Themes for 2023

This month, we’re focusing on themes to watch both in 2023 and 2024. I noted in the most recent Market Commentary that I think we may have a constructive environment for risk assets, primarily crypto, over the next three to six months. Afterward, inflationary worries may transition to recessionary worries and everyone will once again become a macro trader. For now though, crypto.

Market leaders; buy what works

This crypto bear market is unique to prior ones because we actually have the opportunity to invest in things that work right now rather than guess about future adoption. From a risk-adjusted perspective, market leaders in each respective vertical are easy bets to outperform the market. It’s easy to fool ourselves into thinking we’ve “missed” something like Uniswap or Aave, but the reality is these and others are down 90% from their peaks and are the definitive leaders in their respective use cases. And most of the world still has not woken up to DeFi, let alone crypto more broadly. For the last decade, FAANG proved how powerful and simple investing in market leaders can be.

I think this is especially relevant for DeFi, which has an established product-market fit, but the idea holds true for the other themes here as well. This entire space is nascent and participating in the markets while most have left, is contrarian.

Since I mentioned DeFi, the core products I’m interested in are spot exchanges, perpetual swaps exchanges, and lending. As the market matures, more exotic offerings like options and structured products will see greater demand. For now, the better risk-adjusted bets are the vanilla pillars of DeFi.

Consumer applications will bring more users to crypto

Internally, we talk a lot about “digitally native commerce” or any non-financial use cases. We think most consumers will interact with crypto because it’s fun and liberating. The NFT boom in 2021 was the best example of this to date and the phenomenon is only going to grow. The chart below from Electric Capital illustrates this. 80% of first-time crypto transactions were related to NFTs.

Most traction has been in the NFT trading space with the leaders being OpenSea, Blur, X2Y2, and LooksRare in that order. Blur is likely to launch a token soon which has contributed to its volume to date. If Blur can maintain traction, it will be worth paying attention given its competitor, OpenSea, raised at $13.3 billion once upon a time. There’s clearly an appetite for this market.

Music, video, writing, social and gaming are also part of this trend but there aren’t many clear ways to get exposure in the public market. We’ve already made an investment into the music space through Nina Protocol and are closely watching how that space progresses. Once curation improves, we should see adoption really accelerate.

For video, appears to be gaining traction as a Youtube alternative but as of now, there’s no way to gain direct exposure. Lens protocol is a social graph leveraging the Polygon blockchain and has shown steady growth with 30k monthly active users across a variety of applications that are built on top, but it’s similarly difficult to get direct exposure. Gaming and gambling are areas that are sure to take off at some point and there’s some traction across the likes of Magic and Aurory for gaming and Rollbit and Buffer for gambling. These themes have yet to have a breakout application but when they do, interest will pour in.

Decentralized storage explodes with NFT interest

Decentralized storage is the natural progression for data storage; simple hardware requirements, easily codified workflow, cryptography to prove storage and payment, and technical and geographic redundancy. Filecoin has by far the most storage capacity of the decentralized storage networks and appears to be growing quickly with around 100 PiB of monthly storage.

We’ve beaten the drum a lot on Arweave’s use case as the permanent storage layer for NFT data. In a market where there are few places to bet on the secular growth of NFTs, Arweave stands out. They announced a partnership with Meta in November and I expect more to come as established brands build out NFT strategies.

L1 fees will drive interest in L2s and scaling solutions

If we’re optimistic about demand returning to crypto then we need to be optimistic about scaling solutions.

As demand returns, fees on Ethereum will increase and drive usage to Layer 2s and other chains like Solana. The market seems to be front-running this narrative with Optimism’s token up 140% on the year. Arbitrum hasn’t released a token yet but is likely to do so. Matic was one of the better relative performers in 2022 as it pushed forward on a number of business development initiatives and continues to be a good bet as an EVM competitor. The L2 trend is just beginning.

Solana is unique in that it isn’t EVM compatible but it does have a strong developer ecosystem and a unique collection of applications. Of the majors, it was one of the worst performers in 2022 and was tied in with the FTX debacle. Despite the recent stigma, Solana has made improvements to the fee system, has increased uptime, and in many ways mirrors the Ethereum trajectory of 2018.

Interoperability solutions take off

If L2s and other chains like Solana have an increased place in the ecosystem, interoperability will continue to be an important theme. Synapse, Hop, Across, and Stargate are competing for market share. Each takes a slightly different approach with respect to tradeoffs but all have aspirations of being more than a simple asset bridge. The holy grail is to be a cross-chain messaging and liquidity layer where applications can build on top.

2022 under-performers have their time in the sun

The worst-performing names of 2022 also tend to be the most shorted names. Shorts may be the fuel these names need for their revanchist arcs. GCR on Twitter has talked about this theme and we have already seen it play out in January with Aptos. Despite questionable short-term fundamentals, the heavy shorting on Aptos provided bulls the fuel to ride the name up 450% in a month. A similar theme could play out across the market where under-appreciated names surprise to the upside; Avalanche, Fantom, and dYdX come to mind. I think it’s wise to reevaluate biases across the board.

I’m very optimistic about the coming two years in crypto. I expect this year to be volatile in both directions as we prep for a breakout year in 2024 led by a cultural boom that will be tied to new applications, artwork, and communities in crypto.