After the euphoria of 2021, and the soul-destroying bear market of 2022, you could be forgiven for thinking it was time for the crypto space to take a breather. But while crypto might – perhaps – stay out of the spotlight after the emotional rollercoaster of the past two years, it will do anything but stand still. Rain or shine, bull or bear, progress in the blockchain sector is relentless, and the problems and mistakes of the recent past have shown exactly where we need to do the work. With that in mind, here are seven major themes to watch out for in 2023.

1. The Cycle Turns

Nothing lasts forever, even if it seems like it at the time. The jury is still out whether we have seen the bottom for bitcoin, with influential traders split on the odds of seeing new lows. But even if we do (which seems less likely with every passing week), sooner or later confidence will return to the markets and the sector as a whole.

Partly it’s just about giving things time. FTX is still fresh in too many memories, and too many holders have been burned. The court cases may take months or years to play out. But we know from past experience that crypto falls in and out of favour, with bubbles and bear markets in 2013/14, 2017/18, and now 2021/22.

This time, we also have a tough macroeconomic environment to contend with. But again, the worst may be behind us. The Fed is almost at the end of its tightening cycle, and while there may be more pain ahead, interest rates are reaching their peak and inflation may – just possibly – be coming back under control. Neither institutions nor retail traders have lost sight of crypto; they’re just waiting for the right time to make their moves, if they haven’t already.

After the bear market ends, there’s typically a period of consolidation, when interest is muted. But slowly, as new services and features launch, new users dip their toes in the water, and this time they benefit from all the work that was done in the intervening years. And the new cycle begins.

2. Regulation Is Inevitable

The 2022 bear market failed to kill crypto, but it did force change. Lawmakers finally realised that crypto is too big and important to ignore. The losses from failed organisations including Terra, FTX, Celsius and many others were simply too large, with many billions of dollars of consumers’ money vanishing overnight.

The result will be greater regulation around crypto companies and projects – particularly where those organisations handle customers’ money, like FTX. Expect exchanges to bear the brunt of the new rules, designed to ensure – quite reasonably – that companies cannot take their users’ cash and speculate with it themselves. Financial institutions like banks have to meet strict standards about the way their customers’ funds are held and used, and crypto businesses will probably be required to meet the same obligations.

Centralised exchanges are already pre-empting these rules by establishing their own proof-of-reserve standards, seeking to reassure users that they really do hold all the crypto they should and have not spent it or lent it out without permission.

More broadly, there are questions around preventing fraud and money laundering; how stablecoins and stablecoin issuers should be regulated (especially following the collapse of TerraUST); whether crypto should be banned outright, embraced with open arms, or dealt with at somewhere on the spectrum between the two; and how to regulate new technologies in a way that achieves the necessary ends without stifling innovation and pushing companies into different jurisdictions.

In many cases, customers will probably not notice much of a difference day-to-day (unless they happen to actually read those terms and conditions). Exchanges and other crypto services, though, can expect far greater scrutiny.

3. L2s Come Of Age

Ever since 2017, when CryptoKitties brought the blockchain to a standstill, it was clear that we needed some kind of a scaling solution for Ethereum.

After years of research and development, multiple different platforms have been rolled out, with several gaining significant traction. These have taken the pressure off Ethereum mainnet, processing millions of transactions every day, with dramatically lower gas fees. These platforms take different approaches and use different technologies, including:

• Sidechains (e.g. Polygon). These are effectively different chains with their own sets of validator nodes. They are fast and low-cost, but lack the security guarantees of Ethereum mainnet.
• Hybrid L1/L2 solutions like SKALE use additional networks of validating nodes for speed and throughput, but are built on and ultimately secured by Ethereum, offering the best of both worlds.
• Optimistic Rollups (Optimism, Arbitrum) bundle hundreds of transactions and submit them to Ethereum mainnet together. The transactions are assumed to be valid (hence ‘optimistic’), but there’s a lengthy interval for disputes to make absolutely sure, which means withdrawals back to mainnet are subject to a long delay.

The holy grail is for an L2 solution that is fast, private, computationally cheap, and that pushes transactions to mainnet and is secured by it. Zero-Knowledge (ZK) rollups are now emerging as the ideal L2 technology. Use of zero-knowledge proofs (a branch of cryptography) means that transactions are known to be valid without any delays being required, avoiding one of the big problems of optimistic rollups.

ZK rollups are more complicated than optimistic rollups, and development has been slower, but the first full ZK solutions are now launching. Expect ZK-based scaling platforms to gain significant traction in 2023, and potentially dominate the L2 space.

4. Interchain Gains Ground

The proliferation of new blockchains and L2 chains was a solution to Ethereum’s scalability that created a problem of its own. Without efficient pathways between these new chains, liquidity is siloed and locked into a single ecosystem. Much as each blockchain’s advocates believe their chain is the future, most recognise the value of links between chains to on- and off-ramp tokens, and share collateral and opportunities.

And so the rise of new chains has also created a role for bridges between chains. Unfortunately, these have proven to be one of the least secure elements of the crypto ecosystem. Blockchains themselves tend to be extremely secure. Sadly, bridges are generally complex pieces of software, with huge attack surfaces and many vulnerabilities. That can be compounded by poor security practices. Sky Mavis, developers of Axie Infinity, held four of the nine multi-sig keys that controlled the bridge between Ethereum and their Ronin sidechain. When an attacker compromised their server and was also able to gain access to a fifth key (due to permissions that should have been revoked that weren’t), the system was effectively completely centralised – enabling a hacker to steal over $600 million in crypto. Overall, 2022 saw the better part of $2 billion stolen in bridge hacks.

For blockchains to become truly, seamlessly interoperable, we need better solutions for moving tokens around the ecosystem. What’s more, bridges will need to be capable of doing more than transporting assets. Ultimately, it will be possible to execute cross-chain contracts, and access opportunities from across multiple chains frictionlessly – without the user even needing to know which chains are involved. The rise of Layer 0 chains aims to address the problems of conducting interchain transactions by providing a common base layer for many L1 chains, though it’s unclear how existing platforms like Ethereum will fit into this scheme.

5. AI Brings Smarter Blockchains

AI and blockchain have been two break-out technologies of the past year, and so it’s only natural that they should be combined to provide new and more powerful solutions.

AI is actually already routinely used in the DeFi world, with The Graph (known as the “Google of blockchains”) making data readily accessible and searchable to dozens of popular dApps. Beyond that, blockchain AI apps like Fetch.AI, Numerai, SingularityNET and others are enabling developers to build dApps that integrate AI functionality easily. Some of the use cases these platforms are driving include improving supply chain management, optimising trading strategies (there is even a hedge fund powered by crowd-sourced information and machine learning), and delivering more reliable code audits.

Blockchain and AI have both separately generated plenty of hype; 2023 will see many more projects that integrate both.

6. NFTs Gain Utility

2021 and 2022 saw an explosion in NFT trading. While naysayers couldn’t understand why JPEGs were changing hands for millions of dollars and wrote off the idea as a fad, the reality should now have sunk in. The bear market didn’t kill NFTs. In fact, they’re coming out strong as a killer use case for blockchain.

While NFTs gained popularity as a means of trading digital art, they’re becoming so much more than that. They have organically evolved from that early foundation as new projects have arisen, offering new functionality. NFTs are now about identity, community, and access to permissioned services – and that’s just for starters.

The proof of this lies in the way that users have taken to displaying popular NFTs as PFPs across social media. These NFTs signal that their owners are members of a particular community, or even an elite subset of it (if they happen to own a “rare”), which typically also gives them access to premium features within the project’s Discord. Holders will typically enjoy a privileged position that entails closer access to the team and other key members of the community, with some influence over the way the project develops. In addition, the NFTs may act as characters within a game or metaverse. They may even generate revenues.

As 2023 progresses, NFTs will further consolidate their role as a critical Web3 technology, adding further utility as they become the keys to blockchain services of all kinds.

7. CeFi And DeFi Reach An Understanding

For those who have been around in the crypto world long enough to remember, 2022 bore unpleasant similarities to 2014.

2014 saw the collapse of Mt Gox, the largest bitcoin exchange in the world, with the loss of 650,000 BTC, then worth almost half a billion dollars. Users who saw soaring crypto prices wanted to jump in, but were unwilling to custody their own coins, so held them on the exchange. Incompetence, dishonesty and poor security led to Gox closing for good in February, catalysing a lengthy and painful bear market.

2022 brought the demise of FTX, with the loss of many billions of dollars of customers’ money, this time in many different cryptos and stablecoins. Once again, many users had held coins on the exchange out of convenience – but lost them due to the single point of failure this imposed. Similarly, “CeDeFi” apps BlockFi and Celsius provided centralised access to DeFi opportunities, but also brought unacceptable risks.

2023 will see a clearer separation of CeFi and DeFi services, with greater awareness about the risks and responsibilities, advantages and disadvantages of each. Centralised organisations are already taking their obligations more seriously (not least due to the threat of incoming regulation, and increased scrutiny from both lawmakers and the community). One of the ways this is happening is through new industry standards for exchanges’ proof-of-reserves, bringing a greater degree of transparency to centralised exchanges.

In short, the boundaries between decentralised technologies and the centralised companies that provided access to them had become overly blurred. While centralised crypto companies clearly have an important role to play, it is necessarily a limited one, since otherwise they simply reintroduce the catastrophic single points of failure that blockchain was designed to eliminate.

Conclusion

It’s been a tough year, but – as in all previous bear markets – developers have continued to build, dApps and services have been refined, regulation is being hammered out, scams and weak projects have been flushed out of the space, and the strongest use cases have emerged victorious. Whatever the coming year holds, crypto will reach the end of 2023 in a better position than it went into it.