The Merge Settled In, America’s First-Ever Crypto Framework, and More!

This Week in Crypto

Markets dipped shortly after US August CPI data came out to indicate inflation has risen by 0.1% since July to make the annual rate climb to 8.3%. As of writing, Bitcoin is down by 15% over the past week, and although the Merge settled in Ethereum is down by 26%. Moreover, returns on Ethereum’s scalability solution Optimism declined by 35.5%, while those on Lido declined by 20.5% and its TVL is down by 25.5%.

Figure 1: TVL and price development of major crypto sectors

Source: Coingecko, DeFi Llama, 21Shares

Key takeaways:

• The US publishes its first framework for regulating cryptoassets
• ETH is POS, Infura decentralizing the infrastructure layer
• DeFi blue chips are consolidating their ecosystems
• OpenSea launches OpenRarity to give smaller projects more exposure

Spot and Derivatives Markets

Figure 2: Ethereum Liquidations in the Futures Market

Source: Coinglass

Since the announcement of CPI data on September 13 followed by the Merge, there has been a total of around $500M in liquidations of Ethereum positions, with longs having the biggest share as shown in Figure 2.

On-chain Indicators

Figure 3: Ethereum’s Network Value to Transaction Signal

Source: Glassnode

The NVT Signal (NVTS) is a modified version of the original NVT Ratio, using a 90-day moving average for transaction volume, instead of the raw daily transaction volume, making it function better as a leading indicator. NVTS in Figure 3 indicates that ETH’s ratio reached the same level as the prior bear market around June 2018. At that time, ETH was valued at $73.9B which is currently 45% of today’s value while the daily number of transactions today is 1.5x as much as the last crypto winter. In other words, ETH value increased significantly more than its fundamentals.

Macro and Regulations

Last week saw investor allocations to global stocks stoop to an all-time low, and average allocations to cash rising to levels not seen since 2001. Nasdaq had the heaviest crash since March 2020.

The White House just released the framework for how crypto regulations should look; this marks the first-ever comprehensive framework to regulate this asset class. One key takeaway from the published framework is that US law enforcement agencies will collaborate with global security apparatuses, namely the financial intelligence agency Egmont Group, to combat financial crime within the cryptoassets industry. The framework also concluded with a number of reports to be published as further guidance in constructing the respective bills; which include:

• The Office of Science and Technology Policy and NSF will develop a Digital Assets Research and Development Agenda
• In October, the Financial Stability Oversight Council will publish a report discussing digital assets’ financial-stability risks, identifying related regulatory gaps, and making additional recommendations to foster financial stability.
• The Treasury will complete an illicit finance risk assessment on decentralized finance by the end of February 2023 and an assessment on NFTs by July 2023.

Chairman of Securities and Exchange Commission (SEC) Gary Gensler raised concerns about Ethereum’s proof-of-stake consensus mechanism, saying it could be considered a security by the SEC. If made official, this will mean that Ethereum is obliged to full disclosure to the SEC, due to investor-protection requirements.

US Treasury clarified that interacting with Tornado Cash’s code doesn’t violate sanctions unless engaging in any transaction with Tornado Cash or its blocked property or interests in property. The Treasury also noted that for transactions involving Tornado Cash that were initiated prior to its designation on August 8 but not completed by the date of designation, users within the US jurisdiction may request a specific license from OFAC to engage in transactions involving the cryptoassets in question.

In state adoption of cryptoassets, last week saw Norway using the Ethereum blockchain to build its own central bank digital currency (CBDC). Russian publisher of the Independent and Evening Standard, who has recently founded InDeFi, is planning to introduce a ruble-backed stablecoin inspired by the DAI model, aside from the government’s ongoing CBDC project. On that note, December 19 is the designated deadline for Russian regulators and relevant authorities to draft legislation on cross-border crypto payments as well as mining.

Crypto Infrastructure

The Spillover of the Merge: Ethereum's most significant upgrade to date on switching to POS has finally materialized without experiencing any malfunctions. ETHS went live on September 15 as forecasted, and the transition took place without negatively affecting any of the DeFi markets on the back of price feeds sourced off the wrong chain. That said, Ethereum now has two live forks trying to appease the miners and host their migrating hash power.

ETHW, the fork led by Chandler Guo, has already gone live, while its counter ETF (Ethereum Fair), summoned by a group of Chinese users and receiving support and funding from Justin Sun of the Tron foundation, joined shortly after. Unfortunately, the forks were decimated in value as both networks encountered several technical hurdles during their launch, causing their momentum to wane. Exchanges are also split towards which forks they will support. For instance, Bybit, Kraken, and FTX will allow trading of ETHW, while Poloneix, Huobi and Gate.io will additionally support ETF trading. Finally, alternative POW-powered networks like RVN, ETC witnessed soaring hash rates as ETH miners began plugging in their machinery after the merge, a trend we've been drawing attention to over the past month.

Low-level Infrastructure Decentralization. The story, overshadowed by the thrill around the Merge, was Infura's announced intent to decentralize their infrastructural API product. As a reminder, Infura is the most established node provider easing the mission of connecting and interacting with the Ethereum network without running a full node. It provides developers and users with an endpoint to onboard their requests to the Ethereum network and disentangles the dApp development process. Infura's current point of contention is that a single provider, ConsenSys, runs it. Another is that it concentrates all of Ethereum's network activity under a centralized service and thus opens the door potentially for data collection and censorship. To address those woes, Infura revealed they will launch a parallel decentralized infrastructure network that will work in tandem with their current centralized product, with an early access program to onboard new candidates. This is crucial as the Tornado Cash sanctions debacle has recently shown the need for true censorship resistance at the base protocol level. The formidable way to achieve it is by building a geographically distributed network of infrastructure operators not bound by a single jurisdiction and not under the heel of a single organization. Thus, Infura's decision is a great step in this direction.

Upticking Scalability. Last week, Optimism announced the launch of the Bedrock alpha testnet on the network's Goerli layer. The new layer isn't suitable for production-ready development, which is why it'll shut down by October. Starkware announced the first significant upgrade to the chain's programming language, Cairo 1.0. The new iteration will augment the network's security by introducing an intermediated security layer. At its core is Sierra (safe intermediate representation), a new feature designed to offer longer-term stability for the Cairo dApps. Coinbase Cloud also extended its cloud-based staking support towards Polygon. Finally, Solana will be presented with a tailored VM enabling interconnectivity with the Cosmos ecosystem, and accordingly, its IBC-based interoperability. Nitro, the SVM compatible chain, is set to launch early next year, with a testnet expected by the end of Q4.

Decentralized Finance

Figure 4: Top 10 DeFi Assets Weekly Performance

Source: Coingecko, 21Shares

Tornado Cash Sanctions. MakerDAO has begun taking incremental steps to cut its stablecoin’s independence on USDC. After discussing the need for abandoning censorable assets and potentially switching the peg-reliance model to accept ETH, MKR decided to raise its stETH debt ceiling. The move is designed to reduce the ratio of USDC against other supported assets, and which was achieved via reducing fees for six vaults to incentivize collateralizing decentralized currencies.

Consolidation. This week we saw DeFi’s blue chips embark on federating their ecosystems. First, we saw Aave trifle with the untapped derivatives market by revealing ShortAave. The website is currently a mockup of what will be a one-stop shop to open short positions on the platform by borrowing from Aave and swapping on Uniswap in one go. Another was the announcement of Aztec, where the privacy-oriented L2 will integrate YearnFinance’s vault for its private DeFi ecosystem. We also saw Compound debut crypto-backed loans for institutions. The new product offers borrowing USD/USDC at a fixed 6% APR, accepts BTC, ETH and a slew of other ERC20 tokens without a repayment schedule, and its sole condition is to remain over-collateralized. Finally, Ribbon took a cue from FraxFinance’s move into the debt market by launching its money market protocol dubbed RibbonLend. The new offering will present high yields in exchange for unsecured lending to vetted institutional market makers of users’ preferences. As seen, DeFi protocols are fortifying their financial primitives to augment the flow of value accrual back to their underlying native token, in the process, building out more sustainable models over the longer term.

NFTs and Metaverse

Figure 5: NFT Trade Volume by Chain

Source: Dune Analytics, 21Shares

As we have reiterated, bear markets are a time to build as much as it is a battle test for new innovations, like rental NFTs which didn’t quite make it this round. The NFT rental protocol Rentable is shutting its doors after sustaining zero traction. On the build side, OpenSea launched OpenRarity, a new NFT protocol that will bring about standard mathematical algorithms that evenly assign rarity attributes regardless of the project size and popularity. In other bullish news, Doodles raised $54M at a $704M valuation; this will allow the NFT creator to venture and scale into the music, culture and entertainment industries.

In adoption of NFTs this past week: the New York Museum of Modern Art (MoMA) is set to auction $70M worth of art and use its proceeds in acquiring NFTs to expand the museum’s digital reach. A Sci-Fi NFT comic book, 2142, is set to hit OpenSea, while it doesn’t quite mark the first collectable of its kind, its developers claim that they are decentralizing and randomizing world-building so to avoid “flippers,” or users who would buy the comic NFT in hopes for making major profits. 2142 will be sold in bundles; users would need to purchase a total of 15 to 20 bundles to complete the first 34-page comic issue. A minimum of 15 bundles will be required to receive an airdrop of a character, location and item from the 2142 universe that can then be used to craft new, five-page spin-off webcomics.