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Breaking the September Tradition

The Digital Investor

Introduction

Remarkably, September 2023 bucked the trend of historical challenges in the cryptocurrency market, with the overall market cap staying resilient, diverging from the usual “red” month pattern. This shift in sentiment has redirected focus toward SEC-reviewed ETF applications and the growing institutional interest in Bitcoin. Additionally, developments have been on the rise, as evidenced by the surge in Bitcoin’s hashrate and the resurgence of mining stocks.

Notably, Aave, a prominent DeFi player, has forged the Tokenized Asset Coalition (TAC) alongside industry leaders Circle and Coinbase, ushering in an era of asset tokenization. Chainlink, too, achieved noteworthy success through collaborative experiments with Swift and financial institutions. However, amidst these promising advancements, the crypto space witnessed significant losses totaling approximately USD 332 million due to exploits, hacks, and scams in September 2023. Nonetheless, the industry continues to evolve, with Visa’s announcement of integration with Solana serving as a compelling indicator of traditional finance’s increasing integration with blockchain technology.

The month of September emerged as a harbinger of both promise and peril. As the crypto community navigated the intricacies of blockchain technology and digital assets, it bore witness to a series of events that underscored the profound volatility and opportunity inherent in this space. In this edition of the Digital Investor, we delve into the myriad of developments in the world of cryptocurrencies and decentralised finance (DeFi) that unfolded over the month of September, painting a vivid tapestry of triumphs, setbacks, and the relentless pursuit of innovation.

Macroeconomics

The Federal Reserve, in its decision last month, maintained interest rates at their current levels, as widely anticipated. It signaled, however, an additional rate hike by year end, deviating from previous indications of more significant cuts next year. This decision left the federal funds rate within a targeted range of 5.25% to 5.5%, the highest it has been in approximately 22 years. While the absence of a rate hike was expected, there was considerable uncertainty surrounding the Federal Open Market Committee’s future course of action. The S&P 500 declined by nearly 1%, and the Nasdaq Composite fell 1.5%. Projections from the Fed’s dot plot indicated the likelihood of one more rate increase this year, followed by two rate cuts in 2024, two fewer than previously indicated in June, potentially bringing the funds rate to around 5.1%.

Additionally, the current situation in the oil market reveals a deficit of 200 million barrels in crude oil and refined products compared to the five-year average inventory levels. This deficit was primarily a result of a steep post-COVID decline in inventories, the sharpest recorded in the past 25 years. The situation presents two possible scenarios: either there is a genuine shortage in crude oil inventories, which could drive WTI oil prices above USD 110 or even USD 120 per barrel, or the inventory deficit exists because crude oil producers anticipate decreased demand, potentially leading to a price decline. Presently, we find ourselves in a state of uncertainty, unable to determine which scenario will prevail. If the demand for oil proves to be genuine, it could exert continuous upward pressure on inflation. Conversely, if we enter a global recession, or even a downturn in the United States, speculators holding long positions in WTI oil may unwind their positions, causing crude oil prices to dip.

Bitcoin

September has traditionally been a challenging month for the cryptocurrency market, but this time, it presented a departure from the norm. Contrary to historical patterns, the overall cryptocurrency market cap did not endure a “red” September, marking a significant shift. The total crypto market cap witnessed a marginal increase of just 0.5%. While Bitcoin exhibited resilience, outperforming most of the market, a few outliers such as Chainlink (up 16.6%) and Aave (up 6%) experienced notable gains. Conversely, Apecoin, Avalanche, and Polkadot faced substantial losses. During the month, Bitcoin’s dominance increased by 1.2%, hovering around USD 27.5K at the time of writing.

The spotlight in the cryptocurrency landscape is currently on various ETF applications submitted to the SEC and the growing institutional adoption of Bitcoin and digital assets. Franklin Templeton, a USD 1.5 trillion asset manager, recently secured SEC approval for its spot Bitcoin ETF application, signifying a potentially pivotal moment for the crypto industry. However, this journey may encounter obstacles, as the SEC is concurrently reviewing spot crypto ETF applications from other entities. The SEC has also postponed decisions on ETF applications from BlackRock, WisdomTree, and Valkyrie Digital Assets. Notably, in late August, a federal appeals court directed the SEC to reconsider its denial of Grayscale Investments’ request to transform its Grayscale Bitcoin Trust into an ETF. The decisions on these applications are expected to be rendered by May 2024, within a 240-day window.

In the institutional realm, Michael Saylor’s US-based MicroStrategy made a significant move by acquiring an additional USD 147 million worth of Bitcoin, defying the typical trend of limited investment inflow into risk assets like Bitcoin during phases of rising US Treasury Bill yields. MicroStrategy stands as the leading institutional holder of Bitcoin, with holdings exceeding 150K BTC, equivalent to approximately 0.73% of the total supply. Additionally, Deutsche Bank, Germany’s largest bank, announced its foray into digital asset custody services for clients through a partnership with Swiss startup Taurus.

Despite a relatively stable BTC market in the later part of Q3, characterized by subdued spot ETF discussions, the hashrate continued its upward trajectory throughout the quarter, recently reaching a new peak of around 400 EH/s from 250 EH/s at the beginning of 2023. Mining stocks, which endured a challenging 2022, have predominantly rebounded in 2023 in tandem with Bitcoin’s performance. Another positive development for US miners is the diminishing inflationary pressures, with nationwide US energy prices showing a year-over-year decline as of June, according to data from the US EIA. With the next Bitcoin halving less than a year away, US miners are intensifying production efforts while also managing their mining fleets in preparation for the inevitable reduction in block rewards expected next spring.

On the blockchain front, September witnessed a surge in average daily transaction counts to 522K, representing a 12% increase compared to August. Active addresses also experienced a notable uptick, rising by 9% to reach 1.04 million, marking a 12% increase. A Messari report revealed that in the last month, there were 7.7 million inscriptions on Bitcoin, marking a 20% increase from the previous month. These inscriptions generated $4.3 million in fees for miners, reflecting a substantial 105% month-over-month increase. Collectively, Inscriptions-related transactions contributed to 20% of the total transaction fees for the month. Notably, BRC-20-related transactions have dominated Bitcoin inscription activity in recent months, but this landscape could shift soon. On September 26, Casey Rodarmor, the creator of the Ordinals protocol, introduced a novel concept for creating fungible tokens on Bitcoin, known as Runes, offering improvements over the BRC-20 standard, particularly in reducing the creation of UTXOs. For further insights into Runes, detailed information can be found in Rodarmor’s blog post.

Ethereum

Ethereum concluded the month with a 4.4% decrease, slightly underperforming Bitcoin. Nevertheless, there are promising developments on the horizon. In a notable first, asset management firm Valkyrie has obtained approval to initiate the purchase of Ethereum (ETH) futures contracts for its existing Bitcoin ETF. This move involves converting the current Bitcoin futures ETF into a two-for-one investment product, set to take effect from October 3. In addition, ARK Invest and 21Shares have submitted filings for the first-ever spot Ether ETF in the United States. The Ark 21Shares Ethereum ETF represents the inaugural attempt to list a fund in the U.S. that directly invests in ETH, with asset custody entrusted to Coinbase Custody Trust Company. Meanwhile, following a partial victory against the SEC regarding the transformation of its GBTC into a spot Bitcoin ETF, Grayscale Advisors has filed for a new Ether futures ETF.

In September, the Ethereum network celebrated the one-year anniversary of its most significant upgrade since inception, known as “The Merge.” Post-Merge, validators have emerged as the primary driving force behind the Ethereum network, with an influx of new validators joining Ethereum after the implementation of withdrawals in the Shapella upgrade this past April.

The rapid expansion of the Ethereum validator set since the Shapella upgrade earlier this year has raised scalability concerns among developers. As the number of validators continues to increase, so do latency and bandwidth requirements on the network. Assuming a steady demand for validator activation, Galaxy Digital projects that the validator set will more than double to 2 million validators over the next 9 months. Ethereum developers plan to address this issue through EIP-7514, which aims to limit the number of validators activated per epoch (approximately 6.4 minutes) to 8, down from the current 12. This represents a short-term solution to curb the growth of the validator set.

Liquid staking has gained traction due to factors such as the technical complexity and the 32 ETH requirement for running an independent Ethereum node. Liquid staking service protocol Lido Finance has been steadily increasing its market share and is poised to reach a dominance level of 33%. This level of dominance grants significant influence, allowing the entity to independently delay finality. However, concerns have arisen that such a level of dominance could potentially tarnish Ethereum’s reputation, particularly among corporations and governments, potentially hindering its prospects as a global settlement layer. To address these concerns, Lido is exploring measures to enhance its decentralization. This includes exploring a dual governance system that reduces governance control for LDO holders and introduces mechanisms to address misaligned incentives between ETH stakers and LDO holders. Furthermore, Lido’s V2 upgrade aims to create a more decentralized validator set. While it is unlikely that Lido would engage in any harmful activities against Ethereum, the potential damage from any such activity increases once Lido surpasses the 33% threshold.

L2 Developments

Canto has recently made a notable transition from being a layer 1 blockchain to becoming a layer 2 solution on the Ethereum network. It has transformed into a zero-knowledge (zk) layer 2 solution, built using Polygon’s Chain Development Kit (CDK). Initially launched in 2022, Canto aimed to offer decentralized finance (DeFi) as a public good. If consensus is reached among participants on Canto Commons, the network’s governance forum, it could tap into liquidity from the Polygon ecosystem and inherit the security features of Ethereum, rather than relying on fraud proofs and economic incentives.

The previous edition of our Digital Investor mentioned how the introduction of Polygon’s CDK underscores the emergence of modular rollup ecosystems built on shared infrastructure. Key players in this landscape include Optimism Superchain, Arbitrum Orbit, zkSync Hyperchain, and Starknet L3s, each striving to capture value within the ecosystem.

In September, Optimism, an optimistic rollup solution, quietly conducted its third community airdrop, benefiting over 31K unique Ethereum wallets with an airdrop worth approximately USD 27 million. Since its launch in 2021, the Optimism blockchain has accumulated a total value locked (TVL) of USD 657 million, making it the sixth-largest blockchain according to DefiLlama. An earlier surprise airdrop this year led to an 11% price drop in the OP token as circulating supply increased. The ecosystem has allocated a total of 570 million OP tokens for future airdrops.

The crypto community also received news of Celestia’s announcement of the TIA token, accompanied by a 6% genesis airdrop to developers, researchers, Ethereum rollup users, and Cosmos users. While the airdrop may appear modest, with over 576K eligible addresses receiving less than USD 200 on average, the majority of the token supply is allocated to insiders, continuing the trend away from the traditional ethos of full community ownership.

This trend of VC-incubated layer 2 tokens with a similar token allocation approach can also be observed in tokens like Arbitrum. Protocol development in the realm of high-technology, high-research protocols like rollups requires substantial upfront capital funding. In a competitive market, token allocations serve as incentives to justify funding such projects. Furthermore, the user airdrops represent minimum distributions, with unclaimed funds to be redistributed, along with potential future incentives.

Despite recent declines in launches and activity on layer 2 solutions, one platform that has stood out is FriendTech. After a seemingly quiet period, FriendTech’s activity saw a resurgence, with reports indicating that the friend.tech app witnessed more trading volume than the entire Ethereum NFT market. While it’s too early to draw definitive conclusions, this development could potentially signify a significant shift in the crypto retail landscape. Traditional NFTs, such as profile pictures and artwork, have largely matured, with limited room for immediate growth. FriendTech enthusiasts find optimism in comparisons to NFT project floors like Bored Ape Yacht Club (BAYC) while skeptics point to subpar user experiences and a somewhat shaky underlying value proposition. Both sides present valid arguments, and the future trajectory of FriendTech remains uncertain. Nevertheless, it appears that FriendTech will continue to be a platform of interest in the crypto space.

Decentralised Finance (DeFi)

The decentralized finance (DeFi) giant Aave has forged a significant partnership with industry leaders, including Circle, the issuer of USD Coin, and Coinbase, to announce the creation of the Tokenized Asset Coalition (TAC). This newly established group is dedicated to driving the adoption of public blockchains, asset tokenization, and institutional DeFi. Initial activities planned by TAC include member discussions, a quarterly publication, participation in events, and the formation of working groups. According to the TAC Charter, the group’s overarching goal is to bridge the gap between traditional and crypto financial systems. Besides Aave, Circle, and Coinbase, other founding members encompass Coinbase’s Ethereum L2 Base, lending projects such as Centrifuge, Credix, Goldfinch, and the real-world assets analytics platform RWA.xyz. Notably, the TAC Charter emphasizes that membership is open to any team that shares the same vision, fostering inclusivity and collaboration.

In other noteworthy developments within the DeFi ecosystem, Yearn Finance, a pioneer in the field, has introduced its V3 documentation. Building on the massive successes of Yearn’s V1 (iearn) and V2, V3 introduces a significant enhancement by commoditizing V2. In the past, the creation and management of vaults within Yearn were exclusively controlled by the Yearn team, limiting participation opportunities. With V3, this dynamic shift allows individuals or projects to establish their vaults within the Yearn framework. For instance, a protocol with substantial reserves can leverage its idle funds to generate yield through its strategies within Yearn. The V3 documentation provides detailed information for those interested in exploring further. Furthermore, in September, Yearn launched its Ethereum liquid staking derivative (LSD) product, known as the yETH vault. This vault adopts a dual token model similar to Frax Finance’s Frax Ether, with a key advantage being diversification. The yETH vault pools various LSDs, including those issued by Lido, Coinbase, Stader Labs, Frax Finance, and Swell Network, into a single basket.

Additionally, Chainlink’s Cross-Chain Interoperability Protocol (CCIP), which debuted on multiple blockchains, including Avalanche, Ethereum, Optimism, and Polygon last month, expanded its reach in September with integrations on Coinbase’s rollup Base and Binance’s BNB Chain. A noteworthy development involving Chainlink was a series of successful experiments conducted in collaboration with Swift and several other financial institutions. These experiments demonstrated the successful transfer of tokenized value across public blockchains, involving key participants like BNP Paribas, BNY Mellon, The Depository Trust & Clearing Corporation, and Lloyds Banking Group. More details can be found in this Swift press release. Chainlink continues to maintain a dominant presence in the oracles market, boasting a market share exceeding 46% at the time of this report.

A month marred by exploits

The month of September 2023 proved to be a concerning period, marked by various exploits, hacks, and scams that collectively resulted in substantial losses amounting to approximately USD 332 million, as confirmed by CertiK. Among the different types of incidents that unfolded during the month, exit scams accounted for losses around USD 1.9 million, while flash loans contributed to approximately USD 400K in losses. However, the most significant contributor to the month’s total losses was exploits, which amounted to roughly USD 330 million.

One notable exploit occurred on September 23, when the Mixin Network, a Hong Kong-based decentralized cross-chain transfer protocol, suffered a severe breach leading to a loss of USD 200 million. This breach was attributed to a compromise of its cloud service provider. Another major incident unfolded on September 12, involving CoinEx, a cryptocurrency exchange, which experienced a suspected attack following a substantial outflow from four of its hot wallets. This breach resulted in losses exceeding USD 53.1 million across these hot wallets.

Additionally, on September 4, the gambling platform Stake fell victim to an attack that resulted in a loss of USD 41 million. During this incident, various cryptocurrencies of that value were received by an account before being dispersed to multiple addresses. Even high-profile individuals were not immune to the crypto-related challenges of the month, as entrepreneur Mark Cuban reported a personal loss of USD 900K due to a hack. These incidents underscore the need for heightened vigilance and security measures in the cryptocurrency space.

Visa partners with Solana

Over the last year, Visa has increasingly engaged with the cryptocurrency ecosystem, particularly focusing on Ethereum. However, the high expenses associated with using the Ethereum network contradict Visa’s emphasis on payment infrastructure. It is simply not economically feasible to conduct transactions directly on Ethereum, where transaction fees typically vary from USD 3-5. To address this issue, Visa has announced its integration with Solana which maintained an average transaction fee of USD 0.0002 during Q2 of this year. Visa has also been settling USDC (USD Coin) payments on the Solana chain.

Before Visa’s current involvement in this area, previous efforts like Solana Pay attempted to break into the payments sector. Gaining access to or directly integrating with merchants has proven to be the challenge. Visa however, has established relationships with merchant acquirers themselves, creating a strong network effect. Visa can now leverage its unique market position to collaborate directly with merchant acquirers, who naturally have distribution channels to retailers.

Privacy Pools conceptualised by Vitalik and others

Last month, the introduction of Privacy Pools marked an important development in the world of cryptocurrency privacy solutions. This innovative project boasts contributions from notable researchers, including Ethereum co-founder Vitalik Buterin, and aims to provide an alternative to Tornado Cash for privacy-conscious users. Tornado Cash, a DeFi protocol, allows users to conduct anonymous transactions on the Ethereum blockchain through the use of zero-knowledge proofs. Users can deposit and subsequently withdraw an equivalent amount of ETH that is unlinkable to the original deposit.

Initially designed to empower law-abiding individuals in protecting their identities, Tornado Cash inadvertently became a tool for illicit fund transfers, catching the attention of regulatory authorities. In 2022, the protocol’s smart contract faced sanctions from the US Office of Foreign Assets Control (OFAC). In response to this challenging environment, the Privacy Pools project emerged and is currently in the testnet phase. This innovative solution empowers privacy-focused users to safeguard their anonymity without inadvertently aiding malicious actors. Through Privacy Pools, users can demonstrate that their transactions belong to a low-risk association, reducing the risk of regulatory scrutiny and flagging. Those interested in exploring the technical details of Privacy Pools can refer to its comprehensive whitepaper for further insights.

Conclusion

As we draw the curtain on the tumultuous month of September 2023 in the ever-evolving world of cryptocurrencies and DeFi, we find ourselves reflecting on the multifaceted nature of this dynamic industry. Throughout this month, we have witnessed both the exhilarating highs and sobering lows that accompany the blockchain revolution. The formation of the Tokenized Asset Coalition (TAC), uniting industry leaders like Aave, Circle, and Coinbase, symbolizes the relentless drive to bridge traditional financial systems with blockchain innovation. This collaborative effort serves as a beacon of hope, showcasing the industry’s commitment to harmonizing these two worlds. However, the month was also punctuated by a series of crypto-related exploits, hacks, and scams that resulted in staggering losses. Exit scams, flash loans, and exploits left their mark, serving as a stark reminder that the crypto realm remains a volatile and, at times, treacherous frontier. These incidents underscore the urgency of reinforcing security measures and vigilance within the ecosystem. In this whirlwind of events, the crypto industry continues to evolve, adapt, and redefine itself. As we look ahead, we can only anticipate further innovations, challenges, and triumphs on this remarkable journey through the ever-shifting landscape of cryptocurrencies and DeFi. The journey is far from over, and the adventures that lie ahead promise to be as exhilarating as they are unpredictable.

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Authors

Yves Longchamp

Head of Research AMINA Bank AG

Sonali Gupta

Senior Research Analyst AMINA India

Anirudh Shreevatsa

Research Analyst AMINA India

Rishabh Nagar

Research Analyst AMINA India

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