Original author: Jiawei, IOSG Ventures

Before you know it, 2023 is about to enter the fourth quarter.

Generally speaking, the primary market has been relatively dull recently, with projects repackaging old wine in new bottles accounting for the majority.

Judging from valuation alone, the popularity remains unabated. This article is intended to share some personal views based on recent primary market observations on the infrastructure track.

Transaction life cycle

Depending on the life cycle of the transaction, some infrastructure projects can be divided into the following categories:

Validator

• Validator can be divided into Solo Staker, Staking Service Provider, CEX Staking and Liquid Staking, or it can be divided into two categories: crypto native (Lido) and compliance (Liquid Collective).

• The current pledge rate of Ethereum is about 22%. The author estimates that there will still be room for growth of about 15% in the next one to two years, and there is a high probability that this part of the incremental market will flow in from traditional institutions as a means of asset allocation. Ethereum staking exposure held by traditional institutions helps consolidate and diversify the Ethereum validator set.

• Most hosting service providers (such as Fireblocks and BitGo) cooperate with Staking Service Providers to provide customized, one-stop Yield Aggregation services; at the same time, most wallets, especially hardware wallets, also provide entrances to Staking. This type of cooperation belongs to the Distribution Partnership on the Staking side, which has a greater degree of freedom. Even competitors can cooperate with each other and provide support. Among them, as a Staking solution provider, you will get about 10% -30% of the profit, and the end that provides user traffic will get more profit sharing.

• Currently, the Ethereum staking market is dynamic due to events (such as the SEC’s blockade of Kraken’s staking business in the United States), price war orientation (reducing staking service fees), and target customer differentiation (encryption-native and compliance). competitive landscape. The author believes that the compliance market will be a battleground for military strategists in the future. In terms of geography, with the tightening of regulations on cryptocurrency in the United States, most Staking services are seeking a way out in the Asia-Pacific region. Asia-Pacific and the Middle East are new growth points for the Staking business.

Builder

• Builders integrate Orderflow resources through various channels and bid against each other in auctions to win block space. From a reverse perspective, what Builder does is wholesale block space from Proposer, split it up and sell it to Searcher, acting as a middleman to earn part of the price difference. Builders core competencies mainly include two points: Orderflow and Infrastructure.

• The former is the most basic production material for Block Building. The more Orderflows you get, the more opportunities you have to express MEV. If the Builder cannot control enough order flow, no matter how good the strategy is, it will be difficult for a craftsman to build a meal without rice, and it will be almost uncompetitive in the market.

• The latter can also be said to be Simulation Capability, which means that incoming transactions need to be continuously simulated and executed and bids updated. At the same time, it is also necessary to observe the opponents bids and make corresponding updates. This process is accurate to the millisecond level, and the Builder may update hundreds of bids in a slot of just 12 seconds.

• Builders also need to provide appropriate subsidy (i.e., money-burning subsidies) to help themselves win or maintain market share. Roughly speaking, the market share of Block Building can be understood as the Execution/Inclusion Guarantee, that is, when the Searcher hands you a Bundle, you can ensure the probability that this Bundle will be included in the next block. Because it is directly related to its profit and loss, Searcher has high guarantee requirements for Execution. Therefore, subsidies are regarded as a means of Marketing. The difference in Bid between Builders may be very small, so the subsidy for each Slot does not need to be too much. In this competitive environment, how to wisely choose whether to subsidize or not, and how much to subsidize, is also a game.

• Since the gradual adoption of MEV-Boost after The Merge, Builders competitive landscape has experienced several changes. Based on the advantages and experience accumulation of Orderflow and Infrastructure, the head Builder can form a monopoly position, and this monopoly position is difficult to shake. Overall, the author believes that Builders have presented a winner-take-all situation, with the top four Builders occupying 85% of the market. Judging from the business model, its profits are relatively slim, and its stability and sustainability are uncertain. It is difficult for builders in the midstream or downstream to obtain sustainable and sufficient economic incentives, and they may eventually have to give up competition, which further strengthens the dominance of upstream builders. (What is discussed here is Neutral Builder. If it is Searcher-Builder Entity, the situation will be better, but because it involves arbitrage between CEX-DEX, the profit situation is difficult to estimate.)

User and wallet side

• OFA (Orderflow Auction). OFA means that the user or wallet sends the order to OFA and provides part of the order information for the buyer to judge the value of the order, and the buyer chooses whether to participate in the auction based on the bid. The final bid is sent back to the user or wallet as a kickback. Currently there are two main products: MEV-Share and MEV Blocker. To date, the latter has returned approximately 443 ETH in rebates to approximately 320,000 users.

• OFA is generally a good thing for users (although a recent Blocknative article noted that OFA leads to greater slippage and slower execution speeds) because the value generated by their order flow is reflected in the network, Received rebates that were not available before; at the same time, false starts and sandwich attacks were avoided. Moreover, wallets can also use order flow as a means of monetizing traffic. On the other hand, OFA, as a new channel for Searchers and Builders to obtain Orderflow, provides some diversified choices. However, if more users and wallets adopt OFA instead of sending transactions to the public memory pool, it means that the cost of obtaining Orderflow becomes higher, squeezing profits upstream of the supply chain.

• Intent is a concept with a wide span in the transaction life cycle. Intents can be seen as a paradigm shift in blockchain transactions.

• In traditional trading methods, users specify the path. Its like inviting someone to a meal. I choose a restaurant and specify what each dish is, how to pair the meat and vegetables, etc. The core of Intent is to put forward the demand, how much you are willing to pay for this demand, conduct bidding, and finally select the best candidates. I can set a per capita consumption of 500 and let different restaurants arrange it. In the end, I will choose the best plan. Where demand is equally met, competition will be reflected in price. The restaurant conducts reverse bidding, which reduces the users cost.

• The author believes that Intent is an important investment direction. Mainly based on three reasons: First, transactions are the basic form of self-expression for entities on the chain, and Intent has achieved a paradigm shift on this basis; Second, this field is relatively early, including projects and developers including Flashbots and Essential , the community is still in the exploratory stage, and the pattern is undecided; third, Intent is relatively complex, and the design space including technical architecture and economic incentives is relatively broad. Different solutions may be very different, and it is impossible to make a premature conclusion as to who will be the winner.

• Even so, I believe that for a long period of time, there will still be an intermediate state where the two transaction paradigms, traditional transactions and Intent, coexist. The idea of ​​Intent-centric seems premature.

In summary, by dividing according to the transaction life cycle, we can see the trend of infrastructure exploration to the upstream of the transaction life cycle. In this process, the degree of specialization and refinement is significantly improved, while constantly introducing competition diversity and ensuring competitive conditions. balanced.

Rollup-centric roadmap

Vitalik proposed a Rollup-centric Roadmap in October 2020, which means that Ethereum needs to provide centralized support for Rollup in the short to medium term. First, the expansion of the Ethereum base layer will focus on expanding the data capacity of the block to provide more space for data availability, which will subsequently be reflected in the introduction of data sharding and EIP-4844. Second, Ethereum’s infrastructure is adjusted to support Rollup (such as ENS’ L2 support, wallet L2 integration and seamless cross-L2 asset transfer).

Judging from the current vigorous development of various modular components, we already have the prototype of the Rollup-centric Roadmap vision. Under this architecture, Ethereum gradually takes a back seat, offloading the burden of the execution layer and becoming a sufficiently secure settlement layer and data availability layer. The general Rollup is mainly responsible for the task of expansion, carrying most of the applications and user traffic, and further realizing support for dedicated execution environments for privacy, games and other applications through L3 (ie Fractal Scaling). RaaS provides developers with the tools to quickly launch infrastructure. Restaking leverages existing Ethereum staking exposure to provide economic trust, decentralized trust, and Ethereum Alignment for new modular components. As the utility of ETH continues to expand, these components are also strengthening Ethereums status as a base layer and providing value feedback.

Monolithization and modularization have always been a topic of debate. When the system reaches a certain level of complexity, modularization is usually a proven choice. For example, a car is a typical modular product. As an engineering design principle, modularization has the advantages of standardized interfaces, independence, reusability, and flexibility.

Infrastructure projects are still narrative-driven and problem-solving driven, and their business models alone cannot support huge valuations. In this modular context, competition between modular projects is increasingly leaning towards BD Game. The low market sentiment in the bear market has amplified the importance of BD and tested the project sides operations, marketing, and brand building capabilities. Needless to say, Rollup and DA projects require users and customers. The premise for Sequencer to achieve network effects is that the adopter has enough value to be captured. RaaS is not a new story. Substrate implemented one-click chain publishing in 2019. The tool itself comes second. The key lies in what kind of applications the developers using the tool can create. Only then can we talk about value feedback. In terms of Shared Security projects, the growth of EigenLayer and Babylon also relies on the demand side to provide sufficient economic incentives and sustainability. Copying a DEX or similar application on each Rollup cannot be called an ecosystem, but requires Friend.tech to create differentiated products.

From the current point of view, Ethereum and its L2 ecosystem still occupy a dominant position. More mainstream applications, a more solid user base, and long-term tested security are all continuously strengthening the moat of this ecosystem. As L1, Celo has also recently switched to Ethereum L2 and is supported by Restaking. After the narrative of Alt-L1 gradually declined and the volume of the application chain narrative was gradually replaced by App-Rollup, the new project had to answer the question of whether it is attached to Ethereum. For example, although Celestia dominates the narrative of modular blockchain, it has no direct connection with Ethereum itself. As a general DA layer, from a large perspective, Celestia faces competition from Ethereum and, at the same level, competition from EigenDA based on Restaking. Under this mental model of project categorization, orthodoxy seems to dominate people’s macro judgments about projects. But in any case, when it comes to investment logic, it mainly depends on whether it solves actual problems instead of creating demand out of thin air; whether it proactively speaks out to the outside world instead of working behind closed doors.