Executive SummaryIntroductionBitcoinOther Payment ChainsEthereumOther Platform ChainsDecentralised FinanceConclusion
Thursday, 7 October, 2021
The Digital Investor
Scaling New Heights
September was a tumultuous month as good and bad news alternated. In the same month, bitcoin became legal tender in one country while another country banned all trading activities. In our view, bitcoin has shown enough resilience and maturity that adverse regulation, even from a large country like China, is more a speed bump than a death knell. On the positive side, Lightning Network is becoming the killer solution for micropayments as it was integrated for tipping on Twitter and adopted by millions of Salvadorans.
Table 1: Price performance in USD of the assets in coverage universe as of 30 September 2021
Source: SEBA Bank, Coinmetrics
September was a tumultuous month as all digital assets closed in the red. Unsurprisingly, Bitcoin outperformed in a down market, losing only 7%. The markets started the month strong in anticipation of El Salvador adopting bitcoin as legal tender on 7 September, nicknamed "Bitcoin Day". Bitcoin price increased above USD 50,000 on the day before crashing by 11% as traders “sold the news”. This is not the first time crypto overheats in the lead up to a positive event. One of the most prominent cases of this phenomenon was in the lead up to the Coinbase listing on 14 April, when bitcoin reached its all-time high at USD ~63,000, just the day before. The following days saw very high liquidations, and in the subsequent months, the bitcoin price declined by more than 50%, falling below USD 30,000 in July. It has recovered to USD 50,000 at the time of writing. We covered this phenomenon in our Crypto Market Monitor, “Sell the NewsSell the Newslink1”.
Figure 1: Open interest peaks in anticipation of good news; however, leads to high liquidations after the event
Source: SEBA Bank, Skew Analytics, Coinmetrics
In September, China extended the crypto ban to all digital asset trading activities. Since then, Huobi, an exchange focussing on China, has stopped opening new accounts from the region and will be closing accountsclosing accountslink1 of all Mainland China users by 31 December 2021.
Figure 2: Hash rate and network difficulty have recovered 50% from the bottom in July 2021
Source: SEBA Bank, Coinmetrics
September was not all negative news. “Bitcoin Day” was historic as bitcoin became legal tender in El Salvador. Individuals in El Salvador shared pictures of them buying foodfoodlink1 or coffeecoffeelink1 at multi-national chains using bitcoin. The Salvadoran president, Nayib Bukele, announcedannouncedlink1 that 2.1 million people were actively using the Chivo wallet. Last month also, Twitter integrated Lightning Network for users to tip each other. This is a significant development as it may encourage other large tech companies to incorporate crypto. Earlier, companies like Microsoft XboxMicrosoft Xboxlink1 and SteamSteamlink1 integrated Bitcoin as a payment solution, and recently Amazon published a job openingjob openinglink1 for a “Digital Currency and Blockchain Product Lead".
Figure 3: Sharp increase in the number of open channels and bitcoin capacity on the Lightning Network
Source: SEBA Bank, Bitcoin Visuals
Other Payment Chains
Litecoin had an exciting month as well. Fake newsFake newslink1 broke out that Walmart entered a partnership with the coin and will allow LTC payments across its online and offline stores starting 1 October 2021. This news spread quickly, with major news outlets like Reuters and CNBC publishing it. However, Globe News Wire, the publisher of the news, was duped by a person using a “walmart-corp.com” email address that is owned by a domain squatter.
Figure 4: NVT ratios of coins were lower in September compared to August
Source: SEBA Bank, Coinmetrics
Market capitalisation to realised value ratio or MVRV ratio is a more behavioural indicator, unlike the NVT, which is a more fundamental indicator. MVRV measures the degree to which holders are in profit, with holders more likely to sell at higher levels because of the disposition effectdisposition effectlink1 found in behavioural finance, where investors are more likely to sell their winners and hold on to their losers. On an absolute basis, LTC is the cheapest, with an MVRV ratio of just 1.1, followed by ETH at 1.7. Both BTC and XLM have an MVRV ratio of 2.1.
Figure 5: MVRV ratios of all coins have fallen during September
Source: SEBA Bank, Coinmetrics
In August, Ethereum implemented its last significant upgrade, EIP-1559, which changed its tokenomics. With almost two months since the update, we can measure the impact it has had on net inflation. Before EIP-1559, approximately 14,000 ETH were issued daily. Since 5 August, the average daily issuance has dropped to ~7,500 ETH. Despite the reduction of ETH issuance, the security budget of Ethereum has barely changed as miner revenues fell by a mere 5% since the implementation of EIP-1559 compared to July 2021. This means that Ethereum is as secure as ever, and there is no reason for miners to be dissatisfied.
Figure 6: Ethereum’s net inflation has halved while miner revenues are not significantly affected
Source: SEBA Bank, Etherscan, Coinmetrics
Inflation on Ethereum has an inverse relationship with the gas fee, with higher gas fees causing more burn and lower inflation. However, the high gas fee has also increased transaction costs making the blockchain more expensive to use. Let us take a moment to understand why gas prices are so high on Ethereum. Even as the gas fee is high, usage of the blockchain indicates that users continue to believe the benefit they derive from the transaction is greater than the transaction cost. Ethereum is the first and largest smart contract platform and has a culture of smart contract innovation. As new use cases for smart contracts are developed, they come first on Ethereum. This was seen in 2017 with ICOs, 2020 with DeFi and again this year with NFTs. As a new use case develops, early investors see huge returns on their capital. This brings new investors and new projects as it creates excitement around the new theme. Since investors expect a high return on capital, they are willing to pay a high transaction fee as the cost of doing business. However, since gas prices are the same across transaction sizes, slowly smaller investors get priced out. Other chains then give these users a cheaper way to invest by replicating the hot trend on their platforms.
Figure 7: Ethereum is slowly losing market share to competing platforms
Source: SEBA Bank, Defi Llama
Other Platform Chains
Polkadot and Cardano, two competing platforms to Ethereum, are still at an early stage. Polkadot does not yet have smart contracts, and while Cardano does support them, there are no significant implementations yet.
Table 2: Staking statistics of Ethereum, Cardano and Polkadot
Source: SEBA Bank, Polkadot, Staking Rewards, Stakers.info
Cardano recorded a significant increase in on-chain activity. Average active addresses increased by 51% to 151,000, and the average number of transactions increased by 85% to 89,000. On the other hand, Polkadot saw a steady increase, with average active addresses rising by 12% to 30,000 and average transaction count increasing by 28% to 183,000.
Figure 8: Cardano and Polkadot saw increased activity on the platforms in September
Source: SEBA Bank, Coinmetrics
Decentralised finance (DeFi) on Ethereum has suffered for multiple reasons. Gas prices are elevated, non-fungible tokens have become the dominant theme, and as we covered in the latest Digital RegulatorDigital Regulatorlink1, there is a regulatory overhang. Consequently, user growth has slowed to only 18% growth in Q3 2021 compared to 65% in Q2 2021. DeFi on Ethereum added only 535,00 new users in Q3 2021, with a total user base of 3.4 million.
Figure 9: DeFi user growth on Ethereum has sharply fallen
Source: SEBA Bank, Dune Analytics
While the data above captures only users on Ethereum, all DeFi protocols under coverage have diversified to Ethereum scaling solutions or alternate platforms. Uniswap and Synthetix have beta products on Optimism and Arbitrum, Aave is on Polygon and Avalanche, Yearn Finance has experimental vaults on Arbitrum, Polygon, Binance Smart Chain and Fantom, and ChainLink is going to be platform agnostic with services already on Polygon, Binance Smart Chain and Arbitrum and plans to expand to other chains as well. The strategy of going horizontal across platforms makes a lot of sense for these products as it allows them to diversify and capitalise on the success of any chain. As users move to other platforms, they are likely to already associate with these brands, giving them an edge over newer players.
Table 3: DeFi products are following the users and going multi-platform
Source: SEBA Bank, Project websites
Despite the slowdown, the DeFi space is not dormant. Uniswap rolled out an updaterolled out an updatelink1 to its trade routing algorithm. Orders can now route through multiple liquidity pools to reduce slippage. This improvement is especially relevant for larger trades, where interacting with only one pool would cause a higher amount of slippage.
September was a tumultuous month as good and bad news alternated. October has started on the right foot. We remain constructive in Q4 as adoption continues, and new developments are likely to create new opportunities. Scalability solutions are implemented, providing faster and cheaper transactions to end-users. In this context, the Lightning Network is an excellent example of how transformative scalability solutions are. Without it, El Salvador and Twitter would not be able to make bitcoin a unit for micropayments.
Table 4: Quarterly returns of BTC in USD
Source: SEBA Bank, Coinmetrics
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