After nearly two years of rising prices, the crypto bull market is coming to an end, in line with the US Federal Reserve’s course change. A comprehensive look back at the space’s third market cycle, innovations in the blockchain space, institutional adoption, and a look at the future of digital assets.
By the end of 2020, after the Covid shock and in line with the first new emerging use cases on blockchain infrastructure, a new crypto bull market was born. In December 2020, the alpha animal Bitcoin managed to break its old all-time high of $20,000 from 2017 for the first time after 3 years of a bear market. A lot has happened since then: Bitcoin and other cryptocurrencies have reached new all-time highs and the blockchain infrastructure has matured again. But as always in such phases there were exaggerations and the crypto market is currently paying for these antics with its ongoing hard price correction.
An overview of developments in the crypto industry and a look at the current course correction, including a preview of the area’s possible future.
2020 – Bitcoin wakes up from the bear market
The COVID-19 crisis and subsequent quantitative easing (QE) measures by the US Federal Reserve led to an unprecedented expansion of the money supply in 2020. This increased investors’ risk appetite, with some also considering the new asset class of digital assets. And so Bitcoin premiered shortly after the third halving of its inflation rate: American software maker MicroStrategy became the first publicly traded company to announce that it would diversify its assets into Bitcoin.
The company’s investment quickly scaled up, with the real impact hidden in a new narrative for the digital asset. MicroStrategy became a successful poster child for the adoption of Bitcoin as an alternative to gold, which should be part of every company’s investment strategy. Public appearances and private conversations by CEO Michael Saylor reinforced this narrative; A few months later, car manufacturer Tesla was also convinced. PayPal and other payment providers, as well as Wall Street banks, have now integrated the largest cryptocurrency into their services and numerous other developments have led to more attention for cryptocurrencies in general.
First seeds of Web 3.0
Parallel to the developments in the Bitcoin ecosystem, the field of decentralized financial applications was born on the largest smart contract compatible blockchain Ethereum. This made it possible to process financial transactions directly between participants at a new level (P2P). Its permissionless nature allowed anyone to use the DeFi applications. Decentralized trading places and credit platforms emerged to which liquidity could be lent or borrowed against the deposit of crypto collateral with a yield curve freely created by supply and demand.
Thanks to the integrated Automated Market Maker (AMM) protocols – which are a central part of blockchain-based exchanges – it was now also possible for anyone to participate in liquidity pools and receive a share of the trading costs from that pool. Bitcoin and other cryptocurrencies can be deposited into credit protocols as collateral, to borrow against and otherwise invest. With the emergence of various DeFi platforms, a battle for liquidity emerged, which was fought with inflationary token issuance of the respective platforms to increase attractiveness. Over time, countless DeFi applications have been created on various blockchains, seeking to tie liquidity and users through ever-increasing distributions of their own protocol tokens.
Non-fungible Tokens (NFTs)
However, aside from crypto-specific mutual funds and interested retailers, the DeFi space failed to attract a large audience from behind the stove. Collectors, artists, gamers, individualists, cultists, and other individuals found their blockchain use case through another emerging development. As a follow-up to memecoins, the ERC-721 standard — a non-fungible token variant on the Ethereum network — found a use case that appealed to a wider group of blockchain users. It was the birth of NFTs, a genre that went unnoticed for a long time but fueled the crypto hype.
Individual tokens can be linked to digital objects. Images, as the most common example, can now be permanently attributed to a user via the wallet address. Limited collections sold like hotcakes among digital collectors, and as trading platforms were not long in coming, a marketplace quickly emerged, quickly recording daily sales of several hundred million dollars. The hype ensured that countless new “limited” collections were launched every day. Other NFT use cases in games and the metaverse further fueled the trend.
The blockchain infrastructure is reaching its capacity limits
The rapid growth of DeFi and NFTs led to congestion on the Ethereum blockchain, causing transaction costs to skyrocket. The blockchain trilemma had struck and new outsourcing opportunities had to be found for the increased demand for blockchain capacity.
It was the birth of alternative smart contract platforms and Layer 2 solutions built on the Ethereum blockchain as a public ledger. New blockchain platforms emerged, most of which were Ethereum compatible, so that the successful DeFi and NFT applications could be cloned onto the new chains. And you guessed it: to bring users and validators to the new blockchains, native tokens were created for almost every new solution, which could be used mainly for transaction costs, but of course also served as a medium of exchange and speculation. The clones of the successful applications in turn had their own tokens, diluting the reach with further issuance.
The euphoria surrounding digital assets, driven by the new use cases, took bitcoin and all other cryptocurrencies to new realms. A separate asset class was in its infancy and the traditional financial world also wanted a piece of the digital pie. After the listing of Bitcoin futures and options on US exchanges, the first Bitcoin ETF listed on the US exchange followed in October 2021. An award for the oldest cryptocurrency and a starting point for many major US banks to offer digital asset services to their clients.
A daily growing supply meets a limited demand
The market was greedy, the demand huge and the supply even greater. In November 2021, one month after the highly anticipated Bitcoin ETF, the total market capitalization of the approximately 30,000 outstanding tokens officially counted was just over $3 trillion – with Bitcoin, which has now risen to over $65,000, accounting for a good third of the total market cap calculated 11 months ago we had a bitcoin price of $20,000 and a total market cap of $750 billion.
Every day, tens of millions of new tokens were issued, new NFTs created, and venture capitalist allocations unlocked. DeFi protocols paid out their own token returns in the 3-digit percentage range to lock in vital liquidity. Added to that were the usual block rewards from miners, which are only about $60 for Bitcoin. million a day. Of course, no one could say when the music would stop playing. However, the futility of the projects, as well as the sheer infinity of new digital tokens that are looking for their buyers every day, indicated a phase of exaggeration.
It wasn’t until November 2021 that most cryptocurrencies also recorded their highs which were over 80% higher than today. What had to happen at some point followed: the market could no longer absorb the range of products that were newly created every day. The reversal trend has undoubtedly been accentuated in recent months in line with the overall market. The general risk-averse behavior enforced by quantitative tightening (QT) has had a particularly strong impact on the overheated crypto market recently. Even if it hurts, it was probably necessary. Many of the problems that come to light are homegrown. Too many projects with no real benefit, too much euphoria surrounding the young Web3 and too many protocols based on Ponzinomic models.
The crypto market is in the midst of a cleansing storm wave. Larger and prominent names were also swept up in the vortex. The weaknesses of the counted institutions are no different from the traditional financial market. Too much leverage, lack of diversification and unrealistic management of the balance sheet structure often lead to collapse in stressful situations. In the crypto market, however, there is no central bank that comes to the aid of market participants “too big to fail” and creates zombie companies with an interest rate environment that is not in line with the market. Here the free market decides about life and death. Even if it hurts, this is the only way to create a robust market that is superior to the traditional financial market and stable, with crisis-resistant market parties who (have to) manage their risks.
Crypto is here to stay
The mess of the market correction is huge at first glance. But there is light at the end of the tunnel: if you look at the fundamental developments in the blockchain industry, you will undoubtedly see enormous progress. The past 2 years have been wild and the hangover is part of the party. The further developed infrastructure around crypto and its derivatives is nevertheless remarkable. Venture capitalists have recently invested billions in infrastructure and an estimated 300 million people worldwide now use crypto applications. With a growth rate of almost 100%, the one billion mark could be exceeded in 2024. The combination of the added ingredients has the potential to revolutionize interactions on the internet. With the help of tokens, users are directly integrated into an ecosystem, which has now also been discovered by well-known companies outside the financial world. The synthesis of blockchain-based applications with Web2 and real-world applications eventually leads to the metaverse of Web3, a realm of unlimited possibilities and enormous potential.
Thanks to continued regulation, the area is increasingly merging with traditional finance. This makes perfect sense. Blockchain-based financial systems create transparent, manipulation-free and efficient processing systems that are superior to current financial infrastructures. Markets available 24/7 and risk systems controlled by smart contracts liquidate underfunded lines of credit without any ifs or buts. However, the financial system 2.0 or Web3 will not exist independently. A merger of the respective systems will bring the greatest benefit over time and usher in the next era, which can be classified as similar to the advent of the Internet in the 2000s.