fact, Dogecoin often rises sharply in response to comments from Elon Musk, for example, when Elon temporarily replaced Twitter's blue bird logo with Dogecoin, causing the price of Dogecoin to surge. However, these short-term gains are often hype-driven and unsustainable, and prices often return quickly. In the absence of any fundamental growth or development reasons, investing in memecoins is often essentially a competition between players. It is often a game of early investment and zero-sum game, rather than a game of making a big pie.

Payment Methods The traditional financial system is built on old technology, resulting in high costs, long waits, and in some cases discriminatory practices, poor user experience, and suboptimal security. For example, ACH and remittance payments can take up to five days to transfer, credit card networks charge merchants 2-3% fees, resulting in higher consumer prices, and complex settlement systems delay the settlement of stock trades, all of which lead to suboptimal convenience, cost, risk, and capital efficiency. Even in fintech, innovation is mainly focused on the front end, while the back end still runs these traditional and old systems. In contrast, blockchain technology innovates on the back end and reimagines these systems. Currently, blockchain-based payments can be made 24/7, 365 days a year, at almost zero cost, and settlement is almost instantaneous. Enterprises can accept digital asset-based payments using only public keys, without the need for specialized hardware or payments to card issuers, merchant acquirers, and card networks. The blockchain itself can serve as a real-time, verifiable, and immutable public ledger generated by open code execution, thereby significantly improving transparency and reducing disputes. In the future, financial inclusion will be improved, and participation will only require a device connected to the Internet. User experience will be improved, key pairs will serve as identities, account numbers, and passwords, and security can be strengthened by users keeping their own private information rather than having it scattered among countless institutions, companies, and websites.

In addition to monetary payments, blockchain technology can enable many other forms of value exchange and introduce new capabilities that cannot be achieved by the existing financial system. For example, tokenization will eventually bring about the exchange and account recording of almost all other assets besides currencies, such as blockchain-based digital forms of traditional securities, called tokenized securities. These speed and cost advantages introduce new capabilities and builds, such as making previously impractical micropayments possible, charging per stream a portion of each song to better reward creators, Or on a per-webpage basis to reduce DDoS attacks. Programmability will enable new functionality such as subsidy payments that can only be spent on specific categories, composability will make accepted token formats common and usable in the digital realm, and fragmentation will increase accessibility and liquidity. These examples feature significant improvements in speed, cost, inclusivity, and transparency. Despite the huge benefits, cryptocurrency payments still face some challenges. First, there are strong network effects within traditional systems (merchants accept credit cards because buyers hold credit cards, and buyers hold credit cards because merchants accept credit cards). Similarly, consumer behavior takes decades to change, such as the cash-to-card shift (where shoppers use credit cards instead of cash), which is a multi-decade phenomenon. Additionally, regulation is unclear, acceptance/integration is currently limited, UI/UX needs improvement, and there are challenges around fraud, security, chargebacks, and disputes that need to be addressed.

Examples of digital asset payment systems include: Bitcoin was originally intended to be a peer-to-peer electronic cash system, but due to technical limitations and a fixed supply, it has become a store of value. Ethereum not only supports its own cryptocurrency ETH, but also supports the creation of tokens and the development of various payment solutions through its smart contract capabilities. XRP provides a payment protocol designed to facilitate fast, low-cost international remittances, offering its services to banks and financial institutions to facilitate cross-border payments of XRP. Stellar is similar to XRP, but it focuses on providing financial services to individuals who do not have access to traditional banks. Dash focuses on privacy, speed, and UI/UX with its PrivateSend and InstantSend payment features. Stablecoins are still the main payment mechanism, such as USDT payments on the Tron blockchain.

Scaling/Layer 2 Ethereum is the most popular smart contract layer 1 blockchain, but due to its choice to optimize for decentralization and security, it is slow relative to competing L1s, it is slow, often suffers from network congestion during periods of high activity, low throughput, and high transaction costs. To address this, many scaling solutions aim to process transactions outside of the mainnet while relying on the security of the Ethereum mainnet to varying degrees. The main types of scaling solutions are: Sidechains: Independent blockchains connected to the mainchain via a two-way bridge. Sidechains support EVM-compatible smart contracts for scaling and testing purposes. They may not be as decentralized as Ethereum, and since they have their own consensus mechanism, they do not inherit Ethereum's security guarantees, and therefore are not technically a second layer. State channels: Users can transact directly with each other an unlimited number of times outside of Ethereum, and then package and submit transactions to the mainchain. State channels can achieve high throughput and low costs, but require locking payment channel funds into multi-signature contracts and do not support general smart contracts. Plasma: Plasma uses smart contracts and Merkle trees to create independent blockchains called subchains, which are copies of the mainnet and maintain their security through fraud proofs, which are used to arbitrate disputes on the mainchain. However, Plasma cannot scale general smart contracts. Rollup: Rollup executes transactions on a separate chain before batching, compressing, and publishing the data to the mainnet. Transaction execution occurs outside the mainchain, but publishing the data back to the mainchain allows anyone to recreate the state and verify the validity of the transaction, thereby achieving high throughput and low cost, and inheriting many security properties of the mainchain.

Rollup is the most popular type of scaling solution and comes in two flavors: Optimistic Rollup (OR): OR assumes that transactions processed on L2 and published back to the mainnet are valid unless the transaction is challenged, at which point a fraud proof is generated. If the proof is invalid, the correct state is restored and the transaction submitter's collateral is slashed. OR is further along than ZKR and has a first-mover advantage, but withdrawals take longer due to the challenge period and require good monitoring. Examples include Arbitrum and Optimism. Zero-Knowledge Rollup (ZKR): ZKR bundles transactions and executes them off-chain, generating a cryptographic proof called a validity proof that is published to the mainnet along with the batched state changes. ZKR enables fast withdrawals with fewer trust assumptions, but has only recently been launched on the mainnet. Examples include: zkSync, Scroll, Polygon zkEVM, and Starknet.

Rollup brings together many transactions, executes them off-chain, bundles compressed transaction data or state differences into one transaction, and sends the data back to Ethereum. Rollup utilizes sorters to collect, sort, and send batched transactions back to the mainnet. Ethereum Rollup sorters are currently centralized and use only FIFO transaction ordering, but efforts are underway to utilize shared sorters (multiple Rollups use the same sorter to achieve atomic cross-chain composability) and decentralized sorters (to improve trustlessness, although there are challenges). Centralized sorters lead to censorship risks of collateral (governments may force Rollups to censor) and liveness risks (if the sorter is shut down, L2 cannot fully operate, although some have safety mechanisms that users can force funds back to L1). Rollup makes money through sorters, with revenue coming from L2 transaction costs, and in the future, it can also make money from order transactions and extracting MEV. Rollup fees are mainly the cost of publishing data back to the mainnet, which will decrease after Ethereum implements the Dencun upgrade in early 2024. General-purpose Rollups (such as Optimism Mainnet and Arbitrum One) remain challenged by competition for L2 blockspace for applications, increased risk of cross-chain fragmentation and bridging between Rollups, and increased developer overhead for deploying dapps on multiple chains. A popular solution is to create a composable Rollup ecosystem that shares infrastructure so that ecosystem chains gain customizable execution environments, simplified cross-chain communication, and increased revenue opportunities. Note that this is part of a trend toward roll-apps, where each dapp is its own Rollup, typically built as an L3 sitting on top of an L2, and therefore does not need to worry about blockspace scarcity caused by other applications. Examples of Rollup ecosystems, often accompanied by developer toolkits, include Optimism SuperChain, Arbitrum Orbit, zkSync HyperChain, and Starknet L3s.

Examples of L2/Rollup include: Arbitrum: Arbitrum is an optimistic Rollup solution that provides Arbitrum Rollup (generalized OR, current version is Arbitrum One), Arbitrum AnyTrust (low-cost OR with off-chain data, current version is Arbitrum Nova), Arbitrum Orbit (interconnected universe of customizable chains, settled with One or Nova), and Arbitrum Stylus (allowing smart contracts to be written in Rust), all supported by Arbitrum's technology stack Nitro. Optimism: OP Mainnet is a Layer 2 optimistic Rollup equivalent to the Ethereum Virtual Machine. It provides OP Stack (a standardized, shared and open source development stack to support Optimism) and The Superchain (a chain network with shared bridging, decentralized governance, upgrades, and communication protocols currently under development). Importantly, Coinbase built its Layer 2 Base using OP Stack. Polygon: Polygon offers a range of scaling solution options, the most popular of which is Polygon PoS (a sidechain that relies on its own validator network for security), but Polygon plans to upgrade to a zkEVM validium (similar to ZKR, but data is available off-chain). Polygon also has the Polygon zkEVM and its Polygon Chain development kit, and is converting its MATIC token to an ecosystem-wide POL token. Mantle: Mantle is a best-of-breed solution, similar to OR, but uses off-chain data availability. Mantle uses MantleDA and its Data Availability Committee to handle its data availability. Linea: Created by ConsenSys, Linea is a type 2 zkEVM, meaning it is fully compatible with Ethereum dapps.

Starkware: StarkWare developed StarkEx (independent permissioned Validity Rollup) and StarkNet (permissionless decentralized ZKR). Starknet uses STARKs instead of the more common SNARKs for zero-knowledge Rollup, providing enhanced security but with larger proof sizes that take longer to verify. Starknet uses the Cairo smart contract language, although there is also a compiler that can convert Solidity code to Cairo code.

Stablecoins Stablecoins are digital currencies whose value is pegged to another asset (usually the U.S. dollar) and are designed to reduce the volatility inherent in cryptocurrencies. Stablecoins are primarily used to facilitate simple and efficient cryptocurrency trading (fiat-to-crypto conversions are cumbersome, so about 75% of cryptocurrency trading volume involves at least one stablecoin), but are increasingly used in decentralized applications, payments, remittances, and settlements. Stablecoins have many advantages, including speed, cost, transparency, inclusion, and programmability, and are considered one of the "killer apps" for cryptocurrencies. Stablecoins are generally divided into three types based on their collateral: Fiat-collateralized, where a central party is responsible for minting and destroying stablecoins, usually with cash or fixed-income instruments as collateral. Fiat-collateralized stablecoins have the strongest record of price stability, are very simple, and will be the first stablecoins to have a robust regulatory regime, but they introduce an element of centralization into an otherwise decentralized environment and therefore require additional trust assumptions. Fiat-collateralized stablecoins account for about 90% of the stablecoin market capitalization, with USDT and USDC being the most popular examples. Crypto-collateralized, where smart contracts rely on monetary policy, arbitrage, and over-collateralization to maintain their pegs. Crypto-collateralized stablecoins eliminate many of the centralized drawbacks of fiat-collateralized stablecoins, but require over-collateralization, making them less capital efficient. Maker’s DAI stablecoin is the most famous example.

Algorithmic stablecoins, where a stabilization mechanism maintains a peg without collateral, are more theoretical in nature. Algorithmic stablecoins have the advantages of capital efficiency and decentralization, although so far they have not achieved price stability, with failed examples including Empty Set Dollar, Basis Cash, Iron Finance, and TerraUST. Stablecoin companies make money through transaction fees or by earning interest on the reserves that back the stablecoin. Issues surrounding Tether’s USDT backing have persisted throughout the history of cryptocurrencies, and many fiat-collateralized issuers have stepped up reserve transparency and publish monthly attestation reports. Finally, it is important to note that regulation of stablecoins varies by jurisdiction, with some regions having a robust regulatory regime (e.g., the EU’s MiCA), others having an evolving/unclear regulatory regime (e.g., the United States), and others outright prohibiting it (e.g., China).

Blockchain Bitcoin The Bitcoin network is a decentralized database/distributed ledger consisting of a group of computers called nodes running the Bitcoin Core software. All nodes follow predetermined, coded rules to reach consensus on valid transactions and maintain an identical local copy of the database, which only records who paid what to whom and when. Special nodes are called miners, who strive to solve the mining puzzle first to propose a block and receive Bitcoin in the form of a block reward. By selecting the winning miner according to predetermined coded rules and requiring miners to expend energy and computing resources to solve the puzzle, the network between unknown parties is able to reach consensus on which valid transactions should be added to the decentralized ledger without a central leader, even if there is the possibility of bad behavior. Payments on the Bitcoin network are denominated in Bitcoin, and the Bitcoin supply is limited to 21 million, which is achieved through block rewards that are halved approximately every four years. This construction method - a group of unrelated nodes follow code-based rules to reach consensus on valid transactions and record valid transactions locally without a central leader, leads to the realization of key characteristics such as decentralization, trustlessness, censorship resistance, immutability, permissionlessness, anonymity, and scarcity. Bitcoin was originally designed as a “peer-to-peer electronic cash system” but due to technical limitations and a fixed supply, is now generally viewed as a store of value/non-sovereign digital reserve currency.

The Ethereum blockchain has historically had limited transaction types and typically only hosted a single application, like Bitcoin or Namecoin, forcing developers who wanted to create new applications to build entirely new, specialized blockchains. Conceived by Vitalik Buterin in 2013, Ethereum is a Turing-complete virtual machine capable of processing general-purpose code and arbitrary computations without modifying the underlying blockchain itself. To this end, Ethereum's nodes not only track payments like Bitcoin, but also process code called smart contracts and reach consensus on the state of the network. Vitalik likens this to the introduction of the iPhone, which served as a platform for third-party developers to create applications. In addition, common standards and open source code enable applications to interact with each other and build on top of each other, creating a composable programming environment. Similar to Bitcoin, Ethereum is decentralized, trustless, censorship-resistant, immutable, permissionless, open source, and anonymous. Ethereum previously used a similar proof-of-work consensus mechanism to Bitcoin, but switched to proof-of-stake in September 2022, an effort known as The Merge. Because Ethereum is a decentralized protocol running on thousands of machines distributed around the world, it cannot simply stop the network to perform upgrades, but must do so "mid-flight." As a result, The Merge is considered one of the greatest feats in blockchain engineering history. Miners have been replaced by validators, who stake (i.e. lock) ETH into smart contracts and propose or validate blocks in exchange for rewards roughly proportional to their share of the total network stake. Validators that perform poorly or act maliciously will lose their staking rewards and may even see their stake slashed. Users pay “gas” on the Ethereum network to interact with the network, such as deploying smart contracts or sending tokens, and proof-of-stake validators are incentivized to process transactions and secure the network. In return, validators receive both rewards issued by the protocol and transaction fees. Gas, denominated in gwei (one hundred millionth of an ETH), is a multi-dimensional resource, and the price of gas per unit is dynamic, fluctuating based on supply and demand. Gas consists of a base fee, which rises and falls based on changes in network demand, and an optional tip (which goes to the validator).Since the base fee is destroyed, Ethereum can experience a negative net issuance (more destroyed than created) during times of high activity, giving rise to the deflationary notion of an ultrasonic currency.

In the past, Ethereum has chosen to focus on decentralization and security, while placing speed on the back burner. Ethereum’s roadmap consists of six phases, such as “The Merge” and “The Surge”, that aim to improve these features, with one notable approach being to offload computation to second-layer scaling solutions (i.e. rollup-centric route map). Notable roadmap highlights include single-slot finality, which will substantially reduce the time required for a transaction to be considered final, and danksharding, which will substantially reduce data availability costs (i.e., proving that data has been provided to recreate the state), as well as proposer and builder separation, which would separate the roles of block builders and block proposers to mitigate and redistribute some of MEV’s negative externalities. Ethereum has a rich decentralized application ecosystem, covering DeFi, NFT, DAO and other fields. While other blockchains have been optimized for other characteristics such as speed, during bear markets in particular, activity remains focused on Ethereum due to its strong network effects.

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