Key Moments & Lessons From 2021
CRYPTOCURRENCY & BLOCKCHAIN
Article by Lesia M.
- Hot Trends 2021
- DeFi 2.0
- 2022 Outlook & Beyond
- Big Upgrades of 2021
- Institutional Adoption
- Bitcoin ETF — Expectations vs Reality
- Government Adoption & First Legal Tender
Hot Trends 2021
Year 2021 has brought numerous significant innovations within the crypto space, shifting it away from the DeFi-led narrative into a yet unseen uni(/meta)verse of cultural drive & users-owned Web 3. Watching this transition (and transitioning together with the space) has been a rich learning experience.
With that in mind, let’s look back on the development of some of the most important trends in 2021.
2022 Outlook and Beyond
Think ICO boom of 2017. Coming up with a whitepaper and bringing soma charisma to investors’ meeting was often a good starting point for initial fundraising. Whitepapers were copied and outsourced (for as low as $100) — and brought in millions of funding. Today, freelancers offer to create a unique NFT art collection comprising 1K pieces for as low as $300. Ongoing NFT mania traces 2017’s ICO boom alarmingly close, so what are the lessons we can learn from the past?
While coming up with a whitepaper in 2017 was often enough to secure seed funding, projects aiming to extend into Series A rounds or beyond had to deliver a blockchain-based product, be it a new coin, crypto platform or dApp.
We believe that in 2022, the next step for the metaverse & Web 3 would be full integration with the blockchain technology. The novelty of owning a digital property will soon wear off if there is no actual digital space to interact with. Such integration goes far beyond building individual metaverses: the wide range of emerging projects will have to be built on scalable blockchains optimized for DeFi; bridged across Layer 1 blockchains they are built on; soft- and hardware will have to be introduced to enhance user experience, with a guarantee of high degree of decentralization and ownership.
In the next stage of crypto development, metaverse-focused projects will expedite building on scalable blockchains powered by Smart Contracts (Layer 1s, e.g. Solana, Terra, Avalanche and Layer 2 scaling, e.g. Polygon), consequently increasing network value with the inflow of users and developers.
A vital milestone in crypto development is improving blockchain interoperability. Some multi-chain solutions (e.g. Polkadot, Cosmos) as well as cross-chain oracles (e.g. Chainlink) will be essential for this stage.
Scaling blockchain technology comes together with the need of extensive off-chain computation (e.g. GPU-based rendering Render Network); reliable security & scaling protocols (e.g. Zero Knowledge Proofs zkSynch, StarkEx); data indexing and querying (e.g. The Graph).
Big Upgrades of 2021
London upgrade finally introduced the long-awaited Ethereum Improvement Protocol 1559. EIP-1559 ensures that a portion of Ethereum’s gas fees is burnt, with the remaining amount going to miners. From the users’ perspective, EIP 1559 was supposed to provide a predictable fee-payment experience creating less network conjunctions on the one hand, and enforce the reduction in ETH issuance (inflation rate) on the other hand. Even though ETH users haven’t really felt either, this move comes as part of a larger plan to shift Ethereum from proof-of-work to proof-of-stake model, and we are yet to see the true impact.
Since the implementation of London Hard Fork, Ethereum network has burnt over 1.3m ETH worth around US $4.9 billion.
Taproot, Bitcoin’s long-anticipated upgrade, was finally activated on November 14 at block 709,632. Bitcoin’s biggest upgrade in 4 years is designed to make transactions cheaper, more private, more flexible and more scalable. In the best traditions of a decentralized network, Taproot upgrade was locked in by 90% of Bitcoin miners reaching consensus within one difficulty period back in June. Three distinct upgrades to the Bitcoin protocol are Schnorr Signatures, Taproot, and Tapscript.
Cardano’s Smart Contracts
Launched in 2017, Cardano is currently the fourth largest blockchain supporting Smart Contracts functionality, providing a platform for crypto projects and decentralized applications. Even though Smart Contracts were in development since project launch, their final deployment came around in September 2021.
With the launch of Smart Contracts, Cardano expects to become superior to Ethereum, as the latter is only transitioning to the Proof of Stake protocol. One of Cardano’s most obvious advantages is the project’s high degree of decentralization. Cardano’s 3,000 stake pool operators are responsible for 100% of block production. The higher the number of block producers on the network, the higher degree of security they provide making the 51% attack highly unlikely. ADA’s tokenomics is yet another evidence of the project’s preference for decentralization, with only 16% of crypto assets belonging to the team & founders and 84% sitting in the hands of investors.
Still, real-life application of Cardano could take a while, since the platform’s usability and scalability are yet to be improved. At the moment of writing developers prefer building their projects on alternative chains: Solana, BSC, Polygon or Avalanche.
Polkadot is a much younger project (launched in 2020) offering a blockchain platform for cross-chain interoperability. Its founder, Dr Gavin Wood, is also one of the early Ethereum founders.
The main feature of Polkadot are its parachains — custom, application-specific blockchains that run in parallel within the Polkadot ecosystem. It is designed to connect 100 parachains, with the first 5 parachains onboarded successfully on December 17 after winning the auctions: Acala, Moonbeam, Astar, Parallel Finance and Clover. Test parachain auctions were run on Palcadot’s canary network Kusama earlier this year.
Polkadot is planning to launch five more Parachain slot auctions between now and March 10th.
This year crypto space saw an ever-growing inflow of institutions — financial and corporate alike. We offer to take a look back at some of the most significant steps in the adoption of cryptocurrency & blockchain in 2021.
In March, Visa Inc came out with a statement that it will allow transactions in USDC and throughout 2021 has gone from partnering with cryptocurrency exchanges to offer Visa debit cards that earn crypto rewards, to directly accepting payments in USD Coin, to offering crypto-consulting service to boost mainstream adoption, to purchasing a $150,000 Crypto Punk for its corporate collection. Mastercard also took steps for further adoption of cryptocurrencies as both payment methods and investments and now allows all the banks and merchants on its network to offer crypto services.
April 2021 felt like the month when all U.S. mega-banks decided to make their entrance into the crypto market. Goldman Sachs started offering a wide range of bitcoin investments and other digital assets to its wealth management clients. Investment options included physical bitcoin, derivatives and other traditional investment vehicles. Morgan Stanley allowed qualified investors to access three of external crypto funds, two of which are run by Galaxy Digital and the third one by both IS Investments and NYDIG. JP Morgan announced the set-up of a bitcoin fund provided by NYDIG, which was eventually launched in August. JP Morgan accepting bitcoin investments was a notable change in tone, as the CEO, Jamie Dimon, has been knows to heavily criticise bitcoin in the past. On the other hand, crypto offerings of mega-banks remain restricted to wealth-management clients. Bank of America shows interest in the space as well, but for now only engages in crypto through its Global Research division (which aired a high-level report on crypto in November).
Banks and traditional financial institutions have been slow to respond to the rise of fintech in the last 20 years, let alone the retail buzz around blockchain and crypto solutions. The long-awaited “co-opetition” between banks and tech is more timely than ever, with around 60 fintech companies currently reaching $1bn in their market cap. Circle, Square, Revolut, Wirex, Zeux and many other ‘challenger banks’ all provide retail cryptocurrency offering alongside with payments and money transfer solutions. Availability of cryptocurrency offerings on these platforms is driven by high customer demand since their customers generally follow new technological developments and are willing to embrace innovation.
VC Investment in crypto space reached an all-time-high in Q3 2021 as per Galaxy’s research report dating 23/11/2021. At the same time, the gap between crypto VC valuations and broader venture market continues to widen, raising questions of whether such build up is sustainable in the long run. Nevertheless, such meaningful institutional inflow in crypto space goes in line with our view that ongoing corrections are not a sign of crypto winter, but rather a year-end profit taking with new capital waiting to be deployed following market re-bounce.
Outside of finance & payments industry, 2021 was the year when luxury auction houses started accepting cryptocurrency. Tangible eight-figure objects can now be bought with cryptocurrency at Sotheby’s, Christie’s and Phillips.
S&P Dow Jones Indices launched several crypto indexes, including the new S&P Cryptocurrency Broad Digital Market (BDM) Index, which included over 240 coins at launch. The Bloomberg Galaxy Crypto Index (BGCI) was launched by Bloomberg Index Services Limited and Galaxy Digital Capital Management. The index is a capped market capitalization-weighted index designed to measure the performance of the largest digital assets traded in USD. With the changing perception of digital assets, prominent institutions are all launching cryptocurrency indexes to face the growing need for transparency and standardization in the space.
Tesla/crypto relationship had a rollercoaster 2021, with the company adding bitcoin to its balance sheets and accepting it as payment early this year, only for Musk to reverse his supposedly bullish views of the cryptocurrency and suspend bitcoin payments due to environmental concerns. Finally, in the July’s “B Word” conference, Musk softened his tone on bitcoin and confirmed that Tesla will reintroduce BTC payments as soon as ‘there is reliable confirmation of reasonable (50%) clean energy usage by miners’.
Microstrategy kept buying highs and lows in 2021, bringing the total holdings up to approximately 122,478 bitcoins, purchased at an average price of $29,861 per bitcoin by the end on 2021.
BTC tipping feature was made possible on Twitter thanks to the Lightning Network, allowing influencers to earn money without geographical restrictions. For now, this tipping feature only supports the Strike app, but gives an option of adding one’s BTC address to the profile to receive BTC from other apps. Strike CEO claimed that combining Bitcoin global monetary network with one of the biggest internet networks on Twitter will be an ‘absolute payment disruption that’s been a long time coming’.
And, of course, Facebook rebrands to Meta (for better or worse).
Bitcoin ETF: Expectations vs Reality
Hopes for an SEC-approved bitcoin ETF had been high beginning of the year — then low — then high again when the US SEC Chairman Gary Gensler hinted at the possibility of a Bitcoin and Ethereum futures ETF. Immediately, market was full of speculations and opinions on the matter.
Finally, mid-October, these hopes became a reality. Or as close as it could get. On October 15, Bloomberg published an article about the upcoming BTC futures ETF approval. BTC price soared 10% in one day.
$BITO — first-ever bitcoin futures ETF launched by ProShares — demonstrated price action in line with the most optimistic expectations. It enjoyed the first-mover advantage and traded over $1b on its first day, with over 24.4m transactions at a closing price of $41.94. This brought ProShares Bitcoin futures ETF to being the second-largest ETF ever by its first-day trading volume. Valkyrie’s $BTF launched second, enjoying $77.6m transaction volume on its first day, while the third ETF, VanEck’s $XBTF, covered a fraction of its predecessors’ first-day volumes, with only $4.8m worth of transactions.
One of the most quoted concerns surrounding bitcoin futures ETFs is the tracking error. Tracking issue implies that the ETF futures contracts would not track the underlying bitcoin so well, since far-month contracts clash against contango in futures prices.
Because of the tracking error, ETF issuers prefer front-month contracts, which track the underlying BTC better than longer-dated ones: e.g. December futures track BTC much closer than January or February contracts. So why don’t ETFs just stack up on December contracts then? CME limits the number of futures contracts per ETF issuer to 4,000 contracts, dropping to 2,000 three days before expiration. If an ETF’s demand exceeds this limit, they are obliged to dive into far-month contracts. As new ETFs enter the market, they open up access to more front-month CME futures. At the same time, if demand continues to grow, existing ETF issuers will be forced to shift assets into further-dated contracts, amplifying the tracking error vs BTC. How issuers construct their EFTs will directly reflect institutional investors flow.
Circling back to Bitcoin spot ETF, probabilities remain rather low as it currently stands. Even with the successful entry of Bitcoin futures ETFs, analysts are not optimistic about a spot equivalent being approved any time soon. Not until we will see an introduction of a new regulatory regime overseeing the crypto spot market. Up to the point where Fidelity had to turn away from the SEC and launch its spot bitcoin ETF in Canada.
Regulatory Adoption & First Legal Tender
Regulators continue to show interest in the crypto space as mainstream and institutional adoption grows. 2021 was a big year for regulatory adoption and hard bans alike.
First and foremost, 2021 will be forever engraved in crypto history as the year El Salvador became the first country to adopt Bitcoin as legal tender. While the move received heavy criticism from the World Bank and the International Monetary Authority, El Salvador’s went ahead with the cryptocurrency adoption, launching the state-run Chivo wallet and buying Bitcoin dips. By the end of November 2021, El Salvador’s treasury holds a total of 1,220 Bitcoin according to official statements, which equals to over $57 million at the moment of writing.
Some of G7 nations do not rest far behind. Germany established itself as a crypto-supporter in 2021, after its ‘Fund Location Act’ allowed 4,000 Spezialfonds, managing $1.8 trillion, to invest up to 20% of their capital in bitcoin. In addition, Germany runs a close second in the global bitcoin nodes distribution (bitnodes.io) AND has a number of bitcoin ETFs trading on Deutsche Borse.
US regulators have taken attempts to oversee crypto in 2021, but for the time being remain behind their colleagues in Canada, Germany or UAE. One of the biggest headlines was the $1.2 trillion bipartisan Infrastructure Bill, signed by Joe Biden on November 15, which narrows a cryptocurrency tax reporting provision that would raise $28 billion over 10 years. The Bill has a rather broad and unclear definition of a ‘broker’: it could encompass any entity facilitating crypto transactions (including miners, hardware and software developers) and would make financial reporting and disclosures mandatory for these ‘crypto brokers’. Two amendments were proposed to narrow the scope of provision, exempting miners, validators and entities that do not provide custody and trading services. Interesting point was that one of these amendments tried to exempt only proof-of-work validators, which could be interpreted as implicit backing of Bitcoin as opposed to Ethereum. In the end, Senate failed to amend crypto wording in the Bill leaving the new cryptocurrency tax requirements quite controversial.
US Senate held a crypto hearing on December 8th in an attempt to speed up legislation. Stablecoins, their backing and potential impact on the wider economy were major topics of the hearing. Circle CEO Jeremy Allaire (USDC stablecoin) openly claimed that
“reserves backing USDC are held in custody and control of the US regulated banking system, strictly in cash and short-duration government treasuries, with regular 3rd-party audits from world leading firms”.
Paxos’ CEO (USDP stablecoin) by and large echoed the claim. Notably, Tether executives were absent from the hearing, bringing our minds back to Bloomberg’s October article ‘Anyone Seen Tether’s Billions?’.
Another point of Senate’s concern was regulation of crypto exchanges and investor protection. FTX’s CEO Sam-Bankman Fried highlighted in his testimony that unlike traditional exchanges,
“FTX provides open and free market data to all users, full access to the platform and to the same set of instruments as institutions, with monitoring of transactions for illicit activities run 24/7 by a risk engine”.
Coinbase CFO elaborated further on the topic of security, claiming that only 2% of all client assets are held in hot wallets, and that Coinbase protects customers from all attacks on the hot wallet and provides insurance in the event of losses on the platform.
Finally, one big question that transitions into 2022 is whether the SEC sees cryptocurrencies as securities. As is obvious from the above, it has been quite a challenge to try and fit digital assets into an existing regulatory framework. This time last year, SEC filed a lawsuit against Ripple Labs, declaring third-largest cryptocurrency at the time was a security. Coinbase announced suspension of XRP trading following the lawsuit. Today, Coinbase claims that
“Law clearly shows that blockchain assets are not securities and are either a new form of digital property or a new way to record ownership”.
Not all countries, however, are looking to regulate cryptocurrencies and digital assets. Some prefer to put a hard ban on all crypto-related activity whatsoever. China crypto ban was amongst top questions we were receiving from our clients after Q2 2021. Exchanges ceased onboarding new clients in mainland China onshore, as well as announced plans to offboard all Chinese clients by end of 2021. Market corrected around 15% end of September following these announcements, only to reverse to a strong recovery going into October.
China banning all crypto activity did not come around as a surprise for industry participants. In fact, the country has been imposing strict regulations and restraints on cryptocurrencies for many years. Quantitative analyses conducted by Wharton School revealed that, in general, regulatory announcements did not affect the volume of transactions on cryptocurrency networks. In addition, experts have no doubt that the cryptocurrency market will be able to reach its peak with or without China’s participation, with Facebook (not operating in China) being a great example.
In her interview to Forkast, Angelina Kwan — former regulator for Hong Kong SFC — states the following: “Our view is that going forward, Hong Kong will continue to maintain its autonomy in managing its financial and administrative affairs… As the digital assets industry becomes increasingly regulated, Hong Kong becomes more attractive — not less — as a financial center governed by the rule of law.”
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