Tornado Fallout Fuels Shift to Privacy Coins

In the aftermath of sanctions on Tornado Cash smart contracts, privacy-related coins outperformed in August while projects with stricter censoring lost market share.

Digital asset prices fell in August, as tech stocks performed the worst among all S&P 500 sectors. Amidst continued high inflation and more restrictive central bank policy, the Bitcoin/Nasdaq 30-day correlation remained elevated at 47% vs. the 5-year average of 9% and the 1-year average of 36%.

Despite the macro environment, institutions continue to allocate to the space—specifically worth noting is Blackrock’s partnership with Coinbase to provide crypto access on its flagship Aladdin platform. Blackrock also launched a private trust to enable direct spot Bitcoin access. Overall, listed crypto ETNs saw inflows in August, driven by Ethereum (ETH, mkt cap $197B) momentum into the merge. Globally, more than 150 crypto funds, including hedge fund and venture strategies, have raised $36B in the first half of 2022, compared with $18B raised in all of last year. We count an additional $1B in venture capital raised in August. This dry powder is still keeping private valuations somewhat elevated vs. liquid tokens, in our view.

Negative news around regulation provided headwinds in the month, specifically the U.S. Treasury’s unprecedented sanctions of Tornado Cash smart contracts, which prompted Infura and Alchemy, two major Ethereum infrastructure providers, to block access to the Tornado protocol. One anonymous Tornado Cash user even sent Tornado Cash ETH to many famous, doxed ETH addresses in the hopes of bringing visibility and making a few innocent souls into criminals. Github deleted Tornado Cash code repositories and one Netherlands-based Tornado developer was arrested. We believe the Office of Foreign Assets Control’s (OFAC’s) action reflects pressure brought by the Biden Executive Order signed last March. This 9 September marks the 180 day deadline for seven separate federal agencies to respond to the executive order, which emphasizes the need for interagency cooperation. We would not be surprised to see additional enforcement actions against unregulated crypto protocols over the next month. Still, recognizing the crypto community’s commitment to issues of free speech and code, privacy-related coins outperformed in August, led by Decred (DCT, mkt cap $430M, +12%), Ergo (ERG, mkt cap $100M, +51%) and Secret (SCR, mkt cap $175M, +1%), even as Tornado Cash (TORN, market cap $13M) fell 66%. Overall, projects that adhered to stricter censoring lost market share in August, as you will read in later paragraphs. We believe the politics around private money will change as fiat debasement becomes more obvious to the younger generation and inflation constricts real growth and perverts institutions. Overseas, we are encouraged by adoption such as occurred in Argentine’s fourth largest province, Mendoza, which announced its intention to receive taxes in crypto in August.

August also saw a continued focus on consolidation and resignations: Genesis CEO Mike Moro stepped down amidst a 20% reduction-in-force. Alameda Research, the proprietary market-making and trading arm of Sam Bankman-Fried’s crypto empire, parted ways with CEO Sam Trabucco and merged its venture investing business with FTX. And Crypto VC DragonFly acquired competitor MetaStable Capital. Among crypto native companies, Fei/Tribe DAO, a failed merger valued at more than $2B at its peak, and Babylon Finance, another victim of the $80M hacking exploit on Rari, announced plans to shutter. We believe the bear market will continue to force consolidation to the benefit of leading players.

For the month (7/29-8/31), the Nasdaq Composite fell 4%, Ethereum fell 10%, MVIS CryptoCompare Smart Contract Leaders Index fell 11.5%, and Bitcoin fell 16%. Among other crypto sectors we track, centralized exchanges performed best, down 6%, while defi-related coins fell furthest, down 24%.

Bloomberg, Messari, CryptoCompare, MVIS, VanEck research as of 31/8/2022. See index definitions below.

Smart Contract Platforms

Among smart contract leader index constituents, there were four coins with positive returns in August: ATOM, EOS, FLOW and NEAR.

EOS (EOS, mkt cap $1B) rose 50% after the EOS Network Foundation (ENF), a nonprofit organization that oversees the growth and development of the EOS blockchain, opened registrations for its upcoming “Yield+” incentive program. Yield+ is a liquidity incentive and reward program to attract decentralized finance (DeFi) applications that generate returns for their users. EOS also announced a hard-fork set for 21 September and a rebranding to “EOSIO”. The rebranding and upgrade serve as EOS’s symbolic divorce from Block. One, the company that originally designed the network, nine months after the EOS community elected to stop the issuance of 67M EOS, or around $108M, due to Block.one over the next five years, on concerns the company no longer represented the community’s best interests.

ATOM (ATOM, mkt cap $3B) outperformed as more coins were staked on the network, locking up supply. ATOM is set to become a primary collateral asset of three new stablecoins (USK, IST, CMST) that will launch within the Cosmos ecosystem. Minting these stablecoins will require the “lock,” or depositing, of ATOM tokens similar to the Maker (MKR, mkt cap $730M) model. IST is particularly intriguing as its native Agoric (BLD) blockchain will support smart contracts in Javascript, the most widely used programming language with 17.5M developers, compared to 2.2M who code in Rust (Solana) and ~200,000 on Solidity (Ethereum). Adding to the Cosmos momentum, liquid staking will come to ATOM in H2 2022. Current data from Staking Rewards shows that 65.84% of issued ATOM tokens are staked for a minimum yield of 17.85%, with a 189% increase in the number of ATOM tokens staked over the past 30 days. Consistent with our $140 price target for the ATOM token, VanEck is among these stakers, expecting this ratio to rise as new Cosmos ecosystem chains like Agoric stake ATOM tokens for security.

Bloomberg, Messari, CryptoCompare, MVIS, VanEck research as of 31/8/2022.

Media & Entertainment

Metaverse tokens continued to underperform as on-chain activity on platforms like The Sandbox and Decentraland languish. Combined, land sales at the five largest metaverse platforms fell 43% in August to $19M. Sandbox and Decentraland monthly land sales are now down 98% and 89%, respectively, from their peak.

Chiliz (CHZ, mkt cap $1B) was a notable outperformer in the month, up 46%. CHZ powers Socios.com, a platform where fans can purchase and trade branded fan tokens such as Paris Saint-Germain (PSG, mkt cap $34M) and FC Barcelona (BAR, mkt cap $30M). Currently, Socios powers 62 of 67 fan tokens listed in FanMarketCap, comprising $205M in market cap in addition to the CHZ token. On 5 August Socios received regulatory approval to offer virtual currencies and digital wallets for its fan engagement and rewards platform from Italian regulators, expanding the company’s presence in southern Europe. Then, on 22 August, Chiliz founder Alexandre Dreyfus announced the protocol’s intention to stop utilizing the Ethereum blockchain to launch their fungible and nonfungible tokens and replace it with their own native chain, CHZ 2.0. "We don't have to rely forever only on ERC20 or ERC721 equivalent," said Dreyfus. We expect the new Chiliz chain to add significantly more value to the CHZ token, which will be used as gas and for staking in addition to its current utility as the medium of exchange for Fan Tokens on Socios.

We continue to focus considerable attention in understanding the state of blockchain gaming. Among the 25+ blockchain games we track (and play) weekly, we observed 1.87M users in the week ending 29/8, a 28% increase over July levels. By layer 1 blockchain, Solana (9%) and FLOW (25%) stand out as recent market share winners; Ethereum and Ronin (which hosts the Axie Infinity game) are recent losers. Although we estimate 40%+ of these “gamers” are actually bots, nevertheless we are encouraged by the recent growth.

Bloomberg, Messari, CryptoCompare, MVIS, VanEck research as of 31/8/2022.

DeFi

Defi TVL (total value locked) fell 9% in August as leverage has been slow to return in the space. Traders continue to post collateral to leveraged positions; thus, we now observe only $28M in leveraged ETH positions able to liquidated within 20% of the current price. This is a healthier position for DeFi than we have seen year-to-date. Traders are crowded into the futures markets to hedge outsized ETH spot exposure ahead of the merge, amidst hopes for a meaningful ETH proof-of-work airdrop. There is little demand for leverage against those ETH assets, as is more typical in a bull market.

Among DeFi coins, which underperformed again in August, Kyber (KNC, mkt cap $317M) was the notable winner, up 65% as the automated market maker (AMM) announced partnerships with Lido Finance and Avalanche-based DEXs Yeti and Benqi. Kyber’s latest protocol Elastic purports to give liquidity providers more capital efficiency by concentrating liquidity and compounding fees, similar to Uniswap’s V3 algorithm. On September 1 Kyber announced a hacker had used a frontend exploit to steal $265,000 worth of user funds, which the protocol said would be reimbursed.

GMX (GMX, mkt cap $430M) was another DeFi winner in the month, up 12%. GMX is a decentralized perpetual futures exchange that supports spot and margin trading on Arbitrum and Avalanche with up to 30x leverage. It offers zero price-impact trades through the use of Chainlink oracles and price feeds from large centralized exchanges, as opposed to AMMs whose LPs provide price discovery but also bear the risk of impermanent loss. Liquidity on GMX is provided through a basket of assets called GLP, which consists of BTC, ETH, USDT, USDC, LINK, UNI, FRAX, AVAX and Dai. GMX can be a very attractive place to conduct asset swaps in DeFi given low slippage and minimal fees. GMX revenue rose 50% in August, taking share from leader dYdX (DYDX, mkt cap $200M), whose revenue fell 10%. dYdX stumbled after blocking so many Tornado Cash-associated wallets that they ended up apologizing and backtracking; dYdX also backtracked on its plan to require user biometric data in return for a $25 bonus on deposits of $500 or more.

Uniswap (UNI, market cap $3B), the largest DEX by market cap and trading volumes, underperformed, down 25% in August as the long-awaited fee switch proposal passed unanimously and investors “sold the news.” A second vote to turn off the fee switch will be submitted 120 days after this pilot. Still, Uniswap market share of DEX volume rose to 65% in August vs 48% in July.

Lastly in DeFi, we want to highlight that among stablecoins, USDT (Tether) supply has increased by $1.7B since the Tornado Cash ban, while USDC (Circle) has fallen by $2.4B. Circle, the issuer of USDC, blacklisted wallet addresses associated with the crypto-mixing service. Tether did not. Like dYdX, USDC is losing market share because of this move.

Bloomberg, Messari, CryptoCompare, MVIS, VanEck research as of 31/8/2022.

Exchange Tokens

Centralized exchange tokens continued their pattern of outperforming in weak markets and keeping pace in strong ones, highlighting the enduring appeal of the buy-back and burn tokenomics employed by several including FTX’s FTT token. As if to punctuate our point, someone leaked internal documents to CNBC revealing FTX’s 2021 net income of $388M on revenues of $1.02B, which grew 1,000% in the year. Although the revenue growth is impressive, in absolute terms FTX is still dwarfed by Binance (FY21 revenue: $20B) and Coinbase (FY21 revenue: $7.84B). Still, at least 33% of fees generated on FTX markets are used to buy FTT and then subsequently to burn the token, potentially providing a predictable return to FTT stakers that public equity investors do not enjoy.

Bloomberg, Messari, CryptoCompare, MVIS, VanEck research as of 31/8/2022.

Bloomberg, Messari, CryptoCompare, MVIS, VanEck research as of 31/8/2022.