Key Takeaways：

• Bing Ventures' research team believes that the crypto market will likely show positive signs of bottoming out in 2023 after an extended bear market.

• With deteriorated macro monetary conditions and liquidity, the crypto market suffered a dramatic reduction in market capitalization. But in the long run, it’s a healthy development.

• If this cycle follows the patterns of the previous ones, we expect the market to continue to consolidate until the first quarter of 2023.

• When institutions' liquidity is drained, the market will once again become the ancient whales' gambling table.

• Technological innovations will become the main narrative in the latter part of 2023 when the industry enters the recovery phase.

• Six innovative areas are worth paying attention to while cryptocurrency recovers and lays the foundation for a new bull run in 2023.

For the book value of the crypto market, 2022 was a terrible year. Starting with the crash of LUNA/UST in the middle of the year, one after another black swan events sent the market into a prolonged crypto winter. However, 2022 was a year full of hope for the development of blockchain technology. Concepts such as NFT and Metaverse have begun to catch the attention of mainstream organizations. In short, 2022 has been a year of mixed blessings for the crypto industry.

Additionally, 2022 was also the dawn of many blockchain technologies. From decentralized exchanges to zero-knowledge proofs and Layer2 solutions, and to privacy-preserving public chains, a new wave of technologies underwent accelerated development in the year. These developments point to great potential for blockchain technology in 2023. Meanwhile, new public chain ecosystems and Ethereum use cases have been springing up, enabling more businesses and consumers to access crypto, which in turn promotes the development of the industry.

Looking back at 2022: A Cruel Purge

High-Yield Traps Collapse Successively

The most obvious reason for the decline of cryptocurrency is the spectacular collapse of the "Lehman Brothers" in the industry. High-yield scams created with malicious competition and hype figures were exposed one after another, which eliminated the yield attraction of a lot of tokens and drained the liquidity they rely on for survival. Here are the landmines that we believe directly lead to the deterioration of market liquidity:

1. On May 7th, 2022, LUNA's stablecoin UST was unanchored and began to cause FUD on Twitter. In the following week, the price of LUNA token dropped from $70 directly to $0.0000009. The LUNA crash triggered a butterfly effect. The market plummeted, liquidity dried up, and user panic intensified. Hedge funds Three Arrows Capital, lending platform Celsius, Canadian listed company Voyager Digital, crypto trading, and lending platform BlockFi, crypto management fund Babel Finance, etc. all went bankrupt, delisted, or restructured.

2. On August 8th, 2022, the US Treasury Department listed Tornado Cash on the sanctions list, prohibiting US citizens from using it. Circle and Infura, among other crypto companies, also took action to comply with the sanctions and listed the Ethereum addresses interacting with Tornado Cash on the blacklist.

3. On November 2nd, 2022, CoinDesk released a report on the financial situation of Alameda Research. On November 6th, Binance founder CZ publicly announced to liquidate all FTT on the company's books. On November 11th, FTX applied for bankruptcy protection. In less than ten days, one of the world's largest centralized exchanges, FTX, was bankrupt. FTX’s bankruptcy caused tens of billions of dollars of crypto to evaporate. Crypto users’ trust in centralized institutions was nearly dead.

Liquidity Is Fuel for Bull and Bear Cycles

When external factors start to affect investor decisions, price volatility ensues. The crypto market in 2022 has been virtually under the influence of macroeconomic changes. With worsening monetary conditions and liquidity, the crypto market valuation plummeted rapidly. However, in the long run, this is a healthy development. Referring to Bitcoin (BTC-USD)'s previous two bear cycles, the price has dropped nearly as high as 85% from peak to trough in both cycles. This time around, the BTC price has dropped by as much as 75% from its previous all-time high so far.

The continuous decline in global liquidity has been the biggest driving force behind the crypto market in 2022. Cryptocurrencies are still highly dependent on fiat currencies, especially the US dollar. Meanwhile, their trading convenience also makes them one of the assets with the highest leverage ratio. If global liquidity were more abundant, the return on high-risk assets such as cryptocurrency would be higher. Conversely, cash flow in cryptocurrency would be more constricted.

Over the past year, the correlation between cryptocurrencies and macro markets has been very strong. Despite Bitcoin's weak bounce-back in July and October of 2022, the fundamentals driving the global crypto market have deteriorated due to the Fed's strong rate hikes and persistently high CPI data. High-interest rates lead to a rapid increase in liquidity costs, and institutions become more conservative in their valuation and expected returns of cryptocurrency.

The Double Whammy of Cyclical Bear Market Plus Structural Bear Market

2022 is a year of a true and sustained bear market in that it's a superposition of two typical types of bear markets. A cyclical bear market is usually the result of liquidity pressures caused by global economic recession and continuous interest rate rise. A cyclical bear market usually lasts for 1-2 years and requires more time to recover. Based on the Fed's interest rate policy over the past year, it can be said that a cyclical bear market has lasted at least one year. The second type of bear market is a structural bear market, characterized by asset bubble bursts or debt crises. The duration of a structural bear market depends on the speed of recovery from the disaster. The recovery of confidence usually requires more external stimulation, which will rely on new narratives in the cryptocurrency space and the broader macro tailwinds.

According to the meeting minutes of the Fed's December 2022 meeting, the Fed's commitment to combating inflation has not changed, and it is expected that interest rates will remain at a high level until more progress is made. The meeting minutes showed that Fed policymakers generally believed that restrictive policies needed to be maintained until the finally released inflation data was on a path of sustained decline to 2%. This means that the US will not relax its monetary policy too early before seeing a clear downward trend in CPI data.

Especially deterred by many past experiences, policymakers will only be more conservative. This means that it may take longer to reach an officially acceptable inflation rate. There is currently no FOMC member publicly expressing the signal of rate cuts in 2023. A key time point will be the Fed meeting to conclude on February 1, 2023. The magnitude of this rate hike will determine the direction of risk assets such as cryptocurrency in the first half of this year, especially as the total market capitalization of cryptocurrency has not yet effectively broken the cycle high in 2018, which will be an important indicator to observe.

2023 Outlook: 6 Narratives to Keep an Eye on While Crypto Recovers

We believe the tightened monetary environment as a result of a strong US dollar has been destructive to the valuation of major crypto assets such as BTC. Whether cryptocurrency regains liquidity in the next year will determine the degree of recovery in the overall valuation. We believe the premise for institutional re-embracing of crypto assets should be a weakening of the US dollar combined with sustained softening of US bond yields.

As sustained high-interest rates weigh down consumer confidence, even US Treasuries, considered a risk-free return, may be sold off. Investors will be forced to sell off treasuries in order to obtain cash due to the panic of an incoming economic recession. This is the opportunity for cryptocurrencies. The narrative of digital cash will be re-activated. Over time, global liquidity tightening may retard economic recovery and trigger a debt crisis.

With the advent of 2023, the capitulation of cryptocurrency in a recession may be coming to an end. As institutional liquidity is drained, cryptocurrency will be back at the ancient whales’ gambling table. Technological innovations in the cryptocurrency space will become the main narrative driving the recovery in the latter part of 2023. The following are potential opportunities we believe can re-establish industry confidence in 2023.

Layer2 will extend the Ethereum application ecosystem.

Layer2, as the mainstream expansion scheme for Ethereum, has two major advantages. Firstly, it can improve Ethereum's processing capability and solve the congestion problem on the mainnet. Secondly, it can reduce transaction fees and make it easier for a lot of applications to become practical in the real world. Now the number of Layer2 solutions is on the rise, such as Arbitrum, Optimism, etc. They can interact with the Ethereum mainnet to meet different application scenarios and solve different needs. For one thing, the current processing capacity of Ethereum is extremely limited, which means a lot of Layer2 solutions are needed to scale it by executing transactions on Layer2. For another, with the rapid increase of new use cases on-chain, there will emerge more diversified needs for the execution layer. Therefore, we believe, as one of the major trends for crypto in 2023, there will be a large number of distinctive Layer2 solutions to interact with the Ethereum mainnet.

According to Dune data, as of January 5, 2023, the total value bridged on Ethereum Layer2 scaling solution Abitrum reached 2,091,981 ETH, and the number of users participating in bridging transactions was 511,711. In terms of other L2 cross-chain bridges, the total value bridged on Optimism, zkSync, and StarkNet is 457,648 ETH, 198,389 ETH, and 9,462 ETH respectively. Nevertheless, there are still many important problems to be solved in Layer2, such as block speed, security, reliability, etc. Through continuous technical improvement and innovation in 2023, Layer2 is expected to play a bigger role.

Decentralized stablecoins will grow quickly in value.

Decentralized stablecoins not only have the characteristics of "non-sovereign currency", but also have use cases that can be connected with various activities in real life. In an increasingly turbulent world economy like today's, decentralized stablecoins with superior collateral, pegging mechanisms, and ability to capture value capture will become a choice of users apart from Fiat-backed stablecoins and stablecoins backed by other overcollateralized digital currencies.

Historically, decentralized stablecoins have had two highs. The first was the wealth myth of algorithmic stablecoins led by Empty Set Dollar and Basis Cash from the end of 2020 to the beginning of 2021, and the second was the fever about public chain stablecoins driven by Terra and UST in a double-wheeled model. These two rounds of enthusiasm directly ignited the DeFi craze.

We expect that, with the continuous advancement of regulation and technology, decentralized stablecoins will be able to continue to play the role of catalysts for a bull market. In 2023, the decentralized stablecoins launched by leading DeFi ecosystems, such as AAVE and Curve, will support more real use cases. And it is expected that more and more decentralized exchanges (DEXs) will join the competition of decentralized stablecoins to provide users with convenient, reliable, and secure financial services. This part of the market gap will continue to be taken over by DeFi protocols with solid business volume.

Ethereum Liquid Staking Derivatives will be prosperous.

With the Ethereum consensus shifting from the PoW to the PoS mechanism, the ETH supply mechanism has shifted to net shrinkage. We strongly believe that the future of Ethereum is worth looking forward to, and that Ether (ETH-USD) staking will provide the best risk-return opportunities. In particular, with the increase of liquid staking activities and the advent of the Ethereum Shanghai upgrade, ETH staking withdrawals will be enabled. This means that the Ethereum's liquid staking derivatives ecosystem will further prosper.

At present, only about 14% of ETH supply is staked. In contrast, most other Layer1 public chains have staking rates exceeding 40%. If more people choose to stake ETH after the Shanghai Upgrade, liquid staking derivatives (LSDs) services and product forms will become more diversified. Under the premise of maintaining staking yields, LSDs are expected to be deployed in more DeFi protocols and generate more income.

Although Lido Finance currently holds the dominant position in ETH liquid staking, with the innovation of other protocols and increased composability of DeFi, potential competitors such as Rocket Pool, Stakewise, Frax Finance, and Stader Labs still have the opportunity to capture more market share. Without a doubt, Ethereum still far exceeds other Layer1s in terms of block space demand and fee revenue growth, so this will be one of the most certain opportunities in 2023.

NFTs will have more use cases.

Non-fungible tokens (NFTs) come with brand value and fashionable genes. These characteristics also make companies and celebrities willing to combine intellectual properties (IPs) with NFTs, and NFTs have gradually become a publicity method for companies and celebrities to upgrade their brands and manage their fan base. Gucci, LV, Adidas, Nike, Starbucks, Messi, C Ronaldo, and Trump, to name a few, have all tried NFT marketing. It can be foreseen that NFTs will become more popular among the newer generations of consumers in 2023.

NFTs are also receiving more and more attention in some emerging technological fields. Take artificial intelligence as an example. NFTs have the potential to bring a series of new opportunities. In the future, we can use NFTs and AI to accelerate the speed of art generation, and at the same time reduce the threshold for ordinary users to create art. In addition, with the advancement of the NFT technology, there may be more new use cases in the future. For example, in the field of virtual reality, NFTs can be used for data storage and asset transfer across different virtual realities, which will greatly improve their security and transaction efficiency.

Therefore, from 2023 and onward, the NFT technology can be expected to play a greater role in more and more fields. We predict that NFTFi will be the next growth point, especially with the support of Layer2 solutions. Also, the NFTFi concept will become a source of inspiration for the next generation of crypto derivatives. Secondly, high-performance special-purpose public chains and DAOs with high community stickiness will further erode Opensea's market share. Music, AI, and other new NFT forms will appear in unexpected ways and attract more attention. And NFT projects that tap into untapped subcultures will be worthy of attention.

GameFi will scale up and be more professional.

From the P2E model sparked by Axie to the M2E model set on fire by StepN and then to the follow-up innovations of various X2E models, GameFi has been driven to grow, making it the most favored Web3 track among capitals in the past two years. The continuous emergence of GameFi projects and various game incubators are also driving the professionalization and scaling-up of Web3 games.

In 2023, GameFi models will continue to evolve. We expect more variations to emerge from x-to-earn (X2E) model innovation. More projects will get incubated. More game developers will join in, further expanding and developing the Web3 game industry. As technology progresses and the content of games becomes more diversified, more consumers will join in and the game industry will become more mature.

In addition, new game experiences are worth looking forward to, such as augmented and virtual reality, which will make games more realistic and interesting. Also, it can be expected that blockchain games will integrate GameFi models and NFTs into more game genres in Web2 including MMORPG, FPS, and MOBA.

New identity systems built with DIDs, SBTs, or the like will appear.

At present, a lot of projects are working on building digital identities for Web3. Such work will also be one of the cornerstones for rebuilding user trust in the next cycle. There is already a range of technologies such as decentralized identifiers (DIDs) and soulbound tokens (SBTs) that can be used to describe in image, reputation, and social relations of individuals in a decentralized way. They can be utilized to build Web3 identity and credit systems and facilitate the creation of a decentralized society.

Web3 credit systems will form the basis of a new financial system, where various financial services from payments and loans, to wealth management and insurance, etc. can be carried out without relying on traditional financial institutions. We believe the below segments are worth keeping an eye on.

• Identity Management Tools: Wallets and domain name projects should be given priority. Both control important onramps for extensive users.

• Social Networks: Open and transparent play-to-invest social platforms, interest-based social networks and games in the Metaverse, and dating applications focusing on providing immersive experience and privacy are some types of Web3 social networking that have unique selling positions.

• Credential Issuance Tools/Platforms: Credential projects with high added value are worthy of attention, especially digital states and membership-gated DAOs.

While 2023 will not be short of changes, it will also be the year that lays the foundation for the next bull cycle. We expect the market to bottom up in Q1 2023 and begin to show upward trends starting from the middle of the year. The liquidity situation may change significantly, and the US dollar may weaken. With improved liquidity, the crypto market will usher in a benign stage and start laying the foundation for a bigger bull market in 2024.

In conclusion, despite being in the current bearish cycle, the Web3 industry boasts great potential for the future. Let’s look forward to more innovations and a year of leaping development in this space.

About Bing Ventures

Bing Ventures is a venture capital firm supporting Web3 and blockchain startups and entrepreneurs. The founding members are from top financial institutions such as JPMorgan and Standard Chartered Bank. Our investment themes include Decentralized Finance (DeFi), Web 3.0, Gaming, and Metaverse.

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