Key Takeaways:
- The research department of Bing Ventures believes that the global encryption winter in 2023 is very likely to usher in a positive signal at the bottom after intensification.
- Crypto market valuations have plummeted as macro monetary conditions and liquidity have deteriorated. But in the long run, this is a healthy development trend.
- If this cycle follows the pattern of previous cycles, we expect the market to continue consolidating into the first quarter of 2023.
- When the liquidity of institutions is drained, cryptocurrencies will return to the gambling table of ancient giant whales.
- The technological innovation narrative of cryptocurrency itself will dominate the recovery process of the industry in the second half of 2023.
2022 is a very bad year for the book value of the cryptocurrency market. With the collapse of LUNA/UST in the middle of the year as the starting point, one after another Ponzi crisis started a long encryption winter. But for the development of the entire blockchain, 2022 is a year full of hope. Concepts such as NFT and Metaverse have begun to attract the attention of traditional institutions. All in all, 2022 will be a bittersweet year for the crypto industry.
2022 is also the dawn of a new wave of blockchain technologies, such as decentralized exchanges, zero-knowledge proofs, Layer 2 and privacy public chains, all of which began to accelerate development this year. They herald the greater potential of blockchain technology in 2023. At the same time, new public chain ecology and Ethereum use cases are beginning to emerge, which will enable more merchants and consumers to get in touch with cryptocurrencies, thereby promoting the development of cryptocurrencies.
Looking back on 2022: a brutal purge
High-yield traps continue to collapse
The most direct reason for the decline of cryptocurrencies is still the successive collapse of the Lehman Brothers in the industry. The successive exposure of high-yield scams relying on vicious competition and data falsification has directly drained most of the income attractiveness of encrypted tokens and the cash flow on which they depend. Here are the landmines that we believe have directly contributed to the deterioration of market liquidity:
- On May 7, 2022, LUNA's stablecoin UST was de-anchored, and a FUD frenzy began on Twitter. In the following week, the price of LUNA tokens dropped directly from $70 to $0.0000009. The LUNA crash triggered a butterfly effect. Market conditions have fallen sharply, liquidity has dried up, and user panic has intensified. Hedge fund Three Arrows Capital, lending platform Celsius, Canadian listed company Voyager Digital, cryptocurrency trading and lending platform BlockFi, and cryptocurrency management fund Babel Finance have all gone bankrupt, delisted or restructured.
- On August 8, 2022, the U.S. Treasury Department placed Tornado Cash on the sanctions list, prohibiting U.S. citizens from using it. Crypto companies such as Circle and Infura have also moved to comply with the sanctions, blacklisting Ethereum addresses that interact with Tornado Cash.
- On November 2, 2022, CoinDesk released a report on Alameda's financial situation. On November 6, Binance founder CZ publicly declared that he would liquidate all FTT on the company's books. On November 11, FTX filed for bankruptcy protection. In less than 10 days, FTX, one of the world's largest centralized exchanges, went bankrupt. FTX's bankruptcy wiped out billions of dollars in cryptocurrencies. Crypto users' trust in centralized institutions is dying.
Search term "Crypto", Source: Google Trends
Liquidity is the fuel for bull-bear conversion
Price volatility occurs when external factors begin to influence investors' decisions. The crypto market in 2022 has almost always been affected by macroeconomic changes. Crypto market valuations have plummeted as monetary conditions and liquidity have deteriorated, but in the long run, this is a healthy development trend. Referring to Bitcoin’s previous two bear markets, the price has fallen almost as much as 85% from peak to trough in the past two bear markets. This round of BTC price has fallen by 75% from the previous ATH-All Time High.
The continued decline in global liquidity is the biggest driver of the crypto market in 2022. Cryptocurrencies are currently still highly dependent on fiat currencies, especially the U.S. dollar. At the same time, its transaction convenience makes it one of the assets with the highest liquidity leverage in the world. Risky assets like cryptocurrencies would be more profitable if there was more global liquidity. On the contrary, the cash flow of cryptocurrencies will be more tense.
United States Money Supply M2, Source: Tradingeconomics
Over the past year, the correlation between cryptocurrencies and the macro market has been extremely strong. Although the price of Bitcoin rebounded slightly in July and October 2022, due to the Fed's strong interest rate hike policy and high CPI data, the fundamentals driving the global encryption market have deteriorated. High interest rates have led to a rapid rise in liquidity costs, and institutions have become more conservative in the valuation and earnings expectations of cryptocurrencies.
The double blow of "cyclical big bear market + structural small bear market"
2022 is a veritable persistent bear market, which is mainly reflected in the superposition period of two typical bear markets during this period. Cyclical bear markets are often triggered by global recessions and liquidity pressures from rising interest rates. Cyclical bear markets tend to last longer, usually 1-2 years, and take longer to recover. Judging from the Federal Reserve's interest rate hike policy in the past year, the cyclical bear market has lasted for at least a year. The second type of bear market is a structural bear market, which is characterized by the bursting of asset bubbles or the outbreak of debt crises. The cycle of a structural bear market depends on the resilience of the disaster itself. Restoration of confidence often requires more external stimulus, depending on new narratives for the future of cryptocurrencies and greater macro tailwinds.
Target Federal Funds Rates for 2022, Source: the balance money
Judging from the published minutes of the Federal Reserve's December 2022 meeting, the Fed's goal of fighting inflation has not changed, and it is expected that interest rates will remain high until more progress is made. The minutes showed that Fed policymakers generally agreed on the need to maintain a restrictive policy stance until the final release of inflation data that was on a sustained decline to 2%. This means that the US will not ease monetary policy prematurely until we see a clear downward trend in the CPI data.
Especially under the awe of many historical experiences, policy makers will only become more conservative. This means that it may take longer to move towards an officially acceptable rate of inflation. No FOMC member has publicly signaled a rate cut in 2023. The key time point will be the Federal Reserve meeting ending on February 1, 2023. The extent of this interest rate hike will determine the direction of risky assets such as cryptocurrencies in the first half of this year. In particular, the total market value of cryptocurrencies has not yet effectively fallen below the peak level in 2018, which will be an important observation indicator.
Looking Ahead to 2023: Crypto Canaries Continue to Challenge the Dollar Myth
We believe that the tightening of the monetary environment caused by the strong US dollar has caused a destructive decline in the valuation of mainstream encrypted assets such as BTC. Whether cryptocurrencies can regain liquidity in the next year will determine the extent to which overall valuations are repaired. We believe that the premise for institutions to favor encrypted assets again should be the weakening of the US dollar and the continued weakness of US bond yields.
Even risk-free yielding U.S. Treasuries sell off when persistently high interest rates weigh on consumer confidence. Because investors will be forced to sell Treasuries for cash due to recession fears. This is the opportunity for cryptocurrencies. The digital cash narrative will be reactivated. Over time, the global liquidity crunch has the potential to dampen economic recovery and trigger a debt crisis.
With 2023 on the horizon, the capitulation of cryptocurrencies in recession is likely to end. When the liquidity of institutions is drained, cryptocurrencies will return to the gambling table of ancient giant whales. The technological innovation narrative of cryptocurrencies themselves will dominate the recovery process in the second half of 2023. Below we see potential opportunities in 2023 that could restore confidence in the industry:
1. Layer 2 will expand the Ethereum application ecosystem.
Layer 2, as the mainstream expansion solution of Ethereum, has two main advantages. One is that it can improve the processing capacity of Ethereum and solve the problem of main network congestion; the other is that it can reduce handling fees, so that a large number of applications can be better implemented in the real world. Now many Layer 2 applications are also increasing, such as Arbitrum, Optimism, etc., they can all interact through the Ethereum main network to meet different application scenarios and solve different needs.
On the one hand, the current processing capacity of Ethereum is extremely limited, requiring a large number of Layer 2 to execute specific transactions to achieve expansion. On the other hand, with the rapid increase of application scenarios on the chain, the requirements of the application on the chain for the execution layer are also more diverse. A large number of Layer 2 with different characteristics interact through the Ethereum main chain. This is the blockchain in 2023. trend.
Source: Dune
According to Dune data, as of January 5, 2023, the total value of Arbitrum cross-chain bridging, the Ethereum Layer 2 expansion solution, has reached 2,091,981 ETH, and the number of users participating in bridging transactions is 511,711. In terms of other L2 cross-chain bridges, the current total value of Optimism cross-chain bridge storage is 457,648 ETH, zkSync is 198,389 ETH, and StarkNet is 9,462 ETH. At the same time, Layer2 still has many problems to be solved, such as block generation speed, security, reliability, etc., which are all important issues that need to be solved during the development of Layer2. In 2023, through continuous technological improvement and innovation, Layer 2 is expected to play a greater role.
2. Decentralized stablecoins will accelerate circulation.
Decentralized stable currency not only has the characteristics of "non-sovereign currency", but also realizes the actual use value connected with various activities in real life. In an increasingly turbulent world economy today and in the future, fiat currency-backed stablecoins and other digital currency over-collateralized stablecoins will only be one of the options for users, and users need better decentralization in terms of collateral, anchoring mechanisms, and value capture capabilities stablecoins.
Historically, decentralized stablecoins have had two upsurges in recent years. The first time is the myth of algorithmic stablecoin prosperity promoted by Empty Set Dollar and Basis Cash from the end of 2020 to the beginning of 2021. The second time is the public chain stablecoin wealth management trend brought about by the two-wheel drive model of Terra public chain + UST stablecoin. These two rounds of trends directly ignited the climax of DeFi hype.
Source: The Block
We expect decentralized stablecoins to continue to act as bull market catalysts as regulations and technology continue to evolve. In 2023, the decentralized stablecoins launched by leading DeFi ecosystems such as AAVE and Curve will support more practical applications. It is expected that more and more DEXs will join the competition of decentralized stablecoins, so as to provide users with convenient, reliable and safe financial services. This part of the market gap will continue to be taken over by DeFi protocols with real business support.
3. Ethereum liquidity collateralized derivatives are booming.
Since the Ethereum consensus has officially changed from PoW to PoS mechanism, the supply mechanism of ETH has officially changed to net deflation. We firmly believe that the future of Ethereum is worth looking forward to, and ETH staking will provide the best risk-return opportunities. Especially with the increase in liquidity staking activities and the arrival of the Ethereum Shanghai upgrade, ETH staking withdrawals will be officially enabled. This means that the ETH liquid mortgage derivatives ecology will further prosper.
Only about 14% of the ETH supply is currently being staked. In comparison, the pledge rate of other Layer1 public chains mostly exceeds 40%. If more people choose to pledge ETH after the upgrade in Shanghai, then the service and product forms of Liquid Staking Derivatives (LSD) will be more diversified. Under the premise of maintaining the pledge income, LSD is expected to be deployed in more DeFi protocols and earn more income.
Source: Dune
Although Lido Finance currently occupies the top spot in ETH liquidity staking, with the innovation of other protocols and the composability of DeFi, potential competitors such as Rocket Pool, Stakewise, Frax Finance and Stader Labs still have the opportunity to challenge more more market share. There is no doubt that Ethereum is still far superior to other Layer 1 in terms of block space demand and fee income growth, so this will be one of the most certain opportunities in 2023.
4. NFT will open up more application space.
As a non-homogeneous token, NFT has its own brand value and fashion genes. These characteristics also make companies and celebrities willing to bind IP and NFT together, and NFT has gradually become a brand promotion method for companies and celebrities to upgrade their own IP and conduct fan operations. Including Gucci, LV, Adidas, Nike, Starbucks, Messi, Ronaldo, and Trump have all tried NFT marketing. It is conceivable that after entering 2023, NFT can better cater to users in the new era.
With the development of the times, NFT has also received more and more attention in emerging technology fields. Taking the field of artificial intelligence as an example, the emergence of NFT will bring a series of new opportunities. In the future, we can use NFT and AI technology to accelerate the speed of art generation, while lowering the threshold for ordinary users to create art. In addition, with the development of NFT technology, there may be more new applications in the future. For example, in the field of virtual reality, NFT will be used for data storage and asset transfer across virtual reality, which will greatly enhance the value of virtual reality. Security and transaction efficiency.
Source: The Block
Therefore, after 2023, NFT technology can be expected to play a greater role and play an important role in many fields. We predict that new liquidity increments will be born in the field of "NFT+DeFi", and "NFTFi" will become the source of inspiration for the next encrypted derivatives, especially with the blessing of Layer2 technology. Secondly, high-performance application-specific public chains and DAOs with high community stickiness will further erode Opensea's market share. New NFT forms such as music and AI will appear in unexpected ways and attract more attention. At present, NFT projects with undeveloped subcultural factors deserve attention.
5. GameFi moves toward scale and specialization
From the popular P2E model of Axie, to the popular M2E model of StepN, to various X2E innovations that have been spawned later, this round of GameFi’s growth has been driven, and GameFi has become the most capital-favored Web3 track in the past two years. The continuous emergence of GameFi projects and the emergence of various game incubators are also promoting the professionalization and scale of Web3 games.
Source: Footprint Analytics
In 2023, the GameFi model will continue to develop. We expect more variants to continue to emerge from the X2E model innovations. Some new projects will be invested in various game incubators. More game developers will join in, which will further expand and develop the Web3 game industry. As technology continues to advance and games become more colorful, more consumers will join in, and the game industry will develop more maturely. In addition, new gaming experience is also worth looking forward to, such as augmented reality, virtual reality, etc., to make the game more realistic and more interesting. In the future, blockchain games will integrate the GameFi model and NFT into a wider range of Web2 game mechanisms, such as MMORPG, FPS, MOBA, etc.
6. DID, SBT, domain name and other digital components build a new identity system
At present, many projects are trying to build Web3 native digital identity, which is also one of the cornerstones for rebuilding user trust in the next cycle. Each digital component can be used to describe an individual's digital portrait, digital reputation, digital social graph and digital social relationship, create Web3 native credit, and promote the construction of a decentralized society.
Web3 native credit will become a new financial system that can support many emerging financial services, such as payments, loans, wealth management and insurance, without relying on traditional financial institutions. We think the segmented tracks worthy of attention include:
- Identity management tools: priority is given to wallets and domain names. Both of these occupy very broad user entry positions.
- Social application scenarios: The open and transparent social investment model (Play-To-Invest), the metaverse-based social networking (games), and the dating and social networking that pays more attention to immersive experience and privacy are all irreplaceable Web3 scenarios.
- Voucher issuance tools/platforms: High value-added voucher projects deserve attention, especially some DAOs with digital country projects and elitism.
Source: ETH
2023 will be a year of change, while also laying the groundwork for the next bull cycle. We expect that in the first quarter of 2023, the market will start to show a clear bottom pattern. In mid-2023, we could see the start of a new uptrend. Liquidity conditions could change significantly, and the dollar could weaken. With the improvement of liquidity, the crypto industry will usher in a virtuous development cycle, bringing a positive foundation for a larger bull market in 2024.
Finally, despite the bear market cycle in the industry, we still see the huge development prospects of the Web3 industry, and hope that everyone can walk together and gain something from Web3 together. Although 2022 is a difficult year for the encryption industry, 2023 will be a year of rapid development for the encryption industry, and it will bring more opportunities and challenges. Let us look forward to the innovation in 2023 together!
