Market Update: Q4 2022

Inception Capital

Published in

Inception Capital

15 min readFeb 8, 2023

(originally posted on 23 Jan, 2022)

Welcome back to another OP Crypto Market Update!

Topics

In this report, we are going to provide high-level quarterly updates on each topic below:

Q4 Crypto Market Landscape

Infrastructure

DeFi

Web3 Gaming & Metaverse

NFTs

Q4 Crypto Market Landscape

FTX Collapses

The Fall From Grace & The Subsequent Contagion

After the industry seemed to display healthy signs of recovery in Q3, many maintained an optimistic outlook going forward into the remaining few months of 2022. Ecosystems were beginning to rebuild and intriguing developments in infrastructure had global communities engaged and excited to close the year on a positive note.

However, it’s clear that 2022 was destined to be one of the most eventful and chaotic years in crypto history. In November, the industry was taken by surprise after being struck by yet another black swan event that rivaled the collapse of Terra in both scale and impact.

In fact, the implosion of FTX came as an even bigger shock to the industry since the company had established a strong reputation as a leading CEX in the space, and had been hailed for their operational efficiency and attempted bailouts of the troubled Voyager Digital in Q3. Prior to their collapse, the enigmatic leader of FTX, Sam Bankman-Fried, had also become somewhat of a Golden Boy in the industry due to his commitment to advocating for mainstream adoption and his liaising with government officials to influence the FED’s stance on crypto policy.

We now know that there were more nefarious activities occurring behind-the-scenes at the seemingly dominant exchange. It was exposed that SBF’s prodigal behavior was part of a larger scheme involving his other company, the trading firm Alameda Research, and a gross misappropriation of customer funds deposited into FTX.

The collapse of FTX had left several pressing items up in the air: What would become of customer deposits? Which entities were exposed to FTX and are most impacted by the subsequent contagion? What is the fate of SBF and will FTX have a place in the industry moving forward? Also, what happens to Voyager Digital’s assets that FTX & SBF were planning to acquire?

We won’t be diving deeper into FTX’s shocking fall from grace in this report, as the news has dominated headlines, Twitter feeds and IRL conversations for the whole quarter. Although we’ve listed some resources below that may help answer some of the burning questions left behind by FTX’s negligent behavior:

A Detailed Timeline of the FTX Meltdown by Adam Cochran, Twitter
What is Crypto Contagion? How It’s Spreading After FTX Collapse by Stacy Elliot, Decrypt
An Extensive Flow Chart of FTX Contagion by Molly White
Binance.US to acquire Voyager’s Assets by Rohan Goswami, CNBC
FTX Court Case Update as of January 3, 2023 by Justinas Baltrusaitis, Finbold

However, it is important for us to mention that we at OP Crypto thankfully had no relation to FTT nor any direct exposure to FTX.

Macro Overview

FTX chaos aside, it’s no surprise that 2022 has been an overtly challenging economic year in general. Rising rates and the prolonged European energy crisis has negatively affected growth across the board. According to S&P Global Ratings, a mild recession is to be expected in the U.S. with forecasts for GDP growth being lowered for 2023, while inflation forecasts have been raised.

However, the APAC region is still relatively outperforming the rest and we are likely to see an increased demand for decentralized technologies going forward as global rising rates put greater pressure on central banks. With COVID restrictions being lifted and governments changing their regulatory frameworks around crypto, we are seeing a lot of renewed interest stemming from Asia. This bodes well for us at OP Crypto, as we are looking to ramp up our APAC initiatives and further enhance our presence in the region. You can read our announcement tweet which provides more details on our APAC Initiatives and what we aim to achieve here.

The crypto market as a whole suffered significant losses this year. According to data collected by ImmuneFi (a leading Web3 Bug Bounty Platform) in their 2022 Annual Report, the crypto industry had lost a total of $3.9 billion in 2022, with 95.6% of those lost funds being attributed to hacks. DeFi was the most targeted sector (80.5% of losses) by a significant margin above CeFi. BNB Chain had also surpassed Ethereum as the most targeted chain in the industry. All in all, Q4 2022 saw losses of approximately $1.6 billion with 57.6% being concentrated in DeFi and the remaining 42.4% in CeFi.

Web3 VC Funding

Given the precarious state of the market and rampant volatility that we witnessed over the past months, the entire startup industry experienced venture capital pullback in Q4. While there were significant investment drawdowns in H2 of 2022, VCs still managed to invest over $30 billion into Web3 startups this year, keeping up with last year’s numbers in which $31 billion was invested into the space per data from Galaxy Research. On another positive note, 2022 also saw crypto-focused VCs collectively raise the largest amount of capital ever in a single year at over $33 billion.

(Crypto VC Deal Count & Capital Invested, source: *Galaxy Research*)

After reaching all-time-highs in Q1 2022, VC deal counts and capital invested were down every quarter this year. Turmoil in the digital asset markets in terms of asset prices and market infrastructure have reduced investor risk appetite, and have made the current Web3 VC landscape treacherous for both investors and founders.

(VC Capital Invested by Stage, *Galaxy Research*)

Reduced investor risk appetite is evident in the declining allocation of funds to pre-seed, seed, and early stage projects as we see above. Q4 of 2022 was the first on record where there were more later stage deals than pre-seed.

However, Web3 funding continued to dominate in terms of deal count and was responsible for 31% of all deals completed in Q4 and 24% of all VC money invested.

Infrastructure

Despite the challenging macroeconomic landscape, disheartening scandals and severe market conditions, we can find solace in the fact that 2022 was still a fantastic year for industry development. Amidst all the chaos, we have seen some truly exciting and remarkable innovations in infrastructure that have been built throughout the year.

Let’s look into some of the infrastructure-related narratives that have emerged in Q4:

Account Abstraction (AA)

Account abstraction is a framework for blockchain systems in which assets are held exclusively by smart contracts, and not by externally owned accounts (EOAs). This essentially makes blockchain accounts more programmable, since any kind of account contract can be coded. At this point, many may be asking: “Okay, but so what? How does this improve current systems?”

To understand AA and how it improves blockchain systems, let’s dive into how things currently work: On Ethereum (for instance), any transactions that happens on-chain must be initiated and paid for by externally owned accounts (EOAs). We control EOAs through private keys — a concept most of you are familiar with — which creates a unique signature that verifies that an account belongs to you on the blockchain.

The problem here is that private keys make us vulnerable. If they are lost, then so is your account along with all your funds. They also make us more susceptible to exploits. If your private key is leaked, there is the potential that malicious bots and hackers will drain your accounts. The alternative is custodial accounts (like on Binance, Coinbase, and other CEXs) which are also not ideal. Here’s where Account Abstraction comes in.

As we mentioned, AA makes user accounts more programmable, unlocking greater flexibility and tremendous scaling potential for non-custodial blockchain UX. You could code an account to enable multi-sig capabilities, 2-Factor Authorization or even withdrawal limits. It removes the logic of signing transactions from your account, “abstracting” it, hence the name.

Even though the concept has been around for nearly 5 years, AA is just beginning to gain traction. Now that a lot of the core foundations of blockchain technology have been laid out, developers are becoming more concerned with improving the UX and scalability of self-custody in the interest of global adoption. Account Abstraction seems to be a step forward in this direction.

MPC Wallets

Multi-party computation (MPC) wallets are a new type of crypto wallet that requires more than one user to authorize transactions. Much like account abstraction, MPC wallets aim to solve the issue of private keys and the single point of failure that they can create.

MPC wallets solve this by distributing ownership of a private key between multiple parties, thus each party only holds a ‘shard’ (also called key share) of an individual private key. Using this system, all parties must apply their key shards to sign and approve a transaction.

This also creates further protection from exploits and attacks, as attackers would have to compromise the key shards of all involved parties before being able to transfer funds.

Learn more about MPC wallets:

Seedless Self-Custody: On MPC and Smart Contract Wallets by Nichanan Kesonpat
The Future is Seedless: Wallets for Transitioning Web2 Consumers to Web3 by Chen Li, Ivy Zeng and Ivo Entchev
What is an MPC Wallet? by Rob Behnke, Halbor

Modular Blockchains

Modular blockchains employ the principle of modularity to divide the 4 key functions of a blockchain (Consensus, Execution, Data, Settlement) and then outsource them into separate layers. This is a contrasting alternative to Monolithic blockchains, in which all sets of duties are carried out on a single layer with no outsourcing.

Compartmentalization and division of labor in modular blockchains means that each layer is specialized and designed for a particular function, which will yield better results. In doing so, modular blockchains aim to solve the ‘scalability trilemma’ that blockchain technology faces.

Ethereum was the first network to begin a shift to a modular blockchain architecture, but Celestia, Fuel and Cosmos are becoming the most prime examples of this new structure.

DeFi

Unsurprisingly, DeFi TVL (Total Value Locked) continued on its downward bearish trajectory in Q4, standing at roughly $41 billion at the end of December according to DefiLlama. This is a significant drop from where we began the year, at around $166 billion, down 76% from January.

Ethereum still stands as King of DeFi, with the ecosystem holding over 58% of all liquidity within DeFi. Ethereum dominance is likely to continue for the foreseeable future, as users will prefer to conduct trading activity on Ethereum as opposed to other illiquid chains. Despite the lack of clarity regarding withdrawals, investors still continue to stake ETH within the ETH 2.0 contract. According to Nansen data, the cumulative amount of ETH staked in the ETH 2.0 contract is already over 15.7 million (almost 13% of the total supply), compared to the 8.8 million staked at the beginning of 2022. For those interested in staking ETH, here are some valuable resources:

Retail interest in DeFi was largely decimated as a result of FTX’s downfall, leaving behind only the true DeFi yield farmers and aficionados. Evidence of declining retail interest can be seen in the drop in web traffic and the social media presence of crypto.

Despite market turmoil in 2022, the DeFi ecosystem has proven itself to be highly sturdy as the sector continues to grow even under bearish market conditions. The amount of capital locked in smart contracts across the DeFi ecosystem is significantly larger than it was three years ago, with the total TVL of DeFi having grown nearly 70 times larger in that short period.

In 2022, decentralized exchanges executed roughly $854 billion in trading volume, coming from 5,687,713 unique trading addresses according to Nansen.

Layer-2 scaling solutions continued to dominate 2022 DeFi growth. October 2022 was a major turning point in the DeFi ecosystem, marking the moment where layer-2 protocols officially began consistently processing more transactions than Ethereum’s main network.

While Solana’s TVL has sharply dwindled in recent months, the chain still routinely processed the most daily transactions out of any alternative L1 this year. Coming in second was the Binance Smart Chain, with Avalanche rallying in the latter half of the year — largely due to the launch of GMX — to come in third. These alternative layer-1s still process millions of transactions per day, indicating that they are still maintaining very active investor bases.

Web3 Gaming & Metaverse

Overview (Users)

Web3 gaming tokens were not immune to the sharp macroeconomic downturn that affected all altcoins in Q4. As such, the Web3 Gaming sector reported a significant drop in daily active users (DAUs), likely as a result of profit-driven players exiting the space during these harsh market conditions.

(Web3 Gaming Daily Active Users, source: *Ancient8*)

According to the latest Web3 Gaming Report by Ancient 8, blockchain gaming activity was down to just 421K DAUs as of mid-December, almost a 45% drop from the 750K+ DAUs reported in Q1 2022.

For yet another quarter, the Wax protocol was the most dominant gaming protocol in the sector with close to 350K daily unique active wallets (UAWs) on average in Q4.

(New Projects by Chain, source: *Ancient8*)

However, if we look at the graph above displaying the total number of new blockchain gaming projects by chain, it becomes clear that BNB Chain has grown significantly in popularity and is dominating both Wax and Hive (the top performers) in this category.

Despite this growth, BNB Chain is still yet to release a Web3 Gaming title that can rival the likes of Alien Worlds and Splinterlands — both of which account for the large majority of users on Wax and Hive.

Web3 Gaming/Metaverse Funding & Investments

Despite the industry-wide drawbacks in venture capital investments this year, the Web3 Gaming sector is still receiving consistent and healthy levels of capital.

In November alone, DappRadar data showed that blockchain games raised over $320 million in funding. Overall though, funding for blockchain gaming and Metaverse projects decreased from $5.5 billion in 2021 to around $3.7 billion in 2022, which is to be expected given the year we’ve had.

Nonetheless, major industry players still seem bullish on the sector going forward into 2023. At the end of November, Animoca Brands’ (backer of OP Crypto) co-founder, Yat Siu, had announced plans to launch a $2 billion fund dedicated to investing in Metaverse startups. Since then, Animoca Capital (as the fund is called) has adjusted its ambitions “given the market circumstances” and is now looking at a target of at least $1 billion — still a massive tailwind for the Metaverse sector.

Emerging Trends in Blockchain Gaming & The Metaverse

The constant chaos of 2022 resulted in a mass exodus of retail users and investors. As such, developers had to revert back to “heads-down-building-mode” to ensure their projects are stronger than ever when a more favorable market cycle arrives. Much like in the Infrastructure vertical, the Web3 Gaming sector was host to plenty of emerging narratives and industry developments. Since the Metaverse is still in its infancy, we definitely expect to see more exciting innovations emerge in parallel to the evolution of underlying infrastructure.

Soulbound Tokens (SBTs):

SBTs were first introduced into the mainstream in May 2022 by Vitalik Buterin, economist Eric Glen Weyl, and lawyer Puja Ohlhaver, in their paper titled: “Decentralized Society: Finding Web3’s Soul.” The paper makes a case for a novel type of token that is not designed to be bought, sold, or hold any intrinsic market value. Instead, they are to function as non-transferable tokens that represent an individual’s social identity and achievements in a decentralized society. While they have a broad range of real-world use cases, SBTs applied to Web3 Gaming is likely to be the next step towards verifying players’ skill levels, reputation, and achievements on-chain.

In other SBT-related news, we are excited to announce that Masa Finance (backed by OP Crypto) has officially launched their mainnet as of January 17th, 2023! Masa Finance is Web3’s first premiere Web3 identity and credit protocol, using soulbound tokens to represent your on-chain identity and credit score. The first 50,000 mainnet minters of the .soul token are eligible for the Masa Token airdrop, so make sure to act fast and claim your .soul name from Masa.

NFTs

NFT Market Overview

While many had high hopes for a resurgence of the slowing NFT market, Q4 2022 was yet another disappointing quarter for NFT traders with a total trade volume of just $1.3 billion, down over $8 billion from last year’s tremendous Q4 trading volume of $9.7 billion. NFT search volume in December has dropped almost 90% from in January, indicating a decline of interest in digital collectibles in 2022.

The NFT market size has shrunk down by 92%, however, the plunge in performance should not be seen as a reflection of the lack of the utility or use-cases of NFTs. These are merely the symptoms of bad actors in the space that have severely stunted the growth of the industry as a whole.

As we reported in our previous quarterly market updates, the weekly NFT sales volumes in the first half of 2022 demonstrated solid performance, with a yearly high in the first week of May at $1.8 billion in sales. Since then, the NFT market has fallen throughout the latter half of the year with no clear sign of recovery, as the cryptocurrency market suffered a series of consecutive collapses by Terra, Celsius, 3AC and FTX, combined with challenging macroeconomic headwinds.

NFTFi

This year, we have begun to see undeniable parallels between the early development of DeFi and the financialization of NFTs as they evolve beyond static art. The financialization of NFTs allows NFT holders to earn yield from their digital collectibles, making them more liquid assets.

Some noteworthy use cases of NFTFi include:

Fractionalization of NFTs
NFT Renting, example: reNFT (backed by OP Crypto)
NFT lending and borrowing
NFT derivatives

Relative to DeFi however, the core pillars of NFTFi are still early in development with weak or missing components (decentralized exchange, structured products) needed to unlock deeper liquidity and financialization.

Ultimately, the end goal is to allow NFTs to become extremely liquid, allowing any retail user or institution to immediately enter and exit a position as if it were an ERC-20 token. Paradoxically, non-fungible tokens almost become fungible. We expect this branch of the NFT sector will lead to exciting, novel financial use cases in the future and we are committed to advancing the financialization of NFTs, supporting projects building the rails to enable the NFTfi at scale.

Last quarter, we published an in-depth research report on NFTFi, written by our own Mads Pedersen. It is definitely worth the read — you can access the article for free below:

NFTFi: A Case for the Financialization of NFTs by Mads Pedersen

Closing Remarks

While 2023 is sure to bring challenges of its own following the tremendous setbacks that crypto faced in 2022, the latest trends in infrastructure, the continued growth of DeFi, and exciting developments in Web3 have us all optimistic about the future ahead. We are confident that the broader ecosystem will recover and rebuild to become more robust, more transparent, and more decentralized than ever after the hard but valuable lessons that we’ve learned thus far.

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