2022 Global Crypto Market Report by OKX Research

This article is an original Web3 annual review by Coinlive and OKX; please cite the source if you intend to reproduce the content.

A New Ecology of the Industry Under Financial Crisis (Abridged Version)

This year, global economic growth has slowed down significantly due to the impact of multiple factors, including high global inflation, Russia-Ukraine War, and the chain reaction caused by Covid pandemic. These factors have brought more uncertainty to investment industry. The world's major central banks represented by the Federal Reserve and the European Central Bank have increased the interest rate aggressively to prevent worsening inflation and potential structural risks. The traditional financial investment market has experienced repeated shocks from the rising exchange rate of the U.S. dollar and the successive declines in global stock markets. Major economies are struggling to move forward under the shadow of the financial crisis.

As an important component of investment markets, the crypto market cannot dodge alone either. After experiencing the largest bull-market in history, the leverage behind the prosperous bubble gave birth to the worst crypto market crash since the birth of Bitcoin. The collapse of LUNA-UST, the bankruptcy of Three Arrows Capital, the sudden death of FTX happened one after another. How to find a way to survive in this crypto winter has become the most urgent appeal of the industry.

PART1. Stagflation and rate hikes: Noose and dagger?

The global economy is expected to grow by 3.1% this year, lower than the 6% growth in 2021, and global Consumer Price Index (CPI) expected to rise from 4.6% in 2021 to 9.0% according to a report by the International Finance Forum (IFF). Affected by multiple factors such as global inflation, monetary policy changes in many developed countries, the war between Russia and Ukraine, repeated outbreaks of covid in some regions, and persistent global supply chain bottlenecks, the global economic growth has slowed down significantly.

Changes in Consumer Price Index of Major Economies (Data Source: IFF)

The acceleration of global inflation reasons in many factors, including a rebound in consumer demand due to the improved situation of Covid epidemic, a surge in liquidity generated by large-scale quantitative easing policies, rising commodity prices such as energy and food, and persistent supply chain bottlenecks caused by the pandemic. Among these factors, the increase in commodity prices such as energy and food show the market change triggered by the Russia-Ukraine war and related international relations. Inflationary pressure is expected to continue in 2023, but the market generally believes that global inflation will ease due to various reasons. Below shows three main supporting factors:

1. The prevention and control of covid epidemic has entered a new stage, and the pressure on the supply chain has slowed down.

2. There is a possibility of lower commodity prices due to slowing demand.

3. Global monetary tightening played an effective role in curbing inflation.

However, there is still a huge downside risk in the global economic outlook. If the risks are not avoided, the global economic growth will slow down more than expected, and inflation will continue to deteriorate, which will eventually lead to the possibility of the global economy recession or stagflation.

1. Black swan events such as regional conflicts and epidemics getting worse again

2. Inflationary pressures fail to ease as expected

3. The potential debt crisis caused by continued appreciation of major currencies especially U.S. Dollar

The interest rate hikes and balance sheet shrinking of major central banks represented by the Federal Reserve have triggered global financial tightening, which will have a major impact on the financial stability of some economies. Increased international borrowing costs and capital outflows put pressure on these countries' foreign exchange reserves, depreciating their currencies and making it more difficult to service foreign debt. Due to the impact of the covid epidemic and some other factors, the public debt-to-GDP ratio of emerging market countries reached an average of 64% in 2021. Currency depreciation inflates government external debt denominated in domestic currency, making public finances more difficult and leaving less room for fiscal policy support. According to the International Monetary Fund (IMF), 60% of low-income countries will be in or will be in government debt distress in the second half of 2022, which will directly affect the confidence of investors and consumers and constrain the global economic recovery.

By the 1^st Dec, 2022, the U.S. government debt has greatly exceeded the U.S. GDP of about $23 trillion in 2021, and has approached or even exceeded the statutory debt limit of $31.4 trillion several times.

Changes in the value of some major currencies against the U.S. dollar (data source: IMF)

Therefore, how to curb inflation as soon as possible while avoiding stagflation is the key to promoting global economic recovery.

The Fed has raised policy rates six times in a row this year and signaled more hikes to meet its 2% inflation target. Quantitative easing has more than doubled the Fed's balance sheet from about $4 trillion before the pandemic to nearly $9 trillion in early 2022. The Fed ended its balance sheet expansion in March and began shrinking it in June.

The European Central Bank (ECB) has raised its benchmark interest rate twice this year, from zero to 1.25%. Given the fact that inflation is currently well above 2%, rate hikes are expected to continue. The ECB ended its balance sheet expansion in March this year, but has yet to start shrinking it. As a result, global financial markets reacted sharply to the tightening of monetary policy, with stock markets falling, volatility rising and global currencies depreciating against the U.S. dollar.

The factors above directly affect the financial investment environment and economic growth. U.S. is expected to grow 1.6% in 2022 and 1.0% in 2023, down from 5.7% in 2021. The slowdown in growth was mainly due to a decline in household purchasing power caused by rapidly rising inflation, while tightening monetary policy and financial conditions constrained private investment. The EU is expected to grow by 3.2% in 2022 and 0.7% in 2023, down from 5.2% in 2021. The main reasons include the decline of household purchasing power caused by high inflation, the impact and uncertainty brought by the Russia-Ukraine war on energy supply and prices, and the tightening of monetary policy.

To curb inflation, ECB ends net asset purchases in March 2022, starts raising interest rates in July. Among the three largest EU members, Germany is projected to grow by 1.4% and -0.3% in 2022 and 2023, respectively, France by 2.5% and 0.6%, and Italy by 3.2% and 0.2%.

PART2. Review on the emerging crypto market

The global financial environment is affected by the monetary policies of major central banks, the Russia-Ukraine war, the covid pandemic and other factors, resulting in the decline in market confidence and private investment willingness for a period of time, which further lead to a decline in the overall investment market, and concerns about economic recession.

As one of the major investment markets, the cryptocurrency market is also deeply affected by changes in the global financial environment.

Major events are represented as case studies below:

1. Cryptocurrency regulatory changes in major economies

The regulation of emerging cryptocurrency markets in major economies is also in a state of dynamic development. In the common law countries represented by the United States, the overall ideology is economic liberalism based on the market and industry self-discipline, centered by individual. In June 2022, key members of the U.S. House of Representatives and Senate Commerce Committees jointly released a draft of the “American Data Privacy and Protection Act” (ADPPA). These include stricter compliance obligations for "large data holders". Undoubtedly, crypto-related service providers are an important part of it. The European Parliament and Council also reached an interim new agreement in June 2022, seeking consumer protection and a unified legal framework for cryptocurrencies in the EU. Markets in Crypto Assets Regulation bill (MiCA) will cover crypto assets not regulated by existing financial services legislation. ESMA (European Securities and Markets Authority) will provide guidance in this regard. The new rules will impose strict operating rules on stable coins, limiting their widespread use as payments, with daily transactions capped at 200 million euros.

Meanwhile in Asia, the fight for crypto financial center is on-going. The Hong Kong Special Administrative Region Government of China published the " Policy Statement on Development of Virtual Assets (“VA”) in Hong Kong " in October 2022, clarifying the policy stance and guidelines for the development of the virtual asset industry and ecosystem, and demonstrating the local government's vision for the virtual asset industry. And Singapore, which has always been more positive towards crypto industry, is not to be outdone. As early as May this year, Singapore Deputy Prime Minister Wang Ruijie publicly stated that he would build Singapore into a "decentralized financial center". But what needs to be vigilant is that in a relatively relaxed market environment, avoiding vicious competition in the industry will become a new challenge.

2. Crypto markets fall amid global interest rate hikes

Global inflation is high due to the influence of multiple factors, and anti-inflation has become the main task of the central banks this year. As the core institution, the Federal Reserve has continued to implement a tightening monetary policy this year, and the frequency and magnitude of interest rate hikes have increased significantly.

In the context of global capital tightening, major asset classes have fallen sharply, and the crypto industry, which has a higher leverage ratio than traditional industries, experienced a worse situation.

3. Ukraine announces acceptance of crypto donations during Russia-Ukraine war

In this war, cryptocurrency has become one of the focal points. Within days of the conflict erupting, the Ukrainian government’s official Twitter account posted a post that included Bitcoin and Ethereum wallet addresses, hoping donors would donate BTC and ETH. The initial donation event is just one of the government's moves to embrace cryptocurrencies in times of crisis. Immediately afterwards, the Ministry of Digital Transformation of Ukraine launched the NFT Museum to sell NFTs recording war events in order to raise more funds. The role of cryptocurrencies demonstrates the power of 'no borders' more clearly than ever.

4. Cryptocurrency chain reaction

Factors such as insufficient development of the crypto industry, lagging regulatory, and relatively low market volume have resulted in high risk-return ratio, accumulated leverage, and high degree of closeness to industry lead. All of the factors above lead to a large-scale chain reaction collapse of the crypto industry in 2022.

Everything originated the oversold of Bitcoin. On May 8th, the seigniorage share-based algorithmic stable coin UST issued by LUNA experienced a death spiral due to the sell-off of LUNA. As a result, UST’s value quickly decreased and crashed to zero. This caused the loss and bankruptcy of cryptocurrency investment institutions represented by Three Arrows Capital.

5. Ethereum 2.0 merge upgrade

After June’s liquidity crisis, investors hype over Ethereum merge took the market out of desperation to some extent. Discussion between network's proof-of-work and proof-of-stake ignites more investors’ enthusiasm.

In the end, the merge is officially finalized on September 15, 2022. This is also known as the largest crypto technology update since the launch of Bitcoin, and it can be regarded as one of the milestone events in the history of cryptocurrency.

6. Bankruptcy of FTX exchange

On November 11, FTX, one of the world's largest centralized cryptocurrency exchanges, declared bankruptcy. When declaring bankruptcy, FTX only held $900 million in salable assets, while its liabilities were $8.9 billion, with a funding gap of up to $8 billion. Apparently, user assets have been misappropriated.

The chain collapse of crypto institutions represented by FTX and Three Arrows Capital, is due to the lack of restrictions or low cost on behaviors such as embezzlement of funds, increased leverage, and risk transfer of fund holders, in the investment market where supervision is absent. In fact, in 2022, many countries continue to advocate for increased regulatory intervention in the crypto industry. Although a large number of institutions were in trouble in 2022, this proves that the environment of the crypto investment market is gradually moving towards a healthy and orderly environment.

As mentioned above, there are differences in the regulation of the crypto industry in major economies.

On one hand, the reason for the difference is due to the differences in the level of economic development in different regions. Different from digital financial industries such as digital banking and digital insurance that have matured for a long time and have physical regulatory objects, cryptocurrency is currently the fastest-growing, most controversial and most difficult field in the field of digital finance, and has the potential to disrupt the existing financial system. On the other hand, it is also constrained by the different stages of development of the crypto market.

Compared with relying on external supervision, which needs to be solved one by one from the technical and legal levels, the internal innovation of the industry is more urgent and effective at this moment in 2022.

After the FTX incident, the centralized exchange business that is the foundation of the crypto market has encountered a crisis of trust in the industry. How to ensure the security of funds becomes the foundation of strengthening trust in this industry. Many crypto institutions providing fund custody services start to issues proof of reserves at the same time (PoR: Proof of Reserves, means that custodial businesses holding cryptocurrencies should create public credentials of their reserves and match proofs of user balances/liabilities).

At present, although the proof of reserves can provide a certain degree of proof of financial solvency, it still has certain limitations. Issues such as fake fund snapshots and incomplete disclosure of funds/liabilities still exist. But we have to admit that this has positive significance for improving the transparency of the industry and regulating practitioners. In the long run, the adoption of PoR is a form of self-regulation that can enhance user’s confidence in centralized platforms and the industry. A safer ecosystem will attract more investors and provide opportunities for more institutional capital to invest in the crypto market.

Besides, the market's voice for decentralized exchange has begun to rise. From a practical point of view, decentralized transactions not only increase transparency, but also greatly reduces potential risks in the process of centralized transaction services such as embezzlement of funds, since the entire financial agreement was executed automatically through smart contracts. However, based on the constraints of current technology and the impossible triangle of decentralization, security, and scalability, security improvement is still the current bottleneck for DEX business development.

Moreover, Web3 is developing rapidly in 2022. Web3.0 is relative to Web1.0 and Web2.0. Web3.0 is essentially a contract. This contract forms a common standard through blockchain and other technologies, which is common in different APPs and fields, and it provides the possibility for users to interact in a wider range. Therefore, Web3.0 can be called the Internet of Contract. Today's Web3.0 is actually a new type of network organization based on the architecture of blockchain. The main idea is to return the control of the Internet to users, and to add content to the Internet through user’s creation. In the process of content creating, a decentralized production organization is formed using blockchain, such as DeFi or NFT.

At present, the blue ocean of Web3.0 is waiting for IT companies to develop. But at the same time, it should be noted that the current Web3.0 is actually an extension of blockchain technology, and the major platforms are still in the technical reserve stage. Many Internet platform companies only use the concept of Web3.0 to lay out the future form of their business, and may not have a clear path to realize Web3.0 technology.

Although the blockchain platform represented by Ethereum has many practical attempts, many of which are based on financialization, there is still a long way from an actual tool for the public. Therefore, the current top tier IT companies should reserve at the technical level and actively explore at the application level to provide more possibilities for the future development of Web3.0.

PART3. Summary

2022 may be a difficult year for the crypto industry and even for the global investment market. The influence of several black swan events happened all together is the main influencing factor. But for investors, risks also mean opportunities, and the crypto industry may recover from current state anytime. For practitioners and investors in the crypto market, the word "unstable" runs through the year. From the use of virtual currencies in wars to the outbreak of black swan events back-to-back, the entire market is feeling the coming of the bear market in the ups and downs. The crypto market is both new and global. As mentioned above, the crypto market reacts most sensitively to big events. But because of such characteristics, it is not difficult to find from several incidents that have occurred in 2022 that it has great anti-fragility.

it's like two sides of a coin. On one hand, it represents that crypto finance is not only a new financial format, a new stage of financial development, but also a continuation of the continuous development of the financial industry. On the other hand, the problems in the global financial market have also been magnified and intensified in the crypto market. Through the self-regulation of practitioners and the upgrading of regulatory, the future of the crypto market is still promising.