The Big Picture in Crypto (May 2023)
Purpose: The goal of this commentary is to cover the big picture for the month in the crypto market in 700 words. The newsletter intends to help people keep their finger on the pulse without having to spend hours getting lost in the dark and often lonely crypto rabbit hole.
Word Count: 699
ChatGPT-generated TLDR:
1. Despite many attempts to create the "Next Ethereum," Ethereum maintains its dominance as the world's second largest cryptocurrency and most used “smart” blockchain, making it and its closely integrated alternatives the dominant forces in the cryptocurrency application space.
2. Amid an uncertain regulatory environment, the global crypto market is experiencing reduced liquidity, shifts from centralized to decentralized exchanges, and U.S. companies and start-ups venturing into foreign jurisdictions.
Ethereum and Friends Remain King
The search for the "Next Ethereum" has captivated the cryptocurrency market over the last four years. Despite many well-funded threats, Ethereum has maintained its stronghold. It remains both the world’s second largest cryptocurrency (ether) by market capitalization and the most-used “smart” blockchain (sorry, Bitcoin). Out of all blockchains, it boasts the most applications (over 800) on its network, has the highest total value in those applications, and has the highest USD value transferred in those applications.
Ethereum's role as the market’s “center of gravity” makes it unlikely to be replaced soon. The team has belatedly but effectively updated the platform to address key issues. In 2022, Ethereum transitioned from the energy-intensive Proof-of-Work to a more sustainable Proof-of-Stake. It shifted from an inflationary to a more investor-friendly deflationary blockchain, reducing Ethereum's total supply. Further future improvements, with the next coming in Q4 this year, are likely to further entrench its continued lead.
This dominant position influences the success of Ethereum alternatives. Critical infrastructure like exchanges or custodians can more easily integrate technically similar blockchains. Technically similar blockchains to Ethereum can “copy and paste” the code of Ethereum applications more easily, reducing the development work required for new applications. Further, while the cryptocurrency market generally offers less friction than traditional infrastructures, transferring value from Ethereum to another blockchain can be a challenge. The less friction, the better.
As a result, Ethereum alternatives that are more closely integrated with Ethereum's technical infrastructure have had more relative success. A review of Ethereum alternatives shows that nine of the top eleven blockchains, ranked by total value, are Ethereum Virtual Machine-compatible. These are more compatible with Ethereum than alternatives based on different technical foundations, such as Solana, Sui, or Aptos.
Don’t believe the crypto VC firms talking their book… with crypto applications, Ethereum and its close allies/frenemies are completely dominant.
Regulation and Its Discontents
The DeSantis official presidential bid involved a promise to allow people to “Do Bitcoin” (whatever that means). SEC chair Gary Gensler continues a barrage of enforcement actions in the face of a recent adversarial Congressional hearing. The CFTC charged the world’s largest crypto exchange Binance (and the SEC is now too! A BIG ONE). The Chamber of Commerce defended crypto businesses and Coinbase filed a preemptive suit against the SEC after previously petitioning for a new federal agency that accounts for the idiosyncrasies of cryptocurrencies. Lot going on.
The regulatory tug-of-war poses questions about compliance strategies: Will exchanges emulate Kraken's approach to the SEC or Coinbase's resistance? Are smaller projects lacking Coinbase's resources leaving the U.S.? What's the delineation between the CFTC and the SEC’s regulatory roles? Will Congress act, as proposed by House Republicans? Will bitcoin mining face a 30% tax as proposed by the White House? How will the next president act? Also don’t forget, the SEC v Ripple case is looming!
Internationally, Europe has adopted a comprehensive crypto regulation framework, in a landmark effort that should protect users. Binance exited Canada due to regulatory pressure, sending volume to Kraken. Hong Kong opened up (limited) crypto trading. IOSCO proposes more global regulatory cooperation, which is likely necessary given crypto's global nature and imperviousness to regional infrastructural constraints.
What are some market effects of the regulatory uncertainty?
Reduced liquidity as market makers become more risk-averse, causing noticeable liquidity gaps and declining volumes.
U.S. companies are setting up offices in other jurisdictions (like Coinbase's new Bermuda office) with start-ups hesitant to launch initiatives in the U.S.
Shifts in volumes from centralized exchanges (e.g., Coinbase, Binance) to decentralized ones (e.g., Uniswap, GMX). This process began after FTX's collapse has continued as regulators tighten scrutiny on centralized exchanges. Centralized exchanges with large unprotected customer deposits pose headline risk for regulators (FTX was not a great look).
Voyager Digital customers are getting 35% on the dollar after Binance.US walked away from a loan buyout deal due to a "hostile and uncertain regulatory climate" in the U.S.
That’s all for this month’s Big Picture, until next time!