As you play out the possibilities in any two-state solution, you run into the problem that any solution one side demanded would be unbearable to the other. Geography simply won't permit two sovereign states. In this sense, the extremists on both sides are more realistic than the moderates. But that reality encounters other problems.
Israel's High-Water Mark
Currently, Israel is as secure as it is ever likely to be unless Hamas disappears, never to be replaced, and the West Bank becomes even more accommodating to Israel. Neither of these prospects is likely. Israel's economy towers over its neighbors. The Palestinians are weak and divided. None of Israel's neighbors pose any threat of invasion, a situation in place since the 1977 neutralization of Egypt. Jordan is locked into a close relation with Israel, Egypt has its peace treaty and Hezbollah is bogged down in Syria. Apart from Gaza, which is a relatively minor threat, Israel's position is difficult to improve.
Israel can't radically shift its demography. But several evolutions in the region could move against Israel. Egypt could change governments, renounce its treaty, rearm and re-enter the Sinai Peninsula. Hezbollah could use its experience in Syria to open a front in Lebanon. Syria could get an Islamic State-led government and threaten the Golan Heights. Islamists could overthrow Jordan's Hashemite monarchy and pose a threat to the east. Turkey could evolve into a radical Islamic government and send forces to challenge Israel. A cultural revolution could take place in the Arab world that would challenge Israel's economic superiority, and therefore its ability to wage war. Iran could smuggle missiles into Gaza, and so on.
There is accordingly an asymmetry of possibilities. It is difficult to imagine any evolution, technical, political or economic, that would materially improve Israel's already dominant position, but there are many things that could weaken Israel -- some substantially. Each may appear far-fetched at the moment, but everything in the future seems far-fetched. None is inconceivable.
It is a rule of politics and business to bargain from strength. Israel is now as strong as it is going to be. But Israel does not think that it can reach an accommodation with the Palestinians that would guarantee Israeli national security, a view based on a realistic reading of geography. Therefore, Israel sees little purpose in making concessions to the Palestinians despite its relative position of strength.
In these circumstances, the Israeli strategy is to maintain its power at a maximum level and use what influence it has to prevent the emergence of new threats. From this perspective, the Israeli strategy on settlements makes sense. If there will be no talks, and Israel must maintain its overwhelming advantage, creating strategic depth in the West Bank is sensible; it would be less sensible if there were a possibility of a peace treaty. Israel must also inflict a temporary defeat on any actively hostile Palestinian force from time to time to set them back several years and to demonstrate Israeli capabilities for psychological purposes.
The Palestinian position meanwhile must be to maintain its political cohesion and wait, using its position to try to drive wedges between Israel and its foreign patrons, particularly the United States, but understanding that the only change in the status quo will come from changes outside the Israeli-Palestinian complex. The primary Palestinian problem will be to maintain itself as a distinct entity with sufficient power to resist an Israeli assault for some time. Any peace treaty would weaken the Palestinians by pulling them into the Israeli orbit and splitting them up. By refusing a peace treaty, they remain distinct, if divided. That guarantees they will be there when circumstances change.
Fifty Years Out
Israel's major problem is that circumstances always change. Predicting the military capabilities of the Arab and Islamic worlds in 50 years is difficult. Most likely, they will not be weaker than they are today, and a strong argument can be made that at least several of their constituents will be stronger. If in 50 years some or all assume a hostile posture against Israel, Israel will be in trouble.
Time is not on Israel's side. At some point, something will likely happen to weaken its position, while it is unlikely that anything will happen to strengthen its position. That normally would be an argument for entering negotiations, but the Palestinians will not negotiate a deal that would leave them weak and divided, and any deal that Israel could live with would do just that.
What we are seeing in Gaza is merely housekeeping, that is, each side trying to maintain its position. The Palestinians need to maintain solidarity for the long haul. The Israelis need to hold their strategic superiority as long as they can. But nothing lasts forever, and over time, the relative strength of Israel will decline. Meanwhile, the relative strength of the Palestinians may increase, though this isn't certain.
Looking at the relative risks, making a high-risk deal with the Palestinians would seem prudent in the long run. But nations do not make decisions on such abstract calculations. Israel will bet on its ability to stay strong. From a political standpoint, it has no choice. The Palestinians will bet on the long game. They have no choice. And in the meantime, blood will periodically flow.