Incuba Alpha 2023 Outlook

Where we are in the market?

2022 has been a perfect mirror to 2018. Will 2023 mirror 2019?

We have bypassed the lowest point of the bear market. As for BTC, we see that the price level at ~$16,000 in Nov 2022 mirroring the same movements as that in Dec 2018 when the price was at $3,200.

We are not too positive about the market in 2023 because the market still needs about 1 year to gather momentum while fluctuating up and down repeatedly based on cyclical analysis. But it will bring more short-term windows for tactical opportunities like event-driven and cigarette butts trading. Then we just wait for the next mega-trend patiently. That is what veterans in this industry would call “echo bubble”.

We have deployed about half of our liquid assets on BTC at $17,000 and ETH at $1,250 on a long-term holding basis. Our deployment strategy was driven by four indicators:

1. Cost basis of ST&LT holders
2. Market sentiments
3. Money flow
4. Macro Risks

Detailed analysis is as follows:

1. Cost Basis of ST&LT Holders

Net Unrealized Profit/Loss(NUPL) is an indicator to describe the micro holder structure of BTC.

NUPL well depicts the cost basis of the market by color. The line in red represents a period when the market is under capitulation. It also depicts the bottom of the cycle(2012, 2015, Nov 2018, Mar 2020, and Nov 2022). We don’t see a high probability that BTC will fall below $15,000 and ETH below $900 in the next few years.

We can also observe the user structure of the market by analyzing HODL waves.

As we can see in the chart, users who hold BTC for about 1 month to 3 months are likely liquidated at the bottom such as in 2015, Dec 2018, and Mar 2022. Bubbles of the last cycle will be fully squeezed out with the short-term speculators exiting the market.

The following years (2016, 2019, and likely 2023) came with a rising percentage of long-term believers(who hold BTC for 1 year to 2 years) when smart money gradually flows in and accumulates token holdings, leading to price rebouncing. This is what we call “echo bubble”.

Currently, we are in the stage of accumulation when the number of 1y-2y holders starts growing. But make no mistake, we won’t see the market enter its next bull run until short-term speculators are convinced that the bull market is not imminent and exit the market. Our best guess remains that the next cycle will begin no sooner than 2024.

2. Market Sentiments

The best indicators for observing holder sentiment are volatility and open interest.

At the end of 2022, the volatility of BTC hit an unprecedented all-time low. Market sentiment seemed to have been devastated by several back-to-back FUD events such as the Luna collapse, 3AC, FTX, and Genesis, leading us to the rock-bottom of this cycle.

Recently even after +30% re-bounce in price, the volatility remains at an unbelievably low indicating that token holders are still skeptical and fearful. That’s why we believe there exists a short-term echo bubble. Once again, when we start observing volatility spikes after April or May, we expect to see this bubble burst and push prices down, mirroring the trend in 2019.

On the other hand, the open interests tell quite a strange, yet interesting story.

The OI for BTC is really low but the OI for ETH is extremely high, and we’re unsure as to why there exists this large gap between the two. But since most takers are short orders, shorts will be the gas for longs. We will carefully monitor how the OI of ETH shall be washed out. It will be the tipping point of the recent echo bubble.

3. Money Flow

We constructed an indicator called “Crypto Leverage Multiple” which equals: Total market cap divided by USD stablecoin market cap (USDC+USDT).

It’s similar to PB ratio in the equity market and is used to describe how much of a bubble is backed by one stablecoin.

You could see the leverage multiples hit its lowest in July 2022 and Nov 2022. This would indicate that the valuation of crypto market is extremely cheap at these periods of time. But as the echo bubble persists, the bubble gradually grows to a medium level.

Once the leverage multiple hits the upward benchmark, like it did in April 2021 or Oct 2021, we will sell most of our positions.

4. Macro Risks

Most investors would be concerned about the recent tense debates of CPIs, inflations, interest rate raises and cuts, and BOJ’S YCCs(so-called the last safe haven of global liquidity and risky assets).

We won’t pay much attention to macro economics this year because we believe this is the year where crypto and macro will lose their tightly coupled correlation.

While we anticipate a number of macroeconomic changes, predicting what exactly they are is an exercise in futility and therefore our best approach remains to react and not to predict. This being said, we do appreciate the fact that while history doesn’t repeat, it does rhyme. Given the extreme 2022 we had where we observed painful interest rate hikes, crashes in risky asset markets and most importantly a negative M2 growth rate, we believe 2023 is the year of ‘mean reverse’. We have faith that the crypto market will lose its tight correlation with the macros this year and we need to maintain focus on the internal structure of the crypto market.

Everything that’s happening in the market right now is very reminiscent of the 2019 market where tokens like SOL, AVAX, AXS and MATIC all began to make their mark. The tenbaggers of this cycle are yet to have their moment in the sun, but we do anticipate them showing their potential in the following six months. Although we’re not positive about having a bull run in 2023, we remain highly optimistic in being able to witness the rise of the next 100x winners and, most importantly, monetize from their growth

All in all, we believe the era of de-leveraging will come to an end this year and 2023 will still be a PvP market. The market is anticipating the next innovation such as DeFi, to kickstart a new cycle. So, when the recent echo bubble bursts, we’ll have a once in a blue moon chance to invest in innovative technologies at a relatively low price.

Where we see the opportunities?

We strongly believe that the new run will be boosted by application layers with new format of asset distribution, leveraged model, and followed by the infrastructure that support these Applications.

1. DeFi: will stay as the main use case of blockchain and bounce back from its bottom, but with new tokenomics

The previous bull run started with the DeFi summer of 2020 and we have seen a robust user base ever since. We believe that with users having learned the lesson of “not your key, not your coin” from the recent FTX collapse and additional regulatory pressure, the DeFi user base is going to further grow.

Despite rapid innovation in capital efficiency, routing algorithms, and gas efficiency in the trading/lending protocols, we expect the old DeFi kings to remain strong. Just as users trust financial institutions, the consecutive number of blocks a DeFi protocol operates without significant attacks will become an moat for its business. Protocols that only make minor feature improvements will find it difficult to capture market share from their established counterparts.

While the fundamentals for DeFi protocols remain solid, there is a significant gap between their products and tokenomics. The DeFi summer opened up a new era with the incentive model of liquidity mining, causing their tokens to keep “bleeding”. Pure governance tokens spread through liquidity mining have become a “marketing cost” to attract buyers with impressive “TVL numbers”, but secondary buyers are paying the price. They hardly found a way to convert the TVL into real revenue.

We believe that the first movers to close the tokenomics gap will stand out. Two feasible approaches to revise their tokenomics are:

• Fee Business Model: This model generates revenue from transaction fees and provides token holders with real yield. Token holders can share in the transaction revenue by staking the governance token (e.g. GMX model). This model is suitable for products that can charge juicy fees from their users with a scalable transaction volume base. Some protocols, like Mcdex, Popsicle Finance, and Pendle Finance, have been slowly revising their tokenomics to fit this model.
• AUM Business Model with LTV-backed algorithmic stablecoins: This model earns revenue from interest rates and secondary buying power is generated from stablecoin minting and redeeming (e.g. Curve & AAVE model).

Here, we borrow the words from our friend GBV to further validate this approach:

Instead of deriving revenue directly by charging users of the protocol a fee, protocols like AAVE and Curve are launching stablecoins in which interest payments accrue to the protocol itself. The stablecoin serves as the tool for liquidity provision, thereby alleviating the pressure on the protocol to incentivize liquidity. Liquidity becomes fully owned and controlled by the protocol.

2. NFTs

NFTs have established themselves as a solid type of asset with a diverse group of consumers, collectors, and traders, and with complete infrastructure support (such as on/off ramps, wallets, and marketplaces). There is a strong possibility that the next wave of growth in assets, traffic, and leverage will come from NFTs.

• PFPs will be divergent. The ones that manage to extend their IP outreach (into fashion, anime, games) will survive, while those that lack sustainable content generation will fade.
• Crypto-native NFTs, such as Cryptopunks and Artblocks/Generative Art, will have stronger longevity in the long term. On the one hand, they possess a strong uniqueness, as the process of creating and displaying these works requires the support of blockchain technology and represents crypto-native culture. Additionally, there is strong support from powerful collection DAOs like FlamingoDAO, who have kept buying pieces on-chain and built their impact into the traditional collector communities.
• NFTs on social protocols like Lens Protocol will become the new treasure trove of assets. We expect to see the creator economy boom on social protocols and new “Ponzi” engines that combine NFTs and governance tokens to boost the creator economy on social protocols.

3. Gamefi

We believe that games serve as leading indicators of each technology revolution and provide insights into how users will interact with future digital systems. We also believe that the gaming sector will continue to play a key role in onboarding new users into the world of cryptocurrency.

Account abstraction, which supports a web2-like login experience with features such as social recovery, session keys, and bundled transactions, will be a standard feature of Gamefi. The wallets will mostly be in SDK format, and the value of the wallets will be captured by layer 1 and layer 2 they work with. Leading layer 2 players, such as zkSync and Starknet, are committed to incorporating native account abstraction.

Mini Games + Game Publisher > On-chain Games > AAA Mega Makers

It will become a normal practice for game studios to use NFTs to drive initial traffic during publishing. We may see NFT-version “Curve War” appearing on publishing platforms like TreasureDAO ($MAGIC).

One of the challenges faced in the Gamefi ecosystem is that many game tokens have a strong dependency on the lifecycle of the game, and as the game reaches its end, the value of these tokens may also diminish. But publishers can capture traffic throughout the lifecycle. We believe that a new form of P2E tokenomics will incentivize players with the publisher token, and the games will compete for emission gauge through NFTs and their own native tokens.

We expect to see a typical Web3 publishing procedure, such as:

• Build a CC0 NFT and open the IP for the community to build content around it. Freely launch the governance token $ABC of the platform with NFT staking/NFT-related quests.
• Build the games themselves or introduce gaming studios to the platform.
• Each game launches its own token and pairs it with the platform token on a native swap.
• Incentives are distributed through the platform token with a weighted gauge, where the gauge is weighted by staked NFTs/staked platform token $ABC and staked game tokens.

Onchain game: Dark Forest has been growing into a wild ecosystem with multiple teams building up plugins on top of DF and making money from it. We could see more Permissionless Composability become a new game development paradigm and more on-chain games in 2023.

Dark Forest is a EF lead on-chain game completely run on blockchain where smart contracts / codes / AIs are the key players battling for reward instead of human beings.

Onchain games are popular among Degens and crypto OGs as all the gaming rules are stored in smart contracts instead of traditional backend servers. It allowed both developers and players to do something fundamentally different that they could not do in the Web2 paradigm: Permissionless Composability. With all the gaming data on open database, players/ developers will add new features or even publish a “fork”version without complicated procedures.

the Dark Forest Plugin Ecosystem

But practically speaking, the current on-chain games are too hardcore for even crypto traders who don’t master smart contract well to create wider group of hype and speculation. And it’s super expensive, each move in the game is currently consuming millions of gas on Ethereum, so we’d prefer to look more games scaling solution like layer2s. Also, on-chain games need better front-end and educational-orientated guilds to bring in wilder group of players/ traders. We are also expecting “vault” like products to serve as agents to help retail users to interact with the gaming smart contract.

AAA games are hard to achieve in this cycle, as the majority of gamers are satisfied with the offerings provided by established Web2 studios. Web3 studios need to differentiate themselves and offer unique value propositions to gain market share, which will be focused on technology, paradigm shifting, and community building instead of content generation.

4. Layer 1, Layer 2, Infras

We’ve learnt from Solana that Alt layer 1 was a VC game with low MC and high FDV (and backed by CEX users’ money). While Alt layer 1s like Solana still have their users / developers, we anticipate that layer 2s will gain significant market share from the Alt layer 1s, especially after the Ethereum Cancun Upgrade later this year, which has the potential to significantly lower costs for layer 2s.

We have a positive outlook on the Cosmos ecosystem. On one hand, Interchain security is poised to open a new chapter in interoperability. On the other hand, our thesis is that the Application layer will capture more users in the upcoming cycle. As a result, we anticipate that well-established DApps will seek to have more control over their “economic policy” and set their own gas fees. Additionally, current Layer 1s are using the Cosmos SDK to build sidechains and tap into the growing App-chain ecosystem as well. Polygon, with Lens Protocol, will outperform the majority of zk-EVMs that currently rise in the primary market.

BNB Chain, despite remaining strong and having the largest user base in the industry, has many improvements to be made both on the product and infrastructure side. It also still requires strong native DeFi infrastructure like a native lending market and algo stablecoins. We believe by concentrating our efforts on BNB DeFi, we can both contribute and capitalise on the future growth of the BNB chain.

Pancake transaction volume ranks 2nd across the market

5. Others

We see a raising trend in TIPIN projects (Token Incentivized Physical Infrastructure Networks) projects.

The miners have always played an integral role within the industry and the sales of mining rigs have also served as a crucial source of fiat revenue. We’ve noticed that some PoW miners have been forced to change course on account of declining mining returns and ETH’s shift from PoW to PoS and are therefore in search of hardware-dependent mining targets. In the last cycle, Helium and Filecoin unfolded a narrative around Web3’s open infrastructure and we believe there will be more projects like these that are dedicated to building out the next generation of decentralized infrastructure and collaborating with old miners and thereby promoting the development of TIPIN projects. Here are some reasons why we believe this to be the case:

• Decentralization: TIPINs aim to build decentralized networks, meaning that they are not controlled by any single entity, but rather by a decentralized network of nodes. This results in a more resilient and secure network, and reduces the risk of centralization and censorship.
• Token incentives with hardware sales: By providing token incentives, TIPINs can both subsidize hardware purchase costs, acquire users and distribute the tokens to a wide user base. This will then encourage participants to contribute to the network and receive token incentives for contributing resources such as bandwidth or computing power, or for participating in consensus mechanisms. This incentivizes participants to actively contribute to the network and helps to ensure its continued growth and development.
• Network effects: TIPINs benefit from network effects, meaning that as more people participate in the network, the network becomes more valuable to each participant. This creates a positive feedback loop that drives growth and adoption.
• Monetization opportunities: TIPINs offer monetization opportunities for both the network and its participants. For example, the network can charge fees for using its services, and participants can earn tokens for contributing resources or participating in consensus mechanisms.
• Sustainable revenue: TIPINs offer a sustainable revenue model, as they are not reliant on a single source of revenue but instead have multiple streams of revenue from fees, token incentives, and network effects. This helps to ensure the long-term viability of the network.

Despite being in its early stages, the TIPIN sector is worth watching and has the potential to offer substantial alpha opportunities.

Closing Words

In conclusion, the outlook for 2023 presents a unique set of challenges and opportunities. Our analysis suggests that the market de-leveraging will come to an end this year, and the market will continue to navigate opportunities in DeFi, NFTs, Gamefi, and L1/L2 infrastructure. We believe that the indicators and trends outlined in this report will significantly impact the coming year and that those who are proactive and forward-thinking will be best positioned to succeed. As we move into 2023, we are excited to see what the future holds and stand ready to support those who are looking to capitalize on the opportunities ahead.

Thank you for reading this outlook and we wish you all the best in the coming year.