Following the recent closures of Silicon Valley Bank, Signature Bank, and Silvergate Bank and Credit Suisse’s takeover by Swiss-based rival UBS, ramifications for blockchain tech and crypto-based assets and deals are unavoidable.
The banking crisis arose less than six months after the crypto industry suffered the loss of billions of U.S. dollars upon the failure of FTX. While some proclaim the beginning of the end of crypto assets and Web3 technologies, we continue to see a multi-trillion-dollar asset class and technologies with applications and utility far beyond your wallet. Bitcoin, the leading indicator for the crypto asset class, which first tumbled to ~$16K/BTC from ~$46K, has recently seen an increase to ~$27K as of this writing.
With a new Congress in 2023 and a first-ever Subcommittee on Digital Assets, the road has been paved for thoughtful legislation and effective oversight of federal financial agencies charged with establishing a regulatory framework beyond enforcement. Simultaneously, the community can expect auditors, investigators, and bankruptcy courts to illuminate what went wrong inside some of the centralized financial institutions supporting the dynamic decentralized crypto ecosystem.
How Did We Get Here?
Seven key events and paradigm shifts occurred in 2022 that had a direct impact on the crypto industry outlook for 2023. As summarized in CB Insights’ recently released State of Blockchain 2022 Report:
- Blockchain venture funding and deals hit new highs in 2022
US$26.8 billion worldwide - The FTX failure and bankruptcy, and a drop-off in blockchain tech funding hit hard in Q4’ 2022
With only US$3.2 billion raised, there was a 64% drop in funding in Q4’22 vs Q4’21. The FTX bankruptcy in November 2022 led to a crash in crypto asset prices, a loss of consumer trust, and a web of affected counterparties that will take years to unravel. - The average blockchain tech deal size fell from US$21.2m in 2021 to US$16.2m in 2022
This was driven by a sharp drop in US$100 million+ mega-rounds throughout the year. Investors gained more power over deal sizes, as less capital chased fewer deals. - Blockchain unicorn count stalled out at 79 at the end of 2022
Only two new unicorns entered the market in Q4’22 — Uniswap Labs, the leading decentralized exchange, and Celestia, a Layer-1 blockchain network. - Over half of global blockchain tech funding in 2022 went to U.S.-based companies
U.S-based blockchain companies raised US$15.3bn, while Asia-based blockchain companies raised a record US$4.7bn in 2022, up from US$3.2bn in 2021. - US$15.1bn in funding went to Web3 startups
Dollars flowed away from centralized exchanges (including wallets) from US$6.9bn in 2021 to only US$3.6bn in 2022, and instead concentrated in differentiated verticals like Web3 and blockchain infrastructure. - Blockchain tech infrastructure and development had a record year for funding
This signals investor confidence in blockchain tech’s future irrespective of crypto asset price volatility. In the second half, VCs pulled back on making deals as institutional demand for crypto waned.
What to Expect in 2023 and Beyond?
Q4’22 reflected a significant downturn in VC investment into and activity within the crypto market. That said, despite the downturn, 2022 reflected significant amounts of invested capital and deals.
In Pitchbook’s recently released Q4 2022 Emerging Tech Research – Crypto Report, recent VC trends and emerging opportunities were highlighted and are summarized below.
Practical Use of Crypto Assets
While the crypto market has grown exponentially in the past decade, the practical benefits of crypto assets remain elusive in most cases, as many projects and companies are still in the experimental phase. We believe that retail adoption is unlikely to grow significantly again in the United States until a workable regulatory framework is adopted. The crypto industry also needs payment rails, which U.S. banking regulators were curtailing even before the failures of Silvergate, SVB, and Signature Bank (each of which held significant fiat deposits on behalf of crypto-industry pillars). Meanwhile, crypto asset adoption continues to grow outside the United States, especially in regions such as Latin America.
Securities Tokens, NFTs, and the Real-World Asset Tokenization Phenomenon
Related to digitally native crypto assets such as Bitcoin and Ether, but with demonstrable real-world value, are securities tokens, NFTs, and other tokenized
assets (such as tokenized real estate). The development and launch of these products continues apace and in our view is benefiting from the headwinds faced by the rest of the crypto industry. Well-designed NFTs are not securities. Millions of them exist and more are coming on line all the time.
Not only real estate, but indeed any kind of asset, can be tokenized and sold, then resold, in Securities and Exchange Commission (SEC)-authorized markets and on off-shore platforms. Foley obtained the first SEC and Financial Industry Regulatory Authority (FINRA) approvals for such a market and we are presently advising other old and new market participants and advised on the first sale of real property via non-fungible token. According to survey results release by BNY Mellon, 91% of institutional investors are interested in owning tokenized products. We expect to continue to see and help lead the rapid growth in this sector.
Emerging Technologies
Key developments to watch out for:
- Blockchain networks
- Infrastructure and developer tools
- Access
- Web3
- Decentralized Finance (DeFi)
- Real World Asset Tokenization
- Staking providers
Network Effects Are Kicking In
Metcalfe’s law posits that the value of a network increases exponentially as the network itself grows linearly. We are seeing Metcalfe’s law at work in U.S. and global crypto adoption. More than 50 million U.S. citizens and residents have bought crypto assets. More than 400 million people worldwide own crypto assets. At this point, crypto assets are here to stay.
At the recent ETHDenver conference, politicians were in attendance, hoping to cement the mutual sentiment between government and the crypto industry in favor of cooperation. The creation of the Digital Assets Subcommittee of the House Financial Services Committee certainly is a favorable development, likely to lead to thoughtful legislation.
Further showcasing adoption, the M&A sector continues to document the use of digital assets by transaction parties. Law and business schools teach digital assets, NFTs are on the rise again, and, as noted, real world asset tokenization is growing.
Regulations and Enforcement
We expect the Department of Justice (DOJ), SEC, Federal Bureau of Investigation, and Treasury Department to continue to crack down on bad actors in the cryptocurrency space and address criminality in the dark web. For example, on January 18, 2023, the DOJ, together with the Treasury Department, and French law enforcement authorities disrupted Bitzlato, a China-based cryptocurrency exchange alleged to be the broker of choice for criminal proceeds from the dark net. In light of geopolitical developments elsewhere, the Treasury Department has heightened scrutiny of transactions with Russian interests, through which dark net activity is alleged to be conducted.
Separately, on March 10, 2023, Ether, the native cryptocurrency for Ethereum, fell to its lowest market price in two months when the New York attorney general asserted that it is a security, bracketing it with assets such as stocks and bonds and fueling fears of a wider regulatory crackdown. We are seeing continued monitoring, regulation and enforcement in the crypto asset markets on multiple levels, including a significant tightening of state-by-state money transmission regulation, which is redefining the regulatory framework for the digital asset marketplace.
Additional Thoughts About 20231
- Market success for centralized crypto players will depend upon re-establishing trust
- There will be more enforcement activity until Congress legislates
- Bipartisan work on legislation to regulate stablecoins is moving ahead
- TradFi will continue to lean into permissioned blockchain tech while opposing crypto
- Web3 will make a bigger splash
- NFTs are growing again
- Real-world utility will be a major focus
Despite financial instability, regulatory crackdown, devaluation of crypto assets and the behavior by some participants in the centralized sector of the crypto industry, crypto assets are here to stay in one form or another. Decentralization aligns with the yearning of the human spirit for freedom and self-governance. We don’t see that changing, despite recent setbacks.
