2022

Projections and growth prospects for the year ahead

Jan 03, 2022

Hello readers,

We’re back after a brief break last week for the holidays. I hope everyone had a nice Christmas and a Happy New Year.

I’m pumped to kick off 2022 by breaking down the state of crypto, what we can look for in the year ahead, and the critical elements needed for continued adoption.

Topics covered:

Bitcoin
Ethereum Competition
DeFi (lending/borrowing/exchanges/insurance/payments)
Security Tokens & Digital Private Market Assets
NFTs
DAO’s
Metaverse

If you haven’t subscribed and would like to receive these reports directly to your inbox, drop your email below:

Let’s go.

Bitcoin

Bitcoin limped through the finish line of 2021. So far, the 3rd halving cycle has not produced parabolic price moves like the first two. Below we can compare the cycles to date:

Is the cycle over? Nobody knows. Bitcoin may be entering a new era where the halving cycle is more drawn out, and we don’t see the parabolic price moves and the subsequent 80% drawdown thereafter. This makes sense as the impact on Bitcoin’s monetary policy regarding the scarcity of new bitcoins coming onto the market is reduced with each halving. We are seeing this in the price action with each halving. The dynamics of the Bitcoin market changed significantly in this cycle as well. Bitcoin is becoming a mature, global macro asset right before our eyes. We now have well-formed derivatives and futures markets. We have spot ETFs in Canada. We have futures ETFs in the US. We have 24/7, 365 days/year trading. We have a robust exchange market and $50+ billion of trading liquidity on most days. We have regulatory clarity from the CFTC and SEC - both have deemed Bitcoin to be a commodity and not a security. Institutional players have entered the game and more are likely coming. Publicly traded companies like Tesla, Block, and Microstrategy now hold Bitcoin as a treasury asset on their balance sheet - an inflation hedge strategy. We have a nation-state that has adopted Bitcoin as legal tender, with more likely to join them.

For 2022, I would expect to see more of the same from Bitcoin. Highly respected Wall Street veterans like Ray Dalio and Paul Tudor Jones now view Bitcoin as an inflation hedge. If inflation continues to persist, Bitcoin should be one of the beneficiaries along with other hard assets. As the economic toll of Covid becomes more obvious around the world, we should see more countries running into currency problems. Turkey is the first G20 nation dealing with significant issues, having recently raised its minimum wage by 50% to help the lower class in dealing with runaway inflation. We should expect to see more of this, particularly in the emerging markets. I’ll be looking for increased adoption of Bitcoin in these countries as their currencies become weaker and weaker.

I’m also looking to see more collaborations between the energy industry and Bitcoin Mining. We are seeing some really interesting joint ventures between oil producers and Bitcoin Miners today. Many oil drillers produce a natural gas byproduct as a result of their drilling activities. This byproduct has no economic value, is costly to remove from the drilling site, and is bad for the environment when flared into the atmosphere. Bitcoin Miners are now helping these oil companies monetize this natural gas byproduct by running it through a generator on-site and mining Bitcoin with it. This is an interesting development that is creating a win/win/win situation for the oil companies, Bitcoin Miners, and the environment. This is essentially allowing the miners to leverage free energy to produce bitcoin while reducing harmful emissions caused by the flaring of these natural gas byproducts. The oil drillers are benefiting from reducing emissions, saving $ on the removal of the byproduct, and monetizing something that was previously an expense on their books.

We are also seeing some interesting contracts being drawn up between Bitcoin Miners and grid operators. For example, Bitcoin Miners can leverage Solar and Wind energy to mine Bitcoin in Texas with the excess renewable energy being produced. These contracts are being structured such that when the grid demands the energy, the Bitcoin Miners simply shut off their machines.

It appears that the energy grid is starting to view Bitcoin Mining as a stabilizing force, which is driving costs down in some areas. The reason for this is many communities have excess energy production. We need to have excess at all times so that we are ready for extreme events. But we pay to have this excess energy available on demand. This is where Bitcoin Miners come in. They can turn their machines on and provide a load for the excess energy. This drives energy costs down for members of these communities. And when the grid demands the energy in an extreme event, the Bitcoin Miners simply turn their machines off and pass the needed energy back to the community.

Lightning Network

The last area we’ll be keeping an eye on for Bitcoin is the layer 2 Lightning Network. Lightning is enabling instant micropayments at no fee. This is how you pay for your coffee with Bitcoin. You can even leverage the lighting network to make fiat payments now using Strike App. This means businesses can now accept dollars over the Bitcoin network and do so at zero fees. Why would anyone pay 2.9% to Visa and Mastercard? It’s only a matter of time before credit card fees are a thing of the past. We are also seeing some DeFi applications now being built on Bitcoin (Stacks, Soveryn/RSK, Liquid, etc). We’ll cover these apps sometime during 2022.

Ethereum Competition

Ethereum has some competition. In 2021, we saw Solana and Avalanche see rapid growth and gain significant market caps (combined market cap of about $75b). Polkadot has a market cap today of $26b. These protocols are still quite small when compared to Ethereum ($450b market cap), but have gone mainstream and are now competing for Ethereum’s market share and developer talent. NEAR protocol is another Layer 1 that I am watching to see if it goes mainstream in a similar manner as Solana and Avalanche last year.

Ethereum is also moving to proof of stake in 2022. This is a significant change to the consensus mechanism that will put an end to proof of work mining. By moving to staking to verify transactions, Ethereum hopes to significantly enhance its transaction speed while lowering costs. Gas (transaction) fees are a major problem on Ethereum today. This is forcing retail investors onto layer 2 platforms like Polygon, and in some cases, users are switching over to Solana and Avalanche. If Ethereum successfully pivots to proof of stake (no easy task), speeds up its transaction throughput, and reduces gas costs, this would put pressure on its competition. Remember, Ethereum still has the vast majority of developer talent in the ecosystem. There would be no incentive for them to move to another chain if the move to proof of stake is successful. This would significantly enhance the long-term viability of Ethereum within the ecosystem.

Bridges

We are getting close to being able to build applications and services that can leverage data and functionality across multiple layer 1 blockchains. Bridges are absolutely essential because without them we are essentially building parallel highways with the various Layer 1’s. Look for protocols to launch in 2022 that provide this interoperability across multiple chains. Accumulate Network is one to keep an eye on that is planning to launch in the first half of 2022.

DeFi

The DeFi subsector (lending/borrowing/insurance/exchanges/payments) of crypto had a slow 2021 when compared to 2020. Total value locked sits at $100b today, down slightly from the 2021 high of $110b. The reduced activity in DeFi is primarily due to the explosion of NFTs, gaming, metaverse, etc in 2021. This is likely to change in 2022. I’m closely watching for DeFi to become institutionalized with Permissioned DeFi in 2022. Fireblocks, the leading institutional custody provider for digital assets, recently requested whitelist access for permissioned DeFi with Aave Arc’s governance.

The critical missing piece for permissioned DeFi is identity. Today, users in Web 3.0 operate with pseudonymity. Their wallet address (think bank account) is a string of letters and numbers. It is not directly tied to the user. With that said, I’ll note that users of regulated exchanges must go through KYC/AML checks and identify themselves. This allows law enforcement to track blockchain transactions and ultimately catch criminal activity at the fiat on/off ramps.

For institutions to adopt DeFi, they need to be in compliance with regulators. This means they need to know who their counterparties are in their blockchain transactions. Decentralized identity accomplishes this. Look out for a protocol that will be launching in the first half of 2022 called ONCHAINID. With ONCHAINID, users will be able to tie their wallets to their identity (license, social security #, etc). It’s important to note that the user has the option to share their data with applications and businesses in Web 3.0 in a permissioned manner (via a smart contract). The user still maintains data sovereignty. Something like ONCHAINID can also be used for brand loyalty programs. This enables companies to use Web 3.0 to identify the person on the other end of free giveaways or customer appreciation efforts. It can also be used by non-profits to accept crypto donations.

Ultimately, identity is the missing piece that will drive massive growth in DeFi. It will also allow regulators to create enforceable rules and standards which will drive further adoption.

I’ll note that the idea of identity is antithetical to many in the DeFi community. But the fact of the matter is that we will never see broad adoption without identity. To me, its the best of both worlds. Users still control their data. They allow 3rd party apps or websites access when they need to show that they are legit. Users can revoke that access as needed. Pseudonymity remains. Data sovereignty remains. Users just have the option to opt in when they want.

A few additional areas to keep an eye on: decentralized insurance and the pledging of real-world assets as collateral for loans in DeFi lending. According to Elliptic, the total value lost by DeFi smart contract hacks was $10b in 2021. This is unacceptable. To protect users from hacks, we need to see a rise in viable decentralized insurance protocols. This problem is being worked on. Finally, I’m looking for DeFi to start allowing more real-world assets to be pledged as collateral for loans. Validated data on these assets and owners is the critical missing piece today.

Security Tokens

The security token space is heating up right now. When we think of digital asset securities, we can simply think of existing securities where we are just dematerializing the asset and putting it on a blockchain. Moving the asset to a blockchain for custody, transactions, accounting, and fund administration has significant upside. If you’re interested, I recently wrote about the differences between digital assets and traditional assets.

We should look to private market assets to lead the charge here. Why? Private market assets like Commercial Real Estate are illiquid assets. Blockchains can make these assets more liquid due to their ability to record all of the relevant pricing data for the asset including a third-party fair value mark. This is information that allows investors to establish price discovery. Price discovery leads to enhanced liquidity.

Furthermore, dovish monetary policy as a result of unsustainable debt levels has pushed interest rates to the zero bound. This is forcing investors to lower their discount rates and pay premiums for public assets at already elevated valuations. As a result, investors are moving into private markets. Blackrock has been leading the charge here, recently advising that the 60/40 portfolio is dead. A 50/30/20 portfolio is now recommended with the 20% basket including private market assets.

If you’re interested in exploring this topic deeper, you can check out The Missing Link, a LinkedIn newletter published by the CEO of Inveniam, Patrick O’Meara.

NFTs

NFTs blew up in 2021. I think it’s fair to say that the NFT space is a bubble right now. 98% of NFTs are probably worthless or worth significantly less than their current valuations today. I’m speaking mostly about the art NFTs out there.

This does not diminish the significance of NFTs. NFTs are fundamentally a digital certificate of ownership for everyone to see (like the title to a property). We can think of NFTs as digital property rights. This is significant for the creators of online content. Today, it is difficult for creators to monetize their content online because the platforms they are forced to use own the data and content. This has led to the advertising model taking over the internet. Large networks wall off the data and charge for access to it today. NFTs are dissolving these economic boundaries.

Furthermore, NFTs are allowing for equal access for creators globally. An artist in Africa now has the same economic tools at their disposal as an artist in LA or NY. Finally, NFTs allow content creators to be paid each time their work is resold through royalty payments automatically executed via smart contracts on the blockchain.

We’ll also be watching the gaming sector as a high-growth area for NFTs in 2022. Finally, we should keep an eye on the entertainment industry to start adopting NFTs for ticketing.

Decentralized Autonomous Organizations (DAOs)

While DAOs have been around for a while (MakerDAO launched in 2015), they really did not gain any mainstream attention until 2021, and still have not seen a hype cycle such as the one DeFi and NFTs have experienced. I think we should be on the lookout for that type of hype in 2022 from DAOs.

DAOs could potentially be disruptive to the corporate business model.

A DAO concept that I am particularly interested in is Friends with Benefits DAO, which is backed by a16z. FWB is a social community that leverages Discord. To gain access, users must purchase 75 FWB tokens. This gets you access to the network as well as a lot of inside information on NFT projects and interesting developments within the creator economy. Is FWB potentially what a social network will look like in Web 3.0? Look out for a future report covering DAO’s in the coming months.

Metaverse

All signs are pointing to the metaverse. I like to think of the metaverse as the next iteration of social gathering online. Howard Shultz, the former CEO of Starbucks, popularized the idea of “third physical space” with his coffee shop concept. It was his belief that humans needed a “third space” to assemble outside the office and at home. Starbucks was the answer.

We see this same concept playing out online, particularly with the younger generations. We started with chat rooms on AOL. Then Myspace. Facebook. And now the Metaverse. Cities are entering the metaverse. Concerts. Museums. Even burning man is now in the metaverse. Things are getting weird, I know.

An area that I am particularly interested in exploring is digital land. This sounds absurd, but if we are going to have cities forming in cyberspace, the concept of digital land makes sense to me. You can check out Sandbox or Decentraland to get a sense of what is being built in the metaverse today.

Conclusion

2021 was a big year for crypto. It used to be that you learned about crypto through Bitcoin. It was the gateway drug. This has changed in my opinion. In many cases, folks today are gaining exposure to crypto and Web 3.0 first through NFTs, DeFi, the metaverse, etc. As a result, crypto is slowly weaving its way into our culture.

Crypto continues to scale at an exponential pace. It’s growing at a pace almost twice as fast as the internet did. In comparison to the internet, we are currently at about 1997 in terms of adoption. This is now a $2.25 trillion dollar sector in terms of the market cap of the various networks (this excludes all of the private companies building in the space). It’s possible we could see this figure jump to $5 trillion in 2022.

There is so much to be grateful for as we head into 2022. I’m looking forward to continuing to share my research with you as I cover the space.

Thanks for coming along for the ride.

___

If you have a question, comment, or thought, leave it here:

The DeFi Report

Discussion about this post