January 20, 2022

Infrastructure Lego: The Middleware Thesis

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*originally published on Deribit

The DeFi trend has turned into a frenzy followed by the user-focused trends like NFTs. While we speculate on cryptopunks and chase astronomic yields, Ethereum is hitting its scaling limits and alternative chains are trying to catch up. We are being eaten by MEV and short term speculation propelled by successful DeFi projects and their cheap knockoffs.

The last cycle of 2017 was in the name of big picture topics such as the fat protocol thesis and role of Bitcoin as a replacement for hard money. We think that the current cycle is much more micro-oriented as we have become too zoomed in, focusing on microdetails of financial applications.

_2016 – Joel Monegro breaks the ground with his Fat Protocol Thesis, starting the frenzy of smart contract layers

2021 – All eyes on Tarun Chitra and his granular math-driven papers about every conceivable detail of CFMMs_

Both macro and micro focus are important, but the swing of the pendulum from macro to micro looks like an overcompensation. That is why we would propose to connect the macro with the micro – and look for the middle(ware) ground.

For about a year, we at Zee Prime have been asking: What are the underlying technologies that can improve and scale DeFi and Web3? What is the most impactful crypto vertical to invest in now? Our conclusion is that now is the time we need to improve the infrastructure.

We are not calling for an “infrastructure phase”, it’s a myth, as USV famously put it. But we believe that DeFi applications have run ahead of the infrastructure, and now infrastructure needs to catch up.

We are at the point where end user apps (DeFi farms) jumped too far ahead and now infrastructure needs to catch up with end user demand (scalability issues, bad UX etc). Source: USV

The need for better infrastructure is obvious from high gas fees and failed transactions pricing out non-whale users out of “Crypto Manhattan”. But the real threat is much more subtle. Even if we accept the fees as a premium for true censorship resistance, what are we really paying for when the majority of dapps run on centralized infrastructure that can rug us any moment? Is the Emperor naked?

DeFi rocks and will spearhead the overfinancialization movement of the next decade. But we miss what connects the niche application and the former bigger picture. We believe we need to improve the underlying tech if we aim to move forward without compromising some of the core values of crypto movement. The money legos should be powered by the infrastructure legos.

What is middleware?

Red Hat, provider of open source software products, gives a following general definition:

Middleware is software that provides common services and capabilities to applications outside of what’s offered by the operating system. Data management, application services, messaging, authentication, and API management are all commonly handled by middleware. Middleware helps developers build applications more efficiently. It acts like the connective tissue between applications, data, and users.

This is exactly what crypto lacks nowadays – a strong glue, made from the same principles as the rest of crypto. Something that enables the existing operating system of blockchains to graduate to the next level.

The problems are not on the base layer or the application level. Most problems come from the friction in between; the moment you press the button in the app expecting an actual on-chain action. Think of those dreaded “out of gas” messages or the tx not appearing instantly on Etherscan because a node is out of sync somewhere or the tx not showing an instant success screen because it’s pending.

Crypto middleware projects have a great opportunity to integrate via aligning economic incentives, for example by inserting a token. Assuming that the service provided is valuable, this value that is generated gets channeled into a token-based incentive mechanism. The Web3 infrastructure of the future might be an intricate 3D system spanning different token-powered networks.

Currently we are limited by defining the underlying infrastructure, or “the stack”, in layers. We talk about L1 and L2. The future stack will not be limited to two layers. The future is a flexible stack of many different lego blocks.

We refer to these blocks as middleware each providing a micro-service for the actual end-user use case. Welcome to composable infrastructure legos.

Middleware eats crypto from the inside out

We talked about middleware in the context of general software development, but what exactly is middleware for crypto?

The term middleware ecompasses all of the services your dapp requires about which most users have no idea. A bit like a dapp for dapps. One example might be the oracle, which is a plug-in solutions that enables feeding application data they need. More exotic examples would include Blockswap.network tokenizing validators and their cashflow on different PoS networks.

In order for Blockswap to build a reliable product it needs on-chain data. For this it could in turn rely on Pocket Network as a decentralized source of data. And on top of that, Blockswap’s product can be integrated into different Dapps that e.g. offer yield.

So middleware means all these solutions that do not have to be consumer-facing as they integrated into dapps – basically the B2B side of the crypto economy. If you have imagined that a sophisticated application is just a bunch of “smart contracts + blockchain” you need to update your vision.

This is just a simplified example of a tech stack including “middleware”.

The Chainlink craze is just a sign of what is yet to come once the market realizes the need for critical infrastructure components that allow for actual use cases to exist. Oracles have been the first major wave, now others will follow.

To better understand the future of middleware one should take into account that it is unlikely that Web3 will become a monolithic technology. “The Internet of Blockchains” will not be exclusive to either Ethereum, Polkadot or Cosmos.

Web3 can be a product of spontaneous emergence rather than a top-down design. We imagine various bits of software loosely tied together creating Web3 bottom-up. The future is flexible. The future is pluggable and composable stuff. Middleware enables the existence of the infrastructure lego that powers Web3.

The decentralized internet will not be built top-down nor bottom-up, but it will emerge connected from the middle. At Zee Prime we believe that the future of Web3 will be tied together with middleware.

To better illustrate the case for crypto middleware we will discuss Pocket Network in a greater detail below. Disclaimer: Zee Prime owns POKT tokens and this is not investment advice.

Case study: Pocket Network

One of the universal middleware services that dapps require is Pocket Network.

Pocket (or Pokt(1)) is a decentralized blockchain network that matches developers and applications on the demand side with operators of blockchain full nodes on the supply side.

The goal of Pokt is to create a blockchain agnostic marketplace for data by creating incentives to become a blockchain data vendor by running full nodes. This nice little incentive cycle has a positive outcome of securing decentralized infrastructure while having accessible on-chain data.

All the different dApps, analytic tools, wallets, investors, exchanges etc. need data from blockchains. These data include historical or current balances of addresses, smart contract event logs, slashing and much more.

Customers get data by sending API requests, or relays (in Pokt parlance), to Pokt Network, which will route the request to a random operator of a full node (of that specific blockchain which data is being requested). Pokt slashes node operators who do not provide correct data and also didn’t withhold any.

In order to get access to desired data, customers stake a respective amount of POKT. This novel “single-stake-for-a-service” design enables paying gradually through dilution. Pokt is defining a new way of paying for plug & play Web3 solutions using tokens.

Pokt is a key middleware that will span different chains. As we’re heading further into a transition of finance from centralized to decentralized, the actual underlying infrastructure has to remain decentralized. We believe that Pokt can enable exactly that.

The financial institutions of the future will resemble a technology provider. E.g. they will run nodes that support the underlying infrastructure. Thus, the financial system of the future is more emergent, bottom-up, rather than imposed by central authority. Pokt is selling Decentralization-as-a-Service (Daas) to key players in the financial infrastructure of the future.

The Ethereum base layer is the only part of the stack that is actually decentralized. The networking, DNS, storage and client layers are not yet decentralized. Pokt makes the networking layer of applications we (want to) use every day truly censorship-resistant.

Pokt takes a unique approach to solving the problem of on-chain data availability and censorship resistance of blockchains and challenges competitors with centralized architecture.

In Pokt, the work is spread amongst nodes in groups of 5, enabling collective economies of scale without the necessity for beefy machines. The main problem with some other decentralized alternatives is that the work isn’t shared among nodes, and each individual data provider needs to have massive backups.

Pokt has come up with a solution that is efficient because it’s decentralized.

Source: Link

To truly put the “De” into the DeFi and enable the Web3 thesis to technologically unfold we need a fully working decentralized stack (e.g. ETH > SIA > HNS/ENS > POKT) with tools that make these things easier to build on (e.g. WEB3API).

“Decentralized” vs decentralized

One of the most important and underrated perks of blockchains is redundancy. In today’s over-optimized economy redundancy is not seen as a quality. However, if we are building a new financial system we should steer away from over-optimization. A layer of redundancy is a protection and a security feature.

Bitcoin is built on incentivizing redundancy. Bitcoin’s redundancy is a quality that secures the network. Pokt too incentivizes redundancy by making node-running profitable.

But not only that. This proliferation of node operators will, by design, make the data cheaper as well. Pokt solved the difficult problem of guaranteeing redundancy at a macro level while removing the need for it at an individual node runner level.

Pokt is built on its users hosting full nodes of various blockchains getting paid by POKT. Every relay of data mints POKT tokens, which are paid to the node operators performing these relays(2).

We need a service that provides a scalable infrastructure when people are aping into projects and constantly refreshing their balances. Each refresh is multiple data requests. The actual usage generates massive amounts of data and value. Pokt is positioned to capture the value created on the application layer by relaying all of this data through a trustless protocol.

By removing the need for a centralized entity to coordinate full nodes, Pokt reduces the underlying infrastructure costs compared to dApps running it themselves. It is a solution uniquely enabled through a native, cryptoeconomic design and collective economies of scale.

Pokt matters because current Web3 infrastructure is expensive, it infringes on user privacy and is ultimately centralized. It is expensive because regular full nodes are not optimized for efficiency in querying data, they are optimized for resiliency in p2p networks. We need a native Web3 solution to optimize costs.

The current infrastructure does not guarantee privacy because the centralized infra-providers keep every piece of metadata for requests that go through them, meaning that the whole system ultimately is not censorship resistant. Pokt completely removes this and that is why it is an important middleware component.

Certainly, there is a more cynical take at Web3 especially during the times of BSC gaining momentum. Are centralized services like BSC here to replace decentralization? BSC style networks can be thought of as a kind of “wrapped” blockchains(3). One can experience the hint of decentralization from the comfort of a centralized exchange.

Every application needs scalable infrastructure, and Pokt provides a cheaper, more private, and censorship-resistant alternative. Just imagine what happens if the government authority orders a centralized node provider to stop servicing the e.g. the next decentralized Twitter, or unilaterally decides to increase prices, just because they can.

Pokt has already proven its reliability and the importance of this feature during the Infura outage in early November 2020.

Pokt is one interface to access many chains. Think about it as a Uniswap for blockchain infrastructure. In the next year or two there will be abstraction layers built on Pokt that allow for developers to more easily build on many chains at once.

E.g. Currently a “send tx” is different on BTC vs ETH vs DOT. One needs to construct 3 different “send tx’s” with each SDK within their application to do a cross chain application. Imagine abstracting every read and write to the point where you just need to construct one type of tx and point to the chain that will be going to.This could be built on Pokt.

The Economics of Pokt

By this point, we established that middleware can create a lot of value for applications, node operators and protocols themselves. But as investors, we also have to ask: can a middleware create a moat, and if yes, how? Can we profitably invest in a middleware solution like Pokt?

Using or buying POKT (token) at this stage is an actual bet on growth of demand for blockchain data. The service Pokt offers will be commoditized at maturity. Even at this stage price matters and Pokt wants to provide the best service in a decentralized manner at best prices. Creating moats in a commodity market is difficult.

Besides cheap data, Pokt’s defensibility will also rely on network effects and a brand just like Uniswap or Ethereum. We could also argue that Ethereum’s state-transition service could be eventually commoditized, but we have not yet reached maturity to see this assumption play out. Decentralized blockchain data providers will one day likely become a hot market.

Web3 token models seem to inherently include monetary premium and tribe loyalty. In a way, they all rely on positive cryptoeconomic flywheel. And so does POKT. As more nodes operators will join and more developers will build killer applications using decentralized blockchain data, the demand for POKT is expected to grow.

When Pokt becomes more liquid the cryptoeconomic flywheel will become more fluid and some speculators will be converted to users. The opposite could be also true – Pokt users will be so satisfied with its services that it turns them into speculators on its success. If you believe DeFi will only grow from here you should assume that the TAM for blockchain data will be growing with it.

Pokt becomes a DEX for blockchain data and with DEXes liquidity is what matters. Liquidity is a moat for any marketplace. Data buyers seek deepest liquidity and data sellers go where there is the most orderflow.

Every protocol needs Pokt. Whether it is Polkadot or Solana, each ecosystem will want Pokt, or a Pokt-like solution to be built and integrated. Pokt itself can be a first instance of fluid middleware spanning multiple chains.

Despite the network being in its infancy, the growth in nodes has been significant. If we factor in an increasing price of POKT token in OTC markets, we can see the cryptoeconomic flywheel starting to spin. A little bit of reflexivity is what is needed to build a robust ecosystem.

Since nowadays POKT is still relatively illiquid, the flywheel is less pronounced. This is with the network doing only ~5M relays a day. But an increase in relays will put the flywheel mechanism on a steeper curve. A quick math based on the last 30 days(4):

The total reward per relay = 0.01 POKT current OTC price = 25c Average relays per day = ~5m

30 day network revenue = $375k

This is not bad for a network in “a pre-product phase”. Just to give you an idea: in the same time period, Terra had $798,315, 0x had $809,104, PoolTogether had $255,246 and Loopring had $97,218 in revenue(5).

As the UX of Pokt improves, there will be more relays. The expectations for the new dashboard release are high. If all goes well, the dashboard becomes an actual easy to use product – 3 clicks and you get an endpoint.

How can Pokt become a cheaper solution? Stake POKT instead of paying AWS bills. Data will get cheaper with more relays and more nodes. The price per relay is expected to eventually settle down by order of magnitude in the next few years.

Pokt is a cheaper solution today. With Pokt, developers turn their infrastructure into a yield-generating asset. Instead of paying $50/mo to a centralized solution, developers would buy $500 of POKT once and stake it. Within a few months of using the protocol their cost basis approaches $0.

This higher upfront cost will be mitigated by traditional models such as monthly payments until the POKT is paid for or Web3 models such as lending. (This is where wPOKT will be massively helpful by allowing it to integrate with composable DeFi(6).)

This novel form of payment via staking could become a source of potential friction in adoption, however if Pokt succeeds we may have found an effective way to connect various pieces of Web3 middleware infrastructure with a token.

In it for the tech

In summary, we posit that infrastructure lego blocks will become valuable because they:

  • Offer a 10x better solution to a difficult technical problem (yielding cost, usability, censorship resistance e.g.)
  • Promote positive-sum games and value creation
  • Make existing applications more efficient
  • Enable new kinds of applications to be built
  • Create value (and capture it) even before the UX itself
  • Incentivize the key infrastructure providers to act and organize according to the long term goals and values of the ecosystem (become decentralized)

Middleware explained (stolen from @thegostep + minor editing touches)

Pocket Network is a hot candidate to become an integral part of infrastructure legos because it is a plug & play solution that incentivizes decentralization and offers valuable service to dapps and protocols.

Pokt is an investment for developers of applications just like paying for servers. Staking tokens to get data is an investment that turns developers’ infrastructure into an asset. It is a novel model of accessing a valuable service.

Pokt’s long-term goal is to provide cheapest on-chain data. In the mid-term it will likely have to balance out POKT’s flywheel up by adjusting pricing per relay to secure predictable costs for applications.

We are encouraged by meaningful adoption of Pokt among highly technically capable teams such as BlockSwap Network, Api3, Web3API (yeah these are two different projects, nerds are not best at branding I suppose), Fuse, SKALE and few others.

By the end of 2021 as DeFi becomes more cross-chain, we will see the infrastructure lego thesis play out in a less subtle way.

(1) Pokt as Pocket Network/ POKT as a token ticker

(2) Rewards breakdown: 89% are rewards for the node operators ,1% goes to nodes producing blocks,10% goes to the DAO.

(3) Credit to Lubo for coining this term

(4) March 3rd 2021

(5) These projects were chosen because they were above and below the 375k POKT’s revenue mark. Source tokenterminal.xyz

(6) wPOKT (wrapped representation of POKT token on Ethereum) will be using incentives to allow DeFi participants to crowdsource infrastructure for their favorite dapps.