Last year, we wrote about how cryptocurrencies and other blockchain-based digital assets were poised to see more widespread adoption in 2021—and thanks to the pandemic, the explosion of non-fungible tokens (NFTs), easier access for retail investors through payments platforms such as PayPal, increased institutional and government engagement, etc., they did.
Curious about where this fast-moving sector stands now and where it may go this year? Read on for some highlights and insights from Citi Ventures’ Venture Innovation team.
The digital assets market surged in 2021, growing by 187.5% in total market cap. Though the market remains highly volatile—the price of Bitcoin dropped by 30% in one day last May—its value has now exceeded $3 trillion.
Much of this growth has been driven by increased investment in crypto from institutional investors, governments, and corporates. For example, several mainstream investors have begun investing in Bitcoin as an inflation hedge; the city of Rio de Janeiro is allocating 1% of its treasury reserves to crypto; venture capital giant Sequoia just established a nearly $600MM crypto fund; and companies such as Square and Tesla are using their balance sheets to buy Bitcoin.
We expect more of the same in 2022, with an increase in financial product offerings for institutions and corporates (e.g., ETPs and ETFs) enabling further exposure to crypto as an investment asset. Crypto adoption and usage will also continue to grow through increased interest in decentralized finance (DeFi) lending and yielding offerings as well as the development of a tokenized economy in the gaming industry.
The two largest and most influential blockchain networks, Bitcoin and Ethereum, underwent significant changes last year. In November, the Bitcoin network began an upgrade that will enable it to better execute “smart contracts,” the collections of code that power many of the decentralized apps (DApps) that ride on other networks such as Ethereum.
At the same time, Ethereum—the most-used blockchain network—initiated a shift from the energy-intensive “proof of work” mining model to a “proof of stake” model in which users can validate transactions according to the number of Ether coins they hold. Part of a broader move to a more scalable, secure, and sustainable Ethereum 2.0, this change is expected to reduce the network’s carbon footprint by 99% and lower the cost of transactions, which spiked in 2021 due to congestion on the network. This comes at a good time for Ethereum, as competition has arisen from other networks such as Avalanche and Solana to provide the platform for the NFTs and DeFi solutions driving the explosive growth of the ecosystem.
Perhaps the most noteworthy development in the crypto space last year was the grand entrance of NFTs into the cultural mainstream, as their popularity skyrocketed through digital art and collectibles such as CryptoPunks and NBA Top Shot. Led by the famous $69 million sale of digital artist Beeple’s “Everydays — The First 5000 Days” piece, NFT sales reached almost $25 billion in 2021, 250X more than in 2020.
As we have discussed in our NFTs and the Metaverse series, NFTs are a key component of this new digital infrastructure and commercial opportunity. Many leading retail brands are developing NFT-based digital products and building virtual spaces in the Metaverse to engage with younger and more tech-savvy customers. As the Metaverse ecosystem develops, NFTs will help facilitate identity, community, and social experiences, and could offer new features for the so-called “creator economy”—more on that soon.
Not long after the world learned the term “NFT,” many were introduced to another little-known crypto community—decentralized autonomous organizations (DAOs)—through one DAO’s attempt to purchase a copy of the US Constitution. Though ConstitutionDAO ultimately failed in its bid, it raised $40 million in just a few days and brought the concept of the DAO into the mainstream—a concept we will return to in future articles.
Government responses to cryptocurrencies ran the gamut from warm embraces to cold shoulders last year. In June, El Salvador became the first country to accept Bitcoin as legal tender; on the other hand, China banned all crypto-related activities and shut down its significant Bitcoin “mining” (dedicating computing power to validating transactions on the network) operations.
Much government interest revolves around the potential use cases of central bank digital currencies (CBDC) and fiat currency-backed “stablecoins.” The US Federal Reserve (Fed) recently published a paper on CBDC stating that it does not intend to issue a CBDC without clear support from the executive branch and Congress, then published a more optimistic paper on stablecoins, calling them a “possible breakthrough innovation in the future of payments” and a potential “digital safe haven currency during periods of crypto market distress.” The difference of tone suggests that the Fed is warming to the idea of properly regulated US Dollar-backed stablecoins issued by properly regulated entities such as banks.
Elsewhere around the world:
Looking ahead, we expect to see more CBDC experimentation by the Bank for International Settlement (BIS) and central banks around the world. In response to and complementing CBDC projects, the private sector is expected to gather behind consortium models such as the Regulated Liability Network. Some central banks may decide that the private sector is better suited to offer digital money solutions in the form of stablecoins or consortium-based commercial bank coins, while others will likely continue to progress towards CBDC implementation with or without the support of the private sector.
A major argument against crypto has long been that, as a largely unregulated and anonymous digital sector, it can be used to fund illegal activities. The events of 2021 likely did little to alleviate those concerns, as an August hack of the Poly Network DeFi platform stole over $600 million in tokens and a New York City couple was recently arrested for stealing and conspiring to launder 120,000 Bitcoins. All told, over $7.7 billion was stolen in crypto scams in 2021.
This demonstrates clearly what many in the crypto industry have been saying for years: greater regulation and regulatory certainty are key to driving further growth and mainstream adoption of crypto, particularly among institutional investors. Heretofore the dominant theme in the industry has been self-regulation, but as it scales we are seeing the limitations of this approach. The recent Wormhole hack shows that the risk of systemic failure is growing along with the cost of bailing out the system: the firm behind Wormhole, Jump Crypto, put $360 million of its own capital down in order to stop a cascade of defaults across the Solana ecosystem, revealing the limits of self-regulation.
Regulators are beginning to step into the breach. US regulators seem to be coming under increasing pressure to provide a regulatory framework for crypto assets and DeFi apps, and India’s move to tax crypto assets should help support visibility, transparency, and adoption in one of the biggest possible markets for crypto. At this point, any regulatory certainty and visibility will be a net-positive for the industry, and we expect to see more coming down the pike in 2022. We will return to this subject in future articles.
For more of Citi Ventures’ thought leadership, investments, and efforts in the digital assets space, click here.