The multiple faces of crypto scalability in 2022

Ha Duong, based in Berlin, is a Principal at Ocean Investment and Director of Crypto Strategies at BIT Capital.

If 2020 was the year of DeFi and 2021 was the year of NFTs, then I believe 2022 will be the year of crypto scalability in all its forms.

Much of what has happened in recent months has been fueled by a discussion about the growing need for scalability in crypto networks. Alternative techniques to crypto scalability will be demonstrated in the near future.

I also expect the design space for dApps to significantly grow after we’ve progressed past the current stage of crypto’s maturation.

From Ethereum clones to modular blockchains, there’s something for everyone.

Since CryptoKitties first clogged the Ethereum network in 2017, a slew of other examples have emerged that demonstrate how the main smart contract platform’s current state isn’t yet ready for widespread use. The Scalability Trilemma illustrates how difficult it is to improve scalability without sacrificing other critical aspects like decentralisation and security.

What problem is the crypto ecosystem attempting to solve?

Developers and speculators are looking for solutions that deliver the best transaction throughput in the most basic sense. One of the challenges with scaling transaction throughput is that transaction demand is highly volatile, therefore capacity must be able to scale up and down in response to network demands. Even the most optimised centralised networks have shown that a sudden increase in transaction demand may bring the entire network to a halt – as we’ve seen with crypto exchange disruptions and big CDN outages in the traditional tech industry. The reason for this is that the physical world (computer chips and short or long-term data storage) must supply what the digital world requires (such as fetching, sending, and editing data), and the physical world will always move at a slower pace – especially when global (physical) supply chains are already overburdened.

In discussing how crypto scalability will progress in the future, the connection between physical and digital is quite important. Simply raising block sizes to enhance transaction speed necessitates more powerful hardware to run complete nodes, which raises entry barriers and reduces network decentralisation. This tradeoff has already caused a schism in the Bitcoin community, resulting in the creation of Bitcoin Cash. That tradeoff can occur in a variety of ways, including larger block sizes. If a network requires transaction validators to perform more complex computations or handle more short-term data, it will require specialised hardware or a lot of RAM, effectively excluding most long-tail users from validating transaction integrity in the network and, in the long run, leading to a more centralised network.

The growing usage of modular architectures rather than monolithic blockchains is one significant issue I expect to see more of in 2022. The first generation of smart contract platforms attempted to combine data storage and full Turing-complete computation in a single platform. Data availability and consensus, block verification and building, transaction sequencing and block proposal, and general-purpose or application-specific computation will be separated from the stack in the future.

The most potential scalability solutions for Ethereum all focus on one or more aspects of the stack: Rollups allow transactions to be performed on layer 2 with security related to layer 1 through validity or fraud proofs, whereas Sharding handles data availability, consensus, and block building. Validiums and Volitions are two more fascinating ways to following that use validity proofs, and more platforms utilising these technologies are expected to hit mainnet in 2022.

With the maturation of modular architectures, I foresee the demand for alternative monolithic layer 1 smart contract platforms in crypto to decline in the future. Many existing or aspiring specialised smart contract platforms will find it more appealing to operate security as a layer 2 on top of a safe data availability + settlement layer rather than bootstrapping security from start and building a monolithic chain with known long-term scalability difficulties. In a data sharding + rollup-centric society, Ethereum will benefit since present negative network effects owing to network congestion will be changed into positive network effects due to increased data availability and security.

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Simultaneously, I anticipate some intriguing future developments of even more modular techniques, such as distinct data availability and consensus layers that do not do any calculations. Composability between the various modular building parts is a vital topic to keep an eye on, and while some first solutions have been presented, we’ll have to wait and see how the modular crypto world matures at scale.

Regardless of how much attention is given to Fat Protocols or Thin Protocols, developers of decentralised apps will profit from more flexibility in the end.

After scalability, the design space for dApps is expanding.

Overall, I anticipate more scalability and enhanced UX for dApps in Web3, such as through the abstraction of blockchain interactions. Many design options in user interfaces, as well as the nature of dApps themselves, are limited by the architectures of the platforms on which they are built.

In Defi, for example, Automated Market Makers and Liquidity Pools have become more popular as alternatives to Limit Order Book Exchanges. That is not because AMMs are more effective in general (you don’t see AMMs on Wall Street), but rather because AMMs are an ideal solution for the computation-constrained environment of current Web3 development – millions of users constantly posting, editing, and cancelling limit orders would clog the network and consume a lot of gas for each user individually. We may see the return of the limit order book in DeFi when scalability improves.

This could have an impact on true Defi yields once more. Due to enhanced capital efficiency, there may be less demand for liquidity mining programmes and less need for cash or stablecoins in DeFi with limit order books and less reliance on AMMs. The current Curve Wars may come to an end, and capital may return to more productive applications.

DeFi may be able to go beyond basic financial primitives, composing complicated use cases that can drive more real-world customer demand, such as establishing a full-fledged DeFi bank, thanks to increased scalability. One of the most fascinating areas right now is DeFi options, where we envision DeFi succeeding where CeFi failed by establishing comprehensive crypto options markets beyond bitcoin and ether. However, there are currently no secondary markets for DeFi options, limiting market players’ ability to hedge or express their opinions through options. A liquid DeFi options secondary market could emerge if scalability allows for practical limit order book swaps and reduces the minimum clip size of a deal (due to decreased transaction costs).

Over the previous few weeks, I’ve also spent some time researching the crypto game industry. As a previous avid gamer, I was disappointed to discover that many current games only include a few extremely basic forms of interactions, which resemble DeFi yield farming in-game environment packaging. Increased scalability will enable really long-term entertaining crypto games and new NFT use cases in the future, in addition to increased involvement of traditional game developers and more gaming talent flow.

In a multi-chain and multi-layer world, there is a higher requirement for tools and middleware.

More tooling, infrastructure, and middleware solutions will be required for a modular multi-chain and multi-layer crypto environment than are currently available. Existing and future crypto networks will carve out a niche in the market centred on this new paradigm.

Existing cloud storage protocols may improve their capabilities to include a full data availability and consensus network. Other networks may emerge that focus on delivering pure computation resources as a service for processing zk-Rollups zero-knowledge proofs. Indexing protocols for querying network data from various data layers, as well as cross-chain and cross-layer oracles, as well as composability and liquidity layers, will continue to evolve.

These are just a few basic ideas that will likely require much more time and thinking, but they demonstrate that the way different crypto protocols interact with one another may alter as a result of a possible future shift to a modular crypto world.

 

Disclaimer: These are the writer’s opinions and should not be considered investment advice. Readers should do their own research.

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