21Shares Monthly Review

This Month in Crypto: Executive Summary

Markets have tumbled in fear of a default crisis in the U.S.; President Joe Biden and top congressional Republican Kevin McCarthy are closing in on a deal raising the government's $31.4 trillion debt ceiling for two years while capping spending on most items. Regulatory headwinds pushed two of the world's largest market makers to withdraw from trading digital assets in the U.S. Falling by 5% over the past month, Bitcoin had its share of speculation around its network’s soaring transaction fees, signaling unprecedented congestion. On the upside, Lido was the biggest winner of this month, increasing by 6%. Ethereum’s upgrade unlocking staked ETH has revitalized investor confidence in the cryptoasset. It also boosted demand for protocols like Lido, which saw a 6% increase in net new assets; despite Celsius withdrawing $800M right after the liquidity event. Our dashboards show that Lido processed withdrawals flawlessly to avoid putting additional stress on the activation or exit queue using a buffer of ETH from deposits and rewards.

Figure 1: Price and TVL Development of Major Crypto Sectors in May

Source: 21Shares, Coingecko, DeFi Llama. Data as of May 30, 2023.

Key takeaways from this report:

Bitcoin trials smart-contract functionality while inspiring legacy networks to continue innovating, and Avalanche launches a no-code launchpad to create Web3 applications.
Lido V2 goes live enables withdrawals, Galaxy Digital executes its first on-chain options trade and Tether holds 2% in BTC and continues allocating 15% of net profits to BTC after a strong Q1.
Another try at borrowing against NFTs, as marketplace Blur launches NFT lending protocol and Binance launches NFT lending feature with zero gas fees.

Spot and Derivatives

Figure 2: Total Liquidations

Source: Coinglass

On May 10, we saw over $100 million in liquidations after a pseudonymous source tweeted false information alleging that Bitcoin wallets controlled by the U.S. government were on the move. Most positions liquidated were long, as BTC dropped 5% from ~$28,200 to ~ $26,800 in less than an hour (see Figure 2). The market's overreaction was entirely avoidable. We built a dashboard over two months ago that anyone can access to monitor the U.S. government-controlled wallets in real time and in fact, the assets remained in the wallets.

On-chain Indicators

Figure 3: Percentage of Ethereum in Exchanges

Source: Glassnode

The amount of ETH held on centralized exchanges reached its lowest point in seven years, accounting for only 14% of the total circulating supply. This significant decrease can be traced back to November when users swiftly withdrew their assets from crypto exchanges due to the collapse of FTX. The trend regained momentum in March, triggered by several banking failures resulting in a sense of distrust in the financial markets. As such, non-custodial staking solutions such as Lido and Rocketpool, benefited from the assets exodus from custodial exchanges.

Macro and Regulations

Macroeconomic headwinds made the crypto markets swing in a narrow range: 46% of US banks are tightening lending standards, according to the Federal Reserve’s April 2023 edition of the Senior Loan Officer Opinion Survey on Bank Lending Practices. As crypto decouples from tech stocks, the banking crisis in the U.S. still influenced the selling pressure of some cryptoassets in May. Due to intensified regulatory crackdowns, Jane Street and Jump Crypto decided to sunset market-making in the U.S.. The news significantly increased the bid-ask spread, used to measure market liquidity, for fiat pairs amongst U.S. exchanges.

Ripple and Coinbase push back against regulatory unclarity in the U.S.: The legal dispute between Ripple and the Securities and Exchanges Commission (SEC) dates back to 2020 when the securities regulator accused the company of selling unregistered securities with XRP. On May 17, the court denied the SEC’s motion to seal documents filed by Ripple to defend its case. For privacy and irrelevance in the views of the securities regulator, they wanted to seal a 2018 speech by one of its former directors that acknowledged Bitcoin and Ethereum as non-securities. The court, however, disagreed with these reasons and deemed the documents which included the speech as very relevant to Ripple’s case.

After sunsetting its Borrow program earlier in May, Coinbase filed another appeal against the SEC’s no-reply to its rulemaking petition, which is closing on a year since its original filing in July 2022. Coinbase filed a petition requesting that the SEC propose and adopt rules to govern the regulation of securities including potential rules to identify which digital assets are securities. Coinbase revisited its petition by filing a narrow action last March after it seemed that the SEC had decided to deny the rulemaking petition without making this decision public, thus without making it officially refutable. With the SEC cracking down on Coinbase despite the petition, the legal team behind the crypto exchange is determined to get an answer from the SEC and is already preparing to exercise the right to ask a court if the agency’s decision was proper. This rare narrow action case led by Paul Grewal sets an example for companies and regulators that even legal clarity could be reached with vigilant due diligence. Coinbase and Ripple’s efforts can be considered an industry-wide victory that could influence much-needed legal clarity around the definition of cryptoassets in the eyes of the law.

Hong Kong is opening up to crypto: Hong Kong will start accepting applications from crypto exchanges looking to get granted a license, giving the green light to serving retail investors as long as they disclose the risks involved. Exchanges like HasKey Pro and OSL have partnered with local securities brokers to allow professional investors to trade crypto assets. Following the news, Huobi HK announced it’s expanding its operations to crypto for retail and institutional investors.

Crypto Infrastructure

May was a turning point for Bitcoin as the network began experimenting with new use cases. The trend originated with an anonymous data analyst named Domo creating BRC-20, a token standard analogous to ERC-20 for Ethereum. The purpose of this standard is to create “inscriptions” that carry strings of text on Bitcoin, to minting $ORDI, the largest BRC-20 with ~$200M in market capitalization. The movement inspired the emergence of other standards improving asset-issuance designs including ORC20 and BRC721, which offer higher security and efficiency in uploading data onto the Bitcoin blockchain. The latter witnessed a significant surge in momentum during the past week, creating close to ~10K BTC-based assets.

Figure 4: Number of minted BRC-721 tokens

Source: Forked of @J543 on Dune

That said, BRC20 has gained the most traction, driving most financial activities and contributing substantially to miners' revenue via heightened transaction fees. For example, users have paid miners approximately 1,264 BTC to validate transactions linked to Ordinal inscriptions, compared to 20 BTC for ORC20 and 1.68 BTC for BRC721. It's worth noting that BRC721 aims to consume up to 90% less data and as such provides a user-friendly experience for investors with cheaper fees. Moreover, the adoption of BRC20 has seen notable growth, exemplified by the introduction of Stably, a USD stablecoin launching as a BRC20 token.

Figure 5: Total Number of BRC20 transactions

Source: CryptoKoryo on Dune

Relatedly, the Lightning Network, unveiled the latest network upgrade. Previously known as Taro Assets, the solution leverages the Bitcoin Taproot upgrade to issue assets on top of Bitcoin. The advent of the new upgrade, Taro Assets 0.2 (Daemon), should help reduce transaction costs for issuing and transferring new assets while accelerating transaction settlements.

Figure 6: BTC, LTC, DOGE Daily # of Transactions

Source: bitinfocharts.com

Visa deployed two emulated applications on the Ethereum testnet to advance its experiment with account abstraction (AA). The network upgrade (AA) introduced in March helps users have a smarter wallet that offers a more user-intuitive experience reminiscent of Fintech banking. Dubbed pay-master, the deployed smart contracts could sponsor fees in one instance on behalf of users, or help them pay with an alternative ERC20 token for the gas fees in another, like dollar-backed stablecoins or a CBDC. Visa's experiment marks a monumental milestone in laying the groundwork to onboard millions of users into the digital asset ecosystem. By offering railways that conceal the complexities of blockchain technology, AA implementations provide a seamless transition for individuals entering crypto.

Ethereum encountered two technical challenges that briefly hindered the timely finalization of transactions. However, the diverse range of node client software played a vital role in mitigating the impact of these challenges. Due to this diversity, not all validators were affected by the identified bug, ensuring that transaction processing continued across the network. The Ethereum foundation has promptly released a set of bug patches to address the underlying issue related to validators, although the root cause remains unidentified.

Encouragingly, the amount of ETH deposited in the beacon chain surpassed the quantity withdrawn since the Shanghai upgrade on April 12, currently standing at a net 2.22M ETH. The recent data highlights the increasing confidence users have in Ethereum's potential as a productive asset and underscores their commitment to treating ETH as a long-term, yield-bearing and a deflationary investment.

Figure 7: Breakdown of ETH deposits and withdrawals

Source: 21Shares on Dune

Cosmos is poised to enhance its security infrastructure with the introduction of Mesh Security. Spearheaded by Osmosis, the largest exchange on the Cosmos network, this initiative aims to strengthen the security of application-specific protocols within the Cosmos ecosystem by consolidating the combined individual stakes. This cross-chain security model draws inspiration from the NATO alliance, emphasizing collective defense. By joining this collaborative effort, participating projects can pool their staked tokens, providing enhanced security guarantees and directly defending other chains in the network. Although the model will introduce additional risks to existing validators hoping to generate additional revenue, it is still a worthy ambition to heighten the security of Cosmos. Especially as it levels the playing field with Ethereum as its restaking ability becomes possible later in the year.

Avalanche introduced Ava Clouds, a platform designed to assist in creating personalized blockchains without programming. Ava Clouds offers an automated blockchain builder, a managed validator list, a comprehensive Data Toolkit, and Chain Interoperability. This announcement is particularly timely, as it complements Avalanche's existing offering, Evergreen Subnets, which caters to the requirements of financial institutions. With Ava Clouds, companies can now construct their own tailored blockchains that align with regulatory and business necessities effortlessly while also enjoying the advantages of a publicly secured network. Circle also introduced a native Euro-based stablecoin, EuroC, which shows the increasing institutional interest in the smart-contract platform, mainly as stables serve as a bridge for non-crypto users to experiment with this transformative technology. Finally, the growth of the Avalanche ecosystem can be observed as the number of Monthly active users reached an ATH in May.

Figure 8: Avalanche Active Users (1Y)

Source: Artemis

Decentralized Finance

Figure 9: Monthly Performance of the top 10 DeFi tokens by Market Cap

Source: Coingecko

Tether, the issuer behind the largest centralized dollar-denominated stablecoin by market cap, achieved a record high of $2.44 billion in excess reserves, marking an increase of $1.48B since Q4 of last year. The “Assurances Report” of Q1 demonstrated the company’s assets to be worth $81.8 billion, with the majority invested in the U.S. Treasury Bills. The striking finding is that Tether invested 2% of its reserves in Bitcoin and 4% in Gold. In addition, the company revealed it’ll continuously purchase more Bitcoin, with 15% of its net operating profits accrued from customers’ held deposits. Tether’s allocation to Bitcoin is crucial as it could help it build a war chest that gives it more runaway in the long term as well as serve as a cushion for the expected selling pressure that will emanate from claimants of Mt Gox and the U.S. government auction off the seized assets from the silk road case.

The Ethereum ecosystem

Lido Finance V2 went live after the governance upgrade proposal passed with near-unanimous support. The new version has enabled ETH withdrawals by providing an in-house mechanism to switch back to ETH from stETH and introduce a ‘staking-router’. The latter refers to an apparatus that will onboard validators in a more permissionless manner, designed to help decentralize the protocol’s node infrastructure layer. Lido’s upgraded withdrawal capacity is vital as the protocol is home to close to 31% of the total staked ETH. Thus, it’s essential to monitor the flow of capital through the protocol to have a nuanced understanding of the Ethereum economy.

Figure 10: Lido’s Total stETH Withdrawal Requests

Source: 21Shares on Dune

That said, Lido's buffer helped streamline the withdrawal requests, especially considering Celsius' sizable bid to remove its staked assets (~$815M) on May 16 as part of its liquidation procedure. In fact, the success of the upgrade stirred Aave's founder into proposing to convert the protocol treasury's ETH into stETH and rETH, Lido's, and rocket pool's respective Ether staking derivatives. This trend will continue growing as projects prefer yield-bearing assets that help generate revenue while freeing capital and unlocking the utility of ETH to be used across the financial applications including lending/borrowing without giving up the yield. Implementing this strategy will likely lead other protocols to take foot and trigger a positive flywheel of adoption for liquid-staking protocols.

Figure 11: Dominance of Staking Entities

Source: 21shares on Dune

Further, the total volume processed on Uniswap eclipsed Coinbase for the fourth consecutive month. Although the recent meme-coin frenzy drove the surge in activity on Uniswap, the trend nevertheless reiterates the swelling interest in non-custodial infrastructure following the series of centralized failures the industry had to endure over the past 18 months including FTX. DEX volumes are retracting quite significantly as Ethereum settled near to 40% of the total volume reached in January of this year. DEXs processed $400B in May vs $1.2T in March amidst the peak of the banking failure, with stablecoin volumes hitting the lowest since December 2020. The decline is driven by the high transaction fees, combined with the macro uncertainty revolving around the U.S. markets.

Figure 12: Total Volume Settled on Ethereum

Source: 21Shares on Dune

Galaxy Digital, the US-based digital asset manager, executed its first options trade fully on-chain. The company leveraged Ribbon’s Finance bilateral options trades protocol known as Aevo OTC. The solution enabled Galaxy to execute and settle the agreement via an OTC trade with investment firm Coinfund, with Aevo’s smart contracts acting as an escrow and thus mitigating the credit risk that emerges in the traditional finance structure. This is a crucial milestone in the evolution of DeFi, as it inches the industry closer to replicating the critical services of traditional finance. Further, as Galaxy, amongst other firms, lost capital due to the failed counterparties embroiled in the FTX collapse, leveraging an immutable, unbiased, and neutral settlement layer proved its reliability as alternative financial railways. Finally, the development should drive deeper liquidity into the DeFi space as all the volume is currently concentrated on the centralized venues, as shown below.

Figure 13: Volume of ETH options

Source: The Block

Metaverse and NFTs

Figure 14: NFT Landscape by Chain

Source: 21shares on Dune Analytics

Gaming and Finance (GameFi) leaps towards mass adoption: May also witnessed an integration between the crypto and traditional players in both directions. Sky Mavis’ Axie Infinity went live on the App Store to tap into the 1.36B iPhone users following its launch on Google Play Store in December 2022. On the opposite side of the table, Assassin’s Creed announced that it is tying NFTs on Polygon with 3D physically printed items. Ubisoft, Assassin’s Creed’s publisher, has been the most active among its competitors in the space in the Web3 world. Back in February, the gaming giant minted NFT avatars for its game Rabbids on the gaming-focused, Ethereum-powered metaverse, The Sandbox. In December 2021, Ubisoft was also the first major gaming publisher to release in-game NFT items with Ghost Recon Breakpoint. Although the traction wasn’t very encouraging, they did not shy away from pushing more projects on Web3. Ubisoft’s confidence in Web3 is fascinating, considering it is not a company that merely needs more traction. However, it shows that gaming giants want to stay not only relevant but also first-movers in the space to capitalize on this advantage.

Another try at borrowing against NFTs:

Blur launched Blend, an NFT lending protocol. Today, many users are priced out of their favorite collections because they have to pay the full price of NFTs upfront. Blend allows users to make a "down payment" (like buying a car or house) and pay the remaining balance later to gain full ownership of their digital collectible. Conversely, if users need liquidity but don't want to sell their NFTs, they can borrow ETH against their NFTs without needing to sell.
Binance also marked its first step in the NFT lending space with a new feature for users to borrow ETH against blue-chip NFTs, such as Bored Ape Yacht Club, Mutant Ape Yacht Club, Azuki, and Doodles. The current interest rate on NFT loans is 7.91% p.a., and loan to value ratio ranges from 40% to 60%.

However, it's crucial to note that borrowing against a speculative and sometimes illiquid asset can be extremely risky. Back in August 2022, BendDAO, a protocol allowing users to deposit their NFTs as collateral to borrow ETH, fell into a liquidity crisis when its reserves drained partly due to a rise in ETH’s price back then. BendDAO’s liquidity crisis exhibited the risks of lending against the unique nonfungible tokens, but it has also challenged others to ringfence and further battle-test this space.