2021 in Review
2021 was the year of new games and speculation:
Bitcoin hit all-time high after all time-high
Alt-season emerged in full force
NFTs were starting to run red hot
Ohm and Alchemix revealed themselves to the world and the era of Defi 2.0 silently began
Things were going well, or so I thought! A few more months of this and….
Then came May 2021. Pain. A disconcerting air settled on all edges of the cryptoverse, and muted cries of ‘Devs do something!’ rang out against a backdrop of fear and self-loathing. Portfolio went -60% in a week. But fortunately, the pain didn’t last long.
A quick little depression for summer vacation and then back to bull.
Risk on:
Alt L1s picked up
Ohm forks abounded
Metaverse plays exploded
and NFTs saw fresh excitement
Degeneracy returned in full force. Hell, even euphoric VCs were joking (or not?) about dumping their coins on FOMO-ing retail… times were good again indeed.
Emerging Trends
Yes, I know I’m 2 weeks into 2022 already which means yes, I’ve been able to peak into the future a bit. Jokes aside, there is a speculative list of trends that I see emerging and ones I want to position my portfolio for. Not financial advice.
TLDR
L2 adoption in 2022 will be relatively slow compared to alt-L1 adoption in 2021
Monolithic L1 trade will slow down, with some outperformance by LUNA and FTM
2022 could see infrastructure outperformance, but only if a broader narrative develops outside of cash flows and fundamentals
A conflict (War) becomes increasingly heated between protocols over accumulation of a scarce asset (Curve), with the outcome determining which protocols flourish and which ones simply exist
Collectives of users and builders emerge (what I’m dubbing ‘Defi Nation States’), competing for control over the DeFi trifecta: stablecoins, lending markets, and swapping markets
Expect tokenomic models to change in many projects to reduce destructive inflationary pressures and better align users interests with those of the protocol
Context
Before jumping into all the monolithic L1/ modular blockchain, L2 humbo-jumbo, let’s get a couple things straight. A monolithic blockchain, synonymous with today’s Layer 1s (L1), is a blockchain which carries out all 3 standard functions:
Consensus: process by which validators come to agreement on correct blocks (ie. proof of stake)
Execution: old state transitions to new state (i.e. new block of transactions is added to the chain)
Data Availability: nodes holding history of all transactions
Think Solana, Avalanche or Ethereum in their current forms.
As blockchains like Ethereum scale, it is thought that they will become more modular in design, meaning that different layers will be built to take care of individual functions.
For example, Layer 2’s, as they’re informally called, offload transaction execution from Ethereum L1 (Ethereum mainnet), and in turn, free it up to be solely a consensus and data availability layer.
In the future, Ethereum mainnet may exist only as a consensus layer, with data availability being offloaded to shards and execution being offloaded to Layer 2s.
Okay, with that out of the way, let’s get on with it!
Rise of L2s
2022 will see the rise of L2s en masse: zkSync, Arbitrum, Optimistic Rollups, Polygon Hermez, Boba – the list goes on. My personal belief is that they don’t see an absolute boon in traction initially as some people are anticipating.
One reason for this: L1s are sticky.
In the world of Software as a Service (SaaS) companies, there’s a now ubiquitous phrase parroted by Go-to-Market (GTM) strategists everywhere: ‘Land and Expand’. The idea is to land some piece of software with the customer, have them buy it, use it for a period, and then expand by cross-selling /upselling them with new product combinations, thereby maximizing $/user. Generally, you want to land the stickiest product first so that it’s:
hard for the customer to transition to a competitor product and
gives maximum leverage for upsell
I see 2021 Alt-L1 ecosystems a bit like SaaS products. There might be one killer app that draws users in and notably, keeps them there. For Luna, this is Anchor – the fixed savings rate and lending protocol ($8B in TVL as of writing). As other dApps pop up and increase utility, the chain itself acts as the rails for users to go seamlessly between dApps. They’re being upsold (but they don’t know it because their marginal costs haven’t increased). As long as fees remain cheap, users continue to explore and experiment within the ecosystem with little downside. As the ecosystem grows, the initial users of the chain benefit greatly and become evangelists, spreading the good word to all who may listen.
I don’t foresee big shifts occurring where users of predominantly one chain cross the chasm and start using an L2 immediately. Many of them are happy on their L1s, especially as more innovative dApps are built, expanding the utility of the chain and extending the efficiency of their capital. It’s possible too that some of these users see Ethereum as an elitist and privileged chain, where old money (of the last cycle) virtue signals about security and modularity. They may hold Ethereum in contempt and actively avoid it, even if just by association.
Additionally, L2s seem to aggravate another problem introduced by all these L1s: an increasingly fractured user experience. If you thought holding assets separately on avax, eth, and matic was difficult, just wait…
A few things I’m watching out for that may invalidate this thesis:
Users brag of how heavily incentivized they are to bridge over (think Matic in May/June 2021, Avalanche bridge) and how sleek the user interface is / how quickly cheap transactions settle (think Solana) – word of mouth is powerful in crypto and stirring your emotions (FOMO) is even more powerful
A collective of innovative apps build exclusively on L2s and a broader narrative emerges around those apps
I feel this is already playing out a bit with Dopex and their options vaults on Arbitrum
Ethereum whales move to L2s as blue-chip Ethereum mainnet apps migrate
Ethereum whales have historically had no reason to bridge to any other chain. They could operate at scale under the full security of Ethereum without gas fees making even so much as a dent in their pockets. However, given Ethereum’s roadmap, it is almost inevitable that all users, regardless of size, will migrate to L2s. Question becomes when, not if.
To be clear, I think L2s will gain traction, just slower than alt-L1s did in 2021. As adoption occurs, it will be interesting to see how users/ protocols distribute themselves on L2s:
Will one L2 dominate in terms of users? capital inflows? transactions?
Will certain sectors, like defi, live mainly on one L2?
Will new projects choose to launch exclusively on a single L2?
Watchlist:
$MATIC
Wen Arbitrum coin?
Monolithic L1s
Clearly, 2021 was all about L1s..
I do see the monolithic L1 trade slowing down a bit, however. This space is becoming rather saturated and as I stated previously, not every L1 with a small market cap is going to make it. I believe value will continue accruing largely to the existing predominant ecosystems (SoLunAvax) – of course, with some room for others to run as well (FTM, NEAR). Since so much has already been said about L1s by the community, I’ll try to keep this section brief:
I think LUNA continues to do well, just not on the backs of an ETH killer narrative. LUNA is unique in that it can appeal broadly to 2 storylines:
‘ETH Killer’ / ‘Alt-L1’
‘Decentralized Stablecoin’
This is what will give it an edge in 2022 as the centralized assortment of stablecoins (USDC, USDT, etc.) continue to be under the watchful eye of US regulators. Not to mention the multitude of dApps that are slated to come online in 2022, providing ever more utility to UST / LUNA holders.
I’m personally excited to see Mars Protocol launch (Q2 2022 per their latest update), with its ability to extend uncollateralized credit to smart contracts
Additionally, I see big catalysts for broad UST adoption in kash.io and Alice.
Alice – think Venmo but with the added bonus of up to 20% APY (from Anchor) on whatever cash you’re holding in it
Kash.io – think savings/ investment account that uses Anchor/Mirror on the backend – will soon be releasing a debit card, allowing people to spend their UST.
Since both applications abstract away all the complexity of wallets and on-chain transactions, I expect this to be a big driver of technically unsavvy retail to adopt UST (sometimes, without them even realizing it!).
For further exploration in the ecosystem, would encourage more reading on:
Nexus Protocol
Prism Protocol
White Whale
Kujira
Kinetic Money
Astroport
Valkyrie Protocol
While the UST-USD peg is constantly called into question, many proposals have been floated in an effort to bolster the peg, with Do Kwon himself even teasing an update here. Currently nothing concrete, but one seems to be on the horizon. Waiting with intrigue..
FTM – do you want to fade Daniele Sestagalli and Andre Cronje? I didn’t think so…
SOL – to be honest, I don’t love Solana. The UX is slick and transactions are fast and cheap, but the string of outages lately is a bit unnerving. I don’t see DeFi evangelists like I do on other chains, since most of Sol tokens released with extremely high Fully Diluted Values (FDV) and subsequently, did not see much enviable price appreciation. Maybe I’m wrong and we see continued adoption, but for now, I see sideways.
Kyle Samani seems to disagree though. Maybe I shouldn’t bet against the guy who’s up 2000x..?
ADA of all things sees a rebound in price, as they ~eventually~ gain traction with a dApp ecosystem of their own. Bold… I know.
Watchlist:
$LUNA
$FTM
Infrastructure
According to many folks, 2022 will be the year of pickaxes and shovels! Don’t try to pan for gold yourself, just buy the tooling!
Perhaps this will be true and bridging/ cross-chain tokens will have a truly standout year. Given that the world is increasingly multi-chain, this narrative has some appeal. However, with cross chain being relatively unsexy and evangelization harder when compared to stickier L1s, I’m hesitant – at least for the short term.
Every thesis for infrastructure plays thus far has centered around token fundamentals and cash flow. If we’ve learned anything over the last year, however, it is that narratives devoid of numbers have played key roles in kicking off hype cycles. Revenues, while they accrued to protocols, were not the predominant talking point. Often, attempts at valuing cash flows were used only to support existing hype, but did little to alter the direction of upward price action for fringe or value-poor projects. It’s not until months later that the market started to price in the protocol’s cash flows – and even then, only to provide a price floor.
In my opinion, something more than fundamentals alone will be needed to kick off speculation on infrastructure plays.
What might that be? Perhaps:
A single project emerges that abstracts away the complexity of bridging. Currently, users face bridging matrix hell. What if they didn’t have to identify a bridge at all? What if they could seamlessly transact on various chains without ever leaving their wallet?
If Ohm kicked off a battle for protocol-owned liquidity, maybe so too can another application jumpstart a race to rule the flow of liquidity between chains
As users look to capture the best opportunities on ~every~ chain, and not just their home chain, capital becomes more evenly distributed across the major L1 and L2 blockchains with time. Demand sharply increases for cross chain services as a result.
Watchlist:
LayerZeroLabs
$SYN
$BICO
$RUNE
Curve Wars
By now you’ve probably heard of the Curve Wars: A battle amongst protocols and liquidity providers to control the all-holy Curve gauge. But what is it really and why does it even matter?
Context
Curve is an automated market maker (AMM) like Uniswap, but it uses a different pooling mechanism to offer swaps, resulting in less slippage and better maintenance of stablecoin peg (to $1). Through this design, they have managed to secure the most total value locked (TVL) of all protocols across all chains (~$23B as of this writing).
Meaning: if you want to swap stables, Curve is the place to be.
Introduce the Gauge
Curve’s governance token (CRV) has a supply that is inflating according to its emission schedule. Daily emissions of CRV are used to reward liquidity providers (you and me) for depositing their asset(s) with them.
Now, if you’ve touched DeFi at all in the last year, that’s pretty much standard operating procedure: get token rewards through inflation for provided liquidity. So where do things get interesting?
Well, CRV emissions aren’t simply given to each pool in equal proportions. Instead, the amount of CRV rewards directed toward each pool is determined weekly by CRV token holders themselves.
Basically, whoever holds CRV, holds the keys to the CRV money printer (brrr). Let’s look at the players involved in controlling ~$3M of daily CRV rewards:
1st level: Individual liquidity providers – LPers want CRV tokens so that they can direct rewards to the pools they’re in.
Goal: Achieve a virtuous cycle, where CRV token holders vote themselves more CRV, increasing their influence over the gauge weighting, and happily sit on their hands in high yielding pools
Who: Individual Users
2nd level: Decentralized Stablecoin Protocols – stablecoin projects want LPers to hold their stablecoin.
Goal: Acquire war chests full of CRV to direct CRV rewards to their stablecoin pools, incentivizing LPers to hold their stablecoin, and as a result, have the most stable stablecoin.
Who: Abracadabra (MIM/SPELL), Frax Finance (FXS/FRAX), Terra USD (UST/LUNA)
3rd level: Meta-governance layers – protocols designed specifically to acquire vast amounts of CRV tokens
Goal: incentivize CRV holders to hand over their coveted CRV to the protocol. As the protocol gains more and more CRV tokens, it can direct more and more rewards through the gauge back towards the tokens it holds in its treasury, and can then distribute those gains back to supporters of the protocol. The native tokens of these protocols become themselves a claim on CRV voting power and freshly printed CRV.
Who: [REDACTED] Cartel (BTRFLY), Convex (CVX)
More players continue to join the fray.
I’m particularly intrigued by the Curve Wars, as they present a different avenue to value accrual, and one not based solely on simple adoption metrics. It is the first natively on-chain arms race where protocols themselves are competing for a scarce resource that in some cases, dictates not only protocols’ short term growth trajectories but also their long term viabilities.
Don’t have enough CRV? I’m sorry, anon, but you might just not make it.
Watchlist:
$CRV
$CVX
$FXS
$SPELL
$BTRFLY
Rise of DeFi Nations
But what if I told you Curve Wars were only a smaller battle in a larger war? That’s right, anon. It’s not enough to wield control over the deepest, most liquid stablecoin pools. You need to control the entire stack – the trifecta – the holy trinity:
Stablecoin
AMM/ Liquidity
Lending Market
Who will be the first DeFi quasi nation to replicate the functions of a central bank algorithmically? That is: (1) issue currency, (2) Set market interest rates and (3) direct the flow of liquidity.
Now let’s be clear, there’s not one single entity wielding this type of control. Here I am only suggesting that collectives of users and builders are beginning to align themselves to an application set that appears ready to wield similar control over DeFi’s financial markets. Keep in mind what enables this: DeFi’s inherent composability. Without this crucial feature, seemingly one-off protocols would exist and specialize as if they were in a vacuum, and the same level of cooperation wouldn’t exist.
Here are the players I see emerging in this larger struggle:
Watch for partnerships, acquisitions, and even quid pro quo deals to be cut as these major players look to advance their positions in owning the full stack.
Watchlist:
Dani Sestagalli/ Andre Cronje and broader #FrogNation
Do Kwon and Terraform Labs
Ethereum builders/ devs
EvolVe-ing Tokenomics
If we think of the development of DeFi over its short history, it’s been largely an experiment in incentivizing adoption and attracting capital. As Matt Huang from paradigm pointed out:
Early DeFi projects were hugely inflationary, yielding massive rewards for early adopters (they also sprinkled in a non-zero chance of getting rugged yay). Oftentimes, these protocols took your liquidity and gave you worthless governance tokens in exchange, which then caught a bid from traders. They essentially printed their way into crypto mainstream consciousness, which is of course fine in the beginning, as long as that same inflationary schedule does not then destroy the value of those governance tokens over a longer period (RIP $SUSHI).
With time, it’s become more and more obvious that getting the tokenomics of a project correct is just as important as the project itself! Look for projects to better align token holders to their protocol through changing tokenomics:
Ve- models (mimicking CRV tokenomics): allow token holders to vote-lock their tokens for a set period, during which they can direct token emissions to pools of their choice. Their voting power becomes a function of how long they lock their tokens and the number of tokens locked
Pros: locked tokens are taken out of circulating supply, and the desire to gain greater voting power induces bidding up of remaining circulating supply, such that the token itself may become deflationary (i.e. amount of CRV locked daily exceeds marginal increase in emissions)
Staking mechanism: users can lock up their tokens in exchange for a % of the protocol fees, paid out in the native token periodically
Pros: again reduces circulating supply and buyback mechanism lifts asset price
Watchlist:
$YFI
$DPX
$JONES
$BTRFLY
Other Bold 2022 Predictions
FTM and LUNA both flip Solana
ETH hits $10K ahead of the Merge in Q2 2022
MATIC enters the top 10 by crypto market cap
Market cap growth of applications tied to the DeFi stack will outpace L1 market cap growth
Missing from this article:
Gamefi/ Metaverse – not really an interest of mine, so didn’t mention it here
Decentralized Options/ Structured Products – this is something I’m actively looking into
Stay tuned for next week’s article, where I’ll be looking into Dopex, a Decentralized Options Exchange.