Crypto's Horrible, No Good, Very Bad Year
Crypto's Horrible, No Good, Very Bad Year
In 2023, fans are looking to mainstream adoption, innovations—and more fallout.
By VINAMRATA CHATURVEDI, Published December 06, 2022
Crypto fans paid a high price for lessons learned from a dreadful 2022: Decentralized finance, or DeFi, is vulnerable to hacks. A Stablecoin is anything but. And the collapse of a single leading crypto exchange can send shockwaves worldwide.
There were some bright spots. Ethereum's network upgrade saved as much as 99.95% of the energy that it previously consumed.
And crypto entered many more mainstream conversations as leading financial institutions showed interest in digital assets and the U.S. government started vocalizing its interest in its regulation and possible adoption.
As we look back at 2022, we consider what it tells us about what to expect in 2023. For starters, it probably means more talk of a U.S. central bank digital currency, a more efficient Ethereum network that continues to evolve, a spreading FTX contagion along with a legal reckoning for its founders, and an increased focus on government regulation worldwide.
2022 was marked by the collapse of a leading cryptocurrency and a crypto exchange
Crypto winter lasted all year, with no signs of improvement
Of the top 10 crypto hacks to date, six occurred in 2022
The smooth transition to Ethereum 2.0 was among the most positive news of the year
Authorities worldwide pushed forward on crypto regulation, citing the need to protect customers and promote innovation
Positive Vibes to Hacked Expectations
Crypto industry sentiment was upbeat as this year began, after Bitcoin and Ethereum hit all-time highs in 2021. The non-fungible token (NFT) boom, Bitcoin futures ETFs, and the sense that crypto was becoming mainstream all contributed to a positive vibe.
It wasn't until March when the year's first major hiccup jolted the market. Hackers targeted the Ronin network, which supports the popular Axie Infinity blockchain gaming platform, and stole $625 million, making it the largest cryptocurrency theft to date. It wasn't alone. Many other major crypto platforms, such as Binance and FTX, were also hacked in 2022.
Crypto enthusiasts have argued that blockchain projects are safe from attack, but back-to-back problems shattered that myth. In fact, six of the top 10 hacks of all time happened this year. Yet that doesn't make it more vulnerable, said Cathy Yoon, chief legal officer at crypto firm MPCH.
‘‘There should be more education in terms of how you can safeguard your own crypto," she said. "There needs to be better financial literacy."
The amount of cryptocurrency that had been stolen from users in 2022 as of August, according to blockchain data platform Chainalysis.
Crypto In a Time of War
The Russia-Ukraine war tested the capabilities of crypto as a funding source in the real world, even when there are sanctions and restrictions. It illustrated how blockchain and cryptocurrency could be both useful tools during a crisis, and how it could be used to obfuscate normal systems.
After Russia invaded Ukraine in February, several cryptocurrency platforms began donating and providing aid to Ukrainians. In one month, the Ukrainian government and a nongovernmental organization (NGO) providing military support raised $63.8 million through crypto asset donations. Among these donations were $5.8 million from Polkadot founder Gavin Wood, and a CryptoPunk NFT valued at over $200,000.
Ethereum's Russian-born co-founder, Vitalik Buterin, slammed the Kremlin, calling the invasion of Ukraine a crime.
It wasn’t just Ukraine that got crypto aid. Several pro-Russian groups raised more than $2 million in cryptocurrency donations to fund Russia’s war against Ukraine, despite international sanctions.
A Terra-ble Collapse
At the end of 2021, many touted Terra (LUNA) as among the hottest crypto projects around, mostly because of its algorithmic stablecoin TerraUSD (UST). Terra (rebranded now as Terra Luna Classic) reached a record $119.20 in April 2022 and TerraUSD became one of the top decentralized stablecoins.
The euphoria didn't last long. TerraUSD started dropping below its $1 peg. Unlike other stablecoins such as Tether (USDT), the TerraUSD wasn't backed by U.S. dollar-denominated assets. Instead, a computer algorithm created (minted) and destroyed (burned) both UST and LUNA to bring the price back into equilibrium. The stablecoin didn’t reach equilibrium, however, and on May 9 it lost its $1 peg for the second time and fell as low as 35 cents. On May 12, the LUNA price fell 96% in a day, dropping to less than 10 cents.
Historically, algorithmic stablecoins have failed because creating a token that can maintain a grip on $1 under extreme selling pressure is difficult. Does that mean algorithmic stablecoins are doomed? No, according to the editor of the "Crypto is Macro Now" newsletter, Noelle Acheson.
‘‘You can never say never. Terra did not work and its incentives were not sustainable," she said. "This does not mean that experiments will not continue. There are some other algorithmic stablecoins, such as DAI, that held up very well.’’
In the aftermath of Terra's collapse, the crypto market suffered a bloodbath, which launched the crypto winter. The global crypto market lost $600 million in a week and the value of Bitcoin and Ethereum dropped by more than 50% from their all-time highs.
Ethereum 2.0 is Born
In September 2022, the biggest positive development in the crypto universe was the upgrade of the Ethereum blockchain network to Ethereum 2.0. With this long-anticipated change, Ethereum replaced energy-intensive proof-of-work (PoW) with an environmentally friendly proof-of-stake (PoS) consensus mechanism to verify transactions via staking. The upgrade, also known as "The Merge," marks a major milestone in the history of blockchain and cryptocurrency, as it radically altered the infrastructure of Ethereum.
The smooth network transformation, apparently free of any glitches, fascinated crypto expert Wong Joon Ian. ‘‘The Merge happened without any sort of complications," he said. "So that's pretty unprecedented."
Wong, who also worked for the Solana Foundation, a nonprofit dedicated to the decentralization, growth, and security of the Solana network, said next year will deliver some "amazing" blockchain developments.
It is believed that the upgraded version of Ethereum will lower gas fees—charged to conduct a transaction or execute a contract on the Ethereum blockchain platform. It is expected PoS will increase the network’s scalability and decrease its energy usage by about 99.95%.
It’s not going to happen immediately, Acheson said.
‘‘Gas fees will be lower sometime in the future, as The Merge was all about shifting the consensus mechanism and changing the supply schedule of Ethereum,’’ she said.
In 2023, the Ethereum upgrade will implement sharding, the final phase of the Ethereum 2.0 transition.
After that, improvements to Ethereum's network will continue. Ethereum is home to smart-contract-based decentralized applications (dApps), which have applications in finance, real estate, supply chains, and governance, among other areas, so it remains to be seen how much the upgrade will enhance the overall network.
Rules and Regulations Around the World
What is cryptocurrency—security, commodity, or currency? The multimillion-dollar question remains unanswered. In 2022, governments worldwide passed various laws that aimed to simplify crypto's novel concept, which is still in its infancy.
While regulation is still nascent, Acheson said regulators deserve a toast and their moves should be welcomed as they want to protect their constituents, the citizens, and support innovation. There are, however, many things to consider in crafting regulation, not the least of which is settling on legal definitions and common meanings for words like NFT or cryptocurrency. ‘‘Definitions matter a lot when it comes to legal process and ideas,’’ Acheson said.
In September, the U.S. government recommended creating a digital dollar in its framework for the regulation of digital assets.
One suggestion involved the creation of a U.S. central bank digital currency (CBDC).
The current state of regulations leaves much to be desired. Yoon said regulations being considered by lawmakers reveal a lack of understanding.
"The current state of the bills shows that a lot more education is needed," said Yoon. ‘‘There needs to be some understanding of the technology and what it's meant to accomplish.’’
On the other hand, the Securities and Exchange Commission (SEC) is pushing forward on regulations it already has. In September, Gary Gensler, SEC chair, said most cryptocurrencies are securities, and there is no need for new regulations.
Outside the U.S., the rest of the world seemed to be taking proactive steps to regulate the crypto industry. In October 2022, European Union (EU) lawmakers passed the Markets in Crypto Assets Regulation (MiCA) bill, a landmark piece of legislation aimed at regulating the digital assets market. The laws will come into effect in 2024.
Moreover, the lower house of the British Parliament recognized crypto assets as regulated financial instruments. The draft bill extends current laws regarding payments-focused instruments to stablecoins.
China continues working on a digital yuan (e-CNY), a program expected to develop over the next 12 months. The country began rolling out the next round of its central bank digital currency (CBDC) pilot program in August 2022.
Similar to China, the Indian central bank launched the retail version of its digital currency on a test basis in December 2022. The move came a month after several Indian banks were allowed to settle secondary market transactions in government securities using digital currency.
Brazil seemed enthusiastic about cryptocurrencies as it legalized cryptocurrencies as payment methods throughout the country in late November. The step doesn’t make Bitcoin or any other cryptocurrencies a legal tender in the country, but it definitely boosts the adoption of digital currencies there.
Acheson said she believes not all crypto will be regulated everywhere. ‘‘It is a luxury and all luxuries involve choice,’’ she said. ‘‘I am pro-regulation, but I am very much against the assumption that regulation is a given and necessary factor.’’
The amount SEC asked Kim Kardashian to pay for blogging about a crypto token in October 2022 without mentioning she was being paid.
...And The Great FTX Collapse and Contagion
While the lingering crypto winter stretched on in the fall, there was worse to come. A report published on Coindesk in November 2022 disclosed that crypto exchange FTX was experiencing a severe liquidity crisis and could soon go bankrupt.
Following the news, the largest crypto exchange, Binance, started selling off FTX's native tokens, FTT. The next day, it announced that it would buy FTX, but later declined to do so after finding weaknesses in a review of FTX's finances.
FTX founder and former CEO Sam Bankman-Fried was publicly seeking a rescue package of more than $9 billion to save his crypto exchange, a bailout that didn't materialize. The company filed for bankruptcy protection on Nov. 11, starting a domino effect in related companies. Bankman-Fried stepped down, and the exchange owes money to more than 1 million creditors with liabilities and assets ranging from $1 billion to $10 billion. Immediately following the bankruptcy, James Bromley, a partner at the law firm Sullivan & Cromwell who represents FTX said that "a substantial amount of assets have either been stolen or are missing."
It was disclosed in a court filing that FTX and Alameda Research employees used customers' funds to buy personal items like properties in the Bahamas, obtain personal loans, and more. Bankman-Fried facings fraud investigations, and the company and its board face multiple lawsuits. Plus, previous spokespeople like Larry David and Tom Brady face class-action lawsuits.
Then the fallout began. On Nov. 28, Blockfi, a cryptocurrency lender and financial services firm with close ties to FTX, declared bankruptcy.
Genesis Global Capital, another crypto lender, halted withdrawals in November because of liquidity issues.
Following the news, crypto exchange Gemini announced customer withdrawals are being delayed from its yield-generating product, given Genesis’s role as a key partner in the program. Other well-known firms that invested in FTX included Sequoia Capital, SoftBank, and BlackRock.
The FTX collapse was so contagious that it went viral in the worst way, affecting the health of a swath of other crypto firms, including Genesis, Gemini, and BlockFi.
Wong, who earlier had covered the collapse of Mt. Gox, a Tokyo-based cryptocurrency exchange that operated between 2010 and 2014, said, ‘‘Back in 2014 [when Mt. Gox was hacked], there were rumors for weeks and months, so there was a sense that something was happening. But with FTX, it is sudden and shocking.’’
FTX's bankruptcy likely will go down in history as one of the most complex ever, and its full impact will take years to fully understand.
Amid the shock about the FTX collapse, Acheson has found that the ideological divide between centralized and decentralized finance is becoming increasingly obvious.
‘‘Centralized services are not going away—they are an essential part of mainstream adoption, as most investors will prefer familiar processes and the comfort of not being totally responsible for correctly storing one’s wealth,’’ she said.
‘‘Decentralized functions have shown remarkable resilience, however, and their transparency, especially when it comes to verifying balances and flagging suspicious movements, is likely to attract new interest.’’
The Bottom Line
In 2022, many experiments, bold ideas, and untried concepts were squashed, resulting in wide-ranging reverberations across the crypto universe. But it's likely that crypto will come back even stronger after the various collapses. In 2023, crypto will likely to move toward the mainstream, and the market will innovate, but it will also face increased scrutiny and possible regulations.