HashKey Capital: 2024 Full Analysis of Web3 Investment Track

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8 months ago

As one of the most active crypto VCs, HashKey Capital regularly analyzes and sorts out various Web3 tracks. On the occasion of the 2024 New Year, we will share our internal track judgments and understanding of "open source" as our contribution to the industry.

The authors of this article include (in alphabetical order): Arnav Pagidyala, Harper Li, Jack Ratkovich, Jeffrey Hu, Junbo Yang, Stanley Wu, Sunny He, Xiao Xiao, Yerui Zhang, Zeqing Guo.

ZK

The ZK track expanded from previous scalability and cross-chain scenarios to more application scenarios in 2023, further differentiating into different tracks.

zkEVM

In the zkEVM aspect, there have been some developments in several aspects such as type0, type1, and type2. In terms of categories, type0 is completely equivalent to Ethereum, but still faces technical challenges such as block speed, deployment, and verification state due to its emphasis on equivalence. Type1 has made improvements and compromises based on the EVM, and currently, the overall application experience and opcode compatibility are most prominent. Type2 and others have already launched their mainnets and are developing their respective application ecosystems.

The specific project situations vary and require analysis based on the development roadmap of each project, such as Polygon's CDK and StarkNet's full-chain games.

zkVM

The main technical route in the zkVM field is zkWASM, which has stronger architectural scalability, so its application direction is to collaborate with exchanges to create high-performance DEX. Major projects in the zkWASM field include Delphinus Labs, ICME, wasm0, etc.

In the RISC V architecture direction, RISC0 is the main exploration project, which is more friendly to front-end languages and back-end hardware compared to WASM. However, potential issues lie in efficiency and proof time. The application scenarios are also expanding, such as Reth simulating the Ethereum execution environment, FHE's operating environment, Bitcoin Rollup, etc.

Another aspect is zkLLVM. Based on this technology, Type-1 zkEVM was recently launched. Using zkLLVM, high-level languages can be quickly compiled into zkSNARK circuits.

ZK Mining

In the ZK Mining field, the efficiency of GPU and FPGA is currently similar, but GPU prices are higher, and FPGA is more like a prototype verification. The ASIC scene may gradually differentiate, for example, with the introduction of special-purpose ASIC chips and the demand for additional FHE.

In addition, there is a noticeable increase in Prover DAO, and computing power is a core competitive advantage. Therefore, mining teams that establish Prover DAO will have a significant competitive edge.

ZK Middleware

ZK middleware can include scenarios such as zkBridge, zkPoS, ZK Coprocessor, zkML, and zk trusted computing. The scenario of ZK Coprocessor is relatively clear, and most projects have reached the testing phase. The zkML track is still quite active, and there is already some differentiation in the progress and competition of various projects. In addition, a new track of ZK proof sharing has emerged (sharing proofs to a network and sharing income after batch processing).

MEV

  • It is important to focus on the early stage of the transaction supply chain, namely the intent stage.
  • The next-generation DEX design and infrastructure improvements to address LVR and enhance LP will attract more capital.
  • The development of private auctions/trading pools could greatly improve the transaction supply chain. The development of FHE, MPC, and ZKPs is worth paying attention to.
  • Currently, most systems use centralized relays, licensed solvers, and require trusted builders. However, we believe that the ultimate goal of the track is to be permissionless to achieve the most competitive market.
  • MEV supply chains will undergo changes in APS, document execution, PEPC, etc.

OFA

Order Flow Auction (OFA) began to rise in 2023. High-value transactions will no longer flow to public trading pools but to OFA, providing users with feedback on the value they create. From RFQ auctions to block space aggregators, there are various OFA implementation schemes to meet various needs for price discovery and execution quality. Looking ahead, it is estimated that more and more ETH transactions will be conducted through OFA.

Blockbuilder

As seen through relayscan, the builder market is concentrated among a few companies, some of which are high-frequency trading companies serving their own trading needs. In the future, with the reduction of CEX/DEX arbitrage volume, the advantage of high-frequency trading may also diminish.

Relay

The relay market faces two fundamental issues: (1) market concentration among a few companies, namely BloXroute and Flashbots; (2) lack of incentive mechanisms for relays.

In the future, we expect to see the rapid development and implementation of optimistic relays and proposals for relay incentives.

AA

The AA (Account Abstraction) track can mainly be divided into two categories: smart contract wallets and modular services.

In the smart contract wallet aspect, companies in the AA wallet track have already established a similar pattern to the entire wallet track. It is becoming increasingly difficult to gain traffic solely based on functionality, and instead, attention should be paid to wallet factory.

In the modular service aspect, Bundler and Paymaster are essential functions that these infrastructure providers must offer, and these two services have become standard services.

Current track trends include:

  • Most infrastructure has been established, and the development is relatively stable. From the data of the entire track, it has entered a phase of rapid growth. The number of user wallets has been increasing since June, with over 6 million Userops and approximately 200K MAU as of November.
  • The development of L2 AA is better than L1, and the EF is considering providing native support for L2.
  • The problem of DApps not supporting AA is still severe, and there are issues with implementing cross-chain and cross-Rollup accounts, requiring new solutions to be proposed.
  • Private mempools will converge with MEV and intent, optimizing user experience.

Intents

After receiving attention this year, Intents has developed rapidly, although it faces issues such as malicious solvers and trust in order flow. However, there are feasible solutions to these issues.

For Intents to develop better, it must consider order flow and user acquisition issues. Therefore, from an architectural and business perspective, Intents are well-suited to be combined with the architectures of MEV and AA. Builders and Searchers are the most suitable roles for matching and solving.

Telegram Bot is likely to evolve towards Intents. Their advantage in order flow gives them considerable bargaining power with builders and SUAVE, a bargaining power that may even exceed that of wallets with larger volumes.

DA

There are not many participants in the DA (Data Availability) track, apart from Ethereum, the main ones include Celestia, Eigenlayer, and Avail, with varying project progress. There is a clear winner-takes-all effect, leaving few opportunities for the rest. The overall valuation level of the DA track has been raised with the launch of Celestia and the rise in prices. However, DA is essentially a B2B business, and the income of DA projects is closely related to the quantity and quality of ecosystem projects.

From the customer's perspective, releasing DA on Ethereum is the safest and most expensive solution. After the protodanksharding, the fees on Ethereum have significantly decreased, so large Rollup projects still choose Ethereum as the DA layer. Currently, customers of DA projects, apart from EigenDA, mainly include Cosmos ecosystem projects, RaaS projects, etc. EigenDA has a unique positioning, indirectly related to Ethereum, and may be able to attract some middle ground customers. Additionally, there are some early DA projects and DA projects targeting specific scenarios, such as Bitcoin DA, which may gain a decent market share in niche areas.

Rollup Frameworks & RaaS

The rollup market is already saturated and awaits new developments. Currently, there are at least 30 RaaS projects supported by VCs and infrastructure providers entering the market. It is necessary to understand which use cases have been successful in RaaS and which interoperability solutions can be effective.

Some L2/L3 frameworks (such as OP Stacks) have received a lot of public goods funding and developer adoption.

Specific applications, such as DePIN, may use custom execution environments to utilize Ethereum rollup.

Additionally, there are many new technologies related to rollup, such as Risc0 Zeth/other projects that can change the way rollup verification states are handled without relying on validators or sync committees. When used with primitives like ZKP and MPC, FHE rollup can provide fully universal privacy DeFi, and more.

Cosmos

In the future, Cosmos Hub will continue to strengthen its position in the ecosystem in various aspects. For example, Partial Security of Stake (PSS) can allow some validators to provide cross-chain shared security (ICS) more flexibly, without requiring all Cosmos Hub validators to join, reducing the pressure on many validators and making it easier to promote. On the other hand, Cosmos Hub plans to enable multi-hop IBC to improve user experience. In terms of protocol implementation, there are plans to add features such as Megablocks and Atomic IBC to provide atomic cross-chain transactions, which can form a unified MEV market, similar to Ethereum's shared sequencer, SUAVE, etc.

In the Cosmos ecosystem, the development route of application chain has been influenced to some extent by L2 and other development frameworks, resulting in a decrease in the number of new projects. However, due to its highly customizable underlying framework, it is flexible and can be customized as the mainstream narrative evolves, finding corresponding modifications for public chain targets.

Security

Projects in the security track have made progress at various levels, including tools and protocols at various levels, such as on-chain detection and interception, on-chain tracking tools, manual auditing and bounty services, development environment tools, various technical methodologies (such as fuzz testing), and more.

Each tool is better suited to detect specific vulnerability categories and has specific methods for checking vulnerabilities in smart contracts (static analysis, symbolic execution, fuzz testing, etc.). However, the combination of tools is still difficult to replace a complete audit.

In addition to the different positioning mentioned above, the dimensions to consider for projects can also include maintenance and update speed, size of vulnerability database, carriers, actual needs of partners, etc.

AI

The current direction of the combination of Crypto and AI mainly includes underlying computing power infrastructure, training based on specific data sources, chat tools, data labeling platforms, etc.

Projects in the underlying computing power infrastructure and computing power network fields have innovations at different points, but are generally in the early stages and need to consider future sustainable business expansion paths beyond creating different types of agents.

The data labeling platform transforms traditional manual labeling businesses into a web3 form, and the ability to obtain orders is crucial. Additionally, because low-threshold data labeling is likely to be easily replaced by AI in the future, there is a need to focus on obtaining more orders around high-value and high-threshold data.

Furthermore, there are many new projects combining AI that are developing To C chat tools, etc.

As a Crypto fund, we will focus more on projects with advantages in ZKML, vertical domain data in the crypto field, or products closely integrated with AI, rather than basic infrastructure such as large language models that we are not good at.

DeFi

One change in 2023 may be that many investors need actual yield products, such as those from LSDfi or RWA, rather than emission-based yields. Additionally, due to the significant regulatory pressure faced by centralized exchanges and the need for assets to find liquidity, DEX has a great opportunity, especially with the possibility of high-performance applications on L2. It is important to focus on DEX opportunities on L2.

On the other hand, projects that enable non-native crypto users (including institutions) to access Web3 yield have huge opportunities. Projects that can abstract on-chain elements and provide a secure environment for non-native crypto users will attract a large amount of capital.

Specifically, according to Messari's report, perpetual DEX fees generated by well-known projects including dYdX, GMX, Drift, and Jupiter account for the highest proportion in various niche tracks.

Liquidity staking continued to grow in 2023. Nearly 22% of ETH is staked out of all ETH, with Lido accounting for around 32% of the ETH staking market share (as of the time of writing). Liquidity staking tokens are still the largest DeFi track, with a TVL of $20 billion.

Gaming & Entertainment

Studio

Studio projects have different characteristics and points of concern based on their own categories, as shown in the table below:

Game Category

Game Projects

Characteristics

Points of Concern

Casual Games

Gameta, Gomble, CoinArcade, Octo

Games with traffic and advertising, generally low-cost narrative, attract users to create wallets and make deposits through the mechanism of small games, cultivate users, and then sell them. Many projects also add arena and party game modes for user battles and user retention.

The small game platform itself should have a mechanism to retain users, such as a membership system or through the form of NFT.

Large-scale Games

Shrapnel, Shoot City, Abyss World, SpaceNation, Nytroverse, Mythical games, Metacene

Mainly focused on PC games, developed by seasoned studios, game categories include first-person shooter, MMORPG, or ARPG; long game development time, development cost above $10M.

This category will focus more on core producers, including track record and whether previous game production is in the same category; and the team needs strong cost control over the entire development budget.

Casual/mid core

Ambrus, InfiniGods, Moonveil, Mugen Interactive, Puffverse

  1. Card games, tower defense, and strategy (SLG) games are the main focus; usually supported on web and mobile, these games are easy to get started with but have a certain level of complexity, providing enough strategy and depth for players who want to delve deeper; 2. Benchmark single product cost budget is around $7M.

Similar requirements for producers, and also need strong cost control.

IP Building

SpaceNation, Aether Games, Pixelmon

Products primarily delivered through games, while also producing other medium forms of content such as movies, TV shows, comics, and animations to better empower the main IP. The business logic here is that some other media forms such as anime may have lower traditional customer acquisition costs but better results.

Games themselves can have many categories, and analysis can correspond to different categories.

AI feature games

AI Arena, Oasis, Sleepless AI

Currently, AI-centric innovations such as AI Arena have relatively single products, and the narrative may be short-term without seeing landing.

It is necessary to see whether AI features are just an added layer to catch the trend or if they provide essential improvements and assistance for products and users.

The overall game track can be summarized into the above categories. The overall game quality and team professionalism have significantly improved compared to the previous cycle. We continue to expect studios to enter web3, with mature experience in developing and operating products, and a continuous pursuit of strong learning abilities and game producers/KOL founders who are sensitive to crypto and the community and willing to speak out. In terms of Web3, because there is a short history of chain games and not much mature experience to draw from, we will focus more on whether the team's ideas and approaches align with Web3 and their learning speed, rather than having rich Web3 experience.

In the future, we will continue to focus on UGC. Currently, web 2 UGC has centralized issues that cannot be resolved. In addition to providing tools for users to create content, UGC should also provide a completely transparent reward mechanism and freedom of asset trading. Decentralization is a good way to solve these issues and can provide additional value. We are optimistic about teams with web2 creator resources, introducing these creators to web3 UGC platforms through transparency and higher returns.

Game UA

Summarizing game UA projects, they all focus on building user profiles, combining on-chain, off-chain, and social dimensions, and are divided into customer acquisition (Carv) and operational strategy (Helika) directions. However, all customer acquisition platforms often face retention challenges, but the value of player data increases with the growth of users. If applications bring about large-scale adoption, game data analysis can capture some of this value.

Extending to game distribution platforms, those that were previously focused on infrastructure and tools have gradually lost competitiveness. Now, the ability to determine whether distribution business can succeed still depends on core game products that can bring in a large number of users.

User/Fan Engagement

Projects mainly involve the entertainment, sports events, and film and television industries. Cooperation with IP holders can generally be divided into direct operation by the IP holder and IP licensing cooperation. IP cooperation places lighter operational pressure on the platform, but its effectiveness depends on how much resources the IP holder provides. Direct operation by the IP holder will require more operational effort, but it can better connect IP events/content with end products and grant users more ancillary rights through NFTs, potentially leading to better fan incentives and feedback. Additionally, through tracking and observation, it has been found that platforms with a certain existing community base (such as Karate combat) find it easier to successfully engage fans towards IP direction than starting from scratch with a completely IP-based fan group. Next, we will focus on targets with high IP value, users/audiences/fan groups that overlap with gaming/betting profiles, and direct cooperation with IP.

Institutional Service

The institutional service track can be mainly divided into the following sub-tracks:

  • Trading/Brokerage Services: Including exchanges, liquidity providers, brokers/traders, clearing/settlement, etc.
  • Asset Management: Including fund management, high-frequency trading, arbitrage, custody, etc.
  • Banking/Payment: Including payment processors/deposits/withdrawals, issuing cards, and banking-related services, etc.
  • Other Services: Including trading technology providers, etc.

The overall trend of this track includes:

  • The institutional service track is expected to continue stable growth in the coming years.

  • Compliance is an important trend in the institutional service track, and companies are actively engaged in compliance construction.

  • The responsibilities of various service providers are becoming increasingly clear, with each participant in the track focusing on their core responsibilities, mutual balance, and supervision in the segmented areas, which is conducive to a more honest and efficient market operation.

  • The market share of PB service companies is expected to gradually increase. It is worth continuing to pay attention to companies that are mature in traditional fields but still blank in the crypto field (ECNs, fully regulated clearing house, cross-margin capabilities).

  • During the ETF application window, native crypto service companies will face challenges from traditional financial companies, and the demand for compliant-level products will further increase, reshaping the market landscape.

  • Europe is a hotspot for the development of the institutional service track, and emerging markets such as South America also have certain potential.

Bitcoin

Although Bitcoin has recently received attention due to Taproot, the on-chain of Bitcoin is not a globally shared state, and its entire approach (state, accounts, computational model) is quite different from Ethereum. Therefore, in the medium to long term, the construction of Bitcoin infrastructure and applications needs to be approached differently.

On this basis, it is worth paying attention to Taproot Assets, Rollup, Lightning Network, etc. Additionally, new technology routes such as Statechain are also worth tracking.

Sidechains

Sidechain technology routes, including Stacks, have long dominated the mainstream narrative of Bitcoin's second-layer network because of their relatively small technical burden (can be implemented directly off-chain) and high programmability, making it easy to achieve good ecological effects. However, they will mainly depend on cross-chain and anchoring to the main chain, and may be attracted by other new technology routes that bring more traffic and attention.

Layer2

Many so-called Bitcoin Layer2 projects currently still resemble a sidechain form from the core technical principles, but have built a complete framework for execution, settlement, verification/challenge, and DA based on Ethereum's technical model. The differences in current Bitcoin Layer2 projects mainly lie in the different technology stacks chosen at various levels, such as the use of Cosmos SDK, OP Stack, Polygon zkEVM, Taiko, etc. for the execution layer; there are already some third-party projects implementing the DA layer, and there are also self-implementations. Additionally, there is usually a "account abstraction" layer or integration of multi-chain wallets to simultaneously support Ethereum and Bitcoin address formats for user convenience.

Client Verification

Client verification technologies, including RGB and Taproot Assets, can achieve asset issuance and trading functions with minimal on-chain footprint, and are worth continued attention.

Lightning Network

Lightning Labs plans to launch stablecoins and other assets on Taproot Assets next year. In addition, the promotion of native asset income products such as LSP (Liquidity Service Provider) is also worth looking forward to.

BRC20 Type

BRC20 assets heavily rely on specific infrastructure such as indexers, and it is worth paying attention to this part of the infrastructure and new asset types such as ARC20, but the technical implementation risks need to be considered.

DLC

Although DLC was proposed early, it has been difficult to promote due to limited demand. With the large-scale expansion of the ecosystem, the application of DLC technology may become more popular, especially after cooperating with some oracles. However, attention should be paid to the centralization risks introduced in the process of implementing DLC.

DePIN

DePIN is a track that is easily scalable in a bull market. Similar to games, DePIN is also a track that can easily convert traditional users, and therefore has received industry attention. DePIN has several key elements: 1) decentralization and gameplay/mechanism, which can be said to be the lifeblood of DePIN, and investment in DePIN projects needs to first consider the mechanism. 2) timing, good mechanisms need to be matched with good timing. Projects launched early in the bull market will undoubtedly find it easier to acquire customers early, so the team needs to be sensitive to the Web3 market. 3) industry fundamentals, the type of hardware chosen by the project and the user characteristics it targets may determine the success or failure of the project. The following is a classification based on hardware types:

Focus on ToC scenarios, as well as markets where similar hardware is not yet popular, revolutionary changes may occur: For hardware that is frequently used in ToC scenarios (such as wearable devices), Web3's gameplay and mechanisms actually provide project parties with a better and more efficient product crowdfunding channel, reducing barriers for both users and merchants. In the world of DePIN, because there are clear token incentives, users will have a stronger motivation to purchase hardware (quick return on investment), and merchants can even presell before production. With flexible cash flow, merchants can focus on fundamentals later, such as enriching the software ecosystem, collaborating with other hardware, and empowering tokens in the ecosystem. Especially for underdeveloped areas, without DePIN, they may never purchase certain hardware, but early participation in mining speculation may lead to large-scale real hardware popularization.

Caution in improving hardware: For ToC placement or low-frequency but essential hardware (such as routers), with a large user base and ownership, DePIN can be an opportunity to improve the user experience. In theory, DePIN reallocates resources and demands between suppliers and users, redistributing costs and income to form a more reasonable unit economic benefit, making services cheaper for users. However, there are also challenges: 1) whether it can technically achieve decentralization better than centralized solutions, such as many decentralized computing or storage solutions, which may be more expensive and less efficient than centralized solutions; 2) whether it infringes on the interests of centralized giants commercially. The large user base and ownership mean that there are many major players in this direction, with years of user, brand, and financial accumulation. If the DePIN solution cannot make a revolutionary breakthrough in fundamentals, or cannot unite forces beyond the influence of major brands, it is actually difficult to compete with web2 competitors.

Wait and see the unique mining machine direction: For other low-frequency usage, and even hardware that is optional in daily life, or specifically purchased for mining, DePIN may bring short-term returns, but may not necessarily create user stickiness. It is not ruled out that DePIN may really cultivate new user habits, but there is a certain degree of randomness and it is difficult to predict. Specific projects need to be analyzed on a case-by-case basis.

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