In the world of CCs [Crypto Currencies], 2021 will most likely be remembered for the following among others: 1. CCs have experienced a broader adoption which continues to gain pace [including the adoption of Bitcoin as legal tender in El Salvador] and 2. the emergence of novel business models – prominently displayed through the rapid adoption of NFTs [Non-Fungible Tokens] and DEFI [Decentralized Finance or Democratized Finance]. The relentless pace that the world of Digital Assets, and in particular Crypto, has experienced over the last few years is unlikely to abate and prompts questions about how institutional investors should prepare for the future. As a Shaper [ rather than a Predictor] of the Future, the following three considerations [think of a map which serves as a guide to help us pinpoint the broad direction of travel towards the Future] seem sensible at the time of writing:
1 – REGULATION
Globally CCs/ DEFI have gotten too big to be ignored; and they have been ‘regulated’ differently across the globe. As a result, we see two significant activities unfolding: 1. increased regulation and thus definitional clarity about the treatment of CCs/ DEFI at a national level, and 2. increased alignment at a supranational level to avoid regulatory arbitrage between different jurisdictions and henceforth an opportunity for organizations to operate in a consistent manner on an international level.
2 – MONEY IS MERCENARY/ PLAY TO EARN
With current interest rates at a long time low, investors seek riskier opportunities through ‘Play to Earn’ gateways. In the realm of CCs/ DEFI there is plenty of choice which will further increase demand for CC based propositions or novel business models that provide ample opportunity for alpha generation. However, asset class allocation strategies need to take into account that the correlation coefficient between previous highly uncorrelated asset classes continues to increase – particularly during times of stress, the coefficient has shown marks close to ONE. Furthermore, institutional CCs adoption is likely to compress volatility [volatility curves are likely to compress and flatten in particular on the back of increased institutional participation through derivatives] and thus further lead to an increase in correlation between CRYPTO/ BTC and traditional asset classes. Furthermore, institutional interest in CRYPTO is likely to trigger increased interest towards ESG compliance of CRYPTO [i.e., a demand for Green/ Sustainable CRYPTO through a POW to POS conversion] and first sights of Crypto Activism can be expected given structural arbitrage opportunities [i.e., Grayscale Bitcoin Trust ‘GBTC’ conversion to a physical ETF].
3 – DEFI: EXPANSION, COPYCATS, NFT/ METAVERSE
2021 has seen rapid expansion and proliferation of DEFI as a source of investment income. In 2022, an additional proliferation of DEFI protocols can be expected before an eventual consolidation occurs that weeds out purely speculative distractions [to focus on real world opportunities and the democratization of finance]. In addition, there are questions about the sustainability of DEFI returns – in particular in cases of COPYCAT strategies [copycat open source based forks raise large pools of capital in TVL without differentiation or value added] – when token incentives become the primary source of yield. A dependency on token distribution and price inflation lead to diminishing returns as token rewards fall. Furthermore, liquidity fragmentation across COPYCAT protocols [i.e., the function replicated via open source clone on another chain] further exacerbates the yield squeeze where non loyal liquidity exits protocols once rewards end in lieu of the next new reward paying COPYCAT protocol.
The 2020s have the potential to become the decade of financial market innovation, decentralization and democratization. Front row seats are occupied by DEFI, the METAVERSE and NFTs, which all have the potential to play an active role in reshaping the current configuration of capital markets and the digital economic landscape.
4 – L1 VS ALTERNATIVE L1/ L2
During the course of 2022 the redistribution of power among L1s will be complemented by the rise of L1/ L2 protagonists that have a legitimate claim to become a viable alternative to the slew of incumbents. High transaction costs [GAS fees] on incumbent chains and the need for speed are likely to further accelerate this trend; there may be a compelling relative value trade as these developments unfold.
5 – EXPOSURE: BRIDGES TO THE FUTURE
Any direction of travel is helpful but not sufficient or prescriptive enough to define actionable steps towards the ‘Future’. So how do we get from Grand Ambition/ Big Impact to Small Steps and the execution of ideas? Two questions loom large:
- How do we obtain the appropriate insights and systemic changes that allow us to embark on a journey whilst keeping optionality i.e., making decisions about a change of direction at the last possible moment?
- How can we get appropriate exposure to opportunities commensurate with our risk appetite whilst keeping optionality and minimizing overall financial commitment to a particular direction of travel?
Systems Dynamics and Econophysics can provide valuable insights into group dynamics and the unfolding of complex dynamic systems over time – for instance, through the ability to measure small movements or perturbations capable of triggering larger chain reactions.
The notion of ‘Bridges to the Future’ provides a focus and the ability to build our ‘Future’ through a portfolio of diversified real options that give us the right to traverse multiple bridges to get to the ‘Future’ whilst avoiding a single point of failure and the opportunity to make use of multiple bridges to increase our probability of success [i.e., to ensure corporate relevance as we migrate to the Future].
We surmise that the above considerations can provide guidance and act as a set of landmarks on a map that looks at the development of opportunities across DEFI/ CCs and the Metaverse [i.e., virtual products, services, experiences combined with NFT capabilities applied across music, art, gaming, media and fashion] in an efficient manner to future-proofing our digital explorations.
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