CryptoEQ™ Enthusiast Newsletter

April 2022 | Issue 23

Macro

The primary story in markets for 2022 has been the Federal Reserve’s intentions to raise interest rates to combat the highest inflationary period (8.5% year over year) in nearly 40 years. Last month (March 2022), the FOMC finally acted, raising the Fed Funds Rate by 25 bps, the first interest rate hike since 2018. Now that the Fed has proven its dovish stance, the markets are pricing in many more aggressive hikes over the next 12 months (~six hikes). The implied rate in 12 months going by the Fed Funds futures market is 2.87%, well above the 0.25 – 0.50% range.

Additionally, the Fed signaled it could begin reducing its $9 trillion balance sheet in 2022 (Quantitative “Tightening”), even in the face of surging commodity prices, global food shortages, and the ongoing Russia-Ukraine war. Quantitative Tightening and interest rate hikes aims to have the opposite effect of Quantitative Easing, meaning the aim will be to reduce the money in the system, make borrowing more expensive, encourage saving, and will likely have a direct negative impact on risk assets' valuations.

Looking back, Q1 2022 was a tough time for nearly all investors. Aside from commodities, nearly all markets slid versus their stellar 2020-21 rallies. The S&P 500 was down ~5%, treasuries down 5.6%, and the broader crypto market was down only ~10% after the total market cap saw a 20% rally towards the end of March.

Adding fuel to the fire was the brief inversion of the 10-2 year UST yield curve, a market signal generally preceding recessions. The inverted yield curve indicates short-term interest rates are priced at a higher value than long-term ones. This is a market abnormality as long-term risk traditionally pays at a higher rate due to the increased risk it carries. Investors (typically) demand a higher return for loaning out money for 10 years as opposed to two. An inverted 10-2 year yield curve indicates investors are uneasy about near term markets (2 year) and are willing to get paid less for loaning their money out longer term (10 year).

The Federal Reserve now faces a dilemma: fight inflation with aggressive interest rate hikes but also not raise too much or too fast that it sends the economy into a recession. As interest rates rise, so too does the government’s borrowing costs. Small interest rate increases are still substantial when your debt is $31 trillion+.

Although an inverted yield curve has predated many recessions in the past, the pain is usually not immediate. The S&P 500, for example, tends to trend higher for several months after an inversion occurs.

The fact that crypto is holding up despite rate hikes, geopolitical uncertainty, yield curve inversions, targeted attacks, a strengthening dollar, and increasing regulatory scrutiny speaks volumes about the maturity of the asset class.

Institutional interest in cryptoassets remains strong and traditional VC money continues to pour in. Bridgewater Associates, the world’s largest hedge fund—led by financial star Ray Dalio, announced it’s preparing to back its first crypto fund. Goldman Sachs and Galaxy Digital completed the first OTC crypto trade involving Goldman while 60% of Goldman Sachs’ investors have stated they’ll be looking to increase their crypto holdings over this coming year. Finally, ExxonMobil is expanding its flared natural gas Bitcoin mining pilot program to potentially four new global areas along with the help of Crusoe Energy.

Money Continues Pour In Despite Uncertainty

Bitcoin

Bitcoin’s Q1 was a bit of a rollercoaster (as seen in the image below), but has returned to, more or less, the same price levels when the year started. BTC is trading around ~$45,000 after dipping below $35,000 on some exchanges.

While numerous headwinds remain, one bullish takeaway is displayed below by BTC long-term HODLers. The percentage of the BTC supply that has not moved in over one year (a proxy for long-term HODLers) is nearing all-time highs. For reference, the last time it reached similar levels, Bitcoin was sitting around ~$10,000 in Q4 2020. This illustrates BTC holders are holding with the same conviction, despite the price being 4.5x higher.

BTC Miami 2022 Announcements and Headlines

Two separate jurisdictions, one in Honduras and the other in Portugal, announced that they would create new policies designed to incentivize bitcoin adoption. The autonomous region in Portugal and a “special economic zone” called Próspera on the island of Roatán announced will recognize cryptocurrency as a legal currency.
Strike partnered with Shopify to create a new US payment system. Shopify, Robinhood, BitPay, and others also announced Lightning Network integrations.
Lightning Network Labs announced Taro, a Lightning Network L2 project aiming to bring stablecoins to the Lightning Network.
Tesla, Block, and Blockstream are partnering to mine BTC through solar power.

BTC and Terra

Cover your ears Bitcoin maxis, but part of Bitcoin’s recent price turnaround may be attributed to an altcoin! In February 2022, the Luna Foundation Guard (LFG), a non-profit organized to support the Terra ecosystem (ticker LUNA), announced that it raised $1 billion to purchase bitcoin as new collateral/reserve to back the Terra UST stablecoin.

LFG hopes that by introducing BTC as a reserve asset, it will reduce the risk to LUNA in the event of a downturn in demand for UST. Now, rather than being solely reliant on the LUNA burn mechanism, UST has diversified its risk management by introducing a Bitcoin backstop. A bitcoin reserve allows LFG to send UST burners bitcoin in addition to creating new LUNA supply, buffering the impact to LUNA.

Terra Founder Do Kwon has stated that he plans to buy $10 billion worth of BTC to backstop UST and signals on social media suggest he is already buying $125 million worth of BTC every day.

BTC and oil

As previously mentioned, ExxonMobil is expanding its flared natural gas Bitcoin mining pilot program to potentially four new global areas along with the help of Crusoe Energy. One of the world’s largest oil producers aims to use and sell the otherwise useless byproduct of oil drilling while also reducing impact to the environment.

In certain areas, when drilling and producing oil, natural gas is also produced. Oil producers have to do something with that “associated” gas and, if there is no pipeline to transport this gas (which is often the case in the remote drilling areas), it’s usually reduced to “flaring.” In this common scenario, the best thing to do is to flare–or burn–the gas so the hydrocarbons are broken down in a combustion reaction to CO2 and water. Flaring is better than simply releasing the natural gas into the atmosphere, but we can do better. When gas is flared, it’s essentially wasted in the sense that the energy content of that gas wasn’t productively used.

Rather than flaring, that same “stranded” gas that has absolutely no other use case or economic value can be converted into electricity using cheap, small-scale turbines on-site. This is a perfect energy source for bitcoin miners and their ability to go to the source of energy. Bitcoin miners want the cheap energy and the oil producers want someone, anyone to buy it. Because Bitcoin miners are nimble and not geographically tied down to one spot, like a large plant or pipeline, they provide an economic solution for both parties while reducing the climate impact of oil drilling. It’s truly a win-win scenario.

Switzerland town makes BTC legal tender

In March, the small town of Lugano, Switzerland made bitcoin legal tender, allowing its citizens to pay annual taxes and city services in bitcoin and Tether (USDT). Lugano joins the country of El Salvador in formally recognizing BTC as legal tender.

Ethereum

Testnet merge

The biggest news out of the Ethereum space in March 2022 was the successful “merge event” on the Kiln testnet. As background, the Merge refers to Ethereum’s transition to a fully Proof-of-Stake protocol that will reduce the energy consumption of the network by over 99%. It’s hoped that Kiln will be the last merge testnet before the actual upgrade. This testnet simulation acts as a “trial run” for the transition from Proof-of-Work to Proof-of-Stake for the Ethereum mainnet. While the overall transition was successful, it wasn’t perfect. According to developers, the Prysm client, the majority client in Ethereum, proposed invalid blocks during the change and the Erigon client got stuck due to an incorrect hash calculation. These issues illustrate there’s more work to be done before the specs can be frozen and an actual Merge date is finalized.

In early April, the first shadow fork of Ethereum mainnet was a success with two out of four software clients able to sync correctly leading up to and following the Merge upgrade. The other two, Nethermind and Besu, ran into minor issues which need to be addressed before a date for the actual Merge to take place. This timeline puts mainnet activation of the Merge at the earliest sometime in July but more likely in August or September.

The success of the Kiln merge has led to an increase in staked ETH, especially in Lido, Ethereum’s leading liquid staking solution. The total amount of ETH sent to the Ethereum staking contract accelerated past 10 million on March 8th and now sits at ~11.1 million ETH. Depositors are staking their ETH as technical risk gets reduced and in preparation for the ~8-12% yield staked ETH is calculated to return post-merge thanks to issuance, transactions fees, and MEV.

Eth2 Lido staking March 2022 — Source: Delphi Digital

NFTs

For the last couple months, NFTs seemed impervious to the slowing market. However, over the course of March, the NFT market has shown signs of cooling off after a huge year in 2021. Daily sales volume on OpenSea has fallen to less than $100 million per day in March. Daily sales followed a similar pattern.

Although sales slumped, NFTs continued to grab headlines in March when Yuga Labs, the company behind the Bored Ape Yacht Club (BAYC) collection, bought the intellectual property rights to CryptoPunks and Meebits, two other leading NFT projects. With the purchase, Yuga intends to grant commercial rights to holders of Punks and Meebits. Prior to this, Larva Labs fully controlled the intellectual property of CryptoPunks and Meebits and had restrictions on what the NFT holders could do.

Quick bites

The Ronin Network bridge, which bridges the popular P2E Axie Infinity game to Ethereum, was exploited for 173,600 ETH and 25.5 million USDC due to poor multi-sig wallet security from the Sky Mavis team. The Ronin bridge was secured by a 5-of-9 multi-sig in which Sky Mavis controlled four. Rather than the attacker needing to compromise five different validator keys, they simply needed to compromise the Sky Mavis team and one other AxieDAO node. The Ronin bridge and Katana Dex have been halted by the Sky Mavis team.
Avalanche announced a $280 million subnet incentive program, as well as a $100 million creator fund, focused on web3.
Crypto.com will be an official sponsor of the 2022 FIFA World Cup
El Salvador delayed its $1 billion BTC bond
Decentralized lending protocol Compound discloses details surrounding a critical vulnerability previously patched by developers.
A Cosmos Ethereum Virtual Machine (EVM) compatible-hub named Evmos was forced to roll back its launch due to technical problems with the initial launch. Evmos is designed to enable developers to easily port over Ethereum dApps and implementations into the Cosmos ecosystem. The new launch is expected in mid-April.
Lido Finance announces update on roadmap towards permissionless validation
Beanstalk DAO gets exploited for $80M
Cosmos Hub successfully executes Theta upgrade
Arbitrum releases major update, halving fees and increasing tx speed
Ethereum Foundation Report April 2022 is released!
Meta to take a nearly 50% cut on virtual asset sales in its metaverse
Check out this fun visual for Bitcoin and Ethereum transactions making their way into blocks in real time.

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