This month we are putting together a follow up to our previous issue where we reflected on the trends of 2021. In this edition we will be talking about our market outlook for 2022 and the themes that we are excited about. As always we are constantly learning alongside the evolving macro and fast paced developments in the industry and do not claim that our outlook will play out perfectly, or at all. This edition of the newsletter is also slightly delayed than our usual, not only because we took a lot of time reflecting on what we wanted to share but because frankly, we dropped the ball a little bit. First, we would start this article with our views on the current state of the market leading upto the scenarios we see playing a lot in the rest of 2022.
End of the Hibernation
The past year and a half saw a fairly lengthened bull cycle, which consisted of two separate bull phases divided by a crash in May of 2021. The rallies in most themes were preceded by a narrative taking over the mainstream crypto discussions followed by high volume activity and then capital rotation into the next narrative. First, DeFi was supposed to disrupt TradFi, followed by DAOs disrupting corporations, followed by NFTs as a means to own the internet, which swiftly transitioned into a P2E hype that shifted to metaverse hype triggered by Facebook’s rebrand announcement. All this while the L1 wars narrative played out quietly in the background turning every L1 with any traction to a multi-billion valuation token. Finally ending the year with a L2 war narrative and rotation back into NFTs. The point being that come February of 2022, the market is running out of narratives to justify more capital deployment, leaving retail and institutions in a state of confusion. Returns for sophisticated investors are dwindling due to the lack of exit liquidity on the retail side as the stimulus runs out and people return back to normal lives, devoting less and less time to gambling in the crypto markets. Without the presence of these less sophisticated investors the institutional capital will be forced to hedge against potential downside via sell offs causing dips that lead to deeper dips. This might sound like the onset of a long and destructive bear market, but this is the right opportunity for the market to undergo some corrections. The 2021 cycle saw memes, scams and marketing take the front seat ignoring the fundamentals of the projects. With capital deployment lagging narratives, more and more money was deployed into worse quality projects with founders raising ventures just to meet the oversupply of capital wanting to enter into the craze. Without coming to terms with the oversupplied abundance of cheap-copies, memes and vaporware promises, it would be impossible to move forward. Newer projects with no product yet have themselves become VCs funding, even newer tokens with no roadmap. Thus, We see that some correction is inevitable and it is healthy for the long term. If the macro and equity markets hadn’t turned we could have seen the mania taking the highs even higher but a crash would have been even more brutal in that case. The current prices (Feb 22nd) of $BTC, $ETH seem fair and some major alts still might be a bit higher than what we could call fair price.
Crypto is here to stay
As early believers of the philosophy behind crypto, we have seen many criticisms, doubters and FUDders detracting progress in the space. However this past year has proven that the progress cannot be rolled back. Crypto became the more palatable ‘Web3’ and big tech like FB, Meta and Shopify, started signaling itself as an ally. But overall most people seem to agree that the internet monopolies need disruption. We identified 3 key trends for this change:
Capital: More venture money is entering into the space with bigger tickets and more deals than ever before. We also saw staggering highs of retail investors entering the ecosystem, looking for high risk/reward investments.
Talent: Key leaders in web2 big tech co’s left their roles to join large crypto/NFT companies like Polygon and OpenSea. Due to the open source nature and low barrier to entry, more and more young folks are entering into the space part time and embracing the culture. Despite the talent pouring in, the demand far outweighs the supply creating incredible economic opportunities for these early entrants. This will likely attract more talent to the industry in the near term.
Institutions: In financial asset markets, large structured players always enter into the spaces where there is most money to be made. Last year we also saw record interest from traditional finance giants and banks to get some crypto exposure and create their own strategies for the industry. These are signs of a maturing market that is not going anywhere anytime soon. We will likely see more ETFs and crypto companies doing IPOs.
We believe that in 2022 and onwards we will see this trend play out & crypto protocols will figure out ways to improve procedural efficiency.
One of the main pillars of the ecosystem, DeFi’s success has come from the ponzi reward structure that made its early investors its biggest evangelists. DeFi 1.0 winners were mainly AMMs and Lending protocols which amassed huge TVLs and multi-billion valuations. Post that we saw a new narrative called ‘DeFi 2.0’. The (3,3) meme was fun while it lasted but it really left us thinking on how to create DeFi products with sustainable growth models. We have identified 3 major themes where we see DeFi innovation happening in 2022.
New Primitives: As more activity moves on-chain, we envision the need for more DeFi primitives for newer use cases such as insurance, options, margin trading and perpetuals. We are working with several projects working on this thesis to build a future DeFi product suite.
Sustainable Yields: The success for DeFi’s early adopters came mainly from token printing coupled with a bull cycle that pushed every project to multiple times valuations. But going forward this model will not be reliable especially for latecomers who end up being exit liquidity for the first comers. Sustainable yield generating products such as Options vaults (Ribbon, Friktion, Thetanuts) will become incredibly important as they generate organic yields through option selling to institutions and hedging against market volatility.
CeDeFi: Similar to mutual funds and ETFs in Equity markets, we believe centralized money management protocols is the next opportunity for disruption in crypto. This market already has some leading players like Nexo, Celsius. But, we believe that there are opportunities to allow access to DeFi level yields in a structured product offering that does not require active management from the investors. These protocols stand to benefit from extreme volatility in times of uncertainty and an increasing number of retail investors.
NFTs and Play-to-Earn
As big as this sector became in the later half of 2021, we are unable to see projects with signs of long term sustainability. The use cases for NFTs still remain intact, the current state of the NFT market is driven largely by marketing hype and signaling from top brands/celebrities. The actual long term utility and demand for these products is past our understanding.
P2E however is a big opportunity that is likely going to go through several growing pains. People work because they need to, in order to make a living. But gaming is an activity that you do out of choice, people might even pay money on top of the time they put in, to purchase gated content, in-game assets and other items. In a P2E game, there are people paying to play the game like they do in a regular game, but also those who pay to make a living by playing that game. This group is composed of streamers, professional players and account traders who made an economic activity out of the time spent in game. In P2E you also have the element of speculative in-game economy which everyone can participate in and make money off of. But when rewards thin out due to inflation (Axie), players no longer have an incentive to keep playing unless the game itself is enjoyable. This is the biggest problem with most P2E games in the market right now, they lack the core fundamental experience of a fun video game that people would want to devote time to, in absence of any economic upside. We strongly believe that P2E games with solid fundamentals as games are the only projects that stand the chance to stand for a long time.
The size of the opportunity is also going to attract traditional gaming companies to transition and experiment with games that have P2E economies. We envision that companies that build an actually good game will be the long term winners of the industry.
The Layer 2 wars are coming
Many in crypto regard Ethereum as the de facto smart contract blockchain to build further layers of applications. However, due to the design constraints of Ethereum it cannot compete in terms of its usage cost without additional scaling solutions. There are three types of L2 scaling designs being developed by the Ethereum community. These are:
- Sidechains: Polygon, xDAI
- Optimistic rollups: Arbitrum, Optimism
- ZK Roll ups
Although none of these ecosystems are clear winners, some first movers like Polygon & Arbitrum have created a significant gap from the rest. The L2 wars, just like the L1 wars is also a good candidate for the next pump narrative, on finding the best Ethereum scaling solution. We are excited about these developments and will release a detailed view on this soon.
Overall we believe that the larger market dynamics are showing onset of a maturity phase, which means a crash would be less destructive and last a lesser time. The narratives of 2022 will be based on stronger qualitative value than before. This does not mean that raising capital in the space will be any more difficult than last year due to the sheer abundance and risk taking appetite of so many players. However, exit liquidity will be low forcing investors and retail to hold coins and invest in areas that can support a high conviction thesis. This means less exit scams and vaporware projects with flimsy fundamentals overall.
Disclaimer: This article is a summary of the writers opinions and research. Digital assets are a volatile asset class and readers should be aware of the potential risks of investing in blockchain projects. This is not investment advice & we will not accept liability for any loss or damage that may arise directly or indirectly from any such investments.