The end of the third quarter of 2022 left mixed emotions. Ethereum the Merge couldn’t carry the market going through a gray clouded macro environment. The summer rain LUNA has stopped. Green sprouts from The Merge, ZK-EVM or the reception of NFT and new cash flow bring hope for the last months of 2022.

Kyros Ventures and Coin68 would like to present to fellow readers and investors the Q3 2022 Cryptocurrency Market Report. Our Research team has compiled and analyzed the market fluctuations in parallel with the release of in-depth commentary on prominent topics.

Impact from Macroeconomics

In March of this year, the FED officially announced the first interest rate increase in more than 3 years and offered a prospect of the next 6 increases. Since then, the risk-off sentiment has enveloped the entire financial market with worries about high inflation, which can lead to many consequences that may result in an economic recession.

With 5 times the FED raised interest rates in the fiscal year 2022, the market reacted negatively when Global stocks were simultaneously down bad. For the crypto market, those actions from the US Federal Reserve always bring downward pressure, except for the only increase in July.

However, we can observe a decrease in the price movement of cryptocurrencies which often comes before the official news from the Fed is released. When the news was officially announced, the price did not fluctuate as expected. This shows that the crypto community sentiment has long been shaped by the predicted macro changes of the world’s largest economy.

Specifically, the big caps in crypto all hit bottom in 2022 in the last days of the second quarter when a series of bad macro news from the US inflation situation, the Ukraine war or the black swan UST-LUNA were all priced in. Entering Q3, Bitcoin only dropped slightly by 3.12% and fluctuated in the $18,000-$25,000 price range, even though the hashrate – a measure of network strength – continuously broke the old all-time highs (According to Blockchain.com). Meanwhile, Ethereum is up 25% with the impetus from the historic event, The Merge, and has saved the gloomy crypto market.

The Merge

Ethereum the Merge marks the first time in history that a major blockchain like Ethereum has officially changed its consensus protocol after 8 years of operation. Although it is just one of the important milestones on the road to scaling the Ethereum blockchain, the crypto community in particular and the finance community, in general, reacted quite positively to this event.

The total staking value in the world’s largest smart contract blockchain network has reached nearly 20 billion USD. However, the amount of staked ETH only accounts for about 12% of the current total supply of Ethereum (according to Staking Rewards). Ethereum’s POS is just the beginning of the next generation of disruptive infrastructure, geared toward scalability and cheaper transaction costs. All contribute to bringing blockchain closer to mass application.

According to data from Coin68.com, Ethereum the Merge is the leading topic among Vietnamese readers, accounting for 3.2% of the total views. Right after that with 2.4% can not be any other name – Ethereum Proof of Work, hereafter referred to as ETHW. Promised to inherit the power from the Ethereum POS senior chain, however, projects built on ETHW did not attract the support of OG builders like Aave, Compound, Curve, or Yuga Labs (the company behind BAYC). Support for ETHW mainly comes from exchanges, speculators and airdrop-hunting groups.

ZK-EVM Race

Following Polygon’s announcement of the deployment of ZK-EVM, the popularity of other rollup projects like zkSync and zkScroll also skyrocketed. In fact, there were many comparisons between the solutions of these three platforms. However, because the majority of the plans are still under development and have not yet been implemented on the mainnet, evaluation of the benefits and drawbacks of each solution seem vague.

What sparked the interest in ZK-EVM and fueled fierce competition among projects based on this technology?

First, we must comprehend ZK’s role in reducing the amount of data that must be stored on the blockchain (because the validation of transactions now only needs to rely on the validity proof generated by ZK, not all data related to the transaction). Unfortunately, the Ethereum virtual machine was not designed to optimize the implementation of ZK technology, resulting in ZK-rollups (one of the Ethereum network scaling solutions) being unable to directly support smart contracts. However, with zkEVM, smart contracts running on Ethereum’s virtual machine can now be deployed on ZK-rollups, saving data storage costs while improving transaction validation speed over ZK-rollups. Rollups that are optimistic, allowing workload offload solutions on the Ethereum network to work more efficiently.

Further, ZK technology can assist in balancing user privacy with system security. Although anonymous, blockchain today does not guarantee user privacy because anyone can trace transactions and link them together to determine the user’s identity. Indeed, this is how hackers frequently exploit to carry out dusting attacks and steal cryptocurrency holders’ information in order to impersonate them and perform transactions that drain money from the victim’s wallet. On the other hand, users benefit from the transparency provided by blockchain, which makes data more secure because it is stored on a decentralized network and is difficult to edit. With ZK technology, the blockchain will continue to be secure and decentralized, and users won’t ever have to be concerned about privacy invasions again. This opens up a whole new Layer 3 layer for development projects and provides more advanced financial and social solutions.

Layer 2 projects: wen token?

The rumors about Ethereum Layer 2 projects launching tokens are increasing day by day. In mid-July, StarkNet accidentally leaked its token through an email exchange with Zhu Su when he was trying to prove his innocence to the crypto community. Basically, StarkNet’s token also focuses on three main uses, which are (i) governance, (ii) payment of transaction fees, and (iii) participation in the consensus mechanism on this Layer 2 platform. Noted that, after the first airdrop of Optimism, no Layer 2 project has made an official announcement about the foundation token for its project so far.

The fact that a Layer 2 project has launched a foundation token has so far caused quite a bit of controversy because firstly, it can cause a loss of value for the Layer 1 blockchain token (ETH) when users use the tokens of other blockchains. This Layer 2 platform to pay transaction fees and secondly, the token launch seems to only act as a method of promoting the project, not bringing more practical value to users. The lesson of tokenomics of DeFi projects is still there: if the use of the token is only “Governance,” it is easy to be dumped to the market, thereby also creating a bad reputation.

Even so, we still have names we need to pay attention to in this Layer 2 array. Alpha corner: Aptos, Arbitrum, Aztec Network, Berachain, Sei Network, Shardeum, Sui Network, and zkSync.

Funding landscape

Fundraising in the third quarter was as bleak as the market value in general, when both the Funding value and the Number of Deals fell by 67% and 40%, respectively. However, we can identify a prominent trend in the money flow during this time.

Infrastructure, especially Layer 1, is getting more attention than other segments. In the top 10 biggest deals last quarter, there were 6 deals in the Infrastructure segment, 2/3 of which were Layer 1.

The wave of industry-leading crypto VCs moving to raise capital from institutional investors is becoming increasingly apparent. Recently, one of the largest funds, Pantera Capital, announced it will launch the second Blockchain fund worth $1.25B, continuing to invest in equities and tokens. Before that, the web3 game giant, Animoca Brands, also raised $185 million from two consecutive funding rounds just a month apart.

Large funds are accumulating assets through raising capital or using existing capital to continue to buy shares in crypto companies in their portfolio. For them, belief and vision in a growing crypto market in the long term is a priority over the short and medium-term fluctuations. According to the statements of the heads of Pantera or Animoca Brands, they share the view that the crypto market or web3 games in particular will gradually separate from the traditional financial/game market. Thereby, they expect to earn the advantage of being the first to explore the technology application gap – the Chasm, before the Web3 world goes mainstream (Figure 6).

One of the Web3 niches that utilizes “the Chasm” most actively is NFT.

NFT welcomes leading brands

MetaMask recently added an NFT margin feature for institutional investors; and luxury brands such as Gucci, Burberry, Tiffany & Co., and Walmart have announced plans to enter the NFT market in the third quarter.  Why is the NFT market so attractive to these giants?

Leaving aside the debate over the true benefits that blockchain and NFT can bring to brands, it is undeniable that the heat in this market is tremendous, so it is understandable that brands want to capitalize on the community sentiment to promote their image. In fact, we have a variety of less expensive, easier-to-use technologies to assist brands in engaging with their audiences. However, we do not have a wide range of technologies that are as appealing to retailers as blockchain and NFT.

With respect to the NFT market, top-notch NFT collections such as Moonbirds, Dust Labs (the company behind the blue-chip project DeGods on Solana), and Doodles have also announced fundraising for their projects recently. On the one hand, the participation of venture capital funds can trigger a question about the ownership and control between equity holders and NFT holders. On the other hand, this will also be a great foundation for NFT projects to expand their network to companies in traditional business industries to explore new development approach that is more well-suited to real-world demand.

The crisis has come to an end

The liquidity spiral associated with Terra-LUNA’s collapse in May peaked last quarter. A series of large funds were seriously affected by this shocking event, leading to the decision to file for mass bankruptcy in the third quarter. Three Arrow Capital posted on July 2, the heel note was followed by Voyager (July 5) and Celsius (July 14).

It can be seen that this domino collapse is quite similar to financial crises in the traditional market, where financial institutions operate by leveraging each other’s financial leverage and liquidity to make a profit. Once there is a black swan event or liquidity crisis, institutions with weak fundamentals will quickly be blown away by the market. In other words, the way 3AC, Voyager or Celsius collapses comes with the CeFi model.

Meanwhile, DeFi projects and protocols have weathered the stETH-ETH depeg with careful preparation in advance. Even so, the total value locked in DeFi protocols has plummeted to this year’s low, returning to the $50 billion mark before the DeFi summer 2021 takes place (Figure 8). After each purge, we can expect more stable and sustainable DeFi models.

Still, some big hacks

The Nomad cross-chain bridge is the biggest case with a total amount of up to 180 million USD (according to REKT Database). The cause comes from Nomad’s smart contract error, although previously pointed out by the auditing unit Quantstamp, negligence in the patching process led to the unfortunate incident. More importantly, the stolen money not only flowed to the hacker group’s pocket but also to a group of individual users when they just copied the transaction of the person who first discovered the vulnerability.

Next is the Wintermute hack that caused $160 million in damage. This bug was also warned by the 1inch team earlier, after discovering the vulnerability of the Profanity wallets. Although the Wintermute team blacklisted all affected accounts, they missed one wallet which was exploited by the hacker. Fortunately, this was a wallet that was only exposed to Wintermute’s DeFi transaction, so the company could still operate normally.

The most notable is the scandalous hack of the Slope wallet, although the total damage is not as much as the two projects above. There are more than 9,000 wallets affected by this hack, and the loss is about 5.2 million USD. The cause of this problem was that Slope had accidentally sent the user’s seed phrases passwords to their server, and Slope’s mistake was not encrypting these seed phrases but storing them as readable text, so anyone with access to this server could get the user’s seed phrases. However, Slope still denied that the fault of this hack was entirely his own. Also because it did not make an official conclusion about the hack, Slope also did not have any compensation for users and has been silent throughout the period from mid-August until now.

Thus, it can be seen that although operating on the blockchain platform to ensure transparency, there are many parts of the infrastructure of cryptocurrency projects that depend on centralized devices and infrastructure, in a closed environment where users cannot fully check the risks that may happen to them. On top of that, the absence of a legal framework to penalize cases like this has created conditions for projects that do not take proper responsibility, quietly disappear, and leave all the damage on the user’s side.

Regulation

On DeFi and CeFi

One of the most remarkable events in the previous quarter on the cryptocurrency market was the US Treasury Department’s decision to sanction Tornado Cash for aiding in money laundering activities. The crypto community on Twitter has reacted against this action by the US government, assuming that they have overstepped their bounds and obligations. However, it should be reconsidered that while they advocate for the decentralization of Ethereum specifically and blockchains in general, who will speak up for those hurt by cyberattacks that result in losses of billions of dollars in this wild west market? Who will be held accountable for the global economy’s impact from billions of dollars worth of money laundering? In this case, government intervention is required to make sure that the market is run in the most effective and equitable manner for all participants.

A decentralized culture does not imply a fair one.

Also related to the legal issue, a relative of a former Coinbase executive recently pled guilty to insider trading in a US court in order to recover more than $1.5 million for others involved in the case. Ironically, while blockchain is frequently praised for the “transparency” it provides to its users, there are still flaws in the market. Without the intervention of law enforcement, it appears that the most vulnerable will continue to be retail investors.

Stablecoin

It is impossible to ignore the US government’s efforts to impose “martial law” for stablecoins, especially after the disastrous collapse of LUNA and UST in May 2022. Recently, the US introduced legislation to prohibit stablecoins backed by the same asset class as the issuer, and the US may force stablecoins in circulation to be backed by highly liquid assets such as cash or US Treasuries, reducing the decentralization of these stablecoins.

In a related move, MakerDAO founder Rune Christensen has proposed “floating” DAIs so that they are no longer tied to a $1 value and are completely decentralized. In fact, Rune’s strategy is risky because DAI, in comparison to other centralized stablecoins such as USDT and USDC, has not been widely adopted. Furthermore, Rune’s proposal’s supply-demand adjustment for DAI is heavily reliant on demand for yield farming with DAI – a lesser demand in daily life and is merely market speculation.

From the writer’s point of view, a stablecoin cannot be fully “decentralized” in order to perform its function of being “stable” and pegged to $1.

This is a trade-off between decentralization and sustainability of the cryptocurrency economy that the community must learn to accept in order for the market to develop in a more healthy manner in the future.

Commodities or securities?

The regulation of the cryptocurrency market as securities is also a serious discussion. The authority to regulate cryptocurrencies (except stablecoins) is more or less related to the CFTC and the SEC. 

As for cryptocurrencies like BTC or ETH, they are defined as commodities because their prices are determined entirely by market supply and demand, not by “the efforts of a third party”, which is a vital element of the Howey test — a test used to decide whether an asset class is securities. 

Thus, tokens of some Defi protocols with the primary use of governance and staking will be quickly considered securities because they satisfy almost all the factors in the Howey test. Because purchasing these tokens is a monetary investment in a business with the expectation of benefit and profit from the efforts of a promoter or another third party. However, in the future, projects may add some utilities to “circumvent the law” to be regulated by the CFTC, not by the SEC, because securities laws will require the company to make more reports to prove its transparency when entering the market.

Epilogue

The cryptocurrency market is gradually gaining more and more attention from the masses, starting from lawmakers, to public companies, and ordinary users will be the final destination. Hacks, model collapses, and major network upgrades all add to the crypto landscape with more contrasts in the already bleak macroeconomic and geopolitical landscape. Our focus should be on building and supporting infrastructure platforms that develop a strong foundation. Let’s finish the year 2022 strongly with Kyros Ventures & Coin68!