Market Update: Q3 2022
(originally posted on 17 Oct, 2022)
Altogether, it has been a rough year for the crypto world. The collapse of the Terra ecosystem last quarter, in combination with global macroeconomic pressure, resulted in a decidedly difficult first half for 2022. Economic downturn continued into Q3, which was reflected in the significant crypto market volatility that we have seen over the past few months.
Regardless, many ecosystems have remained robust and have shown positive signs of recovery, as industry leaders and emerging projects figure out how to maneuver through this prolonged crypto winter. Teams across the sector have kept their heads down and have continued building in order to improve on-chain scalability, ramp up adoption and demonstrate exciting use-cases for blockchain technology.
Of course, the biggest news coming out of Q3 has to be the Ethereum network’s transition from Proof-of-Work (PoW) to Proof-of-Stake (PoS), initiating a new era for both Ethereum and the broader Web3 ecosystem.
Topics
Infrastructure
DeFi
NFTs & Metaverse
GameFi
Conclusion
Infrastructure
Starting off with the most significant headline of Q3 2022: The Merge.
On 15 September 2022, the Ethereum Mainnet successfully joined with the proof-of-stake consensus layer, the Beacon chain. This enables the entire Ethereum network to be secured through staked ETH, therefore eliminating the need for energy-intensive mining in order to validate blocks.
The Merge marks a monumental moment in the history of crypto. Following The Merge, the Beacon Chain now serves as both the engine of block production and as the consensus layer for all network data on Ethereum. In turn, this transition to proof-of-stake has had significant, positive impacts on the scalability, energy consumption and deflationary properties of the Ethereum network. Block reward fees are drastically reduced (from ~13,500 ETH to ~2000 ETH), lowering the overall cost of security, while energy consumption has been decreased by an estimated 99.95%, according to the Ethereum organization. The improved proof-of-stake consensus engine also opens up novel scaling opportunities that would be impossible on a PoW system.
Largely thanks to the immense anticipation and hype surrounding The Merge, Ethereum stands out as a clear winner in Q3. Price-wise, ETH has bounced back from its lows in Q2 and as of 31 August, has been up 39% compared to last quarter with a current market cap of ~$163 billion. In contrast, Bitcoin has struggled this quarter, only up by 4% (as of 31 August) after a very difficult Q2, with a current market cap of ~$387 billion.
ETH Volatility has also declined, with the asset trading at a much tighter range throughout July and August.
Post-Merge, Ethereum will be sticking to their rollup-centric roadmap, which seems to already be taking effect. Layer-2 (L2) ecosystems built on Ethereum have made strong recoveries this quarter, with the total value locked (TVL) on Arbitrum and Optimism both sitting above the $900 million threshold at the time of writing: Optimism TVL at ~$912 million, with Arbitrum TVL higher at ~$971 million.
Layer-2 applications have garnered genuine interest this quarter, with the increased volume and usage on L2s somewhat stealing network performance away from the main Ethereum network. Active addresses and transactions on Ethereum have remained neutral, with relatively insignificant QoQ fluctuation.
L2 growth and adoption looks very promising in the coming months. We’ve witnessed emerging protocols like GMX, dYdX and Synthetix dominate conversations around DeFi and crypto, while several teams have announced major developments regarding zkRollups this quarter, with Polygon and zkSync both beginning to harness the potential of zero-knowledge technology. On July 19th, the Scroll team (backed by OP Crypto) announced the release of the pre-alpha version of their zkEVM-based rollup, demonstrating that they are delivering on their ultimate promise of “scaling Ethereum with cutting edge research and technology.” It seems clear that major efforts to scale Ethereum will come from L2 solutions even more so than upgrading the base layer.
Aside from L2 scaling solutions, a new generation of competitive Layer-1 blockchains have arrived on the scene, making some serious noise this quarter. Sui, Cronos, Aptos and Avalanche have taken the Web3 ecosystem by storm; all aim to leverage multiple solutions in order to tackle the Blockchain Trilemma and develop novel chains with high scalability, robust security and true decentralization.
Security concerns, especially regarding cross-chain bridging solutions, have also become a frequently discussed topic this quarter. Of course, protocol exploits and network hacks are not new to the world of Web3. August seemed to exemplify this as we witnessed in the Solana wallet attack, as well as the exploitation of both the Acala Network and Nomad bridge. According to DappRadar, over $211 million were lost in August, 90% of which were attributed to the Nomad hack. Fortunately, Acala managed to recover most of their stolen funds through a community governance referendum, demonstrating the benefits of rigid on-chain governance frameworks, while simultaneously bringing the network’s level of centralization into question.
DeFi
DeFi TVL in Q3 continues much of the same downtrend as in Q2, steadily holding around the $50 billion US dollar mark. As such, liquidity levels on most chains have dried up. ETH remains supreme in terms of liquidity and TVL, holding $31 billion of the $54 billion, respectively.
Retail interest in DeFi has slowed and mostly truly committed users remain, many of which preferring to conduct their trading on ETH as opposed to another illiquid chain. Evidence of this lack of retail interest can be seen in the decline in web traffic and the social media presence of crypto.
An interesting point to look at is the concentration of TVL in the top 12 protocols, holding $30 billion of the $54 billion in TVL, and $43 billion if you include liquid staking. Furthermore, 10 of the 12 all being ETH native show just how much dominance ETH holds during times of directional downturns.
Nonetheless, DeFi continues its bearish trajectory in unison within the broader financial market. However, the biggest talking point of Q3 has been the regulatory actions against the crypto industry. The U.S OFAC sanction of Tornado Cash, and the subsequent black listing of multiple USDC addresses, led to many DeFi protocols having to reevaluate their legal compatibility and revoke sanctioned users from their sites.
Following this, there has been much discourse surrounding stablecoin regulation, in particular, which the U.S SEC and Powell have been vocal about (Fed Powell Urges Stablecoin Regulation). In addition, Gary Gensler and the SEC have taken aim at POS blockchains, calling into question their legality and attempting to define them as securities.
The SEC has also cracked down on many other parts of the crypto industry, such as market makers for market manipulation (SEC takes aim at Market Manipulation). The CFTC has also filed a lawsuit against Ooki DAO and all existing governance token holders (CFTC Lawsuit). This regulation does not come as too much of a surprise given the aftermath of the LUNA/UST collapse.
Although, even after all this regulation and lack of retail interest, there are still many teams empowering a new generation of owners to take control of their assets and access capital and liquidity. The bear market has brought DeFi back to its core principle, lowering the barrier to entry for new and complex financial products.
NFTs & Metaverse
NFT sales this quarter have taken a severe hit as a result of global economic pressures which have pushed retail investors away from high-risk, speculative assets. The monthly trading volume of NFTs has seen a tremendous drop of around 97% in comparison to its peak during the pre-bear market NFT boom in January 2022, and has dropped 75% from the previous quarter, now at roughly $2 billion monthly trading volume.
The decline in NFT sales volume is not only due to rising inflation rates and the wide-reaching ripple effect of the Terra/Luna crash, but also as a result of the drop in ETH price that occurred this quarter. Since a majority of both blue-chip and startup NFT collections use ETH as a base currency, it is inevitable that the decline of ETH price correlates to a slowing NFT market.
In spite of this data, the NFT market continues to expand under difficult circumstances. The number of unique traders has increased by 36% in comparison to last year’s Q3. This indicates that there is still a relatively committed community of NFT traders and collectors that are driving the ecosystem through the crypto winter.
As the hype around NFT profile pictures (PFPs) has finally settled, NFT collections have had to devise new use cases for NFTs in order to create more value and demand within the market. Providing utility is now the name-of-the-game for emerging collections, either through granting additional benefits attached to their NFTs, airdropping other collectibles or enabling access to virtual or in-person events for their holders.
As such, Web3 gaming NFTs have remained the most stable throughout the quarter as they provide immediate utility, often serving as playable in-game assets or characters within their respective video game. NFTs on ImmutableX saw an increase of 87% in trading volume in comparison to the previous quarter, revealing the public’s interest in the blockchain gaming sector.
GameFi
Web3 gaming is often considered to be the sector most likely to drive mass adoption of blockchain technology, particularly due to its potential for empowering gamers and content creators. While overall NFT sales have inevitably taken a big hit this quarter (which has directly translated into a decrease in gaming-related NFT sales), the blockchain gaming sector has still remained robust in terms of user base and funding metrics. This further attests to the resilience and potential of the Web3 gaming ecosystem, even during extended bear market conditions.
Data collected from DappRadar & BGA’s latest blockchain gaming report shows us that unique active wallet (UAW) interaction with Web3 games makes up over 50% of the total industry activity, with over 847,000 daily UAW interactions on average in the month of August.
The Wax ecosystem is still the most prominent gaming blockchain, with over 40% of gaming activity occurring on Wax. However, the gap is closing as alternative gaming ecosystems continue to grow. Hive is close in second, followed by BNB chain, Polygon and then Solana. In September, Hive saw a 12% month-over-month (MoM) increase in UAW activity, BNB chain with an 8% MoM increase in activity, and lastly, Solana with a 21% increase in UAW activity — all bullish indicators that the still nascent blockchain gaming industry is poised to take off in the final quarter of the year.
Funding for the industry has not dried up either, with $748 million raised by blockchain games and metaverse projects in August alone, totalling over $1.1 billion in new funding in Q3 2022.
The top performing games in the industry now have new rivals, as developers in the space continue to produce mobile games using the P2E model.
In more recent news, a new narrative seems to be emerging in the blockchain gaming sector thanks to Illuvium’s co-founder, Kieran Warwick. During Token2049 which was recently held in Singapore, Warwick announced to CoinTelegraph that Illuvium is currently working on three new titles that will all be connected via blockchain, run under the same economy and governed by the same token (ILV). Out of this, Illuvium has coined the term, the ‘Interoperable Blockchain Game’ (IBG), which Warwick claims is “something that has never been done before,” neither in the mainstream or blockchain gaming industry.
It will be interesting to see how blockchain gaming titles develop to become more interoperable and interactive, transitioning away from the P2E and profit-driven gaming NFT models which have currently dominated GameFi.
Conclusion
In a down market, it can be easy to become disillusioned by the volatility and bearish sentiment that fills the space. During these cycles, it is imperative that we focus on the larger picture and take note of the positives coming out of the space too. After all, we have seen both the crypto and equity markets stabilize somewhat this quarter, which is a welcome sight after a difficult second quarter.
In addition to token prices, crypto fundamentals are also beginning to readjust: developers are able to focus on heads-down building without the pressure of keeping up with a rapid bear market. As such, we are seeing teams focusing more on protocol sustainability and real-world use cases.
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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