21Shares Monthly Review

This Month in Crypto: Executive Summary

The total cryptoassets market cap decreased by around 10% month-over-month, according to data gathered by CoinMarketCap. The decline followed the hawkish measures the Federal Reserve’s chair alluded to in his speech on Friday. Bitcoin and Ethereum declined by -16.26% and -10.1% respectively. As shown in the figure below, last month’s three outliers appear to be Ethereum scalability solutions Optimism, Metis, and Polygon who saw 68.23%, 46.35% and 2.96% respectively in the TVL growth over the past month, however, the returns haven’t been positive given the decline of the underlying assets. In the meantime, leading DeFi protocols saw their TVL and returns in the negatives.

Figure 1: Price and TVL developments of the major crypto categories

Source: 21Shares

Key takeaways from this report

Ramifications of the Tornado Cash ban on the regulatory front
DeFi Blue Chips exclusively side with ETHPOS
Ethereum’s testnets transition to POS, next landmark is the mainnet merge on Sep15
Ethereum’s NFT trading volume drop by 17.4% month-over-month

Spot and Derivatives Markets

There have been liquidations of over $950M from the crypto futures market over the last two consecutive weekends in August. Over $600M of long and short positions were liquidated on August 19 following the meeting minutes of the Federal Reserve and over $350M was liquidated following Jerome Powell’s speech announcing hawkish measures to tame inflation. These liquidations may have escalated the downward trend of Bitcoin and the rest of the cryptoasset market.

On-chain Indicators

Figure 3: Ethereum MVRV Z-Score

Source: Glassnode

Fifteen days ahead of the long-awaited Merge, the MVRV Z-Score indicator will help assess the valuation of Ethereum. In Figure 3, we can see that the MVRV Z-Score and the market price have been parting ways on May 9, 2021, as Ethereum rushed towards a market top (red zone). Historically, this indicates that Ethereum’s realized price reached a market bottom (green zone) similar to that of November 2016 as shown in the figure.

Macro and Regulations

Inflation hit new waves around the world in August.

In the first week of August, the Bank of England rose interest rates by 1.75% in the biggest increase since 1995 and projected inflation to peak at 13.3% in October.
In the second week, July’s US Consumer Price Index results showed that inflation stood at 8.5%, beating expectations
China cut interest rates as the economy slumped and unemployment reached a record high
Fed’s meeting minutes got released, with the main takeaway being that pace of hikes would slow if inflation continued to cool down
- Bond yields ticked lower.
- Asia-Pacific markets traded lower.
Federal Reserve Chair Jerome Powell said in a speech on Friday that the central bank will use all its tools “forcefully” to tame inflation. Powell's comments not only sent Bitcoin back to capitulation, but also disappointed stocks in the US, Japan, China, and Australia.

The second factor affecting the crypto industry was the banning of Tornado Cash. The US Treasury blacklisted the crypto mixer, which incurred some ramifications on the regulatory front:

The EU proposed amendments to a bill regulating financial services to limit banks’ exposure to class 2 cryptoassets (all cryptoassets that aren’t stablecoins) to 1% of the institution’s Tier 1 capital at all times.
The Federal Reserve said banks under its jurisdiction should notify them before engaging in any crypto activity.
UK regulators may have more power over stablecoins and other payment-focused cryptoassets. The bill in question will have its first debate in September.

In a time when crypto companies are busy vigorously building, institutional adoption has been on the rise. These are some of the most significant events that happened in this effort:

Binance signed a Memorandum of Understanding with Busan to help build the blockchain industry in the South Korean city, utilizing their educational arm Binance Academy.
Brazilian Central Bank selects Itau to build liquidity pools in decentralized finance.
Argentina’s Mendoza province has started accepting crypto payments for tax payments, in a bid to help taxpayers meet their obligations.

More clarity on some of the most monumental regulations will be settled in September, such as the situation of non-fungible tokens (NFTs) in Europe’s landmark Markets in Crypto Assets framework. In addition, seven reports of Joe Biden’s executive order are coming out in September. These reports are expected to provide guidance on issues related to the energy consumption of proof-of-work mining, risks and rewards of cryptoassets, and the feasibility of launching a US central bank digital currency, among others.

Crypto Infrastructure

Road to the Merge and the ETHPOW bet: All eyes were on Ethereum as the Goerli network executed its final merge rehearsal and the testnet successfully transitioned to Proof-of-Stake. The Merge will be triggered on the main Ethereum network around September 15 by Terminal Total Difficulty (TTD), a cumulative measure of the total mining power built into the chain. When the date comes, and a TTD criterion is met, POS will replace Proof-of-Work. The event's excitement can explain why Ethereum flipped Bitcoin in the options market for the first time. However, not everyone is content with the Merge. Ethereum miners may want to keep the POW system by initiating a hard fork in what people are calling the ETHPOW bet. In this regard, there is no real support for the Ethereum PoW blockchain outside most miners and a handful of exchanges such as Poloniex and MEXC announced they will list spot tokens related to the POW fork, while, Bitmex will launch a futures contract tracking the new fork. On the other hand, Circle (USDC) and Tether (USDT), the largest stablecoin issuers in the world, have pledged sole support for the Merge, while Ethermine, the largest ETH mining pool, announced it’ll deprecate support for any planned POW forks.

L2 Ecosystem: Although the Merge won’t solve Ethereum’s scalability issues directly, it does set the stage for future scaling upgrades, including sharding, which will work in conjunction with L2 networks. In this regard, Arbitrum revealed its latest Nova chain, an L2 built on top of the network’s Anytrust technology, tailored for gaming and social dApps. The chain is already expected to welcome the migration of Reddit’s community points system from Ethereum. Meanwhile, the main Arbitrum network is expected to implement its Nitro upgrade on August 31. Optimism also announced that its major upgrade, Bedrock, is now slated for Q4. The protocol's renovation should aid in reducing withdrawal times, enable nodes to sync 50 times faster, and pave support for future rollup-based technologies like ZK rollups. Finally, Starkware launched its recursive proving system that will decrease gas costs via bundling up to 10-fold the number of transactions processed on the main ETH chain.

Ethereum Competitors: The wider verse of L1s also feels the BUIDL mode. First, Near Protocol unveiled a new Javascript software development kit that will allow the 20 million Javascript developers around the world to write smart contracts in the legacy language. Additionally, Near released testnet phase 1 of sharding, with a mainnet tentative date set for next month. In other news, the Algorand Foundation introduced a new Quantum Proof algorithm dubbed Falcon that will be used to improve the state privacy of blockchains as well as provide quantum-resistant signatures. Finally, Solana is also prepared for a performance boost as Jump Crypto is building a lighter validator client that will improve the network’s decentralization and stability, addressing one of the network’s fundamental weaknesses.

Exchanges and The TornadoCash Mixer Ban: The Treasury’s OFAC (Office of Foreign Assets Control) added TornadoCash, a non-custodial privacy-preserving software, to the SDN list – a list of Specially Designated Nationals with whom American citizens and businesses are not allowed to transact. The repercussions of the ban are unprecedented as it is not a ban on a particular person but open-source software and may be one of the triggers of the recent drawdowns. For instance, Coinbase’s CEO asserted that it would rather shut down its staking service for ETH than censor transactions on the protocol level to comply with a hypothetical censorship order by regulators on the Ethereum blockchain. As it stands, the US exchange would be the third biggest validator on Ethereum once the Merge goes live, which shows how contentious such regulatory enforcement may be on a key revenue generator for the firm. The ban’s guidelines have already coerced several crypto-native service providers into terminating accessibility to the protocol, such as Infura and Alchemy. Both projects are now blocking Ethereum API access to all users to prevent interaction with the smart contract.

Decentralized Finance

Figure 4: Top 10 DeFi Assets Monthly Performance

Source: 21Shares

The Merge: We’ve covered how some heavyweight DeFi projects have already signalled the demise of the ETHPOW potential fork since they will exclusively support the new POS chain. Circle of USDC announced they would solely support the POS chain, following suit with Tether, Frax, Aave, and Chainlink’s decision to adhere to the social consensus and only support the new POS network. These announcements by the vertical’s blue chips make it clear that POW forks will be a highly speculative play without any real footing as DeFi’s most significant service providers continue to disprove the potential bifurcated chains. If the aforementioned blue chips do not extend their supporting infrastructure towards the newly forked chains, we could expect a revival of ghost chains resembling the examples of BSV, BCH where there are billions of dollars locked in the ecosystem, but which they sit idle without any use due to the absence of a functioning DeFi ecosystem of stablecoins and basic financial primitives like DEXs, money markets and asset management protocols.

Scalable DeFi: August saw multiple attempts toward achieving Ethereum’s scalability vision through L2s. For instance, Lido revealed its intent and updated its roadmap to expand support for its stETH across Optimism and Arbitrum. The DeFi ecosystem of alternate L1s has also seen exciting developments. For example, renowned custodian Copper has built a native integration with the Solana network to provide its institutional clients secure access to its DeFi ecosystem via CopperConnect’s Multi-Party Computation (MPC) technology.

Tornado Cash ban and its repercussions. The repercussions of the TornadoCash ban on DeFi began to emerge immediately following the verdict. First, Circle banned 37 addresses with ties to the sanctioned mixer, freezing $75K in the process as a matter of complying with the treasury department’s order. Other DeFi protocols, such as Aave and DyDx, followed the same route. UniSwap, Balancer, and Oasis all have censored Tornado-linked addresses as a function of integrating the same TRM sanctions screening tool. An unknown individual protested the insensibility of the move by sending 0.1 ETH to more than 600 prominent crypto addresses, including Brian Armstrong of Coinbase and Justin Sun. In addition, the sanctions have raised existential issues around their business design for other DeFi protocols. For instance, MakerDAO’s founder weighed out the possibility of an ‘emergency shutdown’ if censorship reaches DAI addresses. This is plausible given that USDC is the largest single collateral backing DAI. Staying on the topic of stablecoins, Tether hired a top 5 accounting firm, BDO, to handle its reserve attestation, with plans to publish monthly transparency reports under this new partnership. The increased transparency is an effort toward regaining some of its lost market share to Circle and is symptomatic of a wider DeFi trend of strictly adhering to regulatory compliance.

Metaverse and NFTs

NFT marketplaces weren’t immune to the overall market sentiment. The trading volume of NFTs on Ethereum has declined by 17.4% month-over-month. In the figure below, we can tell that OpenSea, X2Y2, and LooksRare are the top 3 marketplaces on Ethereum in terms of market dominance by volume.

Figure 5: Market Dominance by Volume

Source: 21Shares, Dune Analytics

BendDAO, a protocol that allows users to deposit their NFTs as collateral to borrow ETH, fell into a liquidity crisis when its reserves got drained on August 21. Not bearing in mind how bear markets can turn NFTs insolvent, many of the protocol’s NFTs under management are now facing potential liquidations to cover bad debt incurred by disincentivized borrowers. BendDAO’s co-founder announced some short-term improvements which include adjusting the liquidation threshold to 70% and the auction period to four hours. As for the long-term improvements, the protocol proposed supporting offers for collateral in BendDAO, reaching out to exchanges to list collateral, and supporting downpayment for auctions

Next Month’s Calendar

As mentioned earlier in this report, September will be a busy month when policymakers and regulators are back from the European summer break. There are also some important indicators that are being released this month such as the ISM Manufacturing Purchasing Managers Index, which is a leading indicator for the US economy. The Average Hourly Earnings report being released on the following day is a significant indicator of overall economic health as spending is correlated to market conditions.