The crypto market entered a deep bear market in 2022 as global liquidity constricted and the Federal Reserve kept raising interest rates. The market value of all crypto assets fell by more than $2.2 trillion this year, while CeFi's institutional business decreased by over 71.4%. After a string of unfortunate events, including the demise of Terra and the insolvencies of 3AC and FTX, the industry was utterly obliterated; several enormous institutions, such BlockFi, and Genesis, are stuck in the nightmare of either going bankrupt or being liquidated. This first part of the report will cover the most notable events of this year.

An overview of the macroeconomic impact

Global inflation and the tightening of the money supply would have to be the key plot points if a narrative line were to be developed for 2022. They serve as the focal point of the macro market activity, which has an impact on all facets of the global economy, including the market for cryptocurrencies. Additionally, because of the very challenging macroeconomic environment, we are presently in, macro issues—rather than endogenous variables like laws, new technologies, and market segments—are what is causing the change in the bitcoin market this year. The following graph elaborates on the worldwide macro market condition based on two key variables: rising global inflation and tightening monetary policy.

cpi year on year

Source: Bloomberg

The graph above depicts the trajectory of the benchmark interest rates in the U.S., EU, and UK since the end of 2021. A furious and quick-moving intensity typified the most recent wave of global interest rate increases. For instance, the Federal Reserve in the United States increased the benchmark federal interest rate to 2.5 percent in just 8 months after doing so the last time around, which took two years. Undoubtedly, the swift rate increases have had a significant negative impact on the price of risky assets worldwide, including cryptocurrencies.

benchmark interest rate

The market entered a lengthy capitulation

2022 was a protracted downturn year for cryptocurrencies. As a result of several disastrous internal events and an external financial climate rife with fear, about $2 trillion in market value disappeared.

With a very moderate decline and a huge market cap, BTC and ETH have remained cornerstones throughout the bear market. While the total market cap of DeFi and GameFi has decreased by 80%–90%, the majority of individual assets have decreased by an even greater percentage: new assets are still coming in, which hastened the overall decline; popular assets depreciated more quickly than they did during a bull market, declining by 90% or even more.

The 200-week SMA indicator is better suited for viewing the range of Bitcoin's lowest price using historical data spanning more than ten years for BTC, a widely used cryptocurrency asset.

btc under sma 200 week

Since BTC did not reach the required 200 weeks for the indicator prior to 2014, the indicator began in the middle of 2014. A market adjustment led to a resurgence after the two breaks in 2015, the intersection in 2019, and the "March 12" breakdown in 2020. However, since it dropped below the indicator in June of this year and again after the breakout in August, the price of BTC has been swaying in the bottom half of the indicator for a considerable amount of time. According to the indicator, BTC is currently suggesting an unprecedentedly intense bear market by moving lower and below for the first time ever in history.

Bleeding capital from DeFi and NFT

The TVL of DeFi decreased from 171 billion USD in January 2022 to a low of 42 billion USD in December 2022, according to Defillama statistics. With a string of mishaps, like Terra, TVL of DeFi has also dropped significantly twice, and the market has therefore turned pessimistic.

on chain tvl

Source: DeFi Llama

The major front in the DeFi war is still Ethereum. As the second half of 2020 approaches, enormous amounts of money have been chasing the exponential expansion of the protocols along with a parallel increase in token values and rates of return; liquidity was also enhanced in the wave. In contrast, token prices and the rate of return is reduced in 2022. The panic is made worse by the withdrawal of liquidity and the flight of money from the market. The current rates on stablecoin deposits on widely used lending protocols are significantly lower than those of the US Treasury. What's more, other further procedures have been breached, and additional events have been set off, including Terra's demise and the destruction of FTX, causing the investor to flee their fund.

Given the current state of the industry, Layer2 has received an extensive promotion, and the DeFi ecosystem may benefit from Layer2's second spring. The cost for common users will decrease due to faster and less expensive scaling, and more users with relatively minimal capital requirements will be able to utilize DeFi, which is also advantageous for DeFi.

From TVL of Layer2, which peaked in April 2022 at 7.5 billion USD, then dropped all the way to 3.7 billion USD in July. In contrast to other ecosystems, Layer 2's TVL has been increasing since it touched the bottom in July, and it is now at 5.32 billion USD. The token sales, the vast number of apps that have landed, and the fact that the majority of Layer2 development teams are working actively on incentives, including airdrop campaigns and token offerings, may all be credited for this. More on-chain activities and ecological initiatives will ultimately become available as the Layer 2 scaling solution develops.

The trading volume of NFT is in the doldrums as the market has calmed. The ultra-high volume in May was caused by the FOMO emotion induced by the other deed issued at the time on the other side. Meanwhile, NFT's overall market value has dropped by half, the price currency for NFT is in ETH, and ETH is very volatile in general. The market capitalization of the NFT market fell by more than 40%, from around 35 billion USD to 21 billion USD. NFT's overall market value dropped less than ETH's because fresh NFT releases have been feeding the market, converting non-NFT users to NFT users.

Even while the NFT market is contracting and the average daily trading volume is about 15% of what it was during the bull market or even lower, the growth rate of NFT-enabled wallets has never slowed down, rising by roughly 80,000 each week. The market is expanding due to more customers and new products, but the total market capitalization of NFTs is gradually declining, which is a phenomenon that pops the bubbles in the NFT market. NFT prices typically follow rational trends, and more users are choosing to buy and hold NFTs concurrently, indicating healthy market growth patterns.

Top events in the crypto market this year

The Terra debacle

The fall of LUNA, which was previously hailed as one of the top 10 crypto assets, is considered to be the most notorious episode ever. Due to the crisis, many investors lost everything, and the cryptocurrency market has since gotten much worse despite a long-standing pessimistic trend.

Terra is a blockchain for payments that was established in 2018 and is based on a dual-currency system that uses the "stablecoin" UST and the "governance token" LUNA. Do Kwon, the creator of Terra, released the Anchor protocol at the beginning of 2022. It offered 20% annualized returns for UST deposits, and it attracted many investors due to both its high return and decentralized nature.

terra UST

Before the UST bubble burst, approximately 75% of all USTs (up to 14B) were on the Anchor protocol. Many traders borrowed UST for staking by mortgaging other cryptocurrency assets in order to earn the UST's 20% annual percentage rate (APR). The price of LUNA increased by over $100 as UST's popularity grew. UST holds the distinction of being the biggest decentralized stablecoin by issuing over $15 billion.

As some people dumped their USTs in Curve, de-pegged the UST from the USD, and the price plummeted sharply in May 2022, Terra lost its bulwark. Do Kwon liquidated 80,000 BTC in LFG holdings to balance UST, but many others joined the dumping since the market was no longer confident. Terra's algorithm changed LUNA into a massive issuance phase, sending LUNA and UST into a death spiral as a result. Due to on-chain traders' inability to keep up with the dumping, the collapse was unavoidable.

Numerous investors have suffered serious losses as a result of Terra's collapse, which caused the price of UST to drop to $0.2 in a matter of days and the price of LUNA to practically zero. Terra's market valuation also collapsed by $40 billion. Additionally, the 80,000 Bitcoins sold by LFG further damaged the market, resulting in a daily decline in the price of BTC.

The Three Arrows Capital insolvency

Su Zhu and Kyle Davies formed Three Arrows Capital (3AC) in 2012 as a cryptocurrency hedge fund. 3AC is well-known for its highly leveraged mindset, having borrowed enormous sums of money from many corporations and investing in several digital asset ventures. As of March 2022, its assets under management have surpassed $10 billion, including tokens such as Avalanche, Solana, Polkadot, and LUNA in its portfolio. Three Arrows Capital is unquestionably a cryptocurrency investing behemoth.

three arrows capital 3ac

In the immediate wake of Terra's demise, word spread that Three Arrows Capital was experiencing financial issues and was accused of misappropriating customer cash. Su Zhu withdrew the digital currency tab from his Twitter account profile, which featured ETH, on June 14, 2022, and stated, "We are in discussion with the necessary parties and are totally dedicated to resolving this problem." Su Zhu, on the other hand, did not identify the nature of the "problem" to which he was reacting.

The next week, digital asset broker Voyager Digital said that it had given Three Arrows Capital 15,250 Bitcoins and $350 million in stablecoin USDC. Back then, the loans totaled more than $675 million. Three Arrows Capital was asked to return all outstanding debts by June 27 or face default; Three Arrows Capital did not repay the loan on time, and Voyager pursued reimbursement from Three Arrows Capital via legal channels. Following the public disclosure of the event, additional lenders of Three Arrows Capital, including Genesis Global Trading, BlockFi, BitMex, FTX, and Blockchain, among others, demanded the return of their loans. Three Arrows Capital was forced to liquidate, even selling out 80,000 stETH (more than $84 million) in the stETH/ETH pool on Curve, leading stETH to de-peg (stETH was once 0.94 ETH).

Three Arrows Capital exposed itself to the cryptocurrency realm, which has far-reaching effects. However, owing to the lack of transparency, no one knew who carried the next grenade; as more and more institutions exposed the bad debts of Three Arrows Capital, the entire sector was in terror, and the money kept departing the scene. Since then, the crypto business met the "Lehman Moment."

The FTX debacle

FTX filed bankruptcy in November after a run on its customers depleted its funds to the point of insolvency. This has to be the event of the year since the start of the current bear market, and the effect is beyond comprehension and time. Sam Bankman-Fried launched FTX and its sister firm Alameda in 2019. FTX had become a powerhouse with a $24 billion market valuation in the three years after its establishment before the crisis. It was the industry's second-biggest controlled exchange. The key founder, SBF, has $15.6 billion in personal assets. But after a week, all of those assets were gone.

ftx sam bankman fried

The disturbing incident dates back a long time since it serves as a centralized exchange for customer assets. Meanwhile, since Alameda, a sibling firm, needed operating money for business expansion, it borrowed from FTX using FTTs and SOLs as security. The original client asset mix is therefore replaced by extremely similar and volatile altcoins, such as FTT and SOL, from stablecoin and BTC, while the difference in book value is minor. Coindesk triggered the event by publishing information from FTX's balance sheet. CZ, the founder of Binance, then declared that he would sell all his FTT holdings to hedge the risk, which sparked panic and led the price of FTT to collapse, resulting in a mass devaluation of FTX's assets on the books and users abandoning FTX at the same time. FTX eventually filed for bankruptcy since its liquidity had been depleted. The residual assets, which were substantially depreciated FTTs and SOLs, were insufficient to pay off the debt.

The FTX event has had a devastating impact on the market. As top crypto businesses, FTX and Alameda have been seen participating in several initiatives, particularly during this year's bad market, they have constantly gone to the rescue of companies in the sector amid crises, presenting an appearance of being the cryptocurrency world's central bank.

Furthermore, other projects dealing with FTX, such as bitDao and MIM, as well as investment firms like Sequoia Capital and Temasek, have faced serious losses, with token price drops and write-offs as bad debts. The FTX tragedy may be dubbed the "Lehman Moment" for the crypto business, with significantly worse consequences and losses than the LUNA disaster and 3AC bankruptcy.

Aside from the market collapse and the losses of the firms and projects involved, this tragedy has had such a negative influence on the whole ecosystem that centralized exchanges, which were the most immediately impacted, have experienced unprecedented suspicion. Since the incident, all major exchanges have been under pressure from enormous withdrawals from users, indicating current users' massive skepticism of centralized exchanges under the weight of panic. In response, major exchanges have taken corrective steps such as publishing proof of reserve, pushing for the establishment of a code of conduct, and providing funds for industry revival.

However, in the long term, the ecosystem will undergo additional changes:

Compliance licenses will be more costly and harder to get, and restrictions will be tougher.
Decentralized exchanges may regain popularity as skepticism in centralized exchanges grows, and the voice of decentralization becomes stronger.
Following this occurrence, the information transparency of any project or institution will be considerably increased.
Users are becoming skeptical of the industry, and the gloomy market will last as the token price continues to fall.

Nonetheless, a wound cannot heal without suffering, and better opportunities always result from greater risk. The industry will get healthier when the contaminated region is appropriately treated and removed as the market gradually calms down.

The Merge of Ethereum

The long-awaited Ethereum Merge, which successfully changed the mainnet's consensus algorithm from Proof of Work (PoW) to Proof of Stake (PoS), was successfully completed on September 15, 2022.

Since its inception, Ethereum, a top-tier computer, has implemented the proof-of-work consensus algorithm to guarantee the security of the system. Various transactions, smart contracts, accounts, and other intricate operations run on top of this fundamental mechanism. The current infrastructure presents a challenge to system scalability as ecological applications on Ethereum keep growing, and the limitations of PoW severely restrict Ethereum's future development. The team has provided a number of network upgrade methods to address the scalability issue.

Following the Merge, Ethereum's block structure, network structure, consensus method, and node types will all alter in accordance. The new blocks can be thought of as a conjunction of beacon blocks and the original PoW blocks, with the strings related to PoW consensus being changed to 0 or constant accordingly. The network structure will embrace the architecture of the "consensus layer + execution layer," in which the consensus layer will organize and command the execution layer to produce and synchronize blocks. After the merge, there will be a greater variety of Ethereum nodes. The installation of stateless nodes will help the network stay as decentralized as possible while also laying the groundwork for future sharing.

Eth the Merge

The Merge of Ethereum marks a significant turning point for the cryptocurrency market. For Ethereum, the Merge is a crucial step toward further performance improvement, and the switch to proof-of-stake paves the way for later sharding and scaling. The issuance of ETH will also decrease significantly following the merge, and since EIP-1559 will no longer exist, ETH will likely experience deflation in the future. Mass GPU mining has been banned for the sector, and miners must now choose between leaving or switching to alternate chains. Other POS chains will inevitably lose market share in the future as Ethereum steadily makes improvements to address the flaws. From a more in-depth perspective, the Merge represents a substantial adjustment in response to the call for global carbon emission reduction. Although Bitcoin's longevity previously demonstrated the reliability of PoW, the iterative computations required by miners to determine the distinct hash value have been a drain on resources. As a result, the switch from Ethereum to PoS will result in a 0.4% annual reduction in world energy usage.

The Layer 2 frenzy

The most significant event in Layer 2 this year was the release of OP by the popular Optimistic Rollup protocol, Optimism, which drove both the segment's growth and its own growth relative to the general state of the market.

Early in 2022, Layer2 growth slowed down despite Layer2 protocols' best efforts to draw consumers and accelerate growth. First, in order to entice users to participate in on-chain activities in order to be eligible for NFT incentives, Arbitrum, the top Optimistic Rollup protocol, launched a campaign for ecological exploration in April called "The Arbitrum Odyssey." The event had to be canceled since the soaring morale overwhelmed the network's predetermined capacity. Shortly after, Optimism revealed the economic concept and announced the OP native token issuance program. Early in June, Optimism established an incentive fund to support builders and OP ecosystem initiatives, using 5.4% of the token's original supply. Through these activities, Optimism's TVL (measured in ETH) increased by more than four times in only six months.

Out of the four well-known projects in Rollup, optimism was the first to release tokens, and its success has acted as an example for others. On July 13, the ZK Rollup team, StarkWare, published three articles in a row outlining the schedule of token issuance on affiliate product StarkNet, initial supply of issuance, and allocation of tokens. StarkNet has already generated 10 billion tokens, and a portion of the initial supply will be given to the supporters and related investors of StarkNet.

Right now, only two of the four leading projects have released tokens, though the other two will eventually do the same. Although zkSync has made a statement on token issues in its official user documentation, Arbitrum cannot prevent token issuance unless the championship is no longer intended to be maintained.

The issue of tokens is being accompanied by technical advancements. In order to improve network speed and lower transaction costs, Arbitrum introduced the Nitro network in August. A significant update to Bedrock will be released in Q4 of this year and will enable Ethereum equivalency, cut deposit time from L1 to L2, and lower transaction prices. Rust-VM is implemented by StarkNet, considerably decreasing the obstacles for Rust language developers. The mainnet for ZkSync 2.0 will be made available in November. Phase 1 is exclusively accessible to the developing team.

When further techniques are implemented, such as token issuance, the network will be equipped with the possibility for value discovery so that developers and users may further be rewarded. Layer 2 protocols are committed to enhancing user experience and performance via technological updates. In hindsight, Layer2's total TVL this year turned a corner at the same time as Optimism's token sale. One of the few sectors that continued to rise during the weak market was Layer2's TVL, which from that point on, increased by 63%. Although this summer isn't quite a "Layer2 Summer," Layer2 has shown vivacious vigor, and perhaps next summer will offer a surprise.

Disclaimer
This article is intended for and only to be used for reference purposes only. No such information provided constitutes advice or a recommendation that any investment or trading strategy is suitable for any specific name.

Year-end crypto market report: A summary of 2022 - Part 1