Beyond the freeze: Blockchain’s revival after the Crypto Winter

Invesco select trust UK equity share portfolio quarterly manager update

Blockchain ecosystem: 2022 in review  

In 2022, headlines painted a picture of doom and gloom for the blockchain industry. Cryptoassets were falling, major central entities (Celsius and FTX) collapsed because of liquidity and governance issues and there were charges against senior figures. 

But in other parts of the ecosystem, the story was more positive. Decentralised Finance (DeFI) protocols functioned as designed and even saw double-digit growth after the FTX collapse, according to Blockchain analytics firm Nansen. 

Meanwhile, traditional financial markets have borrowed blockchain technologies and slowly embraced tokenised assets due to the benefits of reduced cost, atomic settlement and increased liquidity.  
Among them, HSBC recently announced the launch of a distributed-ledger technology bond tokenisation platform. It will potentially issue a GBP tokenised bond and the firm plans to use it to facilitate digital bond issuance, using permissioned blockchain infrastructure.

In a similar vein, some central banks have explored and implemented blockchain as an enabler of a Central Bank Digital Currency (CBDC).

Figure 1. Blockchain applications and benefits

  Crypto DeFi Asset Tokenisation Web3
  • Censor-free speculation
  • Low cost, friction-free trading and credit
  • Fractionalised Ownership
  • Increased liquidity
  • Parallel virtual worlds with a parallel digital economy
Enabled by
  • Public non-permissioned blockchain
  • Centralised Exchanges
  • Automated Market Making
  • Over-collateralised lending
  • Non-custodial wallets
  • Permissioned blockchains for regulated markets
  • AR/VR
  • M-worlds
  • NFTs
  • Volatility of cryptoassets
  • Theft from custodial wallets and CEX’s
  • Fraud
  • Smart contract bugs and exploits
  • Theft and fraud especially on Bridges
  • Consumer protection
  • Legal and regulatory clarity for some assets
  • Technology maturity
  • Open vs closed models
  • Commercial models
Regulatory maturity
  • Slowly evolving regulation e.g. MiCA in EU
  • Essentially unregulated with limited regulated protocols e.g. Swarm
  • Largely regulated in many jurisdictions e.g. Germany, Lichenstein
  • Only through existing crypto and digital asset regulation

Winter has come: a year of unprecedented challenges for Blockchain 

Winter certainly arrived for the blockchain ecosystem in 2022, following years of warnings from crypto naysayers. From the “DeFi Summer” of 2020 and peak non-fungible tokens (NFTs)1 in 2021, 2022 has turned into a year of reckoning.  

Notable events this year include the collapse of Terra – the algorithmic (not so) stablecoin, Celsius, 3 Arrows Capital, Voyager. Most calamitous of all was the FTX collapse in November 2022. Totalling billions, it shook the already volatile crypto market, causing the overall market capitalisation to fall below $1 trillion.  

Blockchain investments: are companies still being funded? 

Staff cutbacks and failures increased in 2022, but quality blockchain companies with strong and experienced founder teams still received significant funding (e.g. Mysten Labs $300 million Series B). This leads to a hypothesis that whilst the chaff is falling by the wayside, the wheat is continuing to grow. 

While investment across the whole technology market declined in 2022, hotspots such as Web3 remain2. Investors poured $2.9 billion into Web3 in 3Q22, bringing total investment over the first three quarters of 2022 to $13 billion, compared with a total of $10.1 billion for all of 2022.  

Mergers and acquisitions (M&A) represent much of the metaverse-related investment (see figure 2 below), followed by internal investment and venture capital / private equity (VC/PE).

Figure 2. Value of metaverse-related investments ($B)

Source: Crunchbase, McKinsey, Value creation in the metaverse.

Improving blockchain’s environmental, social and governance (ESG) credentials

“The Merge”, Ethereum’s move to a Proof of Stake consensus mechanism1, occurred without major problems, vastly reducing electricity consumption and corresponding greenhouse gas (GHG) emissions, and paving the way for future improvements in Ethereum’s transaction rate and costs.

Bitcoin consumes approximately 93.40 TWh of electricity (see figure x below). By comparison, the pre-merge Ethereum used 23.42TWh, dropping to a miniscule 0.001 TWh after the merge (equivalent to the power consumption of 144 US households). 

While cryptos ‘E’ credentials still have a way to go, the use case for the underlying blockchain technology is much more diverse. Better ESG data is one example. Organisations could use blockchain to sync their records systems and as the data on a distributed ledger can’t be edited, it makes the resulting data more credible.

Figure 3. Major cryptocurrencies’ energy consumption

Source: CCAF. Not to scale.

Tokenisation: extending beyond cryptocurrencies

Tokenisation is a process for representing a real-world asset, like a building, into a set of tokens. Each represents ownership of a fraction of the asset.  

A token can also be the asset itself, e.g. a bond might exist solely as a token on a blockchain, with all its characteristics captured in the token. Or the token can be a digital twin of a bond that exists in the real world outside of the blockchain.

Tokenisation promises to greatly increase the efficiency of trading and settlement. It has the ability to simultaneously settle trades immediately after execution (i.e. atomic settlement through Delivery versus Payment (DvP) with tokenised cash), removing counterparty and settlement risk as a result.

The Metaverse: from virtual assets to virtual worlds

Massive virtual worlds combined with new immersive access via augmented reality (AR), virtual reality (VR) and digital assets gives us the metaverse, or metaverses to be specific.

The metaverse economy’s potential size raises questions about what kind of monetary system will sustain it. Potential solutions may include cryptoassets, stablecoins, traditional fiat or potentially Central Bank Digital Currency (CBDC).

While the use of CBDC in virtual worlds may seem fanciful, the Bank of England commented in a blog: “The importance of cryptoassets in the open-metaverse means that if an open and decentralised metaverse grows, existing risks from cryptoassets may scale to have systemic financial stability consequences.” Of course, one solution to mitigate the risk are CBDCs.

Figure 4. Metaverse overview
Metaverse overview, spaces, digital assets and blockchain

Source: Invesco.

Blockchain: the case for regulation

Parts of the blockchain industry have pushed back against regulation previously, but many more now recognise the need. At the same time, regulators have struggled to keep pace with blockchain innovation. 

But with recent failures, like FX highlighting the risk for consumers, it’s clear that increased and effective regulation will be an important part of the journey if the industry is to progress. This could see some proven safeguards carried over from traditional finance but will need to happen without stifling digital assets’ innovation.

We do need some regulations, we do need to do this properly, we do need to do this in a stable way.

Changpeng Zhao, CEO, Binance

The challenges for regulating cryptocurrencies are significant. Different countries are at different stages on the regulatory path and vary in their approach. 

Some, like Australia, are using applying existing laws to the new technology. Others, like Estonia are taking it a step further and applying their existing laws retrospectively while Malta plans to introduce a new regulation, along with the EU’s MiCA directive. 

  • The EU has taken a big step toward regulation with the introduction of the Market Infrastructure for Crypto Assets (MiCA) directive. 

    Covering all 27 member states, it’ll have a significant impact on the cryptoasset industry. The regulation reflects a comprehensive treatment of various types of digital assets and functions and provides clarity on responsibilities.

  • The US also has made progress toward regulation, starting with its Executive Order in 2020 to ensure the responsible deployment of cryptoassets. This regulation focuses on protecting consumers and providing better access to financial services, while mitigating against illicit finance.  

    The challenge will be how to delegate responsibilities between the SEC (for securities) and the CFTC (for commodities/derivatives).

The adoption of crypto is growing rapidly. In fact, recent research shows that the number of crypto users will hit one million by 20302, so regulation must catch up. 

It will be interesting to see how the evolving regulatory landscape and investor sentiment combine with key considerations around blockchain to shape the next evolution of digital asset markets.

Blockchain FAQs

A Central Bank Digital Currency (CBDC) is a digital token. It's like cryptocurrency and is issued by a central bank, linked to value of the country's fiat currency.

A ‘blockchain’ is simply an electronic ledger that records transactions and balances in a given system. The technology allows multiple participants to transfer currency, assets or information and keep efficient records. All blockchain participants can verify this collection of records. It represents a permanent, single version of truth, removing the need for a central authority for reconciliation.

  1. Someone requests a transaction. Transaction can involve a physical asset, cryptocurrency, medical record, legal contract or any other information
  2. The requested transaction is broadcast to all participants (“nodes”)
  3. The network of nodes validates the transaction using known algorithms
  4. Once verified,the transaction is combined with other transactions to create a new block of data
  5. The new block is added to the existing blockchain and is permanent and unalterable
  6. The transaction is complete

There are numerous benefits of using blockchain technologies. They increase record transparency and help with the auditing process. They also help to streamline business processes and can potentially reduce costs when trust or integrity is difficult to enforce.

A cryptocurrency is a non-traditional, decentralised, digital medium of exchange without a central bank or government. Bitcoin is the world’s first and largest cryptocurrency that was invented in 2008 during the depths of the Global Financial Crisis. Bitcoin offers an alternative means of payment and storing value. It is defined by a finite supply and a cryptographically-secured digital, decentralised ledger.

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  • 1A blockchain’s consensus mechanism is the process by which the network processes and verifies transactions. Some consensus mechanisms require participants to race and solve complex mathematical puzzles (Proof of Work) that could consume high amounts of electricity. Other consensus mechanisms use ownership of network tokens (Proof of Stake) to verify and add transactions.

    2Source – Coin Telegraph – Oct 2022

    3Source: AUM as $510m at 6th of February 2023 – Invesco

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Important information

  • Data as at 7 December 2022, unless otherwise stated.

    This is marketing material and not intended as a recommendation to buy or sell any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication.

    Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice.