Welcome to our special end-of-year edition of the Data Debrief. Throughout 2022, the Kaiko Research team diligently covered the near constant flow of industry-defining events with our signature data-driven approach. Today, we will walk you through the year's defining market events with the benefit of hindsight and an eye towards the future.

But first, a big thank you to all of our readers hailing from CeFi, DeFi, TradFi and everywhere in between.Throughout the year, the Kaiko Research team doubled in size, launched our Deep Dive newsletter, appeared on CNBC (multiple times), published our first Quarterly Report, leveled-up our DeFi analysis, and expanded our Chartbook.

We have big things planned for 2023 involving data, visualizations, and a new way to read Kaiko's research. But more on that later. In the meantime, have a very happy holidays! 

- Clara Medalie, Director of Research

Written by Dessislava Aubert, Riyad Carey, and Clara Medalie

The crypto safe-haven narrative gained traction in the beginning of the year after the start of the Russia-Ukraine war. Both ruble and hryvnia trade volumes surged immediately after Russia’s invasion, boosted by record local currency devaluation and market disruptions. Interestingly, the increase was mainly driven by stablecoin volumes rather than BTC, with weekly Tether (USDT) volumes jumping more than five-fold in early March relative to the start of the year.

While hryvnia volume remained robust throughout the year despite local restrictions, ruble volumes have quickly returned to their pre-war levels. This is mainly due to the imposition of international sanctions against Russia, restrictions on payment networks such as Mastercard and Visa, and crypto exchanges’ efforts to restrict Russian accounts. 

Ukraine has embraced crypto throughout the war, formally legalizing its use in March and receiving close to $100mn in crypto donations. 

Looking ahead: Crypto proved that it can be leveraged in times of extreme uncertainty, particularly stablecoins, allowing citizens an escape from volatile currencies. This conflict also demonstrated how quickly sanctions and restrictions enforced by global payment networks can curb unwanted crypto usage.

TerraUSD (UST) was one of the fastest growing cryptocurrencies in history, with its market cap surging from $2bn to $18bn in just 6 months between the end of 2021 and April 2022. However, in just a few days the stablecoin lost nearly all its value, deviating from its intended 1-to-1 peg to the USD, bringing down the entire Terra ecosystem with it. 

UST grew to become the third largest stablecoin, boosted almost entirely by Anchor, a lending protocol on the Terra blockchain offering unsustainably high yields on UST deposits. UST was backed by a mint and burn mechanism using the token LUNA, in addition to more than $3bn of Bitcoin reserves to maintain its peg. This mechanism was put under pressure in early May following a period of significant UST selling, low liquidity, and falling crypto prices, creating a death spiral for both UST and LUNA: as UST de-pegged, traders rushed for the exits to cash out into LUNA, which in turn experienced hyperinflation.

The chart above shows just how quickly liquidity on Binance evaporated during the sell-off and price dip on May 9. Upon de-pegging, bid depth collapsed while ask depth fluctuated widely, ranging from $2mn to $20mn, likely contributing to the difficulties that UST had in re-pegging. For a detailed analysis of the Terra ecosystem collapse check our deep dive here.

Looking ahead: It now goes without saying that if yields seem too good to be true they probably are. The Terra collapse was also a great example of the importance of on-chain data when investigating warning signs of a token or project’s health. In 2023, pay attention to what happens on DeFi protocols! 

In the months following the Terra collapse, crypto experienced its own version of a credit crunch. In June, Celsius, one of the largest centralized crypto lenders which managed roughly $12bn in assets, announced it was pausing all withdrawals due to “extreme market conditions." The platform had been facing an increased level of customer withdrawals for weeks prior to the announcement following rumors about potential insolvency and its exposure to Terra. 

Celsius's liquidity situation deteriorated rapidly due to a combination of poor risk management and bearish market conditions (for more in-depth analysis see our Celsius deep-dive). In particular, the company invested a large portion of its clients' funds in Lido Staked Ether (stETH). As a liquid staking token, Celsius was able to use stETH on other DeFi protocols. However, stETH was significantly less liquid than ETH and began trading at a discount to ETH of about 5% as investors anticipated Celsius liquidating its holdings. When Celsius halted withdrawals, markets reacted swiftly and bearish contagion spread throughout other lending platforms and large crypto institutions, which suffered similar liquidity problems. 

Looking ahead: stETH is a relatively small crypto token, but played an outsized role in the collapse of Celsius and wider crypto credit crunch. This scenario demonstrates the risks involved when centralized platforms invest client funds in high-risk DeFi protocols. Again, if yields seem too good to be true (in this context, on centralized platforms), they probably are. 

More broadly, the crypto credit crunch continues to play out today and could have a bearish impact on markets should bankrupt lenders be forced to liquidate their crypto holdings in the new year.

In July, Binance removed fees for 13 BTC pairs, which had the effect of immediately boosting crypto trading on its platforms. The exchange’s market share surged to over 72% relative to 14 other exchanges, up from 43% at the beginning of the year. To counter falling volumes, exchanges have started getting creative. Fee removals — temporarily or permanently suspending fees for selected trading pairs — which appear to have an immediate impact on trade volume are increasingly popular, along with trading contests.

While suspending fees is not a new practice and has arguably improved liquidity when done right, in the long run this model contains risks for exchanges as the forgone revenue could be difficult to sustain. Interestingly, Coinbase has opted for a different strategy, revising its fee structure to target large investors and launching new services, such as Ethereum staking.

Looking ahead: Despite experiencing a record $6bn in outflows following fears around the soundness of its reserves in December, Binance continues dominating spot trading.  However, as the world’s largest exchange, it faces growing scrutiny from both regulators and customers, which could reach a boiling point in 2023. Traders are increasingly valuing transparency, and there could very well be a shift towards more regulated centralized platforms. 

​​In 2022, the largest Ethereum DEX Uniswap emerged as a formidable competitor to centralized exchanges with its trade volumes nearly equalling Coinbase's for the first time in history. The increase in Uniswap’s market share relative to Coinbase is likely due to a combination of factors: more tokens available on Uniswap, lower gas fees relative to last year, bot volumes (estimates put this at around 50% of volume), and Uniswap users being more crypto-savvy and likely to trade during a bear market.

Uniswap has gained significant traction relative to other DEXs as well, as it now commands over 80% of Ethereum DEX volumes, gobbling up nearly all of competitor SushiSwap’s volumes (for a more detailed analysis of the DEX market check here). 

Looking ahead: Uniswap's volume has been impressive throughout this bear market. Will governance turn on the long-awaited fee switch to divert some revenue to token holders? How will DEXs be affected by regulations? And can any DEX make a dent in Uniswap V3's dominance?

Overall, cryptocurrency market structure continues to be dominated by centralized exchanges with Ethereum-based DEX volumes still magnitudes lower compared with their centralized peers. However, DEXs have shown remarkable resilience to the current market turmoil and innovations continue to make them more competitive with CEXs, especially following the collapse of FTX.

In 2022, the Ethereum network successfully transitioned to proof-of-stake, completing without a hitch one of the most consequential upgrades in its history and reducing its energy consumption by about 99%. Merge-related optimism boosted capital inflows into crypto markets throughout the summer. Ethereum’s perpetual futures open interest hit a yearly high of $6bn in August, driven by both a rise in the amount of open contracts in native units (at all-time high) and spot USD prices. Funding rates were mostly positive between July and August despite turning negative in the run-up and the immediate aftermath of the Merge. 

Looking ahead: While ETH’s price fell after the Merge, in the long run, the upgrade bodes well for the future of the network as it paves the way for future scalability improvements. However, it has also been controversial, as nearly 70% of blocks are OFAC compliant, boosting concerns about censorship that will continue in 2023.

While there is growing anticipation (and some concern) around a deadline for ETH staking withdrawals and the network's scaling roadmap, Layer 2 scaling solutions built on top of Ethereum have gained significant traction and will likely continue to do so in the new year (we discuss more on L2s here).

The FTX collapse was the biggest crypto-related event of the year, and probably the most widely covered event in crypto history. While many doubted the sustainability of Terra’s Anchor protocol, FTX’s business model was perceived as sound and the exchange benefited from a solid reputation in the industry. It all started with a CoinDesk article which revealed that trading firm Alameda Research — which is closely linked to FTX and former CEO Sam Bankman-Fried — held large amounts of FTX-issued FTT token on its balance sheet. FTT was only listed on a handful of exchanges, with the majority of market activity dominated by FTX and Binance.

As we’ve often written this year, liquidity is crucial, and FTT’s already thin liquidity dried up hours before its price fell below $22 as fears spread about Alameda and FTX’s solvency. FTT had a market cap at one point greater than $8bn, yet had bid-side depth of just a few million, meaning neither FTX nor Alameda would have any way to liquidate the token without massive slippage. 

FTT concerns led to mass outflows from FTX, which halted withdrawals shortly before filing for bankruptcy. It has since been revealed that FTX misappropriated its clients’ funds and had a hole of over $8bn. There's a good chance you've read enough about FTX this year, but we dug into the data around its collapse here.

Looking ahead: In hindsight, it seems obvious that FTT was a massive vulnerability, as a token with almost no utility, liquidity, or demand. To prevent the next FTX collapse, the industry must question all business models and balance sheets and demand transparency from the centralized venues they use. 

Crypto liquidity is dominated by just a handful of trading firms, including Wintermute, Amber Group, B2C2, Genesis, Cumberland, and (the now defunct) Alameda. The loss of one of the largest market makers, had a direct negative impact on crypto markets liquidity which we called the “Alameda Gap.” This gap is exacerbated by losses that other market makers incurred due to the collapse of FTX.

Since November 2, the day that CoinDesk published its investigation of Alameda’s balance sheet, BTC liquidity within 2% of the mid-price has fallen from 11.8k BTC to just 7k, its lowest level since early June. Kraken’s BTC depth has fallen by 57%, Bitstamp’s by 32%, Binance’s by 25%, and Coinbase’s by 18%. The chart above aggregates market depth across 18 exchanges including FTX. However, even when excluding FTX from the chart, there is still a huge drop in depth. While liquidity has stabilized since and currently hovers around 11k BTC, it remains significantly lower than pre-FTX collapse. 

Looking ahead: Hopefully the drop in liquidity is temporary, and there are already signs market makers are re-entering markets and re-gaining confidence. However, it is likely that market makers will be more careful choosing the exchanges on which they hold funds, perhaps boosting the market share of more regulated exchanges.

Historically, market capitalization has been a controversial metric, as it does not consider liquidity and token inflation. Most recently, Alameda misrepresented the value of numerous tokens on their balance sheet that proved to be virtually illiquid on open markets. It is clear that a more thorough approach to valuing tokens is needed and liquidity must be a metric investors incorporate going forward to properly assess the risks of their holdings. We built a ranking based on a model combining spreads, market depth, and trade volume data for 28 tokens to better understand each token’s liquidity.  

For example, the third largest token by market cap Binance’s BNB token, only ranks 6th in our liquidity ranking due to its poor ranking in depth and spreads. By contrast, Chainlink’s LINK performed well in the spreads and depth metrics and despite its lower trading volumes on centralized exchanges, arrived 9th in liquidity rank vs. 21^st by market cap. 

Overall, crypto market liquidity is very concentrated; as of November 2022, the average depth for BTC and ETH was over $190mn and $130mn, respectively. For context, average depth for most altcoins is below $30mn. Overall, the top 10 crypto assets attract 80% of total market liquidity.

Looking ahead: The industry must begin to recognize that market cap and fully diluted valuation are theoretical numbers that do not accurately reflect the value of a token, especially if a large holder is looking to cash out. A return of altcoin liquidity would be beneficial for the market, as well as DeFi protocols that rely on price oracles for less liquid tokens. 

2022 was marked by a shift in monetary policy regime, with global central banks putting an end to a nearly-decade long period of loose monetary policies. Since March, the U.S. Fed has tightened by a cumulative 425bps. The ECB hiked by 250bps YTD, the fastest increase in rates since the creation of the eurozone. Other central banks followed suit, contributing to creating the least attractive environment for risk assets in years. Even the Bank of Japan stunned markets last week with a yield control policy change, signalling that its days of ultra-loose monetary policy could be over next year.  

Risk assets sold-off in union registering double-digits losses, with the correlation between BTC and U.S. equities hitting an all-time high in April. However, while macro has been the main driver behind crypto price action throughout most of the year, this changed after the FTX implosion. Correlations dipped to as low as 0.17 immediately following the collapse and have stabilized below 0.6. Overall, despite briefly decoupling from US equities markets, crypto is not insulated from the broad macro backdrop.  

Looking ahead: Global recession worries and tightening liquidity will continue to weigh on risk assets especially as quantitative tightening speeds up. However, the U.S. Fed and other central banks are widely expected to slow down the pace of rate hikes next year, perhaps providing respite for risk assets. 

Thank you for supporting Kaiko Research over the past year! Happy holidays to all! 

- The Kaiko Research Team

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