Market Performance

30 Day Performance of Market Cap Weighted Indexes

Headlines

Ethereum’s Sepolia testnet went live on February 28th and finalized
Jump Crypto Just Counter-Exploited the Wormhole Hacker for $140 Million
Jump Crypto made $1.28B from helping restore UST’s $1 peg in 2021 in exchange for discounted LUNA tokens
Tether nears 50% of stablecoin market, highest in 14 months
Nishad Singh, the former director of engineering at FTX, to plead guilty to criminal charges
SBF charged for unlawful political contributions and defrauding the federal elections commission
Hong Kong receiving softening stance on crypto from China, contributes to the “China narrative” for crypto in the month of February
SEC objects to Binance.US’ $1B Voyager deal, alleging sale of unregistered securities
Crypto hedge fund Galois Capital to shut down and return its remaining money to investors
Bulgarian investigators claim fugitive 'Cryptoqueen' was murdered in 2018
Spotify is testing a new service called "token-enabled playlists,"
Bank of Russia to pilot CBDC in April
The SEC subpoenaed Robinhood in December regarding crypto listings and custody of assets
Yuga Labs first Bitcoin NFT project TwelveFold - limited series of 300 generative Ordinals
Solana network outage after ‘forking’ incident
Liquid staking TVL now second-largest among DeFi protocols
Coinbase suspending BUSD trading

The Bitcoin Ordinals Debate Rages On

Over the course of February, one could not scroll crypto Twitter without encountering the Bitcoin Ordinals debate. Ordinals enable the creation of Bitcoin-native non-fungible tokens (NFTs). Ordinals, developed by Casey Rodarmor, use the input field in Taproot transactions to embed image-related data into the Bitcoin blockchain. The Taproot upgrade, which was activated in November 2021, allows for the cheaper storage of arbitrary data and permits users to store as much data as they want in a single transaction, provided they pay for it and the total block size remains under 4MB. Prior to Taproot, users needed to use multiple transactions or inputs to store large amounts of data.

A side effect of Ordinals and Inscriptions is the growing adoption of Taproot, which surpassed 5% on February 1 and reached ~18% on February 9th (image below). The introduction of NFTs on Bitcoin has also resulted in an increase in fees, which can be a positive for the long-term security of the network.

Ethereum, the Shanghai Upgrade, and Account Abstraction

On February 7th, Ethereum’s Zhejiang testnet successfully conducted a simulation of staked ETH withdrawals, marking an important first milestone in the testnet sequence for the Shanghai/Capella upgrade. Zhejiang was the first of three testnets in this sequence before the actual mainnet upgrade can be confidently scheduled. On February 28th, Ethereum’s Sepolia testnet went live on and finalized, marking the successful implementation of the second testnet. Following Sepolia, Goerli, which is considered the most critical public Ethereum testnet, will be the final step before staked ETH withdrawals can be enabled on the Ethereum mainnet. The Shanghai upgrade, which contains multiple features, is most eagerly awaited for its ability to enable withdrawals. "Exited" validators will have access to full withdrawals, while active validator balances above 32 ETH will have access to partial withdrawals. As of today, core developers anticipate that Shanghai will take place in late March/early April.

The Shanghai upgrade of the Ethereum network will allow ETH that has been staked since December 2020 to be withdrawn. While there is concern about a significant sell-off, the reality may be more complex. Validators who wish to stake or unstake their ETH must enter a timed queue, serving as a stability mechanism to maintain a consistent number of validators on the network, thereby limiting the amount of ETH that can be unstaked daily. The waiting period for withdrawals varies based on the amount withdrawn, as shown in Figure 5. Assuming only 9% of the total staked ETH enters the queue, it would take approximately one month to clear withdrawal requests.

It is important to note that just because investors can unstake their ETH, it does not mean they will. In addition, the top 10 Proof-of-Stake blockchains, ranked by market capitalization, have an average of 53.40% of their total token supply staked with varying withdrawal periods. The average yield is higher than Ethereum at 9.58%, but the real yield adjusted for inflation is 3.9%, nearly 1.5% lower than Ethereum. With 14% of Ethereum's total supply locked and an uncertain withdrawal period due to the upcoming Shanghai launch, it is reasonable to expect that the percentage of staked ETH could increase to upwards of 50% in the long term.

Furthermore, it is worth mentioning that about 33% of the total staked ETH is staked through liquid staking protocols, which allow for liquidity despite the tokens continuing to be locked up. These protocols have experienced volatility in the past year, indicating that many of these stakers may have already sold their claims to holders with higher conviction.

On March 2, 2023, the Ethereum Foundation deployed ERC-4337 on the mainnet to implement the proposed Ethereum Account Abstraction, which has been in development since September 2021. The Account Abstraction does not require any modifications to the consensus layer, utilizes the transaction mempool and UserOperation functionality, and does not add any new transactions.

This deployment adds two new features: first, it combines the functionality of an Externally Owned Account (EOA) and a Contract Account (CA), enabling the execution of contracts and the issuance of transactions from a single account. Second, it supports ERC-20 fee payment and fee substitution functions with Paymaster. AA offers more flexibility in validating transactions on the blockchain by allowing programmable validity to verify and validate any blockchain transaction. Unlike the rigid requirements currently hard coded into the Ethereum protocol, AA enables multi-owner accounts via multisig signature verification, the use of post-quantum signatures, and the removal of signature verification entirely for a public account.

With AA, validity conditions can be programmed in a customizable way into a smart contract on a per-account basis rather than hard coding them into the Ethereum protocol, which would apply to all transactions in a generalized way. One potential use case of AA is auto payments, but the broader goal of AA is to make Ethereum transactions more efficient and customizable by allowing users to deploy an account contract with any of the features described above or other features. Overall, AA represents an important step in the evolution of the Ethereum network by offering greater flexibility and functionality for users.

Coinbase and L2s

Beginning in February, Coinbase integrated with Ethereum rollup, Arbitrum, allowing users to deposit and withdraw straight to the L2. However, Coinbase’s biggest announcement last month had to do with Arbitrum competitor, Optimism.

Coinbase made a significant announcement about their new Layer 2 project, named Base. It will use Optimism's OP Stack and collaborate with Optimism as a Core Developer. ETH will be used as the gas token for security purposes, and it will have full EVM equivalence, enabling large applications built on the EVM to move to the chain. Coinbase will use a single sequencer to operate the platform, and a percentage of transaction fees on Base will be sent to the Optimism collective, governed by OP. This news caused an 8% increase in the price of OP tokens in a few minutes, as it provides more credibility to the OP Stack and encourages more projects to build on it. For Coinbase, this presents an opportunity to use the sequencer to extract MEV and leverage their brand recognition while also contributing to the decentralized and open source ethos of crypto. Furthermore, this development helps to grow the USDC supply, which provides benefits to Coinbase.

Macro

One of the Federal Reserve's favored inflation metrics, Core PCE, showed a slight increase in both monthly and yearly time frames in its latest reading. Annualized, core inflation has risen by 4.7% compared to the previous year. This is significant because it was expected to decelerate to 4.3%, making it an unexpected increase. While the primary trend is still downward, it's possible that 4.5% could be the lowest inflation will get over the next year or two. There are growing beliefs that inflation will be structurally higher as monthly core PCE prints remain around 4.75%. While it's unlikely to challenge 6% again, if it continues to stay close to 5% and doesn't trend below 4% or toward 3%, the Fed will likely continue hiking rates. The market also recognizes this dynamic, as seen in the change in forward expectations for the Fed Fund's terminal rate. Currently, the futures market has fully priced in hikes for March, May, and June. The author believes that the Fed will raise rates by at least 50 bps more, with 25 bps increments in March and May.

During the meeting, there was a discussion among participants about raising interest rates by 50 basis points. Unemployment rates were stable at 3.5% in December, but inflation was still high at 5%. The committee agreed that restrictive monetary policy should remain in place until there is evidence of a sustained decrease in inflation. Investors are keeping an eye on jobless claims and inflation readings. The futures market has priced in a 76% chance of a 25 basis point increase on March 22. This is significant because the market had been certain that the Fed would eventually have to pivot and crypto would continue to rise. However, the Fed's language is pushing back on that idea, and they do not seem to be slowing down their plans to control inflation anytime soon. As a result, the rest of this year may be uncertain, with ongoing efforts to combat inflation in the background. This does not necessarily mean that there will be a market crash, but it may limit potential growth and lead to more sideways action.

Regulatory Crackdowns

U.S. regulators and the SEC were busy in February, doling out headlines and enforcement actions seemingly every couple of days. This includes

A joint statement by the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Treasury’s Office of the Comptroller of the Currency (OCC) that strongly discourages banks from engaging with cryptocurrencies. The statement recognized that banks are not prohibited from offering services to any type of customer, including those involved in the crypto industry. However, the regulators also highlighted the particular risks associated with crypto-related companies and assets, cautioning banks against holding or issuing cryptocurrencies as principal. They also pledged to closely monitor exposure to crypto assets.
The Board of Governors of the Federal Reserve System recently released a policy statement on crypto activities and state-chartered banks, following a joint statement by banking regulators about the risks associated with crypto assets for the banking system. The policy statement aims to create a level playing field for state-chartered and federally-chartered banks, and it denied Custodia Bank's application to join the Federal Reserve System. The statement clarifies that neither national nor state-regulated banks have the authority to hold crypto assets as principal, which means they cannot hold crypto as an investment asset on their balance sheets. While issuing stablecoins is "presumptively unlikely" to align with safe banking practices, the Board did not entirely rule it out. The Board also highlighted the importance of verifying parties transacting with banks, including unhosted wallets, and noted that banks can custody digital assets in a regulated, safe, and sound manner.
The SEC ordered Paxos to stop issuing BUSD. The New York Department of Financial Services (NYDFS) has ordered Paxos Trust Company, the issuer of the Binance USD (BUSD) stablecoin, to cease the creation or minting of new tokens. This move comes amid the controversy surrounding the BUSD stablecoin, also known as the Binance USD, and Paxos' announcement of its intention to end its relationship with Binance. The reason for the halt is unclear, but it may be related to the issuance of BUSD on other blockchains, known as Binance pegged BUSD, which was not approved by the NYDFS. Concerns have been raised about BUSD, including allegations of insufficient backing for pegged assets, comingling of client funds, and attempts to create an interest-paying stablecoin.
Additionally, the SEC sent a Wells notice to Paxos, suggesting that the agency may take action against Paxos, the issuer of the stablecoin BUSD. Although the notice is not public, Paxos confirmed that the SEC considers BUSD to be a security, and that its offering was not registered under federal securities law. However, Paxos has publicly disagreed with the securities classification. Additionally, the NY DFS ordered Paxos to halt the creation of new BUSD tokens, and Paxos announced its decision to sever its ties with Binance. It is unclear why the DFS halted the issuance of BUSD, but it may be due to the issuance of Binance pegged BUSD on other blockchains, which was not authorized by the DFS. Paxos's competitor, Circle, has not received a Wells notice from the SEC and issues the second largest stablecoin, USD Coin (USDC).
The SEC recently filed a complaint and settled with Kraken over its staking-as-a-service offering, with Kraken agreeing to pay a $30M fine and end the service. This marks the first enforcement action against staking services triggering securities regulation, although the underlying assets used to stake are not considered securities. SEC Chairman Gary Gensler has previously expressed concern about staking services, and Coinbase has now published a blog post stating that its staking services are not securities. While Ethereum has transitioned to proof of stake, many newer cryptocurrencies also allow owners to generate returns by participating in the block-building process.
The SEC has filed charges against Genesis and Gemini Earn for their involvement in the unregistered sale of securities to retail investors in the aftermath of the bankruptcy of Genesis' lending arm, which impacted users' balances in the Gemini Earn program. According to the complaint, the Gemini Earn program, in conjunction with Genesis, constituted an offer and sale of securities that should have been registered. In addition, the SEC has charged Terraform Labs and its CEO with fraud in relation to the sale of crypto asset securities Mirror (MIR), Terra (LUNA), and Terra USD (UST). The SEC alleges that MIR, marketed as a "governance token" for the Mirror Protocol, and UST, an algorithmic stablecoin, are both securities.

Staying Safe Against Crypto Scams

With macro looking bleak and regulators cracking down, it is important for user to worry about what they can control. We can forecast and speculate until the cows come home about inflation, the economy, Gary Gensler, etc., but those are exogenous variables for a trader/investor/HODLer. Let’s optimize what we can control. Things like strategy, allocation, and security. This month, we’re focusing (yet again) on security. None of this means anything if you cannot secure your crypto. Last month we focused on wallets, this month, let’s discuss some common scams and how to identify them.

Scams are big business (first image below) and make up a significant portion of the total crypto lost over the years (second image below). However, there isn’t just one way to get scammed. Big business means scammers are becoming more sophisticated and use more than just one method.

Total Cryptocurrency Value Received by Illicit Addresses, 2017-2022

Both images from Chainalysis’ most recent 2022 illicit crypto activity report.

Phishing

One common method of stealing user information in the cryptocurrency space is through credential phishing, which occurs when users enter their account information on a fake website, often designed to look like a legitimate one. To create these fake websites, hackers can use tools like the Social-Engineer Toolkit and Goclone to copy the front-end design of a website and host it on a similar domain. To prevent falling victim to these attacks, it's important to verify the authenticity of the website's URL and add frequently used websites to your bookmarks bar to avoid phishing sites.

In addition to fake websites, hackers can also use fake communication messages such as emails, social media messages, and phony customer service chats to obtain user information. To protect against these types of attacks, users should install anti-phishing plugins in their browsers and use password managers like Lastpass, NordPass, or Keeper Security to protect their passwords. It's also important to set complex passwords with a mix of uppercase and lowercase letters, numbers, and special symbols and to never use the same password for multiple accounts.

These types of attacks are often low-cost for hackers, but can result in high profits if just one or two people fall for the scam. To protect the security of the decentralized ecosystem, users are encouraged to report suspicious websites immediately.

Social Media/Telegram/Discord Scams

Scammers also use social media to con people. FTC reports indicate that hackers create bogus official accounts or use well-known accounts to post messages claiming to give away cryptocurrency. They lure readers into clicking fraudulent links or sending cryptocurrency to the scammer's address. To avoid social media giveaway scams, XREX recommends verifying information validity from multiple sources, ignoring free advertising, being cautious before sending coins, and being aware of pop-ups from wallet apps related to transfers or authorizations.

It is important to remember that transactions in decentralized finance cannot be reversed, and users should always be vigilant about scams and take appropriate measures to protect themselves.

Various Wallet/Seed Phrase Attacks

One of the biggest concerns in the world of cryptocurrency is the various scams that exist to trick people into giving up access to their digital assets. One such scam is seed phrase phishing, which involves tricking users into divulging their seed phrase, which is a master key to unlock access to all their crypto assets. These phrases are usually 12 to 24 word mnemonics that represent a user's private key, making it easier to remember and recover. If someone has access to a user's mnemonic, they can gain access to the user's encrypted assets, similar to a bank account username and password. Users should never leak their mnemonic phrase and should store it properly, and should report suspicious websites immediately to help keep the DeFi ecosystem safe.

Another type of scam involves malicious wallets and plugins that imitate the user interface of genuine wallets. These scams trick users into thinking they are using the official wallet, when in fact a backdoor has been set up in the backend, allowing scammers to steal the user's wallet mnemonic and assets. To avoid these fraudulent wallets and plugins, users should never use crypto assets on jailbroken or rooted devices, and should download mobile apps from official sources such as the Apple AppStore or Google Play Store. iOS users should also avoid installing or trusting profiles from unknown sources, which could inadvertently install malicious programs.

Approval scams are another type of scam that attempt to gain a user's right of transfer to certain addresses. These scams involve phishing, in which hackers trick users into granting approval permission to hackers, allowing them to transfer the victim's assets to their wallets through the transferFrom function of the ERC20 Token contract. Users can avoid approval scams by revoking authorization immediately if they accidentally authorize an unknown address, confirming the transaction content before executing the transaction, and regularly checking the authorization status of wallet addresses and revoking permissions for unknown addresses using tools such as Ethereum Token Approval, Revoke.cash, or Approved.zone. By being vigilant and following these recommendations, users can protect themselves and their digital assets from these common cryptocurrency scams.

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