Crypto Investors Hit by Pitch

Digital assets struggled through a volatile April with Bitcoin falling 16% and Ethereum 15%, the MVIS CryptoCompare Smart Contract Leaders Index down 22%, and the Nasdaq Composite down 13%.

Among S&P 500 sectors, tech & communication services, comprising many Web2 stocks whose margins may eventually be vulnerable to disintermediation via digital assets, were among the worst performing of the 11 level GICS S&P 500 sectors, down 14% and 18%, respectively. Bitcoin’s 30-day correlation with the Nasdaq hit a two-year high in April of 0.70 as investors marked down valuations to account for sharply higher bond yields globally and recession fears. Despite the weak price action, however, crypto volatility actually declined in April with Bitcoin and Ethereum 30-day volatility reaching 1-year lows of 35% and 48%, respectively. Notably, DeFi sector volatility rose to 81%, counter to other categories we track in our digital asset taxonomy, implying DeFi’s sector-leading performance in April should be discounted somewhat in risk-adjusted terms.

“A Decentralized Economy Needs Decentralized Money” – Terra’s Washington Nationals sponsorship goes live

<

Source: Bloomberg, Messari, Cryptocompare as of 29/4/2022.

Digital Assets Market Cap by Sector

Source: Bloomberg, Messari, Cryptocompare as of 29/4/2022.

Layer 1 Smart Contract Platforms

Crypto’s disappointing performance in April was driven by sharp declines in most layer 1 blockchain protocols, reversing March’s counter-trend bear market rally. Layer 1 refers to base level blockchain protocols which can validate and finalize transactions without the need for another network. Now 184 days since Bitcoin reached its all-time high on November 8, the top 10 smart contract platforms are down an average of 60% from their peak. In our view, the underperformance of smart contract leaders reflects: 1) higher valuations among these layer 1 projects; 2) an emerging M&A trend which is more pronounced in DeFi; and 3) a growing appreciation of Bitcoin’s relative immutability which we detailed in a recent blog on the topic.

Among the smart contract index constituents, NEAR protocol was the best performer, down 2% on the month. After announcing a monumental $800M global ecosystem development fund last October aimed at supporting developers building applications on the EVM-compatible NEAR Blockchain, the NEAR community has now onboarded 40,000 students and 120 NEAR-certified teachers, while extending grants worth $124M across 509 recipients. Focusing first on DeFi applications, the protocol has seen considerable momentum especially across their flagship cross-chain Rainbow Bridge, which has facilitated $1.5B in cross-chain swaps at fees 1,000x lower than Ethereum. Total value locked on the NEAR blockchain has reached $800M, up from $100M at the beginning of 2022. The #1 dApp on the NEAR blockchain is Ref Finance, a community-led, multi-purpose decentralized finance platform with 16,000 monthly average users, up 75% in April. Ref’s backers include Jump Crypto, Alameda, Kucoin Ventures and OKX. As for the sustainability of NEAR’s ecosystem growth, NEAR has attracted open-source dApp developers faster than any other layer 1 chain since launch (although the source of this data excludes some layer 1s like Avalanche, Terra and Flow, which have more closed-source Github repositories and thus appear to have lagged). It is possible, though by no means assured, that NEAR, with the April release of the USN algorithmic stablecoin backed by Tether & NEAR reserves, will battle LUNA for supremacy of the algorithmic stablecoin market in coming quarters. Unfortunately, NEAR tokens are not available yet at Coinbase or Gemini.

The second best-performer among smart contract leaders index constituents was Terra (LUNA), the algorithmic stablecoin operator that was the focus of our deep dive research in March. LUNA fell 3.5% in April, but notably, Terra’s UST dollar stablecoin added another $2B in market cap reaching $18B by April 26. After adding Bitcoin to UST’s treasury in March, Terra diversified further in April as Terraform Labs (TFL) and Luna Foundation Guard (LFG) announced joint plans to add $200M in Avalanche (AVAX) coins in order to “strategically align ecosystem incentives.” The for-profit TFL then announced an additional $820M gift to the non-profit LFG one week later. It seems increasingly obvious to this analyst that Terra’s leadership is hurrying to deploy resources to further decentralize the protocol before U.S. regulators can bring an enforcement action. The moves also highlight the emerging M&A in the space. As Terra tweeted on April 7, “It’s becoming increasingly evident that mutual collaboration amongst major ecosystems and communities is the optimal path forward to positive-sum outcomes in a budding interchain world.” See the table below for additional M&A in the month.

Source: VanEck Research as of 29/4/2022.

Among other significant weights in the smart contract leaders index, Algorand (ALGO) and Polkadot (DOT), underperformed in April. Algorand, down 32% in April, looks impressive on paper led by Silvio Micali, the inventor of zero knowledge proofs, and has claimed partnerships with several sovereign nations including the Marshall Islands and El Salvador. However, as there are still few working dApps, transaction volumes have been quite low so far. We believe that may soon change with Algorand TVL rising 50% m/m in April (following March +50% as well) vs. total DeFi TVL flat, though the absolute numbers remain still low at less than $300M. As for Polkadot, -29%m/m, ecosystem traction has stalled due to the slow deployment of projects through the parachain auction onboarding mechanism and because of technical issues. With respect to its blockchain’s operation, Polkadot is currently experiencing parachain block production time delays and has been slow to implement the true extent of its cross-parachain communication capabilities. On the other hand, DOT parachain Aster (ASTR) surpassed $300M in TVL this month, and both UST and USTD stablecoins announced they will deploy to Polkadot. We believe Polkadot’s upcoming global conference on June 29-30 may coincide with the release of long-awaited cross-chain bridging and messaging infrastructure improvements, which could act as a catalyst for the coin price. Several keystone projects that depend on efficient cross-chain communication, including Acala (ACA) and Composable Finance (LAYR)¸ could be major beneficiaries of any upgrades to Polkadot’s parachains interoperability.

A Primer on Polkadot

Polkadot is not a true layer-1 smart contract platform, because it does not actually have the ability to natively execute smart contracts. Rather, it is more aptly called a “layer-0” because its architecture is that of a network of blockchains that blockchains can connect to in order to achieve a higher level of security. Because Polkadot is secured through the Proof of Stake architecture, its economic security is related to the value of the coins staking the network. To break this security model, an adversary would have to control 66% of all coins staked on the network—a non-trivial sum at $7B. In practice, this security plays out by enabling connecting blockchains, called “parachains,” to rely on the security of Polkadot’s value through Polkadot’s validator set. Thus, each parachain taps Polkadot’s validator set to help create secure blocks on the parachain’s own blockchain. At the same time, through use of Polkadot’s validator set, illustratively called the “relay chain,” all the parachains can also securely communicate with each other to call contracts, pass messages and transfer assets. The strength of this model is manifold.

Rather than having to create their own economic security to bootstrap their own validator sets, nascent blockchains can “borrow” Polkadot’s validators, staked with billions of dollars, to secure the value of their chains. Moreover, through the message passing architecture of Polkadot’s relay chain, there is no need to employ dangerous multi-signature bridges like the Solana-ETH Wormhole that have been hacked for billions of dollars of user funds because Polkadot is the bridge. Finally, the relay chain architecture enables horizontal scaling while preserving the integrity of the security guarantees by division of labor in running the blockchain. While Polkadot secures the whole network, the blockchains that connect to it create their own execution environments. This empowers each parachain to tailor its blockchain from the ground up to optimize performance and functionality for specific use cases. Operationally, a gaming parachain could host a game’s execution environment while the NFTs representing in-game assets could be sent to a second, NFT-focused parachain for modification and trading while a third, DeFi-focused parachain could build derivatives based off of the values of those NFTs’ in-game performance. This could all be accomplished through the seamless and secure passage of information across Polkadot’s relay chain to each parachain.

Additionally, the Polkadot is not a single blockchain of blockchain. It is two, different networks of blockchains. Polkadot has a sister network called Kusama that uses the same code base and architecture to create a test network that employs actual monetary value. Before upgrades and changes to Polkadot code occur, they are first deployed to Kusama (KSM) to understand how they operate “in the wild.” Investors who participated in the ICO of Polkadot in 2017 received KSM tokens as part of their allocation of DOT tokens. Since that time, the networks have differentiated themselves and cultivated different communities. In direct contrast to Polkadot, Kusama employs a faster governance process, is geared more towards retail participants, is more experimentally focused and offers cheaper security fees (but less overall economic protection) for parachain lease slots.

However, unlike a permission-less environment where applications can freely deploy their code, connecting a blockchain to Polkadot is not free nor is it permanent. The connecting blockchain must pay to lease one of Polkadot’s limited parachain slots. Each lease slot is auctioned to the highest bidding blockchain through what is called the “crowdloan.” To participate in a crowdloan, Polkadot holders lock their DOT tokens behind a project’s parachain bid in a secure wallet that the parachain team cannot access. This lock of DOT tokens persists for the duration of the parachain lease, which is 96 weeks (48 weeks for Kusama). The Polkadot tokens that are locked behind a parachain team’s bid cannot earn staking rewards and cannot participate in Polkadot on-chain governance. However, to economically compensate DOT holders for their opportunity cost and to entice DOT holders to vote for their parachain lease, parachain candidates offer rewards to the DOT holders who back their projects. The reward mechanism is often in the form of the native tokens that will power the parachain candidate’s blockchain. Rewards for crowdloan participants have sometimes been extremely profitable, as some projects have given away 30% of their blockchain’s value in the form of tokens. Participants in the Moonriver crowdloan on Kusama received as much as 35x the value of their locked KSM tokens during all-time highs of Moonriver’s MOVR token. At the end of the parachain lease, the voters receive their tokens back. Also, if a parachain candidate does not receive enough backing to win a lease slot, the token holders also receive back their pledged tokens.

Source: Bloomberg, Messari, Cryptocompare as of 29/4/2022.

Metaverse

“When the publisher is loading all these third-party tags from Google and others, they can fight each other. They can override each other, they cookie stack, they cheat. What's worse, you can take the whole publisher content, scrape it into a fake environment in a bot, and the bot pretends to be a user clicking on the ad. You get paid the ad revenue because the ad buyer didn't cross-check the publisher's ID in Google's Ad Exchange, which is a fraud operator against the true New York Times ad ID. It's bad. Google still gets the fee when this advertising money is stolen by fraudsters. It makes Google complicit with the fraudsters, to some degree. It misaligns the interests again, it's a conflict of interest.”

– Brave CEO Brendan Eich, 24/2/22

The MVIS CryptoCompare Media and Entertainment Leaders Index (MVMELE) fell 25% in April. The worst performer and #1 constituent, Axie Infinity (AXS, 19% weight), fell 41% after a North Korean hack of its Ronin side chain took $625M. Axie has since pledged to reimburse lost user funds. While all coins in the metaverse index were down in both USD and ETH terms, Basic Attention Token (BAT) performed the best, falling 20%. BAT’s flagship product, the Brave browser, is arguably the single largest blockchain-based application with over 50M monthly users. Brave is a privacy-focused internet browser that blocks third-party trackers and unwanted ads automatically. Turning Google’s model on its head, Brave Ads runs an open advertising platform that rewards opt-in users with 70% of the value of the ad revenue that Brave receives for any given ad campaign, denominated in the native BAT token. Brave’s latest feature, announced this month, automatically bypasses Google’s Accelerate Mobile Pages (AMP) and instead takes users straight to the original website. “AMP is harmful to users and the web at large and furthers the monopolization of the web,” according to a recent Brave blog post. Brave added 1M users last month, an all-time absolute record for the browser. The project claims a 90% ad campaign renewal rate with sponsors, including Verizon, Dentsu, BlockFi and eToro. (For more on Brave and BAT, we highly recommend listening to Brave’s origin story from Brendan Eich, the chief architect of Netscape & Mozilla, who appeared on the Acquired podcast in February.)

While the broader suite of metaverse tokens performed poorly last month, innovation and development continue, resulting in some bright spots. For example, the “X to Earn” theme, where crypto rewards in the form of tokens or NFTs are used to incent desired user behavior, is proliferating quickly. “X to Earn” is a novel concept that advances the reward dynamics of Web 2.0 from free use of the product to ownership of the product and getting compensated to use the product. This new structure is intended to spur marketing, network effects, adoption and brand loyalty. In this new paradigm, utilization of the application directly rewards users’ contributions with items of monetary value. The greater the contribution of the user, the greater the value that the user potentially derives from his or her rewards. The theory is that this user-focused ownership structure and potential for recursive value accrual will incentivize users to use the ecosystem, stay attached to it, and bring others to use the application as well. The suite of “X to Earn” applications include Axie Infinity in the “Play to Earn” category, Let Me Speak in “Learn to Earn,” and STEPN in “Move to Earn.” STEPN is the most recent unicorn of the space with a +1,800% return since its coin’s (GMT) launch in March 2022. STEPN is a “Move to Earn,” Web3 lifestyle application that rewards players for recording movement with GMT coins that can be used to mint tradable NFT sneakers. We are also intrigued by the Hivemapper project, a “Drive-to-Earn” mapping application that aims to compete with Google Street view by incentivizing community members to install a 4k camera in their car to map their surroundings in order to receive HONEY tokens. HONEY will be used as the unit of account to purchase these map APIs for use in ancillary dApps and IoT devices. It’s not hard to imagine ride-sharing companies like Uber and Lyft shifting to such a user-owned maps network with a cheaper take-rate than Google Maps. For perspective, you can spend $80k per month on Google Maps API without even talking to a Google salesperson. We believe the emerging “X to Earn” model will expand to include additional application development and corporate marketing initiatives. As the economic models are refined, “X to Earn” may come to define the progression of the metaverse. For now, however, the metaverse sector remains early stage “unprofitable tech.” So, despite these early-stage fundraising wins, liquid token prices underperformed.

Source: Bloomberg, Messari, Cryptocompare as of 29/4/2022.

Infrastructure Applications

The MVIS CryptoCompare Infrastructure Applications Leaders index (MVIALE) fell 32% in April. Chainlink (LINK) paced the declines, also down 33%. For background, Chainlink runs a market-leading decentralized oracle network (DON) which, as of April 25, secures $103B or 61.6% of total value secured decentralized oracles. Oracles networks like Chainlink’s allow smart contracts to verifiably and securely access real-world data such as market prices, time of day, weather and GPS location. Chainlink’s “market share” in this critical segment is flat on a year-over-year basis, but down from a peak of 74% earlier this year, as internally developed oracles such as that used by Terra Luna’s Anchor application appear to be gaining traction, having grown from 0% to 18% of TVL in the last year. LINK’s delay in rolling out staking functionality, originally planned for 2022, has also frustrated investors. On that topic, co-founder Sergey Nazarov reiterated in January his expectations that Chainlink’s “cross chain interoperability protocol” (CCIP), aka Chainlink 2.0, will allow developers to “generate a smart contract that is actually multiple contracts on multiple chains interoperating with each other.” Nazarov highlighted that the migration to CCIP will underpin a “linear staking model” to be introduced this year, allowing the most successful node operators to receive a greater proportion of unlocked issuance. While the focus of the new staking model is primarily security, the redesign may align economic incentives, giving weight to node reputation and the size of the node operators’ deposited stake, which would act as a security guarantee for purchasers of Chainlink services (data APIs). Such a mechanism might also open the door to individuals being able to delegate or send LINK to node operators, with the collateral being used to generate LINK rewards, a portion of which would be rebated back to users akin to a discount on data costs. We are optimistic that Chainlink 2.0 and former Google CEO Eric Schmidt, who joined the protocol last November as an advisor, will both drive value creation for the community. As for current valuation, Chainlink’s market cap to “total value secured” recently hit an all-time low, highlighting considerable pessimism in the market.

Among infrastructure outperformers, The Graph (GRT) fell 15%, outperforming most Layer 1 smart contract platforms and infrastructure applications alike. The Graph is a decentralized querying protocol that can index (classify) blockchain data and supply users with access to those indices. This Graph is a major operational efficiency improvement for developers that is analogous to finding the exact page of an encyclopedia article using the index in the back of the book rather than randomly thumbing through the pages to land on the article. Users and dApps can query data on blockchains such as Ethereum, Filecoin and even non-EVM (Ethereum virtual machine) compatible chains such as NEAR. The main innovation is that The Graph achieves the functions above in a decentralized way by creating economic incentives among interested parties to work together. Curators stake GRT to flag what content on a blockchain might be worthwhile to index. Indexers operate nodes that index the blockchain data, receiving GRT rewards in return, and provide query processing services to consumers. And consumers are the end users paying GRT query fees to indexers, curators and delegators in order to access and retrieve the given subgraph data.

Of course, users can also rely on blockchain node operators such as Infura and Alchemy, which host their own centralized databases. But those private services are so centralized as to hardly fit under a web3 rubric (“user controlled internet”). Indeed, Infura suffered an outage on April 22 that caused their flagship Metamask wallet to stop working for the majority of users. This followed an outage in November that had an even wider impact, forcing many crypto exchanges to temporarily pause ether withdrawals. Infura’s parent Consensys announced a $450M Series D round in March at a $7B valuation. Granted the comparison is not apples to apples, but with GRT token at $1.7B market cap, we see compelling value in the decentralized market leader.

Source: Bloomberg, Messari, Cryptocompare as of 29/4/2022.

DeFi

The MVIS CryptoCompare Defi Leaders index fell 14% in April, making it the best performing sector we track via MVIS indices. Synthetic asset protocol Synthetix (SNX), which lets users mint new crypto assets that mimic both real world assets (like the U.S. dollar) and crypto assets (like Bitcoin) was the best performing coin in the index, up 4%. In April Synthetix launched its perpetual futures product on the Ethereum-scaling solution Optimism, with BTC, ETH and LINK featured as inaugural pairs. (Synthetix has long been one of Chainlink’s biggest “customers” according to a 2021 report from the University of Houston, TX.) Synthetix is now the single largest dApp on Optimism by TVL. Meanwhile, Optimism has generated considerable momentum with $500M now locked in DeFi, up another 10% in April, and capped off April by announcing an airdrop of a new OP token, rewarded to early users, repeat users, DAO voters, multisig signs and Gitcoin donors on the Optimism network.

Among DeFi losers, Uniswap (UNI), the largest decentralized exchange (DEX) by market cap and trading volumes, fell 22% as trading volumes dwindled amidst declining volatility and the continued bear market. DEX market share of spot crypto volumes has declined from 13.5% in January to 10.6% as of the end of April. Within that subset, Uniswap share has fallen from 52% to 49% over that same period. Still, we must highlight the long-term trend: in 2022 the Uniswap exchange has regularly traded as much volume as Coinbase on any given day; throughout most of 2021, Coinbase volumes regularly outpaced UNI’s by a ratio of 3:1.

Source: Bloomberg, Messari, Cryptocompare as of 29/4/2022.

Source: Bloomberg, Messari, Cryptocompare as of 29/4/2022.

Exchange Tokens

Exchange tokens are digital assets that are native to centralized crypto exchanges. Exchange owners often give tokens to customers as incentives for trading, liquidity provision or holding account balances. Generally, they can be used to earn rebates on trading volume, reduce trading fees or act as a governance mechanism. Some, like the Gemini Dollar (GUSD), are centralized stablecoins, while most others see their values fluctuate with volatility similar to the broader crypto market. Because they often offer trading rebates on their respective exchanges, exchange token demand tends to increase during volatile periods with high levels of trading activity. Notable exchange coins include CEL, CRO, FTT, BNB, KCS and HT. BNB is the largest exchange token by market capitalization, representing ~70% of all exchange token value.

Overall, exchange tokens fell 12% in April, outperforming the broader universe. Huobi Token (HT) was the top performer staying relatively flat (-0.1%) while exhibiting a compressed trading range ($9.03 - $9.91). Huobi exchange recently launched new products including funding rate arbitrage, advanced grid trading, single coin margin trading, and coin-margined swaps. These products are aimed at attracting high frequency traders who would also find economic value in holding the HT token to offset fees and receive other rewards. The exchange also burned about 597k ($5.8M) HT tokens in March, with the cumulative number of tokens burned through March 15 at 292M out of 500M. Worst performing of the top exchange tokens over the past month has been the FTX Exchange Token (FTT), which has lost 21% of its value. The FTT price drop comes amid long-standing complaints by FTX exchange participants of disruptive market practices and widespread spoofing on the exchange. FTX has since hired Eventus, a market surveillance firm, to identify and halt predatory trading behavior. Binance, in addition to the $10M in aid that it donated to Ukraine in February, will also be providing 11M Ukrainian refugees with a crypto debit card. Furthermore, Binance will load each card with $75 in its stablecoin, the BUSD, each month, for the next 3 months. Crypto.com’s Cronos (CRO) has also seen some positive news with the announcement that its token will be integrated into the Trust Wallet and be accessible to Trust Wallet’s 25M users. Cronos has also recently partnered with Chainanalysis to enable real-time monitoring of the Cronos network.

Source: Bloomberg, Messari, Cryptocompare as of 29/4/2022.