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Crypto 2023: Regulation, CBDCs, and an expansion of the digital asset class

Kitco News

Welcome to Kitco News' 2023 Outlook Series. Uncertainty continues to dominate financial markets as central bank monetary policies push the global economy into a recession to cool down inflation. Stay tuned to Kitco News to learn from the experts on how to navigate turbulent financial markets in 2023.

(Kitco News) -  It was a less-than-stellar year for the cryptocurrency market in 2022 as the high-profile collapses of Terra/Luna and FTX sent contagion shockwaves across the industry and erased more than $2 trillion from the total crypto market cap all-time high that was reached in November 2021.

While the turbulence seen throughout the year has led some to declare that they are done with crypto for good, the more resilient investors in the market are now looking ahead to better days in 2023 with the outlook that “it's only up from here.”

Central bank digital currencies

One of the major themes to emerge over the course of 2022 was a push by central banks around the world to begin exploring the creation of central bank digital currencies in an effort to compete with the growing popularity of decentralized cryptocurrencies.

By the end of the year, a total of 114 countries – which represent over 95% of global GDP – were at various stages in the exploration of a CBDC, according to data provided by the Atlantic Council. A total of 60 countries are in an advanced phase of exploration including China and India, which are both in the pilot testing phase.

According to Ryan Shea, Crypto Economist at Trakx, the interest in creating CBDCs “stems from the need to respond to the increasingly digital nature of our lives and the growing irrelevance of cash within the economy, which is the only form of central bank money available to the non-bank private sector at present.”

Shea also pointed to the programmable nature of CBDCs as a feature that makes them attractive to policymakers, referring to them as a “central planners dream (and a crypto-anarchists nightmare).” He derived this moniker due to their ability to influence spending patterns by restricting what goods and services can be bought with CBDCs, as well as their ability to automate tax collection through the use of smart contracts.

The greening of crypto

Another major development in 2022 was the completed transition of Ethereum from a proof-of-work (PoW) consensus mechanism to proof-of-stake (PoS), which helped make the network more energy efficient and set it up for improvements in scalability.

According to Shea, this will lead to a trend he described as “as the greening of crypto” that will be especially evident in the field of Bitcoin mining. “Given how fossil fuel prices in particular have been trending higher, cost incentives will push Bitcoin miners to becoming more environmentally friendly over time without the need for government green subsidies, something not many other industries can claim.”

The Fed effect

It wasn’t just the crypto market that had a rough year in 2022 as the traditional markets also entered bear market territory in response to rising inflation and interest rates. With the Federal Reserve signaling that it intends to continue raising interest rates in an effort to reign in inflation, there’s a good chance that the current market weakness will continue into next year.

“As we move into 2023, leaving the failure of centralized finance (CeFi) behind, we are still met with challenging macroeconomic factors. Interest rates are rising and monetary stimulus is being withdrawn, which is likely to produce a tougher funding environment that will narrow the field of potential digital asset winners,” noted Seamus Donoghue, Chief Growth Officer at METACO, a leading provider of security-critical software and infrastructure to the digital asset ecosystem. “I expect to see far more unicorns that were focused on the disruption of traditional finance fall from grace.”

Donoghue suggested that next year could “see more collaborative fintech companies working with established institutions to accelerate the transition to a new financial stack, replacing the antiquated operational model currently in use with next-gen technology to power a future where every asset will be tokenized.”

This suggests that one of the major trends of 2023 could be the integration of blockchain technology with the legacy financial system in an effort to increase efficiency and bring it into the digital age.

Establishing the digital asset class

As digital assets become more widespread and well-known, many are now highlighting that the asset class is more than just cryptocurrencies. This is likely to continue into 2023 as new use cases for blockchain technology are made available to the general public.

“The new year will bring with it a transformation in the way every asset will be represented, redesigning the financial infrastructure upon which capital markets operate,” Donoghue said. “Bringing asset representation to distributed ledger technology (DLT) is an opportunity worth hundreds of trillions.”

According to Shari Glazer, a web3 investor and founder of Kalos Labs, “Luxury brands will incorporate web3 programs through collaborations with existing web3 projects and through their own NFT [non-fungible tokens] activations. Exclusive, physical merchandise will be a bigger part of these programs and provide a new motivation for non-crypto-natives to buy NFTs.”

These developments also suggest that the digital asset custody space will likely see growth as the majority of people are not interested in the self-custody of their assets and would prefer to have a trusted financial institution hold their crypto.

“Expect to see market forces drive custody and asset servicing towards specialized, large-scale custodian banks and securities services firms, with most market participants consuming custody-as-a-service,” according to Donoghue.

Increased Regulation

Another major theme for 2023 will be the establishment of a global regulatory framework around cryptocurrencies.

Multiple countries around the world, including the United States, Australia, France, the European Union and even Ukraine have announced their intentions to develop a more robust regulatory framework for crypto next year.

“Regulation is the path to broader mainstream adoption,” Donoghue said. “The era of market creators is over, ushering in the era of market definers that will help define the regulatory guardrails, security standards, and investor protections for a still nascent industry. I predict that 2023 will breed new technology standards and efficiencies while opening access to exciting business models impacting asset classes old and new.”

Ryan Shea also sees a concerted push for regulation in 2023. “Due to the high profile failures of several crypto firms during 2022, which were entirely attributable to the dubious practices and behaviors of individuals not the technology, governments not only feel compelled to act to protect and safeguard consumers, but they feel qualified to act because they have witnessed numerous similar events in tradfi over the preceding decades. Consequently, this regulatory push is being both strengthened and accelerated.”

But not everyone is as optimistic about the coming regulations including Pedro Isaac Lopez, Chief Growth Officer at THORWallet DEX, who worries that the backlash in response to the collapse of centralized platforms like FTX and Celsius “will give rise to more stringent regulations applied improperly.” This includes regulations for decentralized finance (DeFi).

“As we discovered from the various market meltdowns involving Celsius Network, Voyager Digital, and the latest being FTX, centralized finance (CeFi) is knitted together with red flags,” Lopez said. “CeFi lending services were operating like traditional financial institutions without the proper investor protections, either 1:1 or reserve lending, leaving those platforms and their users massively exposed.”

Defending the honor of DeFi, Lopez said “We must collectively acknowledge that DeFi lending protocols worked as designed, largely without any major concerns of contagion. To conclude that the distinct DeFi industry should be subject to tighter regulations is misdirected.”

As for how the market will respond to the extended downturn it experienced in 2022, Lopez noted that “If we can draw anything from the last cycle, it is that Bitcoin will likely recover more quickly than the rest of the market.”

“As in previous cycles, many projects will expend their runway and die out. Users and retail investors should be exercising caution as such. The silver lining is that bear markets are for building!” Lopez said.

With the global economy continuing to struggle and central banks around the world raising interest rates, Lopez pointed out that “Blockchain and cryptocurrencies came as a consequence of the 2008 financial crisis, with an aim to create a more inclusive financial system, where power is no longer centralized and the need for trust is eliminated through code.”

This is the first major economic crisis to arise since Bitcoin emerged on the scene, and there is a good chance that 2023 will present the opportunity to see if it can perform as intended during times of economic strife.

“A pivotal moment is coming for the crypto industry,” Lopez said. “We must keep the focus on how crypto can foster innovation, create jobs, improve financial inclusion and ultimately generate economic growth. A nuanced approach that avoids polarizing people is necessary, otherwise, we may kill the most promising tech in a long time.”

Other promising areas of development

Aside from the obvious focus on regulations in 2023, there are a variety of other promising blockchain theme’s currently emerging, according to Dr. Youwei Yang, Chief Economist at Bit Mining Limited.

These trends include the development of ZK Rollup Layer2 scalability solutions and Zero Knowledge Proof (ZKP), decentralized identity (DID) solutions, more privacy-protected blockchain verifications, cross-chain bridges, the Data Economy, and a new generation of decentralized finance applications such as ReFi (Regenerative Finance), which is linked to ESG.

On the entertainment side of things, Dr. Yang noted new developments with SocialFi, which could boost the monetization and gamification of social networking to emphasize community ownership, and decentralized video and music platforms that will help the creator ownership economy to prosper.

“All these new developing themes seem exciting; however, it needs a warmer macro and crypto environment to prosper,” Dr. Yang said. “I foresee the crypto winter will last until about the summer of 2023, as that’s when major central banks will finish quantitative tightening and global macro conditions may ease a bit by then. That’s when some of these newly developed crypto projects will deliver, so there may be small pumps here and there.”

Dr. Yang also noted that conditions could remain tight until the Fed pivots to quantitative easing via rate cuts, “which could be later than 2023 or even 2024.”

“On the other hand, the regulatory landscape may change, and it takes time, such as adding clarity on tax, token issuing & trading, and ESG. The institutional infrastructure is developing as well, which could be ready together with the regulations. All combined the bull is more likely to happen in 2024,” Dr. Yang concluded.

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.