For many Web3 enthusiasts, the past year has been a rude awakening. The market prices of major digital assets have dropped significantly, TVL across various DeFi protocols has plummeted, the trading volume of Non-fungible tokens (NFTs) has slowed, and, most importantly, some pioneers of the space like 3AC, FTX, BlockFi, etc. have declared bankruptcy due to poor risk management and misuse of consumer funds. Even as the debris continues to fly, investors must avoid conflating market volatility or unscrupulous actors with the potential uses of digital assets and the technologies that support them.
While we are still early with technology and its challenges due to the overall bearish macro scenario, applications for the next generation of the internet continue to emerge in many industries, with potentially transformative implications.
It remains to be seen how far and fast these technologies and their applications can proliferate; the road is proving difficult, with persistent obstacles ranging from poor user experience to fraud. Importantly, the regulatory landscape for Web3 remains uncertain, with calls for greater clarity on particular assets and increased consumer protection for funds held in custody. However, recognising this new digital wave’s key characteristics and the potential disruption it may bring is critical for businesses across various industries.
Further on in this issue of the newsletter, we cover major themes that we can anticipate emerging in the field of decentralised finance (DeFi), as well as how we see DeFi developing through the year 2023.
DeFi in 2023 – Way Forward
Despite the failure of a significant number of centralised businesses over the course of the past year, the DeFi ecosystem has been preserved. Although this does not mean that decentralised finance firms were unaffected by the many bankruptcies in the centralised industry, extended bear market circumstances and harm to consumer trust in crypto assets are detrimental to DeFi. As we step into 2023, we see a silver lining to this cloud and look at some trends as DeFi looks to sustain and grow out of the bear market.
Tokenisation of Real-World Assets (RWAs)
Moving on-chain has huge potential to unlock huge liquidity and utility for real-world assets (RWA). MakerDAO, a large DeFi lender, has invested in US Treasurys and corporate bonds and teamed with banks to lend using RWAs as collateral.
Source: Dune Dashboard
Some key features of RWAs:
- creates digital assets representing real-world assets that can be sold on numerous platforms, increasing efficiency.
- reduces financial transaction costs by eliminating intermediaries. This makes financial services and asset investments cheaper for people and corporations.
- allow anyone with an internet connection to buy and sell digital assets, making financial markets and assets more accessible. This can democratise finance.
- creates safe, immutable digital assets that defy fraud and tampering, making financial transactions more secure.
- Some projects building in this space are Centrifuge, MakerDAO, Goldfinch, Credix, Mohash and the very recently launched RWA Market on Aave.
RWAs are a great way to combine traditional institutions with DeFi liquidity. According to a recent report from Coinbase, RWA tokenisation could become a multi-billion TVL opportunity in the next 3-5 yrs. An earlier report by BCG also mentioned that the total size of tokenised illiquid assets, including real estate and natural resources, could reach US$ 16.1 trillion by 2030.
Stablecoin Adoption
Stablecoins continue to be one of the most mature use cases for DeFi. Protocol-native stablecoins may launch around the corner, but the market leaders are well-established. USDT remains the long-time incumbent; USDC has a strong foothold on Ethereum and its rollups. As the industry matures, we see a key role that stablecoins will play in 2023 –
– as DeFi becomes more popular, stablecoins will be used as collateral and to facilitate transactions.
– DEXs allow users to trade cryptocurrencies without a central authority, which may boost stablecoin acceptance.
– use cases will expand in the web3 domain, including providing liquidity for decentralised apps (dApps), enabling cross-chain transactions, and facilitating micropayments.
– greater regulatory clarity: As the stablecoin market matures, regulators will clarify the legal status of these digital assets. This could boost stablecoin adoption and confidence.
– stablecoin market is likely to become more competitive in the coming years, with new entrants entering the space with newer models and existing players looking to differentiate themselves.
Layer-2 scaling and ZK Rollups
ZK rollups – layer 2 scaling solutions are placed to gain traction in the decentralised finance (DeFi) space due to their ability to increase the transaction throughput and reduce gas costs significantly.
DeFi ZK rollups have several advantages:
– Scalability: ZK rollups batch transactions and execute them off-chain, reducing Ethereum blockchain load. This increases DeFi application throughput and lowers transaction fees.
– Security: ZK rollups use zero-knowledge proofs to verify transactions, reducing fraud and increasing security and privacy at the transaction level
Overall, ZK rollups have the potential to play a significant role in the future development of DeFi by addressing some of the scalability and security challenges that are currently holding back wider adoption of these technologies.
Regulatory-compliant DeFi
It is possible that regulatory intervention in the decentralised finance (DeFi) space could occur in 2023 or the coming years. The exact timing and nature of any regulatory action will depend on various factors, including the growth and development of the DeFi market, the actions of DeFi firms and users, and the stance of regulatory bodies worldwide. As quoted in the Messari Thesis for 2023, “DeFi is seen as the highest-risk subsector of crypto by members of Congress, and it will be challenging to communicate a different story effectively. If the value of crypto writ large is a complicated story, just add DAOs, and it ratchets up the complexity to 11 for people who do not live and breathe the details of our industry.”
DeFi regulatory action may focus on several areas:
- as DeFi grows more popular, regulators may safeguard consumers against fraud, scams, and other financial abuse. DeFi firms may need new consumer protection laws
- robust KYC practices and knowledge of counterparties while using dapps
- regulators may try to stop market manipulation and other misconduct. Fair and transparent marketplaces may require new regulations and norms
- need to protect user data and privacy. Regulators may set standards to guarantee DeFi providers responsibly manage user data and comply with privacy laws
Overall, regulatory intervention in the DeFi space will likely be necessary as the market continues to grow and evolve. The goal of any regulatory action should be to ensure the integrity and stability of the DeFi market while also protecting the interests of consumers and investors. Read more about this in our investment thesis.
Woodstock X ETH India
India Blockchain Week showcased grassroot talent and innovation in India. As active participants in the Indian ecosystem, the Woodstock team was able to engage with not just blockchain experts but with brilliant minds across the blockchain ecosystem.
Eth India was a three-day hackathon that set the record for the largest Ethereum Hackathon, with 2k+ participants and 450+ projects. Woodstock’s portfolio companies had a sublime presence with several booths, hackathons, workshops, bounties, demo days and other events showcased by Biconomy, Covalent, Frontier, Push Protocol, Router, and Marlin.
The main themes of the hackathon were Account Abstraction, Payments Infra, ZKP solutions, NFT utilities, and Decentralised Social Media. Regional problems like local payments via crypto were also targeted. Find all the Eth India projects here.
We saw participation from more than 300+ cities, while almost half of the builders were new to Web3, indicating a solid interest in Web3 amongst the Indian youth. The depth of knowledge was impressive, considering the ecosystem’s nascency.
ETH India was an extremely fruitful event for team Woodstock. We got to experience the heat of the Indian Web3 youth. Since it was a developer-first event, it was a great opportunity to interact with and understand the grassroot developer talent of the country. India emerged as a strong Infrastructure market as most of the builders we talked to had an inclination towards solving Infrastructure problems in Web3. ETH India makes us more bullish than ever towards the growth aspects of the country home to the world’s largest young techies. We are confident that India will be a powerhouse in Web3 over the coming few years.
How Woodstock Fared?
Woodstock Fund II has performed significantly better than the market. Having started investing at the beginning of 2022, the NAV of the fund is at a modest discount of ~15% at the end of October 2022. In comparison, BTC and ETH were both down 55-60% in the same timeframe, and prominent funds have also suffered significant losses.
While asset performance is a key factor in fund performance, counterparty risk assessment and risk management are also important factors in safeguarding AUM. We have been prudent, relatively risk-averse, and had strict diligence processes for both projects and counterparties.
Out of the two biggest falls (Terra and FTX) in the web3 space this year, Woodstock had no direct exposure to either of the companies or their ecosystems (Genesis, BlockFi, Voyager, Solana). Our experience in the last 4 years as a venture capital firm has helped us steer clear of
- unsustainable financial models as seen in Terra and its ecosystem,
- over-leveraged lending and borrowing as employed by 3AC, FTX, and Alameda,
- unreliable technology as developed by Solana, and
- concentrated-power setups as witnessed in Terra and FTX.
We have evaluated thousands of ideas, business models, technology paradigms, and legal structures to make sound investment decisions. We will continue to do the same with our robust due diligence process. Our post-investment portfolio support.
WOODSTOCK IN THE NEWS
- We hosted Marios Tryfonides, Managing Director at Integritas CFS and Shailesh Puthran, Partner at Woodstock Fund, for a Masterclass on “Best Risk Management Practices for Web3 Assets.” The session was moderated by Pranav Sharma, General Partner at Woodstock.
- Pranav Sharma, General Partner at Woodstock, was a keynote speaker at the IIT Bombay Tech Fest. He spoke about the emerging trends of web3 and how job opportunities in this space will evolve over the next few years.
MARKET NEWS
- Investment giant BlackRock has committed $17 million to bankrupt bitcoin miner Core Scientific as part of a new $75 million loan from the miner’s secured convertible note holders, according to a U.S. Securities and Exchange Commission filing that was filed on Thursday.
- FTX Japan customers will be able to withdraw their funds as of mid-February, the subsidiary of FTX Trading said in a blog post on Thursday, making them some of the first customers of the collapsed crypto exchange to get their money back.
- MicroStrategy, co-founded by Michael Saylor, has added to its Bitcoin stockpile, purchasing about 2,395 BTC for $42.8 million between Nov. 1 and Dec. 21 through its MacroStrategy subsidiary, according to a filing with the Securities and Exchange Commission on Wednesday.
- A former employee of DeFi protocol Ankr maliciously caused a $5 million exploit earlier last month, according to a statement published on Ankr’s website
- Polygon co-founder Sandeep Naliwal unveiled a new Web3 accelerator – Beacon.
- Binance.US has agreed to purchase bankrupt crypto lender Voyager’s assets for $1.02B.
- Yuga Labs, the Web3 startup behind Bored Ape Yacht Club, announced that former Activision Blizzard President and Chief Operating Officer Daniel Alegre would be joining the company as CEO, effective in the first half of 2023.
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