2022 will go down as one of the most momentous in the industry’s short but storied history. But the growing pains on display this year are a vital part of the maturing process amid the continued adoption of decentralised systems globally.
Saying that 2022 was a rollercoaster for blockchain and digital assets is somewhat of an understatement. Well before the collapse of FTX, pandemic-era fiscal and monetary policies ignited the inflationary forces building since the GFC, and, together with a hot war in Ukraine created a perfect storm for risk-on assets right across the board. Since then, hawkish policies, a rampaging dollar, and a falling stock market have all continued to pressure crypto markets, with bitcoin posting its second-worst year on record, down 65% for the year.
The FTX collapse along with the demise of numerous enterprise blockchain projects (hello Tradelens and B3i) has resulted in one of the worst crises of confidence the industry has ever faced. But by filtering out the doom and gloom we can remind ourselves that such crypto winters offer an opportunity to monitor the projects that knuckle down and build through the bear market and to take stock of which market trends will pave the way for future developments in cryptocurrencies, blockchain, and the whole Web3 economy.
Part 1 of this 7-trend overview for the blockchain and digital assets space in 2023 looks at regulation, the ongoing Layer 1 wars, and the DeFi resurgence.
The implosion of FTX will undoubtedly speed up the formulation of cryptocurrency regulation in the US and elsewhere, including for reporting and auditing requirements as part of efforts to mitigate against similar failures in the future. While this can, and should, be viewed as a positive to ensure the future stability of the industry, it must be pointed out that FTX and the many failures that came before it also represent a catastrophic failure of those supposedly doing the regulating.
For example, it is now well established that disgraced FTX ex-CEO, Sam Bankman-Fried donated handsomely to both Democratic and Republican parties – a factor that may not be sufficient to spare him jail time over the circumstances behind FTX's collapse – and it's an open secret that he had a cozy relationship with SEC chair Gary Gensler. Therefore, pinning one’s hopes on Gensler and the SEC to formulate favourable legislation conducive to the flourishing of the digital assets space does not appear to be a great bet given that so much carnage unfolded on his watch.
Case in point: a new bill introduced in December by Senator Elizabeth Warren and Senator Roger Marshall, the Digital Asset Anti-Money Laundering Act, was introduced with the stated aim of “bringing the crypto and digital asset ecosystem under existing anti-money laundering and know-your-customer ("KYC") rules.” But it appears to have very little to do with preventing a repeat of such a collapse or protecting retail investors. Rather, it may permanently and completely hamstring decentralised ecosystems – from developers, public blockchain node operators, and validators – by burdening them with archaic and totally unrealistic reporting requirements that hamper their ability to participate in decentralised networks and dApp development.
So while all CeFi (centralised finance) companies that hold user assets in an exchange or lending capacity should be subject to a regulatory framework to prevent fraudulent activities, it's also clear that the risk of potential knee-jerk and self-serving governmental regulations that may kill off the industry's viability remains high. This could pave the way for great swathes of the industry to move to jurisdictions in Asia and Africa where regulations are less burdensome.
Layer 1 wars
The competition between the blockchain Layer 1s is arguably the most important battleground in the industry and one that will rage on long after people have forgotten about FTX and Sam Bankman-Fried.
Despite several predictions that the many 'Ethereum killers' would surpass the premier smart contract platform in 2022, Ethereum actually gained ground this year in terms of market cap and now equates to over 60% of the aggregate value of the top smart contract platform tokens listed today.
After a relatively successful transition from proof of work (PoW) to proof of stake (PoS), we predict that Ethereum will continue to be the most widely adopted Layer 1 blockchain in 2023. Even though The Merge has not yet yielded significant downward pressure on gas fees, the 99% cut in power consumption, deflationary tokenomics, and improved programmability and staking models have strengthened Ethereum’s position for now, and there are more updates in the pipeline. Shanghai, planned for Q2 2023, which will enable withdrawals of staked ether locked in contracts since staking went live in December 2020, and EIP-4844 will enable proto-danksharding to help Layer 2 scalability.
Figure 1: Top 10 blockchains devactivity in 2022
On the other hand, Ethereum’s perceived lack of decentralisation, high gas fees, and consistently delayed upgrade rollouts have left a vacuum that is being filled by Polkadot, Cosmos, Cardano, Algorand, and others, will intensify over 2023. Cardano, for example, whose Vasil Hard Fork in October (and which was largely overshadowed by the hype around the Ethereum Merge) increased the network’s capacity and lowered users’ transaction costs, reflects why it led the Layer 1s in terms of overall developer activity throughout 2022, according to data from Santiment (Figure1).
As the competitive landscape heats up, we may see an increase in Layer 1 specialisation where particular projects come to dominate particular verticals. For example, Ethereum will continue to dominate DeFi while chains such as Algorand will attract payments providers and governments looking to roll out CBDCs by virtue of its capacity to quickly handle multiple transactions. At the same time, some Layer 1s will fall by the wayside or even end up becoming sidechains of other Layer 1s. For example, Charles Hoskinson has already indicated that Solana could become a side chain of Cardano and around 74% of users agree that Solana should join Cardano instead of remaining an independent chain, according to the latest poll.
Defi is poised to make a massive comeback in 2023 and it is not difficult to see why. While many have opined that the multiple collapses witnessed in 2022 (Voyager, Celsius, BlockFi, FTX) "proves" that bitcoin and blockchain’s promise of decentralisation is a fraud, the reality is that these failures have laid bare why we need distributed systems now more than ever.
Ironically, it is the Defi protocols using Ethereum-based smart contracts that were ultimately made whole during the wave of failures, when lending platforms repaid their collateral and did so without using depositors’ funds to pay for armies of chapter 11 bankruptcy lawyers or for company operations while assets remained frozen.
Figure 2: Transactions and users on DeFi platforms in the seven days to November 15
All of this is leading to a better understanding both of the fact that "crypto" ≠ bitcoin and that CeFi ≠ DeFi, and is reflected in the behaviour of investors and traders who have shunned centralised exchanges (CEXes) in favour of decentralised alternatives (DEXes) in the wake of the FTX collapse. As of November 2022, Uniswap, one of the most popular decentralised exchanges became the second-largest exchange in the cryptocurrency market for trading Ethereum, processing more transaction volume than Coinbase and Kraken, with only Binance surpassing it. In the week ending November 15, these exchanges completed almost $31 billion in trades. which represents a 178% rise from the prior week, according to DappRadar. Of course, DeFi is not without its problems, but improved UX, simplified fiat on-off ramps, and concerted efforts to tackle hacks will support the momentum towards DeFi as the “not your keys, not your coins” penny continues to drop among retail and institutional investors and traders.
Disclaimer: The information contained within is for educational and informational purposes ONLY. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision. No commercial relationships or partnerships exist with any of the technology providers, manufacturers, or suppliers herein.