In November 2021, the total cryptocurrency market cap reached an all-time high of $2.9T. The market has moved significantly to the downside since, falling 65% year-to-date (YTD) from $2.2T to its current level of $770.5B. DeFi TVL has experienced a similar drop, plummeting 76% YTD from ~$170B to $40B. This decline is not unexpected, as DeFi TVL is largely composed of volatile cryptocurrencies. TVL is down just 8.6% YTD in ETH terms, meaning the TVL decline was driven by negative price action more so than users withdrawing funds from DeFi protocols. However, DeFi yields have contracted significantly since DeFi Summer and are now generally less attractive than the risk-free yields on US treasuries.

It has been a challenging year for many companies in the industry, with several notable bankruptcies, including FTX, Alameda, BlockFi, Celsius, Voyager, and Three Arrows Capital. In addition, a number of Bitcoin miners, funds, and other crypto companies have struggled to stay afloat. Many "Alt Layer-1s" such as Solana, Avalanche, Terra, and Near have seen significant losses, with most experiencing a YTD decline of around 90%. Terra’s LUNA saw a 99.99% loss in value over the same period as a result of UST’s death spiral. “Contagion” was the primary theme throughout 2022, with Terra’s collapse acting as the first domino to fall that sparked massive deleveraging over the course of this year. We are hopeful the worst is in the rearview mirror, but with the uncertainty looming around DCG/Genesis’s solvency, it remains to be seen if the last domino has fallen.

Despite the negative sentiment, builders continued to march forward. Ethereum successfully merged to the proof-of-stake beacon chain, Layer-2s gained adoption across the board, and the Cosmos “application-specific blockchain” thesis continued its momentum.

Ethereum

The most important event within crypto over the past year has certainly been “the Merge”, in which Ethereum transitioned from Proof of Work to Proof of Stake consensus on Sep 15. Many analogized this transition to “changing a plane’s engine mid-flight,” showing just how difficult the feat was and why it took several years to come to fruition. While there is some controversy around whether PoW or PoS provides more robust security, the most important impact of this  change is the new supply dynamics of ETH. Post-Merge, the ETH supply has inflated by just 3.8K versus the 1.2M of inflation that would have taken place if the network were still operating under PoW consensus. The chart below visualizes the USD value of inflation (or deflation) under PoW and PoS, and assumes a PoW block subsidy issuance rate of 13,500 ETH per day and an ETH value of $1,250.

In other words, over $1.5B of sell pressure has been removed from the market as a result of the Merge in under just four months. Additionally, miners under a PoW network must sell some of their newly mined coins to cover operating expenses, and they do not lock up the native asset of the chain because there is no slashing mechanism required to align incentives. The amount of ETH staked continues to climb at a steady rate, with roughly 13% of the total supply locked in the staking contract earning an attractive yield of around 5-6%.

Looking beyond the activation of staking withdrawals, the next major upgrade on Ethereum’s roadmap is the inclusion of EIP-4844, also known as Proto-Danksharding, which is a step towards complete Danksharding where L2s post “blobs” instead of calldata to Ethereum to reduce gas costs. Other EIPs of note that will likely gain more attention are EIP-4488, an alternative to Proto-Danksharding that reduces the cost of posting calldata, EIP-4337, which allows for Account Abstraction at the L1 level, and EIP-1135 which should reduce gas costs for the L1 and is heavily lobbied by the Uniswap team who is building their V4 product with that upgrade in mind.

Ethereum L2s

Layer 2s on Ethereum continued to see greater adoption over the course of 2022 as distinct ecosystems and communities began to form along with the offering of significantly reduced transaction fees compared to the Ethereum L1. The percentage of total Ethereum gas consumed by L2s has seen steady growth over the past year, with Optimism and Arbitrum sharing a majority of the load.

Arbitrum

Arbitrum One remains the most dominant L2, capturing over 65% of all rollup TVL at ~$1.1B despite having no token to give out as incentives. Arbitrum’s largest highlight as a network was its upgrade to Nitro, which improved many areas of performance and cost, such as compressing calldata and providing greater interoperability and gas compatibility, that lead to significantly reduced transaction fees.

Arbitrum’s DeFi ecosystem experienced rapid growth, with many unique apps that originated from and whose primary outpost is Arbitrum. This includes a large array of perpetual future exchanges, such as GMX, Mycelium, and Rage Trade, as well as options protocols like Dopex and Premia. Arbitrum also hosts TreasureDAO, a suite of blockchain P2E games incorporating elements of DeFi and NFTs that have gained traction this year. Trader Joe announced its move to Arbitrum this December, showing that the rollup is becoming a sought out destination for applications to establish themselves. Offchain Labs, the team behind Arbitrum, also launched Arbitrum Nova in the back half of 2022. Nova is tailored to applications that require high transaction throughput and low fees by posting data related to transactions to a data availability committee off chain. As we head into 2023, we can expect more details around their token airdrop and allocation, which could be valuable when you compare network usage to Optimism and the current FDV market cap of OP at $4.1B.

Optimism

The second largest general purpose L2 by adoption is Optimism, another optimistic rollup on Ethereum, which has captured $650M in TVL representing a 32% market share of all rollups. Optimism is also home to a growing ecosystem of DeFi protocols, including Synthetix and related applications such as Kwenta for perpetual futures, Lyra for Options, and Overtime for sports betting. Optimism also hosts Velodrome, an AMM heavily influenced by Curve, as its primary venue for liquidity and spot trading. The largest development for Optimism this year was the announcement of OP Stack, allowing anyone to take advantage of their modular design and codebase to create rollups of their own. With many rollups under this umbrella, this creates a vision of a “Superchain'' where using the same development stack means direct composability across all OP Stack chains. The first of these OP Stack chains are OPCraft, a Minecraft copycat in which all elements of the game are logged on-chain, and the Optimistic Game Boy, a Game Boy emulator that logs all actions on-chain. In 2023, we can expect more projects, including the Aevo options exchange built on Ribbon Finance, to take advantage of the tailor made solution and direct composability with other OP Stack chains.

On April 26, Optimism announced their OP token and first airdrop allocation. 25% of the token allocation will go towards an Ecosystem Fund, which is already being distributed to applications, 20% will go to retroactive public goods funding, and a total of 19% will go to airdrops. Shortly after launch, the team found a code bug in which they were actually emitting 20% of the supply instead of 2%. This was quickly fixed, but there is certainly more OP supply than initially estimated. Only 5% of the 19% was given in the first airdrop, so we can expect 14% of the supply is left for further airdrops and some of this additional allocation will be given out to active users in 2023.

zkEVMs

One of the more interesting areas of development for Layer 2s has been with zkEVMs, zero knowledge rollups that try to maintain a level of equivalency or compatibility with the EVM, marrying the immense scalability of the former with the network effects of the latter. The three major players in this realm are Polygon, Scroll, and zkSync, with others like ConsenSys and Taiko attempting the model as well. None of these solutions have gone live with a completely open and permissionless mainnet; zkSync is currently in “baby alpha”, Polygon is in their final phases of testnet, and Scroll is in pre-alpha testnet. This could be one of the primary narratives of 2023 as these products begin to open their doors to users and EVM based applications set up shop, and whether or not these solutions begin to steal market share from Arbitrum and Optimism. This is in addition to other general purpose zk rollups that use different virtual machines for execution, such as StarkNet.

Cosmos Ecosystem

There are now 53 IBC-enabled chains in the Cosmos Ecosystem, totaling $9.7B in market cap. Users transferred $745M of value over IBC in the last 30 days, with a majority of volume flowing through Osmosis, the largest DEX in the Cosmos.

TVL of Cosmos SDK-based chains plummeted -93% after the collapse of Terra. However, the implosion was an unintentional stress test on the Cosmos tech stack. On May 11, Terra executed a record-high 1.2M transactions, more than double the daily average, while Osmosis processed a record-high $500M of volume, more than double its previous high. All Cosmos SDK and Tendermint based blockchains remained up and running and IBC worked as intended.

In June, dYdX announced its plan to launch dYdX Chain as an application-specific blockchain (app chain) in the Cosmos Ecosystem. The dYdX team is highly respected and has been building their product since 2017, so the decision to leave the Ethereum Ecosystem is groundbreaking. The current version of dYdX lives on an Ethereum L2 (StarkEx), but the team stated that moving to the Cosmos Ecosystem paved a shorter path to decentralization. The next iteration of dYdX will feature a fully decentralized, off-chain order book run by the validator set. Each validator will locally store and maintain their version of the order book, creating a scalable and decentralized perps exchange. While this system has tradeoffs, leveraging validator memory sufficiently decentralizes the order book - a stated priority of the dYdX team. The concept pushes the current bounds of the validator design space, so the value proposition of building an app chain hardens if dYdX is successful.

Later in October, Circle announced USDC support for Cosmos via Circle Chain. The Circle Chain is an asset issuance that will mint USDC into the Cosmos Ecosystem, allowing users to send native USDC to any IBC-connected chain. It is a likely candidate to become a consumer chain of the Cosmos Hub’s Interchain Security. Stablecoins play an integral role in DeFi, and there is currently no dominant stablecoin native to the Cosmos Ecosystem. On Osmosis, there is only $430K on IST, a CDP stablecoin backed by ATOM and built on the Agoric protocol (Cosmos native). There are also ~$17M of wrapped stablecoins on Osmosis, including USDC, USDT, BUSD, and DAI, but 2022 has shown us that wrapped assets carry an unnecessary amount of risk. While there is room for a more decentralized option, USDC is well positioned to kickstart DeFi in the Cosmos Ecosystem and become the dominant Cosmos native stablecoin.

The Cosmos Hub

The Cosmos Hub is responsible for the birth of the Cosmos Ecosystem. The protocol funded the creation of the core technologies used by Cosmos app chains today. However, it now finds itself with outdated tokenomics and no meaningful source of revenue. Further, Osmosis threatens its position at the top of the Interchain. Osmosis continues to improve its “hub-like” qualities while the Cosmos Hub remains stagnant. The DEX has more liquidity, IBC volume, and active addresses than the Cosmos Hub. ATOM is listed on most centralized exchanges, so one of its main use cases has been onboarding users into the Cosmos Ecosystem. Suppose a user wants to purchase a Cosmos Ecosystem token. In that case, the process looks similar to buying ATOM on a CEX, transferring it to a self-custody wallet, IBC transferring the ATOM to Osmosis, and then swapping it into the desired asset using Osmosis. However, Binance recently listed OSMO, which shortens the above process by cutting out the need to buy ATOM and bridge to/from the Cosmos Hub.

The Cosmo Hub needs to reassess its position in the ecosystem, build towards sustainable revenue generation, and upgrade its first-gen tokenomic model. The ATOM 2.0 proposal aimed to do just that by transitioning the Cosmos Hub into a new role that would put it at the epicenter of ecosystem expansion and drive value back to the protocol. ATOM 2.0 aimed to leverage Interchain Security to onboard new app chains into the ecosystem, creating revenue for ATOM validators and stakers. The new revenue stream would offset a decrease in ATOM issuance, bolstering the protocol's sustainability while considering the impact on validator income. Hardening the monetary policy would also better position ATOM as the de facto reserve currency of the Cosmos Ecosystem. The proposal also introduced a new economic engine, the Scheduler and the Allocator, that would create additional protocol revenue streams for the protocol. The proposal went live in November but failed with 37.4% “No with Veto” votes. The opposition felt the proposal was too broad and believed it should be divided into a series of smaller proposals.

The ATOM 2.0 vision hinged on the successful implementation and adoption of Interchain Security, which is expected to be ready in Q1 of 2023. While governance will need to approve the launch of Interchain Security, there is already a queue of potential consumer chains. Consumer chains pay the Cosmos Hub to secure their chain, so it will be important to watch where this revenue flows. Ideally, it follows the ATOM 2.0 vision and flows to validators and stakers, less a tax that flows to the community pool. A recent proposal increased the community pool tax to 10% to increase the protocol’s funding.

Alt L1s

Solana

The Solana ecosystem experienced a massive drawdown in TVL and activity after the collapse of FTX. TVL tumbled 96%, from $12B to under $500M YTD. The Solana Foundation announced that it had exposure to FTX: $1M in cash equivalents, 3.24M shares of FTX stock, 3.43M FTT tokens, and 134.54M SRM tokens stuck on the exchange. Further, Alameda and FTX purchased 50.5M SOL tokens from the Foundation with varying linear unlock schedules that run until 2028.

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

Along with the cataclysmic decline of the ecosystem throughout the back half of 2022, the network itself suffered from several performance related outages. Due to Solana’s initial base fee design, the network was an amusement park for bots, who could leverage the absence of priority fees to overload the network with transactions, halt DeFi liquidations, and even force the network out of consensus. However, on June 1, validators elected to hard fork the network. Shortly after, a new base fee mechanism was introduced that dynamically adjusts the base fee based on a target load for the network. This new mechanism also accounts for a priority fee, which significantly reduces the risk of network DoS attacks.

With the majority of Solana DeFi sharply switching from a VC-fueled movement to a community-led project, the future for the ecosystem looks bleak, but there are a few beacons of hope. Plans for the upcoming Saga phone will continue. Saga will use xNFT Backpack to enable users to run a plethora of dApps directly from their mobile operating system. Further, Jump Crypto has been working steadfastly to introduce Firedancer - an open-source validator that will increase the reliability, throughput, and scalability of the entire Solana network. With Saga and Firedancer, Solana’s strategy remains hyper focused on onboarding the next wave of users to crypto, regardless of what hurdles the community faces.

Avalanche

In the second half of 2022, the Avalanche ecosystem experienced a period of relative stagnation. The fall of 3AC in June, a major proponent of projects building on the network, resulted in diminishing investments in the Avalanche ecosystem in an already risk-off environment. Total value locked (TVL) decreased from ~$12B to ~$1B. Avalanche’s 92% drop in TVL lines up with the 89% decrease in the price of AVAX over the same period.

Despite Avalanche’s champion, 3AC, being exposed as overleveraged fraudsters, some developers kept shipping updates. Major advancements came from Trader Joe in the form of an NFT marketplace, Joepegs, and its concentrated liquidity AMM: Liquidity Book. As mentioned previously, Trader Joe announced it will deploy on Ethereum L2, Arbitrum, though the team seems to still consider Avalanche their primary focus. THORChain, a network for cross-chain swaps, completed integration for AVAX in Q4. Crypto game developers flocked to the ecosystem, with notable developments and announcements from Shrapnel and Ascenders as both move towards a full launch. DeFi Kingdom and Crabada launched subnets which helped set an example that projects can grow on Avalanche C Chain, and once mature enough, create a custom subnet.

Avalanche successfully implemented the Banff upgrade on October 18, a large step toward subnet-to-subnet communication called Avalanche Warp Messaging. With subnet interoperability, the network could become a more significant competitor to Cosmos. Avalanche launched a native BTC bridge in June, BTC.b, which has gained significant adoption throughout the last 6 months of 2022.

Aptos

Libra, which pivoted into Diem, was the blockchain and cryptocurrency announced by Facebook (Meta) in 2019. After internal controversy, regulatory scrutiny, strategic pivots, and lost partnerships, Diem failed to launch. A large portion of the engineering and research teams went on to create Aptos, a Layer-1 blockchain hoping to realize the original vision of Libra and the MOVE smart contract language.

After raising $475M throughout 2022 at a valuation over $1B surrounded by immense ‘buzz’, the team finally launched the token and network in October. Much to the dismay of investors and Crypto Twitter, the project saw little to no user adoption or developer interest. The token quickly dropped from over $13 to $4 and is currently trading at a ~$500M market cap and a ~$4B FDV. Early investors can mark their investment in the green while anyone who bought the token on the open market has lost capital. Aptos is the perfect example of a “VC Chain”: A token fundraise model retail investors may want to stay away from in the future. Despite these headwinds, the chain runs as intended; with the team’s Silicon Valley connections and the capabilities of the MOVE language Aptos has the potential to see more dApps and adoption in the future.

Network Infrastructure

Oracles

One of the most notable developments in blockchain infrastructure towards the end of the year was the launch of Chainlink’s staking mechanism. LINK holders can now stake their tokens to improve network security and earn LINK rewards. This marks a fundamental shift for the oracle provider and further decentralizes the protocol. However, LINK staking is not to be confused with the typical PoS consensus mechanism associated with other blockchain networks. Instead, this mechanism can more closely resemble a service guarantee around the reliability of oracle data. If a node operator fails to meet its obligations of a service agreement, then a portion of staked LINK can be slashed and redistributed to more reliable node operators.

Chainlink provides an on-chain source of truth for DeFi lending markets, so enhancing oracle security is paramount to the continued success of DeFi. The protocol implemented an initial staking pool cap of 25M LINK. This guarded launch will help the protocol gradually upgrade in a safeguarded manner. In its infancy, staking will be incentivized via LINK emissions, but over time these will be sunsetted out and user service fees will become a major source for incentives. Further, Chainlink will launch a Partner Growth Program, where various protocols and DAOs can offer incentives to staking participants in exchange for price/data feeds. While other oracles exist, Chainlink has by far seen the most adoption and battle testing. With the launch of staking, the future remains bright for Chainlink.

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

Bridges

Bridges saw substantially less activity throughout the second half of the year, mainly because on-chain activity dropped across the board. Another contributing factor is likely the sheer volume of hacks that occurred throughout the year, totaling at least $2.1B.

Bridges remain to be critical infrastructure for a multichain future, but substantial improvements in security are needed to mitigate the risk of loss for liquidity providers and end users. If anything, 2022 proves that we still have miles to go before we can hop between chains worry-free. We are still waiting for Synapse and Stargate to deploy their own “layer zero” chains, which could greatly improve the user experience for all things multichain. As we head into 2023, we can expect the successful deployment of a Synapse network or Layer Zero network to help solve the siloed liquidity problem, where dApps compete to maintain liquidity across multiple networks, instead of having one liquidity layer for all deployments to utilize. The chart below shows the TVL of six notable bridges on their native networks.

While overall bridge TVL declined significantly and bridge volume stagnated, bridge activity to and from L2s, such as Optimism and Arbitrum, did show substantial growth in the latter half of the year. Combined with the metrics discussed above about L2 utilization, these ecosystems show promise. Arbitrum, specifically, has GMX to thank for the increased inflows. Optimism inflows likely spiked from airdrop hunters and participants seeking to use Velodrome, Lyra, and Synthetix.

Final Thoughts

While the large drop in asset prices led to a crater in TVL across the board, there were a lot of positive developments this year. Ethereum was able to successfully migrate from PoW to PoS and create a reduction of $1.5B in sell pressure in under four months. Optimism and Arbitrum adoption continued to climb showing the demand for the EVM and Ethereum L2s. Cosmos made huge strides in increasing the presence and value accrual of the Cosmos Hub while providing an attractive enough developer environment to lure dYdX from StarkEx. While “Alt Layer-1s” such as Solana and Avalanche have taken a huge hit this year in terms of TVL, developer mindshare, and VC capital, developers remain as ambitious as ever, steadfast on creating the best experience for developers and still aim to onboard the next billion users into crypto. While bridges were the subject of many hacks this year, security around these networks continues to strengthen, especially with the developments of Stargate and LayerZero, Circle’s Cross Chain Transfer Protocol, and the atomic composability of zk rollups. Next year shows a lot of promise, as we will continue to see developments of Ethereum’s roadmap, the launch of zk rollups, zkEVMs, and L3s, the release of Solana’s Saga phone, new exciting Cosmos app-chains such as dYdX, and more.

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