Quarterly Blockchain Newsletter - Q3 2022

SECTION ONE: PERFORMANCE OVERVIEW

In the third quarter of 2022, the price of bitcoin (BTC) rose slightly, by 3.3%^[1], while the price of ether (ETH) rebounded by 31.6%^[2], resulting in YTD performances of -57.5% and -63.3%, respectively. Coin Metrics’ CMBI 10 Excluding Bitcoin Index, which measures the return of a basket of the next ten-largest crypto assets after bitcoin, weighted by their free-float market caps, finished the quarter up about 23.8%, resulting in a YTD performance of -68.2%.^[3] The table below shows that bitcoin and ether outperformed key traditional market indexes in the third quarter, although they are still lagging on a YTD basis.

FIGURE 1: Standard period returns (as at September 30, 2022)

Note: Returns greater than one year are annualized. Returns of ether are represented by the Fidelity Ethereum Index, bitcoin by the Fidelity Bitcoin Index, U.S. equities by the S&P 500 Index, U.S. growth equities by the NASDAQ Composite Index, Canadian equities by the S&P/TSX Capped Composite Index, and investment-grade bonds by the Bloomberg Global Aggregate Index. All returns are in base currency (US$, except for S&P/TSX Capped Composite, which is in CDN$) and gross of fees. The performance shown above is for illustrative purposes only and does not reflect the actual or hypothetical performance of Fidelity Advantage Ether ETF^TM or Fidelity Advantage Bitcoin ETF^TM (the “ETFs”), but rather reflects the performance of ether and bitcoin based on the price of ether and bitcoin as reported by the Fidelity Ethereum Index and the Fidelity Bitcoin Index, respectively. The ETFs are not index-tracking ETFs and may be subject to, among other things, management fees, brokerage fees and other fees and expenses. The Fidelity Ethereum Index was launched on December 31, 2020, and accordingly, data for ether that is for a period prior to the launch date is hypothetical back-tested data based on calculations of the hypothetical index price over that time period had the Fidelity Ethereum Index existed, using the Fidelity Ethereum Index’s existing index price calculation methodology. The Fidelity Bitcoin Index was launched on December 31, 2019, and accordingly, data for bitcoin that is for a period prior to the launch date is hypothetical back-tested data based on calculations of the hypothetical index price over that time period had the Fidelity Bitcoin Index existed, using the Fidelity Bitcoin Index’s existing index price calculation methodology. There could be material differences between back-tested performance and actual results. Past performance, whether actual or back-tested, is no guarantee of future results. Past performance is not indicative of future returns. For more information on the Index methodologies, please see https://research2.fidelity.com/pi/FidelityIndex/RebalanceSchedules. Investing directly in an index is not possible. 

FIGURE 2: Standard period volatility (as at September 30, 2022)

Note: Standard deviations are annualized based on monthly return data. Returns of ether are represented by the Fidelity Ethereum Index, bitcoin by the Fidelity Bitcoin Index, U.S. equities by the S&P 500 Index, U.S. growth equities by the NASDAQ Composite Index, Canadian equities by the S&P/TSX Capped Composite Index, and investment-grade bonds by the Bloomberg Global Aggregate Index. All returns are in base currency (US$, except for S&P/TSX Capped Composite, which is in CDN$) and gross of fees. The performance shown above is for illustrative purposes only and does not reflect the actual or hypothetical performance of Fidelity Advantage Ether ETF^TM or Fidelity Advantage Bitcoin ETF^TM (the “ETFs”), but rather reflects the performance of ether and bitcoin based on the price of ether and bitcoin as reported by the Fidelity Ethereum Index and the Fidelity Bitcoin Index, respectively. The ETFs are not index-tracking ETFs and may be subject to, among other things, management fees, brokerage fees and other fees and expenses. The Fidelity Ethereum Index was launched on December 31, 2020, and accordingly, data for ether that is for a period prior to the launch date is hypothetical back-tested data based on calculations of the hypothetical index price over that time period had the Fidelity Ethereum Index existed, using the Fidelity Ethereum Index’s existing index price calculation methodology. The Fidelity Bitcoin Index was launched on December 31, 2019, and accordingly, data for bitcoin that is for a period prior to the launch date is hypothetical back-tested data based on calculations of the hypothetical index price over that time period had the Fidelity Bitcoin Index existed, using the Fidelity Bitcoin Index’s existing index price calculation methodology. There could be material differences between back-tested performance and actual results. Past performance, whether actual or back-tested, is no guarantee of future results. Past performance is not indicative of future returns. For more information on the Index methodologies, please see https://research2.fidelity.com/pi/FidelityIndex/RebalanceSchedules. Investing directly in an index is not possible.

Macro drivers

Macroeconomic factors continued to play an important role in driving the prices of cryptocurrencies, as well as other risk assets. Throughout the third quarter, the correlation of bitcoin with major stock indexes remained high, at over 60%.

FIGURE 3: Rolling 90-business-day return correlation between BTC and stock indexes

Given their historically high volatility and the emerging nature of the asset class, cryptocurrencies are largely trading as risk assets. Investors are seeking to de-risk their portfolios amid tighter monetary policy and recession concerns, and we believe this has weighed on cryptocurrency prices, as reflected in the underwhelming YTD performances of bitcoin and ether. Bitcoin and ether prices were notably responsive to the release of key macroeconomic figures such as inflation and target interest rates. Some examples over the quarter are noted below.

• July 13: BTC and ETH prices dipped in response to higher-than-expected U.S. CPI data (9.1% in June, compared with 8.8% expected)^[4], which reached the highest level in more than 40 years. BTC fell by 4.5% in the minutes after the CPI figure was released, dropping below $19,000 before recovering above $20,000.
• July 27: BTC increased by over 8% following the announcement by the Federal Reserve (the Fed) that it was raising interest rates by 75 basis points^[5]. ETH prices rose 16% that day, in part due to the rate decision and in part due to the successful implementation of a test software update related to the Merge (see below) two days earlier than expected.
• August 10: July U.S. CPI inflation came in below expectations at 8.5% (compared with 8.7% expected). BTC climbed 4% in the hours following the release of the CPI before slowing later in the day.
• August 19: BTC and ETH plunged nearly 10%, falling in sync with traditional markets amid renewed fears that the Fed and other central banks will have to get more aggressive in fighting inflation. The decline started with unexpectedly high inflation data in Germany.
• August 26: BTC and ETH dropped after Fed Chair Jerome Powell doubled down on restrictive monetary policy at the Fed’s Jackson Hole economic symposium.
• September 13: BTC and ETH prices fell on the release of August U.S. CPI data, which showed an unexpectedly high 8.3% increase in prices (compared 8.1% expected).
• September 21: BTC and ETH traded slightly lower following the Fed’s expected 75-basis-point interest rate decision.

Selling pressure seems to have eased off recently, as evidenced by data tracked by ByteTree Asset Management that show the amount of BTC held by U.S. and Canadian closed-ended funds and Canadian and European ETFs has ranged between 833,000 BTC and 842,000 BTC since mid-June.^[6] It is interesting to note that over the week following the Fed’s rate hike on September 21, BTC and ETH held up rather well, while stock indexes declined and the British pound crashed to an all-time low against the U.S. dollar. BTC also rose after the Bank of England said on September 28 that it would intervene to stabilize the U.K. bond market; the announcement raised hopes that central banks might soon abandon the policy tightening that has shaken crypto and traditional markets alike this year.^[7] Relative BTC stability amid the recent decline in fiat currencies such as the pound, renminbi and yen seems in line with its “alternative store of value” narrative. At least in the short term, macro factors could likely continue to drive cryptocurrency prices as the crypto market adjusts to a new macroeconomic paradigm of not-so-easy money.

CeFi drama

Bitcoin’s price volatility was relatively subdued in the third quarter, with BTC largely trading sideways in the range of $19,000 and $24,000 for most of the period^[8]. This period of relative stability followed significant volatility in the second quarter that was caused by a series of negative crypto-related headlines, in addition to general macro pressures on risk assets. As a reminder, the second quarter saw the implosion of LUNA and the Terra blockchain network, followed by insolvency concerns regarding multiple crypto-related companies, including crypto lender Celsius Network and crypto hedge fund Three Arrows Capital (3AC). These events led to a slew of layoffs, bad debt and bankruptcy filings throughout the crypto industry.

The fallout from these events continued into the third quarter. Shortly after the start of the quarter, 3AC and Celsius, as well as crypto lenders Voyager Digital and Vauld Group, all filed for bankruptcy protection, in the first half of July. Vauld reportedly owes more than $400 million to its creditors, with 90% of that amount deposited by individual retail investors.^[9],[10] Voyager filed for Chapter 11 bankruptcy protection in the U.S. Southern District Court of New York, estimating that it had more than 100,000 creditors and somewhere between $1 billion and $10 billion in assets. It also recorded the same range for its liabilities.^[11] On July 28, the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve Board issued a joint cease-and-desist letter to Voyager, directing the firm to remove “false and misleading” statements that its user’s deposit accounts are FDIC insured.^[12] In September, Voyager initiated the process of selling its assets, attracting leading bids from crypto exchanges FTX and Binance.^[13] On September 27, the winning bidder for Voyager’s assets was announced to be FTX.

Celsius filed for Chapter 11 bankruptcy on July 13, indicating that it held $4.3 billion of assets and $5.5 billion of liabilities.^[14] The company is currently going through bankruptcy proceedings. In September, a new filing from the Vermont Department of Financial Regulation suggested that Celsius had been effectively insolvent as early as 2019.^[15] Celsius has admitted that “the company had never earned enough revenue to support the yields being paid to investors.” The filing also suggests that “at least at some points in time, yields to existing investors were probably being paid with the assets of new investors.” Although regulators didn't use the term, this fits the definition of a Ponzi scheme. Vermont regulators stated their support for the appointment of an independent examiner with broad powers to investigate Celsius, including investigating whether Celsius “improperly deployed assets to manipulate the market price of CEL (a token issued by Celsius), thereby artificially inflating the value of the company’s net position in CEL on its balance sheet and financial statements.”^[16]

The failure of these centralized crypto companies, however, does not call into question the fundamental functionality and value proposition of blockchain technology, which is based on the idea of creating decentralized systems. The increased regulatory scrutiny resulting from recent events may accelerate regulatory developments in crypto and enhance the stability of centralized actors who play a role in the broader blockchain ecosystem, which may contribute to cryptocurrency adoption in the long run. Singapore’s central bank, for example, is considering introducing further safeguards on access to crypto among the general public, following the collapse of various crypto projects based in the country.^[17] In addition, Terra’s collapse brought into focus the systemic importance of stablecoins, spurring stablecoin-related legislative efforts across major jurisdictions.

The Merge

Despite bitcoin’s relatively flat performance in the third quarter, ether’s price went up over 30% over the quarter^[18]. This is largely due to positive sentiment regarding the Merge, an event that completed Ethereum’s transition from proof-of-work (PoS) consensus to proof-of-stake (PoS) consensus. Consensus mechanisms allow blockchain networks to decide on new blocks to add to the blockchain. In PoW consensus, “miners” expend computing power for the chance to propose new blocks and earn associated rewards. In PoS consensus, “validators” deposit cryptocurrency as stake in the network for the chance to propose new blocks and earn associated rewards.

Ether’s price increased on July 6 and August 10, in response to the successful transition of the Sepolia and Goerli testnets to PoS on those dates. (“Testnets” are test networks used to stage dress rehearsals of software upgrades before they are implemented on the main Ethereum network.)

The Merge was successfully completed at 2:43 am ET on September 15. Ethereum is now a PoS blockchain. Currently, about 14 million ETH have been staked, representing around 12% of total ETH supply (see chart below). It is important to note that staked ether and associated validator rewards cannot be withdrawn until after an upgrade following the Merge, called the Shanghai upgrade (expected to occur six to 12 months following the Merge). Even after the Shanghai upgrade, staked ether may not be very liquid. Withdrawal times will depend on how many other people are actively trying to withdraw. Only six validators may exit per epoch (every 6.4 minutes, so 1,350 validators, or about 43,200 ETH per day), and this limit will decrease to as low as four as more validators withdraw, to prevent large amounts of staked ETH from leaving at once.^[19] Therefore, there may be an exit queue that could delay withdrawals for days, weeks or even months.

FIGURE 4: Total ETH staked on consensus layer

PoW mining consumes large amounts of energy. The Bitcoin network, which uses PoW, is often criticized for its environmental impact. The transition to PoS consensus is expected to decrease Ethereum’s energy consumption by 99.9%.^[20] In addition, the transition to PoS helps prepare the Ethereum network for future upgrades related to scalability (making transactions faster and cheaper) and to decentralization, both important areas of development for Ethereum. Ethereum’s co-founder Vitalik Buterin has said that Ethereum’s development is only 55% complete after the Merge.^[21]

However, PoS is less battle-tested in terms of security than PoW. PoS design is also more complex to implement, and may introduce new vulnerabilities that could undermine the security of the network. Since in PoS, ether is the resource that determines influence over network consensus, another potential concern is centralization risks related to the concentration of ether ownership, as well as the concentration of staking activity among a few staking service providers. The chart below shows that the top three staking entities currently control more than 50% of the stake on Ethereum’s PoS network. In the hours following the Merge, it was noted that crypto exchange Coinbase and decentralized staking protocol Lido added over 40% of the network’s new blocks.^[33] Ethereum’s development goal of making it easier for the average user to run an Ethereum node aims to address such centralization risks.

FIGURE 5: Staked ETH distribution by staking entity

After the Merge, the amount of new ether issued per day is expected to decrease by about 90%.^[23] This is because rewards for PoS validators are much lower than the rewards that were issued to PoW miners, since operating a validator node is not as economically intense as being a miner. The decrease in the issuance rate is expected to bring the net issuance rate to zero or less. The exact monetary inflation rate going forward is uncertain, because there is variability both in terms of the amount of new ether created through validator rewards and the amount of ether burned (destroyed) as transaction fees in accordance with EIP-1559. Therefore, ether is expected to go from being an inflationary coin to a disinflationary or deflationary coin, which may have a positive impact on ether’s price. The fact that people can stake ether and earn yield on their stake may also have a positive impact on the price of ether.

Since the Merge, ether’s price has decreased by about 10%. This is in part due to a general market decline in the second half of September. It could also be a case of investors “buying the rumour and selling the news,” In addition, miners selling their ether have weighed down the price of ether. Around the time of the Merge (September 12 to September 19), Ethereum miners dumped over 16,000 ETH, worth more than $20 million. The decline reduced the miners’ combined balance to about 245,000 ETH.^[24] As miners no longer have an economic alignment with the network, these sales could continue to be a source of downward pressure on ETH in the short term, although it should be noted that the miners’ remaining holdings represent only a small fraction of the current total ETH supply of 119 million.

For those who wish to explore in further detail the mechanics of Ethereum’s PoS mechanism, the associated goals and risks, the transition process, the EthereumPoW fork, etc. I’ve written a dedicated piece on the Merge, available on fidelity.ca.

SECTION TWO: ADOPTION

FIGURE 6: Total value transferred on the Bitcoin and Ethereum networks

FIGURE 7: Daily number of active Bitcoin and Ethereum addresses (rolling 30-day average)

In July, Russian President Vladimir Putin signed a law banning digital payments across the nation.^[25] The law bans the use of digital securities and utility tokens as a means of payment for goods and services in Russia, adding to the previous digital asset law drafted in 2020, which banned cryptocurrencies from being used in payments.^[26]

In August, Coinbase announced a partnership with BlackRock, the world’s largest asset manager, to provide institutional clients of Aladdin®, BlackRock’s end-to-end investment management platform, with direct access to crypto, starting with bitcoin, through connectivity with Coinbase Prime. Coinbase Prime will provide crypto trading, custody, prime brokerage and reporting capabilities to Aladdin’s institutional client base who are also clients of Coinbase.^[27] Joseph Chalom, Global Head of Strategic Ecosystem Partnerships at BlackRock, said that their institutional clients are “increasingly interested in gaining exposure to digital asset markets and are focused on how to efficiently manage the operational lifecycle of these assets.”

In September, a consortium of broker-dealers, global market makers and venture capital firms, including Charles Schwab and Fidelity Digital Assets, announced the upcoming launch of crypto exchange EDX Markets (EDXM).^[28] EDXM will enable a highly liquid cryptocurrency ecosystem that aggregates liquidity from multiple market makers to reduce spreads and improve transparency. EDX will open for a pilot round of trading in November and is expected to officially launch in January.^[29]

In September, Nasdaq, the second-largest U.S. stock market operator, announced the launch of Nasdaq Digital Assets, a new group focusing on digital assets that will start by offering BTC and ETH custody services for institutions.^[30] Nasdaq is also expanding its anti-financial crime technology to weed out money laundering, fraud and market abuse in digital assets.^[31]

Crypto in South America

In countries facing high inflation and currency devaluation, stablecoins and other crypto assets can offer a way for people to store value, without running into the restrictions and risks associated with acquiring and storing foreign currency through traditional institutions.

In July, stablecoin purchases in Argentina rose following the resignation of Argentina’s economy minister Martin Guzmán as consumers sought to protect themselves against devaluation of the Argentine peso and high inflation.^[32] Inflation in Argentina is expected to hit 95% this year.^[33] In 2001, in the midst of an economic crisis and widespread capital flight amid concerns of peso devaluation, the government froze bank accounts and blocked withdrawals from U.S. dollar-denominated accounts in a process known as “corralito.”^[34] This led to a lingering distrust of institutions in the nation, which has fostered the adoption of crypto assets.

In August, crypto exchanges in Chile reportedly saw a 50% increase in stablecoin transactions over the past three-month period. Chileans increasingly turned to stablecoins to protect their assets from recent record inflation and peso devaluation.^[35] In June, the country’s annual inflation rate surged to 12.5%, its highest level in 28 years.^[36]

Crypto in Sub-Saharan Africa

In September, blockchain analytics firm Chainalysis published a report outlining crypto usage in Sub-Saharan Africa. Although the region accounts for only around 2% of on-chain transaction volume globally, Chainalysis notes that Africa contains some of the most well-developed cryptocurrency markets of any region, with deep penetration and integration of cryptocurrency into everyday financial activity for many users.^[37] Nigeria and Kenya rank 11th and 19th on Chainalysis’ 2022 Global Crypto Adoption Index; these countries exhibit strong adoption when weighted for purchasing power and population, especially on P2P exchanges.^[38]

According to the report, Sub-Saharan Africa’s retail market and outsized usage of P2P platforms make it unique compared with other regions. Retail transfers make up 95% of all transfers, with small retail transfers under $1,000 accounting for 80% of all transfers, more than in any other region.^[39] Crypto usage in the region is driven primarily by everyday necessity, as opposed to speculation. Chainalysis contrasts affluent Western countries that use crypto to increase wealth with poorer African countries that use crypto to preserve and build wealth amid unfavourable economic conditions.^[40].

SECTION THREE: OTHER KEY DEVELOPMENTS

General

Spotlight: U.S. imposes sanctions on Tornado Cash

 In August, the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) added Ethereum addresses related to mixing protocol Tornado Cash to its list of sanctioned entities.^[41] This marks the first time that the U.S. government has imposed sanctions on a smart contract application. As a result of the sanctions, all individuals and entities in the U.S. are prohibited from using the application, directly as users or indirectly through third-party services.^[42] Tornado Cash is a cryptocurrency mixing service that operates on Ethereum and other blockchains. It is used to obfuscate the transaction trail of on-chain transactions. OFAC indicated that it was sanctioning the protocol for anti-money laundering reasons.^[43] Tornado Cash has mixed over $7.6 billion worth of ETH since launching in August 2019, and almost 30% of the funds sent through it have been tied to illicit actors, including Lazarus Group, a major North Korean hacking organization.^[44] However, it is also a protocol that is used largely for legitimate purposes, to improve user privacy. Vitalik Buterin, the Ethereum co-founder, has admitted to using Tornado Cash to donate to Ukraine.^[45]

Due to the immutability properties of blockchain, the Tornado Cash application still exists and remains accessible on Ethereum. However, since the sanctions, various points of centralization have contributed to making access to this protocol difficult for many users. For example, third-party node operators such as Infura and Alchemy began blocking requests to Tornado Cash.^[46] This affects users of MetaMask, the most widely used Ethereum wallet, which relies on Infura by default to interact with Ethereum. In addition, Tornado Cash’s Discord server was shut down, its code was removed from GitHub (although this was relisted on September 22), its USDC holdings were frozen by the stablecoin’s issuer Circle, and several major DeFi apps, including Aave, Uniswap and Balancer, began to prevent use of their own front-end interfaces by crypto wallets tied to Tornado Cash.^{[47],[48],[49],[50]}

The sanctions against Tornado Cash sparked outcry from the crypto community, especially after the arrest of Tornado Cash developer Alexey Pertsev.^[51] The sanctions do seem to mark an unprecedented reproach of computer code. In September, major crypto exchange Coinbase announced that it is funding a lawsuit against the U.S. Treasury over the Tornado Cash sanctions. In a blog post, Coinbase highlights concerns that these sanctions harm innocent people and stifle innovation, arguing that the Treasury “acted outside its authority” – that is, while the Treasury can sanction people (along with their property), Congress never gave it the power to sanction open-source software.^[52] Rather colourfully, Coinbase offers the analogy that “sanctioning open-source software is like permanently shutting down a highway because robbers used it to flee a crime scene.”^[53]

The sanctioning of Tornado Cash has brought blockchain’s centralization risks into focus. Various points of centralization undermine the principle of decentralization on which elements of Ethereum’s value proposition, notably censorship resistance, depend. Improving decentralization is one of the key elements of Ethereum’s development road map, and may reinforce the network’s resilience to government sanctions.

Solana Labs accused of violating securities law: In July, a class action lawsuit was filed in a California federal court against Solana Labs, a company that works on the development of the Solana blockchain, and related parties.^[54] The lawsuit was filed by Mark Young, an investor who purchased the SOL token in August and September 2021, on behalf of himself and all others similarly situated.^[55] In the complaint, Young describes Solana as a highly centralized cryptocurrency whose insiders have benefited at the expense of investors.^[56] Young accuses the defendants of making enormous profits through the sale of SOL to retail investors in the U.S., “in violation of the registration provisions of federal and state securities laws.”^[57] This development highlights a key issue: that although blockchain networks aim to be decentralized in principle, many of these networks remain quite centralized from various perspectives in practice. It also echoes the ongoing uncertainty regarding cryptocurrencies and securities regulation. In June, in an interview with CNBC, SEC Chair Gary Gensler reaffirmed the SEC’s view that bitcoin is not a security, but refrained from extending the label to any other cryptocurrencies.^[58] To date, the SEC has settled with and extracted fines from many token projects over the years regarding unregistered offerings.^[59]

Chainalysis estimates $2 billion stolen from cross-chain bridge hacks so far this year: In August, blockchain analytics company Chainalysis published a report estimating that $2 billion worth of crypto has been stolen from cross-chain bridges this year.^[60] Cross-chain bridges are used to send tokens between blockchains. While bridge designs vary, it usually involves users sending funds to the bridge protocol on one chain and locking the funds into a contract. Users are then issued corresponding funds on another chain to which the protocol is bridged. According to Chainalysis, bridges are an attractive target because they often feature a central storage point of funds (funds locked up in a smart contract or stored with a centralized custodian) that back the “bridged” assets on the receiving blockchain.^[61] A notable cross-chain attack this year was the Ronin Bridge exploit, which saw the protocol lose $625 million in ether and USDC after being targeted by North Korean hacking group Lazarus.^[62] Interoperability between blockchain networks is a major area of development, with many new models still being developed and tested. Usually, they introduce an additional intermediary layer that coordinates the bridging, which can have adverse security implications.

Coinbase launches a liquid staked ETH derivative token: In August, Coinbase launched its own liquid staking token, called Coinbase Wrapped Staked ETH (cbETH).^[63] Liquid staking issues users who have staked their ETH (see section on the Merge above) with a token representative of their staked ETH, which they can use for other purposes (e.g., in DeFi protocols). These representative tokens can be used to claim the underlying staked assets. Coinbase is currently the second-largest staking entity on Ethereum, behind decentralized staking protocol Lido. The launch of cbETH, an ERC-20 token, allows Coinbase to compete with Lido in the liquid staking market. Once staked ETH withdrawals are enabled on the network, cbETH will be redeemable for the underlying staked ETH, plus accrued staking rewards earned by Coinbase’s validator node operators. Coinbase notes that ETH and cbETH are not expected to be interchangeable on a 1:1 basis: as the underlying staked ETH continues to accrue rewards, each cbETH token is expected to represent more staked ETH, which may result in a divergence in prices for these assets over time.^[64]

U.S. in the process of drafting a stablecoin bill: The House Financial Services Committee is preparing a bill that would regulate stablecoins. The draft bill would allow both bank and non-bank entities to issue stablecoins.^[65] Bank issuers would seek approval from their typical federal regulators, such as the OCC, while non-bank issuers must first get approval from state regulators and then register with the Federal Reserve.^[66] Meanwhile, the draft bill would impose a two-year ban on the new issuance of “endogenously collateralized” stablecoins, defined as stablecoins that “rely solely on the value of another digital asset from the same creator to maintain their fixed price.”^[67] This category seems primarily to be targeting algorithmic stablecoins such as UST, whose de-pegging from the U.S. dollar in May resulted in the collapse of the Terra blockchain. The draft legislation would mandate a study of Terra-like tokens from the Treasury in consultation with the Fed, the OCC, the FDIC and the SEC.^[68] The use of “solely” and “same creator” in the draft definition does seem overly specific, however, and may not apply to most stablecoins. While the draft bill is indicative, the bill has yet to be finalized.

DeFi

Uniswap may turn on its fee switch: In July and August, a proposal to turn on fees accruing to the Uniswap protocol passed through the first two phases of Uniswap governance.^[69] Uniswap is a major decentralized exchange application on Ethereum. Despite its popularity, the protocol itself has yet to amass revenue; as to date, all protocol fees have been paid to liquidity providers (people who contribute liquidity to the protocol’s liquidity pools). This may be about to change, however, due to a proposal by Leighton Cusack, the founder of PoolTogether, to turn on what’s called a “fee switch,” such that the Uniswap DAO may accrue a portion of the fees earned by liquidity providers for selected pools.^[70] Specifically, the proposal suggests taking a 10% cut of liquidity provider fees for three pools (ETH-DAI, ETH-USDT and ETH-USDC) for a predetermined period, as part of a trial approach.^[71] This proposal highlights the ongoing debate as to the extent that DeFi revenue should favour users versus token holders. If Uniswap turns on the fee switch, it risks losing market share, as liquidity providers may switch to other platforms if they see their margins compressed. It should be noted, however, that many other major decentralized exchanges (e.g., Curve, Balancer, SushiSwap) take a cut of liquidity provider fees, which should mitigate this concern.

Aave to launch its first stablecoin: In August, the Aave community passed a proposal to launch a native crypto-based stablecoin, GHO.^[72] Aave is a major decentralized borrowing and lending platform, and GHO will be Aave’s first native stablecoin. To maintain its peg to the U.S. dollar, GHO will rely on over-collateralization and arbitrageurs to step in when the stablecoin’s price deviates from $1. If a user repays a borrow position (or is liquidated), the GHO protocol would burn that user’s GHO. Interest payments on the stablecoin will be sent to the protocol’s decentralized autonomous organization (DAO), generating revenue for the community, and allowing the DAO to bolster its treasury for funding future projects.^[73] GHO is comparable to MakerDAO’s DAI stablecoin, in that it is decentralized and crypto-collateralized. These stablecoins differ from centralized, fiat-backed stablecoins such as USDT or USDC. It will be interesting to see how GHO’s reserve profile develops, as DAI is commonly criticized regarding the centralization and censorship risks of relying on USDC for significant portions of its collateral.

Solana’s TVL revealed to be largely fake: In August, an investigation led by CoinDesk revealed that two brothers, Ian Macalinao and Dylan Macalinao, used pseudonymous developer profiles to inflate the TVL on Solana by $7.5 billion.^[74] This $7.5 billion made up a substantial portion of the roughly $10.5 billion of TVL on Solana in early fall of 2021.^[75] TVL (total value locked) refers to the total value deposited in DeFi protocols and is often seen as a key metric to measure DeFi activity on various blockchains. According to the CoinDesk investigation, Ian Macalinao had been building projects as 11 purportedly independent developers to create a vast web of interlocking DeFi protocols.^[76] “I devised a scheme to maximize Solana’s TVL: I would build protocols that stack on top of each other, such that a dollar could be counted several times,” Ian wrote in a never-published blog post reviewed by CoinDesk.^[77] Solana’s inflated TVL helped spur the narrative that it was an emerging competitor to Ethereum and contributed to driving the price of Solana’s native token, SOL, from under $40 in July 2021 to a peak of $259 in November 2021.^[78]

NFTs

Reddit partners with Polygon to launch NFT store: In July, Reddit announced a partnership with Polygon for its new NFT avatar marketplace that allows users to purchase NFT profile pictures.^[79] This feature does not need a crypto wallet, allowing users to easily purchase the NFTs via credit or debit cards. These NFTs would be minted on Polygon and can be stored on Reddit’s own custodial crypto wallet, Vault.^[80] For each NFT sold through its avatar marketplace, Reddit keeps 5% of the sale and gives the remaining 95% to the artist. ^[81] The artist also receives a royalty from each secondary sale, similar to how many other profile picture NFTs operate today.^[82]

Tiffany & Co. unveils CryptoPunk necklaces: In August, Tiffany & Co. debuted and quickly sold out a limited collection of 250 custom jewel-encrusted pendants for holders of CryptoPunks, a popular NFT collection.^[83] CryptoPunks was launched in 2017 and consists of 10,000 unique 8-bit-style generated characters stored on the Ethereum blockchain. The necklaces were only available for CryptoPunk holders to purchase in the form of NFTs redeemable for the physical necklaces.^[84] This is yet another example of how NFTs can be used as access passes that can be tied to various exclusive privileges.

Meta lets users post their NFTs on Facebook and Instagram: In late August, Meta announced that it would allow users to post their NFTs on Facebook, after rolling out NFTs on Instagram earlier that month to 100 countries.^[85] Meta supports NFTs from the Ethereum blockchain, Polygon and Flow, a blockchain best known for NBA Top Shot. Flow’s native token FLOW rallied on the news of the Facebook integration.^[86] On September 29, Meta announced that everyone on Facebook and Instagram in the U.S. can now connect their wallets and share their digital collectibles.^[87] These integrations could expose vast new audiences to crypto collectibles due to Facebook and Instagram’s wide network of users.

Metaverse

Reality Labs posts its seventh straight quarter of losses: In July, it was reported that Meta lost $2.8 billion on $452 million in revenue from its virtual reality division, Reality Labs, during the second quarter.^[88] Meta’s Quest 2 headset is currently the most popular VR headset on the market, although the overall market remains relatively small.^[89] During Meta’s second-quarter earnings call, CEO Mark Zuckerberg acknowledged that such losses could continue for several more years until VR applications and its metaverse platform are mature enough to tap into the “massive opportunity” worth “hundreds of billions of dollars.”^[90]

Epic Games “definitely won’t” follow Minecraft NFT ban: In July, Minecraft's developer Mojang Studios said that it would be excluding the integration of NFTs, alongside blockchain technology as a whole, on its popular virtual world platform, citing the speculative aspect of NFTs, among other reasons.^[91] Following this announcement, Tim Sweeney, the founder and CEO of Epic Games, the company behind the virtual world platform Fortnite, said that his firm “definitely won’t” follow Minecraft in banning NFTs.^[92] It remains to be seen to what extent various metaverse-like platforms will incorporate aspects of blockchain technology.

Walmart enters the metaverse with Roblox experiences: In September, Walmart announced that it is entering the metaverse with two experiences, Walmart Land and Walmart’s Universe of Play, on gaming platform Roblox.^[93] The retail giant’s first foray into the virtual world will feature a blimp that drops toys, a music festival with hot artists, a number of different games and a store of virtual merchandise that matches what customers may find in Walmart’s stores and on its website.^[94] Walmart’s marketing chief, William White, said the company will use Roblox as a testing ground as it considers other moves in the metaverse and beyond.^[95]