Crypto shakeup: How to view the crypto space moving forward?

The following is a guest post from Shane Neagle, Editor In Chief from The Tokenist.

Since the introduction of altcoins, after Bitcoin paved the road for them, we have seen many projects give 10x gains in relatively short periods. It has also been accepted that the crypto space oscillates between altcoin and bitcoin seasons, suggesting more investing opportunities down the line.

A deluge of memecoins flooded the market as well, serving as a more robust gambling system (compared to online casinos). As crypto space lost $530 billion market cap over the last 30 days, it is prudent to examine its fundamentals once again.

Is such a concept as ‘altcoin season’ meaningful moving forward? Is there more to cryptos than cyclical speculation? To answer those questions, we must first remind ourselves of narratives past.

The Merge Foreshadowing

During the evolution of the crypto space, Bitcoin became de-facto the only proof-of-work digital asset worth considering, following Ethereum’s The Merge in September 2022. As a transition from proof-of-work (PoW) to proof-of-stake (PoS), The Merge represents a cleavage in blockchain philosophies.

While Bitcoin’s proof-of-work (PoW) requires computational resources, Ethereum’s PoS eliminates such barriers in order to boost transaction speed and efficiency. In other words, Bitcoin further differentiated itself as a store of value, while Ethereum focused more on cost-effective blockchain utility.

At first glance, this may seem perfectly complementary, but there are several underlying problems that eventually reared their heads.

• PoW is more amenable to decentralization contrasted to PoS, which relies on the cumulative wealth of validators in the “rich get richer” feedback loop.
• PoS is divorced from hard assets, such as energy and machines, while Bitcoin is grounded in them.
• And because Bitcoin’s PoW is part physical, part digital, it is less reproducible than PoS as a commitment mechanism. In turn, this contributes to Bitcoin’s network effect and safeguards against devaluation in the long run.

Altogether, the PoW-PoS bifurcation translates into PoS fragmentation. If PoS-based assets, and PoS-based platforms competitive to Ethereum, are more reproducible, they can be launched with minimal upfront costs. With this foundation, there is no single altcoin asset to cling onto. Ultimately, with a low barrier of entry, this led to the fragmentation of the crypto market across +34,000 digital assets.

From the Bitcoin-Ethereum perspective, as the two largest digital assets by market cap, PoS-led fragmentation manifests as a corrosive effect on Ethereum price level.

Performance of Bitcoin (BTC) vs Ethereum (ETH) since The Merge on September 22, 2022. Image credit: Cryptoslate via TradingView

To put it differently, Bitcoin’s key features, PoW and scarcity, are reinforcing Bitcoin fundamentals. In contrast, Ethereum suffers from network effect erosion from competing PoS chains, which offer similar functionality and incentive structure.

Moreover, the increased complexity outside of Bitcoin is creating a barrier to entry from new capital inflows. Who can spend time filtering thousands of assets and bet that they will have staying power beyond one year? Even sophisticated investors leveraging popular futures trading algorithms often struggle to navigate the fragmented market effectively.

In fact, this is precisely why memecoin mania gained traction. The complexity and fragmentation of the crypto market lends itself to thinking of digital assets outside their fundamentals. Instead, focus is then on celebrity endorsements, humor, viral marketing, which often turns into pump-and-dump schemes.

Inevitably, this creates a negative feedback loop:

1. Crowded and confused altcoin market births memecoins.
2. Rollercoasting memecoins inevitably erode trust in the altcoin market itself.
3. Legitimate innovative projects are then less likely to gain traction, as capital is misallocated.

But there is an even greater problem than that. Let’s assume that this negative feedback loop created by memecoins doesn’t exist. One has to consider if there even is a market for blockchain based solutions, as it was previously imagined.

Erosion of Underlying Fundamentals

Through anti-money laundering (AML) and know-your-customer (KYC) requirements, governments around the world have expended great efforts to subdue the crypto ecosystem. Let’s quickly remind ourselves of key promises before regulative sweeps took place:

Decentralization as elimination of intermediaries – nearly everything is now intermediated through fiat rails, including transfers from self-custodial wallets.

Financial inclusion as access for the unbanked/underbanked – it is still more convenient to use legacy banking than blockchain tech, which is inherently complex and requires digital literacy. According to the latest EMarketer report, cryptocurrency payment penetration is hitting a wall.

Although the number of crypto payment users is expected to rise by 82.1% from 2024 to 2026, this is from a tiny overall population base of only 2.6%. It may very well end up being the case that a digital dollar, a stablecoin like USDT, will subsume this effort entirely in place of a direct CBDC.

Censorship resistance as a guarantee that transactions cannot be reversed or intercepted by governments and organizations. Governments regularly pursue innovative mechanisms to cancel such efforts, from debanking to the persecution of smart contract developers.

Although Treasury sanctions against Tornado Cash were overturned in January, there is little indication that financial privacy will become a human right any time soon. In fact, indicators point in the other direction.