From an excellent article by Daniel Levy:
"Maintaining the peace treaty with Egypt has morphed over time. The peace process under Mubarak's tenure has ultimately entrenched occupation and settlements and made a mockery of its Arab participants.
Post-transition Egypt is unlikely to continue playing this game. And without Mubarak's enthusiastic endorsement, the process itself is likely to further unravel. It is hard to imagine other Arab states leaping into this breach, or the Palestinians accepting 20 more years of peace-process humiliation, or indeed of Syria adopting the Egyptian model and signing a stand-alone peace agreement with Israel.
Israel's strategic environment is about to change. Israel’s options would appear to be narrowing. Thus far Israeli establishment voices have discussed two options. One has been to dig in, to fear-monger, to convince the West that Israel is its outpost of stability in a sea of hostility, and to hope the military stays in power and democracy is tamed.
In the words of Prime Minister Netanyahu, "might" is the answer. The second approach advocates an urgent return to the peace process. Neither will work. The first will exacerbate Israel's predicament, and the second is too little too late.
Israel has a third option, albeit one that is dramatic and out of synch with today's zeitgeist. It would be perhaps Israel's best and last chance for a two-state solution. While it would involve cutting Israel’s losses, it would also have the potential of unleashing huge benefits - economic, security and more, for an Israel accepted as part of the tapestry of a democratic Middle East.
Broadly speaking, this option has three components. First, an Israeli withdrawal to the pre-1967 armistice lines almost without preconditions or exceptions - minor, equitable and agreed-upon land swaps and international security guarantees could fall into the latter category.
Second, Israel should undertake an act of genuine acknowledgement of the dispossession and displacement visited on the Palestinian people, including compensating refugees where appropriate, and thus set in motion the possibility of reconciliation. Third, there needs to be a clear Israeli commitment to full equality for all of its citizens, notably including removal of the structural barriers to full civil rights for the Palestinian Arab minority.
Admittedly, this is a path less traveled and one likely to remain so, and while the alternatives to this path may well include democracy in the region, they could preclude a future for the State of Israel.
Much will also depend on the next steps that Palestinian leaders take. It would be a strategic error of momentous proportions to revive the old and failed modalities of the peace process. Albeit both belatedly and driven by external developments, it is time for a reunified Palestinian national movement and a renewed and relevant Palestinian strategy for freedom to emerge."