2023 Digital Asset Market Outlook

Reflecting on a Turbulent Year

Every year, peering into a predictive ‘crystal ball’ is tough at the best of times, let alone predicting fast-paced digital asset markets. Year ends offer a unique time to observe investor behaviours and evolutions in a constantly changing market structure. How well did the Author’s written 2022 predictions do? We critically review and rank last year’s Outlook predictions, drafted in late Dec-2021. hat does the 2023 Outlook hold?

As we head into a likely multi-year recession, we draw from past learnings to offer insights into the coming 2023 Outlook year ahead. After an overwhelmingly successful #MiamiWeb3 event, our team was in the unique position to gather wider industry 2023 viewpoints, not just our own. We are optimistic about the growth of DeFi Services in 2023.

5 Predictions for the 2023 Outlook

There is no limit on “who” can contribute to the ‘open-ended’ digital asset economy. Many will try to set rules around ‘how’ those participate, this will be hotly debated in 2023. We look at how HK / Singapore is clearly charting their path and reflect on the progress the UAE / GCC will make next year. All the while we await the result of the “US regulatory turf war” for industry regulation and as political implications, H1’2023 carries forward.

2023 will be a year of two halves

while facing external macro and internal market challenges, H1-2023 will be dominated by outflows and reshaping of the digital ecosystem. We are more optimistic for H2-2023 given when measured from trough to trough the wider decentralized digital asset industry remains firmly at the centre of a unique super-cycle growth, regardless of short-term hiccups.

Reflecting on a Turbulent Year

2022, unfortunately, will be remembered by ‘centralized bad actors’, e.g., 3AC, Terra Luna and FTX leading to wealth destruction events. However, let's revisit the Author's prior year’s predictions and score how we ranked in accuracy.

Overall, not a bad job of outcomes on Authors predictions. Many of came to fruition in some form.

Exhibit B: It has been a challenging year for risk assets, including digital assets. It is worth noting that the “Cumulative” performance over the years has outperformed comparable TradFi asset classes. We expect this to gather steam as geo-political frictions increase and investors seek alternatives to sovereign controlled financial assets, increasingly used as bargaining chips against each other as they jockey for position.

Of course, the outright fraud in the 2022 selected case casts a shadow, but the general theme remains intact: “Digital Assets are here to stay.” What is important for readers to note: Blockchain technology did not fail. The underlying assets and mechanisms remain intact and valid. Rather the Centralized Finance (CeFi) failures are what fell short. Infrastructure and governance will focus on limiting any one individual responsible officer to?redirect?customer?assets?without appropriate security controls and counterbalancing checks.

Exhibit B: Digital Asset Underperformance 2022 YTD Follows Significant Appreciation from the 2016 Year End

Exhibit C: Despite short-term setbacks, one should measure the progress of the industry in longer-term secular cycles. Measured trough to trough, the industry has grown as both institutional and retail participation and awareness increased. As history has shown, the market will be taking this in its stride, adapting and accepting greater regulatory oversight. Increased urgency for regulation may enable greater institutional engagement, a shift in focus and capital from speculative trading to projects with real-world functionality, including incumbents investing in companies with roadmaps to profitability, accelerating industry maturity.

Overleaf, we aim to justify, with some evidence, on why exactly our predictions were supported by actual events.

2023 OUTLOOK

Market value evolutions will change (Exhibit D), and immediately apparent is what started with Bitcoin dominance and blockchain exploded to new industries, driven by “creatives” driving a new era of finance, tech and pop-culture, intertwining unique elements of DeFI, security, identity, entertainment and loyalty engagement.

Prediction 1: Near-Term Risks Heightened, Public Adoption Slows as Institutional Adoption Gathers Pace

The fallout from FTX’s collapse will be contained to the digital asset sector, specifically centralized entities. The digital asset ecosystem is highly interconnected, contagion risk will ripple during H1-2023, impairing large digital asset players while select, well-run competitors will survive. Traders will look to sit on the sidelines while adjusting to a new regulatory reality. However, signalling that the underlying community will be moving on, we are optimistic about the growth of DeFi Services and expect this to grow in lockstep with increased regulation. After all, during the turmoil, these protocols were void of human error and greed and transparently sailed through systemic disruption smoothly. Separately, institutions view 2023 as a unique opportunistic gap to catch up.

Prediction 2: Macro-Driven Multi-Year Recession. Institutions Stay the Course to Find New Economies of Scale.

Sovereign states and Institutions peer through the “Recession” veil and accept that new economies are required to be built as old economic models and jobs pass away. Incumbents will use the ‘public-chain’ market slowdown and build on their ‘regulatory compliant’ ecosystems attempting to tighten dominance of value flows. Banks and AMs will launch new products tied to blockchain technology with gradually more announcements to arrive on their ‘inclusive intermediary only’ permissioned blockchain ecosystems.

Refer to our past Research Report: 22-Nov-2022: “Charting the Road Ahead. We reiterate Sovereign States now takes the sector seriously, recognizing political disruptive potency and driving their pilot digital asset projects. Hence, a certainty is for more regulation as incumbent corporate institutions, banks and other financial intermediaries grow their digital asset involvement.

Already we see Goldman Sachs launching programmes to ‘selectively’ acquire both talent and distressed projects. More announcements to come from TradFI incumbents, e.g., banks and Asset Managers, to take advantage of current digital asset industry CEFI woes.

Prediction 3: UAE (GCC) and ASEAN Sets the Digital Trend in 2023

The crypto sector is a leading indicator by at least 18 months and a pro-cyclical contributor of the UAE’s recent digital rise. China’s official Middle East summit visit is confirmation of the trend. Exhibit E / F shows why we believe the GCC region is set to thrive. Diversification away from the oil sector and digital job creation is a national priority, and the next 12 months will see the UAE digital economy grow.

Exhibit F: GCC National Priority for GGC States to Go Digital

The GCC holds 4/5 spots for internet penetration, and 4/6 for global social media penetration. It has a young population, 33% of the GCC population is below 25. Millennials and Gen Z Will account for 75% of the workforce by 2030.

Prediction 4: Web3 Adoption - Positive at Lows Just as We Were at the Highs

As the global recession bites, we are optimistic for gradual price recovery in Layer 1’s over in H2-2023 following the attraction of talent to the Web3 space. Faced with tougher competition, e.g., Instagram vs. Tik Tok, Web2 tech companies will follow their ‘Financial institutional cousins’ and transform the social media, gaming, and entertainment platforms next year. Layer 0’s / 1’s, smart contract-enabled blockchains - as new internet operating systems – will be adopted as Web3 applications slowly shift the balance of power and profits from platform operators to platform users, disrupting through an uptick gradual market share capture. Sovereign states will look to rejuvenate stagnate economies, e.g. UK financial sector, with some digital asset innovations to remain relevant.

Prediction 5: Market Consolidation and Increased Global Regulation

As mentioned, hardly a ‘prediction’ and rather a ‘certainty’, although the correction is proving painful, consolidation trends will drive M&A activity given the depressed valuations and glaring gaps in regulated services. Increased regulation and short-term pain as compliance costs increase in 2023 is generally a positive indication for longer-term mass adoption. After all, we are only in the first innings of a major change in applications that will take place over the next 30 years.

As we wrote in our 11-Nov-2022 CryptoVerse: Charting the Road Ahead: “Crypto Industry Leaders Must Step Up… Despite the market turmoil, there is a huge opportunity, albeit guided by heightened regulation and cost of compliance and diligence on the providers that remain. The industry must accept this as a net-net good thing. Policymakers recognize the potency of the technology, and lightspeed innovation of market entities. Both Singapore and HK have laid out visions for their ‘digital asset’ economy, summarised for each jurisdiction in Exhibit G and Exhibit H, respectively.”

Exhibit G: Lion City (Singapore) Future Vision for Digital Asset

The subsequent shift in focus from speculative trading to development and adoption of blockchains and applications with real-world functionality as a prerequisite for industry maturity and long-term sustainable growth.

Exhibit H: Hong Kong International Finance Centre

GCC Regulation: The legal situation in the UAE is rather?complex. In line with prediction #3, we can expect that the GCC and UAE are generally comfortable with charting their own course for virtual assets. Binance received Financial Services Permission (FSP) from the Financial Services Regulatory Authority (FSRA) of the Abu Dhabi Global Market (ADGM). This boost of the local UAE ecosystem, accompanied with to be announced synergies from the region, make a full-blown industry slowdown in the local region unlikely, in our view. Expect more positive market developments for the industry.

US Regulation (Exhibit I - Overleaf): - the ties of FTX Sam Bankman-Fried had with the US policymakers complicates where exactly the US is going into 2023.

One thing we can expect policymakers either distance themselves or increase their harder stance positions on creating balanced legislation.

Q1-2023 will see continued interagency ‘turf-wars.’ However, the pressure is now on them to deliver stern legislation in a fast and quick fashion, as they must be seen as doing something to reign in a young and potent industry.

Exhibit I: US Regulation a Minefield of Uncertainty and Interagency Turf Wars

2023 OUTLOOK SUMMARY

“We are at the start of an Anthropological Leap in Technology and Human Interaction” – Tim Draper (#MiamiWeb3)

While the crypto industry has faced many major setbacks and challenges as described above, it must be emphasized that these are not failures of the underlying cryptocurrency technology but failures of the coordination and implementation of this technology by humans and commercial enterprises.?For example, does a bank robbery mean that the ‘fiat dollars’ stolen are fundamentally flawed??It does not.?Instead, it reveals the bank's poor security practices in protecting customer assets.

Mass adoption of new technologies inevitably comes with growing pains. Due to the lack of in-depth understanding of any new technology, i.e. the Internet has, at various times, been exploited by those with malicious intentions.?Likewise, the current crypto experience is the first iteration of the digital world we are set to live in, providing people with digital assets and services that are not restricted by centralized authorities. Of course, we can expect some counter-reaction from policymakers as well as, unfortunately, negative actions by ‘bad actors.’

Thinking back to countless country examples to date, we are reminded of the core purpose and potential of digital assets.?After all, when the Lebanese or Venezuelan pick any dystopian state government in existence today, which misappropriates from its citizens, a loss of confidence sees the population convert money into hard currency, typically USD, and now bitcoin and other digital assets.

Digital assets remain a significant, and growing, force in the global economy, both for individuals and corporates.?Despite the current market downturn, user engagement and trading volumes will eventually recover, especially during recession and periods of increased global friction. While digital assets today are often associated with volatile prices and sensational headlines, their underlying technology has the potential to transform finance, technology, gaming, real estate, entertainment, and governance, among other fields.?Governments realize this and will continue to drive their own adoption curves.

Like any transformational journey, this transition will inevitably be turbulent. Just as intended, digital assets, decentralized web and underlying technologies are resilient and will survive even the harshest of recessionary environments.

Author: Kevin Loo, Managing Director, IDEG

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