It was fun while it lasted. But the times of the crypto gold rush, massive fiscal stimulus, negative real interest rates, and emerging metaverse narratives now seem like a distant memory. The pendulum swung the other way in 2022, with the Federal Reserve raising rates faster than any other time in recent history in their efforts to curb inflation.
As a result, companies in every corner of the technology sector have been reeling from the rising cost of capital from practically nothing to the highest level in a decade. This has translated into a huge drop in valuations, with no exceptions for Big Tech. Even companies like Apple – with their multi-billion dollar annual cash flow – have suffered a 24% drawdown in share price through 2022.
The damage is especially severe in growth-centric companies whose plans for profitability have yet to materialize. Fintech companies have reversed all their COVID-era gains compared to traditional banks. Pandemic darling Peloton has gone from a price-to-sales ratio of 15x to a measly 1x.
But crypto has seen the worst of it. You’d now be hard pressed to find the euphoric “WAGMI” optimism as the entire ecosystem seems to be unraveling amongst the chain of bankrupt centralized exchanges – whose contagion effects are still being played out.
In the year ahead, our sobering belief is that crypto prices will not rally – at the very least – until correlated technology stocks do so as well. However, what happened with FTX should mark the most grievous event of this correction, and so the storm will eventually come to pass. Evidence is showing that adoption is still growing, despite trading volumes remaining flat.
Our outlook will examine how specific sub-sectors are faring during this crypto winter, followed by commentary on the inevitable regulatory wave.
In 2022, the total cryptocurrency market cap tumbled 63% further, from $2.2 trillion to $0.8 trillion. Rising interest hikes and a possibility of recession have led crypto investors to adopt a ‘risk-off’ approach, with some exiting the space entirely in favor of traditional asset classes.
Aside from continued interest rate hikes, the collapse of FTX led to a destabilizing effect across the broader market. As the world’s third-largest exchange, FTX had been the main sponsor in dozens of protocols, many of which now find themselves financially stranded.
For these reasons, we do not expect the cryptocurrency market rout to ease in the near-term. It will take months for the full extent of contagion effects to play out, with many companies staying intentionally opaque, but scrambling to stay afloat behind the scenes.
If history is anything to go by, we will see low trading volumes and flat prices for some years as consolidation gathers around halving cycles and deflationary economics. When liquidity inflows eventually return, they will be concentrated in Bitcoin and Ethereum – with the pair leading the way for risker small cap altcoins like in past cycles. Proven tokenomics models, maturity of ecosystems, and relative market liquidity are all factors that make Bitcoin and Ethereum the ‘safest’ assets within the cryptocurrency space.
As fears culminate around centralized exchanges, certain crypto enthusiasts rejoice as they believe demand will migrate towards decentralized services instead. While it is true that the total number of wallets interacting with DeFi is growing, the total value locked (TVL) in DeFi protocols continues to shrink alongside the price of Ethereum.
The worry here is that investors are losing faith in DeFi as a whole and withdrawing their assets. Decreasing Ethereum prices could be causing investors to sell their assets to try to minimize their losses, which in turn is causing the TVL to decrease.
While we will not be so bold as to argue that sustainability of DeFi is purely contingent on underlying cryptocurrency prices, the correlation cannot be ignored. If crypto prices do not recover, we cannot believe that DeFi will see a meaningful upside either.
That’s not to mention the smart contract exploits and blowups that we’ve seen over 2022 as well. Axie Infinity’s Ronin chain suffered a loss of 173,600 ETH in one of the biggest hacks in DeFi history. Terra Luna’s algorithmic stablecoin went into a death spiral because it failed to take into account extreme market volatility.
You cannot make this up— Eric Golden 🍌🦇🔊 (@ericgoldenx) March 29, 2022
Hacker steals $600MM in ETH from Ronin blockchain the one underlying Axie
Hacker then goes short Ronin & AXS (Axie token) knowing as soon as news breaks that tokens will plummet
But NO ONE notices and they get liquidated on short before news breaks
With impending regulatory and compliance standards soon to come, we believe that the DeFi of 2023 and beyond will look drastically different compared to its permissionless, often undercollateralized, yield farms of years past.
Over the past year, all NFTs saw drastic reductions in valuation measured both crypto-denominated terms as well as absolute US dollar value. The newest speculative crypto asset was seen as the frothiest and thus saw a massive selloff in the first half of 2022, even prior to the chain of liquidations in the wider crypto markets. Bloomberg reports that trading volumes have collapsed 97% from the highs – but even despite this, not all NFTs are dead.
Instead, we believe in the future of NFTs as an alternative asset class due to its vast consumer reach in the areas of collectibles, social tokens, gaming, fine art, and more. Of particular focus is the phenomenon of flagship ‘PFP’ collections such as Bored Ape Yacht Club and Azuki in their ability to revolutionize the way we understand ownership and identity in the growing digital economy.
For holders, the best NFT collections represent one-half social club, one-half intellectual property ownership. For the teams building these projects, it is an emergent brand enterprise whose future is built alongside their fans.
Our view is that recent price corrections are part of healthy cyclical adoption. Legitimate projects now seem to have their floor prices settled, with some collections like DeGods actually matching its US dollar value as its host cryptocurrency falls.
DeGods - Price Action Analysis— SolanaSh33t (@Spr3adsh33t_Sol) January 10, 2023
Floor Price: 540.0 SOL
24 Hour Volume: $197110
Buy Floor Now: https://t.co/AXxgv5tHyu#DeGods #NFTs pic.twitter.com/ON1lK1SBHI
However, there are still major issues to be addressed in the year ahead. Users and marketplaces will have to come to a consensus on where they stand regarding perpetual royalties. Teams will have to set clear boundaries when mixing venture capital with crowdsourced funds. And most importantly, in order for the space to mature, projects will need to experiment in new ways of delivering utility in order to drive future participation.
Overall, we believe that a small handful of premier NFT collections can present key value opportunities given the reductions in price. But we urge interested speculators to exercise caution as a lack of transparency from existing incumbents may signal no proactive initiatives made to achieve sustainable profitability.
The recent indictment of Sam Bankman-Fried, CEO of FTX, has served as a catalyst for governments around the world to take a more urgent and comprehensive approach to regulating the crypto industry.
In a press release issued by the Securities and Exchange Commission (SEC), Chairman Gary Gensler emphasized that the alleged fraud committed serves as a "clarion call to all crypto platforms” to ensure compliance with US laws, and to prepare for increased regulatory scrutiny and disclosure requirements. With a warning that the “runway is getting shorter”, failure to meet these requirements would result in action taken from the SEC's enforcement division.
While this may slow the pace of chaotic innovation that the crypto space is known for, we believe that regulatory clarity will be a net positive for the cryptocurrency space as a whole. Nonetheless, it will be important for lawmakers to remember that the issues in 2022 were caused by bad actors and human error, and not because of anything wrong with crypto or the technology behind it.
The goal for the new rules should be finding a balance between making sure there are standards in place to protect people's investments, but also giving room for innovation to happen.
Are NFTs Dead?
BY MARCUS LEE / MMM DD YYYY