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Crypto Markets Persevere, Investor Appetite for Web 3 Grows, and More!
Markets continued to tumble on the back of regulatory headwinds in the US and speculation around the soaring transaction fees on the Bitcoin network, signaling unprecedented congestion. Bitcoin and Ethereum fell by 5% and 1% over the past week following the continued banking crisis. One of the biggest winners of last week’s rally was Stacks, which saw an 8.6% increase in returns and an 8% jump in total value locked (TVL) as its use case echoed louder on the back of Bitcoin’s rising transaction fees. In the application layer, Lido accrued the most TVL of 1.4% on the back of ETH inflows in anticipation of its staked ETH withdrawals expected to happen this month.
Figure 1: 7-Day Price and TVL Developments of Cryptoassets in Major Sectors
Source: 21Shares, CoinGecko, DeFi Llama. Close data as of May 8, 2023.
Key takeaways
• The surge in Ordinals inscriptions contributes to Bitcoin network congestion with rising transaction fees.
• Speculation drives BTC outflows from centralized exchanges like Binance, which briefly paused BTC withdrawals.
• Bitcoin continues to grow beyond the store-of-value use case and enters the realm of Decentralized Finance with a new-yet-basic token standard, BRC-20.
• Bitcoin is experiencing its CryptoKitties moment with BRC-20 tokens as Ethereum did during the ICO craze of 2017-2018; this congestion crisis laid the foundation for decentralized applications and scaling solutions.
What happened?
• March 2023: An anonymous on-chain analyst named Domo created BRC-20, a token standard for minting tokens or “inscriptions” that carry text strings on Bitcoin.
• Domo minted $ORDI, which stands as the largest BRC-20 of $73M in market capitalization.
• NFT inscriptions surged on Ordinals, 4.5M at the time of writing
Figure 2: Number of Ordinal Inscriptions’
Source: 21shares on Dune Analytics
• Total transaction fees soared and temporarily exceeded the block subsidy reward of 6.25 BTC for the second time in history.
Figure 3: The Percentage of Fees Accrued from Bitcoin Ordinals
Source: 21shares on Dune Analytics
May 7:
• Speculation spread on Twitter around the reason behind soaring transaction fees; some concluded that the network was under a “Denial of Service attack.”
• Others have immediately rebuffed that conclusion, arguing that the rise in transaction fees is due to the increased demand for the Bitcoin network. However, selling pressure on BTC still increased by 3% overnight.
• Binance paused BTC withdrawals twice on Sunday, for two hours each, due to record-high pending transactions.
May 8:
• Binance resumed withdrawals and announced transaction fees adjustment while exploring integrating the
Lightning Network.
What to expect?
Bitcoin’s growth beyond a Store-of-Value (SoV)
With the recent advancements driven by Ordinals and BRC-20 tokens, Bitcoin is now becoming a platform capable of hosting various use cases beyond payments. The developments surrounding Ordinals will change the public perception of Bitcoin as a stagnant blockchain and introduce novel concepts to help drive talent and innovation to the largest crypto asset by market capitalization. Inscriptions could be the catalyst needed to help trigger the explosive growth of scalability solutions that enable the Bitcoin network to reach its full potential and start offering revenue streams for miners who can’t rely solely on new Bitcoin emissions, as the last bear market has shown. We can argue that Bitcoin is experiencing its CryptoKitties moment with BRC-20 tokens like Ethereum did during the ICO craze of 2017-2018, which then laid the foundation for DeFi and scaling solutions.
Increased Appetite for BRC-20 Token Standard
Although most of the new tokens are meme-coins, to reflect the broader meme craze, it’s only a matter of time until more fundamentally sound applications and use cases enter the market. For example, a forked version of Uniswap V2 on Bitcoin is already deployed, allowing anyone to trade seamlessly and 24/7 Bitcoin-based cryptoassets. We also predict blockchains designed as simple payment networks could introduce comparable standards to onboard more on-chain activity onto their platforms. Litecoin community has already taken the lead with its inauguration of LTC20, a fork of the BRC20 standard, to experiment with asset fungibility on top of its mainnet.
Further, we expect Tier-2 exchanges to list BRC-20 tokens to benefit from their early speculative adoption, although most lack utility so far, and investors should remain cautious. For instance, Gate.io and Crypto.com listed ORDI, the native token of the protocol used to create Bitcoin NFTs, to take advantage of the asset’s surging traded volume, recording close to $100M. We may expect more innovation inspired by the Ethereum ecosystem. Interlay Labs, the company behind the BTC-based DeFi protocol, has already proposed BRC-21, a new token standard that allows for a more sophisticated implementation of tokens like minting and redeeming. An innovation that would introduce the concept of native tokenization on Bitcoin, like US dollar stablecoins.
Figure 4: Breakdown of Bitcoin Marketplaces and Wallets by Processed Volume
Source: Domo on Dune
Growing Attention Towards Scalability Solutions
Figure 5: BTC Average Fee Per Transaction in $
Source: Blockchain.com
We expect more development across the broader scaling infrastructure, such as Stacks, RSK, Liquid, and Rollkit. Scaling solutions are necessary to improve the user experience seamlessly without paying high transaction fees.
We could also expect renewed developer engagement and funding to solve Bitcon’s most crucial problems. On the flip side, it’s possible to expect a community divide where on the one hand, the most conservative participants may want Bitcoin to remain simple. In contrast, others would try to push the boundaries of innovation. The latter received some support already with Lightning’s Taro protocol helping with general token issuance on Bitcoin instead of RGB, which is more relevant for supporting complex financial applications.
Miners’ Revenue to Flourish with Rising Use Cases
Although the explosion of Ordinals has effectively crippled the network via its unusable elevated fees, the development has greatly benefited Bitcoin miners. Before 2023, transaction fees barely made up to 4% of miners’ revenue due to the lackluster demand on the Bitcoin blockspace. However, if the recent speculative wave doesn’t slow down in the near term, we could expect miners’ profit margins to continue to grow incrementally. This should particularly help miners build a cash buffer to weather the uncertainty in the U.S., considering it is their largest stronghold after the miner departure from China in 2021.
For reference, transaction fees have surged by 1,500% from $1.2 to ~$15 in a week. As seen below, Bitcoin miners have generated close to $40M during just the first week of May from transaction fees, a level last seen in June 2021 amidst the last bull market. This is a remarkable milestone as it shows the potential of Bitcoin as a globally trusted settlement layer for a complex ecosystem of applications, combined with being a non-state monetary system.
Figure 6: Bitcoin Miner Revenue Breakdown (Issuance + Transaction Fees)
Source: 21shares on Dune
MEV is likely to manifest on Bitcoin
Figure 7: Bitcoin Transaction Value in $
Source: blockchain.com
The practice of validators, including, excluding, or reordering transactions to extract the most value from fees, otherwise known as Maximum Extractable Value (MEV), could happen to Bitcoin if the network continues to process high-value transactions. There needed to be more incentive for validators to participate in this toxic economic behavior as the Bitcoin network was primarily limited to a simple payments network without any complex logic before 2023.
However, the innovations introduced by Ordinals and BRC20 indicate that more value will be transferred across the network as a function of the issued fungible assets market value. That means miners will be incentivized to reorder transactions from the highest fees to the lowest to profit off this activity. That said, we anticipate that MEV will take place on the Bitcoin network first since most scalability platforms haven’t reached mass adoption.
Potential Resurgence of Increased Block Size Debate to Scale Bitcoin
Figure 8: Bitcoin Mempool Congestion
Source: mempool.space (as of 12 PM, May 9, 2023)
As the Bitcoin network processes five transactions per second on average, the vast influx of demand is crippling the network’s ability to continue processing transactions promptly due to the staggering backlog of 410K pending transactions. The congestion driven by the BRC20 craze might drive some of the community to push once again the idea of increasing Bitcoin block size to accommodate for a higher number of transactions.
Figure 9: Bitcoin Block Size
Source: 21shares on Dune
Block-size wars are a trend that took off in 2017 when the contentious debate brought forward multiple Bitcoin forks, with Bitcoin Cash being the most notable. That said, there’s a strong case against adopting this approach as it reduces BTC’s decentralization since it becomes costlier for nodes to store the entire blockchain history due to its rapidly growing network size. May that be, dissidents could still push the idea of forking BTC, analogous to how Ethereum was forked into multiple protocols following the merge last September, despite lacking any significant community support. However, we don’t expect bifurcated networks to hold any value aking to ETH’s recent forks post the Merge.
Next Week’s Calendar
Source: Forex Factory, CoinMarketCal
Read full report here
Research Newsletter
Each week the 21Shares Research team will publish our data-driven insights into the crypto asset world through this newsletter. Please direct any comments, questions, and words of feedback to research@21shares.com
Disclaimer
The information provided does not constitute a prospectus or other offering material and does not contain or constitute an offer to sell or a solicitation of any offer to buy securities in any jurisdiction. Some of the information published herein may contain forward-looking statements. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties and that actual results may differ materially from those in the forward-looking statements as a result of various factors. The information contained herein may not be considered as economic, legal, tax or other advice and users are cautioned to base investment decisions or other decisions solely on the content hereof.
• Regulatory Crackdowns Fire Up in April
• Macro Uncertainty, Geopolitical Headwinds, and Bitcoin’s Fourth Halving
• The Arrival of Ethereum’s Most Anticipated Application
Macro Uncertainty, Geopolitical Headwinds, and Bitcoin’s Fourth Halving
April brought a challenging landscape for Bitcoin. Geopolitical tensions flared in the Middle East when Israel targeted the Iranian Consulate in Syria on the 1st of April. In an unprecedented response, Iran retaliated directly with a drone strike against Israel, intensifying hostilities. The event contributed to a decline in the stock market and a temporary pullback in Bitcoin’s price. As mentioned two weeks ago, although Bitcoin historically served as a safe haven during crises like the Russian Invasion of Ukraine, its response to Iran-Israeli escalation may have been adverse.
However, a closer look at the market reveals a more nuanced picture. The impact on Bitcoin was primarily felt in the futures market, where open interest peaked at $35 billion on the day of the Consumer Price Index (CPI) print, leading to significant liquidations when inflation came in hotter than expected for the fourth month running. Resilience in the labor market, coupled with strong domestic demand, is evidence that despite Fed efforts, the US is not yet in a position for rate cuts, which may pose further turbulence for risk-on assets. Encouragingly, long-term holders demonstrated resilience amidst escalating tensions. Unlike short-term fears reflected in futures markets, long-term holders increased their supply by 0.1% over the past week, for the first time since January, as the Israeli response seemingly coincided with a local bottom for long-term holder supply. This is a bullish signal, showcasing belief in the asset, irrespective of recent market activity. Nevertheless, we can see that BTC will continue to be stuck in the $60K – $70K range until we get more clarity on the macroeconomic and geopolitical front.
Figure 1: Bitcoin Short-Term Holder Supply vs. Long-Term Holder Supply
Source: Glassnode
Despite the macroeconomic headwinds, significant progress was made in the institutional adoption of Bitcoin. Despite a break in Blackrock’s Bitcoin ETF 71-day net inflow streak, the conclusion of the 90-day due diligence period for fund managers considering the spot ETFs revealed that over 100 institutions, such as BNY Mellon and Banco do Brazil, are exposed to Bitcoin. Morgan Stanley is also actively exploring allowing 15,000 brokers to provide this exposure to their clients. They also filed to broaden access to BTC ETFs by expanding it to 12 more funds, signifying the growing acceptance of Bitcoin by TradFi institutions. Finally, the launch of Bitcoin ETFs in Hong Kong marked a significant step towards adoption in Asia, potentially influencing other jurisdictions like South Korea, Japan, and Singapore to follow suit while expanding Bitcoin’s access to Hong Kong’s $1.15 trillion wealth management sector.
Beyond the market’s activity, April also marked a historic event for Bitcoin: the fourth halving, reducing Bitcoin’s annual inflation rate to below 1%, making it even scarcer than Gold. Historically, Bitcoin trades 50% down from its peak leading up to the halving. This year, Bitcoin defied historical trends, reaching a new all-time high prior to the halving, attributed to the surge in demand from the aforementioned US Bitcoin ETFs, coupled with ongoing technical advancements within the Bitcoin ecosystem, such as Ordinals, BRC-20s, and Runes, as touched upon in the last newsletter.
These advancements are transforming Bitcoin beyond its original vision as a purely decentralized payment network. The emergence of Ordinals and Runes has amplified on-chain activity, reflected in surging transaction fees. This is particularly beneficial for Bitcoin miners, who saw their block reward cut in half due to the halving. Higher transaction fees help compensate for this lost revenue, ensuring the continued security of the Bitcoin network. Notably, as shown in Figure 2, Bitcoin transaction fees made up 75% of Bitcoin miner revenue, soaring to $128 on the day of the halving. While the surge might have been driven by the desire to have a historical inscription, it does underscore the potential impact on miners’ revenue as Bitcoin’s on-chain ecosystem matures.
Figure 2: Bitcoin Miners Revenue
Source: 21.co on Dune
Launched in April, Runes Protocol offers a novel approach to creating fungible tokens on the Bitcoin network. It addresses inefficiencies associated with the BRC-20 standard, which have burdened the Bitcoin blockchain due to its inefficient data handling. Ultimately, Runes presents a key innovation that bolsters Bitcoin’s security budget by offering miners an alternative source of revenue, while reducing their dependence on block rewards. Runes has already rewarded miners with almost $150 million, impressively making up 80% of fees generated on the Bitcoin network on April 23, as shown below.
Figure 3: Share of Bitcoin Transaction Fees
Source: CryptoKoryo on Dune
While Bitcoin’s daily transaction volume surpassed 1 million, rivaling Ethereum’s activity, the initial excitement surrounding Runes might recede before a more long-term, sustainable surge in the network’s DeFi activity. The initial phase often focuses on meme-like tokens attracting rapid but fleeting interest. However, the development of sophisticated DeFi protocols like exchanges and Automated Market Makers (AMMs) will enhance Bitcoin’s application layer, streamlining token trading similar to what ERC-20/ERC-721 standards did for Ethereum. This paves the way for a more robust and mature DeFi ecosystem on Bitcoin, which we will closely monitor in the months to come.
Regulatory Crackdowns Fire Up in April
April saw the continued regulation-by-enforcement trend, cracking down on non-custodial infrastructure and the Ethereum ecosystem. On April 10, the Securities and Exchange Commission (SEC) sent Wells Notices to Uniswap and Consensys for alleged violation of federal securities law. Uniswap announced its intention to resolve this through court. The details of the SEC’s Wells Notice remain unclear. However, it could have been triggered by Uniswap’s pending revenue-sharing initiative, which has had a domino effect on the ecosystem. In the short term, the crackdown could dissuade protocols from following suit, which would have incentivized their users to stake and delegate their tokens for a share of the revenue.
On April 25, Consensys filed a lawsuit against the SEC for “unlawful seizure of authority,” arguing that Ethereum is not a security nor that MetaMask is a securities broker. The recent crackdown could put a strain on the crypto infrastructure industry in the short term, as it could severely disrupt the ecosystem while encouraging companies to explore alternative jurisdictions aside from the U.S. market.
Earlier in February, the SEC adopted rules that widened its interpretation of a dealer to include “as part of a regular business” in addition to the initial definition, “any person engaged in the business of buying and selling securities . . . for such person’s own account through a broker or otherwise.” The newly adopted rules have now triggered an outcry in the crypto community, deeming the legislation too broad, as it includes average market participants in cryptoasset liquidity pools (liquidity providers), who essentially have a very different role than a broker.
For example, liquidity providers on Uniswap can be anyone, given they have the capital to deposit and earn yield, unlike professional market makers in traditional finance whose responsibilities extend beyond that. Providing liquidity on Uniswap is open to anyone to enable permissionless markets, which makes this an important characterization due to the impact it could have on how DeFi functions in the US. While the ongoing crackdown could cause uncertainty in the short term within the Ethereum ecosystem, regulatory clarity will ultimately be reached in the long run, as we’ve seen on several counts of hurdles over the past few years.
Ethereum’s Most Anticipated Application of the Year is Live
EigenLayer is finally live on Ethereum’s mainnet. It’s a new primitive that allows ETH users to “re-stake” their existing staked ETH to validate the security of external networks. EigenLayer has been eagerly anticipated as it optimizes capital efficiency by allowing users to earn additional yield on top of their native staking rewards. Further, it allows younger protocols to borrow the security assurances of Ethereum, circumventing the need to bootstrap their own security from scratch. This translates to a more cost-efficient approach while simultaneously bolstering their decentralization. Nevertheless, the protocol comes with inherent risks.
By opting to earn additional yield, users, and validators subject themselves to heightened smart contract risks as they become exposed to the vulnerabilities of both Ethereum and the additional protocols relying on its security. Moreover, a large portion of ETH could end up being “re-staked” in EigenLayer instead of just validating the security of Ethereum, creating a problem of misalignment. Simply, some validators might opt to maximize their profits by pursuing strategies that prioritize short-term gains over the long-term security of the network. Additionally, the growing enthusiasm for the protocol suggests that a significant portion of the crypto economy might rely on Ethereum’s security. Currently, 15% of all staked ETH is allocated towards Eigen’s re-staking strategy. The continuation of this trend could lead to centralization, posing a risk as Ethereum might inadvertently become a single point of failure over a longer time horizon.
Wide-spread slashing is another concern. In essence, if a substantial amount of ETH is re-staked in a singular protocol, then a slashing event due to unintended or malicious behavior could significantly impact honest ETH stakers. Thus, Eigen proposed a slashing committee comprising esteemed ETH developers and trusted community members, empowered to veto such occurrences and safeguard Ethereum’s integrity.
The final risk concerns a new breed of tokens known as Liquid re-staking Tokens (LRTs), which operate atop EigenLayer. LRTs, akin to Liquid Staking Tokens (LSTs) issued by the established Lido Protocol in 2021, aim to unlock similar capital efficiency by allowing users to use their re-staked ETH as collateral for lending and borrowing. Given that re-staked ETH in Eigen can’t be used across DeFi platforms, users have turned to LRT protocols like Ether.fi and Renzo to seek higher levels of capital flexibility, with their re-staked assets. For context, LRTs grew exponentially by a factor of 28 throughout Q1, increasing from nearly 100K units to the current figure of 2.8M, as shown in Figure 4, illustrating its soaring demand.
Figure 4: Growth of Liquid re-staking Tokens (LRTs) on EigenLayer
Source: @hahahash on Dune
While LRTs can offer amplified gains through leveraged lending, they can also exacerbate losses, increasing systemic risk in market downturns. Since some LRT protocols can’t offer withdrawals yet, users may be forced to swap their LRT tokens on thinly traded secondary markets, intensifying their decline. Last week, we saw an instance of this risk manifest when Renzo’s ezETH lost its peg. This happened as the ETH derivative experienced heavy selling on various exchanges, causing it to trade at over a 75% discount compared to ETH. This coincided with the company facing scrutiny over its controversial token distribution plan, which is scheduled to launch on April 30.
All in all, the impact of EigenLayer is not to be understated, as the excitement surrounding the new primitive has propelled it to become the second-largest protocol on Ethereum by Total Value Locked (TVL), boasting an impressive $15.6B. This already eclipses the TVL of established players like Solana by fourfold, highlighting the immense adoption that EigenLayer is witnessing despite its brief existence. Further, the excitement building up to its launch since it unveiled its roadmap in March has propelled the Ethereum validator entry queue to its highest level since October. The queue now necessitates a minimum waiting period of 8 days before new validators can join the network, as seen below in Figure 5. Nevertheless, stay tuned as we prepare to release a more in-depth exploration of EigenLayer risks over the coming weeks.
Figure 5: Ethereum Validator Entry Queue in Days
Source: ValidatorQueue
Next Month’s Calendar
Source: Forex Factory, 21Shares
Research Newsletter
Each week the 21Shares Research team will publish our data-driven insights into the crypto asset world through this newsletter. Please direct any comments, questions, and words of feedback to research@21shares.com
Disclaimer
The information provided does not constitute a prospectus or other offering material and does not contain or constitute an offer to sell or a solicitation of any offer to buy securities in any jurisdiction. Some of the information published herein may contain forward-looking statements. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties and that actual results may differ materially from those in the forward-looking statements as a result of various factors. The information contained herein may not be considered as economic, legal, tax or other advice and users are cautioned to base investment decisions or other decisions solely on the content hereof.
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