Simran Jagdev

Global Macroeconomics

Looking at the traditional cycle which is currently closely intertwined with the crypto market cycle, we are approaching later stages in terms of what has been priced in historically.

FED will most likely stop at 3+ % fed funds rate and adjust its policy framework or become very data dependent vs. being too specific on forward guidance.

Risks remain outside globally from monetary policy error standpoint. In particular, asymmetric risks remain with regards to monetary policy of BOJ and ECB.

Inflation most likely reached a peak and commodities are signalling weakening of global growth which should also lower inflation on forward basis. We are not going to historical 2% target but more likely set for structurally higher inflation of 4-5 % for 2023.

Supply side inflation is easing judging by supply pressure index

Long term inflation expectations are well anchored while short term expectations remain elevated.

We are in technical recession in US while growth in Europe is also pointing out to recessionary environment.

Most economic indicators point to global recession.

Here are our key takeaways:

Crypto Macro and Web3 Fundamentals

This has been one of the fastest drawdowns in the history of crypto, measured by the time to fall 70%.  It reflects the speed of financial conditions tightening, but also could suggest we could be closer to the end of the drawdown. 

Over the past two months, crypto beta (ETH/BTC) has decoupled from traditional risk assets.  This is a departure from the trend over the past year and reflects the tremendous deleveraging that occured across the crypto markets.  

Ultimately, the industry experienced a full-fledged financial crisis, led by CeFi (Centralized Finance) lenders and over-leveraged crypto funds. It’s no surprise that we’re now seeing bankruptcy proceedings and a new regulatory focus on investor protections. We have seen this playout throughout the history of traditional markets.  The opacity of exposure and liquidations created additional market uncertaining, increasing volatility and reducting liquidity. Meanwhile on-chain, liquidation levels are transparent and comfortably distant from spot. In contrast, during this crisis,DeFi (decentralized finance) is fulfilled its promise – forced asset transfers that followed smart contract code,  predictable, orderly, and visible to all. 

Stablecoins are a key part of the ecosystem. They played an important role over this crisis. The different dynamics of each stablecoin, their mechanism, collateral, and transparency led to winners and losers.

We are seeing signs that the market has re-shifted focus on the Ethereum merge. This has been reflected in pricing in the derivatives market (i.e. options). In addition, the ETH to BTC ratio has reflected a major shift in sentiment. 

There are also signs that retail and institutional sentiment is shifting.

Total value locked in Decentralized Finance on Ethereum fell over 71%.  However, in recent weeks it has increase approximately $13 billion from the lows. 

Similarly, the imbalances in the stETH/ETH curve pool are gradually starting to normalize.  While there are still issues, it has been improving. 

Yields on DeFi protocols suggest little appetite for risk (leverage).  Yields have slightly increased from the lows, but risk sentiment is still low. 

Web3 address activity is something we monitor very closely. It’s difficult to track the address data, especially across chains. However, our estimates show growth in total addresses but a decline in active addresses. In July, we saw a slight growth in the active addresses on the Ethereum network. 

We monitor several factors, including the number of transactions, that can have implications on the price of ETH. Transactions have been steadily declining along with its price since November of last year. However, there has been an uptick recently in the number of transactions as the price of ETH stabilized in July. We see this as a potential sign that tides are turning and the price of ETH may have reached its lower bound.

When looking at how NFT’s have performed during the sell-off, marketcaps for the top 100 NFT projects held up fairly well.  The NFT marketcap priced in ETH increased by 24% since May while the price of ETH declined by 27%. A healthy sign for the NFT sector showing resilience in this market. 

Large DeFi protocols are beginning to launch their own native stablecoin. This creates an additional layer of capital efficiency on the respective protocol as users can mint stablecoins to deploy to other opportunities while their collateral remains locked on the platform. Perhaps more importantly, this provides the protocol with a secondary revenue generating mechanism, given that all interest accrued flows back into the treasury.

ZK technology is advancing much faster than originally anticipated. Polygon, Matter Labs, and Scroll have all made recent announcements that they are close to launching their respective ZK product, which in some cases could be deployed as early as September 2022. This is important because ZK rollups are generally thought of as much more efficient than their optimistic counterparts, which gives Ethereum a better scaling solution and also puts pressure on existing optimistic rollups.

Conclusion and Takeaways

Relative to macro volatility, crypto has remained stable as retail and institutional appetite for risky investments continue to remain low and limited by both cash crunch and attractive risk-free yields. Here are the top 10 charts showing crypto stabilizing and remaining steadily resilient in turbulent markets:

1. Both investors and leading protocols are turning to risk-free assets given attractive rates

Divergence in USDC and US Treasury yields have spurred the outflow from stablecoins in favor of risk-free assets. As a result, the market cap of USDC has declined 19% since June, as both investors and protocols can earn additional yield by turning to off-chain bonds. Among them is Maker DAO, who recently made the unprecedented step of diversifying its holdings by collateralizing DAI with yield-bearing assets (US Treasuries).

USDC vs. US Treasuries (2y) USDC market cap

1. However, relative to recent macro volatility, crypto has remained stable

For an asset that has historically been considered highly volatile, Bitcoin’s 10-day realized volatility has set new lows when compared to that of Dow Jones albeit tremendous macroeconomic uncertainty. 

Realized volatility of stocks (Dow) vs. crypto (BTC) has broken all time lows

1. Crypto outperformed traditional assets in Q3, despite rough macroeconomic conditions

Crypto experienced a severe downturn across all sectors at the end of the second quarter, after the $60B implosion of the Terra ecosystem and fallout from VC firm Three Arrows Capital. However, the third quarter demonstrated resilience as crypto returns turned positive despite continued macro headwinds that continued to impact traditional assets.

Quarterly returns across crypto and traditional assets

1. Web3 address activity – active wallet decline stabilizes

As total addresses continue to grow across all the top chains, consecutive decline in active addresses since May reversed and is up 11% for the month of October. Largest contributor was Binance, up 31% from the prior month. On average for the year, Binance represented 38% of all active addresses, followed by Solana at 29% and Ethereum at 19%.

Active addresses stabilizing, led by Binance

1. State of Ethereum gas usage by transaction type

In addition to transaction count, gas usage by transaction type is another indicator of user demand as the throughput of Ethereum is limited in units of gas available per block. These charts capture various use cases in relation to on-chain transactions and gas consumption.  Ethereum usage this year has been declining or flat across popular transaction types such as stablecoins, bridges and NFTs. However, gas consumption for DeFi, specifically Uniswap, has been relatively robust despite decline in ETH price suggesting relatively higher demand and economic value assigned by users.

1. NFT sales count remains suppressed but gaming remains resilient & diverse

Weekly NFT sales count also remained suppressed for the quarter and the month. However, sales in gaming have remained positive for the quarter while arts and collectibles trended downward. This may be due to the fact that sales within arts and collectibles predominantly come from NBA TopShot while sales in games are relatively diversified. New marketplaces such as X2Y2 have also enabled features that may be more suitable for use cases outside of arts and collectibles.

1. NFT marketplace and chain share – concentration spurs competition

At one point, OpenSea was commanding more than 70% of volume (May 2022). However, competing marketplace X2Y2 has surpassed OpenSea volume. The reason for X2Y2’s popularity was the fact that it reduced transaction fees to zero to encourage listing and trading of high quality NFTs, and distributed 600k native tokens to buyers and sellers to subsidize gas fees generated during transactions. In August this year, X2Y2 also undertook a controversial decision to remove royalty fees for collections, giving buyers the choice of whether to pay royalties or not.

1. VC funding in blockchain slows but outperforms broader trend

Venture capital has slowed down across the board and blockchain-based companies have not been immune. Nevertheless, investors in the space are proving more resilient than in other industries.

1. Gap between blockchain and venture capital valuations widens

Blockchain companies are displaying growing valuations despite less capital, meaning investors are concentrating on fewer, higher quality deals. But investors are also starting to mark down valuations of companies most exposed to global macro headwinds.

Median valuations in blockchain vs. other venture capital

1. Investment in CeFi & NFTs shrinks; shift to other Web3 projects

Capital breakdown has shifted away from NFTs and CeFi amidst market turmoil and regulatory uncertainty, towards core Web3 developments (gaming and protocols) and infrastructure. DeFi has also grown its share of capital following the 3AC fallout and collapse of several CeFi firms.

Funding breakdown by category

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Found this research useful? Connect with the ConsenSys Cryptoeconomic Research team at [email protected]

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Legal Disclosure

ConsenSys Software Inc. is not a registered or licensed advisor or broker. This report is for general informational purposes only. It does not constitute or contain any individual investment advice and is made without any regard to the recipient’s objectives, financial situation, or means. It is not an offer to buy or sell, or a solicitation of any offer to buy, any token or other investment, nor is it intended to be used for marketing purposes to anyone in any jurisdiction. ConsenSys does not intend for any person or entity to rely on any facts, opinions, or ideas, and any financial or economic commentary expressed in this report may not be relied upon. ConsenSys makes no representations as to the accuracy, completeness, or timeliness of the information or opinions in this report and, along with its employees, does not assume any responsibility for any loss to any person or entity that may result from any act or omission based upon this report. This report is subject to correction, completion, and amendment without notice; however, ConsenSys has no obligation to do so.

September 15th, 2022 was a historic day for the Ethereum community. Ethereum, the world’s largest programmable blockchain, successfully switched to the Proof of Stake (PoS) consensus mechanism. The implications of this move away from energy-intensive Proof of Work (PoW) are profound for the blockchain and the planet: the Merge reduced worldwide electricity consumption by 0.2%. 

The Merge was the culmination of the efforts of an open community of Ethereum Core Developers (CoreDevs), researchers, and client teams—many of whom work for ConsenSys. For nearly seven years, they worked together to build an Ethereum that was more sustainable, more secure, and more scalable. 

To thank all the CoreDevs and contributors, and to mark this landmark moment in our nascent ecosystem, ConsenSys presented the CoreDevs with a set of commemorative NFTs, with the team’s names embedded in the metadata. Regenesis is a collection of art NFTs that are a testament to the capability of decentralized software development. It will forever be tied to the birth of PoS Ethereum, as it holds one of the first NFTs that was minted on Block 1.

But before we get into more details about the NFT collection, let’s recap what the Merge is and why it is important. 

Why Merge?

Until 2:43 am ET on September 15, the Ethereum network had two blockchain layers running in parallel – one running PoW, called the execution layer (the historic state of Ethereum and block production), and the second running PoS, called the consensus layer. Then, the two layers merged, effectively ending PoW and transitioning the Ethereum mainnet fully to PoS. This event was termed the Ethereum Merge. 

To understand the magnitude of this upgrade, consider an analogy: the Ethereum network is a car running on a gas engine, but instead of providing motion to the car, Ethereum’s engine provides security to the entire network. As part of an upgrade, the automotive engineers decide that they want to replace the gas engine with a more efficient electric one, reducing the car’s carbon emissions by 99.99%. They also want to make the switch while the car is running full throttle, and to do so in such a way that the driver doesn’t notice that the engine has been switched. This is what Ethereum’s CoreDevs achieved through the Merge. As a result, the Ethereum network switched from PoW to PoS, with no downtime and no impact to or action required from end users or developers. 

Regenesis: The first public NFT mint on PoS Ethereum

Regenesis is a collection of art NFTs celebrating the historic technological milestone the Ethereum community just achieved. ConsenSys commissioned a series of illustrations, each depicting an elaborately detailed world embodying one of the prime benefits of the Merge: sustainability, security, and scalability.

The first piece in the collection illustrates sustainability. Adopting PoS reduced Ethereum’s energy demand by 99.99%, to support the next generation of sustainable Web3.

The second piece focuses on how the adoption of PoS lays the foundation for scalability, setting the stage for limitless innovation and massive global change in the future.

The third piece illustrates security: Ethereum’s updated crypto-economic model democratizes network participation and provides stronger security guarantees for end users and developers alike. Proof of Stake also opens the door for maximal decentralization and will unlock flowering ecosystems and application development on Ethereum and its L2s. 

The Merge is not just a moment for crypto insiders, it is a milestone in the history of the internet. To celebrate the occasion, we are inviting everyone to use Web3-native tools like MetaMask to claim their own piece of this historic moment:an open edition NFT of one of the first collections on PoS Ethereum available at consensys.net/merge. The claim window will close on Sunday 18th September at 6:45am UTC.

We are in the midst of a crypto bear market. Crypto valuations have been down 70% since their high of 2021, in line with the overall US securities market. But perhaps we should see the increasing correlation of crypto markets with the US stock market as an indication of the maturity that the crypto sector has gained since the last crypto winter. 

This increasing correlation between crypto markets and US equities may, in fact, partially be a function of the amount of institutional money that has flowed into the crypto market over the past couple of years, according to Arcane Research, a crypto analytics company. 

A clear sign of the growing interest of institutional investors in crypto is that even the bearish market conditions have not deterred some firms in the traditional financial (TradFi) space from putting their money in crypto, or furthering their plans to offer crypto investment options to their clients. This points to the argument that a crypto bear market is the time to develop growth strategies, and play the long game.

Let’s take a look at which TradFi firms are still bullish on crypto and what moves they are making.

Investment Banks

US-based JPMorgan Chase (JPM) hinted at a crypto recovery in an analyst note at the end of June this year. The bank said that the current downturn in the crypto market may be nearing its end “given the fact that crypto entities with the stronger balance sheets are currently stepping in to help contain the contagion”. The note referred to crypto firms like FTX reportedly looking to buy out the assets of highly-leveraged companies such as Three Arrows and Celsius. 

JPM also used blockchain for a collateral settlement on May 20th, 2022. The bank transferred tokens representing the money market shares of BlackRock Inc on its private blockchain as collateral. JPM says the use of blockchain to settle transactions will allow investors to settle trades outside of market hours as well as use a wider range of assets as collateral. 

Goldman Sachs, a leading global investment bank, in July used blockchain to settle a security lending deal with BNY Mellon. The two financial institutions settled a transaction worth “hundreds of millions of dollars” using digital records. Earlier this year, Goldman had also partnered with Coinbase to offer its first bitcoin-backed loan. 

The vote of confidence in favor of crypto is not limited only to US financial entities. In the UK, Barclays is reportedly putting in “millions of dollars” to buy a stake in Copper, a company that provides custodial services to institutional investors, among other things. 

France’s BNP Paribas is also looking to enter the crypto custody space, Coinbase reported on July 19. The bank, which has nearly $13 trillion in assets under custody and is one of the largest French banks, has partnered with Metaco for its crypto push. 

Metaco, a Swiss tech company, is also a partner to Citibank and Societe Generale (SocGen), as part of the banks’ focus on tokenizing securities. Citi’s Securities Services team will work with Metaco to focus on “tokenized securities: representations of stocks and bonds moved around and settled using blockchain tech”. Meanwhile, SocGen’s FORGE, its digital assets subsidiary, will work with Metaco to issue, invest and manage their digital native security tokens issued on a blockchain. 

Retail Banks

Brazilian banks are leading the way in crypto adoption among retail banks. Itau Unibanco said in July that it was considering allowing retail investors to buy and sell cryptocurrencies. Itau, which is Brazil’s largest private lender, was also looking to launch an asset tokenization platform and custody services for its institutional investors. 

Banco Santander, the Brazilian subsidiary of Spain’s Santander Group, said in late July that it was also looking to launch crypto trading services for its clients. Nubank, Brazil’s largest digital bank, launched its crypto trading platform in June, and last month reached 1M users on the platform. The company had expected to reach the milestone in a year, but outdid the expectation by 11 months. 

In the US, Huntingdon Valley Bank, a 100-year old community bank, opened a stablecoin vault with MakerDAO in July this year. The bank will be able to borrow $100M worth of DAI tokens, with the option of this credit line going up to $1B over the next 12 months. 

Even though the Bank for International Settlements has been skeptical in its approach towards cryptocurrencies, it said in July that banks can have up to 1% of their reserves in crypto assets. 

Hedge Funds

Hedge funds have led investments in crypto, with 38% traditional hedge funds investing in digital assets, according to a PricewaterCoopers report. And they are continuing this trend in the bear market. 

Citadel Securities, a sister company of hedge fund Citadel, is reportedly building a “crypto trading ecosystem”. The company has so far partnered with Virtu Financial, Sequoia Capital, and Paradigm for this initiative. More wealth managers and market makers are expected to join the consortium as the marketplace nears launch. 

Point72 Ventures, billionaire Steve Cohen’s hedge fund, participated in a $20M funding round for a decentralized finance (DeFi) firm focused on data and trade execution for institutions. The hedge fund has also been beefing up its crypto unit staff. Among other positions, Point72 is hiring a crypto technology head who will report to the hedge fund’s chief tech officer. 

Brokerage Firms and Market Makers

The digital assets arm of brokerage firm Fidelity Investments said in May that it would add 110 developers and engineers to its workforce. In addition, it plans to add 100 customer service specialists. Fidelity’s digital assets unit was launched in 2018 to allow institutional investors to trade in BTC and crypto. The announcement came after the retirement plan provider said in April 2022 that it would allow crypto exposure for its 401(K) retirement accounts.

MicroStrategy doubled down on its crypto offensive and disclosed in its regulatory filings that it had put in $10M in BTC, purchasing nearly 480 bitcoins. The company started investing in BTC for the first time in August 2020, and so far has nearly $4B locked in BTC.

Susquehanna International Group, a quantitative trading firm and market maker, invested $10M in KuCoin, a Singapore-based crypto exchange. 

TradFi and DeFi come together

For a long time, the debate in institutional investment in crypto was about TradFi vs DeFi. The increasing popularity of DeFi was often considered a death knell for TradFi. However, the digital asset management strategies of a number of TradFi companies in the downturn point to the fact that TradFi and DeFi will complement each other in the future. After all, it is all about the long game.

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Crypto adoption among institutional investors has been on the rise. According to a CoinShares report, institutions invested $9.3B into the crypto market in 2021, up 36% from 2020. As adoption for the new asset class continues to increase, it is important to understand the changes that are coming to Ethereum, the world’s largest programmable blockchain.

To understand the future of Ethereum, we need to remember first and foremost that it is a technology platform. Ethereum is the foundation on which the future of the internet (Web3), and the future of finance (DeFi) is being built. The second thing to remember is that more than half of the entire DeFi ecosystem is being built on Ethereum. And as with any efficient technology, the Ethereum roadmap is full of upgrades to its infrastructure that make it future-proof. The first such upgrade, called the Merge, will occur in mid-September 2022. It will be a historic moment for the nascent crypto industry and will set up Ethereum for increased security, sustainability and scalability. 

Currently, the Ethereum network has two blockchain layers running in parallel – the layer running Proof of Work (PoW), called the execution layer (the historic state of Ethereum and block production), and the layer running Proof of Stake (PoS), called the consensus layer. The Merge is the event when these two layers will merge, effectively ending PoW and transitioning the Ethereum mainnet fully to PoS.

DeFi and Institutions: The Story So Far

About 60% of all DeFi activity today happens on Ethereum. The network adoption and utilization has been on the rise, which is a strong signal for network maturity. Transactions have surpassed an average of 1M+ per day over the last 12 months. In addition, over 13.3M ETH has been staked by over 415M validators, accounting for nearly 11% of all ETH supply.

This traction demonstrates that the number of users and liquidity coming to Ethereum is incomparable to other Layer 1 chains. An increasing amount of institutional activity across the network also underscores the network’s popularity. 

Over the last two years, many leading institutions have taken meaningful steps into the DeFi and Web3 ecosystem by pivoting their business model to focus on Web3, and by deploying capital into the ecosystem. 

DeFi Financial Market Infrastructure players have matured and created fundamental base services to accelerate adoption and trading on decentralized networks. The number of DeFi applications has exploded, resulting in the exponential increase of institutional yield opportunities. In addition, DeFi applications and protocols have begun to develop institution-focused services. Large holders of ETH—including cryptocurrency exchanges, funds, and custodians—are recognizing that holding ETH bestows a powerful position within DeFi. They have been earning rewards at 4.06% annual yield on their ETH positions. 

Despite current geopolitical and macroeconomic factors, and the recent market volatility,  institutional appetite for being a part of the Ethereum ecosystem has been strong. Financial institutions—investment banks like Goldman Sachs and Barclays, hedge funds like Citadel Securities and Point72 Ventures, and retail banks such as Banco Santander and Itau Unibanco—are putting their money in crypto, or furthering their plans to offer crypto investment options to their clients.

DeFi and Institutions: After the Merge

For a long time, the debate around institutional investment in crypto was about traditional finance (TradFi) vs DeFi. The increasing popularity of DeFi was often considered a death knell for TradFi. However, the digital asset management strategies of a number of TradFi companies in the downturn point to the fact that TradFi and DeFi are now coming together to complement each other. This trend is likely to increase post-Merge, as institutions acknowledge that it is all about the long game.

With the Merge, Ethereum will cut down its energy usage by 99.95%, tremendously reducing its carbon footprint. Annual ETH issuance is also expected to drop by 89.4% after Ethereum’s transition to PoS, creating a deflationary pressure on the ETH token. In addition, the Merge will change the way value is accrued across the Ethereum network. Currently, any value that ETH generates (gas fees) is paid back to the network in the form of rewards to miners. Following the Merge, the value from network usage will accrue to both the validators and token holders. 

The Merge will also increase the security of the Ethereum network by democratizing network participation and improved decentralization of the PoS mechanism. As a result, the cost to attack the Ethereum blockchain will be more than $11B at current prices, roughly 10-20X more expensive vs PoW. In addition, the security of the network running PoS will rise over time as more validators will come on board, and the amount of staked ETH will increase.

On-chain apps and Layer 2 solutions will likely leverage the improved security conditions and multiply on top of Ethereum

We discuss how these changes to the Ethereum network will translate into opportunities for institutional investors in detail in our upcoming report, “The Impact of the Merge on Institutions”. You can register to receive the report in your inbox on September 5th here. On September 12th, the key contributors to the report will talk about it on our “Breaking Down the Merge for Institutions” webinar on September 12th. You can register for it here.