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October 7, 2022
Optimism in the Bear

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I. Entering the Bear

We began allocating back into crypto venture funds earlier this year (March 2022) with the thesis that i) crypto is on the edge of hyper-adoption and ii) sometime in the next 12-18 months, we could be presented with a similar investing environment to what we saw as LPs in 2018. 

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In 2018 Bitcoin plunged from its all time high of nearly $20,000 in Dec 2017 to just over $3,000 at the end of 2018 (-85%). Most other coins experienced even worse free-fall as short-term speculators fled and mass media declared “bitcoin is over”. Also during the thrash of that bear, and into the sideways markets of 2019, many of our fund managers deployed into what would become some of the best-returning crypto assets of the last 5 years (OpenSea, Filecoin, Solana, dydx, Near, Polkadot, Cosmos etc..). 

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Our belief with investing in crypto venture in the bear is that amidst the current market, best-in-class returns will be generated by many of the same fund managers who’ve seen this story before, who’ve demonstrated to the crypto ecosystem that they’ll join founders in the trenches, and who’ve helped the best builders make it to greener pastures on the other side. 

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What we did not expect in Q1 was that such a sharp drawdown in markets would come as soon as it did. Internally we had expected that, if a downturn came and even half of our capital was deployed into that down market, we’d have strong positioning. As it turns out, ~80% (assuming the bear lasts for the duration of our deployment period) will be invested at valuations that are roughly 50-70% off the peak of what they were last year. This stands in stark contrast to funds that were raised and deployed in the ebullience of the 2021 bull (when we sat on the sidelines).

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Even more important than valuations coming down is that the space has been largely de-noised. The tourists have left. The froth is gone. And largely who remains are gritty founders building for the right reason: long-term valuation creation. 

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Market Outlook for Q4

In light of the media’s return to the “crypto is dead” narrative, we thought it’d be helpful to check back on the following themes:

  • i) Developer Adoption
  • ii) Consumer Traction 
  • iii) Institutional Adoption 

To be clear, hyper-adoption has clearly not yet (6 months later!) arrived. But beneath the surface of painful macro conditions, devastating falls from all time high prices, and heightened public skepticism…we see endurance on all three of these fronts.

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i) Developer Adoption

One of our core beliefs from past cycles has been that, even amidst a down market, developer activity would continue to flourish.  The slide below highlighted the quantity and quality of projects that were built in that 2018/2019 downturn from the developers who stuck around: 

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The market tumult of 2022 is testing this thesis in full force: by the of end of Q3 2022, the global crypto market cap was down -58% YTD, the NFT market cap had declined -67% in $$ value from Q2, and non-crypto macroeconomic and geopolitical concerns were more present than ever.

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Still, on-chain developer activity continues to grow. Despite ETH declining more than -65% in price, developer activity as measured by verified smart contract deployments in Q3 was up by over +40% YoY and up by more than +50% YTD vs 2021. To put that into context, that means that over +35% of all smart contracts ever deployed and verified have been deployed in just 2022 YTD alone. 

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Verified Ethereum Smart Contracts Deployed by Year

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In Q3, developers downloaded the Ether.js and Web3.js libraries (two of the core tools for building web3 applications) at an unprecedented rate (+178% YoY):

What we believe will be more meaningful and not yet captured in the above metrics, is that these developer commits are necessarily going more towards projects with real utility and less towards liquidity-driven musical chairs and unsustainable yield chasing. 

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ii) Consumer Traction (spotlight: NFTs & web3 social)

NFTs - Despite Q3 NFT trading volume dipping to $2.71 billion (-67% from Q2), transaction count was actually up +8.3%. In September, trading volume increased 10.4% vs. August, with transactions again outpacing at 21% month over month growth. The number of unique NFT holders increased by 35% compared to Q3 2021. 

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The NFT landscape has and will continue to evolve – in Q3, for example, Ethereum NFTs accounted for 91% of the total $$ trading volume but only 26.2% of transaction count as lower-cost NFTs on chains like Solana began to launch. We believe these and other growing pains will lead to use-cases built for everyday people (not just collectors) and higher fidelity product market fit for NFTs. If and when that happens our exposure should be well-positioned to participate across all aspects of the stack.

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Web3 Social - Social Media as we know it today emerged with Facebook (2004) and Twitter (2006), which then set the stage for Instagram (2010), Snapchat (2011), TikTok (2016). The lifeblood of each platform is ad revenue driven off insights from user data. The user and creator are guests in the platform’s digital domain, unable to actually own their content, own their relationship with their followers, or change what algorithmic media they see. The platform is the gatekeeper who must prevent the user from taking value anywhere else. Meanwhile, the walled garden is easily overtaken by bots that engagement farm at the expense of real users’ experience and discourse. All the while, the user builds value for the platform at risk of being deleted, losing everything, at any point the platform decides. The list goes on…

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A new model is emerging, enabled by crypto rails, that treats the “social graph” as an open database rather than a walled garden. Each user owns their own social graph, their data, their followers, and their content because anything the user does is tied to their unique wallet address and blockchain history at the protocol layer.  

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The result is an open source social network like Farcaster where any of the following are possible:

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  1. No Ads / Optional Ads - protocol can capture revenue to its treasury via use. Users can choose to monetize their data by allowing ads to be served to them or not. Farcaster plans on using a subscription model so that the platform’s incentives are aligned with better user experience. 
  1. Spam-resistant - users are authenticated via crypto wallets, along with whatever degree of authentication (eg: Quadrata passport, NFT, on-chain reputation) is desired. 
  1. Censorship-resistant - the code and protocol are open source and immutable. The data is and will always be there, so if the core team misbehaves, users can fork the code and move to a new version, fully-restored. This also puts a limit on protocol rent extraction. 
  1. Emergent Ecosystem of Clients - imagine being able to create your own private Twitter client where access is token-gated by a specific NFT, on-chain credential, or proof of specific on-chain behavior. Imagine being able to build or use a client that overlays whatever algorithm you feel is most healthy for you. The data is composable for the community to experiment. See some early examples from the Farcaster ecosystem below.
  1. Efficiency of Distributed Team - relative to web2 centralized social networks, much of the value in web3 social will be built and captured by the community, allowing for a leaner core team (ie: not the +30,000 engineers employed full time by Meta). 

Already dozens of user built Farcaster clients have emerged – these are permissionless dapps built on top of the Farcaster protocol, each better and more quickly brought to market by a community member than anything the Farcaster core team could do on its own:

The dialogue and traction on Farcaster feel incredibly authentic, the creativity very real, and the user growth very real. Not surprisingly, there’s a Farcaster client to visualize Farcaster data:

Farcaster.network Snapshot (Oct. 28, 2022)

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Farcaster.network Snapshot (Oct. 28, 2022)
Farcaster.network Snapshot (Oct. 28, 2022)

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iii) Institutional Adoption - one very different aspect of this bear market vs. 2018/2019 is that institutional and large corporate players are sticking around. They’re taking advantage of the quiet period to integrate, build, and be ready for when the next wave of mass adoptions comes. In just the last couple months (click dates to read): 

  • Twitter is now testing NFT Tweet Tiles, allowing users to buy/sell NFTs via tweets (Oct 27, 2022)
  • Newly-elected UK prime minister, Rishi Sunak, wants to make UK a crypto hub (Oct 27, 2022)
  • Cash App (over 44 million monthly active users) added support for Bitcoin Lightning Network (Oct 27, 2022)
  • Fidelity will begin offering ETH to institutional clients at by October-end (Oct 25, 2022)
  • Banking API giant Plaid launched its first web3 product, integrating with +300 EVM wallets (Oct 25, 2022)
  • Reddit announced that over 2.5 million users have opened NFT wallets since July (Oct 19, 2022) 
  • Société Générale got regulatory approval in France for crypto trading and custody products (Oct 17, 2022)
  • Mastercard announced plans to help financial institutions offer crypto trading (Oct 17, 2022)
  • Metamask and fintech firm Sardine announced they'll offer instant Bank-to-Crypto transfers (Oct 14, 2022)
  • Bain published research pointing to the gaming industry growing to $300B in 5 years (Oct 13, 2022)
  • America’s oldest bank, BNY Mellon, will become the first large U.S. bank to hold crypto (Oct. 11, 2022) 
  • Google Cloud and Coinbase will soon allow developers to pay for Google services in crypto (Oct. 11, 2022)
  • Betterment, the largest online financial advisor, launched 4 crypto portfolios for clients (Oct 11, 2022)
  • Zuckerberg has started to warm to an “open, interoperable metaverse is better for everyone” (Oct 11, 2022)
  • Google has integrated Etherscan to make Ethereum addresses Googleable (Oct 11, 2022)
  • Singapore has granted Coinbase +15 others approval to offer crypto payments in the region (Oct 10, 2022)
  • The OECD proposed a cross-border crypto regulation framework for the G20 to review (Oct 11, 2022) 
  • Visa announced it’s teaming up with FTX to offer crypto debit cards in 40 countries (Oct 7, 2022)
  • Fidelity launched Ethereum Index Fund to give clients exposure to ETH (Oct 4, 2022)
  • Japan’s PM: the country “will promote efforts to expand the use of Web3.0 services” (Oct 3, 2022)
  • Meta announced users in the U.S. can now connect crypto wallets to Instagram (Sep 29, 2022)
  • Warner Music announced a partnership with OpenSea for upcoming music NFT drops (Sept 29, 2022)
  • BlackRock launched a new ETF to give European customers exposure to crypto companies (Sep 29, 2022)
  • Nasdaq announced plans to enter into the crypto custody space (Sep 22, 2022)
  • The PGA Tour will partner with Autograph on a golf-focused NFT platform in 2023 (Sept. 19. 2022)
  • Nomura Holdings, one of Japan’s largest investment banks, will launch a digital assets arm (Sep 19, 2022)
  • Singapore banking giant DBS is rolling out a crypto trading platform for accredited investors (Sep 23, 2022)
  • Ethereum’s successful merge to Proof-of-Stake reduced its carbon footprint by 99.99% (Sep 15, 2022)
  • JP Morgan led a $20M Series A into institutional tokenized security platform Ownera (Sep 14, 2022)
  • Fidelity, Schwab, Citadel Securities Plan to Launch New Crypto Exchange (Sep 13, 2022)
  • KKR Made Piece of its PE Fund Available on Avalanche blockchain (Sep 9, 2022)
  • The $1.4 trillion asset manager, Franklin Templeton, will roll out crypto accounts in Q4 2022 (Sep 8, 2022)
  • Fortnite creator, Epic Games, launched its first blockchain-based game ever (Sep 15, 2022)
  • Starbucks will launch Starbucks Odyssey, a crypto enabled loyalty program in late 2022 (Sept 12, 2022)
  • Australian Securities Exchange (ASX) revealed it’s building out tokenized asset trading (Aug 16, 2022)
  • BlackRock launched a new bitcoin private trust to give US clients exposure to BTC (Aug 14, 2022)
  • Reddit will be rolling out tokenized Community Points non Arbitrum (Aug 9, 2022)
  • The Schwab Crypto Thematic ETF (STCE) began trading on NYSE Arca (Aug 4, 2022)

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Additional Resources

Some partners have requested that we share what we’re reading. Below are some specific articles covering topics we feel will be increasingly relevant as we move towards 2023: 

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