2024 Crypto Market Outlook - V3
2024 Crypto Market Outlook - V3
2024 Crypto Market Outlook - V3
Market Outlook
Contents
01 Key themes for 2024 5
02 Bitcoin 22
03 Ethereum 31
05 Tokenization 57
06 Stablecoins 61
07 Regulation 66
Scott Bauguess
Katie Harries
Shaida Safai
Mike Urciuoli
Anthony Bassili
Jaydip Mahida
Jaclyn Sales
Ning Wei
Viktor Bunin
Katie Mitchell
Andrew B Samuel
Claire Wells
Robin Cook
Brandon Myint
Lukas Staniszewski
Crystal Yang
Ben Floyd
McKenna Otterstedt
Greg Sutton
Alex Zosos
Neil Gallagher Jordan Salberg Hoolie Tejwani
additional resources
We encourage readers to visit and subscribe to our team’s other publications to stay up to date.
Additional Resources
3
A note from
The total crypto market cap doubled in 2023, which suggests that the asset
class has already exited its “winter” and is now in the midst of a transition.
Still, we think it'd be premature to put labels on this or see the positive
performance as vindication against the cynics who reveled in crypto’s greatly
exaggerated demise. What’s clear, however, is that in spite of the hurdles
directed towards the asset class, the developments we witnessed over the
past year have defied expectations. They are evidence that crypto is here to
stay. The challenge now is to seize the moment and build something better.
2.5
2.0
US$ trillions
1.5
1.0
0.5
0.0
2017 2018 2019 2020 2021 2022 2023
The catalysts for crypto’s recovery in 2023 have at times been extrinsic to the
innovations that typically characterize its value. Both the US regional banking
crisis and the proliferation of geopolitical conflict, among other things,
reinforced bitcoin’s status as a safe haven alternative. Moreover, spot bitcoin
ETF applications from some of the top US financial institutions have been an
implicit acknowledgement of crypto’s potential to disrupt. This may be the
precursor to greater regulatory clarity, removing the frictions that would
otherwise prevent capital from flowing into this asset class.
But progress rarely moves in a straight line. To create a more resilient market,
developers will need to continue building towards real world use cases that
help us cross the chasm from early adopters to mainstream users.
The foundations of what this might entail are already evident – from web2
analogues like payments, gaming, and social media to crypto-specific
advancements like decentralized identity and decentralized physical
infrastructure networks. The former are easier to understand for investors, but
these projects face an uphill battle against well-established web2 giants. The
latter could transform the technological landscape, but the development
timelines are longer while meaningful user adoption is further out on the
horizon. However, blockchain infrastructure has come a long way in the last
two years, enabling the necessary conditions for these applications to
experiment and innovate – and putting us far closer to an inflection point.
Against this backdrop, we think the secular trend for institutional crypto
adoption will accelerate. In fact, anecdotally, the later stages of the 2023 rally
have started to attract a broader set of institutional clients into the crypto
space, from traditional macro funds to ultra high net worth individuals. We
expect the availability of spot bitcoin ETFs in the US to advance this trend,
potentially leading to the creation of more complex derivative products that
rely on compliance-friendly spot ETFs as the underlying. Ultimately, this
should improve liquidity and price discovery for all market participants.
Chapter 1
Bitcoin hegemony
Flows in 2023 played out largely as we expected in our Crypto Market Outlook
2023. Digital asset selection transitioned towards higher quality names,
leading bitcoin dominance to steadily increase above 50% for the first time
since April 2021. This was driven in large part by multiple well-known and
established financial stalwarts applying for spot bitcoin ETFs in the US, as
their participation in the space has helped to validate and enhance crypto’s
prospects as an emerging asset class. Although there may be some capital
rotation into riskier parts of the asset class next year, we believe institutional
flows will remain firmly anchored on bitcoin at least through the first half of
2024. Moreover, pent-up demand from traditional investors seeking to enter
this market will make it harder to supplant bitcoin hegemony anytime soon.
C onsequently, it turned out that there wasn’t necessarily a need for more
blockspace. ut of the depressed expectations that ensued, developers
O
decided to use the crypto winter to build. They dedicated their time to
confronting the technological hurdles that hinder new blockchain use cases
from developing.
The first stage of that progress has been to build the infrastructure necessary
to enable a web3 future, such as scaling solutions (layer-2s), security services
(restaking), and hardware (accelerators for zero-knowledge proofs) to name a
few. These remain important investment opportunities for the crypto space,
but arguably, a lot of infrastructure has now been built over the last two years.
As this enables more decentralized applications (dapps) to emerge, we think
the trading regime for crypto will transition alongside these endeavors. That
is, we expect more market players to focus on finding the potential web3 apps
that can help crypto bridge the gap between early adoption and
mainstream use.
The trading regime for crypto may pivot towards web3 apps
in 2024, as market players focus more on use cases.
Many market players rely on web2 analogues for their investment ideas in this
space, like payments, gaming, and social media. Other use cases have emerged
that have a more distinct crypto native flavor, including decentralized identity,
decentralized physical infrastructure networks, and decentralized compute.
We think the challenge isn’t just identifying the sectors but picking the
winners. Achieving dominance in any given sector isn’t just about having the
first-mover advantage (although it helps); it’s also about achieving and
monetizing the right network effects. Before early 2004, there were at least
six other social media platforms, including Friendster and MySpace, that had
made their mark but which didn’t achieve the same network size or
prominence as Facebook, for example. Given the nascency of the digital asset
class, we expect many market participants to rely more on proxies and
platform plays to capture the opportunities we’ll see in the next cycle.
Some are focused on gaming or NFTs (Beam, Blast, Immutable X, e.g.) while
others are focused on DeFi (dYdX, Osmosis) and/or institutional participants
(Avalanche’s Evergreen subnet, Kinto).
At the same time, the concept of modular blockchains is gaining more traction
within the crypto community, with many L1s stepping in to fulfill one or more
core blockchain components including data availability, consensus,
settlement, and execution. In particular, the launch of Celestia on mainnet in
late-2023 reanimated the conversation around modular blockchain design by
providing a readily-accessible, plug-in data availability layer.2 That is, other
networks and rollups can use Celestia to post transaction data and guarantee
that that data is available onchain for anyone to check. Other Ethereum
Virtual Machine (EVM) compatible L1s are opting to focus on smart contract
execution by transitioning to Ethereum L2s, like Celo.3
50B
40B
Total value locked (USD)
30B
20B
10B
0
Jan 2023 Mar 2023 May 2023 Jul 2023 Sep 2023 Nov 2023
Ethereum Tron BSC Polygon PoS Solana Avalanche Arbitrum Optimism Others
Sources: DefiLlama and Coinbase. Values are taken on a 5 day rolling basis
2 See Coinbase Cloud. ”Unpacking Celestia: An Introduction to Modular Blockchains” published August 21, 2023.
3 See cLabs. “cLabs Proposal for Celo to transition to an Ethereum L2” published July 15, 2023.
That said, integrated (or monolithic) chains like Solana continue to have an
important place in the crypto ecosystem, meaning the debate between the
modular vs integrated theses may not be resolved anytime soon. Nevertheless,
we think the trend towards increasingly differentiated chains – whether by
sector or function – will continue through 2024. However, the value of these
blockchains ultimately still comes down to which projects are building on top
of them and how much usage they attract.
For example, if we compare the canonical bridges linking Ethereum with L2s
versus alt L1s, the share of ETH locked on rollup-linked bridges has grown from
25% of all bridged ETH at the start of 2022 to 85% by end-November 2023.
Meanwhile, despite the growth in rollup usage, transaction counts on
Ethereum have remained relatively stable averaging around 1M per day.
Comparatively, the aggregate activity across Arbitrum, Base, Optimism, and
zkSync currently average more than 2M transactions per day. (See Chart 4.)
4.0M
3.5M
3.0M
Daily Transaction Count
2.5M
2.0M
1.5M
1.0M
0.5M
0.0M
Jan 2021 Jul 2021 Jan 2022 Jan 2023 Jul 2023
Sources: Coinbase and Dune. Transaction counts taken on a 10 day rolling basis
On the other hand, the de-dollarization theme has been a topic of discussion
since at least the early 1980s, and despite that, the USD still remains the
world’s reserve currency. Indeed, the USD’s outsized role in global finance and
trade means the USD’s share of all international transactions has hovered
around 85-90% for the last four decades. (See Chart 5.) What has changed is
the weaponization of global finance that began with increased US sanctions
on Russia as a direct result of the war in Ukraine. This has accelerated interest
in developing new cross border payment solutions as more countries are
striking bilateral agreements to reduce their dependence on the USD. Both
France and Brazil (among others) have started to settle commodity trades in
Chinese renminbi, for example.4 More trials are being conducted with central
bank digital currencies to avoid today’s cumbersome system of
correspondent banks.
200%
180%
160%
140%
120%
100%
80%
60%
40%
20%
0%
1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 2019 2022
Because every transaction involves two currencies, the sum of foreign exchange turnover each year is 200%.
Source: BIS Triennial Survey 2022.
4See Bloomberg, Brazil Takes Steps to Transact in Yuan as China Ties Grow, published March 30, 2023 and Reuters, China's CNOOC, French energy firm Engie complete yuan-
settled LNG trade, published October 17, 2023
Crypto advocates argue that bitcoin and other digital stores of value have an
important role in this emerging shift from a unipolar to multipolar world, as
the value of having a supranational asset that is not owned or controlled by
any single country seems evident. Monetary transformations often take place
in periods of socioeconomic upheaval that are only understood well after they
happen, like paper money in 11th century China, promissory notes in 13th
century Europe, or credit cards in mid-20th century America.
On the other hand, while digital cash and distributed ledgers will likely form a
major part of the next transformation, displacing the USD in the global
financial system is no small task. For one thing, the entire crypto market cap is
only a fraction of the $13T in USD-denominated bonds available to non-banks
outside the US.5 The USD’s share of foreign exchange reserves has declined
over the last 30 years, but it still comprises the overall majority at 58%.6 But
bitcoin doesn’t necessarily need to disintermediate the USD to play a valuable
function as an attractive alternative in unstable conditions, which could
potentially help it find a place as part of more countries’ reserve assets. Nor is
the structural adoption of bitcoin and crypto contingent on the collapse of
the USD, which explains why we saw bitcoin strengthening in tandem with the
USD in early 2H23. Over the long haul, the monetary regime change that’s
happening and crypto’s part in that will likely be momentous, even if we may
not be around long enough to see the toppling of the old order.
5 See BIS. “BIS global liquidity indicators at end-June 2023” published August 2023.
On the latter, we’ve argued since March 2023 that inflation had already peaked
and that moderating aggregate demand should cyclically support a stronger
disinflationary trend going forward.7 In large part, that has already
materialized, while structural forces like artificial intelligence can lead to
greater automation and lower input costs. That said, shifting demographics –
such as the departure of baby-boomers from the workforce – may act as a
counterbalance to that. Taken together, we think the combination of an
economic slowdown and a moderation in price pressures should pave the way
for the Federal Reserve to cut rates by mid-2024, if not sooner.
In our view, lower capital costs could support risk assets in 2Q24, but 1Q24
may present some challenges depending on how entrenched the Fed’s
position is. Crypto may not be entirely immune in that scenario. But our
economic outlook also translates to a weaker USD trend next year, which
would be an opportunity for cryptocurrencies, as these assets tend to be
priced in USD. Although the correlations between changes in many macro
variables and bitcoin (and ether) returns have come down over the last year, an
amenable macro backdrop still forms a core part of our overall constructive
market thesis for 2024.
BTC/USD Copper CRY DXY ETH/USD Gold MOVE S&P 500 US 10Y US 2Y US Bond VIX
BTC/USD
Copper
CRY
DXY
ETH/USD
Gold
MOVE
S&P 500
US 10Y
US 2Y
US Bond
VIX
On the upside, we think more legislators in the US recognize the rising risk of
global regulatory arbitrage with several US House Committees advancing the
Clarity for Payment Stablecoins Act and the Financial Innovation and
Technology for the 21st Century Act (FIT 21 Act) in 2023.
Separately, the potential approval of spot bitcoin ETFs in the US could widen
crypto access to new classes of investors and reshape the market in
unprecedented ways. Compliance-friendly ETFs could become the underlying
for a new set of financial instruments (lending and derivatives, for example)
that could be traded among institutional counterparties. We believe the
foundations for crypto regulation will continue to be built in 2024, leading to
more incremental regulatory clarity and greater institutional participation in
this space in the future.
Tokenization, redux
Tokenization is a vital use case for traditional financial institutions and we
expect it to be a major part of the new crypto market cycle, as it is a critical
part of “updating the financial system.” This primarily involves automating
workflows and eliminating certain intermediaries that are no longer needed in
the asset issuance, trading, and record keeping process. Not only does
tokenization have strong product-market fit for distributed ledger technology
(DLT), but the current high yield environment makes the capital efficiency
offered by tokenization much more relevant than it was even two years ago.
That is, for institutions, tying up capital for even a few days in higher interest
rate environments is much costlier than doing so in lower rate environments.8
Over time, we believe that even more business and financial sectors will
incorporate aspects of tokenization, though regulatory ambiguity and the
complexities of managing different jurisdictions continue to pose significant
challenges for market participants – alongside the integration of new
technologies into legacy processes. This has driven most institutions thus far
to rely on private blockchains, due to the risks associated with public
networks such as smart contract exploits, oracle manipulation, and
network outages.
8 See Coinbase Research. “Tokenization and the New Market Cycle” published October 30, 2023.
800M
700M
600M
Value Locked (USD)
500M
400M
300M
200M
100M
0
Jan 2023 Mar 2023 May 2023 Jul 2023 Sep 2023 Nov 2023
Franklin Templeton Benji Investments Ondo Matrixdock Backed Finance
Maple Hashnote Others
Sources: RWA.xyz and Coinbase.
Does not include US Treasury tokens minted for the usage in a single protocol like those in Maker Vaults. Value taken on a 5 day rolling average.
10 See FandomSpot. “Study: 69% of Gamers Hate NFTs” published March 21, 2022.
14,000
12,000
10,000
8,000
6,000
4,000
2,000
0
Jan 2021 May 2021 Sep 2021 Jan 2022 May 2022 Sep 2022 Jan 2023 May 2023 Sep 2023
Source: Dune.
DePIN represents a strong real-world use case for blockchain technology that
can potentially disrupt the existing paradigm, but it is still relatively immature
and faces a number of hurdles. These include high initial outlays, technical
complexity, quality control, and economies of scale to name a few. Moreover,
many DePIN projects have been focused on how to incentivize participants to
supply the necessary hardware for these projects, but only a few have started
to tackle the financialization models for driving demand. Although a
demonstration of DePIN’s value may come early, realizing the benefits could
nevertheless take years. Thus, we think market players will still need to take a
long duration view in order to invest in the sector.
Decentralized identity
Privacy is a new frontier for blockchain developers, who are leveraging
innovations like zero-knowledge (ZK) fraud proofs and fully homomorphic
encryption (FHE) to enable computations on user data while still keeping that
data encrypted. The applications for this are extensive, particularly as it
pertains to decentralized identity – which describes an end-state where users
have full control and ownership of their personal data. For example, this could
enable a healthcare research organization to analyze patient data, helping
them discover new trends or patterns for specific diseases but without
revealing the sensitive health information of any patients. To achieve this,
however, we think individuals would need to have control over their own
identity data – a departure from the current status quo of having this
information sit on the servers of many disparate centralized entities.
To be sure, we’re still in the very early stages of tackling this problem. But ZK
systems and FHE were once considered purely theoretical concepts that have
recently seen more experimental implementations within the crypto industry.
In the next few years, we expect to see greater advancements in this field that
may get us to the point of having end-to-end encryption in our web3
applications and networks. If so, then we believe decentralized identity could
have a strong product-market fit in the future.
With the Dencun upgrade set to potentially reduce rollup transaction fees by
2-10x, we think more decentralized applications (dapps) may pursue a “gasless
transactions” path, effectively allowing users to focus only on high-level
interactions.13 This may also enable new non-financial use cases to develop.
Account abstraction can also facilitate robust wallet recovery mechanisms to
create failsafes against simple human error (like losing a private key, for
example). The goal is for the crypto ecosystem to attract new users as well as
encourage existing users to become more active participants.
12 See J.P. Morgan. “The Future of Wealth Management” published November 2023.
13 Not only will Proto-Danksharding reduce the costs of putting rollup data on the layer-1 mainnet as part of Ethereum Improvement Proposal (EIP) 4844, but EIP-1153 will also optimize
gas fees for the network.
14 See EigenLayer Blog. “Launch of the Stage 2 Testnet” published November 16, 2023.
Chapter 2
Bitcoin
market outlook
Bitcoin’s (BTC) rally in 2023 has been a function of three key factors. First, the
token had already been heavily oversold in late 2022, following FTX’s collapse.
Second, the US debt ceiling showdown (in January 2023) and US regional bank
failures (in March) helped burnish bitcoin’s flight to quality credentials. Third,
a further catalyst then emerged in 2H23 when multiple financial institutions
including BlackRock, Invesco, and Franklin Templeton filed spot bitcoin ETF
applications, accelerating bitcoin’s “store of value” narrative. The result is that
bitcoin has outperformed both crypto peers as well as traditional assets like
US technology stocks, not only in absolute terms but on a risk-adjusted basis
this year.
Bitcoin
23
Ripple Labs vs
40,000 US regional SEC ruling
banking crisis
MiCA
approved in BlackRock files
35,000 spot BTC ETF
Europe
Grayscale wins
SEC lawsuit
30,000 Bitcoin
US $
Ordinals
launched
Mt Gox to start
25,000 repayments
US House
Coinbase HK allows licensed committees pass
20,000 launches crypto trading key crypto Bitcoin Runes
International platforms legislation proposed
Exchange
15,000
Jan 2023 Feb 2023 Mar 2023 Apr 2023 May 2023 Jun 2023 Jul 2023 Aug 2023 Sep 2023 Oct 2023 Nov 2023 Dec 2023
Although there will be a temptation to see bitcoin profits rolled into tokens
further out the risk curve, we think bitcoin will continue to be the anchor for
the digital asset class in 2024, particularly as spot ETFs (if approved)
represent a bitcoin-specific conduit for capital from new segments of the
population. Moreover, the bitcoin halving (which will reduce rewards for
mining bitcoin) is expected to drive BTC prices higher as it enhances the
token’s prospective scarcity and improves its supply-demand technicals.
(More on this in the next section.) Together, these factors may continue to
drive the secular adoption trend for bitcoin.
Spot ETFs can help meet the demand coming from the investors
and institutions that want access to crypto but don’t have
recourse to buying and holding such assets directly.
However, there are also a few sources of anticipated selling pressure for
bitcoin in the months ahead. These include 141,686 BTC (alongside 142,846
BCH and JPY69.7B in cash) held by the Mt. Gox Rehabilitation Trust that needs
to be repaid to creditors by October 31, 2024 (delayed from October 31, 2023).
As of November 30, 2023, this represents around $5.2B in crypto assets that
may be distributed in the months ahead, although the Trustee has already
started making the cash component of the repayments (JPY200k per person)
to creditors this year. Creditors may choose to sell some or all of the crypto
distributions they eventually receive, so the precise impact on the bitcoin
price is hard to estimate. Additionally, the trustee may need to sell some
crypto to satisfy any creditors who elected to be repaid entirely in cash.
Bitcoin
24
15M
10M
5M
USD
-5M
-10M
-15M
Jan 2023 Mar 2023 May 2023 Jul 2023 Sep 2023 Nov 2023
Ask (0.1%) Ask (0.5%) Ask (1%) Ask (2%) Bid (0.1%) Bid (0.5%) (Bid (1%) Bid (2%)
See US Bankruptcy Court for the District of Delaware. Case No. 22-11068 (JTD). Re: FTX Trading Ltd, et al. “Stakeholder Update Materials” prepared for creditor meeting on
17
Bitcoin
25
Bitcoin halving
All of this is to say that we think the next halving could indeed have a positive
impact on bitcoin performance, but the context does matter. In May 2020 for
example, the last Bitcoin halving coincided with unprecedented levels of global
central bank quantitative easing and pandemic-related fiscal stimulus,
dramatically increasing the world’s money supply. This raised bitcoin’s “supply
scarcity” profile at precisely the right time.20 The backdrop for the upcoming
2024 halving may be similarly amenable to bitcoin, as we expect global growth
to slow and many central banks including the Federal Reserve to cut interest
rates in 1H24. This narrative converges nicely with potential spot bitcoin ETFs in
the US, which will provide a wider audience with a previously unavailable
hedging vehicle to defend against rising economic and geopolitical uncertainty.
18 Note that we distinguish bitcoin the token in lowercase and Bitcoin the network in uppercase.
19 See Coinbase Research, "Monthly Outlook: Why an ETF Matters" published November 13, 2023.
20 See Coinbase Research. “Bitcoin Halvings and the Liquidity Problem” published June 14, 2023.
Bitcoin
26
Network impacts
Separately, we think the halving will have a two-pronged impact on the Bitcoin
network’s fundamentals. It will likely (1) affect supply side dynamics among
bitcoin miners as well as (2) act as a litmus test for the viability of sustaining a
proof-of-work (PoW) network in the face of significant drops in block rewards.
The decline in rewards amidst an overall increase in network hash rate means
a portion of bitcoin miners may no longer be productive enough to continue
mining in the absence of significant increases to price or transaction fees. In
our view, this could lead to further consolidation among select miners who are
able to reduce their operational costs amidst narrowing profit margins. Chart
11 depicts the Hashprice Index, a measurement pioneered by Luxor of the
expected revenue per terahash of compute power each day.20 The Hashprice
Index in USD indicates whether a fleet of miners can be profitable given their
overall efficiency and cost of energy, while the Hashprice Index in BTC is
inversely correlated to network hash rate and signals increasing mining
competition in the space as the Hashprice Index falls.
Chart 11. Bitcoin profitability per terahash of mining power is likely to hit new lows post-halving
0.000045
2020 Bitcoin Halving
0.000040 0.40
0.000035
0.000030 0.30
USD/TH/DAY
BTC/TH/DAY
0.000025
0.000020 0.20
0.000015
0.000010 0.10
0.000005
0
Jan 2019 Jul 2019 Jan 2020 Jul 2020 Jan 2021 Jul 2021 Jan 2022 Jul 2022 Jan 2023 Jul 2023
Bitcoin
27
Following the 2020 halving, the Hashprice Index dropped from $0.15 to $0.07. A
similarly aggressive drop will likely follow the 2024 halving, possibly
decreasing the Hashprice Index to below $0.04 for the first time – unless there
is significant bitcoin price appreciation. The newest Bitmain Antminer S21 rig
released in August 2023 operates with an efficiency of 17.5 joules per terahash
(J/TH) at a maximum 200 terahashes per second (TH/s). Based on the bitcoin
price and network hashrate as of November 1, 2023, 1 TH/s earns approximately
$0.07 per day in revenue. To break even on the approximately $4800 upfront
cost of the S21 at those economics requires nearly one year of mining sans any
operational and energy costs. This could be even longer in a post halving
environment. In light of these economics, we believe that bitcoin prices have
to rise for the network hash rate to continue growing post-halving, lest the
network experiences a slowdown in 2H24. Miners need to pay their energy
costs in fiat currency and may not be able to do so with the smaller
distributions of bitcoin rewards.
Note that while electricity costs are normally significant for independent
miners, institutional miners are often able to have negligible or even negative
net costs for energy due to power curtailment credits, independent energy
infrastructure, or other agreements with local power grids to consume excess
energy supply. According to Riot’s 8-K filed on November 8, 2023, the firm has
a 2023 YTD cost of $0.0137 per kilowatt hour (kWh),22 less than 10% the average
cost of $0.15/kWh in the US West South Central region.23 During Q3 2023, Riot’s
net energy costs were even negative. Thus, in the short-term, we believe that
the upfront cost of mining machines is more important to overall miner
economics than the cost of energy for institutional miners – barring any
exogenous shocks to energy markets themselves.
However, cheap energy costs (in the US) are subject to regulations and energy
agreements. Riot’s raw cost of energy without credits and special agreements
hovered above $0.03/kWh throughout 1H23. If block rewards were halved at
today’s hash rate, this cost could significantly eat into mining profitability. At
the same time, a number of public mining companies, including Riot and
Marathon, have the capacity to increase their hash rate by as much as 40%
going into the halving in a move that we believe could further
diminish margins.
Bitcoin
28
Chart 12. A handful of Bitcoin mining pools currently dominate the network hash rate
100%
2020 Bitcoin halving
90%
80%
70%
Percentage of Blocks Mined
60%
50%
40%
30%
20%
10%
0%
Jul 2020 Jan 2021 Jul 2021 Jan 2022 Jul 2022 Jan 2023 Jul 2023
Foundry USA AntPool F2Pool ViaBTC Binance Pool Mara Poolin BraiinsPool
Technical upgrades
In light of decreasing fixed block rewards for miners, our view is that catalysts
for raising the variable block rewards from transaction fees will be
increasingly important. The core Bitcoin protocol is in a largely stable state,
with the Taproot upgrade in November 2021 being the only major protocol
upgrade in the past 5 years -- at least with regards to changes that have
required a soft fork.
Bitcoin
29
80% 1200
Bitcoin mining reward breakdown
1150
60% 1100
BTC
1050
40% 1000
950
20%
900
850
0%
Jan 2023 Mar 2023 May 2023 Jul 2023 Sep 2023 Nov 2023
Ordinal Transaction Fees Non-Ordinal Transaction Fees Fixed Block Reward Total Miner Rewards (RHS)
Source: Coinbase. Transaction fees and rewards are taken on a rolling 7 day average.
Bitcoin
30
That said, we think that a future where secondary layers contribute significant
revenues to the protocol may be several more years away, primarily due to the
challenges of acquiring developer mindshare and attention. Stacks requires
developers to learn a new programming language and execution
environment.24 Rootstock is EVM-compatible, but raises the question of its
advantages over Ethereum or its rollups. Meanwhile, RGB is still in its
nascency and BitVM’s journey from an idea to a fully-fledged environment is
one that will take years of research and development. (For example, see zero-
knowledge technology as a prime example of implementations being a multi-
year endeavor). The recently unveiled Babylon network, which enables
“staking” bitcoin to secure alternative networks, could see adoption among
passive bitcoin holders, although, in our view, it is unlikely to generate
meaningful volumes of onchain fees due to the infrequency of transactions.
Furthermore, its staking protocol is still in the very early stages, after only
unveiling its minimally viable product (MVP) on November 9, 2023.
The lightning network (LN), perhaps the most well-known Bitcoin scaling
solution, saw a plateau in the amount of bitcoin locked in lightning channels in
2023, slightly down from 5130 BTC at the start of the year to 5052 BTC as of
end-November – in line with a drop in nodes (3% reduction) and channels (22%
reduction).25 That said, there have been observations of increased usage within
LN itself, such as that by River Lightning whose nodes have more than tripled
monthly transaction counts in 2023 YTD.26 Technical progress on LN has
continued with over $400M of venture capital funding into LN-based startups
throughout 2022 as well as growing support by exchanges, like Coinbase,
announcing plans to support LN. Notably, Lightning Lab’s release of Taproot
Assets introduces a means to issue and transfer tokens (like stablecoins) on
the Bitcoin network.27 That said, the lightning network does not yet provide
much revenue to miners since transactions are only settled at the base layer
when channels are opened and closed. Thus, while we are optimistic for
transformative innovation around Bitcoin in the longer term, we believe
idiosyncratic factors like the halving, a potential ETF approval, and the
broader macro backdrop will be the primary drivers of the Bitcoin narrative in
the coming year.
27 See Lightning Labs. ”Taproot Assets on Mainnet: A New Era for Bitcoin and Beyond” published October 18, 2023.
Bitcoin
31
Chapter 3
Ethereum
market outlook
Ethereum
32
2,000
Kraken
discontinues China’s
1,900
staking in US Evergrande files
1,800 for US bankruptcy
1,700
Polygon
1,600 zkEVM launch
1,200
Jan 2023 Feb 2023 Mar 2023 Apr 2023 May 2023 Jun 2023 Jul 2023 Aug 2023 Sep 2023 Oct 2023 Nov 2023 Dec 2023
Ethereum
33
10M
5M
USD
-5M
-10M
Jan 2023 Mar 2023 May 2023 Jul 2023 Sep 2023 Nov 2023
Ask (0.1%) Ask (0.5%) Ask (1%) Ask (2%) Bid (0.1%) Bid (0.5%) (Bid (1%) Bid (2%)
Note that the Cancun/Deneb (Dencun) Fork is planned for sometime in 1Q24
and may reduce fees on L2s by another 2-10x with the implementation of
Proto-Danksharding, which creates new data space on blocks called blobs. But
we believe that Proto-Danksharding is unlikely to fundamentally alter ETH’s
tokenomics, especially when compared to The Merge or the Shanghai/Capella
(Shapella) Fork. For example, after the Shanghai Fork formally enabled staked
ETH withdrawals, demand for staking far outpaced the demand for exits,
contributing to a net inflow of almost 9M ETH between April and November
2023. That has consequently lowered the ETH reward rate by 80bps from the
start of the year to around 4.00% as of end-November.29
Where Cancun may directly affect ETH tokenomics is in proposal EIP-7514 (see
“Future upgrades” section), which introduces a cap on the maximum churn
limit for new validators per epoch. Because Ethereum has hundreds of
thousands of validators, significantly more than most networks, there's a
burden on the network to support such a large active set. So if too much ETH
is staked, it risks destabilizing the network. EIP-7514 is a step towards finding
a permanent solution to constraining the ultimate validator set size.
Restricting the pace at which validators can enter the network can
theoretically slow the amount of ETH that gets locked up by lengthening the
entry queue but also potentially keep staking yields stable for longer.
29 Based on Composite Ether Staking Rate (CESR) developed by Coinfund and CoinDesk.
Ethereum
34
This proposal may take on added significance ahead of spot ETH ETFs being
reviewed in the US next year. This is because these products have the
potential to attract a new institutional audience, who may have an interest in
staking their ETH holdings to earn passive income.
Chart 16. Realized transactions per second for Ethereum and rollups
70
60
Transactions Per Second
50
40
30
20
10
0
Jan 2022 Apr 2022 Jul 2022 Oct 2022 Jan 2023 Apr 2023 Jul 2023 Oct 2023
Sources: L2Beat and Coinbase. Transactions per second are taken on a rolling 10 day average.
Ethereum
35
Network activity
Demand for Ethereum blockspace has shifted increasingly towards DeFi and
other financial related activity in 2023, accounting for more than 40% of all
transaction fees on the network as of the end of November. (See Chart 17.) The
rise of Telegram bots such as Maestro, Banana Gun, and Unibot (otherwise
known as “sniping tools”) this year, for example, highlights the shift towards
consumer-focused interfaces for tracking and trading crypto markets. In
particular, the sudden tripling of Telegram bot transaction fees occurred at
the same time that Uniswap’s interface fees went live on October 17, 2023,
showing a rise in competition for convenient, low-fee interfaces.
Comparatively, rollup demand for Ethereum blockspace has remained
relatively steady throughout 2H23.
Chart 17. The top 50 contracts on Ethereum account for more than half of all transaction fees spent
100%
14k
12k
Percentage of Transaction Fees Spent
80%
40% 6k
4k
20%
2k
0% 0
Jan 2023 Mar 2023 May 2023 July 2023 Sep 2023 Nov 2023
Sources: Coinbase and Etherscan. Chart is produced by taking the top 50 gas consuming contracts from January 1, 2023 to November 14,
2023 and categorizing them. Transaction fees are taken on a rolling 5 day basis. Note that this only measures transaction fees consumed
by the contract called and does not account for subsequent internal transaction calls.
There also has been a notable drop in blockspace demand for NFT-related
transactions throughout 2Q23, which the sector has not yet recovered from.
While this was caused in part by a decrease in overall NFT activity, we also
believe that a large portion of NFT activity has shifted to bitcoin Ordinals
which saw its initial surge in volume over April and May 2023, around the same
time Ethereum NFT gas demand dropped. (See Chart 18.)
Ethereum
36
350k
300k
Transaction Count
250k
200k
150k
100k
50k
0
Jan 2023 Mar 2023 May 2023 Jul 2023 Sep 2023 Nov 2023
staking
Staking on Ethereum has increased by over 57% following the Shanghai Fork
in April 2023, which formally enabled withdrawals of staked ETH and
effectively signaled the completion of The Merge – the blockchain’s transition
to the proof-of-stake (PoS) consensus mechanism. As of end-November 2023,
there are 882k active validators that have locked up 28.2M ETH, which is
around 23.5% of the total 120.3M ETH supply in circulation – up from 12.9% at
the end of 2022. At the moment, there appears to be very little congestion in
the validator entry and exit queues, signaling that we’ve potentially reached a
short-term equilibrium as far as investor demand for Ethereum staking
is concerned.
30 See Coinbase Research. ”Weekly: Constructive for Q4” published September 29, 2023.
Ethereum
37
Indeed, immediately following the Shanghai Fork, validator entry queues were
at peak capacity for several months, leading staking yields to drop from
4.75-5.00% to 3.75-4.00%, as the base reward is inversely proportional to the
square root of the total balance of all validators. This suggests that current
rates may be the provisional threshold for new entrants given the risks
involved, such as opportunity costs, lock-up periods, and slashing. This is
important as the base rate on staked ETH provides a floor for the crypto
ecosystem, in our view, providing a benchmark for alternative
crypto investments.
However, we believe there is room for the staking ratio to grow, even if it
remains below the 50-75% (of token supply) observed in other alternative
layer-1 networks. The prospect of spot ETH ETFs in the US, for example, is
spurring more discussions about whether these could result in more demand
for ETH staking. That said, there are still outstanding impediments to
incorporating staking into ETF workflows, such as concerns surrounding
withdrawal periods, legal ambiguity, custody, and tax accounting.31 But we
think this may be an opportunity for liquid staking in particular as this service
can help mitigate the potential issues that may arise around redemptions and
liquidity risk. Currently, the total market cap of liquid staked ETH tokens
equals 13.5M ETH, representing 47% of all ETH staked on Ethereum.
30
25
20
ETH Millions
15
10
0
Jan 2021 May 2021 Sep 2021 Jan 2022 May 2022 Sep 2022 Jan 2023 May 2023 Sep 2023
31 We’ve previously covered some of the regulatory concerns surrounding staking in our report “Growth of the Liquid Staking Market” published November 7, 2022.
Ethereum
38
Future upgrades
The introduction of blobs is expected to increase the average block size more
than three-fold from ~150 kB to ~0.5 MB (assuming the target 3 blobs per
block out of the 6 maximum), enabling more rollup data to be compressed into
each block at cheaper costs.32 Furthermore, the separation of blob gas pricing
from calldata transactions minimizes the impact that congested L1 executions
will have on L2 transaction prices.
Ethereum
39
Further optimizations for blob data sharing strategies between rollups are
also undergoing research, which could theoretically lead to further gas cost
reductions.33 Still, we anticipate realized benefits for reduced rollup fees
sometime in 1H24.
That said, in our view, a max limit churn of 8 is unlikely to have any realized
impact on the effective pace of validator activation in the very near term –
barring any significant catalysts that drive up staking demand. Potential
drivers that could cause this, such as significant restaking yields or a spot ETH
ETF with staked ETH, are still in relatively early phases. A churn rate of 8 still
enables 57,600 ETH to be staked each day – accommodating more than $115M
of daily staking demand at a price of $2000 ETH.
33 See Arxiv. “EIP-4844 Economics and Rollup Strategies” published October 2, 2023.
Ethereum
40
Since the validator entry queue first emptied out in mid-October 2023, the
effective churn rate has been approximately 2.9 on average between October
15 and November 15. Thus, while EIP-7514 is a precautionary measure, we do
not think it will constrain validator onboarding significantly.
Restaking (security-as-a-service)
In our 2023 Crypto Market Outlook, we alluded to the growth of middleware
solutions that could introduce a new revenue stream for ETH validators in the
form of “security-as-a-service”.35 Effectively, the concept of “restaking” by
EigenLayer could be a way for validators to secure new features in Ethereum –
like data availability networks, rollups, bridges, oracles, etc – or even secure
other networks, possibly earning additional rewards in the process.36
Developers would benefit by having their middleware run and be secured by
Ethereum’s validators, avoiding the more time-intensive alternatives of either
changing the Ethereum network or launching their own new protocol.37
Yet despite these promising developments, there have been concerns raised
around the threat restaking could pose to Ethereum, most notably by Vitalik
Buterin (the co-founder of Ethereum) who notes that overloading Ethereum
consensus could lead to forks in certain scenarios, particularly when the
economic value secured by restaking passes a certain threshold.39
35 See Coinbase Research. “Crypto Market Outlook 2023” published December 20, 2023.
38 Note: Coinbase Cloud is part of EigenLayer’s Operation Work Group and is participating in the testnet. See announcement on X.
39 Vitalik Buterin's Blog. ”Don't overload Ethereum's consensus” published May 21, 2023.
Ethereum
41
Updates to MEV. Maximal extractable value (MEV) refers to the profit that
validators can earn via their ability to order (and re-order) transactions in a
block. Some forms of MEV are neutral or even relatively benign like buying and
reselling discounted ETH during liquidations of margin-called loan positions.
This can help ensure price stability in the market. MEV can also take
advantage of arbitrage opportunities between exchanges, which can help
improve price discovery. However, other forms of MEV can be seen as
malicious, like front-running trades or “sandwich attacks.” The latter is a more
aggressive form of front-running that levers users’ market orders to
artificially inflate prices for designated sellers, causing price slippage for the
network’s users.
One of the issues with MEV is that it can create negative externalities. For
example, from the validator perspective, MEV rewards depend on the level of
network activity at any given time, meaning extraction opportunities may vary.
Ethereum
42
A validator proposing blocks in one epoch may be able to earn a lot of MEV,
while in another epoch, a different validator may only earn a negligible
amount. Larger validator sets may benefit because they can smooth MEV
rewards among all stakers, but solo stakers could either be very lucky or
unlucky with regards to the uneven distribution of their MEV rewards.
140
5000
120
4000
100
Gwei
ETH
3000 80
2000 60
40
1000
20
0
Jan 2023 Mar 2023 May 2023 Jul 2023 Sep 2023 Nov 2023
At least 366,000 ETH of value has been extracted from the ecosystem since
The Merge, translating to a daily payout to block proposers of approximately
$1M in realized extractable value (REV) – a term coined by Flashbots to
quantify the observed value extracted from the blockchain from REV
opportunities.40 As onchain activity (measured by gas price) increases, so too
does REV.41 (See Chart 20.) Measuring payouts to block proposers is generally
a conservative floor for estimating the amount of REV capture in a system, as
other creative ways to capture value are difficult to measure consistently.
40 See Flashbots. ”Quantifying Realized Extractable Value” published May 15, 2021.
41 See Flashbots. “Modelling Realised Extractable Value in Proof of Stake Ethereum” published September 2022.
Ethereum
43
In our view, one of the largest open problems exposed by MEV is the
centralization of sophisticated block builders and relays. Centralization of
block builders could lead to transaction censorship, and Blocknative’s
shutdown of their MEV-boost relays and other research suggests that the
economic role of relays may have been somewhat overlooked.42 While it is
unlikely that an upgrade to address these issues will go live in 2024, a future
upgrade introducing a carefully designed ePBS implementation and possibly
MEV-burn could alleviate some of these issues. In the meantime, to combat
builder centralization, Flashbots is developing its Single Unifying Auctions for
Value Expression (SUAVE) protocol to decentralize the block builder role.
SUAVE is an adapted EVM chain that can act as a plug-and-play mempool and
decentralized block builder for any blockchain, and is slated for release
in 1H24.
42 See Arxiv. ”Ethereum’s Proposer-Builder Separation: Promises and Realities” published September 24, 2023.
Ethereum
44
Chapter 4
Rollup dominance
Despite a number of newer alternatives, the Ethereum Virtual Machine (EVM)
remains by far the largest developer ecosystem within crypto. Within
networks running the EVM, we have seen a continued shift in activity from
alternative layer-1s (L1s) to layer-2 rollups. At the same time, activity on the
Ethereum mainnet measured by daily transaction count has remained steady
at roughly 1M per day. (See Chart 21.) As mentioned earlier, we believe that the
fear of L2s cannibalizing Ethereum mainnet activity has not yet been realized
– this cannibalization has instead occurred predominantly against
alternative L1s.
Chart 21. Onchain activity has been gradually shifting from alternative EVM L1s to L2s
20M
15M
Daily Transaction Count
10M
5M
0
Jan 2020 Jul 2020 Jan 2021 Jul 2021 Jan 2022 Jul 2022 Jan 2023 Jul 2023
Sources: Dune and Coinbase. Rollups tracked are Arbitrum, Optimism, zkSync, and Base. Alternative L1s tracked are Polygon PoS, Avalanche C-
Chain, Binance Smart Chain, and Fantom. Transaction counts are taken on a rolling 10 day basis.
Chart 22. The amount of ETH locked into rollups continues to increase
2.5M
ETH/WETH Locked in Bridge Escrow
1.5M
1.0M
0.5M
0.0M
Jan 2022 Apr 2022 Jul 2022 Oct 2022 Jan 2023 Apr 2023 Jul 2023 Jul 2023 Oct 2023
Source: Coinbase. Canonical rollup bridges tracked are Arbitrum, Optimism, Base, zkSync Era, StarkNet, immutableX, Linea, Mantle, PolygonZk, and
Scroll. Other bridges tracked are Polynetwork, Multichain, Nomad, Harmony, Polygon PoS, Avalanche, Wormhole, Stargate, Omnibridge, Mantle, Rainbow
Bridge, Gravity, Hop, Across, Connext, Symbiosis, Axelar, Ronin, and Celer.
43
See Etherscan. Arbitrum Sequencer data and Metamask Swap Router data.
Rollup consolidation
The launch of more than a dozen EVM-compatible rollups puts into question
the unique value proposition of each new rollup. The advent of rollup
technology stacks (such as OP Stack, Polygon CDK, or Arbitrum Orbit) and
rollup-as-a-service providers (such as Caldera and Conduit) – designed to
facilitate the development of customized L2 networks – is only accelerating
this trend. In our view, this is reminiscent of the L1 EVM launches in 2020-21,
each purporting to have its own solutions to scalability. Most activity
ultimately consolidated across a handful of chains, driven by their unique
premises and developer outreach. Strategies for rollup differentiation have
been similar and range from creating different execution environments such
as StarkNet’s CairoVM to attracting developers and launching unique
protocols such as friend.tech on Base.
In our view, the EVM-based rollup space is becoming congested with most new
entrants finding it difficult to attract significant market share. (See Chart 23.)
Take zero-knowledge (ZK) rollups for example. These have not yet been able to
take significant market share from Optimistic rollups because their
transaction fees and realized transactions per second (TPS) are not
meaningfully lower compared to optimistic rollups, although this may change
in the future. For now, what differentiates native ZK bridges from optimistic
bridges is mainly instant withdrawals, and it doesn’t yet seem like that’s a
significant enough improvement, given that third party bridges unlock similar
functionality for optimistic rollups. The rapid expansion of ETH locked into the
not-yet-released Blast L2 also represents user demand for earning yield and
may signal a new opportunity for the more than $2B ETH locked in bridges to
become productive assets.
2.5M
2.0M
ETH Locked by Rollup
1.5M
1.0M
0.5M
0.0M
Jan 2022 Apr 2022 Jul 2022 Oct 2022 Jan 2023 Apr 2023 Jul 2023 Oct 2023
Source: Coinbase. Other rollups tracked are ImmutableX, Linea, Mantle, Polygon ZK, and Scroll
More than half of all rollup bridged ETH is currently attributed to Arbitrum. In
our view, this concentration of activity is primarily driven by its first mover
advantage as well as its enhanced security with live fraud proofs. Fast second
movers like Optimism, institutionally backed chains like Base, and the first-
mover zkEVM rollup, zkSync, have also seen substantial adoption. Starknet has
seen increasing traction as well, although it had a slow start partially due to
the overhead of its new CairoVM developer environment, which extended
application development timelines. As the leading rollups continue with their
plans for improved security and decentralization, we foresee this
consolidation pattern generally continuing throughout 2024.
44
See Electric Capital. Open-Source Crypto Taxonomy in GitHub.
45
See Electric Capital. “October 2023 Developer Update” published October 18, 2023.
Nevertheless, collecting this data can be time consuming and labor intensive,
while there are several limitations of such heuristics –
determining how to associate project repositories with specific chains
can be very difficult, as projects may build on private repositories or
without clear labels,
commits may only reflect routine changes and not necessarily new
functionality or meaningful progress,
developer counts do not reveal whether projects involve “10x engineers”
who do disproportionately more work than others, and
more lines of code could be a sign of poor code structure rather than
new features.
Thus, ascertaining a transparent picture of developer activity has continued
to be a challenge in this space. Instead, we think that an alternate heuristic for
developer activity could be combining two key onchain metrics: (1) the number
of unique addresses that have deployed contracts with at least one
interaction post-deployment, and (2) the percentage of total gas demand that
these deployments consume. Note that we only include contracts that have at
least 1 interaction post deployment to eschew contracts that might be
deployed in error.
As an example, the meme coin frenzy during May 2023 saw a notable increase
in both the number of unique contract deployers and the proportion of gas
spent on contract deployments on Ethereum, Binance Smart Chain, and
Arbitrum. In our view, this surge was reflective of a collective increase in
creating new ERC-20 tokens, initializing liquidity pool contracts, and
deploying more onchain bots during that time. These three chains had the
deepest liquidity and most active trading venues at the time, which explains
why similar upticks in activity were not seen on other EVM chains.
Following the May peak, however, we saw a heavy decline in developer activity
in both Arbitrum and Binance Smart Chain, while Ethereum developer activity
has been comparatively tenacious despite having the highest
transaction fees.
In our view, this is reflective of the sustained innovation on and interest in the
Ethereum mainnet. Among rollups, Base is a notable outperformer and has
continued to retain outsized developer activity throughout several months
after its launch. Despite having overall lower TVL and DeFi activity, we believe
this outperformance arises from its efforts in attracting developers to create
novel applications.
1600
Number of Unique Contract Deployers
1400
1200
1000
800
600
400
200
0 Jan 2023 Mar 2023 May 2023 Jul 2023 Sep 2023 Nov 2023
Ethereum Arbitrum Avalanche C-Chain Base Binance Smart Chain Fantom Optimisim Polygon
Source: Coinbase. Deployer address counts are taken on a rolling 5 day basis. Only includes contracts that have at least 1 interaction post deployment.
Base stats only begin on 1 September to normalize for an overweighting of contract deployments in its first month post-launch.
Chart 25. Percentage of transactions fees spent on creating contracts with at least one interaction
2.5%
% of Gas Demand Spent on Deploying Contracts with >1 interaction
2.0%
1.5%
1.0%
0.5%
0.0%
Jan 2023 Mar 2023 May 2023 Jul 2023 Sep 2023 Nov 2023
Ethereum Arbitrum Avalanche C-Chain Base Binance Smart Chain Fantom Optimisim Polygon
Source: Coinbase. Transaction fee percentages are taken on a rolling 5 day basis. Only includes contracts that have at least 1 interaction post
deployment. Base stats only begin on 1 September to normalize for an overweighting of contract deployments in its first month post-launch.
Chart 26. Correlation in Transaction Fee Variability for between EVM Chains
1
Ethereum 1 0.77 0.69 0.65 0.55 0.48 0.46 0.42
0.9
Arbitrum 0.77 1 0.61 0.59 0.49 0.23 0.44 0.59
0.8
Optimism 0.69 0.61 1 0.61 0.36 0.33 0.4 0.42
0.7
Binance Smart Chain 0.65 0.59 0.61 1 0.31 0.2 0.35 0.43 0.6
Polygon PoS 0.55 0.49 0.36 0.31 1 0.23 0.15 0.31 0.5
Source: Coinbase. Correlations are computed from August 1, 2023 to November 12, 2023 to include Base launch. A correlation heatmap taken from
January 1 shows a near identical correlation pattern, but with Fantom less correlated to the rest due to a massive spike in transaction fees on Fantom in
mid-June.
48 See Vitalik Buterin's Blog. ”Should Ethereum be okay with enshrining more things in the protocol?” published September 30, 2023.
Investors have been heavily allocating to Solana throughout 2023, with net
fund inflows to Solana second only to Bitcoin, surpassing Ethereum and other
multi-asset funds flows.49 In our view, this reflects a view of Solana as the
technological platform of choice for a new wave of highly performant
applications that cannot currently be supported on Ethereum or its rollups
(though this may change in the future). Indeed, we believe that improved
transaction throughput and lower fees are necessary to improve UX to
onboard a series of new use cases, and Solana has an early lead in that regard.
49 See Coinshares. ”Digital Assets Fund Flows Weekly” published November 13, 2023.
80% 50B
44B
40%
42B
40B
20%
38B
0% 36B
Jan 2023 Mar 2023 May 2023 Jul 2023 Sep 2023 Nov 2023
Ethereum
Tron
Polygon PoS
Solana
Avalanche
Sources: DefiLlama and Coinbase. Excludes staking, borrows, and double-counting of tokens.
Notably, only eight chains (of the 235 analyzed by DefiLlama) have a TVL of
more than $500M, and seven out of these eight chains (except for Solana) are
EVM-compatible. These are the chains depicted in Chart 27. In aggregate,
these eight chains constitute approximately 90% of all TVL in the crypto
environment. Half of the eight chains sit directly within the Ethereum
ecosystem and include two rollups (Arbitrum and Optimism) and one commit-
chain (Polygon PoS) in addition to Ethereum mainnet. In our view, the
concentration of TVL in EVM-based networks is due in large part to its tested
security and to longer development timelines for alternative ecosystems.
Ethereum’s TVL increased from $22B to $26B from the start of 2023 to end-
November, growing slower than the market as a whole. However, Arbitrum’s
doubling of TVL from $1B to $2B perhaps indicates that Ethereum’s growth is
beginning to move to rollups in a testament to their increased trust
and adoption.
Meanwhile, Binance Smart Chain’s TVL has dropped both on an absolute scale
(from $4.6B to $3B) as well as relative to other chains (from 12% to 6.5% of
TVL). Tron far outperformed the market, increasing its TVL share from 10% to
17%, following a growth from 2% to 10% over 2022. In large part, this has been
fueled by a 50% growth of USDT issued on the chain from $31.7B to $45B. Tron
has more circulating USDT than Ethereum ($45B vs $39B), and its leading
protocol, JustLend, has more than 30% of its collateral stored in the form of
stUSDT, a yield bearing form of staked USDT.
With two exceptions, most of the primary tokens of the aforementioned top
TVL chains have largely traded in line with ETH, reflecting their tight
relationships with Ethereum. (See Chart 28.) BNB, the native gas token of
Binance Smart Chain, dropped from a 2023 high of 28% of ETH’s market
capitalization to less than 15% as of end November. On the other hand, SOL
(Solana’s token) greatly outperformed, trending from 4% to 14% of ETH’s
market cap. Most of these gains accrued in Q4 starting after Solana Labs’ v1.16
client release on September 23 and sustaining its rally through the Firedancer
announcement at the Breakpoint conference in early November.
25%
20%
15%
10%
5%
0
Jan 2023 Mar 2023 May 2023 Jul 2023 Sep 2023 Nov 2023
Sources: Amberdata and Coinbase. Arbitrum data only begin on March 23, 2023 following its airdrop. Market capitalizations are taken on a 5 day rolling
basis.
Chapter 5
Tokenization
Becoming more mature
The tokenization of real world assets (RWA) – that is, creating digital tokens
that represent the ownership of traditional (offchain) assets like real estate,
art, equities, and bonds – is not a new theme. But it gained significant traction
in 2023, in part due to a realignment of tokenization’s business use cases
following an accelerated pace of interest rate hikes in the US and elsewhere.
In the current environment, tokenization captures an opportunity to increase
the availability of illiquid assets or to provide access to assets that may be
uncorrelated with other instruments in a well-diversified portfolio.
Tokenization
58
7B
6B
First Fed hike in the cycle
Value Lockd (USD)
5B
4B
3B
2B
1B
0B
Jul 2021 Oct 2021 Jan 2022 Apr 2022 Jul 2022 Oct 2023 Jan 2023 Apr 2023 Jul 2023 Oct 2023
Sources: DefiLlama, RWA.xyz, and Coinbase. Value locked is taken on a rolling 5 day basis.
With that in mind, the growth of Maker RWA collateral to more than $3B is
particularly noteworthy. We think this highlights one playbook for institutions
to interact with public chains because it minimizes the number of entities on
the blockchain that require direct interaction, and it also unlocks the liquidity
and interoperability of DAI within the broader DeFi ecosystem. Throughout
2024, we anticipate a continuation of this trend with institutions primarily
partnering with protocols and teams that have long-standing track records in
order to minimize their counterparty and smart contract risks, while gaining
access to the liquidity offered onchain.
50 See Coinbase Research. “Tokenization and the New Market Cycle” published October 30, 2023.
Tokenization
59
Meanwhile, the institutional use case for tokenization is now largely focused
on capital market instruments – like bank deposits, money market funds and
repurchase agreements (repos) – in our view. In large part, that’s because tying
up capital in higher interest rate environments is much costlier than doing so
in lower rate environments, making the capital efficiency of instantaneous
settlement much clearer to financial institutions.
However, these efforts have largely been on permissioned chains and with
closed source smart contracts. Technology providers in the private blockchain
space appear to be consolidating around four primary solutions: (1)
Hyperledger’s platform suite, (2) Consensys’ Quorum, (3) Digital Asset’s
Canton, and (4) R3’s Corda. Each platform has its own distinct ecosystems, but
different projects built on the same technology stack are not automatically
interoperable due to the physical separation of networks.
51 See US SEC. “SEC Finalizes Rules to Reduce Risks in Clearance and Settlement” published February 15, 2023.
Tokenization
60
Thus, the issue with the proliferation of permissioned chains and protocols for
tokenization is that it can lead to the fragmentation of liquidity among chains,
diluting key tokenization benefits including atomic settlement and cross-
product interoperability. Such limitations are driving a number of initiatives in
the tokenization space. For example, in November 2023, J.P. Morgan leveraged
multiple bridging technologies to enable cross-chain liquidity for tokens
issued on three different chains in a permissioned manner, as part of a
demonstration for the Monetary Authority of Singapore’s Project Guardian.52 In
our view, this issue of liquidity constraints will continue throughout 2024,
such that most tokenized assets will not see a particularly active secondary
market due to market access challenges.
That said, given that most tokenization efforts are currently either locked
behind permissioned chains or whitelisted protocols, we do not think most
tokenization efforts will have an immediate impact on the broader crypto
markets. However, we believe there will be improvements in onboarding flows
and processes, while additional standardized regulatory-compliant tooling
will become more widespread next year, laying the foundations for long-term
sustained growth of the sector.
52 See J.P. Morgan. ”The Future of Wealth Management” published November 2023.
Tokenization
61
Chapter 6
Stablecoins
Year in review
Stablecoins
62
Chart 30. Ethereum stablecoin supply changes trends with Uniswap volume changes in the absence of
major exogenous events
1.0 0.2
0.5 0.1
0 0.0
-0.5 -0.1
Jul 2021 Jan 2022 Jul 2022 Jan 2023 Jul 2023
Uniswap Volume MoM Stablecoin Marketcap MoM (RHS)
Sources: DefiLlama and Coinbase. Uniswap volume is taken on a rolling 30-day average.
Stablecoins
63
Chart 31. Aave V2 deposit interest rates have trended up throughout Q3 and Q4
30%
25%
Deposit Rate (APR)
20%
15%
10%
5%
0
Jan 2023 Mar 2023 May 2023 Jul 2023 Sep 2023 Nov 2023
Sources: Aavescan and Coinbase. Deposit rates are taken on a 10 day rolling basis. Although Aave V3 has been released since March 2022, Aave V3 TVL
only caught up to Aave V2 TVL in September 2023
W ithin circulating stablecoins, USDT has greatly increased its share of the
total supply. Its market capitalization has grown from $66B at the start of
2023 to more than $89B as of end-November, bringing its share of the
stablecoin market up from 49% to nearly 70% currently. (See Chart 32.) In our
view, this has been driven primarily by the shutdown of BUSD (issued by Paxos
for Binance), whose market capitalization has dropped from a peak of more
than $23B to less than $2B as of end-November. The token is set to be fully
unwound in mid-December. The drop in the supply of USDC from $44B to $24B
throughout the past year also appears to have aided the shift towards
USDT supply.
Stablecoins
64
TrueUSD (TUSD), whose market capitalization has risen nearly 500% from
$756M to more than $3B this year, has also likely been another beneficiary of
the BUSD shutdown as nearly 70% of its issued supply on Ethereum is held on
Binance linked addresses.53 DAI (a collateral-backed stablecoin maintained by
MakerDAO) has also been resilient in its market capitalization (currently over
$5B) as the Dai Savings Rate (DSR) has been competitive with high end yields
and currently sits at 5%.54 The DSR was paying as much as 8% in August 2023.55
180B
160B
140B
Circulating Supply (USD)
120B
100B
80B
60B
40B
20B
0
Jan 2022 Apr 2022 Jul 2022 Oct 2022 Jan 2023 Apr 2023 Jul 2023 Oct 2023
Sources: DefiLlama and Coinbase. Circulating supply is taken on a 5 day rolling average.
A growing market
Non-interest bearing stablecoins are a tested playbook for earning the yield
behind customer deposits and has driven a number of new players to the
market. This includes PayPal’s PYUSD, Aave’s GHO, and Curve’s crvUSD.
However, adoption of these stablecoins is still limited and relatively
centralized in their holder base. More than 65% of PYUSD on Ethereum is held
in a single address compared to less than 3% for USDC and 7% for both DAI
and USDT. GHO and crvUSD are also fairly centralized with their top holders
controlling 19% and 24% of their circulating supply respectively.
55 See Blockworks. “DAI Savings Rate is at 8%, just not for Americans” published August 7, 2023.
Stablecoins
65
The existing deep liquidity pools of USDT, USDC, and DAI entrench liquidity in
favor of existing players – as exemplified by Curve’s active 3-pool (an
automated market maker or AMM specialized for stablecoin swaps containing
the aforementioned three stablecoins).
Stablecoins
66
Chapter 7
Regulation
In our view, the lack of well-developed regulatory frameworks for digital asset
markets and their participants will pose challenges over the next 12 to 18
proposals such as the US. Against this backdrop of uncertainty, however, there
are some early indications that the prospects for regulatory clarity are
Regulation
67
amounting to over two dozen crypto asset related actions during 2023.56
statutory authority to oversee (and write rules for) digital asset commodities.
be classified.
At the same time, significant legal judgments over the previous year have
begun to reveal some of the shortcomings in the SEC’s stance towards crypto.
In July 2023, SDNY Judge Torres ruled against the SEC on key legal questions
in its enforcement action against Ripple Labs,57 disagreeing with the SEC’s
definition of a “security.” In August, the DC Circuit also ruled that the SEC’s
denial of Grayscale’s application for a spot bitcoin ETF was “arbitrary and
capricious,” because the SEC had “failed to explain its different treatment of
similar products,” given that bitcoin futures ETFs are already live.58 These
cases provide positive indications that, although the judicial system moves
courts of law.
digital asset ecosystem is inhospitable,59 with the result that all but the
that actively engage in these activities. Our anecdotal view is that this is
driving an adverse selection dynamic, putting smaller banks and fintech firms
scrupulous jurisdictions.
56
See SEC. Crypto Assets and Cyber Enforcement Actions.
57
See SDNY. SEC v. Ripple Labs, Inc filed July 13, 2023.
58
See DC Cir. Grayscale Investments, LLC v. SEC filed August 29, 2023.
59
See Bank Reg Blog. ”FDIC IG Report Provides New Details on FDIC's Approach to Crypto” published October 18, 2023.
Regulation
68
risk. We are seeing increased engagement with teams who are choosing to
build their projects outside the US and/or are hesitant to bring products to the
US market. SEC and CFTC actions against NFTs and DeFi developers,
The crypto industry has been calling for regulatory clarity in the US because
and the United Kingdom, this offshoring trend could accelerate further unless
crypto market structure and stablecoins that were passed by the House
reintroduced for consideration – see table 1.) Most of the bills are related to
view, this includes the Financial Innovation and Technology for the 21st
Century Act (FIT 21 Act), which delineates powers between the SEC and CFTC
and creates a path for federal registration of digital asset trading venues, as
well as the Clarity for Payment Stablecoins Act of 2023, which provides
the industry.
60
See SEC. “SEC Charges LA-Based Media and Entertainment Co. Impact Theory for Unregistered Offering of NFTs” published August 28, 2023. Also CFTC. “CFTC Issues Orders
Against Operators of Three DeFi Protocols for Offering Illegal Digital Asset Derivatives Trading” published September 7, 2023.
Regulation
69
Committee)
Crypto-Asset National
Referred to Committee on
Security Enhancement Provides for BSA and AML and sanctions
Senate , ,
Banking Housing and
and Enforcement Act requirements for DeFi
Urban Affairs (Senate)
(CANSEE)
Money Laundering Act Senate regarding Bank Secrecy Act (BSA) and , ,
Banking Housing and
Financial Technology
Establishes an independent Financial Ordered reported to House
Protection Act of 2023
and tools .
: , , .
Sources GovInfo GovTrack and Coinbase
Regulation
70
Separately, different states within the US have also been treading down
Digital Financial Assets Law (DFAL), which grants the Department of Financial
companies operating in the state and also puts the onus on exchanges to
“identif[y] the likelihood that the digital financial asset would be deemed a
states like Wyoming and Utah have passed legislation clarifying the legal
passing the Wyoming Stable Token Act – which enables the state to issue
will be crucial for the US in order to maintain its leadership role in financial
Union came into force on June 30, 2023, but the laws will only take effect
starting June 30, 2024 for the stablecoin provisions (titles III and IV) and then
December 30, 2024 for the remaining titles (I, II, V, VI and VII).
the crypto industry, delivering a single rulebook across the EU. It introduces
asset service providers (CASPs) – though lenders are a notable omission that
firms that receive a MiCA license in one member state will gain access to the
entire EU single market. Note that the European Securities and Markets
Authority (ESMA) has been granted additional powers to take direct action
61
See California Legislative Information. AB-39 Digital financial asset businesses: regulatory oversight.
Regulation
71
money) tokens or EMTs under MiCA – occupy a large part of the new rules,
standards including liquidity management, dual supervision (by the EBA and
the potential financial stability risks posed by such stablecoins. For non-euro
Regulatory Authority (FSRA) of the Abu Dhabi Global Markets (ADGM) became
it was one of licensing in Abu Dhabi, with several exchanges and stablecoin
issuers successfully obtaining licenses from the FSRA. Turning their focus to
registered the first Distributed Ledger Technology (DLT) Foundation under this
VARA announced the Virtual Assets and Related Activities Regulations 2023,
others – can market, promote, and engage with digital assets in Dubai. This is
comply. VARA also revised its custody rulebook to address obligations related
Department of Economy and Tourism (DET) or any Dubai Free Zone Authority
(FZA). These one-year Full Market Product (FMP) licenses require a detailed
62
See ADGM. “ADGM introduces the world's first DLT Foundations Regime” published November 2, 2023.
63
See ADGM. “IOTA becomes the first DLT Foundation registered with ADGM in Abu Dhabi” published November 30, 2023.
64
See VARA. Virtual Assets Regulatory Authority.
Regulation
72
United Kingdom. The Financial Services and Markets Act 2023 (FSMA 2023)
came into force on August 29, 2023 which gives the UK government and
regulators the power to develop more detailed rules for crypto. Effectively,
FSMA 2023 is an amendment order to FSMA 2000 that integrates crypto into
the existing regulatory regime that governs investments. This puts digital
assets under greater oversight of the Financial Conduct Authority (FCA) and
The UK government will introduce legislation for the crypto industry in 2024,
crypto technology, will involve more stringent rules for exchanges, custodians,
the FCA and the Bank of England (BOE) have released discussion papers
transactions.66 The BOE will supervise "systemic stablecoins" that have the
crypto industry.
Australia. Since 2018, Australia has been making impressive strides toward its
plans for a new licensing obligation under the Australian Financial Services
February 2023 on token mapping.69 The proposal, which also sets forth
minimum obligations for certain services such as trading and staking, will
Investments Commission.
regulation and recognises the important role that the technology can play in
65
See CNBC. “UK confirms plans to regulate crypto industry with formal legislation” published October 30, 2023.
66
See HM Treasury. “Update on plans for the regulation of fiat-backed stablecoins” published October 30, 2023.
67
See Coinbase Blog. “Australia Leads the Way in Thoughtful Crypto Regulation” published March 28, 2023.
68
See Australian Treasury. “Regulating Digital Asset Platforms” published October 16, 2023.
69
See Australian Treasury. “Token Mapping” published February 3, 2023.
70
See Australian Treasury. “Modernising Australia's Payment System” published June 7, 2023.
Regulation
73
Treasury's efforts on payments and digital assets, the Attorney General’s work
on updating the AML regime will continue into 2024. It contemplates the
appropriate updates needed to capture digital assets and will likely lead to
Hong Kong. In an effort to reassert itself as a global financial hub, the Hong
June 1, 2023. Although the shift in Hong Kong’s stance towards crypto over the
last three years has been notable in and of itself, the aspirations carry greater
Chinese wealth.
Investors today can trade digital assets that are included in a “minimum of two
statements to the SFC on liquidity, liabilities, and profit & loss. As an example
onshoring of custody and exchange activities where private keys (and wallet
seed phrases) must be stored locally. Only two SFC-licensed virtual asset
Note that in late October, the SFC expanded its guidance with respect to
clients with a v
irtual asset-knowledge test or supply those clients with the
products and stablecoins in the near future, as part of its efforts to expand its
tokenization and web3 ambitions. It is also expected that the Hong Kong
71
See Coinbase’s submission. Comment on “Modernising Australia’s anti-money laundering and counter-terrorism financing regime” published June 16, 2023.
72
See Securities and Futures Commission (SFC). “Guidelines for Virtual Asset Trading Platform Operators” published June 1, 2023.
73
See Securities and Futures Commission (SFC). “Joint circular on intermediaries’ virtual asset-related activities” published October 20, 2023.
Regulation
74
customer access, business conduct, technology and cyber risk, and market
integrity. Both consultations concluded this year. For stablecoins, 2024 will
see a new framework which will allow for the issuance of MAS-regulated
transparent disclosure.74
for which final guidelines are expected to be announced in early 2024. While
also announced that DPTSPs would not be permitted to offer staking and
technology & cyber risk. Final guidelines are expected in mid-2024, covering (1)
following the Securities and Futures Act definition), (2) new customer
networks for tokenized digital assets in collaboration with the Bank for
initiative, Project Guardian, involves financial regulators from Japan, the UK,
and Switzerland, as well as the International Monetary Fund and has enlisted
studies across wealth management, fixed income, and foreign exchange are
DBS, and Citigroup. This initiative aims to tackle the policy challenges and
market design.
74
See Monetary Authority of Singapore. “Consultation Paper on Proposed Regulatory Approach for Stablecoin-Related Activities” published October 26, 2022.
75
See Monetary Authority of Singapore. “MAS Strengthens Regulatory Measures for Digital Payment Token Services” published November 23, 2023.
76
See Monetary Authority of Singapore. “Project Guardian - Open and Interoperable Networks” published June 26, 2023.
77
See Monetary Authority of Singapore. Project Guardian.
Regulation
75
As part of its tokenization efforts, MAS has also revealed its intention to
cross-border e-CNY pilot with China. Under this pilot, MAS and the People’s
Bank of China will allow travelers from both countries to use e-CNY for
78
See Monetary Authority of Singapore. “MAS Lays Foundation for Safe and Innovative Use of Digital Money in Singapore” published November 16, 2023.
79
See Monetary Authority of Singapore. “Singapore and China Enhance Digital Finance and Capital Markets Cooperation” published December 7, 2023.
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76
Chapter 8
Coinbase Institutional
Updates
2023 in review
With 245,000 ecosystem partners in over 100 countries, Coinbase has grown
its products and services globally, including in the areas of derivatives and
layer 2 solutions. We have obtained new licenses that enable us to access new
In the US, Coinbase Financial Markets, Inc. (CFM) has secured regulatory
80
See Coinbase Blog. “US traders can now trade regulated leveraged crypto futures through Coinbase Financial Markets” published November 1, 2023.
Regulation
77
In Europe, Coinbase chose Ireland as its EU MiCA hub, in what marks another
presence in Benelux and the Nordics and securing an AML registration with
international strategy.83
Separately, institutional interest in the asset class has picked up over the last
continues to play a central role here as the leading partner for the world’s
To better service all institutional client types through the full transaction
Launched new order types – volume-weighted average price and stop limit
81
See Coinbase Blog. “Introducing Coinbase International Exchange” published May 2, 2023.
82
See Coinbase Blog. “Coinbase Advanced customers in eligible non-US jurisdictions can now trade perpetual futures” published October 18, 2023.
83
See Coinbase Blog. “83% of major hubs are providing increasing regulatory clarity on crypto” published September 6, 2023.
84
See Coinbase Blog. “Introducing Exciting New Updates for our Brazilian Community” published March 21, 2023.
85
See Coinbase Blog. “From Singpass to Free Bank Transfers: a Seamless, Safe, and Convenient Experience for Retail Customers in Singapore” published March 15, 2023.
86
See Coinbase Blog. “Brian visits Canada in milestone moment for the country’s crypto journey” published November 28, 2023.
Regulation
78
applications in the US
Launched the Coinbase Prime Web3 Wallet, which provides institutions with
Rolled out our new volume-weighted average price (VWAP) and iceberg
Many institutions are rapidly integrating into the space to prepare for a ramp
50% % % 33 % 23 %
300 20 33 1 9%
% 24 %
40% 22
2 5% 21 %
200
30 % 21 %
1 7%
20 % 9% 40 % 8%
100
3
31 % 32 % 5%
3 32 %
3
% 2 5% % 2 5%
10 20 1 8%
0 0 %
2Q21
3Q21
4Q21
1Q22
2Q22
3Q22
4Q22
1Q23
2Q23
3Q23
1Q21
2Q21
3Q21
4Q21
1Q22
2Q22
3Q22
4Q22
1Q23
2Q23
3Q23
1Q21
4Q20
3Q20
2Q20
1Q20
Base
Base using ETH are less than USD 10 cents each, significantly lower than typical
transaction costs. Our goal with Base is to make onchain the next online and
onboard 1B+ users into the crypto economy. In pursuit of this goal, Base serves
as both a home for Coinbase’s onchain products and an open ecosystem where
anyone can build. As of end-November, Base had $594M in total value locked on
87
2Beat. “Base Project Overview” published November 30, 2023.
See L
Regulation
79
of many L2s rather than a single L2, with different L2 ecosystems that
and currently do not plan to issue a new network token. Base has committed
Base has committed to contribute either 2.5% of Base's total revenue from
sequencing or, if it's more, 15% of the profit Base makes from L2 transactions
theme that will be expressed within the Base ecosystem in 2024 and beyond.
first initiatives for institutions in this sector took place in October 2023 with a
world assets has surged as sovereign bond yields have increased sharply,
One of the many ways that Coinbase directly supports the crypto economy is
creating more economic freedom for the world. The overall volume and value
of deals in the global venture capital environment has slowed sharply since
costs (as interest rates have increased) as well as worries surrounding the
early 2023. CB Insights reports that global venture funding this year (as of
end-3Q23) totaled only US$194B, which is a little over half of the total funding
88
See Base Blog. “Base’s Commitment to Decentralization with the Superchain” published August 24, 2023.
89
See CoinDesk. “Tokenized U.S. Treasuries Arrive on Coinbase’s Base with Backed’s RWA Token Issuance” published October 6, 2023.
90
See CB Insights. ”State of Venture Q3’23 Report” published October 12, 2023.
Regulation
80
reputational damage caused by the fallout from FTX’s collapse in late 2022
for potentially limited pools of capital and talent. According to The Block, the
first 11 months of 2023, down from $32.4B over the same period in 2022,
despite a massive uptick in November this year.91 We think there’s a risk that
with fewer resources being channeled to crypto, this could lead to delays in
the development of new applications or tools that may otherwise attract new
Chart 35. Venture funding for crypto and blockchain projects (US$ M)
6000
5000
4000
US $M
3000
2000
1000
Jan 2021 July 2021 Jan 2022 Jul 2022 Jan 2023 Jul 2023
91
See The Block Pro. “October Blockchain Funding Recap” published November 10, 2023.
Regulation
81
and while the level of dry powder has declined year-on-year, the total size
remains well above the amount in the pre-pandemic era. Moreover, many high
quality entrepreneurs have continued to build in crypto and web3, with funds
founders. Coinbase Ventures currently has more than 400 portfolio companies
investments and follow-ons in 2023. At the highest level, we break the market
down into the categories described in our pie chart below. The distribution of
DeFi 23%
CeFi 18%
Source: Coinbase
Regulation
DISCLAIMER
This document is intended only for sophisticated investors; it is for informational purposes only and does not constitute the provision of
investment advice. Client assumes full responsibility for its trading activity and should consult its advisors for its specific situation.
Coinbase is not registered as an investment advisor and Coinbase assumes no liability, obligation, or responsibility for client decisions
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presented here are not guaranteed and prior results do not guarantee future performance. Recipients should consult their advisors
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