Thoughts on the Cryptocurrency Crash and Cyclicality

Cryptocurrency is performing differently in this cycle than in the past, but we still believe in its future potential.

Your TVL is not safe

After the Terra collapse and TVL fleeing DeFi, many began to question (with good reason) the health and utility of beloved DeFi protocols. We’ve experienced one of the most bullish bull runs ever, fueled by excessive money printing and a lack of things to do but speculate in crypto due to the pandemic. The absurd events surrounding the fall of UST and LUNA have basically caused quite a stir because it shows us that, most likely, nothing is safe. If we can’t trust venture funds that invested in Terra or the tens of billions of dollars that have been deposited into the ecosystem, what might be the next house of cards to fall from our hands?

Protocols like Aave, Uniswap, Lido, and Curve all work in the current state of DeFi, but what happens if everyone loses trust in these decentralized bastions of open finance? Many began discussing the stETH/ETH “peg” and what the true golden ratio (1:1) is. Some looked at DEX volumes and began to develop a sense of questioning the utility of these sometimes worthless governance tokens and how they may never increase in value for holders. Others began to wonder what would happen if the appetite for risk in DeFi and crypto as a whole disappeared — who would lend money to Aave or Compound if the risk outweighed the paltry reward? Does our emperor really have no clothes to wear? Is this all just a fever dream to create multi-generational wealth out of thin air? If the big guys don’t know the future and don’t know how to manage risk, then there’s a good chance that none of us little guys know either.

After UST hit zero, Twitter was abuzz with posts and thoughts about how other stablecoins might collapse — clearly in response to market events. Some of these reasons are more rooted in reality than others, but the message is the same: market participants have reason to be scared. Unlike TradFi, if things go bad, there’s really no one to save us other than Binance or FTX. If we lose all our money in a leverage-fueled fiasco, the Fed and BlackRock won’t step in to help us recoup our losses and rebuild our system from the ruins — we’re alone.

The news of Three Arrows Capital’s closure came as a shock to almost everyone. Not too long ago, Su Zhu was explaining his reasons on UpOnly that we are in some kind of crypto super cycle. Su is largely regarded as one of the best managers, mainly because he is.

Hearing that 3AC lost most of their money and was forced to sell everything is a very hard fact to accept. Su Zhu couldn't do it, let alone us? There is no doubt that the recent large-scale selling can be attributed to funds and potential redemptions, partly due to the relatively strong overall strength of alts. The main force fell more than 50% in a week, which is crazy. The strange thing is that alts didn't fall off a cliff completely. Most alts have fallen nearly 90% from their ATH, and a considerable number of them have reached oversold levels.

Protecting against the inevitable

I believe 95% of altcoins may never return to their ATH. Here is a quick look at the total market cap of cryptocurrencies:

Looking at this chart, if you assume that most of the current alts and their respective protocols are not vaporware, it is hard to justify more selling. Unfortunately for us and our wallets, recent events have shown that our system is truly rotten. In the markets we are seeing, gains will dissipate and protocols will lose active users. People are no longer motivated to participate in the future of finance, mainly because there is not much to do. For those protocols that have tokens, they become illiquid and the only thing you can do is sell (probably at a loss) or HODL and pray that they are still around for the next cycle.

We still have a long way to go in cleaning up the FDV and getting the token circulating supply to its stated max supply, but it’s already happening at a pretty respectable pace. Just a few months ago, I wouldn’t have touched some of these tokens because their valuations were ridiculously high. Now, things are a little different. You can get a ton of great DeFi tokens at reasonable valuations, many of which have much less dilution risk than they did in Q1 2022. I’m not saying these will all be 100x investments, but if you cast a wide net and cross your fingers, you’re bound to find something that works.

Unfortunately for those reading this, I didn’t live through the first few cycles in crypto, so I can’t speak to the transition from a bull to a bear market. From what I can tell, many of the most notable currencies and protocols disappeared, leaving protocols with literally worthless governance tokens. I think the key difference between the last cycle and this one is the growth in the number of protocols generating revenue and the total crypto market cap. Here’s a list of protocol revenues by sector over the past week:

As you can see, even in a bad market environment, there is still money to be made. This is a huge positive. If you believe a protocol will persist and continue to build in a bear market, then there is no reason to believe the token will go to zero. However, there are other factors to consider that make this guessing game even more difficult. For example, why would someone in the future see our current alt and decide to bid up? Why buy it when you can trade in your old stuff for a shiny new token with potentially stronger token economics? Why buy an old token with no meaningful appreciation in value when you can make a killing and potentially buy a new cycle version of SOL or JEWEL?

Even if DeFi transforms into a more boring, respectable state, are these the tokens people are craving? Will something like UNI be as exciting as DOGE? I know, this is all very pessimistic, but bear with me.

I believe a handful of DeFi protocols will become truly decentralized superstructures that can exist forever. I believe those who hold the tokens of these protocols will gain tremendous value. I believe DeFi will be stronger than ever, no matter what form it takes. What I don’t believe in is excessive liquidity mining, useless forks, DeFi on dead chains, protocols without quality teams, and FDV tokens, which make me want to scream. Thankfully, we’ve already seen some of the above characteristics manifest in the form of massive outflows of DeFi TVL:

Doesn’t look good, does it? Excluding DeFi Llama’s $71.5 billion, the top 10 DeFi protocols account for more than 50%, with Maker accounting for 10.7%, followed by Aave. What might this indicate?

I believe these protocols represent the most trustworthy stuff in this space because they are already experienced with this difficulty, hold up well according to their mission statements and have demonstrated utility. Further down the line, the picture is less so.

As I said before, much of DeFi is based on rampant speculation and obfuscated Ponzi schemes that bring huge wealth to those who are lucky enough to notice it and participate in it first. Liquidity mining is the most typical example, which is a mechanism that often rewards the earliest users. I believe that all of the current top ten protocols will remain and achieve some form of success in the next cycle.

But what about protocols that didn’t appear directly at the top but deserve a mention? There are many promising candidates in DeFi, and I have summarized a few that I believe will perform well in the coming years:

• Maple Finance

• Osmosis

• Liquity

• Ribbon Finance

• GMX

• Frax Finance

• DX

• Olympus DAO

• Bastion

• Angle Protocol

• Trader Joe

• Euler

• Synapse

Looking at the entire cryptocurrency landscape, it’s easy to feel like most of it could go to zero, mostly because it’s hard to be optimistic when retail investors just want to buy DOGE or walk away to make money. But that’s not the case, cryptocurrencies are more than just a few coins that make ignorant retail investors money.

Speaking of retail investors, I thought I should also share some thoughts on NFTs. In this round of bull market, we did not see infinite bids for homogeneous tokens, but instead saw the retail and mass adoption of NFTs for several reasons.

NFT Festival

NFTs became popular because they share the ethos of cryptocurrency, but without the unnecessary boring parts. NFTs are funny pictures that you can share online and set as your profile picture. NFTs are leveraged bets on ETH, and many of them are very good investments if you buy them at the right time. For a while, NFTs were highly liquid, though that’s not the case anymore. The community that has developed around these silly pictures is probably something most people involved in the space wouldn’t have expected. If you had predicted two years ago that everyone from Steph Curry to Justin Bieber would be buying digital images of apes, everyone would have lost their minds. If you claimed that NFTs would form an entire cult online and spark huge social movements around the world, you’d probably have been kicked off crypto Twitter. But that’s exactly what we’ve seen.

Now looking at the number of NFTs, the picture is a bit different:

I’m sure NFTs have only slightly declined in popularity, and the drop in volume can largely be attributed to the overall market downturn and a sharp drop in risk appetite. There is almost nowhere to keep your money now - if you have it in stocks, cryptocurrencies, or even cash, you are screwed and will definitely suffer losses. As the floor prices of many NFTs are likely to continue to fall due to the decline in ETH, why speculate on NFTs?

I believe that in every cycle there are moments that surprise those who have experienced it. In particular, DeFi Summer and NFTs are two events that suddenly appeared and surprised many people. Will such events happen again in a few years? Of course they will.

Whether this comes in the form of Web3 games, metaverse advancements, or something completely unfamiliar, I have no doubt that the firepower of crypto will result in amazing 1000x innovation.

CeDeFi lacks innovation

On the topic of innovation, it’s important to acknowledge the recent unsavory incident with Celsius. For those unfamiliar, Celsius is a custodial platform where users can deposit their funds and earn yield with ease. This may sound a little familiar.

Last week, Celsius suspended all withdrawals on their platform, essentially locking up users’ funds and leaving many without the ability to stop liquidations or simply take control of their hard-earned cash. As you can imagine, this did not go over well. As of June 20th, it remains largely unconfirmed whether Celsius is insolvent, or what form of insolvency they will experience. Either way, they screwed up.

It’s unclear what they did with the users’ funds, but many are speculating that they took heavy losses on Terra and face severe losses from UST’s collapse. Will they deposit funds into Anchor for easy yield? It’s highly likely. After Terra went bankrupt, a slew of garbage apps offering 15% or more yields went out of business, and retail investors took a hit. Centralized DeFi is garbage, and it’s sad to see so many people get ripped off for something they may not even understand. As for getting their money back, there’s no timeline on when withdrawals will be open (if ever), or if users will be fully compensated.

In terms of centralization, when it comes to things like exchanges and stablecoins, the best thing to do is probably to check your long tail risk. In hindsight, the implosion of Terra was all too obvious. But what domino can we expect to see fall next? I’m not saying things will get worse for USDC or Coinbase, but it’s wise to hedge against those possibilities in the best possible way. No, I’m not saying your number one goal should be to “survive a bear market,” because I’ve never lived through one and don’t want to say the same thing as many people do.

The printing press is gone...it doesn't matter

Regarding cyclicality, we have definitely broken the historical pattern in some form:

There is every reason to believe that enough has happened over the past week and enough selling has occurred to form some kind of bottom, but what if this time is truly different? Cryptocurrencies have always been highly cyclical, with multiple cycles behaving roughly the same way. It would be odd for Bitcoin to have a double top in 6 months, and even stranger to break below the 2017 high.

This conclusion can be drawn from both the bull and bear perspectives, but the more likely assumption is that none of us knows where this huge market will go. We live in a world that has just barely escaped the shackles of a two-year pandemic, everything is rising in price, inflation is rampant, and there seems to be no sign of slowing down. The Federal Reserve has begun to raise interest rates, but no one knows when this will end and to what extent.

I have no doubt that cryptocurrencies will continue to serve as a bastion of innovation and a digital casino that exists in a metaverse ruled by anonymous cartoon characters — but are we screwed anytime soon?

If crypto is truly breaking its historical cyclicality and we are traversing uncharted territory, there is a good chance this will go lower than we think. Key differences this time include a higher ATH, more VC funding entering the private markets, and more attention thanks to the widespread acceptance of meme coins and NFTs. If there was a gun to my head and I had to predict a bottom for BTC over a longer time frame, I’d guess we’d be in the 15-20k range in 3-6 months as macro conditions stabilize. This isn’t as rosy as it sounds, as I predict many alts will fade away and lose any attention they once had. VC funding will also dry up, as private markets tend to lag public markets for short periods of time.

It is in anyone's best interest to remain diligent and keep a close eye on crypto. There is no better opportunity than this, unless you are a super geek and want to get into AI or biotech. For the rest of us, we just continue to hitch a ride on geniuses like Vitalik and ride off into the sunset. I have started to see a decrease in substack/mirror/medium posts, which gives us some qualitative insight into the attention we are getting on crypto. I urge you to do your best to make the most of this bear market. Just like many of us in 2021 were clueless about alts from previous cycles, there will be new market participants who have no idea what the curve war is or why we are fighting it.

Do what you will with this information.

I don’t believe in the end of the world, like /biz/ is telling you to hoard silver and exit all markets. It’s time for DCA to get strong and work on improving itself. Let this recent tweet from GCR provide you with some solid advice:

Twitter is a valuable tool that you should utilize to maximize your chances of success in an increasingly PvP cryptocurrency environment.

Hopefully this post is a good summary of recent cryptocurrency events and a look into my thought process during the great bear market of 2022.