What do we expect from this year — top 10 themes for blockchain
The year has started with Bitcoin and Ethereum reaching new all-time highs, supported by a new wave of attention to the blockchain space and wider crypto adoption by the institutional and traditional finance players. Despite a mild correction, the general sentiment is as optimistic and bullish as never before. And while the Bitcoin rally is taking a break, it is a good time to look at the upcoming trends for this year.
This article will cover 10 key themes which we will focus on in 2021. The list is based on our own experience and the conversations with the blockchain community and our portfolio companies, it doesn’t pretend to be complete. So, let’s start.
1) Banks Embrace Digital Assets
Last year, we have seen a number of significant precedents signaling of upcoming crypto and banking/payments spheres fusion. Front runners like PayPal have already launched access to crypto for their users. It is very important, that recently users of such services are able to access real digital assets, not just CFD or derivative custodial structures like in the earlier products (for ex. Revolut). We expect that in 2021 this trend will be picked up by more traditional financial institutions of various scales. Due to high-margins and the rapidly growing demand, crypto on/off-ramp business is set to gain scale among retail financial services.
At the same time, we see an emerging pull of the leading crypto companies like Kraken, Xapo, or Bitwala towards more traditional business models. They are becoming regulated banks, broadening their product offerings and distributing their services to a wider audience.
As a result, we can expect that the on/off-ramp market will become more crowded with traditional finance players. Due to their scale and infrastructure, such institutions can provide better service than pure crypto businesses. Also, more intense competition will cause a further compression in fiat-to-crypto exchange fees. Both of these developments would challenge current business models of the crypto exchanges and on-ramp services. But in the end, the availability of digitals assets within the well-known, reputable and regulated financial platforms will make buying crypto as simple as fiat FX.
2) Insurance is Becoming a Bottleneck
There are two major reasons why insurance is now a major bottleneck for further development of digital assets and why we accelerated the development of insurance-linked digital projects (Read about our latest investment in Nayms)
First, everyone is talking about institutional money flowing into the crypto. But institutions require the appropriate infrastructure. Professional asset managers are not used to custody and exchanges without comprehensive insurance. Yet the capacity and product offerings of existing crypto-insurance players are restricted at the moment. The market needs new instruments to attract more liquidity and new participants.
The second reason is related to the DeFi growth. With more wealth flowing into the DeFi, and the increasing complexity of such protocols, the issue of vulnerabilities and faults in the smart-contracts is becoming critical. Better availability of smart-contract insurance is among possible solutions, that will fuel further DeFi growth.
3) New Types of DeFi Lending
We are impressed with the success of non-custodial lending protocols as one of the most important and fundamental achievements of the crypto space. Compound and AAVE have shown us how anyone in the world who just have access to the internet can lend or borrow without any intermediary. At the same time, practical use cases for the existing lending protocols are quite limited, first of all, due to the lack of reliable offline links and collateral ratios being the only credit risk protection.
This year we expect to see projects developing the next wave of the non-custodial lending protocols. Such protocols can use alternative types of collaterals like NFTs or tokenized real-world assets, as well as try to provide undercollateralized or even non-collateralized loans.
4) DeFi vs KYC
Despite the welcome move by the new Biden administration to freeze the controversial FinCEN initiative in respect of KYC requirements for non-custodial crypto wallets, the question of how the new decentralized finance world can meet international KYC/AML legislation is still there. It is obvious, that with further DeFi volume growth, regulators will become more persistent in this field. It may cause an erosion in the DeFi space, separating protocols and liquidity into KYC-friendly and unfriendly camps. On the other hand, the pressure on the DeFi space may drive for the wider adoption of Decentralized or Self-Sovereign Identity (DID/SSI) solutions in the crypto space.
5) L1 vs L2
The pros and cons of horizontal and vertical blockchain scaling are well analyzed and debated, but only this year these two approaches will finally get tested in practice.
With the growth of DeFi and on-chain trading, current Ethereum throughput and transaction costs have decisively become unaffordable. Since Eth 2.0 would not be fully operable at least until 2023 when the Phase 2 implementation is expected, the developers and users are forced to migrate to blockchains that are cheaper and faster than Ethereum. It creates a mid-term opportunity for parallel ecosystems, primarily for EVM-compatible blockchains like Polkadot, Binance Smart Chain, and Near.
Ethereum community responds with a Rollup-centric strategy, trying to scale the existing Ethereum network with the Layer-2 solutions, first of all, Zero-Knowledge (Loopring, ZK-Sync, and DeversiFi) and Optimistic Rollups (Optimism, IDEX). Last year both concepts have passed the research stage and are now actively implemented and testing by several teams.
This year should show for the first time which way is more suitable for developers and users in practice. While developers of the infrastructure (like wallets, interfaces, oracles, and other middleware) will be forced to join the race by supporting new ecosystems and L2 solutions to stay relevant.
6) Native DeFi & Wrapped Assets
Another hotly debated topic (somewhat related to the previous one) is the question of how assets from other blockchains, including Bitcoin, could participate in DeFi economy.
For a particular asset, its availability within DeFi protocols gives a significant market advantage. Firstly, coins locked in DeFi are withdrawn from circulation leading to the supply shortage and price impact. Secondly, in a bear market lending protocols allow asset holders to borrow fiat against the collateralized asset, without selling it. Finally, trading availability at DEXes makes the asset more liquid. There are more reasons why blockchain protocol developers want their assets to have access to the DeFi ecosystem.
Blockchains (eg. those mentioned above) that in some way compete with Ethereum, of course, will bet on building their own DeFi ecosystems. But what about others?
Last year we have seen a number of projects aiming to build Bitcoin DeFi, usually using sidechains, as well as projects building DeFi on other chains, and some of them were able to attract funds and support from notable players. Despite this, we are still quite skeptical about the native DeFi on non-EVM blockchains. The power of DeFi is in the compatibility, which allows to build it as a “money lego”. Isolated ecosystems are hardly scalable.
An alternative is wrapping assets to ERC-20 tokens to make them compatible with the existing DeFi protocols on Ethereum. Excluding centralized issuance, the most well-tried way to do it is the usage of distributed networks of Multi-party computation nodes to issue and manage assets like renBTC or tBTC. We already see several ambitious attempts in this direction (Qredo, THORChain) and this year they will accelerate development, growing in quantity and quality to bring cross-chain compatibility to DeFi.
7) Non-Fungible Tokens (NFTs)
Last fall crypto media was full of headlines like “Would NFTs be the next big thing in crypto?”, “NFTs are the new DeFi”. What is behind such optimism?
In our opinion, it is not the right way to treat NFTs as one ecosystem. Unlike DeFi, NFT projects are much more segmented and independent from each other. Furthermore, NFTs are just a tool, not an application or a type of business model.
So what are those NFTs applications? There are plenty: collectibles, gaming, identity, loyalty, tokenized real-world assets, arts, goods, rights, and probably many more we still don’t know. Each application field is actively tested by many teams. In which segment NFTs will become massive at first? We are not yet certain. What is clear is that there should be a common infrastructure like NFT marketplaces, exchanges, and wallets, agnostic to the particular application.
8) Privacy Tech
In recent months, we have seen several major news feeds related to Big Tech and personal data management, like the new Whatsapp data policy. The problem of personal and behavioral data concentration within the tech giants gets more noticeable year-by-year.
Many projects in the blockchain space offer solutions to different aspects of this problem. Usually, such solutions require modernizing almost every part of how the internet works to become practical. While the global concepts of Web 3.0 are more long-term vision, there are separate cases that already can be improved today.
There is a number of technologies that fit within “Privacy tech”. They are not directly related to blockchain but are actively developed and tested by blockchain companies.
It is worthing mention here at least three of such technologies: homomorphic encryption and Secure Multi-Party Computation, Zero-Knowledge proofs, and Trusted Execution Environments. Recently, blockchain enthusiasts have made significant progress in these areas, and this experience can be transferred to other application fields.
9) STOs in Action
In the last couple of years, security tokens have been expected to become the next big thing in the digital asset space. Unfortunately, so far we see slow, but steady progress in this area, despite the fact that the technology solutions required for STO are available for a long time. The reason is simple: unlike crypto, security tokens are highly dependent on compliance and local regulation. So far, the majority of security token issuance platforms have been growing in the US, a country with very strict requirements for securities issuance. It creates opportunities for other countries to become a popular jurisdiction for STOs.
Other problems faced by the STOs are lack of secondary markets and liquidity. Together with new technology risks, it refrains investors (which can be only accredited ones) from investing in security tokens. STOs are facing a classical “chicken and egg” problem.
We think that STO space just needs time and more successful stories to gain more traction. This year we expect a number of fundraising campaigns by notable companies, that will go in a form of security token offerings, and can attract more investors and accelerate the adoption of the whole segment.
10) Stablecoins Enter Payments
Until now, stablecoins were used primarily to manage risks and for other trading purposes at the crypto exchanges. And even with this limited use case, last year stablecoin supply has grown almost 6 times. But stablecoin adoption for wider use is accelerating. Starting from this year U.S. financial institutions are allowed to use stablecoins for payment activities. In the nearest future, we will probably see how stablecoins enter the $2.1 trillion global payments market. Merchants adoption is a key indicator to watch. It creates multiple business opportunities for the crypto acquiring services and all the infrastructure layers from issuers to wallets.
Another major factor that will definitely affect all crypto market this year is the rise of CBDCs. Central banks of almost all developed countries are working on their own national digital currencies, and some of them (including China, Korea, and Sweden) already launched retail pilots. We would not predict the exact dynamics between CBDCs and current crypto assets, but we expect to see the first CBDCs listed on a crypto exchange this year.
We expect 2021 to be a year when digital assets and traditional finance will deeply embrace each other. We are excited about this juncture, as well as its timing, and keen to continue our support of projects building bridges from both sides.
