Looking Ahead to 2022: The Explosion of Crypto Scalability

Author: Contributor Network, Ha Duong (Head of Ocean Investment)

Original Title: 《Outlook 2022: The many faces of crypto scalability》

Translation: Linqi, Chain Catcher

If 2020 was the year of DeFi and 2021 was the year of NFTs, I believe that 2022 will be the year when crypto scalability shines.

Many of the events that have occurred over the past few months have been driven by a growing debate about the demand for scalability in crypto networks. In the near future, alternative approaches to crypto scalability will emerge.

Moreover, I anticipate that once we move past the current phase of crypto evolution, the design space for dApps will expand significantly.

From Ethereum Killers to Modular Blockchains

Since CryptoKitties caused Ethereum's first congestion in 2017, this situation has been recurring, indicating that the current state of major smart contract platforms is still not suitable for mass adoption. The scalability trilemma illustrates how difficult it is to enhance scalability without compromising other important dimensions such as decentralization and security.

What problems is the crypto ecosystem actually trying to solve?

From the most naive perspective, developers and speculators are looking for solutions that can provide the highest transaction throughput. One of the challenges in scaling transaction throughput is that the demand for transactions is highly volatile, so capacity needs to be able to scale up or down according to network demand. Even the most optimal centralized networks show that sudden spikes in transaction demand can lead to a complete network stall. The reason is that the real world (chips for computation and short- and long-term data storage) needs to meet the demands of the digital world (acquiring, sending, editing data), and the real world always progresses at a slower pace, especially when global (real-world) supply chains are already operating at maximum capacity.

The interaction between reality and digital is highly relevant to the future scalability development of crypto. Simply increasing block size for greater transaction throughput requires more powerful hardware to run full nodes, thus increasing barriers and leading to a decrease in the degree of decentralization of the network.

This trade-off has led to the emergence of BCH and the split in the Bitcoin community. A larger block size is not the only way to achieve this trade-off. If a network requires transaction validators to perform more complex computations or handle more short-term data, this will lead to a similar increase in demand for specialized hardware or large amounts of memory, thereby excluding most long-tail users from validating transactions on the network, which will lead to a more centralized network in the long run.

I expect to see a key theme in 2022 being the adoption of more modular architectures rather than a single blockchain. First-generation smart contract platforms attempted to do all the work from data storage to full Turing-complete computation on one platform. In the future, we will see the stack broken down into data availability and consensus, block validation and construction, transaction ordering and block proposal, as well as multi-purpose or directed computation.

Transitioning from monolithic architecture to modular architecture. Source: Celestia

The most promising scalability solutions for Ethereum address some combination of specific areas or stacks: sharding addresses data availability, consensus, and block construction, while Rollups allow transactions to be processed on L2 and link to L1's security through validity or fraud proofs. Validiums and Volitions use validity proofs, and more platforms leveraging these technologies may gradually enter the mainnet in 2022.

As modular architectures mature, I expect the demand for alternative monolithic L1 smart contract platforms in the crypto industry to decrease. For many existing or aspiring specialized smart contract platforms, building a long-term scalable monolithic chain from scratch will be less attractive than operating as a second layer on top of a secure data availability + settlement layer. Ethereum will benefit from this, as in a data sharding + rollup-centric world, the negative network effects caused by network congestion will once again transform into positive network effects due to higher data availability and security.

Visualizing Rollup contracts. Source: Vitalik Buterin

At the same time, I hope to see some interesting new developments, even more modular approaches, such as independent data availability and consensus layers that do not perform any computation themselves. A key issue to note is the composability between various modular components; even though some preliminary solutions have been proposed, we still need to understand on a large scale how the modular crypto world will evolve.

Regardless of how attention shifts between fat protocols and thin protocols, ultimately, developers of decentralized applications will benefit from greater flexibility.

Expansion of the Design Space for dApp Post-Scalability

Overall, I expect greater scalability and better user experiences, such as broadening the design space for dApps in Web3 through the abstraction of blockchain interactions. Many design choices for user interfaces and the nature of the dApp itself are constrained by the current architecture of the platform they are built on.

For example, we see AMMs and liquidity pools rising in DeFi as alternatives to exchange limit order books. This is not because AMMs are generally more efficient (you don't see AMMs on Wall Street), but because AMMs are ideal solutions for the computation-constrained environment of current Web3 development. Millions of users continuously posting, editing, and canceling limit orders would congest the network overall, and each user's gas fee consumption would be substantial. With more scalability, we might expect a return of limit order books in DeFi.

This could again impact the true DeFi yield. As the reliance on limit orders and AMMs decreases, due to improved capital efficiency, the demand for liquidity mining projects may decrease, as well as the demand for cash or stablecoins in DeFi. The current Curve war may come to an end, and capital may once again find more productive uses.

With improved scalability, DeFi may transcend basic financial primitives and compose complex use cases, driving more real-world user demand, such as establishing a mature DeFi bank. One of the truly exciting areas right now is DeFi options, where we see DeFi succeeding in areas where CeFi has failed, providing a robust crypto options market beyond Bitcoin and Ethereum options.

However, currently, DeFi options lack a secondary market, so the potential for market participants to hedge or express ideas through options remains limited. If scalability can enable viable limit order book exchanges and reduce the minimum fragment size of transactions (by lowering transaction costs), a liquid DeFi options secondary market could become a reality.

Increased scalability will also enable truly long-term participation in crypto games and new NFT use cases in the future.

In the past few weeks, I have also spent some time researching the field of crypto gaming. As a former passionate gamer, I have been disappointed to notice that many current games only involve some very basic types of interactions, which more or less look like DeFi yield farming wrapped in a gaming environment. Beyond the increasing involvement of traditional game developers and the flow of more gaming talent, improved scalability will also enable truly long-term participation in crypto games and new NFT use cases in the future.

Growing Demand for Tools and Middleware in a Multi-Chain and Multi-Layer World

A modular multi-chain and multi-layer crypto ecosystem will also require more tools, infrastructure, and middleware solutions than currently exist. Existing or new crypto networks will find their place in a market focused on this new paradigm.

Perhaps existing cloud storage protocols will expand their service offerings, evolving into a complete data availability + consensus network. Potentially, other networks will emerge that focus on providing pure computational resources as a service, concentrating on processing zero-knowledge proofs for Zk-Rollups. Index protocols for querying network data from different data layers, cross-chain and cross-layer oracles, or composability and liquidity layers will also continue to evolve.

These are just some basic ideas that may require more time and thought, but they indicate that as we potentially transition to a modular crypto world, the ways in which various crypto protocols interact will change.

Conclusion

We are still in the early stages of grasping what all of this means. I am eager to explore how token economics and value capture will evolve in such a modular world, as well as other anticipated impacts, such as the effects on MEV and DeFi composability. The expansion of block space as a massive supply shock will impact the use cases of most cryptocurrencies and the investment cases behind them.

During this transition period, many opportunities will arise for entrepreneurs, talent, investors, and any type of ecosystem participants. New protocols will emerge, old protocols will become axes, and some will be phased out. Due to the openness of the crypto world, there will always be multiple approaches, and I am excited to see them continuously advance and develop throughout 2022 and beyond.