Market Update: Dec 2021

(originally posted Dec 20, 2021)

This quarter was marked by market rotation into L1 tokens and Layer-2 solutions, accelerating adoption of GameFi/Metaverse, and growing interest in DAOs and social tokens. Please see our high-level updates on each topic below:

• Infrastructure
• Metaverse
• GameFi
• DeFi
• DAO
• Social Tokens

Infrastructure Update 1: All eyes on Ethereum

In 2020, Ethereum began the transition to a proof-of-stake network. We’ve seen some exciting updates since then, such as EIP-1559 in August (London Hard Fork), but PoS will not become operational until at least 2022, at the earliest.

In a post entitled ‘Endgame’ that was released this month, Vitalik Buterin, Ethereum’s co-founder, laid out the vision for the Ethereum network in regards to scalability. Buterin suggests, based on a hypothetical network with large block sizes and 1000s of TPS, that long-term block production will be a centralized process because very few agents will be able to meet the high demands of nodes to facilitate such large block sizes. Nevertheless, block validation can remain decentralized. Buterin suggests that using Zero-Knowledge proofs allows users to validate block transactions themselves, thus avoiding centralization issues.

With scalability limitations and unaffordable gas fees, the Ethereum foundation and Buterin are in the spotlight as Ethereum progresses to maintain its position at the forefront of Layer-1 protocols. With so many reputable smart-contract competitors gaining momentum, the next 6 to 12 months will be critical to ensuring the long-term success of Ethereum.

On other L1s: While Ethereum scaling solutions are still being deployed and while the multi-chain narrative plays out, Layer-1 competitors fill the void with significantly lower costs and scalable options.

Avalanche, Solana, Terra, and BSC are the main L1s that stand out. Each of these L1s has established strong user bases and has been adopted across multiple applications across DeFi, NFT, and GameFi. OP Crypto Capital Management Ltd. has developed strong connections with these ecosystems and looks forward to supporting real challengers in these blockchains.

Here are a few highlights:

• Avalanche Foundation Launches Fund Worth Over $200M Dedicated to Supporting Ecosystem Development, Innovation by Avalanche
• Terra’s Luna Becomes Top Ten Cryptocurrency As Market Selloff Sends Bitcoin Down by Robert Hart
• Solana Ventures, FTX, and Lightspeed launch $100 million blockchain gaming fund by Yogita Khatri

Infrastructure Update 2: Layer-2 solutions are emerging, and the Layer-1 wars are heating up

On the Layer-2 solutions: Our view is that all EVM compatible ecosystems will eventually need an L2 scaling solution to open up new opportunities beyond DeFi and NFTs.

Web 3 entertainment, decentralized file storage, DAO community engagement, and many other business models will be empowered by L2 and unlock trillions of dollars of value on the network — creating a potential 10x of the existing L1/DeFi market cap.

Why Layer-2 on Ethereum? A Layer-2 solution does not change the basic protocol of Layer-1 but improves performance through the application layer under the chain. It does this while simultaneously taking advantage of the robust decentralized security model of Layer-1, and mining removes an otherwise centralized feature in its design. There are several layer-2 solutions launched in 2021 with different approaches to scaling and data storage. Boba Network, Matic/Polygon, Arbitrum, and Immutable X are notable competitors.

OP Crypto (BVI) Fund I L.P. has invested in Scroll Tech in its quest to build a Layer-2 solution based on ZK-Rollups, which are at the forefront of cryptocurrency research. We believe that ZK- Rollups is the most secure solution for financial-related DApps and is the preferred solution of Vitalik and the Ethereum Foundation.

Where we would look for opportunities in infrastructure:

• Layer-2 scaling solutions and toolings.
• New applications built on top of Avalanche, Terra, and Solana which uniquely capture the strength of each platform.
• New applications built on top of layer-2 like IMX and Polygon.
• Bridges with an intuitive user experience and high security that allow users to move assets across blockchains easily.

Curated reads on infrastructure:

• Scaling the Ethereum Network: A Primer on Layer-2 by Conor
• Layer-2 Landscape Infographic by Coin98

Metaverse

The Metaverse can be viewed as a collection of interrelated online virtual worlds that offer a digital reality where users are able to live, work, interact and play together. The current state of the metaverse consists of large individual metaverses which lack interoperability and cross-metaverse digital assets transfers. Much like how the internet is a web of interconnected websites that are partially interoperable, the future of the Metaverse will be a web of interconnected and fully-interoperable metaverses.

A new dimension of popularity for the Metaverse was brought about by Facebook rebranding itself to “Meta”, with a follow-on announcement that the company will hire 10,000 employees in the EU to help build its Metaverse applications. The company is keen to shift focus from its traditional models of social-media engagement to a Metaverse built by Facebook. It also announced that it’d invest $10B annually to do so, which would lay the foundation for the whole industry and would accelerate innovation and development in hardware and graphics software for the entire space. Facebook’s move towards a future in the Metaverse has boosted returns for most major metaverse projects in November.

Adidas has also been making efforts to position itself as a significant player in the Metaverse space. In November, Adidas partnered with Coinbase’s NFT Marketplace and purchased a virtual world in The Sandbox. In December, Adidas announced that it was entering the Metaverse in collaboration with Bored Ape Yacht Club, Gmoney NFT, and PUNKS Comic. Nike has also introduced its virtual universe and plans to tokenize shoe ownership on the Ethereum blockchain. This may develop into a wear-to-earn model, which will aim to create clothing for various digital closets.

(A screenshot from Sandbox)

As an investment company focusing on early-stage projects, our investment thesis for Metaverse projects is to promote ecosystem growth, interoperability, and mass-market adoption. Hence, we invested in Metamundo, which provides a dedicated marketplace and enables one-click compatibility for 3D NFTs across most currently active metaverses.

Curated readings on the Metaverse:

• Metaverse Primer by Matthew Ball
• Crafting an Open Metaverse — by Rabbithole
• Pathway to an Open Metaverse by 6529
• Where Crypto Meets the Metaverse by Piers Kicks
• Awesome metaverse

GameFi

Metaverses where land, buildings, avatars, and names can be bought and sold as NFTs in marketplaces are quickly becoming the next frontiers for social interactions and gaming. Play-to-earn (“P2E”) ecosystems are creating a new type of metaverse economy where the future of work is redefined.

The second half of 2021 saw a rise in GameFi projects that implemented P2E models with Axie Infinity gathering over 2 million active daily users and daily trading volumes reaching as high as $35M. The P2E model enables democratization of finance through providing rewards for active gaming on platforms. Axie’s largest market is the Philippines, which is now home to 40% of its daily users. Democratization is key in GameFi projects, and Axie’s push in this sector has enabled billions of dollars to be invested in similar projects.

We’re currently investing in multiple GameFi projects predominantly in the Solana ecosystem. Aurory is a P2E game built on Solana which promotes blockchain education and use cases in a fun and rewarding manner. Stardust is another project we’re currently invested in that helps indie game developers create novel blockchain assets, regardless of their expertise in blockchain, and use these assets in their games.

Curated readings on GameFi:

• Explain It Like I’m 5: GameFi — Messari

DeFi

Stablecoins

• USDT remains the reserve trading currency for almost all of the largest exchanges in the world, and provides the highest liquidity out of all stablecoins. Tether published two audits of its reserves, settling various lawsuits against it being under-collateralised.
• In 2021, Tether’s share of stablecoin market cap declined from 80% to 50% (as of December 2021), mainly due to the rise of USDC and UST (Terra’s USD stablecoin). UST has been the fastest growing stablecoin this year, already acquiring over 5% of the stablecoin market with a market cap of over $8.4B.
• We are delighted to say that OP Crypto (BVI) Fund I L.P. has invested in Terra’s new Ecosystem Fund, alongside investors from Galaxy Digital, Pantera Capital, Parafi and many others. The Fund’s main mission is to accelerate development of applications, tooling, and protocols on the Terra network.

Olympus DAO

• Launched in March 2021, Olympus DAO aims to be a decentralised reserve currency by creating $OHM, which is a token that is backed by assets instead of being pegged, like other stablecoins. The Olympus Treasury holds a basket of assets which are accumulated through bonding. The Olympus DAO sets a target amount of assets to be accumulated by offering $OHM at a discount to the value of the collateral deposited; this $OHM can be redeemed through a vesting process. Since its launch, Olympus has accumulated $900M in its treasury, and its market cap topped $4.2B in November.
• Since the launch of Olympus, there have been over 150 OHM forks with a market cap of around $7B (CoinGecko). Many of these forks have had ponzi-like attributes and have ultimately been rug pulls. Judging purely by the size of the community and by the number of forks that OHM has spawned, we believe Olympus DAO might be a contender for 2021’s most important new project in the DeFi space.

DeFi perpetuals

• The decentralised derivatives platform dYdX saw an outage on the 7th and 8th of December for a total of 8 hours, putting the leadership of the platform in question. With the integration of Starknet, Starkware’s permissionless ZK-Rollup, dYdX operates as an L2 network over Ethereum, enhancing transaction efficiency without compromising Ethereum’s composability and security. According to Starkware, dYdX can process 45 transactions per second, over 10 times what Ethereum’s blockchain can handle. A ZK transaction needs just 486 gas units, while a simple transaction on Ethereum takes 30,000 gas units, resulting in data compression of 98%. Starknet’s ZK-STARKs improve upon ZK-SNARKs by removing the need for trusted on-chain verifiers by using public verifiable randomness to create a trustlessly verifiable decentralised system. They are also a step-up in scalability and are quantum resistant (as opposed to ZK-SNARKs), thereby increasing security against malicious attackers. With dYdX’s volume often outpacing Coinbase’s this year, dYdX is efficiently using ZK-Rollups and L2 solutions to scale past Ethereum’s scalability issues, leading to massive growth in the DeFi perpetuals space.
• Perp Protocol v2 was released to mainnet in early December, which leverages Uniswap v3 to provide the Concentrated Liquidity functionality for perpetual swaps (Medium).
• With the launch of several L2s in 2021, there has been an exponential increase in transactions on decentralised derivatives platforms like dYdX and Perp Protocol because of lower fees and latency.

Sushiswap, a DEX on Ethereum, had an internal conflict about the team’s compensation not being competitive. Some of the core team members who threatened to leave said that they would require a total of $18.3M from the Sushi Treasury, which was refused by 68% of voters (rekt.news). This story brought into question whether DAOs are truly as decentralised as they claim to be and how internal conflict can be resolved.

DAOs

DAOs have been one of the most important organisational structures in crypto. Most recently, they have been functioning as platforms for strong communities centred around specific projects. DAOs are open-source, decentralised, are centered around a specific project or function, and offer strong incentives for their members.

(Sourced from DAO Landscape by Coopahtroopa)

With the market cap of DAOs rising to over $30B in recent months and communities within some DAOs rising to become larger than 50k members, we have seen a significant demand for tooling in the space. With the Tooling Landscape growing rapidly, it is sometimes difficult for newer DAOs to integrate with pre-existing frameworks, which has led to a need for tools that provide multiple templates on which to build upon.

Aragon is a DAO deployment platform on Ethereum which streamlines the organisational process for new DAOs. It offers a robust, full-service solution to creating and managing DAOs with several proposal mechanisms through its Aragon Voting app. In recent months, the size of its treasury has increased to over $900M, and the DAO has processed over $4.5B in transactions.

We believe one of the major routes to mass-market adoption with DAOs can be through lowering the barrier of meaningful contributions and allowing people with aligned values and interests to enter the space. Another risk is that members can be part of several DAOs with completely different functionalities, leading to less active contributions in each of the communities that these members are in. On 8th December, Messari announced the launch of the “Messari Governor”, a platform for engaging actively in the governance of many top DAOs. We actively look to invest in projects that accelerate the smooth mass-market adoption of DAOs.

We believe security has also been one of the major issues facing DAOs. With the recent hack of BadgerDAO, $120M in assets were drained due to faulty UI on the Badger website. With the need for tighter auditing of DAOs comes the need for larger auditors. CertiK recently raised $80M at a valuation of nearly $1B. We actively look for solutions which increase security and prevent malicious activity, thereby leading to smoother mass-market adoption in the space.

We’ve also invested in Parcel, an out-of-the-box DAO treasury management system, which is currently in use by top DeFi protocols, including Compound, Aave and Synthetix.

(Sourced from Organization Legos: The State of DAO Tooling by Nichanan Kesonpat)

Curated reads on DAOs:

• DAO Ecosystem Overiew Dashboard by DeepDao
• DAO Landscape by Coopahtroopa
• Organization Legos: The State of DAO Tooling by Nichanan Kesonpat

Social Tokens

Social tokens are an incentivisation technique to promote working towards projects in a DAO. They help build a virtual economy where early believers and contributors can share the upside and create robust communities. Social tokens also allow for development of a fair reward system and help promote a much more equitable distribution of power than the traditional startup model.

“The point of creating a social token is to incentivize collaboration by making it easy to collaborate with individuals that you don’t know and that you don’t specifically trust. Instead of setting up contracts and legal status to cover each contributor at the beginning, social tokens enable transactions on a blockchain, meaning there is an irrefutable record of the exchange.” — Insider

Interesting social token projects:

• The Modern Billboard Collective: tokenized equivalent of the Million Dollar Homepage. The Modern Billboard Collective is a group of startups selling ad space on their websites — represented as NFTs on a billboard — that are freely tradeable.
• Friends With Benefits: private discord server which requires at least 75 $FWB tokens to gain exclusive access to the community and a meaningful ownership of the DAO. They describe themselves as a digital city with a key focus on diversity and inclusion and have grown to over 2000 active members. Popular investors include a16z, who also actively participates in its governance system.

Additionally, we found that these reports and dashboards are worth mentioning as we go deeper in the space:

• State of Global Blockchain Funding (CBinsights)
• The 2021 NFT Market Explained (Chainalysis)
• NFTs and Crypto Replace Cash as a New Holiday Gift (The Wall Street Journal)
• Mapping the NFT revolution: market trends, trade networks, and visual features
• Dashboard: Bridge-Away-(from-Ethereum)

In general, the growth in crypto across all verticals and areas solidifies our commitment to backing the best teams and products that can bring blockchain adoption to the next hundreds of millions of people around the globe. We look forward to working with you in the months and years to come.

ABOUT OP CRYPTO

OP Crypto is a leading high conviction, early-stage venture capital firm in the crypto and blockchain industry, specializing in pre-seed and seed stage investments. The fund successfully raised $50M in September 2021 and has since invested in over 30 projects, including companies such as Scroll Tech, Snackclub, Merit Circle, Omni, and Fyde.

With the support of prominent investors like Bill Ackman and Alan Howard, as well as institutions like Galaxy Digital, Huobi, and DCG, OP Crypto has access to a global network of venture funds, scouts, and ecosystem partners to source the most competitive deals in the market.

With a core team based in the United States and strong ties to the APAC region, the fund serves as a bridge between East and West. Additionally, a dedicated portfolio team provides post-investment support to founders in areas such as marketing, tokenomics, and networking.

Learn more about OP Crypto at: Website

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