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2023 crypto outlook

Key takeaways

  • The recent collapse of several large crypto institutions has created uncertainty in the market.
  • Hot crypto topics for the coming year include the bear market, bitcoin's volatility, post-Merge Ethereum, government regulations, and upcoming innovations.
  • Consider thinking critically about any potential crypto trades, particularly in light of market uncertainties.

If there's one constant in the world of crypto, it's that it's never boring. In 2021, the markets went parabolic, with bitcoin making all-time highs and altcoins (non-bitcoin cryptocurrencies) taking off left and right. Then, 2022 ushered in a crypto bear market, bankrupting several crypto platforms and slashing bitcoin's price by over 70%.

What will 2023 bring? Here are 5 big questions to be aware of as we head into the new year.

1. Can government regulations help provide stability for the crypto markets?

With the recent collapse of several large crypto institutions, the industry is watching for new government regulations now more than ever. Recent news events have made many feel uneasy about entering the crypto markets, but stronger legislation on how crypto institutions are allowed to operate could help restore confidence.

While 2022 saw plenty of discussion around potential frameworks, including an executive order from the White House, little has been set in stone.

Jason Ward, Head of the Blockchain Incubator for the Fidelity Center for Applied Technology (FCAT) is also watching for regulatory clarity in 2 additional areas. The first is whether crypto assets will be classified as securities or non-securities, or if different crypto assets will fall into different categories. This can have significant implications for how strictly crypto is regulated going forward.

The second is whether regulators might establish a minimum tax threshold for crypto transactions (hypothetical example: Any purchase paid for with crypto under $100 would be exempt from capital gains or losses). While cryptocurrencies like bitcoin are designed to be exchanged for goods and services, transactions are currently taxable events, which makes it inconvenient for many users.

"Tax treatment around small transactions is holding back [crypto holders] in general," says Ward. "More clarity around [tax treatment] could clear the way for greater utilization."

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2. Can crypto recover from this bear market?

There's no doubt about it: The crypto industry is going through a rough patch right now. The general sentiment is one of uncertainty.

Skeptics point to the recent bankruptcies of several large crypto platforms as a major question mark for crypto's long-term viability. While the thesis for crypto was built on the idea of decentralization, the industry is still getting hit by many of the same problems that hurt centralized entities.

Moreover, while stronger government regulations might help solve some of these problems, some skeptics argue that they'll only take the industry further away from its decentralized vision.

Meanwhile, bitcoin, the largest cryptocurrency by market cap, is down over 70% from its all-time high. Some critics point to the fact that historically, many growth stocks that fall this far never recover their all-time high. 

In contrast, crypto advocates argue that bitcoin's fundamentals remain strong. And despite what happens with the rest of the industry, they believe its viability as a currency is ultimately what dictates crypto's future.

"Bitcoin is still scarce, the network is still running, the miners are still here, and everything is still operating on the original core code," says Fidelity Digital AssetsSM Research Director Chris Kuiper, who is bullish on the future of Bitcoin. "Not much has changed in terms of [bitcoin advocates'] core investment thesis." 

Crypto winters also aren't new. From December 2017 to December 2018, for example, bitcoin dropped over 84% before eventually rallying to new all-time highs. Advocates emphasize that the industry has weathered similar situations in the past.

3. Can bitcoin's price become more stable?

Bitcoin was created to become a currency free from manipulation by a single decision maker. In order for it to fulfill its vision, however, its price may need to experience less volatility than it currently does.

According to the BitMEX Daily Historical Bitcoin Volatility Index (.BVOL24H), bitcoin's volatility has been declining on average since 2017 as of December 2022, though it‘s likely to remain relatively high for some time. Kuiper thinks its stability will increase with time and greater adoption. "More people investing in bitcoin means less power for any single entity to move the market," he says.

Recently, bitcoin's price has been mostly correlated with the stock market, which has been reactive to the Federal Reserve's policies. During the economic downturn of 2018, bitcoin dropped over 80% from its December 2017 high. And when the market roared after the coronavirus drop in 2020, bitcoin followed suit, skyrocketing over 1,500% to a new all-time high.

To become a viable currency free from the ups and downs of the broader market, it may need to lose this correlation. 

4. Will post-Merge Ethereum succeed?

The Merge was one of the most anticipated events of 2022. Ethereum's shift from proof of work to proof of stake slashed its power usage by over 99%—a big development given it was previously the second biggest cryptocurrency in terms of energy consumption. It has also started to add deflationary pressure, which advocates argue is healthy given it has no hard cap on its supply.

However, post-Merge Ethereum has some big questions to answer in 2023. The biggest is when those who have staked* their ethereum will be able to withdraw. The current expectation is that withdrawals will become available when the Shanghai Upgrade, its next big system update, goes live. But as of now, the launch date for the update has not been set.

"The lack of liquidity [caused by the inability to withdraw staked ethereum] has reduced the number of ethereum holders who have chosen to stake their assets," says Fidelity Digital AssetsSM Research Analyst Jack Neureuter. "Many proof-of-stake networks have staking rates [the percentage of supply which is staked] between 50%–80%, but ethereum's is currently only around 13%."

Advocates expect the staking rate to rise rapidly after the Shanghai Upgrade goes into effect, which could have a positive effect on ethereum's value. The question, of course, is when the update will launch.

5. What new developments are on the horizon?

One of the most exciting aspects of crypto is that it has been a hotbed for innovation, and it doesn't look like the momentum will let up in 2023.

In 2022, the first house was sold as an NFT (non-fungible token). NFTs are smart contracts, which are like legal agreements verified with blockchain technology. Smart contracts have already been applied to decentralized finance (DeFi) and collectible art, but 2023 could see them applied to more use cases in industries like real estate and legal services.

On the DeFi front, one development to watch is evolving liquid staking protocols, which aim to let holders use staked assets even while they're staked. Currently, those who have staked ethereum can't use the coins they've deposited. Under a liquid staking protocol, however, they'd be able to use their staked coins while still earning interest. Note that these protocols may come with risk and volatility.

Also watch for further innovation in appchains, which are blockchains built for one specific application. They contrast with blockchains like Solana and the Ethereum network, which are designed so multiple apps can be built on top of their systems. "Appchains will likely be a point of contention as projects like dYdX and Cosmos transition from an Ethereum application to their own blockchains," says Neureuter.

Ultimately, these concepts only scratch the surface of what's brewing. Crypto evolves at lightning speed, so expect plenty of new developments in 2023. This also reinforces the importance of doing your due diligence before buying crypto, including understanding crypto's inherent risks, and allocating purchases in ways that are consistent with your risk tolerance, time horizon, and financial goals.

*Staking is when crypto owners agree to lock up their coins for a period of time, which means they can't sell them or exchange them for goods. For example, ethereum holders might choose to stake their ethereum in the Ethereum network. This increases ethereum's overall security. In return, stakers earn interest.

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