Executive Summary
2021 was nothing short of an eventful year, most importantly marked by defining moments accelerating the pace of innovation and adoption in the crypto industry. While 2020 was labeled as the year of institutional and corporate engagement and the dawn of DeFi, this year, the unprecedented interest in crypto onboarded a whole new wave of entrepreneurs and investors never seen before. Many who leapfrogged Bitcoin and even Ethereum to build and use the first generation of Web 3 applications.
At 21.co, we are thrilled to share our Year In Review and 2022 Crypto Markets Outlook. One of the major challenges of this report is turning it into a coherent story summarizing the year and heading it towards the future. If we had to define the year 2021, it will be labeled by the following patterns:
- Continued Institutional Engagement: The institutional adoption starting with Tesla boosted with the Coinbase public listing
- The China Ban: The China ban on cryptoasset mining and trading
- The DeFi Bear Market: The discrepancies between fundamentals and price developments for Ethereum-based DeFi applications
- The Web 3 Movement: The resurgence of NFTs, expansion of its various use cases for music, gaming, and movies alongside the rise of the Metaverse
- Ethereum Competitors: The developments of the crypto infrastructure with Ethereum competitors at the forefront of public attention
- The Developments of the Crypto Infrastructure: Interoperability and scalability solutions also dubbed Layer 2s
- Expectations for 2022: This year’s overlooked use cases to keep an eye on in 2022
Continued Institutional Adoption
In February, Tesla took the whole community by surprise by revealing on its annual SEC 10-K Form it had invested $1.5 billion in Bitcoin. The news drove to the largest candle in Bitcoin history of $8,871, with the price rising from $38,058 to $46,929 — almost 10 years after Bitcoin traded for the first time over $1 on February 9, 2011.
On the same day, the Federal Reserve of St Louis published a paper on Decentralized Finance stating that DeFi may potentially contribute to a more robust and transparent financial infrastructure. In the same vein and quite in a novel way, Miami was considering giving city employees the opportunity to get their salaries paid in bitcoin alongside paying their local fees and taxes.
In March, on the institutional front, banks started to provide exposure to this asset class through private placements. Morgan Stanley announced to exclusively offer access to bitcoin-related funds to its wealth management clients. Morgan Stanley’s wealth management unit manages nearly $4 trillion in client assets across more than 16,000 advisors. They effectively became the first major US bank to offer bitcoin exposure, capping investments to as much as 2.5% of total net worth per client. As the demand for Bitcoin investments has significantly surged in the second half of 2020, the bank considered the asset class as inevitably investable according to an internal investor note. Due to the lack of a spot Bitcoin ETF in the United States, Morgan Stanley exposed its clients to three bitcoin funds, two of the funds on offer are from Galaxy Digital, while the third is a joint effort from asset manager FS Investments and NYDIG.
In April, the most significant catalyst of the cryptoasset market for Q2 2021 was Coinbase's direct listing on Wednesday 14 April 2021. The listing saw the company initially go public at more than a $100B valuation. Coinbase’s listing represented a milestone in the increasing legitimacy of the cryptoasset industry as it fostered traditional finance to pay more attention to the lucrative business models facilitated by Bitcoin and blockchain technology. A direct listing mechanism was used by Coinbase, where the company did not issue new shares but rather investors and employees were free to sell their own shares on the market with no lockup, (ticker: COIN). Some of the largest initial providers of liquidity for Coinbase shares were leading investment funds such as Paradigm and USV, as well as Coinbase’s executive team.
There were three medium-term implications of the outcome of the direct listing: (1) the new wealth enjoyed by Coinbase employees and investors could potentially flow back into the crypto market; (2) the crash in the cryptoasset market following the listing shows that there was significant overleveraging by traders on the first day “Pop”; (3) Coinbase’s direct listing will likely be a forebearer of many other crypto-businesses going public in 2022.
Institutional engagement and price expectations led the market to become overleveraged and trigger several corrections, especially throughout Q1 and Q2. The crypto industry had a historic first quarter in terms of spot trading volume. The monthly spot volume across crypto exchanges was over $1 trillion in both February and March, and slightly less in January, around $977 billion. According to Coinbase’s Q1 earnings, $112 billion or about 54% of the assets invested on the exchange come from professional investors more likely to trade via their OTC desk such as Ruffer Investment for its $745 million investment in Bitcoin. The aggregated open interest of Bitcoin futures grew by more than 187% from the start of the year to reach an all-time high of $27.29 billion on the day of Coinbase public listing. The bitcoin futures market is the largest segment in the industry and processed at least $1.5 trillion in volume in the same period. Following the Coinbase direct listing, the wider crypto market experienced a deleveraging-driven downturn.
Last words on Bitcoin:
- September marked a landmark in the history of Bitcoin; El Salvador became the first sovereign country to officially accept Bitcoin as a country-wide legal tender on the same pedestal as the US dollar. El Salvador purchased 200 additional bitcoins yesterday, holding a total of 400 BTC valued at $20.4 million at that time.
At 21.co, we believe we are still in the embryonic stage before reaching widespread adoption of Bitcoin in El Salvador. It will take more time than expected as the country relies on a heavy cash economy, with only 58% of Salvadorians having access to the Internet, akin to the Internet penetration figure of the US in 2002. In addition, Bitcoin best serves as a long-term store of value rather than a daily payment method. Hence, we anticipate Salvadorians to adopt Bitcoin predominantly for the former use case.
The institutional adoption of Ethereum was underestimated and started to emerge at the end of Q4 2020. At 21.co, we witnessed the early innings of institutional engagement beyond Bitcoin with Ethereum and identified the sharp rise in the number of wallets with at least 10K ETH (~$33 million). Conversely, smaller wallets holding between 10 and 1K ETH significantly decreased as market participants took profits to use the plethora of applications built on Ethereum. Professional investors realized the value brought forth by Ethereum as the most dominant settlement layer processing over 1 million transactions daily and as the most vibrant and engaged developer platform.
Rothschild Investment Corporation invested over $4 million in Ether, while the European Union's investment arm, the European Investment Bank, issued bond tokens on Ethereum by raising 100 million euros.
Hedge fund giants, Millennium, Matrix, and Point72 dipped their toes in the decentralized finance (DeFi) sector by setting up crypto funds
In May, for the first time in history, Ethereum crossed the $400 billion mark in market cap, valued at over $3.5K or circa 2.7 times its previous all-time high price reached in mid-January 2018 around $1.3K. The fundamental adoption of Ethereum is real and numbers speak for themselves with a +2,000% increase YoY in transaction volume on the Ethereum network and a 7,000% rise in investments in decentralized financial applications.
Another reason for this spectacular rise for Ethereum was likely the looming switch to Proof of Stake potentially happening sometime in Q1 2022, which by design consumes less energy than Proof of Work systems like Bitcoin. In fact, outside inflation concerns, ESG, and climate risks were dominant topics amongst asset managers as indicated by BlackRock. As such, the growing narrative of Ethereum as an ESG-compliant cryptoasset was en vogue, defining Ethereum as the energy asset to fuel the Ethereum economy composed mainly of crypto-native financial services (DeFi) and digital media, art, music, and games (NFTs).
The China Ban
On May 21st, the State Council of the People's Republic of China, the executive governing body of China, issued a statement on financial stability, which included a crackdown on Bitcoin mining and trading activities. The crypto market sentiment turned bearish again due to increased uncertainty in China, exacerbating the previous week’s selling pressure as Tesla stopped Bitcoin payments due to environmental concerns.
Source: Coin Metrics
Bitcoin fell by 8% within an hour as market participants based in China anticipated tougher restrictions. In anticipation of a liquidity crisis in the Chinese market, the selling pressure continued of which 80% predominantly came from short-term traders who purchased Bitcoin over the past 6 months at that time. Crypto holdings were converted to USD-pegged stablecoins such as Tether and USDC, which reached new highs in market value, USDC broke the $20 billion mark in market capitalization for the first time in history.
Volatility spiked across assets. DVOL (the Deribit Implied Volatility Index) serving as a great volatility indicator or the fear gauge, unexpectedly soared. DVOL is the VIX of the bitcoin market that measures implied or expected volatility based on Bitcoin's options traded on Deribit, the largest options exchange. This panic selling also affected the long tail of cryptoassets, most of which dropped by more than 50% from their respective all-time high and hence wiped out hundreds of billions of dollars in total market value.
The Bitcoin market experienced a significant sell-off, which accounted for $2.56 billion in net losses for traders, surpassing the most notable deleveraging events such as in March 2020 ($1.38 billion) and during the last bear market in 2018 ($0.95 billion). The silver lining is that this year’s liquidity has been by an order of magnitude deeper than in 2020. As such, the bitcoin market absorbed that week's sell-off much better than in previous years.
The restrictions from China have also manifested signs of a disrupted network. On June 30, our Research team discovered that at some point, a set of transactions on the bitcoin blockchain took almost an hour to settle. It generally takes ~ 10 minutes for settlements to occur, but the crackdown on Bitcoin mining pushed miners to shut down operations. It was reported that the majority, ~90%, of Chinese miners went offline to comply with government orders. The hash rate decreased to levels not seen since June 2020, effectively the sharpest drop in computing power in Bitcoin history.
At 21.co, we anticipated this adjustment to make mining more accessible to the least competitive miners until the remainder of miners got back online. Namely, in July, the mining difficulty was back to levels where the price of Bitcoin was traded at ~$9K. To put things in perspective, a year ago when Bitcoin traded below the $10K mark, the total miner revenue represented ~ $9M. Conversely, in July this year, the total miner revenue was three times as much as the total revenue in 2020, accounting for more than $29M. Fast forward to the end of 2021, the hash rate effectively increased in tandem with difficulty and is approaching full recovery.
As our research team predicted in 2020, Bitcoin mining has been experiencing a China exodus and gradual shift to North America. In line with our prediction, a few months after the crackdown, the University of Cambridge’s Centre for Alternative Finance released the 2021 Bitcoin mining map indicating that the US is now the leading Bitcoin mining centre with at least 30% of the market share.
In hindsight, we’ll look back at this correction and situation in China as one of many defining moments proving the robustness of the Bitcoin network. Today, it would cost over $1.6 billion to reverse the state of Bitcoin transactions for an hour. The decentralized nature of bitcoin is a crucial feature to keep the network running. No other payment services more centralized by nature could function amid a crackdown. This is a positive light for the future of Bitcoin in times of crisis.
The China crackdown was a double-edged sword. On the one hand, it slowed down bitcoin’s engagement and transpired into Bitcoin’s Sortino ratio. Despite a 68.28% YTD performance vs 29.45% for SPY, Bitcoin had a lower 1-year Sortino ratio (2.81) than the S&P 500 (3.10). On the other hand, the China ban was the biggest promotion for DeFi.
Source: The Case for Bitcoin
The DeFi Bear Market
In September, the regulatory treatment of cryptoassets became a lot more specific and precise than before in China. The PBoC issued a circular stating that cryptocurrency-related transactions and venues are deemed illegal activities in mainland China while overseas crypto services are prohibited from serving China-based users.
Crypto exchanges and other services took drastic measures:
Mining pool service, StarkPool announced the shut down of its operations
Crypto exchanges, Binance and Huobi will prohibit access to Chinese users
E-commerce giant, Alibaba, banned the sale of crypto mining machines on its site.
At 21.co, we are expecting more crypto services to prohibit access to Chinese users in the coming year. Crypto exchanges will undoubtedly remove China from their geographic range of services. The list of blacklisted locations is usually composed of North Korea, Iran, and even the United States — in a discovery conducted by our research team last year.
We also predicted a firewall on crypto services upon learning this announcement. The crackdown on crypto venues represented the most important promotion and product-market fit for DeFi. We already saw capital inflows to DeFi applications reaching all-time high daily trading volumes, such as dYdX — a derivatives platform built on StarkEX, a scaling application.
In 2021, price developments of Ethereum-based DeFi tokens did not indicate any strength in fundamental metrics such as the growth in total value locked throughout the year. Curve (-90.3% from ATH), MarkerDAO (-61.8%), Aave (61.9%) and Compound (-77.6%) are all Ethereum-based DeFi applications with the most user traction. The market sentiment towards DeFi tokens accentuated the discrepancies between speculation and fundamental adoption. For example, Curve grew its assets by 1,561.8% since the start of the year, while its token, CRV, trades down -90% from its all-time high value hit prior to the China ban.
At 21.co, we look beyond price developments as they do not tend to always reflect innovation, but in the long run, if a project keeps executing across core fundamental areas, value will eventually be reflected in its price action.
The DeFi sector was not immune to hacks — particularly when it came to unaudited code. The third quarter represented the highest dollar amount of hacks in history, accounting for $886 million, predominantly from unaudited protocols. This is a reminder that DeFi is still early in the adoption lifecycle, similar to the early years of crypto exchanges back in 2011. More importantly, projects need to strengthen their security practices, such as launching bug bounties and battle test their products in real-world conditions for an extended period. This mind-blowing figure was 2.7 x greater than the previous year’s high of $319 million in Q2. According to Rekt, $1.3 billion has been stolen in 2021 alone (see image below). The largest hack to date, costing investors $600 million, was an attack on Poly Network, an interoperability network for trading assets. The silver lining is that blockchains' flow of funds is transparent and therefore easy for law enforcement agencies and the community to track and identify the digital trail of attackers. The support of the crypto community has been essential, and as a matter of fact, in many cases, hackers often returned a portion of the stolen funds.
The Web 3 Movement
Summer 2021 was defined by a paradigm shift for first-time crypto investors that we can call “Class 2021: Web 3”. The prevalent retail investor would in the past buy mainly Bitcoin and Ether on centralized exchanges and store the assets on hardware wallets like Ledger or Trezor. However, the explosive resurgence and recognition of crypto-native art collections, music, and games (NFTs) have given a new face to this industry and attracted new cohorts of builders such as illustrators, musicians, game developers, photographers, movie producers, fashion designers, and 3D artists. Most of the newcomers have one thing in common, the Web 3 vision or the ‘creator economy” where Internet services are built to reward contributors and users while removing as many gatekeepers as possible.
“(...) Web3 can, if properly developed and with the right kind of regulation, provide a meaningful shift in power back to individuals and communities.” — Albert Wenger’s article on Crypto / Web 3
New exciting integrations and marketplaces came out these past three months, such as Fractional unlocking access to the most expensive NFTs by allowing owners to sell a fraction of their piece of art at a relatively more affordable price. In addition, Tik Tok released a creator-focused NFT collection available on Immutable X, a marketplace where creators will record some of their best videos available for sale to their fanbase — onboarding billions of users to the NFT world. Proceeds will essentially go directly to the creators and NFT artists involved, providing TikTok and NFT fans with a way to show support to the creators they love.
On the demand side, the buying pressure for Ether has been second to none, pushed forward by newcomers snipping NFT collections made of avatars portrayed in profile pictures like Bored Apes (launched in May), Word of Women (launched in July) or participating in play-to-earn games like Axie Infinity. This resulted in NFT marketplaces experiencing enormous month-over-month growth in trading volume, increasing by more than 900% from July to August to reach an all-time high of over $3 billion alone in August from slightly over $300 million in July. The third quarter ended with the second-highest dollar amount in volume with $2.8 in total.
Source: Sotheby's
The real spotlight shone on the spectacular growth of the NFT-gaming project similar to Pokemon, called Axie Infinity — generating over $800 million in revenue over the last 90 days. This is 3x greater than Opensea’s revenue in the same time frame. The AXS token experienced a growth of 110% in the week of September 28, putting the company at a higher market cap than established gaming companies such as Ubisoft and T2. The blockchain game also enjoyed the highest volume within the growing sector by reaching $2.25B in token sales since inception. What prompted the rally was the news surrounding the plans to airdrop AXS worth $60M to early adopters and the launch of a staking service that locked 29% of the circulating supply into the staking smart contract.
Besides art, media, and gaming, the imminent use case for the NFT sector will undoubtedly be music. NFT music will reduce the barriers between artists and their fans. For example, 3LAU, the American DJ and electronic dance music producer, launched Royal — a platform for fans to invest in their favorite musicians and share their potential success by owning a piece of an artist's work through royalties. This will be a game-changer. Ownership is certified on-chain, removing gatekeepers and resulting in lower rent-seeking costs for artists. Until now, only record labels and agents had this privilege.
The NFT sector was fundamentally the growth catalyst on Ethereum, as DeFi was last summer. For the first time in history, Ethereum's trading volume on Coinbase outpaced that of Bitcoin in a quarter as cited in their Q2 report, accounting for 26% of the total volume versus 24% for Bitcoin in this period.
Facebook announced a major corporate rebranding to Meta in reference to its strategy to focus on the next generation of social networking happening in virtual reality. In addition, the firm announced its intentions to support NFTs in the context of selling goods and services in the virtual world. “This will make it easier for people to sell Limited Edition digital objects like NFTs, display them in their digital spaces and even resell them to the next person securely,” according to Facebook Head of Metaverse Products Vishal Shah.
Some critics attributed this move to increased regulatory scrutiny with the waves of scandals, such as the leaked documents from Frances Haugen, a former employee at Facebook — describing algorithm discrimination and oppression. However, at 21.co, we believe Facebook's announcement was an essential promotion for the crypto industry's virtual & augmented reality sector. The tainted image of the social media giant is amongst the main reasons decentralized applications exist to dismantle the power a corporation like Facebook exerts over users.
Crypto-native virtual-reality applications shone as investors seeked alternatives to Facebook. Ethereum-based virtual games such as the Sandbox (ticker: SAND) and Decentraland (ticker: MANA), where players can play, build, own, and monetize their virtual experiences — rose by more than 263% and 275%, respectively in the week after the announcement. On the flip side, Facebook has the competitive advantage of owning virtual reality hardware, Oculus. In 2014, Facebook announced the acquisition of this leader in immersive virtual reality technology, for a total of approximately $2 billion. The paradox between software and hardware in the VR and AR sectors will be important to monitor as this sector moves towards mainstream adoption. The bull case scenario for Facebook / Meta is that by owning Oculus, it might become the largest beneficiary of the adoption of the Metaverse sector as users will likely be using more immersion VR goggles significantly in the future.
Source: Kaiko
Meta could win the VR/AR hardware race but not necessarily succeed in the application/software category. While its virtual space will be available to billions, due to distrust placed in Facebook, users will most likely divert to crypto-native applications like Sandbox and Decentraland. So either Facebook will make those crypto virtual spaces available on Oculus alongside its in-house application or take the opposite direction. Needless to say that embracing decentralized VR and AR applications on Oculus will be one of the most important moves for Facebook / Meta to reinvent itself.
Ethereum Competitors
This stratospheric demand put Ethereum as a victim of its unmatched success reflected in relatively high gas fees driven by increasingly more sophisticated market-order attacks and manipulation, called maximum extractable value (MEV). In a nutshell, the concept of MEV describes bots attempting to front-run users by mimicking lucrative transactions and bidding higher transaction fees to get their arbitrage opportunity prioritized on the Ethereum network by miners. Market friction has formed a strong narrative in favor of Ethereum competitors and driven developers to learn and build on other networks with value propositions zeroed in on higher throughput and lower transaction costs than Ethereum. These networks include Solana, Avalanche, Fantom, and more.
Solana has been the fastest growing chain to reach the $1 billion mark in TVL in just 95 days, in comparison it took 140 days for Fantom, and 199 days for Avalanche. However, comparing the identical TVL amounts of these networks against Ethereum indicates that these networks are likely undervalued. For instance, Fantom, with over $1 billion in TVL was valued at $3 billion, while Ethereum had an equivalent market cap of about $25.5 billion in June 2020 with the same TVL.
It is important to note that these blockchains are relatively more centralized and less secure than Ethereum as they have fewer validators and staked capital allocated to secure the network. However, many see the road to decentralization and security as a marathon, not a sprint. So we can expect this infrastructure to not happen overnight. The 17-hour Solana outage, which occurred on September 14 was caused by trading bots and a demonstration of how early in their development stage these Ethereum competitors are. Battle-testing during the development phase is, therefore, more critical than theoretically superior processing capabilities of a blockchain. 50,000 transactions per second are evidently not enough for the Solana network to onboard over a billion users.
Most services built on Ethereum alternatives are predominantly clones or variations of Ethereum’s native applications. These include decentralized exchanges, yield aggregators, and lending platforms. Many also implement the same playbook to incentivize capital inflow through incentivised yields via liquidity mining programs and airdrops. For example, Fantom, Avalanche, and Celo allocated hundreds of millions of dollars to liquidity schemes to lure users from Ethereum last quarter. Fantom hopes to attract ecosystem builders beyond DeFi, while Celo provides wider DeFi accessibility tailored for mobile users.
Terra enjoyed its most significant network upgrade to date with the deployment of the Colombus-5; it will initiate Cosmos’ Inter-blockchain-communication (IBC) standard after a community vote. IBC allows for interoperability and transfer of assets between blockchains. Another monumental change pertains to the tokeneconomics of LUNA, as the token will now be directly burnt as a result of minting UST, instead of sending it to the community pool.
The migration of capital to networks outside Ethereum has led to the unprecedented adoption and growth in total value locked (TVL) or the assets under management (AUM) held by decentralized financial services applications built on Ethereum alternatives. One concern is that these liquidity schemes do not foster long-term user traction and engagement. Forensic studies led by Nansen indicated that nearly 60% of the user base of these applications take their capital out for other investment opportunities within 48 hours as the rewards drop. This also creates selling pressure for the newly awarded tokens, which may lack vesting schedules.
The Developments of the Crypto Infrastructure
In Q3, the underperforming cryptoassets in the top 15 by market cap were Polkadot and Cosmos; both are interoperability protocols whose investment case has not fully resonated with investors. Our research team believes the narrative will shift as Ethereum competitors continue to grow and the need for blockchain interoperability starts to rise —we expect to see this soon, especially as Polkadot could gain more traction with Parachains.
Parachains are also dubbed 'Layer 1s' (L1), in other words, blockchains like Bitcoin and Ethereum or Solana can be implemented in the Polkadot platform to become interoperable with one another thanks to ‘Relay Chains’. The Polkadot design requires these parachains to win an auction to operate in the Polkadot ecosystem via a community vote called crowdloans. The Polkadot token, DOT, will serve as the currency the community uses to vote for a given 'Parachain' to win an auction.
Most of those auctions have previously been launched on Kusama, the testnet of the Polkadot blockchain to battle test real-world conditions prior to implementing them on Polkadot. Millions of dollars have been raised via crowdloans on Kusama, here is the list of auctions.
In the meantime, as interoperability platforms have yet to launch, scalability solutions dubbed L2s such as StarkEX, Arbitrum and Optimism have been flourishing — increasing by 592% in Q3 overall with TVL estimated at $2.5 billion. The outlier of this category has been Arbitrum with an extraordinary growth rate 1,547,253.8% from just $92K in TVL in June 30th to over $1B by the end of Q3. It’s likely that scalability solutions will keep up with this rate of adoption as more applications get integrated and these solutions improve over time with upgrades, optimizations in tandem with greater adoption. In a nutshell, these L2s bundle transactions and settle them on the Ethereum network at a later point in time. This technique removes the computation and storage required out of Ethereum while maintaining Etheruem’s security and increasing the capacity up to 20,000 transactions per second for a few cents in fees compared to over $30 on Ethereum. Right now, Ethereum’s throughput for complex transactions in DeFi is limited to 15 transactions per second. In simple terms, Ethereum is like the Fedwire settling commercial banks’ transactions while L2s are the commercial banks offering consumer-facing services.
All in all, this is great news for the whole crypto industry and the DeFi infrastructure. This would mean that over In the coming year, we'll witness greater interoperability across blockchains, not only those that are necessarily compatible with Ethereum. This will improve user experience by orders of magnitude and unlock the next generation of internet services that are already budding in financial services (DeFi) and media, art, and games (NFTs).
Expectations for 2022
Macro
The Ether:Bitcoin (ETH:BTC) market-value indicator crossed for the first time in 3 years, the 50% mark. In other words, Ethereum takes over 50% of Bitcoin’s market capitalization. The uptick started this past summer fueled by the rise of NFTs predominantly. It is too early to tell whether Ethereum will flip Bitcoin’s market value in the near future but the pace of innovation to solve Ethereum current issues such as market manipulation and high transaction fees are under significant progress.
PoW miners might face more friction outside China. There’s a rising concern from some politicians over the energy consumption of PoW networks like Bitcoin. Countries could try to curb mining by shutting access to miners or attempting to completely ban these practices. Politicians in Norway and Sweden would prefer the latter despite the fact that miners leverage renewable assets, while Iran and Kazakhstan chose the former. After three major coal-fired power stations suffered shutdowns on October 14, the Kazakh government decided to limit power supply to some consumers including Kazakhstan's crypto miners, which accounted for 18% of global Bitcoin hashrate.
One of the other reasons we are optimistic about the future of this space, compared to the last cycles, is the pace of innovation and the financial support entrepreneurs receive not just from VC firms but also from a crowdsourced network of talents and resources with initiatives such as Braintrust. The good indication of this new era is the amount of VC investments made in this industry, which increased by more than 300% YoY.
VCs will need to reinvent themselves to stay relevant and attract as many entrepreneurs as possible this decade. They will need to provide non-monetary value to the community and teams, many started such as Paradigm solving major vulnerabilities in DeFi.
DeFi
The rate of adoption of user-friendly DeFi applications will pick up speed in 2022 with the new wave of Chinese users left out by centralized exchanges. The most dominant DeFi applications will contemplate integrations into Layer 2s such as StarkNet, Aribitrum, and Optimism to improve user experience. Nonetheless, Polygon PoS will be the biggest beneficiary for the first half of 2022 unless Layer 2s launch their own tokens and find relevant partnerships and marketing initiatives to sustainably incentivize developers to migrate rapidly to bootstrap usage. Uniswap and ParaSwap have already launched on Polygon.
Many crypto and DeFi projects based in the US could either opt for crypto-friendlier environments in order to grow without regulatory friction or prevent US customers from interacting with their interface like dYdX.
Major crypto firms will start lobbying en masse to gain more regulatory clarity. The Crypto Council for Innovation launched earlier this year, will lobby policy makers, take up research projects and serve as the burgeoning industry’s voice in championing the economic benefits of digital currencies and related technologies. FTX.US will become one of the most important companies on the lobbying front, thanks to its CEO’s large donations to Joe Biden’s campaign.
Binance limited the leverage level to 20x instead of +100x and ceased margin trading on various fiat currencies such as the Euro, Australian dollar, and the British Pound. As such, we should anticipate derivative trading to diverge to crypto-native products in DeFi such as Dydx and Perpetual Protocol, Ribbon, etc.
Regulatory scrutiny could grow in light of the comment of SEC Chair Gary Gensler on the requirement for both centralized and decentralized crypto services to comply with US securities laws. Therefore, restrictions or delisting of cryptoassets deemed unregistered securities might prevail in the US.
Uniswap, the leading decentralized exchange within DeFi, removed such security tokens from their interface (not the protocol itself) owned by Uniswap Labs, their company registered in the US. Uniswap also employed TRM, a blockchain analytics firm for compliance reasons. Other DeFi applications might follow suit.
Investors have become a lot more knowledgeable over the past year and will be participating in DeFi and Web 3 more than ever. Many protocols have started to develop institutional-grade options to serve this cohort of investors such as Aave, MetaMask, Hashflow, Compound, etc.
Stablecoins
Government officials around the world have raised concerns over USD-pegged stablecoins, including Chairman Powell of the Federal Reserve. On that note, more stringent regulations could be applied on US-based stablecoin issuers; either regulators could impose a bank charter or require issuers to hold government debt instruments.
Traditional service providers are already embracing technologies coming from the crypto industry. Visa will eventually enable its network of consumers, businesses, banks, and governments to use USDC. This endeavor is a testament to the fact that conventional finance seeks to tap into the innovation behind the crypto infrastructure.
Given the fact that stablecoins enhance the US dollar dominance around the world, many countries such as Russia and China de-dollarising parts of their financial system could prevent their local banks from accepting stablecoin deposits as they attempt to build their own CBDC. Russia for example cut the dollar share of its foreign exchange reserves down to 24% from 45%.
Algorithmic stablecoins will be an important vertical to keep an eye on. UST could become the de facto medium of exchange in DeFi as the Terra ecosystem interacts with other chains through IBC. Other investors will feel more comfortable to still use USDC or USDT to benefit from blacklists of wallet addresses in case of a hack.
NFTs
AAA crypto-native games will take more time to develop than expected and might even fail to deliver or raise another round of financing to meet expectations.
Games that will receive a lot of traction will be the ones easier and faster to ship or from projects who have been building in silence over the past few years.
Music NFTs will be one of the most engaging verticals where artists will take control over their fate. It is challenging to overstate how big an innovation it is. According to Mikel Jollett: “1,000,000 streams on Spotify nets $3,000. Of this, 84% goes to the label (if the artist is on a major, 50% if indie) and a whopping $480 goes to the artist”. With music NFTs, gans will be able to own songs through royalty-backed NFTs, musicians can upload songs on censorship-free platforms like Audius or tokenize their videos on Glass Protocol. The fanbase can even support artists through decentralized record-label such as Good Karma DAO.
Solana will attract more NFT artists and celebrities like Stephen Curry through the FTX NFT marketplace.
Opensea will potentially lose market share as it faces more competition with Coinbase, FTX, Rarible, Zora, SupeRare, Nifty Gateway, etc.
Arweave and IPFS, cloud storage solutions have the chance to become more en vogue as the concern over outage of centralized web hosting services like AWS will emerge.
As predicted earlier this year, many NFT avatars would become music bands, movie and cartoon characters such as Crypto Punks, Bored Apes, and MetaHero. PUNKS Comic and Universal Music Group are great examples.
In 2022, more brands, especially shoe manufacturers and apparel companies will leverage the metaverse and NFTs to display items and physically deliver pieces to NFT members. Adidas and Nike are the leading brands on that front.
NFT projects and promoters won’t be immune to regulatory oversight, especially NFTs that could be classified as unregistered securities and outright scams like pyramid schemes advertised on social media channels like TikTok or Instagram.
DAOs
The use cases likely to gain momentum will be 1) quadratic funding with Gitcoin 2) and crowdfunding with Syndicate Protocol. Those use cases will expand the pie to investing in crypto, support overlooked R&D initiatives to solve real-world problems, and provide a universal basic income for people in need with ImpactMarket.
Infrastructure
Cosmos and Polkadot will be ecosystems to closely monitor over the coming year. They will need to attract projects and networks with the most user traction to get quick wins. Terra joined Cosmos in October, as such Cosmos might continue to be miles ahead of Polkadot on the interoperability vertical from a usage perspective. Interoperability solutions will be an important component to improve liquidity provision, composability, and efficiency in DeFi.
Helium Network is becoming an important part of the web 3 infrastructure with a mission to make the world a more connected place through a ubiquitous, global wireless network. The partnership with FreedomFi, a connectivity company that manufactures open source 5G devices could gain more adoption in 2022.
Layer 2s will become chain-agnostic, Optimism and StarkWare already signaled this endeavor. The years of research and development of L2s will benefit non-ETH blockchains like Avalanche, Solana, Fantom and NEAR to scale as settlement layers for the Internet of Value (Web 3).
