STATE OF THE MARKET

FEBRUARY 2019, V1

An Overview on The Current State of Crypto Investing and Adoption

February 19, 2019

Written by Andrew Lee

Sections:

1.ICO INVESTING FATIGUE

2.DAPP ADOPTION

3.OPEN FINANCE

4.GAMES

5.CONCLUSION

1.ICO INVESTING FATIGUE

Returns from investing in ICOs were a lot like “musical chairs,” as early Bitcoin adopter Brock Pierce called it. Investors kept buying Ethereum to make big bets into ICOs that were mostly increasing in value until it all came crashing down. ICOs raised only $65M in Nov 2018, its lowest number since Q1 2017, according to TokenData. The ICO fundraising bubble grinded to a correction in the primary funding markets as well as secondary markets on crypto exchanges, with crypto exchange volume falling out massively for altcoins since 2017. There are a number of challenges that make ICO investing unattractive for investors today:

1.Regulation Clarity. A lack regulatory clarity on utility token fundraises have hurt investor enthusiasm for the space. The US SEC has already forced two ICOs to refund investors, Paragon and AirToken. After dismissing claims last year, a federal court granted victory to the SEC in its case against ICO Blockvestfor security violations as well. The regulatory risk and lack of extremely clear US regulation around utility tokens have stopped investor enthusiasm.

2.Team Token Transparency. In addition, Bitmex issued a report that estimates that at least $1.5B billion in ICO founder tokens were sold in secondary markets. For ICO founders, those profits were earned often with very little effort and transparency. Investors have flocked around privacy protocol MimbleWimble partly because it had no premine and required generalized mining equipment, which ensured that no central team could financially benefit unproportionally compared to the rest of the community.

3.Poor Treasury Management. As the Ethereum price crashed from above $1,400 to below $100, many ICO treasuries were heavily impacted, further degrading investor confidence behind the execution ability of ICO teams. December 2018, when ether crashed below $100, was the largest month for ICO treasury withdrawals with 400k ETH moved out of ICO project wallets.

4.Product Delivery and Marketing. Finally, negative returns on ICO tokens with little accountability for the projects made ICO investments hurt investor confidence. TenX, for example raised $83M and is now 71% below ICO price, and its founder had left the team. Envion raised $100M and is now 95% below ICO price with only $40k in daily liquidity. Zen Protocol raised $46M and is 94% below ICO price. What’s even worse is that some ICOs that raised $10–50M+ are completely illiquid on secondary markets with no volume at all, such as Hybrid Block, BCT, Gladius and likely hundreds if not thousands more. Many of the ICO investors have begun to point fingers at the projects for a lack of marketing for the cause in price and volume drop, but there is an overall trend in lack of trust and transparency for ICO teams in general negatively impacting returns.

5.Large Raises Still Not Trading. Extremely large ICO raises, such as Dfinity ($195M), Filecoin ($200M), Telegram Open Network ($1.7B), Polkadot ($144M), Orbs ($118M), Hashgraph ($100M), Blockstack ($52M), Videocoin ($50M), have still not traded on secondary crypto exchange markets yet. Although centralized exchanges such as Binance do not disclose their user data, decentralized exchange IDEX hit a peak of 8.77k users, based on wallets used to sign in, in May 2018, and is down to only 600–900 daily users in February 2019. It is a serious concern whether there will be enough buy pressure to support the sky high ICO valuations mentioned above. RIF by RSK, which raised 22k BTC and has an OTC market expensive at 3x the private sale rate, saw a 60–70% loss from its private sale price once it started trading in January 2019. If the trend holds, it is likely the ICO investors in $100M+ raises will suffer significant losses.

6.Extremely Underperforming Tokens. Holding almost any ICO from 2017 and 2018, or buying into almost all the altcoins off exchanges in the past year and holding them long-term would’ve punished investors’ portfolios. Zilliqa is 92.46% below ATH, ICON is 98.27% below ATH, NEO is 95.77% below ATH and Ontology is 94.17% below ATH, VeChain is 99.95% below ATH. With such crushing losses, investors would have to lose confidence in holding crypto assets long-term in ICO projects, triggering lower levels of capitulation. The severe drop in prices also brings into question how much of the quick ROI was manipulated and pushed and sold off into the peak hype moment, versus genuine buying activity.

The lack of accountability and transparency with ICO raises have inspired some to look into other forms of fundraising, such as STOs, equity deals, raising in stablecoins and Vitalik’s DAICO model (which proposes creating a smart contract and community vote for releasing funds), although though none of the alternatives have come close to widespread adoption. Many people in the space have acknowledged that ICOs are an imperfect form of fundraising because the team raises money before delivering their product and the teams get to financially benefit from their vested tokens. The complaints and concerns have loudened now that the returns and momentum in fundraises, liquidity and most importantly, quick returns, have all grinded to a stop.

Significant Events Moving Forward

Bitcoin is in its 3rd bear market and is 81.53% below an ATH price near $20k in December 2017, as of February 2019. In 2011, Bitcoin drew back 92% from $30 to $2.50, in 2013–2015 it fell 84% from $1k+ to below $200. There are a few optimistic events looking forward that could help support the price.

1.Halvening. On May 20, 2020, the reward for mining new Bitcoin blocks will drop from 12.5 Bitcoins to 6.25 Bitcoins, which will be about only 900 bitcoins per day. There have been two halvening events since Bitcoin’s creation in 2009. Bitcoin was $12 at its first halvening in November 2012 before hitting a $1k+ ATH, and $660 in July 2016 at its second halvening before hitting an ATH near $20k.

2.Bakkt. Bakkt is owned by the Intercontinental Exchange. ICE owns the New York Stock Exchange and futures exchanges and clearing houses in the US, Canada, Europe and Asia. Bakkt also works closely with Microsoft and Starbucks, and it’s anticipated Starbucks will soon accept crypto through Bakkt, according to Blocks Decoded. Bakkt aims to release regulated physically settled bitcoin futures in the first quarter of 2019, and is closely working with the Commodity Futures Trading Commission to gain regulatory approval. Gold grew 5x in price in 10 years after physically-backed gold ETFs were introduced in 2003, according to Market Watch. Bakkt raised $182.5M from Boston Consulting Group, Galaxy Digital, Goldfinch Partners, ICE, M12 (Microsoft’s VC fund), Pantera Capital and Protocol Ventures. Bakkt aims to facilitate crypto infrastructure in the area of retail payments, futures, 401(k) and IRA saving plans, and wallets and insurances.

3.Institutions and ETF. The launching of additional third-party custodial solutions in 2019 could be a significant transition to getting more institutional capital flowing into crypto assets. Fidelity expects to launch its Bitcoin custody service by the end of Q1 2019 and works with 13k+ financial institutions. In addition, the VanEck-SolidX Bitcoin ETF was refiled with the SEC on Jan 30 2019, allowing the SEC to make a final decision by September 27, 2019.

4.DApps. Despite the investing fatigue around ICOs, there is still developer interest in building DApps on top of protocols which could add new enthusiasm into the market, as outlined in the following section.

II. DAPP ADOPTION

We are at the infrastructure building phase of blockchain protocols that will provide a back-end infrastructure for decentralized applications, or commonly referred to as DApps. The web and mobile applications we use on a daily basis typically run on a front-end and centralized server infrastructure that runs the code. However, blockchain protocols can offer a different kind of back-end with stronger trust guarantees in regards to data integrity, asset ownership and code execution, by leveraging cryptography and consensus among nodes.

What Value Do DApps Bring to End Users

With blockchain protocols, applications can fundamentally change and add value to end-users in several ways, including:

1.No Single Authority. Without a single authority, applications running on blockchain protocols have security against a single authority that can change, censor or shut-down the app. This is particularly interesting in the applications around media distribution, social networks, marketplaces and games.

2.Transparency of Logic. In addition, the way the DApp logic is processed can be made transparent on a decentralized protocol via smart contracts, making sure the app works transparently and publicly as shown. With today’s major social networks, they are closed source and users are unable to see the plumbing and workings behind the scenes.

3.User-Owned Assets. Users will soon be able to be given full control of their assets, which is validated by nodes, through cryptographic signing. This will give users unparalleled control and consent of their assets on the internet, which may include money, identity, personal data and other forms of personal value.

The three characteristics mentioned above are some of the fundamental shifts in online applications that blockchain protocols may deliver on. However, despite the interesting change in fundamental infrastructure, real mainstream use cases are still speculative at an earliest conception stage of real world adoption in large part due the youth of the DApp industry but also due to infrastructure limitations.

Obstacles to DApp Development

Although there is promise and developer enthusiasm for DApps, there are technical and business challenges to developing DApps on blockchain protocols today. The major technical limitations include scalability and developer user-experience include:

1.Scalability. The protocols themselves need to be able to scale to enough transaction throughput with low enough latency for its related use case. To provide comparison on how much throughput mainstream consumer applications need, Facebook receives approximately 175k requests per second while Ethereum currently operates at 7 TPS, as mentioned by Fred Ehrsam. Until blockchain fees and scalability improves, DApp developers will need to choose what data needs to be validated by nodes as well as work around the technical tradeoffs between speed of centralized infrastructure vs. security and transparency of blockchain-based protocols.

2.Developer Ease. Platforms need to be easy to use for developers. That means quality development documentation, a mainstream language for writing smart contracts (such as C or SQL) and easy and fast ways to write and read on-chain data.

3.Fees. Ethereum has gas fees and EOS requires staking EOS to use the network. It’s an estimated 0.035 ETH per KB on Ethereum’s network, or 35,000 ETH ($4,225,900) to store a GB. EOS requires RAM, and 1MB of RAM is approximately ~120 EOS (~$333.60). In summary, blockchain protocols are performance lacking and extremely expensive to run DApps on top of today.

EOS~1–4k TPSDPoS w/ 21 nodes1 secC++Free, but requires staking which is expensiveEthereum~7 TPSPoW43 secSolidityExpensive gas fees, ~$0.045Tron~750 TPSDPoS w/ 27 nodes1 block (~3–15 seconds)Solidity (uses EVM)~.00001 TRX/transaction

A comparison of three live smart contract platforms today: EOS, Ethereum and Tron.

DApps also face challenges in a business context as well. Since DApps are built on harder to use protocols compared to centralized web infrastructure, and benefits of decentralization are often invisible to the end-user, it becomes a challenge to create mainstream consumer use cases. Some of the business and product challenges include:

1.User-Experience. User-experience is a major hurdle to adopting blockchain applications. Normal web and mobile applications don’t involve signing off transactions with cryptographic private keys, and blockchain dapps need to be user-friendly enough for users to not realize they’re using blockchain. Downloading a new type of browser or installing a crypto wallet such as Metamask provides too much friction for average as well as crypto-familiar users.

2.Discovering Product Market Fit for DApps. DApp creators are still gaining clarity around where users care about trust and privacy the most in mainstream consumer applications.

3.Monetization. In the previous eras of internet companies, they relied on scaling to enough users and monetizing with revenue, charging for a product, or taking marketplace fees. The biggest centralized social web and mobile apps monetized by advertising. This presents challenges to DApps which are still speculative with product market fit and adoption. According to DApp survey by Fluence, 55% of DApp respondents were planning to monetize via transactional fees, 16% via transaction fees, 16% via subscriptions, 11% via ads, and even less via NFTs (Non-Fungible Tokens) or staking Ethereum.

Although DApps are at an early phase in development, there is potentially promise and here are some potential scenarios for DApp adoption ideas for the future:

Delete Facebook Movement

CNN Anchor Jake Tapper published a viral tweet in March 2018 that read, “Don’t make the mistake of thinking you’re Facebook’s customer, you’re not — you’re the product. Its customers are the advertisers.” There is a massive cultural movement around users mistrusting Google and Facebook for its use of user data for ads. Many argue that the tech giants have monopolistic control over users’ data and often sell it without users knowing. Celebrities such as music product will.i.am has also taken a public position on it. Spark Capital partner Bijan Sabet, who’s firm led an early investment in Twitter, also claimed he was too trusting of the big tech companies with his data. And other crypto thought leaders are deleting Facebook and Google Apps. Despite requests and attention for additional privacy, it’s still unproven whether a large enough population cares about migrating to new centralized social networks. Private search engine DuckDuckGo has only 0.19% of all global search volume, while Google at 77.44% followed by Baidu with 14.33%. In addition, end-to-end encrypted messaging apps like Signal and Telegram have gotten strong adoption, but the benefits of blockchain to their products might not add any value to e2e encrypted user messaging.

III. OPEN FINANCE

Open finance, decentralized finance and DeFi apps are terminologies used to describe a trend in blockchain projects built for finance use cases. In particular, the ability to hold collateral in smart contracts has opened up a wide range of infrastructure and finance products that could be built on Ethereum. Although Ethereum is slow on Layer 1 and may not be used for super robust game or consumer applications from the get-go, it is capable of safety storing on-chain digital assets and offering a decentralized and safe settlement layer where people can write contracts for collateral and other forms of decentralized financial contracts. We’ve seen the amount of eth locked in DeFi apps grow 10.1% since the start of the year (Jan 1, 2019) to reach a total of 2,109,845 eth by February 18. DeFi apps are an interesting product sector in the blockchain space, but definitely are far from any mainstream adoption so far. Smart contract-based collateral stablecoins, such as MakerDao, certainly hold a lot of future promise.

Here is a list of some of the current open finance DApps:

IV. GAMES

Games are starting to be the number one use case for crypto protocols in terms of daily active users. It’s a tiny market, for example there are only less than 5k DAUs on ETH games, but at the very least, it’s showing signs of life.

Games make up 46% of ETH DApp DAUs, and it’s possible this trend will grow and we’ll see crypto games take shape in one of the two following game types:

1.Gambling Games. There will likely be two types of gambling games that will get traction: casino games, and casual games that mix in an element of gambling. Gambling and betting games: Like dice and casino games, gambling and betting games will continue to gain traction because blockchain can provide transparent odds as well as ease-of-access to to gambling applications. Casual games with a betting aspect: more casual games and video games that we’re used to playing on mobile or console can easily implement an element of gambling. An example might be a battle Royale type game where you knock out other players for their crypto, or a crypto Counter-Strike where you can beat other players for crypto.

2.Non-Fungible Token Games. While gambling is regulatory uncertain and in a lot of cases illegal, games that use NFTs can be a huge market. NFTs are digital content that is verified on blockchain. NFTs create a new ingredient of fun inside games by allowing players to “own” their digital game items which have liquidity for real money value. The addicting loop for blockchain games is the fact that players can earn and own their game items via skill, time spent in game and luck; which can be then sold for real liquid value when the players get tired of the game. It is not directly gambling; but users in NFT games will still have the thrill of being able to make money by playing the game.

Blockchain can add value to games because of the public and distributed ledger can verify direct ownership and authenticity of assets on-chain. Furthermore, the decentralized ledger can give gamers a real and authentic history of the game item; for example, if a sword in a game was particularly effective, the blockchain can verify how many kills/damage that item has done in the past or who owned it. Blockchain will give players direct ownership of their game assets via private key and crypto wallet, which is game behavior that wasn’t possible before. In addition, the existence of secondary markets for NFTS will indirectly allow players to make money while playing games which is totally new for gamers. And finally, blockchain can provide transparency for game rules and odds, which is helpful for gambling and casino games. Chromapolis, a well-received project among the community founded by the Colored Coins founders, is a particularly ambitious platform that aims to put 100% of the game logic onchain, not just assets.

The biggest challenge is being able to make a non-crypto user use a crypto game without knowing they’re using blockchain. The biggest problem to blockchain games is the market size for crypto investors that are also game players is really tiny. Most blockchain games today require installing wallets and fall short of the polish of today’s competitive mainstream game market. A crypto game studio that is able to market to non-crypto gamers yet allow them to stumble into using wallets and NFT exchanges and sending crypto transactions will be able to tap a much larger market of gamers. Furthermore, it’s possible that the main way crypto games will monetize is by selling in-game purchases for digital items that are either via normal app store marketplaces or directly for crypto (BTC/ETH), although subscription and one-time-purchase could also potentially scale.

The infrastructure needed for this market include: game studios that understand how NFTs and blockchain add real value for gamers, gaming development protocols, NFT wallets and finally secondary markets to trade NFTs.

Infrastructure PieceExamplesWalletsCoinbase, Trust Wallet, MetamaskBlockchain Game StudiosMythical Games, Cryptokitties, EcomiProtocolsEthereum, EOS, TronExchanges for NFTsOpensea

Infrastructure pieces need for blockchain games: wallets, studios, protocols and exchanges.

One of the most interesting markets for adoption crypto games is South Korea. Seoul is a very dense city, with super high adoption rates on crypto investing and mobile gaming. Korea is such a high-crypto-and-gaming-penetration population, it will be much easier for crypto games to go viral within the geographic area.

The two most popular games for EOS and Ethereum, EOS Knights and My Crypto Heroes, both are lacking in depth, quality, user experience and game polish. The fact that they still over around a few thousand users shows early promise to what value blockchain adds to games. The communities in particular for blockchain games, even though they are small, are one of the few things that remain active even in the bear market. Crypto games are relatively early, but could be one of the product categories that achieve real adoption.

V. CONCLUSION

The crypto markets are still in a state of correction and transition from the over speculative ICO bubble phase in 2017–2018. If the tech fundamentally solves real world use cases and finds real adoption, there will be justification for large network valuations and infrastructure level entrepreneurship. Although games and open finance show promise, it’s still too early to identify any of the use cases being massively successful yet. It will be important continue to monitor and stay tuned to adoption efforts as it’s unlikely to easily predict where DApp adoption will fall into place; rather, the product-market fit will come through tinkering and trial and error. Bitcoin is currently in its third bear market and events moving forward such as halvening, Bakkt and the launch of an ETF could help trigger bullish turnaround events moving forward. Despite the speculation around additional use cases, Bitcoin is a valid solution for a sovereign store of value and still remains the best live application of blockchain tech, which is meant to enable the movement assets in untrusted hostile environments.

DISCLOSURES: Andrew holds some Bitcoin and Ethereum, zero EOS and zero TRON.