The initial Terra Luna collapse's blow was immense. While the downfalls and bankruptcies that followed it were catastrophic, the fallout from the FTX-Alameda collapse was almost unforeseen. It wasn't just a downfall but an enormous breach of ecosystem-wide trust.
Prior to the collapse of FTX (FTT-USD) in early to mid-November, many assets in the crypto market were positioning themselves for positive returns at the end of the year. Unfortunately, the FTX collapse and other events led the year 2022 to go down as one of the worst years for crypto investors since the industry began with the arrival of Bitcoin (BTC-USD) in 2009. The year 2022 will be the second worst single-year performance for Bitcoin since 2011 in terms of both year-over-year (-64%) and decline from an all-time high (-74%). However, this bear market cycle is distinct from previous ones. Bitcoin's crypto market dominance increased from 32% during Ethereum's (ETH-USD) early January 2018 peak to over 50% during the 2019 crypto market bottom.
Bitcoin's dominance increased as many ICO altcoins failed to reclaim all-time highs during the previous bull run. Given the magnitude of the crypto selloff, Bitcoin's 38% market dominance is low compared to previous cycles. Assets other than Bitcoin have proven resilient in this crypto winter cycle. Ethereum's market dominance is stabilizing in the 18-20% range; ETH dominance figures that were indicators of peaks may now be transitioning to dominance bottoms if ETH is ever to outperform BTC in terms of market dominance.
The crypto market cap fell by 75.8% from its peak to its low. The market capitalization of cryptocurrencies decreased by $1,429 billion (65.4%) to $756.15 billion at the end of 2022. The crypto market cap has returned to levels last seen at the beginning of 2021 due to defaults and bankruptcies. The market capitalization of cryptocurrencies increased by $1,426 billion (188%) in 2021, reaching $2,185 billion by year's end. The failures of Terraform Labs and FTX sent the cryptocurrency market into a tailspin, with fraudulent activity and asset losses destroying investor confidence and attracting regulatory and legislative scrutiny.
The top two cryptocurrencies, Bitcoin (BTC) and Ethereum (ETH) lost 64% and 68% of their value year-over-year, respectively, while Ripple (XRP) dropped to ninth place after a 59% annual decline. Despite everything negative, a few winners stood out. GMX (GMX) and Trust Wallet Token (TWT), both among the top 100 cryptocurrencies by market cap, saw increases of more than 90% and 100%, respectively. Tron (TRX) fell by 28%, while Binance coin (BNB), outperforming its top ten rivals, fell by 52%. However, there were some sizable losses in the cryptocurrency market. Cardano (ADA) fell by 81% and Solana (SOL) by 94%, both of which caused them to drop out of the top ten cryptocurrency rankings. Web3 issues and a decline in NFT trading volumes exacerbated the bearish sentiment.
In 2022, Bitcoin (BTC-USD) was trading at around $44,000, and most analysts predicted that it would surpass the fictitious $100,000 mark in the following months. Instead, Bitcoin is experiencing a historically severe bear market at just under $17,000. 2023 looks difficult for Bitcoin as it faces not one but two "death crosses."
After several landmine events in 2022, 2023 has a few bullets to dodge. COVID's comeback and Genesis trading's solvency issues, while low in probability, still have the potential to cause considerable moves to the downside. While bearish in the short term, 2023 will bring once-in-a-decade opportunities to invest in broad and niche crypto themes. Themes like zero-knowledge proofs, NFT infrastructure, and web3 gaming are expected to see a substantial push on the development side and subsequent value accrual in the coming cycle.
Events like Litecoin (LTC) halving and opening up of staked ETH in ETH's PoS transition are well defined for a long time. But events like the distribution of BTC from Mt.Gox, the hacked exchange, are scheduled for some time in September 2023. While such announcements are significant, a change in the actual date and the timeline has been evident throughout crypto's history. All the BTC and ETH distribution will cause a lot of sell pressure, thus continuing the downward trend in prices.
CeFi-DeFiThe lending/borrowing sector has seen the worst of all. Only a small number of companies in the crypto lending sector remain today as a result of the implosion of 3AC. Despite some areas having better risk management than others, the industry overall suffered. Many lenders provided credit to a small number of the same sizable borrowers, such as 3AC.
The fallout from FTX aftermath has made the stage for performant DeFi protocols and asset management platforms apparent. Teams with high transparency and proper governance that can install trust among users will lead the charge, whatever the mode of delivery. While the resilience shown by Coinbase and other regulated structure centralized services shows the power of well-maintained digital asset services, the amount of opportunity remaining for faster, more efficient, and palatable solutions is still huge.
The enormous losses in the CeFi sector were either uncollateralized loans to leveraged entities with opaque balance sheets or asset custody with those with opaque balance sheets. The issue with balance sheets is that they need to be easier to read. It can be challenging to determine how much debt a company is carrying, especially when there is purported outright fraud in some cases.
Uncollateralized loans in DeFi continue to be subject to centralized underwriting, which contradicts the principles of openness and decentralization. Deposits and loans on DeFi lending/ borrowing protocols rapidly dropped earlier this year when the Terra blockchain's failure caused a wave of cascading losses and a crypto credit crunch, as depicted in the below image. In November, FTX's rapid collapse inflicted yet another blow.
Decentralized financial systems can challenge established economic structures and provide more open, safe, and inclusive financial services. Users must be aware of the risks connected with DeFi, including market swings, the absence of insurance or central backing, smart contract flaws and vulnerabilities, and smart contract bugs. It's critical to conduct your research, only invest what you can afford to lose, and use recognized DeFi platforms and services if you want to reduce the risks related to DeFi. Users will also need to stay informed as DeFi develops and matures and carefully consider the pros and cons before making any financial decisions.
Investment Thesis for 2023People in developed markets will view Bitcoin as a long-term store of value and a defense against M2 inflation rather than apparent CPI inflation. In emerging markets, remittances and non-dollar alternatives are given more consideration. The Federal Reserve would delay raising rates if our recession predictions pass because inflation would likely decline, and the government would continue to print money and run budget deficits. If there were no negative cryptocurrency-related news, the price of Bitcoin could climb a wall of worry back to $25K under the above-case scenario.
The majority of Federal Reserve officials anticipate that the benchmark interest rate will surpass 5% in 2023 as the U.S. central bank fights stubbornly high inflation. Then, rate cuts are expected to begin in 2024 after a pause in rates at that level. This trend supports the longer-term narrative and increases from the September 2023 median prediction of 4.6%. However, the long-term and median projections for 2022 remained unchanged at 2.5% and 4.4%, respectively.
Overall, the outlook for equities, assets, etc., in 2023's first half is bleak, but the second half could see a recovery. Weakening demand, reduced pricing power, margin compression, and tighter financial conditions will affect equities. Still, a rally in risk assets in the second half will be supported by the transition from inflation to disinflation and a change in central bank policy toward growth. Additionally, in the second half of 2023, low valuations might draw investors and strengthen the equity markets.
Although Bitcoin is in for a challenging start to the year, it will take a steeper low in the coming months and start its next bull phase. We anticipate a lot of sideways movement before a genuine cryptocurrency rally gets going. In the first half of the year, Bitcoin should reach a bottom. This downturn does not imply that we will immediately soar to new heights. Like the previous Bitcoin cycle, it is more likely that the second half of the year will see some "sideways" movement.
There will also be a concern in Q1 2023 about other cryptocurrency exchanges failing due to liquidity problems and "bank runs." However, more realistic market participants will view regulatory changes as a critical stage in the growth of the digital asset market. A robust regulatory environment should help to restore investor confidence. The NFT market and the metaverse would gain from an increase in activity. In Q1 2023, the overall crypto market and the digital asset sector may be significantly impacted by the SEC v. Ripple case resolution. Participants in the cryptocurrency market favor this course of action, which US lawmakers may order the CFTC to implement if Ripple prevails.
The recession is still a potential shock for 2023. With China standing out as a significant exception, the rest of the world should continue to deteriorate, and recessions are expected to hit the US, the Euro area, and the UK in 2019. The recession shock will likely impact corporate earnings and economic growth in the first half of the year, but some assets could profit from China's reopening. Under the new system, market and overall volatility are rising. There will likely be a recession, and central banks plan to tighten policy to keep inflation under control. This action will keep developed market equities underweight in our tactical position. At some point in 2023, the market will view risk assets positively for investment purposes.
RegulationsThere is no denying that the regulations expected to arise next year and subsequent years will be crucial and sharp from all angles. As the digital assets ecosystem has seen a lot of things breaking down this year, the building up and structuring with collaboration with authorities worldwide will bring a huge amount of outside capital into the ecosystem. While each country is dabbling with crypto regulations and taxation, institutions like FATF (Financial Action Task Force) and OECD (Organisation for Economic Co-operation and Development) have solid positions and suggestions for the countries part of the global banking system.
The recommendations for the countries across the globe and the differences need to be seen and analyzed case-to-case basis as places like Dubai, which is becoming the global crypto hub, are on the grey list by these authorities. Any regulation that increases participation in the ecosystem while maintaining the privacy of each player will surely bolster the ecosystem.
Different entities are using different approaches to implement a Global Digital ID system. Any variant that compromises the blockchain's pseudonymous features or breaks user privacy is set to receive a massive backlash from the community. This retaliation can lead to an ideological and infrastructure fight between pro-blockchain users and authorities implementing said privacy-violating regulations.
A significant pointer to emerge from 2022 was the certainty of AML features being implemented for the crypto ecosystem. The question of KYC and user identity remains the most prominent in the ID spectrum. While the crypto community sees a lot of differences in opinion and implementation of projects, the institutions trying to capture value from taxation and regulation appear to have much bigger conflicts. Suppose the conflicts push the privacy ending measures to delay. In that case, it will create an environment for cryptocurrencies to rally if no structured implementations are applied, even after a reasonable waiting period.
Altcoin SecurityA big-standing debate in the US is on the pending regulations and the authorities under which each asset class and subclass will eventually end up. While the absolute clarity on this has been pending for a long time, SEC has been very vocal about its standing and prosecution of any crypto tokens that have been promoted or sold with the same intentions as security. For this, the SEC uses the Howey Test. The test helps to determine whether any transaction is an investment contract.
According to the case against LBRY by SEC, the LBC token it distributed was sold as a security. While LBRY never conducted any ICO for the investment or distribution of the token, a few team members have used worn language in some community channels and pitched LBCs value to increase as the project progresses. The wording and implications here are severe as one of the main points of the Howey test revolves around the investment's purpose being financial gains. While some argue that the gains from holding the LBC token aren't significant, at the end of the day, gains are gains. While this particular case was initially touted to create an ample precedent for the rest of Altcoins (everything except BTC) in the ecosystem, the case's findings and ruling have a 50-50 chance of having the verdict of whether the remaining altcoin in the crypto-verse is the security or not.
While the current commentary on the security status of altcoins is flimsy, the bigger issue is the flight many projects take due to unclear regulations for the crypto industry. Whatever the final results, the decision will not only determine the survival of the US as a hub of crypto or web3 innovation, but it might see a considerable talent and capital flight from the country. Jurisdictions with structured and friendly crypto regulations will see a massive inflow of talent and capital, which the US may not want and be able to afford.
Employment and WagesWhile the Fed has finally awakened to the discrepancy in employment data, it'll face a bigger challenge in 2023. This challenge is the wage growth spiral. There's a shortage of economic or low-cost labor in America. But as inflation keeps soaring, wages also need to rise to make working-class participation viable. This situation, in turn, invariably increases the wages for the working class and fuels the commodity and essentials prices higher.
This phenomenon is what the wage growth spiral constitutes. While fighting structural inflation, this social inflation is another beast the Fed needs to tame, contributing to consumer inflation even when unemployment is high. With unemployment projected to increase by 1% in 2023, properties of a classic recession or possibly depression are hard to deny in the current job market scenario. Thus the rising inflation, along with the wage growth spiral, can take the inflation rate to unforeseen heights in the last few decades.
CurrenciesGlobal currencies continue to face heat from the dollar's dominance and a threat from CNY becoming the next big financial bully that has continued to rise. With the Fiat value of each country's currency depleting quickly, pilots for the CBDC versions and global reset in the transfer value mechanism are expected to be ignited by governments and authorities worldwide in 2023.
A big part of the reserves in the new digital asset economy world at the settlement layer is where blockchain shines as the best technology to make all this possible. BTC has the highest amount of decentralization in the current state and the most prominent holding by multiple private institutions.
EnergyEnergy will continue to tend to the upside for some time. With China opening up its economy to the recent Covid aftermath, a resurgence in energy demand will be seen. Energy dependence has brought Germany to its knees as it had to shift to using wood and coal to keep itself warm. All this will make energy prices sore to new heights. Russia - Ukraine war continues to stay hot with no signs of diplomatic understanding. This political situation makes the oil prices more volatile for a majority distribution network. Subsequently, uncertainty in the macroeconomic environment will see a rise. The high inflationary pressure and the upsurge in oil and energy rates will continue to make the macro environment more challenging for risk-on assets like crypto.
ConclusionWhile 2022 was full of uncertainty, statistically, 2023 is set to provide more data on various fronts at a faster pace. All the participants are now well aware of the global issues; hence, the effects will be immediate. The dynamic nature of crypto makes the volatility high and brings up multiple opportunities. We capitalize on and harness these opportunities to deliver the best possible asset management services.
While the asset class is very stark, the effects of broader macroeconomic factors and events have increased for the asset class. The monetary policy, inflationary factors, and a multitude of data are changing rapidly. Every quarter is bringing grave changes in the market conditions, but opportunities are certainly spearing up. We intend not to lose any opportunity while minimizing any downside risks. Growth in assets managed with a vigilant nimble approach is our target for 2023, with further upgrades as and when they come.
Author: Anurag Dixit, CEO and Founder, Kunji
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