Onchain Markets in 2022
A review of 2022 onchain markets and a look forward by parsec
Ultra Degen Reversal
The late months of 21’ stalked the BTC top of Nov 21’ with a basket of assets way out on the risk curve melting up. This basket was headlined by *DeFi 2.0*, a now maligned movement that I would characterize as a group of reflexive DeFi protocols. Reflexivity is a property many market participants actually want, all successful businesses are reflexive, and traders want this as well - as our fallen soldier Trabucco would say “the worst thing that can happen is you lose all your money”. Risk on traders were printing into illiquid traps. But 22’ started off with a bang, OHM - the darling of the secular DeFi outperformance - had been bleeding off a euphoric top, but suddenly the (9,9) strategy of bonding OHM and levering up via fuse was liquidated with haste.
This was the beginning of a trend in 2022, all leverage built up over 2021 was just deferred selling. Abracadabra and the affiliated Wonderland are likely the best distillation of DeFi 2.0. Abra is a leveraged yield farming protocol, with the key innovation being a maker style stablecoin on top ($MIM). Abra poured gasoline on the market double top, despite being categorized as “leveraged yield farming”, all the large markets were just risk on volatile assets (tri-crypto, stETH, SPELL). Notably the most “delta-neurtal” pairing was the UST market, a market given the special (and apt!) designation of degenbox.
Degenbox looped anchor deposits, pushing yields to >100% APR. Ultimately, degenbox was a major tipoff to structural issues with anchor. A non-market supply side rate was going to be leveraged to the hilt to squeeze the incentive dry. Wonderland was the other large “Dani Project” that really took off in - a pure OHM fork with a treasury that was more actively managed capitalized on the emergence of the avalanche ecosystem and attracted retails traders looking for the next OHM. Only a week after OHM delevered, wMEMO got annihilated as the abra cauldron got liquidated. The wMEMO collapse resolved months and months later, with an eventual optional redemption of treasury assets, and a slow death towards book value, a trajectory (all?) OHM forks followed. From the euphoria of >10x book multiples to discounts and heated governance debates with treasury raiders, a perfect encapsulation of the highest highs and lowest lows that 2022 brought.
The Final Throes of the NFT Bull Market 1.0
Much like broader crypto markets, the NFT market double topped, with the second run being held up by the inimitable yuga labs. With the launch of $APE, yuga set into motion the final act of this cycles NFT market euphoria. With APE live, the extra utility that had been layered on was the ability to mint otherdeeds. Additionally, BAYC & MAYC holders got a free mint, a textbook layering of airdrops to prop up the entire bored ape wealth effect. APE, BAYC, and MAYC all soared into the mint. But alas, the mint was botched, a network wide gas war of unparalleled proportions ensued and over $100m ETH was burned in a single day, with the mint proceeds pulling in >$300m.
For a nascent market, and one where most of the wealth is paper, Otherdeed lit what liquidity was left on fire, with terra collapsing a week later and pulling ETH down with it. For the remainder of 2022, the NFT market has toiled, with spots of action here and there but nothing that remotely moves the needle compared to the yuga binge. A deep cleanse is likely required for long term health of NFTs, may 2023 bring fresh approaches and the survival of the talented.
Terra
The only bright spot in a tumultuous market in early ‘22 was terra. LUNA ran and outpaced all other major L1s and was a narrative vacuum. The narrative centered around anchor, a lending protocol where bLUNA, bETH, and other staking tokens could be levered up by borrowing UST against them, depositors earned a flat 20% in return. UST guaranteeing 20% was a honeypot of epic magnitude, attracting over $10bn in capital. Much of this capital was actually bETH & bLUNA depositors borrowing the UST at a ~10% rate and just redepositing to capture the spread and hold onto the ETH & LUNA deltas. The UST demand over months to accumulate such supply (UST market cap topped out around $19bn) was effectively transmuted into LUNA price increases and capitalizing LFG, the backstop fund.
The institutionalization of the anchor trade was ultimately disastrous, on a Saturday a migration to the new 4pool triggered a few large UST sell on curve. In my estimation, a depositor hit risk limits and cut it all as fast as they could, the rest of the story here is essentially one of negative reflexivity, selling led to more selling. In particular, shorting LUNA became consensus among traders very quickly and once the protocol started selling as well it was curtains, evaporating 11 figures of wealth with haste. The destruction of terra brought a violent end to the remaining positive narratives. Decentralized/under-collateralized stablecoins were eschewed, nuking the bribe economy surrounding Curve and Convex. An entire L1 chain was wiped with the bridged UST going toxic across bridges to new ecosystems like osmosis. Degenbox was unwound, sizable bad debt only being avoided by wonderland manually buying >$50m of liquidations at a loss. In 1 week, the curve pools were left sitting on 100% UST, any UST denominated lending was zeroed, and the best spot trade of Q1 was a 0. The DeFi ramifications were immediately clear, ruthless but swift and unambiguous.
The Merge
A notable bright spot, ETH transitioned to Proof of Stake seamlessly, an upgrade with over $300bn of assets at risk. Beyond the security and roadmap goals PoS represented, ETH as an asset earns a windfall from this upgrade. First, ETH issuance decreased by an order of magnitude, accounting for eip1559 burns - the protocol is no longer deeply unprofitable (is occasionally profitable) despite a historically low onchain activity environment since activation. Second, staked ETH is scaling into a hyper attractive asset with the increased yield from transactions fees and MEV tips. Staking rates often sit above 6% with a call option on volatility in the form of MEV revenue, again with the backstop of very little organic onchain trading (the real MEV money maker).
ETH is not without future catalysts as well, rollup adoption is surprisingly sticky with heavy lifts from Arbitrum and Optimism. Few assets come out of 2022 with the economics and catalysts of ETH.
The Collapse of CeFi
The 3AC liquidation, Celsius, BlockFi and Voyager collapses pushed markets to the depths, with ETH wicking under $900 (narrowly avoiding a major liquidation) and stETH dipping to 0.93. With FTXs collapse coming in the end of year to put a cherry on top of the complete failure of centralized and crossover crypto infrastructure. FTX’s impact for onchain markets is double edged, on one hand the $8bn hole is a deletion of “hot money”, more often than not that giant NFT/alt purchase was funded via FTX. The dampened volatility and anemic price action in December is no coincidence. On the other hand, FTXs fraudulent lending activity perfectly distilled DeFi’s use case. Aave’s solvency and loan book is given live, block by block, by the underlying state and services built on top like parsec. Leverage in DeFi will have a long future, with failures and successes, but the sudden discovery of a $8bn asset<>liability mismatch will not be one of them.
Looking Ahead
2022 was harsh from the outset, a mix of leverage and fraud has left the market lacking flows and narrative. Instead of churning out platitudes on yet to be released software, I’ll focus on emerging trends with a better probability of continuing to be impactful and grow.
Liquid Staking Derivatives: As discussed, ETH and specifically staked ETH has a compelling mix of liquidity and strong economics. stETH has a large lead on many fronts, but challengers in cbETH and frxETH (among others) prove that Lido won’t run away with this one. An ecosystem of leverage has already formed around existing LSDs, with products like icETH and gearbox providing improved UX to leveraged staking exposure. I expect more of these products to pop up around DeFi, perhaps even some fixed rate instruments will be successful despite fixed income having a cursed history onchain. Withdrawals being enabled in 2023 will de-risk staking derivatives more broadly by allowing tighter arb loops which will boost liquidity and participation (regardless of any “unlock” effects)
Perpetuals: GMX managed to *increase* their OI during the back half of 2022, a feat that stands out and is a testament to the product the team has built over there. The demand for onchain perpetuals is clear, with pseudo AMM models like GMX additionally creating a yield bearing and collateral worthy asset in the form GLP. With the vacuum left by FTX for cross collateral degen leverage all eyes on existing systems growth and if any new models move the needle (dydx v4/rage/perennial etc…).
AMMs: The automated market maker remains the most compelling DeFi primitive, in my view onchain trading flows have been on a downtrend since May ‘21. Despite that Uniswap V3, Curve V2, and Solidly (velo & canto both forks) have all pushed the state of the art forward. Somehow AMMs remain maligned by narrative (LPs unprofitable, CLOB superiority complexes, etc…). I give a >50% probability that ‘23 sees the reversal of this narrative if onchain flows return, with some compelling tech in the pipeline to boot (crocswap, uniswap upgrades etc…). With many major market makers washed out and CEX liquidity in the worst state it has been since 2020, AMMs have a real opportunity to start quoting competitively. It is no coincidence that both LSDs and perpetuals succeeding onchain hinge on AMMs for liquidity. Serum’s swift death (and lack of any real success) while curve and uniswap hummed along maintains the status quo many are opposed to.
if onchain, AMM > CLOB
Onward
In a year where 10yr treasuries inverted USDC lending yields onchain, it is hard to make too much sense of where things go from here.
Onchain markets, ~5 years into their existence (3 if we are being honest), have survived a complete implosion of crypto markets. MEV bots keep humming along, lenders keep showing up to Aave in size, thousands of addresses press `swap` on Uniswap every day, a new NFT mints daily, billions in stablecoins custodied. The onchain economy moves forward.
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