Title: GSR Digital

Compiled by: Deep Tide TechFlow

With the recent approval of the US Bitcoin spot ETF, the rise of Solana, new experiments around blockchain architecture, and innovations in the Bitcoin ecosystem, cryptocurrencies are heating up. Therefore, GSR Digital provides an overview of various digital asset themes and sub-industries as a reference for experienced individuals and as an introductory guide for newcomers to the industry.

Blockchain-related Concepts

Bridge

Different blockchains have different rules, consensus mechanisms, and token standards, so tokens cannot be simply sent from one blockchain to another. Bridges can transfer tokens and data from the source chain to the destination chain, and in the process, they must perform three main tasks: data transfer, validation, and interpretation. Bridges can be constructed in various ways, with different trade-offs between trustlessness (whether the bridge inherits the security of the connected chains), scalability (whether it is easy to connect multiple chains or if each path requires custom implementation), and generality (whether the bridge can send arbitrary data/messages or only perform cross-chain exchanges). Bridges also represent a significant attack vector, typically evaluated for their security based on the number of supported chains, daily active users, and total locked value.

The three main ways bridges execute cross-chain transactions are:

• Locking and minting: These bridges lock native tokens in the original chain's smart contract and then issue an equivalent amount of wrapped tokens to users on the destination chain. Wrapped tokens act as IOUs, which can be burned later to retrieve the original tokens on the original chain. These bridges have an advantage in staking efficiency as they do not require additional staking or liquidity, but they disperse liquidity on the destination chain, creating wrapped versions of multiple assets, and if attacked, can pose systemic risk to the destination chain.

• Cross-chain liquidity: These bridges facilitate low-slippage exchanges by allowing liquidity providers (LP) to provide liquidity, acting as cross-chain automated market makers. They are inefficient in terms of liquidity but only deal with native tokens, thus limiting the risk to LPs.

• Burn and mint: These bridges burn native tokens on the original chain and mint an equivalent 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 authority to mint native tokens on multiple chains, which typically only applies to real-world assets (Circle's CCTP is an example).

Before minting on the destination chain, the bridge must achieve consensus that the assets on the original chain have been locked or burned. This is accomplished in three ways:

• Local verification: The bridge runs a light client of the original chain on the destination chain as a smart contract for verification. This inherits the security of the connected chain, but a light client must be custom-built for each one-way bridge.

• External verification: The bridge uses its own set of validators to achieve consensus, which may be a centralized entity, multi-signature, or a decentralized group of validators (often using PoA or PoS mechanisms). These bridges have lower security and essentially act as their own blockchain, but without social consensus.

• Local verification: Locally verified bridges act as P2P matching platforms based on a centralized limit order book, involving interactions between parties to cryptographically verify each other. They are secure and easy to set up between multiple chains but can only perform asset exchanges.

• Optimistic verification: A hybrid of the above methods, similar to optimistic rollup, it assumes that the submitted block headers on the destination chain are valid unless proven otherwise during a challenge period.

Cryptography

Cryptography is the study of techniques to secure communication and data in the presence of adversaries. It is a part of the larger discipline of cryptology, along with cryptanalysis.

Cryptography uses various encryption algorithms (referred to as ciphers) to secure communication, where ciphers and keys transform input data (referred to as plaintext) into encrypted output (referred to as ciphertext). Cryptography can be divided into symmetric cryptography, asymmetric cryptography, and cryptographic hash functions.

Symmetric cryptography uses the same key for encrypting plaintext and decrypting ciphertext. It is typically simpler and computationally less intensive than asymmetric cryptography but requires a secure way to share keys and requires each pair of users in the network to have a unique key. Examples include various ciphers (e.g., Caesar cipher) and the Data Encryption Standard (DES).

Asymmetric cryptography (also known as public-key cryptography) uses mathematically related public and private keys to eliminate the need for shared keys, making it more suitable for large/scale/active networks. Public keys can be freely shared and created by the private key, serving as a single-factor authentication mechanism and should be kept strictly confidential. Public and private keys are mathematically related, and while it is easy to calculate the public key from the private key, the reverse is nearly impossible. This provides a way to prove knowledge of the private key without revealing it and allows messages to be encrypted with the recipient's public key and decrypted only 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, and others.

Cryptographic hash functions create digital fingerprints for arbitrary amounts of data by dividing the data into segments and subjecting it to multiple local operations, losing information, and ultimately transforming the data into a fixed-length string of numbers. Hash functions are one-way (cannot derive the input from the output) and deterministic (return the same output for a given input). Bitcoin uses the SHA-256 hash function in its protocol.

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Custody

Digital asset custody providers store and protect owners' cryptographic private keys, enabling owners to sign digital asset transactions. Keys are stored in encrypted wallets, which can be hot wallets (connected to the internet; sacrificing security for speed, liquidity, and automation) or cold wallets (not connected to the internet; more secure but slower and requiring manual intervention).

Custodians represent users in safeguarding keys, while custody technology providers offer technical solutions that enable end users to self-custody securely and efficiently. Custodians bear more risk, are subject to more regulation, and provide fewer assets/features, introducing counterparty risk and slower response times.

Core custody technology solutions include:

• Hardware Security Modules (HSMs): These are tamper-resistant, government-certified physical devices that protect the encryption process and are not connected to the internet. HSMs are difficult to breach but can create single points of failure.

• Multi-signature: This requires multiple key authorizations for digital asset transactions, typically requiring a majority of signatures from keys associated with the assets (e.g., 3 out of 5). Multi-signature mitigates the single point of failure issue with HSMs but may not be supported by all blockchains, may lead to higher transaction fees or reduced privacy, and introduces smart contract risk.

• Multi-Party Computation (MPC): This is a process of splitting a private key into key shares and distributing them across multiple devices. MPC is flexible, enables complex signature rules, allows for later changes or revocations of signature shares, permits a mix of hot and cold wallets, and generates standard signatures, but it is a newer, less tested technology and cannot be used with HSMs.

Custody solutions are managed by various providers (e.g., specialized native crypto providers, traditional financial institutions, cryptocurrency exchanges, major brokers), may focus on retail or institutional investors, and often offer additional services such as trading, lending, staking, governance participation, and/or secure client networks.

Decentralized Autonomous Organization

A Decentralized Autonomous Organization (DAO) is a blockchain-based organization governed by a set of automatically executable rules, allowing for bottom-up decision-making and community organization 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, providing trustless management, organizational transparency, participatory decision-making, borderless cooperation, novel financing methods, and ownership mechanisms. They are used to manage protocols, allocate funds, distribute creative works, guide investments, unite community members, and serve other DAOs.

Membership in DAOs is typically determined by ownership of DAO tokens, which are often freely obtainable and allow any holder to propose and vote on governance proposals (e.g., how to use treasury funds). Additionally, many DAO frameworks have emerged to automate DAO creation, including Aragon, DAOstack, Moloch, and Colony.

The most famous DAO is The DAO, a community-guided venture capital fund established in 2016, which invested its funds based on member voting. The DAO at the time gathered 14% of all circulating ETH, and after $60 million was stolen from its treasury, disagreements over whether to recover the funds led to a network split into Ethereum and Ethereum Classic (ETC).

DAOs are widely relied upon in DeFi protocol governance, such as Uniswap, Compound, and Aave. Recently, DAOs have been established 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 citizen participation, simplify business creation and fundraising, pave the way for shared financial and social capital, enable unbounded and customizable work, better match products/services with demand, and improve elite management, contribution-driven ownership, and rewards. However, to date, DAOs have not met their initial expectations and goals, and are often criticized for low voter participation, potential coercion, lack of privacy, and excessive influence from large token holders.

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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 the need for intermediaries.

Protocol developers typically release their DApps as smart contract code deployed on blockchains such as Ethereum. DApps typically start off centralized but gradually become decentralized and are ultimately controlled by Decentralized Autonomous Organizations (DAOs). DApps often issue tokens to coordinate and incentivize user behavior, rewarding value contributions.

By leveraging smart contract code deployed on decentralized public blockchains and creating peer-to-peer networks, DeFi is both trustless (as programs execute automatically) and rent-free (as there are no centralized intermediaries). DeFi also inherits blockchain properties such as transparency, openness, and immutability, and introduces new paradigms regarding ownership, governance, and incentives.

DeFi activity can be measured by active users, the number of DApps, or Total Value Locked (TVL), which refers to the total value of assets locked in DeFi smart contracts at a specific time. Most DeFi activity occurs on Ethereum or its layer 2 networks, but other blockchains such as Solana and Avalanche also have active DeFi ecosystems, offering advantages such as speed/scalability over Ethereum. Popular DApps include Uniswap (spot DEX), dYdX (perpetual DEX), Aave/Compound (lending), Lido (liquidity staking), and Maker (collateralized debt position/DAI stablecoin).

DeFi began to flourish in the summer of 2020, known as DeFi Summer, when the lending platform Compound began incentivizing activity on its DApp through its COMP governance token, a process known as liquidity mining.

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Derivatives

Derivatives are financial contracts whose value depends on an underlying asset or asset portfolio, used for hedging or speculative purposes. The price of derivatives fluctuates based on changes in the underlying asset, and derivatives can be traded on exchanges with standardized terms or traded over-the-counter with more customized terms.

While traditional financial derivatives include forward contracts and swaps, the most common derivatives in the crypto space include futures contracts, perpetual futures, and options.

• Futures contracts: Futures are financial contracts that require the buyer to purchase the underlying asset at a specified price on a future agreed-upon date, and the seller to sell the underlying asset. Futures contracts are standardized, traded on exchanges, and can be settled in physical or cash. The main cryptocurrency futures are composed of CME's futures products, accounting for less than 5% of all futures trading if including perpetual contracts (i.e., most futures trading is done through perpetual contracts).

• Perpetual contracts: Perpetual contracts are similar to futures contracts but do not have an expiration date. When a futures contract approaches expiration, its price converges to the spot price, while perpetual contracts use a funding mechanism to link the contract to its underlying spot price. Specifically, when the perpetual contract price is higher than the spot price, the funding rate is positive, and longs pay funding to shorts, and vice versa (the funding rate is also based on the difference between the perpetual contract and spot price to incentivize traders to balance demand and link the perpetual contract price to the spot price). Perpetual contracts improve market efficiency by consolidating liquidity from various expiration dates into a single exchange-traded instrument. Binance dominates the perpetual contract market share, and OKX and Bybit are major perpetual contract exchanges. Only 2% of perpetual contract trading volume occurs on-chain, with dYdX excelling in this aspect.

• Options: Options grant the holder the right, but not the obligation, to buy (call option) or sell (put option) a certain asset at a specific price (called the strike price) before or at a predetermined future date. The price of options is determined by the underlying asset price, strike price, expiration time, volatility of the underlying asset, and interest rates. Option traders typically focus on risk measures called Greeks, which measure the option price's response to changes in underlying variables, such as the underlying asset price (called Delta), changes in Delta due to changes in the underlying asset (Gamma), changes in volatility (Vega), and changes in remaining time (Theta). Adoption of crypto options is relatively limited compared to perpetual contracts and spot options markets. Deribit holds 80-90% of crypto options trading volume, and Paradigm is an over-the-counter communication/quoting network accounting for about a third of Deribit's trading volume. Decentralized exchanges (DEX) account for only 1% of total options trading volume, with Ribbon/Aevo, Lyra, and Dopex being major DEX options trading platforms.

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Market Makers

Market makers engage in the act of providing bid and ask quotes as well as quote sizes for a particular asset on an exchange. They increase liquidity for buyers and sellers, who might otherwise see poorer pricing and lower market depth.

Market makers use proprietary software, known as engines or bots, to display bid and ask quotes in the market, dynamically adjusting buy and sell quotes based on price changes and fluctuating trade volumes.

Traditionally, market makers profit by charging a bid-ask spread (e.g., buying at $100 and selling at $101), and they bear the risk of adverse global price movements when holding assets, i.e., price risk. Given the prevalence of trend markets and one-way order flow, market making in the cryptocurrency market is often 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, the 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 trade volume, percentage of best bid-ask prices (i.e., the percentage of time there are best bid/ask prices), and uptime.

Market makers provide many benefits for projects and trading, such as improved liquidity and market depth, reduced price volatility, improved price discovery, and significantly reduced slippage. Perhaps most importantly, tokens play a crucial role in decentralized applications, so liquidity is a key factor in making the technology work.

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Market Structure

Market Structure: The crypto market structure has many unique characteristics compared to traditional finance, including 24/7 trading, self-custody capabilities, the multiple roles of centralized exchanges as brokers/exchanges/custodians, instant settlement, hybrid regulatory oversight, stablecoins as underlying assets, a growing derivatives market, the ability to trade on-chain and off-chain, and enhanced transparency (for on-chain activities).

Compared to traditional finance, the crypto market offers several key advantages, including fewer intermediaries, instant settlement, lower costs, higher efficiency, and greater access opportunities.

The crypto market structure presents some key challenges and risks. Firstly, there is a mix of legal and regulatory oversight, with many regulatory frameworks still evolving. Secondly, risks related to security (smart contract risks, hacks, scams), custody (lost keys, poor access control), and counterparty (misappropriation, anonymous teams) are heightened. Finally, due to dispersed liquidity across different trading venues and on-chain/off-chain, a lack of full-service cryptocurrency prime brokers, limited cross-margining, and the need for pre-funding of trades, capital efficiency is generally low.

Trading can occur on centralized or decentralized exchanges, as well as through over-the-counter markets. While some spot trading is done through decentralized exchanges (accounting for about 15% of total trading volume), derivative trading rarely occurs on-chain (about 2-3%). Perpetual contracts are the most popular trading instrument, followed by spot trading, with options or futures trading relatively less common.

Although the correlation of crypto assets with traditional assets is low, the price of cryptocurrencies exhibits high volatility due to their novelty and structural reasons. Bitcoin's price is highly correlated with global liquidity, often fluctuating in the short term based on macro and crypto-specific catalysts and risks. Long-term, we expect Bitcoin's price to fluctuate with changes in fundamentals (including adoption, usage, development, talent, and capital).

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Maximal Extractable Value (MEV)

Maximal Extractable Value (MEV) is a measure of profit extracted by miners or validators from block production, beyond block rewards and transaction fees, through the inclusion, exclusion, and reordering of transactions in blocks.

Transaction information, including the base fee and priority fee (Gas) of transactions, is typically broadcast to the blockchain network and placed in a pending transaction queue called the txpool or mempool. Miners/validators can choose which transactions to include in their proposed blocks and the order of transactions, historically selecting transactions with the highest Gas prices from the mempool and ordering them by Gas expenditure. However, pending transaction information can be maliciously used, as bots attempt to front-run transactions in the mempool, quickly realizing that ordering transactions based on priority fees is not a strategy for maximizing profit relative to more complex ordering strategies. For example, miners or independent third parties known as searchers may use sophisticated, bot-based trading strategies to arbitrage price differences between DEXs, package their own buy/sell orders around pending DEX transactions (known as sandwich attacks), or execute liquidations for decentralized lending protocols.

While validators are in the best position to exploit such transactions, as they control the inclusion and order of transactions in blocks, the majority of MEV is extracted by highly complex independent actors (although most flows to validators). The design of the Ethereum validator role is intentionally simplified and non-specialized, but in this MEV paradigm, maximizing transaction fees is highly complex and computationally challenging, unlike the early days when miners simply ordered transactions based on the fees paid. Therefore, validators now typically no longer construct their own blocks (although they still can), but generally receive blocks from mutually trusted relays, which relay between block producers and block proposers (validators). Flashbots' MEV-Boost software facilitates this handoff. In this setup, block production is outsourced to a professional block producer market, which aims to maximize MEV, and these producers bid to propose their blocks to the network to validators. The role of validators becomes very simple, just choosing the block with the highest bid. Due to the competitive nature of this bidding process, most MEV income is paid by builders/searchers, which is returned to validators, who actually have the ability to propose and harvest the blocks.

While certain types of MEV, such as CEX/DEX arbitrage to ensure users pay the same global market price and exchange liquidations to ensure loan repayments, are beneficial, MEV has generated many negative externalities. These include squeezed traders executing worse and more expensive trades, as well as broader concerns of network centralization due to the specialization required for competition.

Two very important vectors of MEV competition are private order flow and latency. All else being equal, more trades are always better from the searcher's perspective, so any searcher/builder receiving private order flow rather than trading through the mempool is at an advantage. Additionally, CEX/DEX arbitrage is currently the largest form of MEV, and due to most DEX prices adjusting only between blocks (12 seconds) while CEX prices fluctuate continuously, having the lowest latency to submit the most competitive bid before the auction ends is advantageous. This is particularly notable when the true market price of an asset sharply changes within a 12-second window, allowing participants with the lowest latency to submit the most competitive bid before the auction ends.

There are various companies and strategies to mitigate the negative externalities of MEV, with the most notable being Flashbots, a research institution aimed at revealing and democratizing access to MEV. After successfully launching products such as Flashbots Auction and MEV-Boost, Flashbots is now developing its SUAVE solution to decentralize block production itself.

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Mining

The Bitcoin blockchain is a network composed of unrelated computer nodes that use cryptography and consensus mechanisms to reach agreement and record valid transactions. Special nodes called miners organize pending transactions into blocks and compete to be the first to solve the mining puzzle, add their block to the blockchain, and receive block rewards (along with associated transaction fees). By requiring miners to expend something of value (in this case, computational and energy resources) to solve the mining puzzle, Bitcoin encourages miners to participate honestly, although there is potential risk of bad actors.

Miners organize pending transactions into a proposed block and include a random number called a nonce, then hash their proposed block to make the hash output lower than a target value (a hash function is a deterministic one-way algorithm that transforms any amount of input data into a fixed-length numerical output). If the hash value is lower than the target value, the winning block is broadcast to the network by the miner, verified by other miners, and added to the blockchain, with the winning miner receiving block rewards and block transaction fees. If a miner does not solve the mining puzzle, it will change the nonce (and/or transactions), then hash again, repeating this process until it or another miner solves the puzzle, then the process starts over. Miners typically use mining equipment with dedicated circuits, and each model of mining equipment has its own hash rate (the number of times the device can perform a hash operation per second. For example, the Bitmain S19J Pro can perform about 100 TH/s, or 10^14 hashes/second) and efficiency (power consumption required per hash).

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Modularization

Blockchain has four fundamental functions: execution, consensus, settlement, and data availability. Traditionally, all four functions are executed by the first-layer blockchain, known as a single-layer structure. However, this leads to the trilemma of blockchain, which points out that it is impossible for a blockchain to simultaneously balance decentralization, security, and scalability (for example, increasing block size to improve speed would make the blockchain larger, causing some nodes to be unable to maintain complete copies, ultimately reducing decentralization). However, a new type of protocol is separating and optimizing each function, allowing each component of a modular stack to be optimized for a more decentralized, 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 running transactions from an initial state and transitioning to an end state.

• Consensus: Reaching agreement on transactions and their order.

• Settlement: Validating transactions and providing finality guarantees. For modular chains, this includes validating/arbitrating proofs and coordinating cross-chain message passing.

• Data availability: Ensuring that transaction data has been published so that anyone can recreate the state.

Examples include Ethereum choosing to improve scalability by outsourcing execution to a second-layer network. While Ethereum can still run as a monolith, it is moving towards executing consensus, settlement, and data availability while using 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 allowing 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 functionality), Avail and EigenDA (data availability layer).

Different building approaches can be used to design modular chains, and different solutions can be used for different functions. For example, Solana executes 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 committee (DAC) for data availability, and execution on Validium. Meanwhile, sovereign rollup can use Ethereum for data availability and consensus, with execution and settlement occurring on sovereign rollup.

Modular chains face many challenges, such as their development still being ongoing, rollup sequencers still being centralized (i.e., each rollup currently decides its transaction/transaction ordering and may conduct reviews), and liquidity being dispersed across different execution layers.

Non-Fungible Tokens (NFTs)

Fungibility refers to two items being identical and interchangeable, such as dollars or airline miles, while non-fungibility refers to items being unique and therefore not freely interchangeable, such as original artwork or real estate. NFTs are non-fungible (completely unique) digital assets stored on the blockchain and can be seen as digital representations of ownership based on the blockchain. Please note that for cost reasons, the ID is stored on the chain, which points to the URL of a JSON metadata file (Autoglyphs is one of the few exceptions). Also note that the blockchain has standards for defining fungible tokens, such as Ethereum's ERC-20, and non-fungible tokens, such as Ethereum's ERC-721.

NFTs have typical cryptocurrency advantages, such as immutability, provable scarcity and provenance, standardization and interoperability, and programmability, making digital assets feel as real and permanent as physical items. NFTs can represent ownership of unique valuable items such as digital art, domain names, intellectual property, and event tickets, and can be used for various use cases including collectibles, gaming, media, music, and finance.

Notable examples of NFTs include: colored coins on Bitcoin in 2012; CryptoPunks on Ethereum 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-breaking $69 million); and NBA Top Shot in 2021 (digital NBA cards).

NFTs have historically traded on various NFT markets, with some markets focusing on specific areas, and until the boom market at the end of 2021, OpenSea held 95% of the market share. However, recently Blur has replaced OpenSea as the primary market by using token incentives and enhanced trading features. Overall, NFT trading volume, much of which is "PFP" (avatar NFT) trading, has decreased by about 95%, and prices have dropped by over 80% from their peak.

Despite the significant decrease in trading volume and prices, many believe the importance of NFTs cannot be underestimated, and as new features (such as improvements in 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, they will eventually become ubiquitous.

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Staking

Blockchain consists of transaction blocks created and verified according to predetermined, encoded rules. However, because participants may be malicious, blockchain requires block producers to stake a certain value to prevent bad behavior. Blockchains based on proof of stake (PoS), such as Ethereum, achieve this by requiring block producers (called validators in PoS systems) to lock cryptocurrency in a smart contract, a process known as staking.

In addition to additional balancing mechanisms, validators are randomly selected to produce a block based on their staking ratio and receive staking rewards from transaction fees and protocol issuance to compensate for their work, such as proposing and validating blocks. However, if validators intentionally or unintentionally perform poorly in their duties, a portion of their stake may be slashed. Therefore, staking is crucial for the proof of stake process, as it serves as a means to protect the network.

To stake, individuals can run validator nodes or delegate tokens to validators in exchange for a small portion of staking rewards. Staking rewards vary based on protocol design, staking participation rate, network activity, lock-up period, and the chosen validator (for token delegators). Risks include the unlocking of the staking period, as staked tokens are typically not immediately withdrawable, potential slashing for underperformance, and opportunity cost as staked tokens cannot be used for other activities.

To mitigate high opportunity costs, many staking service providers distribute derivative assets called Liquidity Staking Tokens (LST), which not only represent staked tokens but also accrue interest and can be used in DeFi protocols, such as as collateral for loans or providing liquidity on decentralized exchanges. Staked Ether by Lido (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. While also referred to as staking, it is significantly different from staking in the consensus protocol of a blockchain and is more commonly used to reduce token supply, increase token demand, and reward users.

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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 blockchain 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, among others. Due to the benefits and improvements it brings, businesses, crypto OGs, and regulatory bodies are all heavily interested in this, with the global tokenization market expected to reach $16 trillion by 2030, according to The Block.

Benefits: The benefits of tokenization include:

• Asset management and administration: Simplified operations, reduced administrative burden, automated and transparent record-keeping

• Market efficiency and liquidity: Improved standardization, shortened settlement times, reduced reliance on intermediaries, and increased asset efficiency through reduced administrative costs and decentralization

• Inclusive finance: Lower minimum investment limits, access to more sources of capital

• Economic growth: Increased access to capital and financing through a wider and more diverse participant base

Process: Real-world assets are tokenized and brought onto the blockchain. According to The Block, the process includes:

• Identification: Selecting the real-world assets to be brought onto the blockchain

• Verification: Confirming ownership and value of the assets through legal documents or evaluations. Trusted third parties, such as lawyers or auditors, can verify authenticity, ownership, and valuation

• Tokenization: Creating a digital token or set of tokens to represent the assets on the blockchain. Each token typically represents fractional ownership or a specific claim to the asset and can use smart contracts to define the token's attributes and functions

• Issuance: Verified asset information and created token records are recorded on the blockchain, and token issuance is completed through ICOs, STOs, or direct listings

• Custody/management: Asset management and custody ensure the safekeeping of physical assets and the management represented by the tokens on the blockchain, typically involving traditional asset custodians and blockchain-based custody solutions

Examples: Stablecoins are the most prominent example of tokenization, with stablecoins typically tokenizing the US dollar but also including other assets such as gold (e.g., KAU, PAXG, XAUT). The tokenization market for US Treasury bonds is rapidly growing, with leaders including Franklin Templeton ($300 million), Ondo's OUSG ($130 million), and Matrixdock's STBT ($85 million). In addition to government bonds, other debt instruments are also being tokenized, such as private credit (by Defyca), structured debt (Intain), and debt securities (Obligate). Furthermore, some protocols are also tokenizing or serving as markets for less liquid tokenized products, such as Centrifuge, Goldfinch, Maple, RealT, BSOS, and Re, while other protocols are tokenizing stocks and indices, such as Backed and Swarm. Finally, tokenization extends to carbon credits (Ecowatt, Flowcarbon), physical collectibles (Collector, Tangible), and even data indexes (The Graph), KYC (Shyft Network), and labor markets (Human Protocol), although the latter is typically not within the current tokenization/RWA narrative.

Challenges: Despite these benefits, tokenization/RWA must first overcome various challenges to fully realize its potential. Firstly, a robust and clear legal and regulatory framework must be established. Secondly, standardization is needed in asset representation, ownership determination, and user identity. Thirdly, interoperability needs to be improved to consolidate users and liquidity between chains and applications. Finally, data, custody, and auditing processes need improvement.

Tokenomics

Tokenomics is the economics of protocol tokens, covering various supply and demand characteristics.

Tokens play a crucial role in decentralized entities by coordinating and incentivizing behavior, rewarding value contribution, and facilitating exchanges. Therefore, a strong token economy may support protocol objectives, create/enhance sustainable economic models, and accelerate long-term protocol growth and value creation.

Tokenomics design begins with the objectives of the protocol and then examines how tokens contribute to achieving these objectives. Tokenomics is not about increasing prices by reducing supply, but more about matching supply and demand. There are many tokenomics frameworks, but studying supply and demand may be the most popular.

Supply: Token supply is typically encoded in smart contracts and is more formulaic than demand. Some important considerations about token supply include:

• Supply definitions: Token supply has various definitions, including circulating supply, which is the current circulating and immediately available for sale token quantity; total supply, which is the created token quantity minus the destroyed token quantity (including tokens locked in smart contracts); and maximum supply, which is the hard-coded limit of total tokens, representing the total token quantity that will exist in the future, indicating remaining inflation.

• Supply metrics: The current and future supply of a token is influenced by many different components. These include issuance schedules (many protocols have built-in mechanisms to increase circulating supply to incentivize and reward activity), distribution (tokens may be created and distributed through fair launches or pre-mining), locking (pre-mined tokens may be subject to locking schedules to prevent large supplies from entering the market at once), and distribution (current token holders and the quantity, with the risk of a few large holders).

In general, if most of a token's maximum supply has been used up, or there is stable, predictable inflation encouraging its use, fair launches or pre-mining, a gradual, long-term vesting schedule, a high community token allocation rate, and a fair distribution without large holders, then over time, such a token generally absorbs demand well.

Demand: Token demand is driven by fundamental and speculative characteristics, influenced by the benefits provided by the token.

• Demand creation mechanisms: Token demand may come from various sources, such as internal use within the protocol (e.g., value exchange, governance, access discounts, etc.), sharing protocol income or potential income with token holders, monetary properties, and speculative demand.

• Demand-driving factors are not all equal. Governance rights are typically of lower value due to low voter participation. Speculative demand has a dual nature, as it can help increase token prices but may also harm token prices. Sharing income with token holders is a strong potential benefit and demand-driving factor, but it is difficult to achieve in the current regulatory environment. In conclusion, protocols should focus on providing and growing real use cases/utility for their tokens to drive demand for them, and then match this demand with supply.

Click here to learn more about tokenomics.

Zero-Knowledge Proofs

Zero-Knowledge Proofs (ZKPs) are a method that allows one party (the prover) to prove to another party (the verifier) that a statement is true without revealing any other information. To illustrate, imagine your friend wearing a blindfold and holding a green ball and a red ball. You want to prove to your friend that the two balls have different colors without revealing any information about the two balls. You ask your friend to either switch the balls behind their back or not, and then show them to you again, at which point you can tell if they switched the balls. With each round and a correct answer, your friend may start to believe you, but not fully, as you have a 50% chance of guessing correctly. However, with each round and a correct answer, you are just moving the probability of guessing towards zero, and eventually your friend will believe that the two balls have different colors, without you revealing any information about the two balls or anything else.

Zero-Knowledge Proofs are primarily used in blockchain for privacy and scalability purposes. Examples of the former include hiding transaction information and minimizing information sharing, while examples of the latter include zero-knowledge rollups, which process transactions off the Ethereum main chain, then batch and compress them, and publish them to layer-one state data, while providing zero-knowledge proofs (called validity proofs) to prove that the computation was executed correctly. Future use cases include cloud-scale verifiable outsourcing of computation, open third-party analysis of anonymous data, and enhanced trust, privacy, and remuneration for decentralized identities.

Zero-Knowledge Proofs use arithmetic circuits to prove the validity of statements, are probabilistic (cannot be certain, only speak with high confidence), can be interactive (as in the example above) or non-interactive (the method used in blockchain), and typically exist in the form of zk-SNARKs in the field of cryptography. Zero-Knowledge Proofs have only recently transitioned from theory to practice, and are rapidly improving in key areas such as proof time, proof size, verification time, and trusted setups.

The drawbacks of Zero-Knowledge Proofs are that they are in early stages of development, are probabilistic rather than deterministic, require multiple interactions or significant computation, and typically have some minimal trust assumptions in the trusted setup, which is the process of generating standard parameters for the proof system (although some ZKP implementations do not require a trusted setup).

Zero-Knowledge Proofs are similar to other technologies such as multi-party computation (where multiple parties share data for computation tasks without revealing each other's data) and fully homomorphic encryption (which makes computation on encrypted data possible without first decrypting it).

Popular protocols adopting Zero-Knowledge Proofs include Aleo, Anoma, Mina, Tornado Cash, Iron Fish, Manta Network, Aztec, Argent, Starknet, zkSync, and Penumbra, among others.

Subfields of Blockchain

Blockchain Gaming

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 have many benefits, including:

• Decentralization/Trustlessness: Games are more secure, transparent, trustless, and traceable.

• Ownership: Users truly own their assets in the form of self-custodied NFTs, shifting in-game purchases from expenses to assets.

• Enhanced functionality: Users can resell their assets to others. Composability may allow users to transfer assets between different games or enable developers to build on existing games.

• Greater influence: Blockchain-based games can adopt user-generated content or community governance based on DAOs, allowing users to create in-game/world assets, develop storylines, or improve the game's economic model.

• Incentives: Token incentives can reward users for contributions to the game, such as completing tasks, creating popular content, or bringing in new users.

• New revenue streams: Developers can now oversee dynamic virtual economies, from which they can extract a portion of all business transactions.

Blockchain-based games first emerged in late 2017 with the launch of CryptoKitties. CryptoKitties allowed users to collect and breed digital cats based on deterministic cat attributes and a smart contract-based breeding algorithm, and it became so popular that it clogged the Ethereum network. The next popular blockchain-based game was Axie Infinity, launched in 2021, which is a digital pet universe game that allows players to collect, breed, and battle NFT-based Axie characters to earn tokens from the game. At its peak, Axie had nearly 3 million daily active users, many of whom quit their day jobs to rely on the game for income. Other popular games include Ember Sword, Star Atlas, Splinterlands, The Sandbox, and Sorare, among others.

Game players are often skeptical of blockchain-based games, seeing them as money traps for developers, and GameFi has been criticized for relying on a constantly growing player base and potentially collapsing as quickly as it grew. Additionally, blockchain-based games face many other challenges, such as regulation, security, scalability, user interface/user experience, and general gameplay/graphics issues. However, developers are now primarily focused on the games themselves and the unique benefits brought by blockchain technology, while avoiding volatile incentives. Additionally, given the long development cycles, we are finally approaching the first true AAA-level blockchain-based games, such as Illuvium, Shrapnel, and Otherside.

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

Click here to learn more about blockchain gaming.

Lending Protocols

Lending markets, such as Aave and Compound, are pillars of DeFi, allowing users to borrow or lend crypto assets through smart contracts without permission, to gain leverage, short the market, or earn additional income. Smart contracts enable these services to conduct non-custodial transactions without 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 typically variable, determined by supply and demand (i.e., pool utilization rate) algorithms. An increase in borrowing demand will push up interest rates, providing higher returns to lenders, and vice versa.

Lenders typically receive receipt tokens corresponding to the collateral they lend, similar to the design of liquidity staking tokens. Lending returns are either accrued to the balance of receipt tokens (aTokens) or reflected in the price of receipt tokens (cTokens). Due to the peer-to-peer lending model, borrowers can only withdraw the loan when there is idle capacity, and when the lending pool is fully utilized (i.e., all deposits are borrowed), borrowers may not be able to redeem the loan. However, as interest rates are typically variable and rise with utilization, it is expected that some borrowers will repay the loan in this scenario, allowing lenders to reclaim collateral from the pool. Additionally, since receipt tokens are provided against the loan, if liquidity is urgently needed, borrowers can sell their loan position on the secondary market of decentralized exchanges.

Lending typically requires over-collateralization to help mitigate the risk of bad debt accumulation by the protocol. Borrowers face liquidation risk if the value of borrowed assets sharply rises or the value of collateralized assets falls. Most protocols charge additional fees when liquidating positions, so the health of borrowers' loans should be closely monitored. Borrowing/lending assets are typically supported on a permissioned basis, as risks are usually shared, and supporting smaller/higher-risk assets increases the risk of bad debt accumulation. Therefore, usually only large tokens are supported, but protocols like Euler have taken an approach of isolating the lending market and allowing it to form without permission.

The lending/borrowing market also introduces a completely new financial ecosystem that does not exist in traditional markets, with the most prominent example being flash loans. Flash loans allow borrowers to borrow any available amount of assets without providing any collateral, as long as liquidity is returned to the protocol within the same block (i.e., imagine if ETH is more expensive on Uniswap than on Sushiswap, you can borrow USDT to buy ETH on Sushi, then sell it on Uni within the same block to narrow the interest spread before repaying the loan). If the loan is not repaid within the same block, the entire flash loan transaction fails (i.e., capital does not leave the lending pool).

Central Bank Digital Currencies

Central Bank Digital Currencies (CBDCs) are widely available digital forms of a country's legal tender issued by the central bank. Since 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 currency, and support efficiency and innovation.

CBDCs have two main types: retail CBDCs used by the public for everyday payments, and wholesale CBDCs used as a settlement tool between financial institutions.

CBDCs can improve payment 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 cost/availability, and privacy.

For CBDCs, there are many design choices involving interest rates, household limits, structure, payment verification, functionality, access, and governance, among others. For example, the architecture can be centralized or decentralized, transfers can be through a central intermediary or peer-to-peer, system and payment access/verification can be based on identity/account or token-based, ledgers can contain simple liability data or more complex payment information, ledger access can be relatively open or more restricted. Additionally, the central bank must also determine what responsibilities will be provided in addition to issuance, such as distribution, system management, and device management. Currently, 11 CBDCs have been launched, 21 are being experimented with, 33 are in development, and 46 are in the research stage.

Click here to learn more about CBDCs.

Centralized Exchanges

Centralized cryptocurrency exchanges (CEX) are intermediary platforms that connect token buyers and sellers to facilitate digital asset trading. Unlike traditional finance, most CEXs have a broader role, acting as brokers, exchanges, and custodians.

CEXs create virtual balances for users after receiving fiat/token deposits, and only conduct on-chain transactions when withdrawals are made. This increases speed and reduces costs but introduces a significant trust assumption in the exchange holding user deposits.

CEXs use a central limit order book (CLOB), where different currency pairs have bids (amount willing to pay for an asset) and asks (amount willing to sell an asset for a certain price) on the exchange. The exchange matches bids and asks based on a price-time priority, and market participants can see the depth of the order book, meaning they can see bids and asks beyond the best bid and ask prices.

Orders can be maker orders, providing liquidity and adding to the order book (i.e., limit orders), or taker orders, executing immediately at the best bid or ask price (i.e., market orders) and reducing liquidity. Maker orders typically have significantly lower or even negative trading fees in some cases, while taker orders are usually much more expensive. Additionally, exchanges typically offer trading fee discounts at higher trading volume tiers.

Different CEXs offer different cryptocurrency assets and product trading, such as spot, perpetual futures, and options. Exchanges also typically offer their own tokens, which may grant holders trading fee discounts, access to launchpad listings, and can be used as Gas on the associated blockchain.

Major 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 DEX) and 97% of derivatives trading volume.

Click here to learn more about CEXs.

Distributed Cloud (Computing and Storage)

Decentralized cloud protocols leverage blockchain technology to provide storage and computing services:

• Cloud Storage: Provides space for storing data, but does so offline on cloud servers via the internet. Cloud storage is used for web hosting, file sharing, virtual desktop hosting, automated data backups, etc., allowing users to protect data from disasters, secure sensitive data, supplement storage space, and reduce operational costs.

• Cloud Computing: Any internet-based service for conducting computational processes or running applications. It is used for cloud-based communication platforms (e.g., email), SaaS, remote data analysis, website content and management systems (e.g., CRM, CMS, ERP), facilitating easier collaboration, enabling remote work, improving business flexibility, and integrating important files and applications.

Decentralized cloud companies provide these services through service providers in a P2P network, who either utilize idle infrastructure (e.g., renting unused computer hard drive space through Filecoin) or purchase custom hardware and run networks from scratch in exchange for token rewards (e.g., Flux miners buying and running Flux nodes for Flux rewards). Decentralized cloud providers compete with tech giants such as Amazon AWS, Google Cloud Platform, and Microsoft Azure, offering lower prices, greater elasticity, better privacy, and resistance to censorship.

Decentralized Storage: Decentralized storage solutions distribute data storage across multiple nodes or computers, eliminating the need for a central server and achieving data permanence and resistance to censorship. They act as a marketplace, allowing anyone from individuals to large cloud companies to rent unused hard drive space in exchange for fees and attempt to coordinate and ensure the process (including encryption, storage, retrieval, contract management, storage audits, etc.). Typically, users encrypt data, then split it into smaller parts called shards, which are often replicated for redundancy and stored by nodes on the network. Nodes communicate with each other via P2P protocols, receiving token incentives to ensure storage availability and reliability, and retrieving and sharing data when requested by users, all in a transparent and tamper-proof manner.

Some decentralized storage solutions include Filecoin, Storj, Arweave, and Sia, among others. Filecoin is built on top of IPFS, using a content-addressed rather than location-addressed system to store files (which assigns a unique encrypted hash to each data file, acting as the file's fingerprint, called a CID), making sharing files easier without worrying about their location and ensuring file immutability. Filecoin sits on top of IPFS, providing a P2P market for storage services, incentivizing storage and retrieval providers, and ensuring the process runs smoothly (miners post collateral that can be slashed and submit proofs of storing data, called replication proofs, and that they continue to store data, called time-space proofs). Other storage solutions offer similar services but may differ. For example, Storj uses erasure coding and parallel file transfers to improve performance and availability, rather than relying on a single host for file transfers like IPFS. Arweave is another example, which unlike IPFS, is not permanent and requires ongoing services to achieve permanence, allowing for one-time payment for permanent file storage.

Decentralized Computing: Decentralized computing protocols use geographically distributed computing resources to provide computing, data processing, and data exchange services, often alongside data storage. Most protocols offer CPU, RAM, and GPU (newer options) and allow computation on anything that can fit into a Docker container. Additionally, many computing protocols offer 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, provide computing resources, and offer distributed storage (Flux Drive) and distributed wallet/identity solutions (Zelcore). Akash is a decentralized cloud marketplace based on Cosmos, connecting users with providers of computing and storage services, where individual or company servers can bid for unused capacity, potentially saving users up to 90% compared to AWS. Internet Computer, on the other hand, uses data centers and high-end node hardware to replace traditional tech stacks, directly serving web content to users, acting as a public computing platform, and enhancing the web with scalability, decentralization, and resilience. It's worth noting that other protocols replicate smaller components of the current internet stack, such as Fleek, a decentralized edge network/CDN (similar to CloudFlare).

Companies are increasingly turning to a hybrid cloud model with multiple providers, as traditional cloud costs have roughly doubled over the past two years and struggle to handle new technologies like artificial intelligence. Additionally, companies are adding on-premises servers, placing computing tasks near data sources (known as edge computing) to reduce latency and save on bandwidth costs. This hybrid infrastructure reduces reliance and lock-in on large tech providers, making it easier for companies to adopt decentralized solutions.

Decentralized Exchanges

Decentralized exchanges (DEX) are decentralized applications that act as peer-to-peer markets, allowing cryptocurrency trades to occur directly between users. DEX inherits positive characteristics of cryptocurrencies (decentralization, permissionless, trustless, censorship-resistant, immutable), with two notable features being the elimination of rent-seeking intermediaries and self-custody.

Given the speed and cost limitations of the underlying blockchain, DEX typically use deterministic pricing algorithms called automated market makers (AMM) instead of a central limit order book. AMM utilizes token pools locked in smart contracts, allowing anyone (referred to as liquidity providers or LP) to deposit tokens into the liquidity pool. The token price in the pool follows a formula, such as the constant product market maker algorithm (x*y=k, where x and y are the quantities of two tokens in the pool, and k is a constant), resulting in the pool token ratio determining the price, with slippage determined by the ratio of trade size to pool size, ensuring liquidity is always available regardless of trade size. Arbitrageurs then peg the price to the global market price, buying and selling tokens in the liquidity pool, pushing the price back to its original position when it deviates from the global market price.

Liquidity providers earn trading fees in proportion to the liquidity they provide in the liquidity pool. Additionally, protocols typically incentivize liquidity providers by providing protocol tokens, known as liquidity mining. Liquidity providers face impermanent loss risk, where one of the two assets provided to the pool experiences significant divergence from the other asset, leading liquidity providers to potentially earn better returns by directly holding both assets instead of providing liquidity.

Decentralized exchanges account for approximately 15% of total spot trading volume and 2-3% of total derivatives trading volume.

Uniswap is the most well-known and widely used DEX, with its v2 implementation allowing permissionless pool creation (anyone can create a pool), v3 allowing concentrated liquidity (liquidity providers can provide liquidity within a specific range to improve capital efficiency), and the upcoming v4 providing hooks (for customizing pool behavior). 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 even extending to virtual AMMs, such as DeFi perpetual contract protocols.

Click here to learn more about Dex.

Decentralized Identity

With over 1 billion people unable to prove their identity, the average internet user has 100 passwords, and identity fraud leads to billions of dollars in losses annually, current identity verification systems have many issues. Digital identity initially took the form of users creating personal accounts on each website (centralized model), then users logging in through Google or Facebook (federated model, sacrificing privacy for convenience and security), and more recently shifting towards 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.

Unlike situations where PII is stored and controlled by centralized institutions that may abuse power, decentralized identity allows individuals to self-custody their data. To do this, users create decentralized identifiers (DID) and are then issued verifiable credentials (VC) by issuers, which users can use cryptographic techniques to prove ownership of the DID and make claims that can be verified by verifiers.

Decentralized identity brings improved experiences (logging in with your wallet and bringing your data to websites), enables users to profit from their own data (earning payments for sharing data or viewing ads), enhances digital reputation (providing low-collateral loans), increases privacy protection (selectively disclosing information), and reduces risks (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.

Decentralized identity systems face several challenges. Firstly, solutions are highly fragmented between use cases and blockchains, with almost no interoperability (over 90 DID method specifications across over 80 blockchains), making it a daunting task for entities like the World Wide Web Consortium (W3C) to establish standards. Additionally, most users still struggle with managing keys and obtaining a good user experience. Furthermore, changes in user behavior and the strong network effects of current digital identity constructions being disrupted by decentralized identity will take a long time. Issuers will have to adapt to new management and issuance frameworks, and enterprises and verifiers will need to adopt verification technologies to facilitate acceptance of these credentials.

There are many decentralized identity and credential issuance protocols, some built on general-purpose blockchains like Ethereum (POAP and ENS, issuing attendance proof NFTs and name-to-address resolution, respectively), while others are built on blockchains optimized specifically for decentralized ID management (such as Sovrin, Veres One, and Ontology). Some protocols also offer certificates as a service, allowing other Dapps to easily issue certificates, such as Galaxe and Gateway.

Decentralized Physical Infrastructure Networks

With the need for billions of dollars in investment to build and maintain large-scale physical infrastructure and hardware networks, many tech sectors are dominated by oligopolies, unaffected by new competitors. However, blockchain technology challenges this model by allowing projects to guide and coordinate these networks through user-contributed infrastructure and token incentives. This decentralized physical infrastructure network, also known as Token-Incentivized Physical Infrastructure Network (TIPIN) or Proof of Physical Work (PoPW), incentivizes users to contribute and operate devices on the network, potentially on a scale comparable to existing networks.

TIPIN has several key differences. Firstly, it guides the network through crowdsourced hardware. Secondly, it makes the network owned and operated by users, rather than large companies extracting rent. Thirdly, it democratizes access to the network, as anyone can run a node or use its services. Finally, it is decentralized and censorship-resistant.

In theory, TIPIN can achieve a flywheel effect, incentivizing supply-side participants to deploy infrastructure through token rewards. As the infrastructure network grows, developers create products, and end users generate demand. As demand increases, fees generated from end users attract more hardware providers, creating a cycle. In practice, TIPIN excels in guiding hardware networks, but they do not always meet corresponding user needs.

DePIN networks are created by user-contributed hardware, which can be either 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 existing but idle resources, also in exchange for tokens. For example, Helium was the first project to create a large-scale user-contributed new hardware network, where Helium hotspots are sold to users by the project/third-party manufacturers, providing power to IoT devices (hotspots both build/secure the network through HNT mining and provide connectivity to nearby devices in exchange for HNT rewards). While Helium has built the world's largest LoRaWAN network, the demand did not materialize as expected, and now Helium is more focused on rolling out a 5G cellular network. Other protocols like Filecoin and Arweave allow users to rent or purchase unused hard drive space on others' machines in exchange for FIL or AR tokens, utilizing surplus storage space and increasing data persistence and resistance to censorship due to files being stored on multiple machines.

DePIN is being applied in various infrastructure subdomains, 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 networks: Helium, Chirp
• WiFi: WiCrypt, Wifi Dabba
• Sensor networks: Hivemapper, DIMO, Planetwatch, WeatherXM
• Energy networks: React, Arkreen

Click here to learn more about Depin.

Liquidity Staking Tokens

Liquidity staking is an innovation in the proof-of-stake (PoS) blockchain ecosystem that allows stakers to earn staking rewards while maintaining liquidity. As an exchange for depositing assets into a liquidity staking provider, users receive liquidity staking tokens (LST), which serve as deposit receipts and provide liquidity, fungibility, and rewarding claims to originally illiquid staked assets. In addition to maintaining liquidity, LST can also be freely used for other DeFi purposes, such as borrowing against collateral or providing liquidity in DEX. Overall, LST enhances capital efficiency, increases flexibility, and earns staking rewards in exchange for a small fee priced as a percentage of the reward.

Rewards typically accumulate into LST in two ways. Firstly, rewards may accumulate into the price of LST, making LST more valuable than the underlying asset as rewards are earned. Alternatively, rewards may accumulate into the token balance of LST, increasing the supply of LST (e.g., new LST tokens are minted proportionally to the accrued reward value). While the latter model allows LST to track the underlying asset 1:1, it may have negative tax implications in certain jurisdictions.

Variables to consider include:

• Has LST stood the test of time? How long has the provider been running on the mainnet?
• How much staked assets does the provider control?
• Who manages the staked assets? Is it a single entity? Multiple entities? Can anyone be a staked asset manager (permissionless node operator), or is there a need for whitelisting?
• How much liquidity does LST have? Besides buying and selling liquidity, are there other use cases? Is there widespread DeFi integration?
• What is the fee structure?
• Are there any governance issues? Does the underlying PoS blockchain employ strict staking-based governance, or is it more like Ethereum's soft governance? Does the LST provider have its own governance token, such as Lido's LDO?
• What is the structure of LST?

Liquidity staking has flourished on Ethereum, especially as the network does not allow local delegation of stake, so most ETH stakers on Ethereum indirectly stake through staking service providers, who typically offer liquidity staking. In contrast, ecosystems like Cosmos, Solana, Avalanche, and Polkadot allow local delegation of stake, so delegators can directly delegate stake through the protocol without the need for third-party liquidity staking providers.

The most prominent liquidity staking token is Lido's Staked ETH (stETH), representing Ether staked through the Lido platform at a 1:1 ratio. There are also many smaller competitive liquidity staking providers on Ethereum. Outside of Ethereum, the liquidity staking ecosystem is smaller in scale, but most other blockchains have at least one liquidity staking provider. For example, Solana has Jito and Marinade, Cosmos has Stride, supporting liquidity staking for all IBC-compatible chains, Avalanche has Benqi, and Polkadot has Acala.

While liquidity staking provides more utility and flexibility for stakers, it also introduces new risks and considerations. The value of liquidity staking tokens can to some extent detach from the underlying asset, as the underlying asset may not be immediately redeemable (e.g., unlocking times vary greatly, ranging from days to months or even years). Additionally, smart contracts involved in liquidity staking add technical risks, including potential vulnerabilities or errors. Liquidity staking may also introduce risks not considered in the original protocol design (e.g., new attack vectors may emerge if all stake is delegated to unbonded node operators).

Click here to learn more about LST.

Meme Coins

Meme coins are crypto assets originating from internet memes or possessing humorous or quirky characteristics. These tokens primarily gain popularity and value through community and social media hype, influencer recognition, and viral internet trends, rather than intrinsic value or technological innovation. More specifically, meme coins may derive value by evoking certain emotions and psychological backgrounds, such as being part of a community or believing that others will pay more for the token in the future. This pleasurable value is difficult to quantify, especially considering 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, fostering a sense of belonging and fun. Additionally, community tokens are often created in real-time based on real-world events. Finally, community tokens often have unit bias, using extremely low prices in fractions of a cent and very large supplies, providing a psychological advantage to some individuals.

Dogecoin (DOGE) is one of the earliest, most valuable, and most well-known meme coins. Doge, founded in 2013, is based on the "Doge" meme featuring a Shiba Inu dog. Dogecoin is a simple fork of Bitcoin (a fork of Bitcoin), meant as a joke rather than an innovation. Other examples include: Shiba Inu, Pepe, Bonk, SafeMoon, Dogelon Mars, and more.

Meme coins are known for their extreme volatility and speculative nature. Their value can quickly skyrocket or plummet based on social media trends, celebrity tweets, or community hype, making them a high-risk investment choice. In fact, Dogecoin often experiences sharp increases due to Elon Musk's comments, such as when Elon temporarily replaced Twitter's blue bird logo with Dogecoin, leading to a surge in Dogecoin's price. However, these short-term surges are often speculation-driven and unsustainable, with prices often quickly reverting.

Investing in meme coins often boils down to a game of player versus player without any fundamental growth or development reasons. This is typically an early investment and zero-sum game, rather than a game of making a big cake.

Payment Methods

Traditional financial systems are built on outdated technology, resulting in high costs, long wait times, discriminatory practices in some cases, poor user experience, and inadequate security. For example, ACH and wire transfers may take up to five days to process, credit card networks charge merchants 2-3% fees, leading to increased consumer prices, and complex settlement systems delay stock trade settlements, all leading to suboptimal convenience, cost, risk, and capital efficiency. Even in fintech, innovation is primarily focused on the front end, while the back end still operates these traditional and outdated systems.

In contrast, blockchain technology is innovating the back end of these systems. Currently, blockchain-based payments can be conducted 24/7, 365 days a year, with almost zero cost and near-instant settlement. Businesses can accept payments based on digital assets using only a public key, without the need for specialized hardware or reliance on issuing banks, merchant acquirers, and card networks. The blockchain itself can serve as a real-time, verifiable, immutable public ledger, executed by open-source code, significantly increasing transparency and reducing disputes. In the future, financial inclusivity will be improved, requiring only a device connected to the internet to participate, user experience will be enhanced, key pairs will serve as identity, account, and password, and security can be strengthened by users managing their private information rather than it being scattered across numerous institutions, companies, and websites.

In addition to currency payments, blockchain technology can enable many other forms of value exchange and introduce new capabilities that existing financial systems cannot achieve. For example, tokenization will ultimately bring about the exchange and account records of almost all other assets besides currency, such as digital forms of traditional securities based on blockchain, known as tokenized securities. The advantages of speed and cost introduce new capabilities and constructs, such as making previously impractical micropayments possible, charging for streaming on a per-song basis to better reward creators, or basing it on per-page views to reduce DDoS attacks. Programmability will enable new features, such as subsidy payments that can only be spent on specific categories, and composability will make accepted token formats widely available and usable in the digital realm, while fragmentation will increase accessibility and liquidity. These examples all represent significant improvements in speed, cost, inclusivity, and transparency.

Despite the enormous benefits, cryptocurrency payments still face some challenges. Firstly, 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, changes in consumer behavior take decades to materialize, such as the shift from cash to credit cards (i.e., shoppers using credit cards instead of cash) is a phenomenon that takes decades. Additionally, regulatory clarity is lacking, acceptance/integration is currently limited, user interface/user experience needs improvement, and challenges exist around fraud, security, refunds, and disputes that need to be addressed.

Examples of digital asset payment systems include: Bitcoin, initially intended to be a peer-to-peer electronic cash system, but due to technical limitations and fixed supply, it has become a store of value tool. 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 aimed at facilitating fast, low-cost international remittances, serving banks and financial institutions to facilitate cross-border payments with XRP. Stellar is similar to XRP but focuses on providing financial services to individuals who cannot access traditional banks. Dash focuses on privacy, speed, and user interface/user experience, with its PrivateSend and InstantSend payment features. Stablecoins are currently a major 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 decentralization and security, it is relatively slow compared to competing L1s, often facing issues of network congestion, low throughput, and high transaction costs during periods of high activity. To address this issue, many scaling solutions aim to process transactions outside the mainnet while relying to varying degrees on the security of the Ethereum mainnet.

The main types of scaling solutions are:

• Sidechains: Independent blockchains connected to the main chain through a two-way bridge. Sidechains support EVM-compatible smart contracts for scaling and testing purposes. They may not be as decentralized as Ethereum due to having their own consensus mechanism, thus not inheriting Ethereum's security guarantees, and therefore are not technically considered Layer 2.

• State channels: Users can directly transact with each other off-chain outside of Ethereum and then batch and submit transactions to the main chain. State channels can achieve high throughput and low cost 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 child chains, which are replicas of the mainnet and maintain their security through fraud proofs used to arbitrate disputes on the main chain. However, Plasma cannot scale general smart contracts.

• Rollup: Rollup processes transactions off-chain in a separate chain before batching, compressing, and publishing them to the mainnet. Transaction execution occurs off the main chain, but publishing the data back to the mainnet allows anyone to recreate the state and verify the validity of the transactions, achieving high throughput and low cost while inheriting many security properties of the main chain.

Rollup is the most popular type of scaling solution and is divided into two types:

• Optimistic Rollup (OR): OR assumes that transactions processed on L2 and published back to the mainnet are valid unless challenged, at which point fraud proofs are generated, and if the proof is invalid, the correct state is restored, and the stake of the transaction submitter is slashed. OR is further ahead than ZKR, has a first-mover advantage, but due to the need for challenge periods, withdrawal times are longer and require good monitoring. Examples include Arbitrum and Optimism.

• Zero-Knowledge Rollup (ZKR): ZKR bundles transactions and executes them off-chain, generating cryptographic proofs called validity proofs, which are published to the mainnet along with batch state changes. ZKR supports fast withdrawals, has fewer trust assumptions, but has only recently been rolled out on the mainnet. Examples include: zkSync, Scroll, Polygon zkEVM, and Starknet.

Rollup aggregates many transactions, executes them off-chain, bundles transaction data or state differences, and sends the data back to Ethereum. Rollup uses sequencers to collect, order, and send batched transactions back to the mainnet. Ethereum Rollup sequencers are currently centralized, using only FIFO transaction ordering, but efforts are being made to utilize shared sequencers (multiple Rollups using the same sequencer to achieve atomic cross-chain composability) and decentralized sequencers (to increase trustlessness, although challenges exist). Centralized sequencers pose risks of censorship of collateral (governments may force Rollups to censor) and liquidity (if the sequencer shuts down, L2 cannot fully operate, although some have security mechanisms, users can force funds back to L1). Rollup earns money through sequencers, with income coming from L2 transaction costs, and in the future, through order transactions and extracting MEV. The cost of Rollup is primarily the cost of publishing data back to the mainnet, which will decrease after the Ethereum implementation of the Dencun upgrade in early 2024.

General Rollups (e.g., Optimism Mainnet and Arbitrum One) still face challenges as applications compete for L2 block space, cross-chain fragmentation increases, and bridging risks between Rollups, and developer overhead in deploying dapps across multiple chains. A popular solution is to create a composable Rollup ecosystem, sharing infrastructure to allow ecosystem chains to have customizable execution environments, simplified cross-chain communication, and increased revenue opportunities. Note that this is part of the trend of roll-apps, where each dapp is its own Rollup, typically built as an L3 on top of L2, thus not needing to worry about block space scarcity caused by other applications. Examples of Rollup ecosystems, typically 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, offering Arbitrum Rollup (generic 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, settling with One or Nova), and Arbitrum Stylus (allows writing smart contracts in Rust), all supported by Arbitrum's Nitro technical stack.

• Optimism: The OP mainnet is a Layer 2 optimistic Rollup equivalent to the Ethereum Virtual Machine. It provides the OP Stack (standardized, shared, and open-source development stack to support Optimism) and The Superchain (a shared bridging, decentralized governance, upgrade, and currently under development communication protocol for chain networks). Importantly, Coinbase uses the OP Stack to build its Layer 2 Base.

• Polygon: Polygon offers a range of scaling solutions options, with the most popular being Polygon PoS (relying on its own validator network to ensure security as a sidechain), but Polygon plans to upgrade to zkEVM validium (similar to ZKR, but data can be obtained off-chain). Polygon also has the Polygon zkEVM and its Polygon Chain development kits, and is converting its MATIC token to the ecosystem-wide POL token.

• Mantle: Mantle is a best-of-both-worlds solution, similar to OR but with 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 has developed StarkEx (a standalone licensed Validity Rollup) and StarkNet (a permissionless decentralized ZKR). Starknet uses STARKs instead of the more common SNARKs for zero-knowledge Rollup, providing enhanced security but with larger proof sizes and longer verification times. Starknet uses the Cairo smart contract language, although there is also a compiler that can convert Solidity code to Cairo code.

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Stablecoins

Stablecoins are digital currencies pegged to the value of another asset (usually the US dollar), designed to reduce the inherent volatility of cryptocurrencies. Stablecoins are primarily used to facilitate simple and efficient cryptocurrency transactions (fiat-to-crypto exchanges are cumbersome, so about 75% of cryptocurrency trading volume involves at least one stablecoin), but their use in decentralized applications, payments, remittances, and settlements is increasing. Stablecoins have many advantages, including speed, cost, transparency, inclusivity, and programmability, and are considered one of the "killer apps" of cryptocurrencies.

Stablecoins are typically categorized into three types based on their collateral:

• Fiat-collateralized stablecoins, minted and burned by a central party, usually backed by cash or fixed-income instruments. Fiat-collateralized stablecoins have the strongest track record of price stability, are very straightforward, and will be the first stablecoins with robust regulatory oversight, but they introduce centralization into an otherwise decentralized environment, thus requiring additional trust assumptions. Fiat-collateralized stablecoins account for about 90% of the stablecoin market value, and USDT and USDC are the most popular examples.

• Crypto-collateralized stablecoins, where smart contracts rely on monetary policy, arbitrage, and over-collateralization to maintain their peg. Crypto-collateralized stablecoins eliminate many of the centralization 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 stability mechanism maintains the peg without collateral, are more theoretical in nature. Algorithmic stablecoins have the advantages of capital efficiency and decentralization, although they have not yet 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 supporting the stablecoin. Concerns have persisted throughout the history of Tether's USDT backing, and many fiat-collateralized issuers have strengthened reserve transparency and released monthly attestation reports. Finally, it is important to note that stablecoin regulation varies by jurisdiction, with some regions having robust regulatory frameworks (e.g., the EU's MiCA), some having developing/unclear regulatory frameworks (e.g., the US), and some outright banning stablecoins (e.g., China).

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Blockchain

Bitcoin

The Bitcoin network is a decentralized database/distributed ledger composed of a set of computers running Bitcoin Core software called nodes. All nodes follow predetermined, encoded rules to achieve consensus on valid transactions and maintain identical local database copies, which only record information on who paid whom and when.

Special nodes called miners work to solve mining puzzles to propose a block first and earn Bitcoin in the form of a block reward. The network is able to achieve consensus on which valid transactions should be added to the decentralized ledger without a central leader, even in the presence of the possibility of malicious behavior, by selecting winning miners based on predetermined encoded rules and requiring miners to expend energy and computational resources to solve puzzles.

Payments on the Bitcoin network are denominated in Bitcoin, and the Bitcoin supply is capped at 21 million, achieved through approximately halving block rewards every four years.

This architecture—where a set of unrelated nodes follow code-based rules to achieve consensus on valid transactions and locally record valid transactions without a central leader—has led to the realization of key properties such as decentralization, trustlessness, censorship resistance, immutability, permissionlessness, anonymity, and scarcity.

Bitcoin was initially designed as a "peer-to-peer electronic cash system," but due to technical limitations and fixed supply, it is now generally considered a store of value/non-sovereign digital reserve currency.

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Ethereum

In the history of blockchain, transaction types have been limited, typically only hosting single applications such as Bitcoin or Namecoin, forcing developers wishing to create new applications to build entirely new, purpose-built blockchains. Vitalik Buterin conceived Ethereum in 2013, which is a Turing-complete virtual machine capable of handling general code and arbitrary computation without modifying the underlying blockchain itself. As a result, Ethereum nodes not only track payments like Bitcoin but also process code called smart contracts and achieve consensus on the network state. Vitalik likened this to the introduction of the iPhone, with the iPhone serving as a platform for third-party developers to create applications. Additionally, universal 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 also decentralized, trustless, censorship-resistant, immutable, permissionless, open-source, and anonymous.

Previously, Ethereum used a proof-of-work consensus mechanism similar to Bitcoin, but in September 2022, it switched to proof of stake, an effort known as The Merge. Because Ethereum is a decentralized protocol running on thousands of machines globally, it cannot simply stop the network for an upgrade and must upgrade "mid-flight." Therefore, 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 in a smart contract and propose or validate blocks in exchange for rewards roughly proportional to their total network stake. Validators who perform poorly or engage in malicious behavior will lose 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 incentivize proof-of-stake validators to process transactions and secure the network. In return, validators receive rewards issued by the protocol and transaction fees. Gas is priced in gwei (one billionth of an ETH) and is a multi-dimensional resource, with the price of each unit of gas being dynamic and fluctuating based on supply and demand. Gas includes a base fee that fluctuates based on network demand and optional tips (collected by validators). Because the base fee is burned, Ethereum may experience negative net issuance (more burned than created) during high activity, leading to the concept of deflationary ultrasonic money.

In the past, Ethereum prioritized decentralization and security over speed. Ethereum's roadmap includes six phases, such as "The Merge" and "The Surge," aimed at improving these features, with a significant approach being offloading computation to second-layer scaling solutions (i.e., a rollup-centric roadmap). Notable roadmap highlights include single-slot finality, which will substantially reduce the time required for transactions to be considered final, danksharding, which will substantially reduce data availability costs (i.e., proof that data has been provided to recreate the state), and proposer and builder separation, which will separate the roles of block builders and block proposers to mitigate and reallocate some of the negative externalities of MEV.

Ethereum has a rich decentralized application ecosystem, covering areas such as DeFi, NFTs, and DAOs. While other blockchains have optimized for other features such as speed, activity still remains concentrated on Ethereum, especially during bear markets, due to Ethereum's strong network effects.

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