Back in the Dim Times (1990s), before ad-blockers appeared, there was a program called WebWasher. It's basically a proxy server you run on your own computer and it contained all the ad filters. You just configured your browsers network setting to point to WebWasher and it would handle all the ad filtering.
So even if companies completely remove extension support from their browsers, we'll still have an alternative. :)
But ads are still often delivered by content delivery which is blockable by domain, hence the reason piholes work. Not that in-stream ads aren't the future, perhaps, but life finds a way.
What you're describing is not a man-in-the-middle proxy, but a simple DNS block. That's a very crude approach to blocking ads and notoriously doesn't work for YouTube and Google ads because they're served from the same domain.
I run a pihole myself but there's still a huge difference between browsing with pihole only and pihole+ublock. It's certainly not the answer to the Manifest V3 shenanigans.
however its relatively rare that an ad company provides a bunch of services I want to use. The only exception i can think of is google.
obvs its hard to avoid gmaps because the alternatives are beyond godawful (no, openstreetmaps, i didn't want to go to the coffee shop of the same name in connecticut, I wanted to go to the one 3 km away), but for youtube I use a python tool called youtube-local which is very very effective, strong rec. Im sure google will defeat them eventually, but so far all of the incremental "block a little of this, block a little of that" stuff the g-man has been doing has been bypassed within a few days. Viewtube is also pretty easy to self-host, but they never quite figured out how to make the UI work.
Still not unheard of today if you're using a VPN. For example, if you're using Mozilla VPN (Mulvad), in the DNS settings it gives you choices between regular DNS, DNS + ad blocking, or DNS + ad blocking + tracker blocking.
I did not know about WebWasher, that's very interesting.
Firefox is looking to implement Manifest V3 to keep extension feature parity with Chromium, but their version will not ban the one API that adblockers use. So Firefox will eventually be V3 compliant
Maybe it's my tinfoil hat but if any part of this is related to their google's pursuit of ad revenue, I don't imagine a v3 compliant Firefox will work with adblock for long.
At the very least they would probably make using it a huge headache
I switched to chrome because they were the first to have each tab be it's own process so one bad site/connection did crash the whole program. Also the cloud based password saving across devices was super convenient.
Firefox does both now too, has better ad blocking, and is a little less invasive and bloaty. A lot less invasive if you know how to set it up, which I don't.