Even by the standards of the infamously volatile crypto markets, 2022 was an outlier. Many of the weakest links broke in the contagion that followed the collapse of operators like FTX, LUNA, and Three Arrows Capital. After such a dramatic year, how should portfolio managers prepare for what 2023 may bring?
Markets remain tense as the dust continues to settle after FTX’s failure in November. At the time of writing, the balance sheets of Digital Currency Group and Binance are coming under sustained scrutiny, fuelling fears that others might follow.
Nevertheless, on-chain indicators show that volatility in the major cryptocurrencies is at a historic low, while prices have continued to defy the more bearish analyst forecasts. Most recently, CME Bitcoin futures were priced at a premium again for the first time since the FTX collapse, indicating that institutions are no longer concentrating solely on short-side trading.
Looking ahead, it is inevitable that the events of 2022 will impact how the markets play out in 2023. Investor focus will likely shift away from risky startups and towards later-stage funding for established firms that have lasted the distance by demonstrating a more prudent approach to risk management.
Similarly, 2022 has created the political will among lawmakers to ensure that history cannot repeat itself. 2023 will undoubtedly see a stricter approach to regulation – both in terms of the evolution of laws designed to regulate digital assets and in regulation by enforcement against actors deemed to have breached existing financial rules.
In the EU, the Markets in Crypto Assets Regulation (MiCA) is due to begin coming into force this year. Crypto regulation in the US has now become a political hot potato issue following the collapse of FTX and subsequent reports of donations made to both parties by disgraced founder, Sam Bankman-Fried, leading to questions of accountability and oversight.
The future of stablecoins also remains on shaky ground from a regulatory standpoint as CBDC efforts gain traction in many jurisdictions.
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Seeking alpha in the digital asset markets at this time in 2023 looks a lot different than it did in January 2022. Nevertheless, there are opportunities for those who know where and when to look.
Venture investment is currently at a low; however, VCs remain optimistic that the landscape is substantially more promising now that FTX is out of the picture, as the firm’s lax approach to due diligence combined with a seemingly bottomless supply of funding apparently pushed out other investors. This means there is still capital in the pipeline ready to deploy, and funds are obliged to invest, so VCs anticipate that funding will begin flowing by the summer.
It is also worth noting that some segments of the crypto markets have been withstanding bearish forces better than others. Blockchain gamers have proven particularly impervious to events like FTX, with DappRadar noting that blockchain gaming activity only dipped 12% between September and November and still accounts for nearly half of all blockchain transactions.
The DappRadar report also points out that even as VC funding has declined over recent months, investment in blockchain gaming is on the rise, with VCs also funnelling funding into related segments such as metaverses and infrastructure.
Previous bull markets also give an idea of what to watch out for when seeking signals of a reversal. Two key trends preceded the last major bull run in 2020. Firstly, flagship financial institutions like PayPal and Mastercard began to stake their claim in the digital asset sector. Any organization with users into the hundreds of millions or even billions venturing into crypto is invariably great news for adoption.
Secondly, a flurry of innovation and adoption activity within the crypto and blockchain space happened. In 2020, this phenomenon played out as the “DeFi summer” when practices like yield farming and flash loans became popular among crypto natives.
Finally, sensible regulation of crypto assets is potentially a powerful bullish signal, although it may cause some short-term volatility. However, regulatory certainty will undoubtedly make digital assets more investable in the long term and help bring stability to the sector.
On a short to mid-term timeframe, some factors should sound a note of caution. Bitcoin prices still tend to lead the overall markets, and BTC could still face some challenging headwinds due in part to its increasing correlation with the macro-financial markets and the continuing bleak economic outlook. Furthermore, price pressure is taking its toll on mining operations, with US-based Core Scientific among the latest to declare bankruptcy. With that in mind, the current market rally is a good opportunity for miners to be offloading their coins onto the market to bank in at least some profits.
Many individuals are already talking about the Bitcoin halving, which is often thought to influence price cycles, however let us not forget that the next halving is not due until 2024.
Bear markets in crypto are generally viewed with a sense of doom, but history has proven that they are a prudent time to invest.
When seeking out opportunities in higher-yielding segments, be mindful of balancing portfolio risks and the fact that one cryptocurrency or token does not necessarily carry the same risk weighting as another. For example, infrastructural investments in platforms supporting many applications are likely to be less risky, as many developers, users, and investors will have an interest in keeping the platform running. However, a single application is exposed to the same risks of failure as any other startup.
Similarly, investments with significant exposure in any single jurisdiction could end up being high-risk if regulatory intervention results in uncertainty. One current example is XRP, as Ripple faces the SEC in an ongoing lawsuit, which illustrates the vulnerability of projects to regulatory decisions.
While it is possible that 2023 will see a sustained reversal of the bearish trend, it is always advisable to maintain a hedge in case of short-term volatility. A sensible approach is to keep healthy reserves of liquid tokens such as stablecoins to ensure funds are ready to deploy in response to rapidly changing conditions. In particular, avoid having too many assets invested in staking or earning pools where they may become tied up with minimum lockup periods or withdrawal notice periods.
When timing the market for a potential reversal, there is nothing more important than having visibility over your entire portfolio and how it is performing. But with your assets spread over multiple exchanges, brokers, custody providers, and wallets, keeping a handle on so many moving parts can be one of the biggest challenges facing portfolio managers today.
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Asgari, Nikou, (January 10, 2023), “Chief of Digital Currency Group defends record amid call for sacking,” Financial Times. Available at: https://www.ft.com/content/4d211526-c395-4378-bd5a-dbe653b64fc1
Glover, George, (January 11, 2023), “Binance admits its stablecoin sometimes lost the full backing it needed to keep its price fixed at $1,” Markets Insider. Available at: https://markets.businessinsider.com/news/currencies/crypto-binance-stablecoin-token-crash-dollar-backing-reserves-busd-cz-023-1
Butterfill, James, (January 6, 2023), “Bitcoin 30D volatility is lowest on record,” Twitter thread. Available at: https://twitter.com/jbutterfill/status/1611401523417726980?ref_src=twsrc%5Etfw%7Ctwcamp%5Etweetembed%7Ctwterm%5E1611401523417726980%7Ctwgr%5E738d535f1a333116a33d2b191071119bebc9b896%7Ctwcon%5Es1_&ref_url=https%3A%2F%2Fambcrypto.com%2Fbtc-records-historic-low-in-volatility-is-this-the-end-of-the-crypto-wild-west%2F
Godbole, Omkar, (January 11, 2023), “Bitcoin CME Futures Draw Premium for the First Time Since FTX's Collapse,” CoinDesk. Available at: https://www.coindesk.com/markets/2023/01/11/bitcoin-cme-futures-draw-premium-for-the-first-time-since-ftxs-collapse/?utm_source=Sailthru&utm_medium=email&utm_campaign=First%20Mover%20Jan%2011%2C%202023&utm_term=First%20Mover
Rushe, Dominic, (November 30, 2022), “FTX billionaire Sam Bankman-Fried funneled dark money to Republicans,” The Guardian. Available at: https://www.theguardian.com/technology/2022/nov/30/ftx-billionaire-sam-bankman-fried-dark-money-republicans
Miller, Hannah, (January 9, 2023), “Crypto Startup Funding Falls to Lowest Level in Almost Two Years,” Bloomberg. Available at: https://www.bloomberg.com/news/articles/2023-01-09/crypto-startup-funding-falls-to-lowest-level-in-almost-two-years?sref=0iVJWC65
Gherghelas, Sara, (December 9, 2022), “Blockchain Games Are Resilient Despite FTX Collapse,” DappRadar. Available at: https://dappradar.com/blog/bga-game-report-october-november-2022
Sigalos, MacKenzie, (December 20, 2023), “Bitcoin miner Core Scientific is filing for Chapter 11 bankruptcy — but plans to keep mining,” CNBC. Available at: https://www.cnbc.com/2022/12/20/bitcoin-miner-core-scientific-filing-for-bankruptcy-will-keep-mining.html
Crypto.com Research and Insights Team, (December 20, 2022), “2022 Year Review & 2023 Year Ahead,” Crypto.com. Available at: https://crypto.com/research/2022-review-2023-ahead
