What’s Next for Blockchain Tech and Crypto in 2023? | Foley & Lardner LLP

Foley Forward: Trends 2023

Following the recent closures of Silicon Valley Bank, Signature Bank and Silvergate Bank and Credit Suisse’s takeover of Swiss-based rival UBS, repercussions for blockchain technology and crypto-based assets and deals are inevitable.

The banking crisis occurred less than six months after the crypto industry suffered the loss of billions of US dollars in the failure of FTX. While some are heralding the beginning of the end of cryptoassets and Web3 technologies, we continue to see a multi-trillion dollar asset class and technologies with applications and utility far beyond your wallet. Bitcoin, the leading indicator of the crypto asset class, which first fell to ~$16K/BTC from ~$46K, has recently seen a rise to ~$27K as of this writing.

With a new Congress in 2023 and a first-ever Digital Assets Subcommittee, the way is clear for thoughtful legislation and effective oversight of federal financial agencies tasked with establishing a regulatory framework beyond enforcement. At the same time, society can expect auditors, investigators and bankruptcy courts to shed light on what went wrong in some of the centralized financial institutions that support the dynamic decentralized crypto ecosystem.

How did we get here?

Seven key events and paradigm shifts occurred in 2022 that had a direct impact on the outlook for the crypto industry for 2023. As summarized in CB Insights’ recently released State of Blockchain 2022 report:

1. Blockchain venture funding and deals hit new highs in 2022
   26.8 billion dollars worldwide
2. The FTX failure and bankruptcy, and a drop in blockchain technology funding hit hard in Q4′ 2022
   With only $3.2 billion raised, there was a 64% drop in funding in Q4’22 vs Q4’21. The FTX bankruptcy in November 2022 led to a crash in crypto asset prices, a loss of consumer confidence and a web of affected counterparties that will take years to unravel.
3. The average blockchain technology deal fell from USD 21.2 million in 2021 to USD 16.2 million in 2022
   This was driven by a sharp drop in multi-rounds of USD 100 million+ throughout the year. Investors gained more power over deal sizes, as less capital chased fewer deals.
4. Blockchain unicorn count stalled at 79 at the end of 2022
   Only two new unicorns entered the market in Q4’22 — Uniswap Labs, the leading decentralized exchange, and Celestia, a Layer-1 blockchain network.
5. Over half of global blockchain technology funding in 2022 went to US-based companies
   US-based blockchain companies raised $15.3 billion, while Asia-based blockchain companies raised a record $4.7 billion in 2022, up from $3.2 billion in 2021.
6. $15.1 billion in funding went to Web3 startups
   Dollars flowed away from centralized exchanges (including wallets) from USD 6.9 billion in 2021 to just USD 3.6 billion in 2022, concentrating instead in differentiated verticals such as Web3 and blockchain infrastructure.
7. Blockchain technology infrastructure and development had a record year for funding
   This signals investor confidence in the future of blockchain technology regardless of crypto asset price volatility. In the second half, VCs pulled back on making deals as institutional demand for crypto waned.

What can you expect in 2023 and beyond?

Q4’22 reflected a significant decline in VC investment in and activity within the crypto market. That said, despite the slowdown, 2022 reflected significant amounts of invested capital and deals.

In Pitchbook’s recently released Q4 2022 Emerging Tech Research – Crypto Report, recent VC trends and emerging opportunities were highlighted and are summarized below.

Practical use of crypto assets

While the crypto market has grown exponentially over the past decade, the practical benefits of crypto assets remain elusive in most cases, as many projects and companies are still in the experimental phase. We believe that retail adoption is unlikely to grow significantly again in the US until a workable regulatory framework is enacted. The crypto industry also needs payment rails, which US banking regulators limited even before the failures of Silvergate, SVB and Signature Bank (each of which held significant fiat deposits on behalf of the pillars of the crypto industry). Meanwhile, adoption of cryptoassets continues to grow outside the United States, especially in regions such as Latin America.

Securities Tokens, NFTs and the Real-World Asset Tokenization Phenomenon

Related to digitally native cryptoassets like Bitcoin and Ether, but with demonstrable value in real life, are security tokens, NFTs, and other tokenized assets (like tokenized real estate). The development and launch of these products continues at a rapid pace and follows our view of the headwinds facing the rest of the crypto industry. Well-designed NFTs are not securities. Millions of them exist and more are coming online all the time.

Not just real estate, but indeed all kinds of assets, can be tokenized and sold, and then resold, in Securities and Exchange Commission (SEC)-authorized markets and on off-shore platforms. Foley obtained the first approvals from the SEC and the Financial Industry Regulatory Authority (FINRA) for such a market, and we advise other old and new market participants and advise on the first sale of real estate via non-fungible token. According to survey results from BNY Mellon, 91% of institutional investors are interested in owning tokenized products. We expect to continue to see and help lead the rapid growth in this sector.

New technologies

Important developments to be aware of:

1. Blockchain network
2. Infrastructure and developer tools
3. Access
4. Web3
5. Decentralized Finance (DeFi)
6. Real World Asset Tokenization
7. Betting providers

Network effects kick in

Metcalfe’s law suggests that the value of a network increases exponentially when the network itself grows linearly. We see Metcalfe’s Law at work in the US and global crypto adoption. More than 50 million US citizens and residents have purchased crypto assets. More than 400 million people worldwide own crypto assets. At this point, crypto assets are here to stay.

At the recent ETHDenver conference, politicians were present, hoping to cement the mutual feeling between the government and the crypto industry in favor of cooperation. The creation of the Digital Assets Subcommittee of the House Financial Services Committee is certainly a favorable development, likely to lead to thoughtful legislation.

The M&A sector continues to document the use of digital assets by transacting parties further demonstrating adoption. Law and business schools teach digital assets, NFTs are on the rise again, and, as mentioned, real-world asset tokenization is on the rise.

Regulations and enforcement

We expect the Department of Justice (DOJ), SEC, Federal Bureau of Investigation, and Treasury Department to continue cracking down on bad actors in the cryptocurrency space and addressing dark web crime. For example, on January 18, 2023, the DOJ, along with the Treasury Department, and French law enforcement authorities disrupted Bitzlato, a China-based cryptocurrency exchange that is alleged to be the broker of choice for criminal proceeds from the dark web. In light of geopolitical developments elsewhere, the Treasury Department has increased scrutiny of transactions with Russian interests through which dark web activity is allegedly conducted.

Separately, on March 10, 2023, Ether, the parent cryptocurrency for Ethereum, fell to its lowest market price in two months as New York’s attorney general argued that it is a security, bracketing it with assets such as stocks and bonds and sparking fears. of broader regulatory work. We continue to see monitoring, regulation and enforcement in the cryptoasset markets at multiple levels, including a significant tightening of state-by-state money transfer regulation, which is redefining the regulatory framework for the digital asset market.

Further thoughts on 2023¹

1. Market success for centralized crypto players will depend on the restoration of trust
2. There will be more enforcement activity until Congress passes laws
3. Bipartisan work on legislation to regulate stablecoins is moving forward
4. TradFi will continue to lean into permissioned blockchain technology while opposing crypto
5. Web3 will make a bigger splash
6. NFTs are growing again
7. Real utility will be a major focus

Despite financial instability, regulatory crackdown, devaluation of cryptoassets and the behavior of some participants in the centralized sector of the crypto industry, cryptoassets are here to stay in one form or another. Decentralization aligns with the longing of the human spirit for freedom and self-government. We don’t see that changing, despite the latest setback.

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