2022 was a tough year for crypto. Today the question on every investor and trader’s mind is — what are the big trends that will impact price this year?
The Bitcoin price is up nearly 40% since January 1st. That’s the good news. But at the same time, there are clear indications that bearish headwinds are forming that may make it difficult for crypto to enjoy an extended recovery. Nonetheless, public-facing blockchain technology is improving quickly and many important projects will mature in the coming year. So what type of environment will they be launching into? In this article, we examine four macro trends likely to impact the crypto sector in 2023.
1. Lawmakers vs Crypto - The circle tightens
Before its collapse in November last year FTX was the crypto firm heralded by Washington lawmakers. Millions of dollars in political contributions to Democrats and Republicans no doubt helped that process along. But now, with charges against Sam Bankman Fried and other FTX staffers stacking up, the agencies that should have been providing oversight have been found wanting. Where was the Securities Exchange Commission, for example, as FTX was committing what the SEC now says was a massive fraud? Well, they were investigating Coinbase and Ripple - and fining BlockFi $100 million for marketing an ‘earn’ product.
FTX was a case study of loose corporate practices, and its collapse may have been avoidable if regulators had undertaken even rudimentary due diligence of its operations. John Ray lll is an American CEO who specializes in recovering funds from failed corporations. He was brought on board to replace Sam Bankman-Fried after FTX filed for Chapter 11 bankruptcy. He said he’d never seen “such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.” Former SEC chief of internet enforcement, John Reed Stark said he believed that the FTX incident will spawn more “criminal prosecutions than any other financial fraud in history.”
The cozy relationship former FTX CEO Sam Bankman-Fried enjoyed with Washington is now seen as a huge embarrassment. It has created a new wave of distrust toward the crypto sector. As a result, it seems inevitable that the regulation of crypto companies will ramp up.
Litigation against crypto companies and individuals is a likely trend to continue through 2023, starting with FTX and growing to catch more bad actors hidden in plain sight. On December 13th 2022, the SEC charged SBF with defrauding investors.
On January 19th, 2023 the SEC charged Caroline Ellison, the former CEO of Alameda Research, and Zixiao (Gary) Wang, the former Chief Technology Officer of FTX Trading Ltd, for their roles in a multiyear scheme to defraud equity investors in FTX. Again, the SEC says they will continue investigations to find other parties tied to misconduct connected to FTX.
Litigation of crypto grew in 2022 with the SEC also suing celebrities associated with the promotion of the EtherMax token. The Treasury Department settled with crypto payment solution Bitpay because it allowed its tool to be used in sanctioned countries like Iran. The same government department sanctioned Ethereum mixing service Tornado Cash for being a vehicle for laundering money, including being used by the North Korean Lazarus group.
The Department of Justice announced last week that it would soon file a complaint against the founder and majority owner of Bitzlatzo, Anatoly Legkodymov. The DoJ says the Bitzlatzo money-transmitting business transported and transmitted illicit funds and failed to meet U.S. regulatory safeguards, including anti-money laundering requirements. Legkodymov was arrested in Miami.
Writing for Global Legal Insights, authors from the Paul, Weiss, Rifkind, Wharton & Garrison law firm explain that particularly in the last two years, the US Treasury Department’s Office of Foreign Assets Control (OFAC), and the US government more generally, have become more active in applying US sanctions laws to cryptocurrency companies.
They write that the US government’s application of sanctions to the crypto sector is ‘nascent and still evolving’ and it is likely that it will continue to set new precedents in the short term. These efforts were shaped by President Biden’s crypto executive order, which asked government agencies to prepare reports and recommendations about different aspects and risks posed by crypto.
The Treasury Department has already responded to the Executive order with its document titled “ Action Plan to Address Illicit Financing Risks of Digital Assets”. It prescribes Priority Actions including —
- Monitoring Emerging risks,
- Improving Global AML/CFT Regulation and Enforcement,
- Updating BSA Regulations,
- Strengthening U.S. AML/CFT Supervision of Virtual Asset Activities,
- Holding Accountable Cybercriminals and Other Illicit Actors,
- Engaging with the Private Sector,
- Supporting U.S. Leadership in Financial and Payments Technology:
To the 5th point - The Treasury writes it will “Continue investigating, detecting, disrupting, and prosecuting the illicit use of virtual assets including for money laundering, ransomware, terrorist financing, fraud, theft, digital extortion activity, and sanctions evasion, and holding cybercriminals and other illicit actors accountable.” They will support this action with assistance from the Department of Justice and the Department of Homeland Security.
The European Union is also attempting to ramp up its regulation of crypto assets with the Markets in Crypto Assets (MiCA) regulations aiming to align crypto rules across its 27 member countries. The document is 400 pages long and has been debated for almost two years. Elements of the document include a regulation that requires issuers of stablecoin to hold a prescribed level of reserves and crypto miners being required to disclose their energy consumption.
The European Parliament has yet to finally vote on MiCA. A December vote was delayed and a Q2 2023 vote seems most likely. Long story short – there will be standard regulation on the crypto sector across the EU some time in the near-ish future. Beyond the USA and the EU, Hong Kong is adding new legislation that will boost requirements for virtual asset exchanges for anti-money laundering, anti-terrorist financing, and investor protection. The new rules will be “consistent with the requirements currently applicable to traditional financial institutions.”
Countries like India and China are launching Central Bank Digital Currency (CBDC) pilots, although both major economies could best be described as anti-crypto. There are concerns that following India taking over the presidency of the G20 group of nations, it will push harder for global coordination to regulate cryptocurrencies.
In 2022, Indian Prime Minister Narendra Modi speaking virtually at the World Economic Forum annual Davos Conference said "Cryptocurrency is an example of the kind of challenges we are facing as a global family with a changing global order. To fight this, every nation, every global agency needs to have collective and synchronized action." India will host the 18th G-20 conference in New Delhi between the 9th-10th of September this year.
It remains to be seen how incidents like the collapse of Genesis Lending and the continued fast and loose operations of crypto exchanges globally will be regulated in the coming year. But the regulatory space is likely to be more structured and active than ever before.
2. A staking revolution and how the Shanghai hard fork will affect markets
The price of Ethereum (ETH) is up ~29.7% since the beginning of the year. The key factor in this price rise has been an improved global macro situation but another more specific factor is the hype surrounding the upcoming Shanghai hard fork. This will be the biggest Ethereum upgrade since the Merge and Ethereum developers have committed to a March 2023 implementation. The Shanghai upgrade will include Ethereum Improvement Proposal (EIP) 4895. This will allow for Beacon Chain staked Ether withdrawals. This is Ether that has been staked to the network by validators and delegators and has been inaccessible for months.
There are some concerns that the large unlock will lead to a wave of selling pressure as stakers can finally regain liquidity, but some observers say the unlocked ETH liquidity will be swept up by new demand to stake. There is also a view that ETH staking will increase post-Shanghai given the new flexibility offered to stakers.
Despite being the most staked asset in crypto, the ratio of staked ETH is just 13.99% of the total ETH supply according to stakingrewards.com. This compares poorly to the ratio of staked assets on other major Proof-of-Stake chains like the BNB-chain, Cardano, and Solana, all of which have ratios of staked assets sitting above 70%.
Some analysts predict that the ratio of staked ETH may rise to between 30%-50% post-Shanghai. The market is predicting that some of the biggest winners of Shanghai will be staking services like Lido Finance (LDO) and Rocketpool (RPL). The price of LDO is up ~112% in the last month, while RPL is up ~66%.
3. An uncertain Macro environment - A recession or an economic turnaround will affect crypto prices.
Crypto continues to broadly be driven by macro market trends. Despite crypto and the blockchain being a unique technology unlike any other payment and record-keeping technology, its value in the last year or so has been driven by inflation, interest rates, and a correlation with the US stock market.
Particularly in 2022, the largest driver of price changes was CPI prints and FOMC rate announcements. In the lead-up to each of these macro events, or directly after they occurred, there was often a price reaction.
Source: Tradingview, BLX
The price of BTC dropped sharply after the June 2022 CPI print which indicated that the yearly price increase of everyday goods and services related to the cost of living had soared to 9.1% - well above the predicted 8.8% rate. Prices fell because of the implication that discretionary spending would be more difficult in a high-inflation environment.
With FOMC meetings, where interest rate changes are announced, the price action tends to occur pre-announcement. Before interest rate announcements in May and June, we observed price slides in the lead-up to them. This is primarily due to target rate probabilities being revealed to traders well before FOMC meetings.
Tools like CME Fedwatch reveal market assessments of what interest rates will be pre-announcement. Currently, for example, traders on the CME believe with 99.3% certainty that on the 1st of February, the FOMC will raise target interest rates by 0.25%. The high level of certainty from CME traders suggests that the interest rate hike is already priced in – almost a week before the announcement.
Bitcoin and the crypto asset class in general have begun the year strongly on the back of cooler supply chain (PMI) and wage (non-farm payrolls) reports. These economic indicators suggest that US inflation may have peaked and that interest rate rises in the country will slow.
The first CPI print of the year was released on January 19th. The report, which covered consumer prices in December 2022, showed that prices rose by 6.5% in the month. This was the smallest increase in a year and the sixth month in a row when the inflation rate had slowed.
Bitcoin is up 35.2% since the start of the year on the back of indications that US dollar inflation is lower and interest rate hikes in the country will slow. Bitcoin has just hit 4-month highs and is enjoying strong momentum on the back of more positive macroeconomic data. At a narrative level, there is a view that the US and the global economy is normalizing after the chaos caused by the COVID-19 pandemic.
There are many forecasters and economists, however, who view the current price bull as temporary. In general, the global economic outlook for 2023 appears to be bleak to middling. The World Bank recently slashed its global economic growth figure for 2023 to 1.7% from its previous number of 3%. The World Bank said this would be “the third weakest pace of growth in nearly three decades”, only comparable to periods during the Global Financial Crisis and the height of the pandemic. US growth is predicted to be 1% and in Europe & Central Asia 0.1%.
JP Morgan predicts a mild recession in the US this year, though its forecast is particularly bearish about discretionary spending and capital investments. It suggests more losses in the stock market and across other asset classes simultaneously including crypto, housing, bonds, and alternative/private investments. It predicts fundamentals will deteriorate and constrictive interest rates will continue to be a cloud over speculative investments.
Whether or not the macro turns and Central Banks start to raise interest rates sharply again to get the inflation rate to 2%, what is clear is that the price of BTC and other cryptos will continue to be directed by the macro economic state-of-play.
4. Layer 2s will continue to grow in popularity
Despite the pervasive bear market of 2022, Web3 adoption continued unabated. Web3 is a new form of the internet that enables peer-to-peer interactions without centralized platforms or intermediaries. Incentives in Web3 are not based on capturing personal information, they are powered by cryptocurrency payment incentives. It has been developed by evangelists who argue that the centralization of the internet will not be tenable in the long run.
Users are no longer willing to negotiate with gatekeepers who add permission layers to use applications like search engines, games, and social media platforms.
Partially segregated from the speculative crypto trading market, Web3 sectors including passive income, gaming, and NFT marketplaces have maintained consistent volumes and usage throughout the last three months.
Uniswap V3 (DeFi) Key Metrics. Source: Dappradar.com
Axie Infinity (Gaming) Key Metrics. Source: Dappradar.com
OpenSea (NFT Art Marketplace) Key Metrics. Source: Dappradar.com
This consistent usage and user base associated with Web3 is why there is a growing demand for layer 2 solutions. Layer-2 refers to any secondary framework or protocol built on top of an existing blockchain that adds features that generally improve the scaling capabilities of the base chain.
One of the key advantages of layer-2 solutions is that they don’t require any structural changes of the base layer chain. Layer-2s also leverage the security of the main chain by periodically communicating with them to confirm validity.
Notably, users of the market-leading platform blockchain Ethereum often face high transaction costs and a slow pace during periods of network congestion. Layer-2s allow users to continue to use leading Web3.0 applications without major disruptions caused by heavy traffic.
Optimism Volume and Fees in the last 30 days. Source: Token Terminal
Polygon Size and Fees in the last 30 days. Source: Token Terminal
Arbitrum and Fees in the last 30 days. Source: Token Terminal
In terms of 30-day daily active users, Arbitrum has an average of ~48,000, Optimism has ~61,000, and Polygon has ~381,000. This suggests there are nearly half a million daily users across the primary Ethereum layer-2 solutions. Ethereum daily active users sit at ~470,000.
On January 12th, daily transactions on the Optimistic network hit 800,235, a new record. The transaction volume on the network has surged by more than five times since September. Arbitrum’s daily transactions peaked at 576,012 transactions on November 8th, 2022. Polygon’s highest number of daily transactions was 9,177,310 on June 16th, 2021. Currently, Polygon has ~2.9 million transactions a day. Ethereum averages around 1.0 million transactions a day.
Particularly given the high usage of the Polygon network, Ethereum is beginning to fulfil a role as a back-end settlement layer for layer-2 blockchains that offer cheaper and faster transactions. Its role as a retail-facing platform for consumer dapps is reducing.
With more complex transactions requiring more smart contract complexity, layer-2s become particularly useful because of the cheaper gas solutions they offer.
The Perpetual Protocol is a perpetual futures platform that was originally built on Ethereum, it has now been ported to be an Optimism exclusive Dapp. As well as popular Dapps like Uniswap, Curve, and Opensea launching layer-2 versions, these scaling platforms build their own armory of exclusive Dapps like Synthetix, Quickswap, and Honor World. We have not quite hit a flippening, but there is a trend toward Optimism, Abritrum, and Polygon replacing many of the transactions that were once exclusive to Ethereum.
Source: Twitter - @Dynamo_Patrick
Once MiCA has been implemented, the demarcation line between a compliant crypto project and a non-compliant one will be abundantly clear. While there are still those who believe this will hamper innovation, it should be pointed out that the cost of this ‘innovation’ has been a string of epic financial collapses that have turned more people off crypto than any regulation ever has. Expect the legit players to do all they can to get compliant this year.
Unfortunately, the dominant narrative from crypto’s early years that the sector was isolated from world events has not proven out and the macro environment will remain the elephant in the room for now. But despite 2022 being exceedingly tough, most crypto projects didn’t collapse, lots of money was raised – and the upshot of that will be a range of new retail market focused layer-2 roll outs this year that could bring in new users and start growing the sector again. It’s not going to be an easy year, but cautious optimism is justified.
Link to OG article