Unlocking the Web3 infrastructure of financial Lego, the indispensable middleware Pocket Network

This article was published on Deribit, authored by Matti, translated by Chain to Blockchain.

The DeFi trend has shifted into a frenzy, followed closely by user-centric trends like NFTs. While we speculate on CryptoPunks and chase astronomical yields, Ethereum is reaching its scalability limits, and alternative chains are struggling to catch up. We are being consumed by short-term speculation driven by MEV and successful DeFi projects along with their cheap knockoffs.

The last cycle in 2017 was characterized by overarching themes like the fat protocol theory and Bitcoin's role as a hard currency substitute. We believe that the current cycle is more micro-focused, as we have become overly concerned with the micro details of financial applications.

In 2016, Joel Monegro set a precedent with his Fat Protocol paper, igniting a wave around the smart contract layer.

In 2021, everyone was focused on Tarun Chitra and his mathematically-driven papers on the various details of CFMMs.

Both macro and micro focuses are important, but the swing from macro to micro seems to be an overcompensation. This is why we suggest connecting the macro with the micro, and looking for the foundational middle ground.

For about a year now, Zee Prime has been asking: What foundational technologies can improve and scale DeFi and Web3? What are the most influential cryptocurrency vertical investments right now? Our conclusion is that it is time for us to improve the infrastructure.

As USV puts it, we are not calling for an "infrastructure phase," which is merely a myth. However, we believe that DeFi applications have outpaced the infrastructure, and now the infrastructure needs to catch up.

End-user applications (DeFi servers) have jumped too far ahead, and now the infrastructure needs to catch up with end-user demands (scalability issues, poor user experience, etc.).

Image source: USV

The high gas fees and failed transactions have made it impossible for non-whale users to enter the "crypto Manhattan" at reasonable prices, which clearly requires better infrastructure. But the real threat is much more subtle. Even if we accept these fees as a premium for resisting real censorship, what are we really paying for when most dapps run on centralized infrastructure?

DeFi is unstoppable and will lead the hyper-financialization movement of the next decade. However, we have missed the connection between niche applications and the previously global. We believe that if we want to move forward without compromising some core values of the crypto movement, we need to improve the foundational technologies. Monetary Lego blocks should be powered by infrastructure Lego blocks.

What is Middleware?

Open-source software vendor Red Hat provides the 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 typically handled by middleware. Middleware can help developers build applications more efficiently. It acts as connective tissue between applications, data, and users.

This is precisely what cryptocurrencies currently lack—a solid glue that operates on the same principles as other cryptocurrencies. This allows existing blockchain operating systems to upgrade to a higher level.

The problem is not at the base layer or application level. Most issues stem from the friction between the two; when you press a button in an application, expecting a real on-chain operation. Consider those dreadful "out of gas" messages, or transactions that don't appear immediately on Etherscan due to a node being out of sync, or transactions that don't show as successful due to being pending.

Crypto middleware projects have a great opportunity to adjust economic incentives, such as integrating tokens. Assuming the services provided are valuable, the value generated will be directed towards token-based incentive mechanisms. The future Web3 infrastructure may be a complex 3D system spanning different token-driven networks.

Currently, we are limited to a layered definition of infrastructure or "stack." We discuss L1 and L2. The future stack will not be limited to two layers. The future will be a flexible stack of many different Lego blocks.

We call these modules middleware, with each module providing microservices for actual end-user use cases. Welcome to composable infrastructure Lego.

Middleware Eats Crypto from the Inside Out

We discuss middleware in the context of general software development, but what is middleware for cryptocurrencies?

Middleware covers all the services required by dapps at once, most of which users are unaware of. It's somewhat like dapps themselves. Oracles are an example, serving as a plug-in solution to provide the application data required. More peculiar examples include Blockswap.network tokenized validators and their cash flows across different PoS networks.

To build reliable products, Blockswap needs on-chain data. For this, it can rely on Pocket Network as a decentralized data source. Beyond that, Blockswap's products can be integrated into different dapps, such as yield provision.

Thus, middleware means that all these solutions do not have to face consumers, as they are integrated into dapps, essentially the B2B aspect of the crypto economy. If you think complex applications are just a pile of "smart contracts + blockchain," then you need to update your vision.

A simplified example of the "middleware" tech stack

Once the market realizes the need for key infrastructure components, allowing for actual use cases, the hype around Chainlink is just a signal of what's to come. Oracles have become the first major wave, and now others will follow.

To better understand the future of middleware, we should consider that Web3 is unlikely to become a monolithic technology. The "blockchain internet" will not be monopolized by Ethereum, Polkadot, or Cosmos.

Web3 can be a spontaneously emerging product rather than a top-down design. We envision different software loosely bundled together, creating Web3 from the top down. The future is flexible. The future is about things that are plug-and-play and composable. Middleware makes the existence of infrastructure Lego that supports Web3 possible.

A decentralized internet is neither top-down nor bottom-up, but rather connected from the middle. At Zee Prime, we believe the future of Web3 will be intertwined with middleware.

To better illustrate the case for crypto middleware, we will discuss Pocket Network in more detail below.

Pocket Network

One of the general middleware services required by dapps is Pocket Network.

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

Pokt aims to create a blockchain-agnostic data marketplace by incentivizing the operation of full nodes. This small incentive cycle has the positive outcome of protecting decentralized infrastructure while accessing on-chain data.

All different dapps, analytics tools, wallets, investors, exchanges, etc., require data from the blockchain. This data includes historical or current balances of addresses, smart contract event logs, significant reductions, and more.

Customers obtain data by sending API requests to the Pokt Network or relayers (as Pokt calls them), which routes the requests to random operators of full nodes (the specific blockchain requesting data). Pokt cuts out node operators that do not provide the correct data and do not retain any data.

To obtain the required data, customers need to stake a certain amount of POKT. This novel "one-way service" design allows for gradual payments through dilution. Pokt is defining a new way to pay for plug-and-play Web3 solutions using tokens.

Pokt is a key middleware that spans different chains. As we move further towards the transition from centralized to decentralized finance, the actual infrastructure must remain decentralized. We believe Pokt can achieve this.

Future financial institutions will resemble technology providers. For example, they will run nodes that support the underlying infrastructure. Thus, the future financial system will be emergent and bottom-up, rather than imposed by central authorities. Pokt is selling decentralized as a service (DaaS) to the main players of future financial infrastructure.

The base layer of Ethereum is the only decentralized part of the stack. The network, DNS, storage, and client layers have yet to be decentralized. Pokt truly makes the network layer of the applications we want to use every day resistant to censorship.

Pokt takes a unique approach to solving the issues of on-chain data availability and blockchain censorship resistance, challenging competitors with a decentralized architecture.

In Pokt, work is distributed among nodes in groups of five, achieving collective economies of scale without the need for powerful machines. The main issue with some other decentralized alternatives is that work cannot be shared among nodes, and each data provider needs to have a large number of backups.

Pokt proposes an efficient solution because it is decentralized.

Image source: Link

To truly integrate "De" into DeFi and make the theme of Web3 technically feasible, we need a fully functional decentralized stack (e.g., ETH > SIA > HNS/ENS > POKT), along with tools that make building these things easier (e.g., WEB3API).

"Decentralized" vs Decentralization

One of the most important yet underrated benefits of blockchain is redundancy. In today's overly optimized economy, redundancy is not seen as a quality. However, if we are building a new financial system, we should avoid over-optimization. A redundancy layer is a protective and security feature.

Bitcoin is built on the incentive of redundancy. The redundancy of Bitcoin is a quality that ensures network security. Pokt also stimulates redundancy by incentivizing node operators to run.

But it goes beyond that. By design, the surge of node operators also lowers the cost of data. Pokt addresses the need for redundancy at the macro level while eliminating the need for redundancy at the individual node operation level.

Pokt is built on full nodes of various blockchains hosted by its users and paid for with POKT. Each data relay generates POKT tokens, which are paid to the node operators executing those relays.

We need a service that provides scalable infrastructure when people dive deep into projects and constantly refresh their balances. Each refresh is multiple data requests. Actual usage generates a lot of data and value. Pokt positions itself to capture the value created at the application layer by relaying all this data through a trustless protocol.

By eliminating the need for centralized entities to coordinate the entire node, Pokt reduces the cost of infrastructure compared to self-running dApps. This is a unique solution achieved through local crypto-economic design and collective economies of scale.

Pokt is important because the current Web3 infrastructure is expensive, infringes on user privacy, and ultimately leads to centralization. It is expensive because conventional full nodes do not optimize the efficiency of querying data but are optimized for resilience in P2P networks. We need native Web3 solutions to optimize costs.

Current infrastructure cannot guarantee privacy because centralized infrastructure providers retain every piece of metadata from requests that pass through them, meaning the entire system will ultimately be subject to censorship. Pokt completely eliminates this, which is why it is an important middleware component.

Of course, especially during the booming period of BSC, Web3 is more ironic. Will centralized services like BSC replace decentralized services? BSC-style networks can be seen as a "wrapped" blockchain. People can experience the implication of decentralization from the comfort of a centralized exchange.

Every application needs scalable infrastructure, and Pokt offers a cheaper, more private, and uncensored alternative. Imagine what would happen if a government agency ordered a centralized node provider to stop service (like the next centralized Twitter) or unilaterally decided to raise prices (just because they have the power to do so).

During the Infura outage in early November 2020, Pokt proved its reliability and the importance of this functionality.

Pokt is an interface for accessing multiple chains. It can be seen as the Uniswap of blockchain infrastructure. In the next year or two, an abstraction layer will be built on Pokt, allowing developers to more easily build across multiple chains simultaneously.

For example, currently, "send TX" is different on BTC, ETH, and DOT. A person needs to construct three different "send TX" in their application for cross-chain applications. Imagine abstracting each read and write to only need to construct one type of tx and point to the chain it will reach, which can be built based on Pokt.

The Economics of Pokt

At this point, we believe middleware can create a lot of value for applications, node operators, and the protocols themselves. But as investors, we must also ask: Can middleware create a moat? If so, how? Can we make profitable investments in middleware solutions like Pokt?

Using or purchasing POKT (the token) at this stage is a practical collateral against the growing demand for blockchain data. The services provided by Pokt will be commoditized as they mature. Even at this stage, price matters, and Pokt aims to provide the best service at the best price in a decentralized manner. Building a moat in a commodity market is challenging.

Beyond low-cost data, Pokt's defensibility also relies on network effects and brands like Uniswap or Ethereum. We can also argue that Ethereum's state transition services could eventually be commoditized, but we are not mature enough to see this hypothesis realized. Decentralized blockchain data providers may one day become a hot market.

Web3 token models seem to inherently include monetary premiums and tribal loyalty. To some extent, they all rely on a positive crypto-economic flywheel. POKT is no exception. As more node operators join, more developers will use decentralized blockchain data to develop killer applications, and demand for POKT is expected to grow.

As Pokt becomes more liquid, the crypto-economic flywheel will become more liquid, with some speculators turning into users and vice versa. Pokt users will be so satisfied with its services that they will view themselves as successful speculators. If you believe DeFi will only start growing from here, you should assume that the TAM for blockchain data will grow as well.

Pokt becomes the DEX for blockchain data, and liquidity is crucial for DEXs. Liquidity is a moat for any market. Data buyers seek maximum liquidity, while data sellers go where the order flow is highest.

Every protocol needs Pokt. Whether it's Polkadot or Solana, every ecosystem wants to build and integrate Pokt or similar solutions. Pokt itself could be the first instance of fluid middleware spanning multiple chains.

Although the network is still in its infancy, the growth of nodes has been substantial. If we consider the factors driving the price increase of POKT tokens in the OTC market, we can see the crypto-economic flywheel starting to spin. Building a strong ecosystem requires a bit of reflexivity.

But increasing relayers will make the flywheel mechanism's curve steeper. Based on a quick calculation over the past 30 days:

• Reward per relayer = 0.01 POKT

• Current OTC price = 25c

• Average relayers per day = ~5m

• 30-day network revenue = $375,000

This is quite good for a network in the "pre-production phase." To give you a sense: during the same period, Terra's revenue was $798,315, 0x's revenue was $809,104, PoolTogether's revenue was $255,246, and Loopring's revenue was $97,218.

As the user experience of Pokt improves, there will be more relayers. Expectations for the new dashboard version are high. If all goes well, the dashboard will become a truly user-friendly product. With three clicks, you will get an endpoint.

How does Pokt become a cheaper solution? By staking POKT instead of paying AWS bills. With more relayers and more nodes, data will become cheaper. It is expected that in the coming years, the price per relayer will eventually stabilize at an order of magnitude.

Pokt is a cheaper solution today. Through Pokt, developers can transform their infrastructure into a revenue-generating asset. Developers no longer pay $50/month to centralized solutions but only need to purchase $500 worth of POKT and stake it. Within a few months of using the protocol, its cost is essentially close to $0.

This higher upfront cost will be mitigated through traditional models (e.g., monthly payments until the cost of POKT is paid) or Web3 models (e.g., lending). (This is where wPOKT is very helpful by allowing it to integrate with composable DeFi.)

This novel payment method through staking may pose potential resistance during the adoption process, but if Pokt succeeds, we may have found an effective way to connect various Web3 middleware infrastructures with tokens.

On the Technical Side

In summary, we believe that infrastructure Lego blocks will become highly valuable because they:

• Provide 10x better solutions for prickly technical issues (e.g., high costs, usability, censorship resistance, etc.)

• Facilitate gaming and value creation

• Improve the efficiency of existing applications

• Support the building of new applications

• Create value before the user experience itself (and capture value)

• Incentivize key infrastructure providers to act and organize according to the long-term goals and values of the ecosystem (decentralization)

Middleware Explained

Pocket Network is likely to become an indispensable part of infrastructure components because it is a plug-and-play solution that incentivizes decentralization and provides valuable services for dapps and protocols.

Pokt is an investment in application developers, just like paying server fees. Staking tokens to obtain data is an investment that can turn developers' infrastructure into an asset. This is a novel model for accessing valuable services.

Pokt's long-term goal is to provide the cheapest on-chain data. In the medium term, it may have to balance the flywheel of POKT by adjusting the price per relayer to ensure predictable costs for applications.

Pokt has been meaningfully adopted by a handful of technically capable teams, such as BlockSwap Network, Api3, Web3API (yes, these are two different projects that nerds are not good at branding), use, KALE, and others.

By the end of 2021, as the cross-chain nature of DeFi increases, we will see the Lego theme of infrastructure play out in a more nuanced way.