Weekly Newsletter
Sep 26, 2023

Newsletter - Issue 178

Newsletter - Issue 178

This Week in Crypto

Markets have struggled over the past week on the back of inflation pressures sandwiched by the burgeoning war in Europe and the COVID-zero measures in China, adding flame to the fires of both crises of energy and supply. Returns on Bitcoin and Ethereum have been persevering, increasing by almost 3% and 4% respectively over the past week. The biggest headline was the $114M exploit on Solana’s Mango Market that dragged its total value locked (TVL) down by over 20%, as shown in Figure 1; the attacker later revealed himself, claiming that he is part of a group of investors that benefited from the “highly profitable trading strategy” and that their actions were legal open market actions. Aside from that, the biggest losers within major crypto categories were Cardano and Optimism, whose TVLs declined by -8%. Ethereum’s largest decentralized exchange increased by 7% and its TVL declined by almost 9%. Uniswap Labs’ $165M Series B round raised last week is expected to improve user experience and in turn boost performance.

Figure 1: Weekly TVL and Price Performance of Major Crypto Categories

Source: 21Shares, Coingecko, DeFi Llama

Key takeaways:

  • America’s oldest bank begins accepting crypto holdings
  • More than 50% of Ethereum’s newly produced blocks are now OFAC-compliant
  • Tether fully eliminates its commercial paper exposure backing its reserves
  • Uniswap prepares to launch NFTs

Spot and Derivatives Markets

Figure 2:

Source: Bitcoin Magazine ProBTC-denominated open interest reached an ATH relative to the asset’s market cap, which could signal a breakout move to either side. However, as Bitcoin’s funding rate has been range-bounding near the neutral territory since June, it’s becoming difficult to gauge market sentiment as this tight range signifies that a roughly growing equal number of longs and shorts are being placed. Bitcoin’s dampening volatility has caused the asset to undergo moderate swings between the 18K-20.5K levels. That said, with BTC’s volatility at an ATL that hasn’t been seen since 2020, a hot CPI print in November could bring about a tense move for the asset

On-chain Indicators

Figure 3: Bitcoin Price against Long Term Holder Supply

Source: Glassnode, Blockware Solutions

As shown in Figure 3, the total supply in the hands of long-term Bitcoin holders has reached a new all-time high of over 13.5M Bitcoins. This reiterates the conviction that the value of Bitcoin lies in its long-term investment, given that long-term holders are the winners of Bitcoin’s rally.

Macro and Regulations

Annual inflation in the US rose by 8.2% after the country’s Consumer Price Index recorded a 0.4% increase in September. At the time of writing, CME data forecasts a 99% chance of a 75 basis point rate hike at the Federal Reserve’s next monetary-policy meeting in November. If the predictions materialize, the hike would be triple the Fed’s more typical increment of 25 basis points in prior interest-rate cycles. In quite a timely manner, right ahead of releasing the CPI data, America’s oldest bank, Bank of New York Mellon, started its endeavors with crypto holdings, becoming the first large US bank to safeguard crypto assets.

Lawsuit action is developing on the back of the Tornado Cash sanctions that were imposed back in August. US-based crypto think tank and advocacy group Coin Center is suing the Treasury Department over the Tornado Cash sanctions and warns that similar extreme measures could be taken against networks like Bitcoin and Ethereum. On that note, the Treasury also announced they would launch OFAC’s “largest virtual currency enforcement action to date” on Bittrex after it allowed crypto transactions in sanctioned countries like Cuba, Iran, Sudan, Syria, and the Crimea region of Ukraine. The Washington-based trading platform will be fined $24M by OFAC and an additional $29M by the Financial Crimes Enforcement Network (FinCEN). Next in turn, is YugaLabs, the creator of the popular NFT collection Bored Ape Yacht Club (BAYC). The SEC is allegedly investigating if the company breached federal law by examining whether the NFTs are more akin to stocks and thus should be registered as securities, and is also looking into the distribution of ApeCoin given to BAYC holders.

As much as regulations would help consolidate many money market protocols and in turn, help protect investors, regulators could also be doing more harm than good by discouraging and hurdling innovation. Otherwise, regulation is much needed to avoid exploits like that on Solana’s Mango Market. Although the attacker claims otherwise, the practice of his group arguably represents the premise of one form of market manipulation. At 21Shares, we are incredibly excited about crypto regulations like EU’s Markets in Cryptoassets (MiCA) that is expected to limit exploits and provide more immunity to hacks.

The looming energy crisis has encouraged a group of lawmakers led by US Senator Elizabeth Warren to investigate how much energy the Electricity Reliability Council of Texas (ERCOT) is providing crypto mining companies. In a letter addressing ERCOT’s CEO, Pablo Vegas, the group asked Vegas to provide operational information on miners to assess how much they contribute to climate change. Nevertheless, Binance launched a $500M pool to support loaning Bitcoin miners affected by the macroeconomic events.

In other news, the overall adoption of cryptoassets has received a boost this past week. Portugal 2023’s budget proposal includes a 28% income tax on crypto held for less than a year, similar to a move implemented by Germany back in May. In theory, this is good news for investors and the industry to encourage traders to hold and discourage panic selling. Other positive adoption news includes the following:

  • Google plans to integrate crypto payments for cloud services in collaboration with Coinbase as a custodian. Moreover, the search engine now shows wallet balances of ETH-based addresses.
  • Polygon released a portal for Indian police complaints, which introduces a real-life application to the non-financial use cases of blockchains.
  • Mastercard partnered with crypto exchange Paxos to act as a bridge between banks and crypto trading, another major win for the industry.

Crypto Infrastructure

Figure 4:

Source: MEV Watch

ETH-centric Updates. One of the critical issues Ethereum has been grappling with has been Maximum Extractable Value. To recap, MEV is a process by which validators increase their profits by reordering transactions within blocks they produce. Transactions within POS and POW systems are usually queued up in a mempool, which allows miners/validators to reorder transactions as they wish for their maximum potential gain since it relies on an auction-based model. Unfortunately, MEV can cause what is known as a 'sandwich' attack, where a user's transaction is front-run with another order buying the same asset but with a higher gas fee - resulting in higher slippage and executing less of their original intended transaction as the asset's price hikes. The attacker follows this step by a back-run order where they sell their position and earn a profit based on this quick artificial price increase. A workaround to this predicament is allowing users to send transactions directly to miners without being stuck at the mempool, which is what the MEV-relayer group Flashbots introduced with their Protect RPC endpoints product.

Due to its ease of integration and usefulness, the adoption of the solution skyrocketed over the past year. Nevertheless, its growth was matched with increasing concerns around centralization. This issue became relevant after flashbots announced they would comply with OFAC sanctions that were issued in the aftermath of the Tornado Cash debacle back in August. Fast-forward to today, more than 50% of Ethereum blocks are now processed through MEV-relayers like Flashbots, which produce OFAC-compliant blocks. This increasing figure can be credited to the merge as validators were presented with lucrative economic incentives - via MEV-boost - to reroute the block production process to MEV relayers such as Flashbots in the wake of the POS switch. That said, Flashbots just announced the SUAVE (Single Unifying Auctions for Value Expression), a toolkit that will decentralize the block-production process, and introduce a more diverse set of block proposers that aren’t necessarily OFAC-complaint. Although the rest of the solution's details are still to be revealed next week, FlashBots are working on other solutions like open-sourcing their MEV-boost software to enable more teams to contribute as relayers. This is a critical development as over-reaching sanctions could potentially be issued against base-layer protocols, and thus the crypto community needs to address all central points of failure that would invite censorship. On a positive note, Ethereum became deflationary for the first time since the merge, driven by a XEN token, burning around 4K tokens during the heightened activity on Oct8, then removing another 3K from circulation to this day. The soaring demand for blockspace prompted users to pay up to $1.8M in gas fees to interact with the smart contract that had no supply caps and allowed unlimited minting.

BNB Hack Chain Reaction. Following the BSC token bridge exploitation, the middleware enabling internal interoperability between the BNB beacon and smart-contract chains, BNB executed an urgent hard fork to mitigate the ramifications of the hack. Released on October 12, the patch introduced block headers in sequence checks, amongst other improvements, to the cross-chain contract. In the same vein, the Cosmos team has been exercising heaps of due diligence auditing their interblockchain communication protocol (IBC) due to BNB's bridge hack. This led Ethan Buchman, the founder of Cosmos, to announce that a new patch will be deployed to all IBC-enabled chains as a new vulnerability was found that affects them all.

Scalability. Arbitrum offchain's labs strategically decided to acquire Prysmatic labs, Ethereum's most popular consensus layer node client. The move is somewhat unfavorable, though, as Prysm is the leading consensus client on ETH, and almost 41% of Ethereum's users rely on the solution, raising concerns about centralization. The issue could be prevalent during outages as both networks could be crippled by their reliance on the same provider. In other news, Metis released their new 'smart' L2 to scale ETH even further. The main differentiator between Optimistic-based rollup and other similar solutions is that Metis will store data on an off-chain component called MemoLabs. Rather than store data on ETH, they'll instead opt to submit a Merkle hashes to the base layer, which should unequivocally reduce gas fees.

Decentralized Finance

Figure 5:

Source: 21Shares, CoinGecko

Stablecoins. Binance expanded its Layer1 integration of its BUSD token by deploying a native version on the Polygon chain. BUSD now lives on Ethereum, BNB, Avalanche, and Polygon. The interchain ecosystem of Cosmos is also expected to welcome its own native stablecoin dubbed IST. The project is being developed by Agoric, the open-source development company maintaining the Cosmos SDK. In a positive move for credibility, Tether, the issuing company behind USDT, kept its promise by announcing its full elimination of commercial paper exposure backing its reserves. 80% of Tether’s reserves is now made up of cash equivalents and short-term deposits, of which more than 70% of the company’s cash equivalents are US treasury bills. Aave officiated the release of their new over-collateralized stablecoin GHO after a new governance proposal passed with 97%. The project, which borrows similar design properties from MakerDAO’s DAI, will have its first testnet network in 3 weeks, and will be deployed on Aave’s V3 market on Ethereum instead of V2, which OpenZepplin already audited.

Flourishing L2 ecosystem. Uniswap, the largest DEX by volume, has just passed a governance vote that will see the protocol’s deployment on zkSync. As Zk-rollups is considered the holy grail of scalability, Uniswap’s launch on zkSync is a significant undertaking as the DeFi ecosystem can start growing on the L2 rollup. DEXs are the substratum that lives underneath asset management, lending, and yield-aggregation primitives, which glues together the different moving parts of DeFi. Another exciting event was the flooding of Lido’s wrapped stETH derivative onto Arbitrum and Optimism. The move is a response to Coinbase and Rocket Pool’s recent efforts in dethroning Lido’s dominance over the ETH market, following the introduction of their liquid-staking ETH products, especially as it’ll become significantly cheaper to interact and transact with Lido’s derivative on the two L2 networks. Liquidity has been deepening, with almost $20M worth of ETH, in the form of wstETH, has been bridged to both rollups since last week’s inception.

NFTs and Metaverse

Figure 6: Daily Users against NFT Volume on Ethereum

Source: 21Shares, Dune Analytics

More crypto outsiders are dipping their toes in the NFT waters. For example, world-renowned veteran actor Sir Anthony Hopkins is partnering with Orange Comet to launch an NFT collection that randomly selects holders for a 1-1 Zoom call. Orange Comet is an NFT production and promotion company specializing in art, sports, and entertainment, bringing NFTs into Hollywood. This move inspires a plethora of use cases not only for entertainment but also for education and mentorship portals like MasterClass that are yet to utilize the technology.

On the other hand, Formula 1 is racing towards Web 3 by filing for trademarks under the name “F1” to cover cryptocurrencies, crypto marketplaces, trading and mining, and retail stores for virtual goods on the metaverse. In addition, formula 1 has a track record of supporting and promoting the crypto industry in its tournaments to the extent of getting on the regulatory radar.

As for developments within the industry, Uniswap announced it would launch NFTs as part of the Series B round mentioned earlier in this report, shying away from revealing any details. Ethereum’s largest DEX acquired Genie, the first NFT marketplace aggregator, back in June. However, it remains unclear whether Genie will be involved in this endeavor. X2Y2 unveiled a peer-to-peer loaning function, allowing NFTs as collateral to borrow ETH against. With the BendDAO debacle in mind, NFTs haven’t performed well as collateral due to thin liquidity, causing NFTs’ floor prices to be counter-intuitive. However, we are hopeful that BendDAO’s troubled peer-to-pool protocol would have given some lessons to X2Y2’s peer-to-peer loaning function.

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