Crypto Market Monitor – 21st December 2022

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This Week in Crypto

Markets have crumbled over the past week, which can in part be attributed to skepticism around the proof of reserves of main industry stakeholders that led two auditors, including Mazars, to bid crypto farewell. Bitcoin and Ethereum are down by 7.6% and 11.5%, respectively. The biggest losers of last week’s rally were Cardano (-19%) among the major Layer 1s, Optimism (-21.6%) among the major Layer 2s, and Curve (-21%) among major DeFi players.

Figure 1: Weekly TVL and Price Performance of Major Crypto Categories

^{Source: Coingecko, DeFi Llama. Data as of Dec 13 to 19.}

Key takeaways:

Sam Bankman-Fried to be extradited to the US; charges could sentence him to 100+ years
Polygon is auditing its zkEVM, while Consensys announces its own public beta testnet of the scalability solution
Crypto auditors Mazars and Armanino quit the industry to mitigate reputation risk.
Chainlink released NFT floor pricing feeds on Ethereum.

Spot and Derivatives Markets

Figure 2: BTC Futures Long/Short Ratio

^{Source: Coinglass}

The chart above can depict the current market sentiment, which has been volatile over the past week, reaching the lowest levels month over month. However, investors’ appetite picked up today, leaning towards longing Bitcoin by almost 53%.

On-chain Indicators

Figure 3: Binance Asset Flow y/y

^{Source: 21Shares, Dune Analytics}

There has been a multitude of outflows on Binance in the week of December 12, as shown in Figure 2. Almost $14B worth of outflows from the world’s largest crypto exchange over the past week, and almost $11B of inflows.

Macro and Regulations

Positive CPI data in the US pushed Bitcoin over the $17K mark for three consecutive days. The Fed raised its key interest rate by 50 basis points, making the federal funds rate lie between 4.25% to 4.5%, its highest level in 15 years. The latest move, though lower than the previous 75 basis point hikes, will further increase the risk of a recession. On that note, the Fed thinks sharply higher rates are still needed to fully tame the 40-year-high inflation and get inflation down to the 2% mark.

FTX Aftermath: Former FTX CEO Sam Bankman-Fried (SBF) consented to be extradited to the US to stand before the court for an arraignment and bail hearing. SBF has been charged with eight counts of wire fraud and conspiracy in a court hearing on Monday. The plot thickens as the FTX filing presented to the US court on December 12 implies that SBF’s attorneys and Bahamian officials may be wrangling on hundreds of millions of dollars worth of assets in the Bahamas to settle funds attributed to users based in the island, which means the Bahamian government could have violated US bankruptcy law preventing selective payments to creditors.

Proof of Reserves: The uncertainty around proof of reserves (PoR) is intensifying, as French auditor Mazars announced it is pausing PoR assessments for crypto clients, which include Binance, Crypto.com, and KuCoin, due to concerns regarding the way these reports are understood by the public. More permanently, California-based Armanino is quitting crypto after eight years of auditing players in the industry in an effort to save face after being named in a class-action lawsuit for failing to catch irregularities at FTX.US after performing the exchange’s audit last year. At a glance, this can seem like a setback for the industry, but in fact, it’s a step in the right direction as the market conditions continue to filter out bad actors to restart on a clean slate. For the time being, this could entail venture capitalists demanding crypto companies to only work with auditors of the Big Four accounting giants.

Bank of International Settlements: On another note, the Bank of International Settlement released a report titled “Prudential treatment of cryptoasset exposures” that will limit banks in its jurisdiction to hold no more than 2% of their reserves in Group 2 or unbacked cryptoassets, starting January 2025.

The Digital Asset Anti-Money Laundering Act: Senators Elizabeth Warren and Roger Marshall introduced a new bill proposal titled “Digital Asset Anti-Money Laundering Act” that would expand KYC to crypto users and target self-custody wallets, inaccurately referred to as unhosted wallets in the text. The proposed bill directs Financial Crimes Enforcement Network (FinCEN) to promulgate a rule classifying custodial and unhosted wallet providers, cryptocurrency miners, validators, or other nodes who may act to validate or secure third-party transactions, independent network participants, including MEV searchers, and other validators with control over network protocols as money service businesses. The proposed bill coined the term “Digital Asset Kiosks” to define digital asset automated teller machines that facilitate the buying, selling, and exchange of cryptoassets. Also, under the supervision of FinCEN, the proposed bill mandates that Digital Asset Kiosks should be able to verify the identity of each customer, collecting the name, date of birth, physical address, and phone number of each counterparty to the transaction. These Digital Asset Kiosks will also be asked to provide FinCEN with the physical addresses of the kiosks owned or operated by the operator or administrator on a quarterly basis. That being said, the Warren-Marshall bill has been criticized for its authoritarian measures that stand against not only what crypto represents but also the constitution. In contrast, Tom Emmer wants to restart lobbying for his bipartisan Blockchain Regulatory Certainty Act, a bill that asserts that blockchain entities that never custody consumer funds are not money transmitters.

With regards to adoption, CSOP Asset Management raised $79M ahead of listing the first Bitcoin and Ethereum ETFs on the Hong Kong Stock Exchange on December 16, marking a breakthrough for the industry despite the FTX debacle and its aftermath of troubled market sentiment. The Bitcoin mining industry also received some good news on the back of the announcement made by Japan’s largest power company, TEPCO, which is set to mine Bitcoin with excess energy.

Crypto Infrastructure

Layer 1s: Italy is scheduled to be among the first EU states to leverage blockchain technology to refine their traditional guarantees markets. The research center on Innovation and Finance at the University of Milan announced it chose Algorand to build its new digital guarantees platform as part of the country’s National Recovery and Resilience Plan to boost the economy following Covid. The platform, supported by the bank of Italy and the insurance authority IVASS, is expected to offer an improved infrastructure for banking and insurance guarantees. The mechanism is seen as an alternative to providing collateral as banks or insurance companies promise to cover loans in case of a borrower’s default. The L1 is now better suited to host this innovative offering following the September upgrade, which increased its TPS to 6000 TPS, combined with introducing state proofs. The latter allows interoperability on the back of providing a lightweight snapshot of Algornad’s state that any blockchain can query, allowing them to cross-communicate. In other news, Avalanche released the mobile version of its ‘core’ wallet. Initially launching on Android with the expectation to migrate to IOS early next year, the non-custodial solution enables a one-stop shop to access DeFi and metaverse ecosystems across a plethora of blockchains, including EVM-compatible networks as well as bitcoin. The wallet also supports in-house swapping and bridging from external networks, combined with seamlessly creating subnets. With Core now existing as a mobile, web and chrome extension, Avalanche is taking important steps towards setting up an interconnected experience that should help drive the network’s adoption forward as it abstracts the complexity of having to utilize a list of disjointed protocols to actualize some of the aforementioned on chain activities.

Layer 2s: The zkEVM race is continuing to heat up as Consensys has now joined the slew of other protocols rallying to launch the first truly complementing scalability solution to Ethereum. As a reminder, Zero-knowledge rollups are considered a breakthrough as they facilitate scalability without sacrificing Ethereum’s security guarantees, a notion less visible across Optimistic rollups and sidechains. The leading ETH infrastructure company revealed its private beta testnet on December 12, with more than 150K signing up to test out the network’s experimental playground. The company will begin onboarding users in January of next year, prompting developers and users to begin leveraging existing infrastructure toolings such as Infura and Truffle to send assets from the Goerli network and interact with an ecosystem of dApps that will be announced soon. Similarly, Polygon announced that it had begun a comprehensive audit of its zkEVM rollup. Spearbit and Hexane are the independent firms handling the security testing targeting 37 components that make up the innovative privacy-preserving solution. In that view, the audit is focused on attesting the validity of assertions across vectors: correctness and soundness. In other words, the security firms are investigating if valid proofs can generate invalid state transitions or if invalid proofs would be verified. The current audits will give the clearance for launching what is considered as the last testnet before mainnet deployment early next year.

Decentralized Finance

Figure 4: Top 10 DeFi Assets Weekly Performance

^{Source: Coingecko}

The Solana Ecosystem: The Solana network is still reeling from the collapse of FTX and its intricate web of associated dependent entities that were highly invested in its universe. For instance, the biggest undercollateralized lender of the Solana ecosystem unveiled Maple 2.0, a fundamental overhaul of the protocol’s architecture. In its blueprint, the lender publicizes their intent to terminate lending on Solana and instead focus exclusively on growing its credit pools on top of Ethereum. Nevertheless, that wasn’t the only divulgence, as the upgrade presented significant features that addressed some of the protocol’s shortcomings, such as introducing pool delegates to expedite the handling of defaults, refining the withdrawal request process, and eliminating lockup periods on deposits. In addition, the overhaul also saw the termination of staking MPL – the platform’s native token – and bar it from being used in the default protection fund as it led investors to quickly unbond their stake and sell the token once a default was becoming more visible.

The Ethereum Ecosystem:

In other news, Perpetual Protocol is tackling the issue of value accrual for its token holders as it finally introduces USDC fee sharing. The governance vote, which passed on December 13, will now see the reallocation of 15% of trading fees toward vePERP holders. As a reminder, Vote Escrowed (VE) system is a model that fosters long term alignment between projects governance and their voting where users lock their tokens in exchange of a synthetic VE token. They can then use to increase their governance power and foster increased participation. The size and period of their lockups determine how much more governance power is accrued to the user. Looking at Perpetual Protocol, establishing fee sharing is a critical step towards realizing the notion of real yield within DeFi and a step away from the mercenary and unsustainable yield built around high token emissions.
Finally, Curve finance revealed it chose zkSync as the first zero-knowledge rollup to host its infamous DEX. Expected to launch on mainnet next year, Curve will reportedly begin the dApp’s development during the fair onboarding alpha phase along with hundreds of other protocols. This is a key development for the embryonic ZK-Rollup universe as Curve has played an integral part in DeFi due to offering composability and stability over the more speculative aspects the sub-industry has been associated with. As such, expanding the protocol’s support towards the emerging L2 will help inject further capital and deepen liquidity across its ecosystem.

ETH-Alternatives: Raydium, the Solana-based DEX, was hacked and lost roughly $2M in the process. The initial post-mortem articulated that the exploit emanated from a compromised private key that allowed the attacker to access the pool owner account to collect and withdraw fees earned from pool swaps. That said, the final post-mortem further clarified that the attacker could only target eight constant product liquidity pools leading to the siphoning of a total of $4.4M. The team has already implemented measures to buttress this attack surface, like removing unnecessary admin privileges that would prevent a compromised key from repeating such exploitation. The news is relevant as Radium is now the second biggest DEX by TVL on the Solana chain, after the previously leading DEX Serum was deemed defunct following the news that its upgrade key was compromised after the FTX fallout. Thus, the Solana ecosystem is still struggling to shrug off the chaos that ensued from the collapse of the exchange. Finally, a new Proposal was published seeking to deploy Uniswap V3 on the Binance Smart Chain. The move is expected to be advantageous to the 2nd largest chain by TVL as it introduces the benefits of concentrated liquidity to the ecosystem and helps traders and liquidity providers capture the most value for their capital. A feature that BNB’s biggest DEX pancake swap doesn’t offer. That said, the proposal is expected to last for another week before it enters the temperature check stage and proceeds toward the actual vote.

NFTs and Metaverse

The future is multichain, and Solana’s biggest NFT marketplace MagicEden has been pushing toward this direction with its support for Polygon-based NFTs minting. This is an effort that has been brewing since November 22, when MagicEden first announced adding support for NFT trading on Polygon. In quite a timely manner, Crypto.com also announced its DeFi wallet allows users to store Polygon-based NFTs. On the back of partnerships inked last week, Warner Music Group are launching music NFTs through the upcoming LGND platform Polygon. LGND Music is an innovative music and collectibles platform that will support digital collectibles from any blockchain in a proprietary player, allowing consumers to play their digital collectibles, or “Virtual Vinyls,” on the go.

Innovation in this space is endless; however, it’s only those who have a solid product-market fit who will survive. Chainlink released NFT floor pricing feeds on the Ethereum mainnet, starting off with ten collections. Metamask, GnosisDAO, and Cobo are teaming up for a new soulbound project called Evolution that would live in users’ wallets forever as a form of digital identity. With no intrinsic monetary value, soulbound tokens (SBT) help create a personal identity that will, in turn, allow users to be recognized for their assets and achievements. From a commercial perspective, SBTs also enable organizations to create long-term bonds with their clients. Optimism is also releasing customizable picture-for-proof NFTs, named “Optimist NFT,” representing user identity throughout its ecosystem.

Next Week’s Calendar

^{Source: 21Shares Forex Factory}