1. Ukraine Provides An Impressive Use Case
The opening days of the war in Ukraine saw a critical need for funds to be moved into the country at a time when the banks had been taken offline by cyberattacks. The crypto community stepped up, immediately grasping the role that blockchain-based money had to play in circumstances exactly like this. So long as users had an internet-connected device, it would be possible to send and receive cryptocurrency.
In just the first three weeks of the conflict, the community donated around $60 million to the Ukrainian military and NGOs working in the country, including a single donation of just under $6 million by Gavin Wood (Ethereum co-founder and Polkadot founder) and a CryptoPunk worth $200,000.
Overall, more than $100 million in crypto has been transferred to Ukraine. Stablecoins are now taking centre stage as a tool for remittance across borders, with the UNHCR recently planning to send USDC to displaced Ukrainians via the Stellar network. More broadly, stablecoins have been used to settle an incredible $7 trillion over the course of the year, and are potentially on track to settle more than the Visa network ($12 trillion) next year.
2. The Fed Starts Hiking
Large-scale money printing during the COVID crisis, supply chain problems, and most recently the war in Ukraine, have had a dire effect on the global economy. Inflation has soared, peaking at over 9% year-on-year in the US and even higher in Europe.
Central banks began to raise interest rates to combat this serious problem, even though it would have the side effect of slowing economic growth at a time when activity was already muted – making recession all but inevitable. The US Federal Reserve started hiking rates sooner and harder than other countries. Starting in March, the Fed increased the headline interest rate from 0.25% to 4.5% by December.
While this may sound like dry economic policy, it has had a profound effect on both crypto and the wider markets, as traders adopted a ‘risk off’ approach. The US dollar – now paying a decent yield for the first time since 2018 – strengthened, while stocks, crypto and other currencies fell in value, helping drive crypto deeper into a bear market. Federal Reserve Chair Jay Powell’s speeches and FOMC minutes were pored over by traders seeking to glean information about what the future might hold, and volatility in the crypto markets accompanied every announcement. The latest indication is that the series of rate rises is coming to an end as inflation is brought back under control – but we’re not there yet.
3. TERRA Crashes To Earth
Arguably the most serious event for the crypto sector in 2022 was the implosion of the Terra stablecoin ecosystem. Devised by Do Kwon – now on the run from the authorities – Terra USD (UST) was an algorithmic stablecoin, which relied on its partner token LUNA to maintain its stability. Terra had caught the hype of the last crypto wave, thanks to its apparent ability to solve the near-impossible problem of creating an unbacked stablecoin, as well as the high yields paid on UST deposits. Unfortunately, like so many other algorithmic stablecoins, it turned out to be nothing more than financial alchemy.
In May 2022, UST collapsed. The reasons are unclear, but it may have started with an attack by Alameda, the trading arm of exchange giant FTX. Short selling knocked it off its peg, and then retail traders raced for the exit as they realised they might lose everything. Both UST and LUNA crashed to almost zero, destroying a $60 billion ecosystem. This had immediate consequences, as organisations with significant exposure to Terra – including hedge fund Three Arrows Capital (3AC) and CeFi lender Celsius – went bankrupt. Other organisations tried to cover their huge losses in different ways, and with varying degrees of success. The contagion spread throughout the crypto sector, but the full extent of the damage would take many months to come to light.
4. FTX Falls
After Terra, the other major scandal in the crypto world was the failure and bankruptcy of FTX. 30-year-old entrepreneur Sam Bankman-Fried had built FTX into the second-largest crypto exchange in the world, along with Alameda, its trading arm. The problems started early in November, when rumours surfaced that much of the collateral used by Alameda for lending was in the form of FTT, the native token of FTX. Alameda held a huge amount of this illiquid token, meaning it could be considered insolvent in practical terms.
Changpeng Zhao (‘CZ’), the CEO of Binance – the largest crypto exchange in the world – gave the whole fragile house of cards a push when he stated that Binance would be selling all the FTT they held. The value of FTT fell, threatening the existence of Alameda, and users rushed to withdraw funds from FTX to ensure their safety. It quickly transpired that FTX could not make customers whole. The money wasn’t there.
CZ offered to buy FTX, and for a short period it looked like the deal would go through. Pending due diligence, though, he backed out. The US authorities were already investigating FTX, and its accounts, security and business processes were utterly chaotic. SBF filed for bankruptcy on 11 November. He was arrested on a series of charges at the beginning of December, and faces decades in prison if convicted.
Meanwhile, organisations that held funds on FTX or had lent money to Alameda were severely out of pocket, with an estimated $8-10 billion owed to them. Some large creditors like crypto exchange Gemini and broker Genesis were owed over a billion dollars each. This second wave of contagion is still unresolved.
It is suspected that Alameda took huge losses as the crypto markets crashed earlier in the year. There is an irony that they may have precipitated their own fall by taking down Terra, making millions in the short term but destroying themselves – and much of the crypto sector – in the long run.
5. Ethereum Successfully Merges
Ethereum’s Merge proved a rare high point in the year. The network’s successful transition from a proof-of-work to proof-of-stake chain took place in mid-September, over the course of several days.
The Merge was designed to pave the way for future upgrades such as sharding, which will significantly increase Ethereum’s capacity and help avoid the problems of high gas costs and congestion that have plagued users for years. (The Merge does not, in itself, increase Ethereum’s throughput.) In the short term, it should increase security and decentralisation, and reduce energy usage by around 99.95%. Further updates will come in 2023 and 2024. Meanwhile, L2 scaling solutions remain important – and always will be, since even sharding will not give Ethereum the capacity to compete with TradFi platforms like Visa.
6. Layer-2 Solutions Thrive
As Ethereum mainnet struggles to support a fast-growing and diverse ecosystem of DeFi, gaming, and NFT dApps, new scaling solutions have arisen. Over the course of this year, several of these have attracted large numbers of users, enabling the Ethereum-based world to grow without placing undue strain on L1, which remains a settlement layer for platforms secured by it.
Significant L2 solutions include Polygon, Optimism, Arbitrum, and SKALE, each of which have processed tens of millions of transactions in 2022. Polygon, in particular, has attracted some impressive corporate partners, from Starbucks to Disney. Further L2 solutions that leverage zero-knowledge (ZK) proofs, which many analysts consider more secure and promising than approaches currently on the market, are in development and nearing launch.
7. The US Sanctions Tornado Cash
One of the most curious, bewildering and disturbing events in the crypto world this year took place in August, when OFAC – the US Treasury department that administers trade sanctions – targeted the decentralised mixer Tornado Cash.
OFAC took the step partly as a response to the mixer’s use by the Lazarus Group, a hacker organisation linked to North Korea that had stolen hundreds of millions of dollars in a series of high-profile exploits, including the Ronin Bridge and Harmony Bridge attacks.
While the aims were reasonable and understandable, the odd thing was that OFAC sanctioned a set of open source smart contracts – not a company or individual. Anyone can use Tornado Cash, just as anyone can use Bitcoin or other Ethereum dApps. It’s unclear what this unwelcome precedent might mean for users who have legitimate reasons for accessing Tornado Cash, including people and companies concerned for their financial privacy.
8. NFTs And Social Media: A Match Made In Heaven
One of the big success stories for 2022 was NFTs, which show no signs of losing their popularity. Some of the biggest drivers for NFT adoption were forward-thinking social media companies including Twitter, Facebook, Instagram and Telegram.
Twitter started out by allowing users to link their wallets and display their favourite NFTs as profile pictures, and later on enabled NFT trading on multiple blockchains and marketplaces through a new integration called Tweet Tiles.
Meta now allows US users of Facebook and Instagram to link their wallets and display NFTs. They have also begun testing for a group of US users to allow them to mint and trade NFTs directly from Instagram, using the Polygon blockchain.
Not to be outdone, Telegram released its wallet/domain NFT service on the TON blockchain in June, allowing functionality similar to the Ethereum Name Service (ENS). The launch of the Fragment marketplace on Telegram saw $50 million in NFT sales in its first month.
9. Regulation Is Incoming – But It’s Complicated
After all the scandals of 2022, one thing is clear: the crypto sector is set for more regulation. We know that there are plans to regulate stablecoins, for a start. These have both proved their value this year, but also shown their risks. It’s likely that algorithmic stablecoins will come in for harsh treatment, while fiat-backed coins that maintain high compliance standards will thrive.
Exchanges are likely to be hit with heavy regulation, to ensure they do not commingle customer and company funds, or lend customer funds out without their permission. Exchanges that are publicly-traded companies (like Coinbase) are already held to higher standards, and are regularly audited. More broadly, the status of crypto itself may come into question, with a small number of lawmakers already calling for it to be banned – even as others recognise its importance, and understand that what happened at FTX was fraud rather than a problem with crypto. With SBF being a major political donor, and US politicians having sharply different opinions on crypto, it could be hard for Congress to agree on any legislation.
Lastly, OFAC’s sanctions for Tornado Cash raise the prospect of further pieces of software being targeted – potentially going beyond mixers.
10. Crypto Bottoms Out… Maybe?
As the first and largest crypto, bitcoin sets the tone for the rest of the digital asset markets. The history of Bitcoin includes several speculative bubbles, each one larger than the last.
Having put in a high of $69,000 on 10 November, BTC fell by 78% to a low of $15,479 on 21 November, 376 days after the top.
A drawdown of 78% is roughly in line with previous bitcoin bear markets, as is the duration. Following the 2013 bubble, the 2014-15 bear market bottomed after 415 days, with BTC falling 83%. The 2018 bear market saw BTC lose 84% of its value over 363 days. In both cases, there was a lengthy period of sideways trading after the low.
This time, the macro environment is worse for crypto, with high interest rates and recession looming. On the other hand, institutions are taking greater interest, and financial markets tend to recover before the real economy does. In short, most of the damage has already been done, but analysts are divided as to whether the bottom is in or whether there’s more downside to come in 2023, before the markets finally turn around once more.
Happy new year! That’s all for now. If you think the markets are close to a bottom, why not head over to TimeX and pick up some crypto?