Note: This report was written on March 17, 2026. Numbers and external geopolitical factors have since changed.

Executive Summary

Strategy Inc (MSTR) presents a compelling risk-reward opportunity at its current trading price of approximately $145. Following Bitcoin’s continued pullback from its October 2025 all-time high near $126,000 to the current ~$73,600 level, the equity has been materially oversold. This mispricing fails to account for the continued accretion of the company’s underlying Bitcoin treasury, which has grown to 761,068 BTC, approximately 3.6% of Bitcoin’s total supply. Notably, on March 16, Strategy filed its latest 8-K revealing a $1.57 billion purchase of 22,337 BTC at an average price of $70,194, the largest single weekly acquisition of 2026 and the fifth-largest in company history.

Most strikingly, the stock is now trading at approximately 0.83–0.86x its modified Net Asset Value (mNAV), a discount to the value of its Bitcoin holdings outright. At this level, investors are effectively acquiring Bitcoin at an implied cost of approximately $63,200 per coin through MSTR versus $73,600 on the open market, while receiving the company’s software business and capital markets optionality for free. This represents a historically anomalous entry point: According to China Renaissance data, MSTR has traded at an average mNAV of 1.5x–2.0x since 2021, with only the current drawdown episode pushing it into discount territory.

Further supporting the thesis, management’s $2.25 billion USD cash reserve provides over 2.5 years of preferred dividend coverage without requiring the liquidation of any Bitcoin holdings, structurally insulating near-term operations from Bitcoin price volatility. The Q4 2025 earnings call confirmed that the company raised over $25 billion in capital during 2025, making Strategy the largest equity issuer among U.S. public companies for a second consecutive year.

Investment Thesis

1. The Bitcoin Yield Machine

Strategy’s core value proposition centers on its ability to grow Bitcoin holdings per share through sophisticated capital markets operations. Despite Bitcoin’s price decline, the company reported a full-year 2025 Bitcoin Yield of 22.8%, significantly exceeding its stated target range of 5–14%. Year-to-date in 2026, Strategy has already achieved a 1.2% BTC Yield, generating a gain of 7,826 BTC worth approximately $576 million. This metric measures the percentage increase in BTC per assumed diluted share, confirming that the company’s capital-raising activities remain accretive to shareholders even in a bear market.

The mechanism is straightforward: Strategy issues equity and preferred stock at a premium to NAV (or at par with its BTC holdings), then deploys the proceeds into additional Bitcoin purchases. The company has now made 12 consecutive weekly Bitcoin purchases in 2026. In its most recent filing on March 16, Strategy acquired 22,337 BTC for $1.57 billion at an average price of $70,194 per coin, its largest single weekly purchase of 2026. The prior week saw 17,994 BTC added for $1.28 billion. In total, the company has acquired approximately 88,500 BTC so far in 2026, well ahead of its historical annual pace.

With holdings now at 761,068 BTC, Strategy commands approximately 3.6% of Bitcoin’s total 21 million supply. This concentration makes MSTR the premier institutional vehicle for Bitcoin exposure, surpassing every spot Bitcoin ETF in single-entity holdings. The company’s 42/42 Plan targets up to $84 billion in total capital deployment by 2027, $42 billion from equity issuance and $42 billion from fixed income, with ~$34 billion in authorized but unused issuance capacity remaining across all ATM programs (common stock, STRK, STRC, STRD, and STRF) as of March 15, 2026

2. Value Dislocation

At ~0.83–0.86x mNAV, the premium has not just compressed — it has inverted entirely into a discount. The market is pricing MSTR almost exclusively on its spot Bitcoin value, assigning negligible value to its software business ($123 million quarterly revenue), its proven ability to generate alpha through capital markets arbitrage, or its growing suite of digital credit instruments.

Historical context is critical here. Since adopting the Bitcoin treasury strategy in 2020, MSTR has traded at an average mNAV premium of 1.5x–2.0x, with peaks exceeding 3.0x during bull markets. The current sub-1.0x reading represents only the second time the stock has traded at a discount to its net Bitcoin value, the first being a brief episode during the 2022 crypto winter. Even Canaccord Genuity’s recently reduced price target of $185 (from $474) assumes a recovery to just 1.25x mNAV with a modest 20% Bitcoin rebound.

The consensus analyst price target stands at approximately $354–$376, with 14 analysts maintaining a “Strong Buy” consensus. The range spans from $54 at the bear extreme to $705 at the top, reflecting the widest disagreement of any major equity coverage. Citigroup recently trimmed its 12-month Bitcoin target to $112,000 (from $143,000), citing slower ETF flows and stalled U.S. crypto legislation, while TD Securities maintains a buy rating with a $500 price target. Our target range of $289–$516 spans from slightly below the Wall Street consensus center ($354–$376) to the upper band of analyst estimates and assumes mNAV recovery to 1.3x–1.5x with Bitcoin stabilizing between $90,000 and $110,000.

3. Solvency in a Drawdown

Management’s foresight to build a $2.25 billion cash reserve specifically mitigates the risk of the current price environment. This reserve provides over 2.5 years of preferred dividend coverage at current rates, decoupling operational survival from Bitcoin’s price trajectory. The company can continue to hold and even accumulate through this drawdown phase without being forced to liquidate any Bitcoin.

The capital structure has been further strengthened through the introduction of STRC (Stretch), a perpetual preferred stock instrument that CEO Phong Le described as more stable than MSTR stock, Bitcoin, gold, the S&P 500, and even investment-grade bonds. STRC’s 30-day historical volatility of just 3% compares to 80% for MSTR common stock and 53% for Bitcoin itself. Notably, the March 16 purchase marked the first time STRC contributed more funding than common stock to a weekly acquisition, $1.18 billion from 11.8 million STRC shares versus $396 million from common stock — signaling a meaningful pivot in the capital structure. The STRC dividend rate was most recently set at 11.50% per annum effective March 1, 2026, though as a variable-rate instrument this rate is subject to future adjustment. By stripping volatility from Bitcoin and concentrating it in the common equity, Strategy has created a layered capital structure that can weather extended downturns while preserving optionality for the upside.

Critically, the company’s $8.2 billion in convertible debt does not carry margin call provisions. Even if Bitcoin falls further below the average cost basis of ~$75,696, there is no mechanism that would force liquidation. Michael Saylor has stated that the company plans to convert roughly $6 billion of convertible debt into equity over the next three to six years, further reducing refinancing risk.

4. Fair Value Accounting Tailwind

Beginning January 1, 2025, Strategy adopted FASB ASU 2023–08, which requires Bitcoin holdings to be marked to fair value through the income statement. While this created a $17.4 billion unrealized loss in Q4 2025 (driving the headline net loss of $12.6 billion), it eliminates the asymmetric impairment model that previously penalized the company. Under the old rules, Bitcoin declines were permanently impaired while recoveries were not recognized until sale. The new framework means that any Bitcoin price recovery will flow directly through earnings, potentially creating substantial positive earnings surprises if Bitcoin rebounds.

Strategy also received the first-ever credit rating for a Bitcoin Treasury Company during 2025, marking an important step in institutional recognition and potentially opening the door to more favorable debt financing terms.

Key Risks

1. Bitcoin Price Dependency

The single overriding risk is Bitcoin’s price. MSTR functions as a leveraged Bitcoin vehicle — if BTC rises 50%, MSTR will likely rise more than 50%; if BTC falls another 20%, MSTR could decline 30–40% or more. Bitcoin has already pulled back approximately 42% from its October 2025 all-time high of ~$126,000 to the current ~$73,600, though it has rebounded roughly 12% since late February. A further decline to $60,000 or below (which was briefly approached in late February) would put the entire treasury significantly underwater relative to the ~$75,696 average cost basis. At the current Bitcoin price of $73,600, Strategy’s total holdings are already modestly underwater versus cost.

2. Battleground Stock Dynamics

S3 Partners classifies MSTR as a “battleground stock” with an Active Short/Active Long ratio of 1.23 (within the 0.65–1.35 battleground range). The stock carries the highest capital concentration among battleground names at $13.34 billion in combined active long and short positions. This nearly equal betting on both sides creates elevated probability of violent squeezes and selloffs, contributing to MSTR’s 80% 30-day historical volatility, higher than Bitcoin itself.

3. Dilution Risk

Strategy funds Bitcoin acquisitions primarily through equity issuance. Common shares outstanding have grown from ~100 million in 2021 to an estimated ~332 million currently, with an additional 2.8 million shares sold just in the week ending March 15. The company still has approximately $6.3 billion remaining in its common stock (MSTR) ATM program, out of ~$34 billion available across all five ATM programs. While the Bitcoin Yield metric is designed to demonstrate that dilution is accretive (growing BTC per share), this framework breaks down if the stock persistently trades at or below NAV. At sub-1.0x mNAV, issuing new shares to buy Bitcoin is no longer value-accretive, it is value-destructive. Management’s accelerating pivot toward preferred stock (STRC) issuance, which contributed $1.18 billion of the latest $1.57 billion purchase, partially addresses this concern by reducing common equity dilution, but the risk remains if capital market conditions deteriorate further.

4. Convertible Debt Maturities

The company holds $8.2 billion in convertible notes with maturities concentrated in 2028–2030. If MSTR’s stock price is below conversion prices at maturity, the company would need to repay in cash or refinance at potentially unfavorable terms. Saylor’s stated plan to convert $6 billion into equity over three to six years mitigates this risk, but execution depends on market conditions and share price levels. A prolonged bear market could complicate this conversion strategy.

5. Geopolitical and Macro Headwinds

Bitcoin’s recent volatility has been amplified by geopolitical events, including the ongoing Middle East conflict involving U.S. and Israeli military operations against Iran, as well as renewed tariff uncertainty following President Trump’s escalation of global levies to 15%. Bitcoin has shown approximately 85% correlation with the Nasdaq-100 over 7-day periods, making it vulnerable to broader risk-off episodes. However, since February 28, the day the U.S. launched its first strikes on Iran, Bitcoin has rallied approximately 12%, outperforming gold which fell nearly 2% over the same period. Nearly $700 million flowed into U.S. Bitcoin ETFs in early March, suggesting potential decoupling from traditional risk assets. As of the report date, the conflict is in its 17th day with no clear end in sight, Trump’s Defense Secretary has stated the operation is ‘only just the beginning,’ Iran has launched retaliatory strikes across nine countries, and partial closure of the Strait of Hormuz has driven oil prices to approximately $94.70/barrel. This represents a meaningful and ongoing macro headwind whose resolution timeline is uncertain.

6. Regulatory and Index Inclusion Risk

MSCI recently confirmed that digital asset treasury companies will remain eligible for inclusion in its global market indices. However, future regulatory changes, particularly around corporate cryptocurrency holdings, tax treatment of digital assets, or securities classification, could impact Strategy’s operating model. The corporate alternative minimum tax implications under fair-value accounting also require monitoring, though management has indicated the new accounting treatment helps avoid additional AMT exposure.

Valuation Framework

Our price target range of $289–$516 is derived from a scenario-based mNAV analysis, applying historical and forward-looking multiples to Strategy’s Bitcoin net asset value under various BTC price assumptions.

Notably, the bear case target of $149 represents only marginal upside from the current price of $145, underscoring that this recommendation is predicated on Bitcoin price recovery — investors who assign high probability to further BTC downside should size positions accordingly.

Our base case of $289 assumes Bitcoin recovers to $90,000 (approximately a 22% rally from current levels) and the mNAV multiple normalizes to 1.4x — still below the historical average of 1.5x–2.0x. Our bull case of $378 assumes Bitcoin reaches $110,000 with mNAV expanding to 1.5x.

Catalyst Timeline

• Accelerating BTC Accumulation: Strategy has made 12 consecutive weekly Bitcoin purchases in 2026, acquiring ~88,500 BTC year-to-date. The latest $1.57B purchase on March 16 was the largest of the year.
• Q1 2026 Bitcoin ETF Inflows: Nearly $700M flowed into U.S. Bitcoin ETFs in early March alone. Sustained institutional demand could establish a floor under Bitcoin prices.
• STRC as Primary Funding Vehicle: The March 16 purchase was the first where STRC preferred stock contributed more capital than common equity. With $3.4 billion already issued and the dividend rate rising to 11.50%, STRC is becoming the dominant funding mechanism — reducing common stock dilution while maintaining accumulation velocity. Management targets $6–10 billion in annual digital credit issuance.
• Q1 2026 Earnings (May 4, 2026): If Bitcoin stabilizes above $73,000 through March 31, the fair-value accounting model could produce a meaningful unrealized gain reversal versus Q4 2025’s $17.4B loss. With Bitcoin recovering ~12% since late February, the setup is increasingly favorable.
• 42/42 Plan Execution: Continued deployment of the $34B in remaining authorized issuance capacity would further grow BTC per share, reinforcing the Bitcoin Yield narrative.

Financial Snapshot — Q4 2025

Note: Q4 2025 operating and net losses are driven almost entirely by unrealized mark-to-market declines in Bitcoin under FASB ASU 2023–08 fair-value accounting. These are non-cash accounting entries and do not reflect cash outflows or operational deterioration. The $4.8 billion difference between the $17.4B operating loss and $12.6B net loss primarily reflects deferred tax benefits recognized against the unrealized Bitcoin impairment.

Conclusion

Strategy Inc (MSTR) offers a rare asymmetric opportunity: a leveraged Bitcoin exposure vehicle trading at a discount to the value of its underlying assets. The sub-1.0x mNAV, $2.25 billion cash buffer, 22.8% Bitcoin Yield, 12 consecutive weeks of accumulation totaling ~88,500 BTC in 2026, and strong analyst consensus (“Strong Buy,” consensus target range: $354–$376) create a compelling entry point for investors with conviction in Bitcoin’s medium-term trajectory.

The risks are real — Bitcoin price dependency, dilution, convertible debt maturities, and battleground stock dynamics all demand careful position sizing. However, for investors who believe Bitcoin will recover from the current ~$73,600 level toward its historical trend line, MSTR offers amplified upside with structural protections that were absent during previous crypto winters.

We reiterate our BUY / OUTPERFORM recommendation with a target price range of $289 — $516, representing 99–256% upside from current levels. Risk profile remains High.

Written by Ivan Sokolenko (Research Team Spring/Summer 2025)

Introduction

In 2009, WhatsApp proved a simple idea: messaging should be instant, global, and free. Sixteen years later, money is set to have its WhatsApp moment. Stablecoins are exploding in scale and relevance, outpacing Visa and Mastercard in yearly transaction volume and establishing themselves as the rails of a new monetary OS. But unlike WhatsApp, the infrastructure of this new money movement is not yet unified or purpose-built. Today, stablecoins are routed through smart contract platforms which are not specifically designed for financial-grade execution.

Plasma represents the first Layer 1 blockchain architected to fill this gap, built from first principles for stablecoin-native finance. Its architecture is anchored to Bitcoin for root-of-trust validation, equipped with dual-layer consensus, and engineered for fee-exempt, jurisdiction-aware stablecoin transfers. In doing so, it aims to provide a path toward infrastructure that is jurisdiction-aware, programmable, and financially modular.

The purpose of this paper is to examine how Plasma’s architecture addresses the structural shortcomings of existing blockchains in supporting stablecoin flows at scale. Specifically, it asks whether Plasma can provide superior infrastructure for global stablecoin settlement compared to modular rollups, monolithic high-throughput chains, payments-first networks, and privacy-focused alternatives. To do so, the analysis follows three dimensions: the regulatory context shaping adoption, the architectural choices that differentiate Plasma, and its potential to function as dedicated infrastructure for global monetary flows across both core and emerging use cases.

The intended primary audience for this paper are blockchain developers, enterprises, and policymakers who need to understand how stablecoin infrastructure is evolving. For developers, it details how Plasma’s EVM-compatible design introduces primitives built specifically for monetary logic; for regulators, it explains how programmable compliance can align blockchains with legal frameworks; and for enterprises, it highlights the new rails available for payroll, remittances, and cross-border settlement.

Positioning Against Regulatory Divergence

Between September 2024 and September 2025, stablecoin throughput scaled to institutional size, with USDT processing over $1 trillion per month and peaking at $1.2 trillion in July 2025, while USDC monthly volumes ranged between $480 billion and $1.7 trillion¹. These figures reflect adjusted transfer volumes, which filter out internal flows to better capture real economic activity. However, jurisdictional fragmentation continues to limit infrastructure capabilities on existing general-purpose chains, leading to duplicated liquidity, transfer fees burdened by gas or intermediaries, and settlement risks that constrain adoption at full scale.

It’s important to consider this jurisdictional fragmentation in order to contextualize Plasma’s design choices. The GENIUS Act, passed in the United States in July 2025, established a dual-track framework that gave federal legitimacy to fiat-backed stablecoins, ones directly redeemable 1:1 for U.S. dollars, while explicitly excluding algorithmic and yield-bearing models from that regulatory umbrella. This structure introduced legal clarity for regulated entities but formalized the divide between compliance-grade and yield-embedded stablecoins. An additional CLARITY Act is expected to pass by late 2025 or early 2026. When it does, platforms issuing stablecoins will finally fully know which rules apply, who regulates them, and how to comply.

In Europe, the MiCA framework limits stablecoin issuance to regulated e-money institutions, with foreign-currency stablecoins facing restrictions on use in payments. This makes it difficult for developers to build global applications in Europe without encountering frictions that fundamentally limit user and volume growth. As a result, such rigidity may push developers to chains and jurisdictions that allow programmable compliance rather than fixed regulation.

Hong Kong has moved from exploratory working groups into a formal regime. Its Stablecoins Ordinance, effective August 1, 2025, requires fiat-referenced stablecoin issuers to be licensed by the Hong Kong Monetary Authority, with strict rules on 100% reserves, redemption guarantees, and risk management. The government authority has stated that the first licenses are expected to be issued in early 2026.

Singapore and Japan are tilting toward optionality. The Monetary Authority of Singapore has finalized a framework that focuses on SGD- and G10-pegged stablecoins, with operational details and transition timelines still rolling out. Japan’s digital payment token categories, established under its Payment Services Act, acknowledge that stablecoins can function as both monetary instruments and programmable financial assets, depending on context.

Stablecoins are also experiencing rapid adoption in high-volatility jurisdictions. In countries like Argentina and Nigeria, where inflation can erode local currency value overnight, consumers increasingly turn to stablecoins like USDT as digital cash. In Argentina alone, over 60% of crypto users regularly convert pesos into stablecoins to hedge against inflation, which peaked near 300% in mid-2024, per Reuters². Other key markets such as Indonesia are also seeing rising stablecoin flows, but regulatory approaches vary widely, from Argentina’s strict VASP registration to Nigeria’s tightened oversight, Turkey’s new transfer limits, and Indonesia’s regulatory sandbox framework.

A challenge that remains central for stablecoin infrastructure today is that all of these compliance rules are often hard-coded or applied off-chain, creating fragmentation and regulatory friction for cross-border use. This makes rules inconsistent and difficult to adapt across jurisdictions, slowing adoption and limiting the role of stablecoins in global payments. As Citi Group highlights in their “Stablecoins 2030” Report, “high TPS demonstrates the capacity for stablecoins to move at speed, but delays [in traditional systems] often come from layers of compliance, checks, and settlement processes.” Overcoming this requires infrastructure that can integrate compliance directly into its design rather than layering it on afterward.

Architecture Built for Monetary Logic

General-purpose blockchains tend to optimize for flexibility, leaving payments and compliance as afterthoughts. Plasma takes the opposite approach: it is a purpose-built Layer 1 designed from the ground up for stablecoin-centric financial workflows. At launch, Plasma will integrate directly with Tether through USDT0, a zero-fee, native variant of USDT, ensuring that dollar liquidity is embedded at the protocol level from day one.

The blockchain’s consensus layer, PlasmaBFT, is a customized Byzantine fault-tolerant consensus mechanism derived from Fast HotStuff. It separates block production from attestation, allowing validators to attach modular compliance metadata to transactions without interfering with ordering or state progression. These attestations can represent whitelists, rate limits, jurisdictional approvals, or blacklists. Because block production and attestation are structurally independent, the protocol supports pipelined consensus, enabling blocks to be produced continuously while attestations operate on slightly lagged state. This ensures that economic incentives and compliance incentives remain decoupled: block producers optimize for throughput, while attestors optimize for jurisdictional or institutional rulesets.

A key architectural distinction is Plasma’s dual-validator model. Rather than relying on a single unified validator set, Plasma separates consensus validators from those executing high-frequency USDT transfers. This division ensures that monetary transactions do not compete for blockspace with broader smart contract activity. In practice, this allows stablecoin transfers to scale predictably without being crowded out by other workloads, a necessity for monetary flows and global payments where throughput and certainty cannot fluctuate with network congestion.

The execution layer is similarly purpose-built. Powered by Reth, a modular Rust-based Ethereum client, Plasma retains full EVM compatibility while introducing monetary primitives directly at the precompile and opcode level. These include identity-aware, gas-exempt transfer calls for protocol-registered stablecoins like USDT0; FX hooks for intra-contract cross-currency settlement; and treasury batching functions for multi-party flows such as payroll, vendor disbursement, or recurring invoices.

In other words, developers can interact with Plasma using standard Ethereum tooling, and smart contracts can execute complex financial logic with jurisdiction-specific rulesets. For example, in a cross-border payment flow between Brazil and the United States, a wallet app could convert BRL-denominated stablecoins into USDT0 through Plasma’s FX modules while enforcing identity limits and compliance attestations.

On most L1s and rollups, users are forced to acquire the native token to initiate any interaction. This is a non-starter for most financial applications, especially in retail, fintech, or remittance contexts where end users neither want nor understand the need to hold a separate crypto asset. Plasma eliminates this friction through native gas abstraction. Protocol-level paymasters handle the transaction costs in the background, so a user sending $50 in USDT0 sees exactly that amount leave their wallet and arrive on the other side without ever needing to manage XPL, Plasma’s native token. Developers can choose to subsidize these costs or apply rules such as identity-based rate ceilings. This frictionless experience is critical to shifting from ‘web3-first’ to ‘finance-first’ UI/UX, where stablecoin transfers start to feel as direct and intuitive as using Venmo or Revolut.

The team also acknowledges that legal and reputational trust must often be grounded in external systems. To this end, the chain checkpoints its Merkle root to the Bitcoin blockchain via time-locked OP_RETURN inscriptions, creating an independently verifiable state audit trail anchored to Bitcoin, the most secure and politically neutral ledger in the ecosystem. OP_RETURN inscriptions embed small pieces of data directly into Bitcoin transactions, ensuring they are immutable and timestamped for external verification. This mechanism allows regulators, auditors, and sovereign actors to validate Plasma’s state integrity without relying on internal governance assumptions, creating a non-circular trust model that reflects the needs of monetary flows at scale.

Plasma then extends this model through its forthcoming Bitcoin bridge. The bridge introduces pBTC, a token issued 1:1 against real Bitcoin deposits, allowing BTC to be used in smart contracts without custodians, synthetic assets, or fragmented wrapped tokens. Deposits are observed by a verifier network running independent Bitcoin nodes, which attest to transactions before minting pBTC on Plasma under the LayerZero OFT standard. Withdrawals work in reverse: pBTC is burned and a quorum of verifiers uses MPC signing to release BTC back on the base chain, ensuring no single entity controls keys. Unlike custodial models such as wBTC or cbBTC, Plasma’s pBTC maintains a unified supply directly anchored to Bitcoin.

Privacy is another axis often neglected in stablecoin infrastructure. Most blockchains expose transaction metadata publicly: recipient, amount, and flow type are all visible on-chain. Plasma introduces shielded stablecoin transfers through confidential payment modules that hide metadata while preserving verifiability. This enables routing cross-border payroll, treasury settlements, or enterprise FX transactions in a compliant but private manner, balancing auditability with regulatory necessity.

It is important to outline the role of Plasma’s native token, XPL, as it plays a distinct role from USDT0. While USDT0 functions as the stablecoin used for payments and settlement, XPL secures the network itself. Validators stake XPL to secure consensus, and it governs protocol decisions by enabling votes on upgrades and economic parameters. And as discussed, paymasters abstract XPL away from end users so that everyday activity can occur entirely in stablecoins.

The protocol’s liquidity base is expanding through three flagship programs: EtherFi’s ~$500 million ETH staking-vault commitment, supplying collateral and yield-bearing flows; Binance’s USDT Locked Product, which allows users to stake USDT for daily yield and future XPL allocations, directly linking stablecoin demand to network security; and the new Aave–Plasma USDT Locked Product on Binance, an upgraded program that routes locked USDT into Aave on Plasma to generate on-chain yields. Together, these create a complementary foundation: stablecoins for compliant settlement and diversified yield sources for on-chain markets.

Plasma confirmed that its mainnet beta went live with $2 billion in liquidity, making them the 8th largest chain by stablecoin supply. This ensures that developers building applications can assume reliable settlement capacity from day one. Combined with user-friendly onboarding infrastructure (wallets via WhatsApp, Google, AppleID, etc.), developer tools (APIs, SDKs, POS modules, webhooks), and merchant-facing integration rails, the chain aims to provide businesses with an immediate path to embed stablecoins into existing financial workflows.

While the architecture introduces clear innovations, some cross-chain routing mechanics, governance structures, and economic parameters are still in development and not yet fully disclosed. These elements will determine how the protocol’s design translates into production and institutional adoption as it moves beyond launch.

Plasma in Action — Use Cases, Apps, and Flows

Plasma’s early ecosystem design reflects a focus on flows that are already institutional in size but technically constrained on general-purpose chains. Payroll is one such category. Today, the global payroll services market (i.e. processing, software, outsourcing) is estimated to exceed US $30 billion annually, yet crypto-based payroll has struggled to scale because every interaction requires a gas token or third-party sponsor to cover fees³. Through Plasma, employees could receive net-stablecoin transfers in USDT without touching the native token, while employers can automate streams with compliance attestations attached. This lowers UX friction while making payroll programmable at the base layer.

Remittances are another early target. The World Bank reports an average global remittance fee of 6.5%, equating to more than $30 billion annually lost to intermediaries. Plasma’s zero-fee stablecoin transfers paired with direct fiat on/offramps across 100+ currencies offer a pathway to reduce this burden to sub-1% levels. For migrant workers sending $300 home each month, this translates to an additional $15–20 reaching families per transfer. At global scale, the efficiency gains would likely be measured in billions.

Treasury management and B2B flows also stand to benefit. Plasma’s precompiles enable treasury batching, allowing enterprises to stream payments to multiple vendors or subsidiaries in a single compliant transaction. For a multinational corporation operating across ten or more jurisdictions, this reduces operational overhead while embedding audit trails directly into settlement. With nearly $120 trillion in annual B2B cross-border payments, a 1–3 percentage-point fee differential (e.g., ~0.3% on-chain vs ~2.9% card-like fees; ~6.5% for traditional cross-border payments) means that even 10% adoption would imply roughly $120–$360 billion in annual savings⁴.

Foreign exchange corridors provide a fourth application. Today, corridors like Brazil ↔ U.S. or Nigeria ↔ Europe remain dominated by correspondent banks and remittance networks that extract spreads typically ranging from 4% to 8%⁵. Plasma’s FX hooks allow intra-contract settlement between currency-stablecoins, embedding both conversion and compliance logic natively. If spreads in just one such corridor fell by 100 basis points on $20 billion in annual flow, the savings would approach $200 million, capital that could remain in households and firms rather than intermediaries.

Official partners such as Actual (API-driven invoicing and bill-pay), Blindpay (non-custodial stablecoin payouts), CopperX (crypto-fiat payment gateway), El Dorado (LatAm P2P on/off-ramping super-app), Holyheld (wallet + card payments), Indodax (Indonesia’s largest regulated exchange), Yellow Card (African retail on/off-ramp), and Levl (cross-border payments APIs) are extending Plasma’s rails into real-world contexts. Others like ARST and BiLira are local stablecoin issuers in Argentina and Turkey, embedding national currencies directly into the chain’s framework. Collectively, these integrations mean that developers are already experimenting building a wide variety of use-cases and flows on the L1 chain.

Partners such as Loop Crypto are adapting their recurring payments APIs to Plasma’s model, allowing DAOs, gig platforms, and fintechs to implement subscription flows, stipends, or treasury streaming with compliance attestation built directly into the chain. CopperX is expanding its developer-first payout rails to route both crypto and fiat transactions through Plasma, ensuring that merchants and fintechs can build compliant, gasless payment flows without additional middleware.

Beyond the discussed flows, Plasma’s compliance-first architecture offers developers a foundation to build solutions for other industries where regulation and auditability are critical. Examples of such sectors could be construction escrow and lien-release workflows, healthcare claims settlement, freight and trade finance, government vendor disbursements, or even tightly licensed verticals like alcohol and tobacco distribution which all face slow, fragmented settlement rails and/or heavy compliance burdens.

Plasma itself does not deliver these sectoral solutions, but it could provide the programmable, policy-aware infrastructure upon which developers can build such specialized applications. These examples mentioned in the previous paragraph are not certainties, but rather forward-looking explorations of where else a compliance-first architecture could realistically add value. The true scope of other valuable use cases will become clearer once the chain begins to mature, as data accumulates and developers test what’s truly possible, with significant potential ahead.

Comparative Analysis: Plasma vs. Alternatives

Finally, Plasma’s core differentiation should be evaluated against today’s modular stacks where execution, data availability (DA), and settlement are separable markets. On Ethereum-aligned rollups, post-Dencun/EIP-4844 blobs have reduced the marginal cost of posting L2 data to Ethereum and catalyzed a sharp increase in activity on OP Stack and Arbitrum-derived chains. Base, for example, recorded a peak day of 14,481,743 transactions on September 21, 202⁵⁶.

DA supply has matured into a competitive layer. L2BEAT’s DA throughput panel shows Celestia handling sustained blob bandwidth with identifiable consumer rollups, while Blockworks Research and Everstake analyses quantify rising total data stored as it becomes a common DA back-end for app-specific L2s. EigenDA, by contrast, optimizes for tight Ethereum integration via restaking; Avail publishes live mainnet throughput at 4 MB per block with credible lab-bench expansion to larger blocks⁷. In short, rollups can now choose among Ethereum blobs, Celestia, EigenDA, and others like Avail as DA substrates while still settling to Ethereum.

Plasma’s Bitcoin-anchored checkpointing aims at a different assurance: an audit trail against the most politically neutral base chain. Comparable designs exist in production, like Stacks’ PoX anchoring and Babylon’s checkpointing/timestamping to Bitcoin, suggesting that Bitcoin-rooted verification is a pragmatic complement to modular DA for institutions that demand non-circular attestations.

In the payments-first category, Tron remains the largest incumbent benchmark. As of 2025, Tron processes more than $20 billion in stablecoin transfers daily (adjusted volume), representing over 60% of the global USDT supply in circulation⁸. Its low fees and global reach have made it the backbone of retail remittance and P2P stablecoin flows across Asia, Africa, and Latin America. Yet Tron’s developer ecosystem is relatively limited compared to Ethereum or Solana, with most of its activity concentrated on USDT settlement rather than broad financial infrastructure.

BNB Chain plays a similar role as a retail-heavy settlement hub, especially across Southeast Asia, but with its developer activity concentrated around exchange-linked ecosystems rather than independent protocol development. Solana’s monolithic path continues to emphasize high-throughput state with a 2025 roadmap that includes a second, independently engineered validator client (Firedancer/Frankendancer) and the Alpenglow consensus initiative, both aimed at slashing latency and hardening client diversity. However, these chains also does not embed compliance metadata, programmable attestations, or identity-aware execution at the protocol layer. Plasma’s positioning is therefore not to compete directly with their raw scale of settlement, but to extend the design space by embedding compliance-grade primitives and stablecoin-native gas abstraction that they lack.

On user experience and fee abstraction, the modular Ethereum stack relies heavily on ERC-4337 smart-account rails and paymasters operated at the application layer. Plasma’s proposed identity-aware, gas-exempt stablecoin calls could collapse today’s fragmented “sponsor-gas-via-paymaster” model into a chain-native UX. This is a substantive difference for retail and fintech flows where requiring users to pre-acquire native gas remains the chief source of failed conversions on L2s despite cheaper blobs.

Taken together, the comparative frame is practical: where OP Stack/Arbitrum and alternative DA layers optimize cost and flexibility, where Solana optimizes single-shard latency and client diversity, where Tron and BNB Chain dominate raw stablecoin settlement, and where privacy-first chains optimize confidentiality, Plasma optimizes compliance-grade attestations, stablecoin-first UX, and Bitcoin-anchored auditability inside an EVM that developers already use. That is the axis on which it should be judged as it moves from testnet to production.

Risks and Open Questions

As Plasma moves from technical promise to infrastructure adoption, new questions surface about the scalability and governance of programmable monetary systems. While attestor-based compliance offers flexibility, it introduces complexity in validator responsibilities, raising the possibility of bottlenecks or disputes over attestation schemas. The risk of over-regulation is another challenge, especially as nation-states adapt at uneven speeds. While early regulatory efforts have been made across all continents, further overregulation could lead to compliance logic that is even more fragmented across jurisdictions, ultimately slowing innovation.

There is also a deeper architectural question: should stablecoin infrastructure live on monolithic L1s, modular execution environments, or integrated L2 systems optimized for specific use cases? Plasma’s approach of embedding compliance primitives directly into Layer 1 offers a powerful foundation, but it leaves open the long-term debate over the modular future of programmable money. Composable compliance itself introduces tensions as well. While programmable attestations allow local enforcement without global fragmentation, maintaining interoperability may eventually require shared compliance schemas or standards bodies. The alternative is regulatory divergence at the attestor level that, while technically valid, risks creating friction in global liquidity flow.

Payment-focused chains like Tron have proven the demand for stablecoin settlement at scale, yet their functionality remains narrow and compliance-light. Plasma also enters this landscape not as a general-purpose competitor to a chain such as Ethereum, but as a purpose-built settlement layer that retains EVM compatibility while embedding compliance and monetary logic directly into its core. With this positioning, Plasma can extend beyond today’s payment rails while still operating within an ecosystem already moving trillions in stablecoin volume.

Its mainnet performance metrics such as speed and retention will need to be observed over time and, while important, are not the focus of this analysis, and this paper intentionally refrains from projecting them. Real-world developer adoption is also yet to be tested, and institutional viability will ultimately depend on how effectively its compliance framework integrates with existing regulatory and financial infrastructure.

Despite these open questions, the architecture represents one of the most promising attempts to build a purpose-built settlement layer that could enable global financial flows with legal and computational certainty.

Conclusion

At its core, the Plasma blockchain is here to make stablecoins work the way people already expect money to work: fast, cheap, compliant, and invisible in the background. Billions of dollars move every day over rails like Tron or Ethereum, but users still hit walls ranging from gas fees and failed transactions to rules that don’t match the legal frameworks governments are now implementing.

It promises to combine the predictability of traditional payments with the openness of crypto, giving developers a chain purpose-built for payroll, remittances, and everyday money applications. Instead of fragmenting the stack into siloed rollups or region-specific forks, it introduces a singular chain where financial logic is structured and enforceable, whether the transaction is a dollar-based payroll, a cross-border FX flow, or a shielded treasury disbursement.

This is a new thesis for how digital finance should operate: chains should execute law, capital, and trust in programmable and jursidiction-aware form. If successful, Plasma could set a new standard for modern monetary flows, unlocking mainstream use in markets from Latin America to Southeast Asia and creating the first truly global settlement network that feels as simple as sending a message on WhatsApp.

Written by Ivan Sokolenko (Research Team Spring/Summer 2025)

Footnotes:

(1): Stablecoins Dashboard — Stablecoins Tab. Artemis Analytics,

https://app.artemisanalytics.com/stablecoins?tab=stablecoins

(2): “Can stablecoins play a role in the FX world?” CLS Group,

https://www.cls-group.com/media/14felgnw/cls_shaping-fx_opinion-piece_stablecoin_sept2025.pdf

(3): Payroll Services Market Size & Share Analysis. Mordor Intelligence,

https://www.mordorintelligence.com/industry-reports/global-payroll-services-market

(4): “A Substrate for Money Moves.” Decentralised.co,

https://www.decentralised.co/p/a-substrate-for-money-moves

(5): Remittance Prices Worldwide. World Bank,

https://remittanceprices.worldbank.org/

(6): Daily Transactions Chart (Base). BaseScan,

https://basescan.org/chart/tx

(7): “A Guide to Selecting the Right Data Availability Layer.” Avail,

https://blog.availproject.org/a-guide-to-selecting-the-right-data-availability- layer/

(8): “Stablecoins Dashboard — Chains Tab.” Artemis Analytics,

https://app.artemisanalytics.com/stablecoins?tab=chains

Additional References & Further Reading:

Citi Group Stablecoin Report

“Stablecoins 2030.” CitiGroup,

https://www.citigroup.com/global/insights/stablecoins-2030

Plasma Official Documentation

“Start Here — Introduction.” Plasma Docs*,*

https://docs.plasma.to/docs/get-started/introduction/start-here

L2BEAT Throughput (DA)

“Throughput — Data Availability.” L2BEAT,

https://l2beat.com/data-availability/throughput

Everstake / Blockworks / analyses on networking / data propagation

“Cracking Ethereum’s networking bottleneck.” Blockworks,

https://blockworks.co/news/ethereum-networking-bottleneck

Stablecoin Payments Outpacing Visa/Mastercard

“The Financial Shakeup Surpassing Visa and Mastercard Combined.” InvestorPlace,

https://investorplace.com/hypergrowthinvesting/2025/09/the-financial-shakeup-surpassing-visa-and-mastercard-combined/

Argentina Inflation 2024

“Argentina inflation dips, locals dare hope worst is over.” Reuters,

https://www.reuters.com/world/americas/argentina-inflation-dips-locals-dare-hope-worst-is-over-2024-12-11/

Abstract

The primary purpose of this paper is to examine different emerging technologies focusing on driving improvements to the blockchain space in terms of scalability, security, and decentralization. Our discussion will outline Monolithic, Modular blockchains, as well as layer 2 scaling solutions, to a limited extent. An evaluation of these different sub-technologies in terms of fundamental qualities, use cases, and technical differences will be at the center of our findings. Our investigative and analytical methodology will be objectively justifying our hypothesis, which revolves around the lines of confirming Modular blockchains to have the highest chances of being at the forefront of the future of the blockchain world despite various challenges.

Introduction

Since the inception of the blockchain world in 2008, the space has attested to significant growth, with improvements to the technology in terms of scalability, security, and decentralization continuously being explored by developers and enthusiasts. The traditional monolithic approach, which entails a single layer of integration for all critical functions — data availability, consensus, settlement, and execution, has stagnated in the face of scalability, upgradability, and hardware requirements challenges. As such, the modular approach has surfaced as a prospective alternative.

At this point, one might be asking themselves what exactly is a modular blockchain? How does it work? How is it any different to monolithic blockchains? Unlike monolithic blockchains, the processes and functions are separated into distinct layers or modules. Each module specializes in a specific function of the four, allowing for more optimization.

This approach has gained attention as it addresses the blockchain trilemma — the balance between scalability, security, and decentralization — by enabling trade-offs that improve performance without compromising core principles.

The trilemma, a concept initially coined by Vitalik Buterin, Ethereum co-founder, entails the compromise that P2P¹ networks, which run on blockchain technology, must, or had been forced to succumb to under existing innovation.

Modular blockchains’ central appeal resides in their decomposition of functions into multiple, different components and layers. This encompasses increased efficiency and maximization of performance and scalability. Moreover, modular systems are designed to cater for diverse applications such as DeFi and gaming, with flexibility being one of its core points of magnetism. This paper will delve deeper into the role of modular solutions in enhancing scalability while still leveraging a base layer for security and consensus, all whilst comparing such solutions to more traditional existing alternatives.

Monolithic blockchains oppose the Modular alternative in design and architecture. In fact, its architecture is rather simple and focuses on decentralization to ensure secure transactions and network operations. This paper will outline, examine, and compare both types of blockchains.

General Discussion

Monolithic

Although explored earlier, it is important to redefine and highlight the concept of Monolithic blockchains at this stage. Such blockchains handle all critical functions of blockchain technology, i.e. data availability, consensus, settlement, and execution, in a single layer. This refers to the same nodes, i.e. modules, handling all parts of the process to execute and finalize a transaction through the blockchain.

To tackle the relevance of the monolithic design justifying its use cases, one must first grasp an understanding of its competitive advantage. The latter extends over several points. First and foremost, monolithic has proven to be severely efficient in terms of security. This is because it is designed for self-reinforcement. The nodes behind the structure of a monolithic blockchain see and validate transactions directly and collaboratively. More precisely, this exacerbates the fact that a transaction doesn’t have to be processed off-chain on supplemental streams of nodes, i.e. layers, in order for their validity to be confirmed and for consensus approval to be given. In fact, monolithic chains are simpler in that sense as there is no time delay in nodes’ ability to view transactions and subsequently validate them, or not.

Furthermore, a critical point to highlight revolves around the simplicity in development and use. To developers, who do not have to deal with the complexities of managing and linking multiple components, it is easier to apply and construct monolithic blockchains in comparison to their modular alternative. Lower development costs and faster deployment form the basis for the key supporting arguments here. As to what concerns use cases, which will be more deliberately discussed shortly, the simplicity in development suits the demands and requirements of straightforward applications, such as basic cryptocurrency wallets (CoinBase, Trust Wallet).

On the other hand, recent criticism of the Monolithic blockchains can be attributed to fair reasons. Efficiency is the most significant concept that should be tackled here. Limits on a node’s bandwidth and storage heavily reduce the volume of transactions that can be validated and executed through the monolithic chain at speed. As such, monolithic technology is only rarely seen as a long-term solution for transactional purposes. This is without boarding the dilemma that monolithic technology entraps itself in when it comes to scalability. The comparison (see Chart 1) in transactions processed per second over the last 4 years² between Solana, a network that does not run on a monolithic blockchain, and Ethereum, one that does, reveals a blatant, significant struggle the chain of interest here has in relation to volume relative to speed efficiency. In order to scale and accommodate growing volumes of transactions per period of time, faster and bigger blocks are a necessity. However, such blocks would reasonably take on more hardware requirements and capacity. Due to probable financial constraints and infrastructural burdens, more capable nodes would also mean less nodes, hence poorer decentralization carrying along more considerable security risks.

The presented advantages and disadvantages of implementing monolithic blockchains make it a direct fit for some digital services and technologies. For instance, all Bitcoin, and most cryptocurrency transactions run through a monolithic blockchain, with high security and reliability being the two imperative conditions to be met. Another popular arena for monolithic chains is smart contracts and decentralized applications. A smart contract denotes a blockchain- stored program that is executed once predetermined conditions are eventually met. Such contracts are employed to store or enable transactions between various digital assets. A widely relevant use case would be an Escrow services smart contract. This product acts like a trusted middleman in a transaction between two parties that ensures that set conditions from both ends are met before execution. To the contracts in question, the advantages of use of monolithic-powered transaction platforms make it strongly favorable over modular blockchains. That competitive advantage covers the interest of the buyer, the seller, and the middleman-acting platform. For the two parties at both ends of the transaction, the reduced risk of vulnerabilities thanks to increased efficiency and security makes monolithic chains the most enticing implementable technology. As for the developers and the platform, the architecture can be preferrable as it is more straightforward and simpler in the absence of the need to manage interaction between different layers.

Modular

Modular Blockchains, although discussed and indirectly defined in the paper, constitute the alternative to Monolithic blockchains that has been growing in implementation. Modular systems are centered around an ecosystem of interconnected components. The key differentiation point that such a variation to the technology carries relies upon the responsibility of each component to excel in a limited set of tasks. For further depiction, a modular blockchain approximately equates to a monolithic blockchain designed like a three-part sword instead of a singular part one. Primarily, different functions — i.e. Execution, Settlement, Consensus, and Data availability, are each handled by a different, specialized layer. The execution layer processes and executes smart contracts and transactions. The settlement layer handles validation and finalization of transactions. The consensus layer ensures that all nodes agree on the state of the blockchain and helps with validating the order in which the transactions are processed. Lastly, the data availability layer ensures that transaction data is readily available to all network participants. With a properly integrated and designed overall system, such a blockchain presents some significant, potentially disruptive advantages.

Having corroborated the theme of Modular Blockchains, it is now of critical importance to delve into the depths of the technology at the core of our writing. Modular systems aim to be the answer users are in the search for when it comes to a free flow of information, value transfer, and collaborative operations. To be precise, its Modular technology’s scope of interoperability, alongside its capacity for scalability, that make the strongest case for the innovation’s appeal. It can be seen as an evolutionary improvement building upon cross-chain and off-chain techniques that have been the basis for rollups, chain-based, and bridge-based solutions.

Although this paper’s analytical purpose is not to focus on the methods and operational ways mentioned above, a brief explanation before diving deeper into the specifics of Modular technology might be helpful.

Off-Chain techniques include three main types: Off-Chain channels, which allows direct transactions between two users without having to record each transaction on the blockchain, aiming for reduced fees and eased scalability, Blockstack, which entails an integration of a user- controlled, encrypted data storage system with the blockchain, and Rollups, which target improvement in transaction efficiency by bundling multiple transactions and allowing for their processing off-chain, all whilst keeping their data on-chain.

Cross-Based techniques, on the other hand, are invested into enabling different blockchains to interact. Such techniques can be separated into two categories: Chain-Based Techniques, which secure practicality through blockchain’s traditional mechanisms such as sidechains⁴ and hashed timelock contracts5 (HTLC), which facilitate secure asset exchanges across platforms.

Modular frameworks can be seen as an improvement on all of what such techniques offer and aim to deliver. For example, in terms of synchrony abstraction (timing assumption), Modular chains are more flexible, which paves way for modules to operate independently while still maintaining robust synchronization across the system. Such a structure permits modular layers to synchronize at their own pace. As different modules can implement different synchronization models, the framework is more friendly to the contrasting nature of different nodes that can handle different transaction types and processing speeds. A democratic, agile design such as the modular one is ultimately poised to improve responsiveness of the network. This is in comparison to layer 2 solutions, which typically operate under more rigid synchronization structures.

Another technical upgrade or improvement the framework in question holds is its Proof-of-X Consensus Mechanisms. Proof-of-X consensus represents a set of protocols employed in blockchain to establish which consensus node must act as the leader to propose a block. At this stage, it is of significance to clarify that nodes exhibit their capacities by depiction of their resources. Based upon such an exhibition, the leader node is selected, which then assumes responsibility for the validation of transactions and the addition of the aforementioned transactions to a new block, subsequently shared with others. In fact, Modular blockchains can implement a set of Proof-of-X mechanisms clustered by function, i.e. layer of responsibilities. For instance, the Execution layer could use faster consensus which would better optimize throughput, while the Settlement layer may use slower consensus to address security reliability. Such a flexibility in terms of Proof-of-X processes supports variability in protocols according to the nature of different tasks conducted on the blockchain. Traditional protocols like Proof of Work (PoW) or Proof of Stake (PoS) may be used for some tasks, while newer alternatives like Proof of Authority (PoA) may be used for other tasks.

Conclusion

In essence, such friendly technical amendments and engineering is what makes Modular solutions considerably more appealing to a range of parties involved in the blockchain cycle. From developers to users and consumers, the incentive to prefer Modular blockchains over Monolithic ones or layer 2 empowered solutions is polythetic. From the freedom to customize and upgrade individual components independently for developers, to scalability and specialization that could prove to deliver startup and venture entrepreneurs’ dreams, to a broader range of opportunities offered to investors through coverage of a wider range of applicable use cases (i.e. supply chain management, gaming), Modular blockchains could be well making the case for carrying the hopes of the blockchain future, and finally making the dream of a quasi-universally adopted blockchain technology true. However, one cannot mention the positives of the favored option without presenting its challenges and areas of shortcoming in comparison to alternatives. The issue of security, central and critical to a technology that is aimed at disrupting the status quo of financial institutions and revolutionizing the exchange system in place ever since the 7th century Chinese Tang Dynasty, remains stagnant. The reality is that modular frameworks have faced bigger drawbacks at this level when compared to older frameworks. Nevertheless, the technology is still far from plateauing and remains in its early ages of prematurity. Growing efforts to enhance the rapid development and innovation surrounding the Modular approach, and to further enhance specialization to reach levels of what is to soon be dubbed as micro-specialization, are in place. Injective’s $150 million fund focused on modular-backed interoperable infrastructure and DeFi, as well as Hemi Labs’ $15 million funding round in September 2024, serve as most recent evidence. If any individual or group of interest in the blockchain world is to take away any valuable insight from this paper, it is to be embraced by a sense of optimism empowered by the dynamisms of modular solutions.

Written by Mustafa Dernaika (Research Team Fall 2024)

Footnotes:

(1): P2P (peer-to-peer) networks in blockchain technology are decentralized networks where each participant, or “peer,” has equal capabilities and can interact directly with other peers without the need for a central authority or intermediary. This structure allows for improved resilience, efficiency, and scalability in handling data and transactions.

(2): For the year ending July, 30th 2024.

(3): Source: “Exploring Blockchain Technology through a Modular Lens: A Survey.” ACM Computing Surveys

(4): Sidechains are separate blockchain networks that operate in conjunction with a primary blockchain, often referred to as the parent blockchain or mainnet. They use a mechanism called a two-way peg to facilitate the transfer of digital assets between themselves and the parent blockchain.

(5): Hashed Timelock Contracts (HTLCs) are specialized smart contracts used in blockchain technology to facilitate secure transactions between parties without requiring trust. HTLCs utilize a cryptographic hash function and a time constraint to create a conditional payment mechanism.

References

“What Are Modular Blockchains?” Binance Academy, https://cosmos.network/casestudy/dydx.

“Monolithic vs. Modular Blockchain.” Visa, https://celestia.org/learn/basics-of-modular-blockchains/modular-and-monolithic-blockchains/.

“Monolithic vs Modular Blockchains: A Detailed Comparison.” Coinbureau,
https://coinbureau.com/analysis/monolithic-vs-modular-blockchains/.

“The Blockchain Trilemma: Can It Ever Be Solved?” Bybit Learn, https://learn.bybit.com/deep-dive/blockchain-trilemma/.

“Modular vs. Monolithic Blockchains.”

“How Do Optimistic Rollups Work (The Complete Guide).” Bybit Learn,
https://learn.bybit.com/optimistic-rollups/.

“Optimistic Rollup Architecture.” Espresso, https://espresso.systems/optimistic-rollups/.

“Exploring Blockchain Technology through a Modular Lens: A Survey.” ACM Computing Surveys

arXiv:2309.03502.

Modular And Monolithic Blockchains: An Analysis And Outlook was originally published in System Weakness on Medium, where people are continuing the conversation by highlighting and responding to this story.

Introduction

Ethereum, as one of the leading blockchain platforms, continues to face substantial challenges in scaling its network to accommodate the increasing demand for decentralized applications (dApps) and financial systems. To address these limitations, Ethereum has adopted a rollup-centric roadmap, wherein scalability is achieved through Layer 2 (L2) solutions while maintaining the decentralization and security of the Layer 1 (L1) blockchain. Rollups, which are primarily categorized into Optimistic Rollups and Zero-Knowledge (ZK) Rollups, have become integral to this strategy by enabling higher transaction throughput and reduced costs without compromising Ethereum’s core principles.

This paper seeks to critically examine the future trajectory of Ethereum rollups by analyzing their various stages of development and assessing their implications for the security and centralization of the Ethereum ecosystem. It will provide a balanced evaluation of both the advantages and limitations inherent in the current rollup roadmap, exploring whether the present direction is optimal or if alternative approaches should be considered. Particular attention will be given to how the sequencers impact Ethereum’s ability to address the blockchain trilemma of scalability, security, and decentralization.

The primary objective of this research is to contribute to a deeper understanding of Ethereum rollups and their role in shaping the network’s future. By offering insights into the current landscape of rollup technologies, this paper aims to foster informed discussions within the blockchain community regarding Ethereum’s scalability strategy. While targeted at readers with some foundational knowledge of blockchain and Ethereum, this paper aspires to provide a comprehensive analysis that enhances understanding and promotes further exploration of Ethereum’s evolving ecosystem.

Sequencers, Centralized

The issue of sequencer centralization in rollups is a significant concern that undermines the decentralization ethos of blockchain technology and introduces critical vulnerabilities. Sequencers are responsible for ordering, batching, and submitting transactions from L2 rollups to Ethereum’s L1. While centralized sequencers improve efficiency and throughput, they come with a host of risks, including censorship, single points of failure, and the potential for economic exploitation through Maximum Extractable Value (MEV).

Centralized sequencers have the power to selectively exclude transactions from being included in a batch. This undermines blockchain’s core principle of being open and permissionless. For example, in cases like the $2.6 million exploit on Linea, the centralized sequencer was paused to censor attacker addresses, sparking debates about the dangers of such control. While users can bypass sequencers by submitting transactions directly to L1, this is costly and impractical for most use cases.

The other issue is that if a centralized sequencer goes offline due to technical failures or malicious attacks, the entire rollup halts. This has already occurred in several instances where L2 block production was disrupted by software bugs or L1 gas fee outages. Although mechanisms like “force-include” or “escape hatches” exist to allow users to bypass sequencers and submit transactions directly to L1, these solutions often lead to instability and inefficiencies on the rollup.

Centralized sequencers have significant control over transaction ordering, enabling them to extract MEV by reordering or frontrunning transactions. This not only harms users economically but also creates an unfair advantage for sequencer operators. For example, private mempools on platforms like Optimism’s OP Mainnet exacerbate this issue by allowing sequencers to exploit transaction visibility.

One prominent example is the incident involving the Linea rollup, a Consensys-backed zkEVM solution, where users lost over $2.6 million due to an exploit on a decentralized exchange. In response, the Linea team paused its centralized sequencer and censored attacker addresses to protect users and builders in the ecosystem. While this action was intended to mitigate further losses, it has raised significant concerns about the power of centralized sequencers to unilaterally halt operations and censor transactions. Such actions contradict blockchain’s core principles of censorship resistance and decentralization, exposing the vulnerabilities of centralized control.

Why Centralization Persists

Despite these risks, most rollups continue to rely on centralized sequencers due to practical considerations like cost efficiency and development complexity. Running a centralized sequencer is cheaper and simpler compared to implementing decentralized alternatives. It allows rollups to offer low transaction fees and high throughput, which are critical for user adoption.

Decentralizing sequencers requires significant technical innovation and coordination among stakeholders. Many rollups have included decentralization in their roadmaps but have yet to make substantial progress due to the complexities involved. They also ensure low latency and consistent transaction processing, which are essential for maintaining user experience. Decentralized models may increase latency, making them less attractive in the short term.

Sequencers, Decentralized

There are a few different kinds of solutions that could potentially solve the centralized sequencer problem, one of them being using a shared sequencing network. This aims to provide decentralization-as-a-service by allowing multiple rollups to share a common sequencing layer. This approach enhances censorship resistance, liveness guarantees (low/no downtime), and interoperability between rollups. For example, shared sequencers enable atomic cross-rollup composability while allowing rollups to maintain sovereignty by storing transaction data on L1.

Another one could be the decentralized networks distribute sequencing responsibilities across multiple nodes, reducing the risk of censorship and single points of failure. Anyone can participate in sequencing by running a node, creating a fairer system that aligns with blockchain principles.

Based rollups, also known as L1-sequenced rollups, are gaining traction as a solution that leverages Ethereum itself as the sequencing layer. Unlike traditional rollups with dedicated sequencers, based rollups rely on Ethereum’s validators for transaction sequencing, inheriting its security, decentralization, and liveness guarantees. This eliminates the risks of centralized sequencers, such as censorship and single points of failure, while ensuring seamless interoperability across rollups by aligning transaction sequencing with Ethereum’s block structure.

The Challenge with Data Availability

Data availability (DA) is a critical aspect of rollup security and functionality, ensuring that all necessary data for validating off-chain transactions is accessible to participants. Rollups, such as Optimistic Rollups and ZK Rollups, execute transactions off-chain and periodically post summaries of transaction data to Ethereum’s L1. While this approach enhances scalability and reduces congestion on Ethereum, ensuring robust data availability presents significant challenges that can compromise the security, decentralization, and efficiency of rollup systems.

Data availability ensures that all transaction data required to reconstruct the rollup’s state is accessible to validators, users, and nodes. For example, Optimistic Rollups rely on fraud-proof mechanisms to dispute invalid state transitions. Validators must access transaction data posted on L1 to construct fraud proofs during the dispute period. If this data is unavailable, fraudulent transactions cannot be challenged, jeopardizing the rollup’s security. ZK Rollups, while leveraging cryptographic validity proofs to ensure correct state transitions, still require transaction data to be accessible for auditing purposes and for users to verify the correctness of computations. Without robust DA mechanisms, rollups risk liveness failures — where new blocks cannot be produced due to missing data — or even finalizing invalid transactions. This makes DA essential for maintaining trustlessness and ensuring rollup operations remain secure and efficient.

Publishing transaction data directly on Ethereum ensures maximum security and decentralization but comes with prohibitive costs. Storing calldata on Ethereum’s mainnet is expensive due to high gas fees, making it economically unsustainable for high-throughput rollups. For instance, storing 1MB of calldata on Ethereum can tens of thousands of dollars, more than twenty-five hundred times more than it would have cost on rollups (Updegrave), limiting scalability for rollups that rely heavily on on-chain DA. To reduce costs, some rollups utilize external Data Availability Layers (e.g., Celestia or Avail) that store transaction data off-chain. While these layers improve scalability and reduce congestion on Ethereum, they introduce trust assumptions: a 51% or 67% attack on an external DA layer could render transaction data unavailable or inaccessible. Furthermore, Ethereum’s smart contracts verifying DA claims cannot independently confirm whether the off-chain data is genuinely available. This reliance creates vulnerabilities where malicious actors could collude with nodes in the DA network to withhold critical transaction data while submitting only block headers for finalization on Ethereum.

Liveness failures occur when rollup nodes lack access to the necessary transaction data to reconstruct the L2 state or produce new blocks. Even if transactions are settled on Ethereum, missing data can disrupt rollup operations and undermine user confidence in the system. This issue is particularly acute for Optimistic Rollups since validators cannot generate fraud proofs without access to complete transaction data. In addition, in Optimistic Rollups, validators require access to all transaction data during the dispute period to construct fraud proofs against invalid batches. If even a small portion of this data becomes unavailable during the dispute window, fraudulent transactions may go unchallenged, leading to incorrect state transitions being finalized.

The lack of standardized DA solutions across rollups creates fragmentation within the ecosystem. Each rollup may adopt its own DA strategy — such as publishing calldata on Ethereum or relying on bespoke DA layers — which hinders interoperability between different L2 networks and limits composability within the broader Ethereum ecosystem.

Approaches to Addressing DA Challenges

Publishing transaction data directly on Ethereum provides strong guarantees of trustlessness and decentralization by making all necessary information publicly available for verification. However, this approach incurs significant costs due to high gas fees and limits scalability for high-throughput applications. Modular blockchains like Celestia or Avail provide specialized DA solutions that store transaction data off-chain while maintaining accessibility through cryptographic attestations. These layers significantly reduce costs but introduce risks related to trust assumptions and potential attacks on the external DA network.

Some rollups adopt hybrid approaches by publishing critical metadata on Ethereum while storing bulk transaction data off-chain in external DA layers. This balances cost efficiency with security but requires careful design to mitigate liveness failures caused by partial data unavailability. Data availability sampling allows light nodes to verify block availability by sampling only a fraction of the block’s data rather than downloading it entirely. This method reduces resource requirements while ensuring that withheld data can be detected with high confidence. DAS has emerged as a promising solution for addressing scalability issues in modular DA layers.

Emerging rollup architectures are being designed with modular DA components that can be swapped out as needed. This allows rollups to choose between different DA solutions based on their specific requirements for cost efficiency, scalability, and security.

Do We Actually Care about (De)Centralization?

While addressing security and centralization issues in the rollup space is widely regarded as essential for ensuring the long-term viability of L2 solutions, there are arguments against prioritizing these concerns at the current stage of rollup development. These arguments suggest that the trade-offs associated with enhanced decentralization and security may not align with the immediate needs of users, developers, and the broader Ethereum ecosystem.

One argument is that rollups already inherit a significant degree of security and decentralization from L1. Since all transaction data and proofs are posted to Ethereum, users can exit rollups directly through L1 even if the rollup itself becomes compromised or censored. This reliance on Ethereum ensures that rollups benefit from its robust security guarantees, making them inherently more secure than traditional custodial or centralized solutions. Consequently, some argue that further decentralizing components such as sequencers may not be immediately necessary, as Ethereum’s settlement layer already provides a strong foundation for trustlessness and dispute resolution.

An analysis of the rollup ecosystem reveals that only one of the twenty largest rollups has reached Stage 2 maturity, with three at Stage 1 and the remaining sixteen at Stage 0. This distribution indicates that users prioritize transaction speed and cost efficiency over decentralization and advanced security mechanisms. Stage 0 rollups rely heavily on centralized components, such as sequencers, to ensure high throughput and low latency, aligning with user demands for quick and seamless transactions. However, this focus on performance comes at the expense of decentralization, a core principle of blockchain technology.

The dominance of Stage 0 rollups highlights the challenge of balancing usability with decentralization. While more mature rollups offer enhanced security and trustlessness, their higher costs and technical complexities can deter adoption. This trend underscores the need for developers to advance decentralization without compromising user experience. Failing to address these concerns risks undermining Ethereum’s foundational principles and its vision as a secure, decentralized platform for future applications.

Another perspective is that efforts to decentralize components such as sequencers or governance mechanisms can introduce significant complexity and performance trade-offs. Centralized sequencers currently enable higher throughput, lower costs, and faster transaction processing, which are critical for driving user adoption and ecosystem growth. For instance, centralized sequencers allow for efficient batching and ordering of transactions, facilitating scalability while maintaining a seamless user experience. In contrast, decentralization often leads to increased latency and reduced performance. Critics contend that prioritizing decentralization prematurely could hinder adoption by alienating users who value speed and cost efficiency over theoretical improvements in censorship resistance or fault tolerance.

Furthermore, many rollup projects adopt a phased approach to decentralization, focusing initially on building robust systems with centralized components before transitioning to more decentralized architectures. This strategy of “progressive decentralization” allows projects to iterate rapidly, attract users, and refine their technology without being burdened by the complexities of fully decentralized systems from the outset. For example, most rollups plan to eventually implement decentralized sequencers and governance mechanisms but prioritize addressing immediate user needs — such as scalability and low fees — overachieving full decentralization in the short term.

Practical challenges also arise in implementing full decentralization at this stage. Decentralized sequencers require novel infrastructure designs that balance trustlessness with functionality. Shared sequencing networks or decentralized models face limitations such as increased costs, coordination challenges among participants, and reliance on L1 throughput for cross-rollup interoperability. These hurdles make it difficult for rollups to achieve meaningful decentralization without compromising usability or economic sustainability.

Finally, it is argued that centralization in certain aspects of rollup design may be acceptable for specific use cases. Not all applications require maximum censorship resistance or fault tolerance. For example, gaming or social applications may prioritize performance over strict adherence to blockchain principles such as decentralization. In these scenarios, centralized components like sequencers may suffice to meet user requirements while maintaining low operational costs.

Conclusion

According to Vitalik Buterin, decentralization is needed for: “avoiding points of trust, minimizing censorship vulnerabilities, and minimizing centralized infrastructure dependency.” The road toward decentralization in the rollup space is of paramount importance and cannot be overstated. Rollups have emerged as a critical component of Ethereum’s scalability roadmap, allowing for off-chain transaction processing while maintaining the security of the main chain. However, as these technologies evolve, the next few years will likely set the foundation for Ethereum’s future. If developers fail to prioritize decentralization during this pivotal period, it risks undermining Ethereum’s core principles and its vision as a decentralized platform.

The importance of decentralization extends beyond security; it is also critical for fostering user participation and community-driven governance. Decentralized rollups allow users to actively contribute to network maintenance by running validator nodes or participating in governance mechanisms. This inclusivity not only strengthens the network but also aligns with Ethereum’s broader vision of democratizing access to financial and technological infrastructure. Projects like Taiko have demonstrated a clear commitment to decentralization through mechanisms such as contestable rollups and decentralized governance frameworks. These approaches ensure that rollups remain transparent and responsive to community needs while reducing reliance on centralized entities.

Despite these benefits, achieving full decentralization in rollups remains a complex challenge. Trade-offs between performance and security are inevitable; more decentralized systems may experience reduced throughput or higher costs due to increased resource requirements. However, these trade-offs can be mitigated through innovative solutions such as shared sequencing layers or hybrid models that balance efficiency with decentralization. For example, shared sorting layers allow multiple rollups to collaborate on transaction ordering while maintaining composability and interoperability across Layer 2 networks. Such solutions align with Ethereum’s ethos while addressing practical challenges associated with scaling.

The transition toward decentralized rollups is not merely a technical endeavor; it is a philosophical commitment to preserving the integrity of blockchain technology. Ethereum’s success as a platform for dApps and financial systems depends on its ability to uphold these principles. As highlighted by Vitalik Buterin’s proposed milestones for rollup decentralization, this process requires deliberate effort and long-term planning. Developers must prioritize building robust frameworks that incorporate decentralized governance, permissionless validation mechanisms, and transparent operations.

Written by Jason Yu (Research Team Fall 2024)

References:

Aranovich, Juan. “Should Ethereum Layer 2s Urgently Decentralize Their Sequencers?” Unchained. 6 Jun. 2024, https://unchainedcrypto.com/should-ethereum-layer-2s-urgently-decentralize-their-sequencers/

Awosika, Emmanuel. “Data Availability Or: How Rollups Learned To Stop Worrying And Love Ethereum.” Substack. 20 Dec. 2023, https://ethereum2077.substack.com/p/data-availability-in-ethereum-rollups

GrowThePie. https://www.growthepie.xyz/

Jun. “Making Sense of Based Rollups” Bankless. 26 Sep. 2024, https://www.bankless.com/based-rollups-primer

L2BEAT. Accessed 5 Dec. 2024, https://l2beat.com/scaling/summary

Mirpuri, Jash. “A Deep Dive into Shared Sequencers: The Future of Decentralization in the Blockchain Ecosystem.” Flagship. 12 Jul. 2023, https://flagship.fyi/outposts/market-insights/a-deep-dive-into-shared-sequencers-sequencer-networks/

Ngo, Tom. “L2 centralization is a ticking time bomb for blockchain.” Blockworks. 20 Aug. 2024, https://blockworks.co/news/layer-2-centralization-poses-dangers-for-blockchain

Updegrave, Henry. “Data Availability Comparison: Cost Per MB Posted for Ethereum Blobs Versus Celestia SuperBlobs.” Conduit. 23 Oct. 2024, https://blog.conduit.xyz/data-availability-costs-ethereum-blobs-celestia/

(De)Centralization of Ethereum Rollups was originally published in System Weakness on Medium, where people are continuing the conversation by highlighting and responding to this story.

Vivian Li, li.zhilin@northeastern.edu

Find Vivian on Twitter and connect on LinkedIn.

Read this research paper here.

Staking is a process in which a user locks up a certain amount of cryptocurrency for a set period of time to help support the operation of a blockchain. In return, users can earn more cryptocurrency! Lido enables users to stake Ethereum cryptocurrency and earn these staking rewards, even if they do not have the technical knowledge or resources to run a validator node themselves.

Cole Christiana (VP of R&D), colejchristiana@gmail.com

Although I could only attend for the first day — thank you, Northeastern finals — I witnessed some strong themes at this year’s Expo. Below, I concisely discuss a few.

Firstly, let’s talk about attendance…

The first morning was far from crowded.

This intimacy allowed for more genuine conversations, interactions, and networking — an amazing opportunity to personally connect with some incredible people in Web3.

The few that attended were truly passionate for blockchain.

If prices are down, the hype ceases to exist — and what remains are those who love the tech.

Students yearning for opportunity should attend these events!

I hesitate to share this secret, but if you are passionate and outgoing, you will probably find some opportunity to gain work experience and contribute to Web3.

Inspiration to solve problems with blockchain was abundant.

(Inspired by the Emerging Markets panel.) Those on the cutting edge of blockchain are employing it to solve problems across the globe — specifically, in countries such as Argentina and Kenya, where citizens may not have legal identities or access to a secure banking system. Similarly, privacy and trust were considered in these discussions as other significant values that must be protected in the future.

Regulation…

This theme can be summarized in two words: Gary Gensler. There was a resounding disappointment in U.S. regulators — a torrent rain on our parade. And justifiably so: if our regulators cannot even define processes to govern and direct the ongoing innovation, then you leave our innovators vulnerable, confused, and resolving to build their projects outside the U.S., away from the possibility to get rekt by the SEC or other governmental agencies for doing something THEY DID NOT KNOW they could not do.

A Final Personal Reflection

Whenever I step foot on campus, my eyes open wide in excitement — and attending this year’s MIT Bitcoin Expo was no different. I left with some incredible new friends, potentially new opportunities to contribute to Web3, and a burning inspiration to solve problems with blockchain technology — to bring about a more secure, transparent, efficient, sustainable future for people that do not have the same security and financial privileges that most of us take for granted.

Nicolai Jacobsen, jacobsen.ni@northeastern.edu

Mary Raines Alexander, alexander.mary@northeastern.edu

Read this research paper here.

Abstract

Recent research on Constant Function Market Makers (CFMMs) has shown inconsistent and decreased probabilities of providing as a liquidity provider depositing into Automated Market Makers (AMMs). However, the fees accompanying such trades fail to benefit LPs and are rather manipulated to the advantages of arbitrageurs and lead to impermanent losses. In comparing variable fees to Uniswap’s set fee model, we assumed that oracles provided unbiased information, were completely decentralized, and had no bad actors involved. Therefore, the focus of such research is directed towards the question of fees in regards to LPs’ profits rather than the possible underlying bias of oracles in blockchain. Under such conditions, we analyze and implement a recommendation of a fee model that limits the number of bad actors in its active use by adding a dynamic fee that adjusts in times of varying volatility. Furthermore, the ultimate objective of such a new restructuring of fee analysis is to avoid the arbitrage of prices and return profit to LPs, as an increase in fees during times of volatility can compensate for the impermanent loss experienced by LPs.

Written by NEU Blockchain Alpha Research:

Katie Gjelaj, gjelaj.k@northeastern.edu

Owen Johnson, johnson.ow@northeastern.edu

Introduction

Private equity, venture capital, and other alternative investments have proven to be lucrative investments but have high entry barriers for investors. These investments require significant amounts of capital to be locked up for several years, and as a result, often only the wealthiest 1% of the population are able to invest in this space. Through the application of blockchain technology, investment companies can tokenize funds, moving them onto a blockchain. Financial firms can then offer investors the opportunity to engage in secure and transparent transactions and to invest in more liquid shares — shares that have lower minimum investment thresholds, lower transaction fees, and higher transaction speeds. In an age of new technologies, one can only wonder how these technologies will be adapted to the fields of high finance.

Before understanding how blockchain technology can be applied in the private equity and venture capital space, it is important to understand: What is private equity and venture capital, and how can Blockchain technology be applied to the PE/VC space?

What is Private Equity and Venture Capital?

Private equity (PE) refers to a form of investment in which investors pool their capital to acquire private companies or acquire public companies and take them private. PE firms typically invest in mature companies, which are past series A funding and have already established themselves in their respective industries. PE investors are typically investment firms or accredited investors — investors who meet certain financial criteria established by the Securities and Exchange Commission (SEC) in the United States. As PE is considered an alternative investment, PE investors often have their money tied up until the sale of their shares in the company occurs, through an initial public offering (IPO) or an acquisition by another company, which generally take place three to seven years after their investment. Private equity investment has overall increased in popularity, with as much as $1.1 trillion in private equity buyouts in 2021.

Venture capital (VC) is a type of PE financing that involves investing in small, early-stage companies in seed or series A funding, that are believed to have high growth potential in the long term. Like private equity, investment in venture capital is typically limited to institutions and individual investors with high net worth, who are required to commit significant capital for years. Investors may also offer support and expertise in areas such as management and technology.

How can Blockchain technology be applied to the PE/VC space?

Blockchain is a digital ledger technology that enables assets to be securely and transparently tracked and transferred across a business network. Blockchain can be used to create tokens that represent ownership of assets. In the case of PE and VC, the tokens can represent ownership of a fund or the underlying assets held by a fund. Shares in a tokenized fund — a fund on a blockchain — can be quickly traded at a low cost. This makes shares in a tokenized fund more liquid than those in a traditional fund and, consequently, more attractive.

An Introduction to Tokenized Funds:

Tokenized funds have the potential to cater to investors whose needs are not being met by the current financial landscape. Tokenized funds use digital ledger technology (DLT) to create a decentralized database that securely and transparently records transactions between multiple parties, promoting direct-to-market access.

According to an analysis conducted by The World Economic Forum, up to 10% of global GDP will be stored and transacted via DLT by 2025. By 2027, tokenized markets are predicted to be worth as much as $24 trillion. The World Economic Forum claims PE/VC, hedge funds, and real estate are “the alternative asset classes regarded as most likely to be the first to attract relevant levels of tokenization.”

Invictus Capital offers investment opportunities in the digital asset space and is an early adopter of tokenized funds. Invictus Capital offers a variety of blockchain-based investment products, one of which is the Crypto20, a tokenized index fund that tracks the top 20 cryptocurrencies by market capitalization. Invictus Capital also offers the Invictus Hyperion Fund, a tokenized venture capital fund that invests in blockchain-based startups. This fund provides early-stage financing to these companies and works closely with them in making business decisions. With its funds existing on a blockchain, this technology is at the core of Invictus Capital’s business efforts and success.

Currently, PE/VC funds require custom onboarding, asset managers, cash settlement accountants, custodians, and share creation teams, among other employees. These requirements create a high cost per investor, which encourages fund managers to decrease the number of investors in a fund and, consequently, increase the minimum investment threshold. With tokenized funds, many of the costs of funds can be digitized and, thus, minimized. On The Delphi Podcast, Matthew Finlayson, the Co-Founder of Invictus Capital, highlighted that moving a traditional fund onto a blockchain can result in an 80% cost saving.

Blockchain-based funds, when compared to traditional funds, allow for a broader range of investors to participate by lowering the minimum investment threshold. A blockchain-based VC fund with an equity value of $10,000,000 may have 5,000 investors investing $2,000 each. Traditionally, a VC fund would have 10–20 investors, each being required to invest $500,000 at minimum. A lower minimum investment breaks down the high capital entry barriers to PE and VC fund investment and opens investment opportunities to a larger pool of investors. Moreover, the minimum investment threshold, by increasing the number of qualified investors, enables fund managers to raise more capital. Individual investors are able to invest less capital, attracting a greater number of investors who can meet the minimum investment requirement.

In addition to lowering entry barriers for investors, blockchain-based funds offer other advantages over traditional funds, such as increased liquidity. The smaller investments in these funds make it easier to locate secondary buyers for those who want to sell their position. It would be more difficult for an investor to find someone willing to buy out their position if they have $500,000 invested as opposed to only $2,000. Moreover, traditional funds cannot compete with the fast verification speeds of smart contracts that are used in tokenized funds. Blockchain-based funds have an approximate one-hour liquidity window while traditional funds can take 4–5 days to liquify. Also, traditional PE/VC funds are often locked up for 5–7 years, preventing investors from adjusting their investment horizon, whereas blockchain funds avoid this lock-up period due to their capacity for liquidity.

Regulation Challenges Surrounding Tokenized Funds:

Regulation often follows innovation, and this applies to the case of moving investment funds onto blockchains. Thus, there is little regulation that is specific to tokenized funds. Companies must follow the same regulation that commands traditional funds. For instance, the Financial Conduct Authority (FCA), the regulator of the financial services industry in the UK, typically demands the same requirements from tokenized and traditional funds on their prospectuses, documents that detail the objectives and strategies of a fund. Furthermore, like traditional funds, tokenized funds generally require the same security checks, such as verifying investor identity — though the exact way in which these checks are to be conducted is often not specified.

However, since there is very little law that directly addresses tokenized funds, there is regulatory uncertainty in this area — a factor that deters many firms from becoming involved with tokenized funds. To resolve this issue, the FCA, like other regulatory authorities, has launched support programs to guide fintech companies to allow for innovation in a supervised and guided way. More specifically, the FCA has launched the Innovation Pathways support system, which guides companies involved in not only tokenized funds but also, robo-advice, open banking, cryptocurrency, AI/machine learning, P2P lending, and other fintech products. The Innovation Pathway provides both access to one on one discussions with officials and the opportunity to participate in a regulatory sandbox. While this legislation aids in the implementation of tokenized funds, such legislation is not customized to tokenized funds specifically, and though it can be applied to tokenized funds, it only addresses the implementation and use of such funds in a single country — limiting the use of cross border transactions.

Some legislation has been initiated on a larger geographical scale and directly addresses tokenized securities. The European Parliament and European Council, for example, have implemented new legislation, as of early 2023, that removes company market capitalization size restrictions, retail investor access limitations, and other constraints, all of which alleviate the legal burdens associated with tokenized funds.

Regulation has therefore prompted companies to create tokenized funds and build investor trust in these funds. Still, aside from legislation, there are several other factors that both companies and investors must consider when evaluating tokenized funds — including the process of getting a fund approved, encrypted, and sold onto a blockchain, the implementation and examination of cybersecurity measures, and the adoption of this type of investment by the general public.

Health Care Strategic Growth Fund II: A Tokenized Fund Offered by Investment Giant KKR

KKR & Co. is a US investment firm that manages over $400 billion in investments across several asset classes, including private equity, energy, infrastructure, real estate, credit, and hedge funds. In 2022, KKR made its Health Care Strategic Growth Fund II, which invests in innovative healthcare companies in North America and Europe, available on the Avalanche blockchain. Avalanche is an eco-friendly cryptocurrency and blockchain platform that competes with the more popular Ethereum blockchain. Offering a smart contract platform and near-instant transaction finality, Avalanche has allowed KKR to build an efficient and customized blockchain service for their fund to be invested through.

As part of the relocation of this fund onto a blockchain, KKR has initiated a partnership with Securitize Capital to aid in the onboarding of investors, KYC and AML verifications, and the issuance of tokenized assets. Securitize Capital is a digital asset management platform that is utilized by over 1.2 million investors and 3,000 businesses. Investors who wish to buy shares in this fund can do so on Avalanche through a tokenized fund feeder that is provided by Securitize. The tokenized fund feeder allows investors to purchase shares in the fund that are represented, traded, and recorded on the distributed ledger of the blockchain.

Traditional private funds are easily accessible to only large institutional investors and ultra-high-net-worth individual investors. The implementation of this fund onto a blockchain has increased the fund’s accessibility to individual investors and worked to resolve the accessibility limitations of investment in PE funds. Typically, the minimum investment requirement for individuals looking to buy shares in a similar fund is in the millions. While it is possible for investors to add a PE fund to their portfolio with a lower minimum investment requirement, the ability to take part in a traditional PE fund that is managed by a very reputable firm, such as KKR, at a low cost is rare. With a digital fund feeder, the minimum threshold of the KKR PE fund immediately dropped to $100,000. As the Head of Securitize Capital explains, through this partnership with KKR, “the tokenized fund we have developed is a significant breakthrough in unlocking investor access to private equity investments.” In addition to yielding lower investment minimums, the tokenization of this fund created enhanced recording processes, through the advanced digitization of investor onboarding paperwork and the immutable transactions of a tokenized fund. Furthermore, through high transaction speeds, low-cost fees for transactions, and the diminished need for intermediary parties, the tokenized shares of the fund also have increased liquidity, when compared to shares in a traditional fund.

While the large firms who have put the PE funds they manage onto a blockchain are few and far between, KKR’s initiative to do so and success upon doing so will pave the way for other reputable firms to offer tokenized funds. The transition of the Health Care Strategic Growth Fund II fund onto a blockchain is building the bridge between paper-based and digital financial products. As the CEO of Securitize comments, “this new fund is an important step toward democratizing access to private equity investments by delivering more efficient access to institutional-quality products.” Though the implementation of funds onto a blockchain would drag traditional financial officers into new areas of technology that they have not yet experienced, the benefits of doing so will likely prompt many financial institutions to follow in the footsteps of KKR.

Why does this matter?

Looking forward, blockchain technology is present in the alternative investment space in ways besides tokenizing funds. Some investment companies are simply investing in companies whose business model is centered around blockchain technology — adding these companies to the portfolio of a traditional fund.

For example, Block Media Labs is a venture capital firm that specializes in investing in Web3-based operations. Block Media Labs has an early-stage investment fund, called “Seed Capital,” that invests in innovative Web3 projects such as metaverse video games, digital tokens, NFT collections, and other Web3 innovations. They mention that they “believe in projects that will shape the future of Web3. Whether that be a metaverse, token, NFT collection, or some new innovation, Block Media Labs can help you on your journey to make it a reality”.

Blockchain technology is still in its early stages of development, with many new applications still being explored. As blockchain technology gains popularity and the trust of the public, more PE/VC will begin investing in companies with this technology at their core. However, there is an important difference in the shift from funds investing in companies that use blockchain technology and investment funds using blockchain technology themselves to tokenize their funds. Now, financial services companies are beginning to put blockchain technology at the core of their own business model, improving the way in which the industry traditionally operates.

Blockchain technology has the potential to revolutionize the private equity and venture capital industry. Tokenized funds, which are fully blockchain-based, offer advantages such as direct-to-market access, lower minimum investment, and the ability to trade and sell shares using smart contracts. These funds can cater to a broader range of investors and lower the high costs associated with traditional funds. Additionally, blockchain technology provides improved transparency and traceability, giving private equity and venture capital firms better visibility into the health and progress of their portfolio companies.

As the adoption of blockchain technology continues to grow, more private equity and venture capital firms likely will begin to explore the use of tokenized funds and other blockchain-based solutions to improve their operations and better serve their investors.

Written by NEU Blockchain Alpha Research:

Katie Gjelaj, Owen Johnson

Abstract:

As the world becomes more globalized, an influx of workers from developing regions are heading to the United States, Europe, and other developed regions to earn higher wages then they would back home. With this, the need for a cheap and efficient system of remittances is stronger than ever. Each year, over 500 billion dollars worth of remittances are sent back to households and individuals in developing countries and comprise a large chunk of the wealth they need to survive. Unfortunately, due to the centralized nature of current remittance services, as much as twenty percent of the payment that a migrant worker sends back home can be lost due to fees imposed by service providers. Through the use of cryptocurrencies, blockchain technology has the power to drastically improve the way we send money around the world by making the process cheaper, faster, and frictionless. This paper analyzes the specific ways that blockchains are able to achieve this as well as looks at how key players in the space are already trying to implement them. The decentralization and shift to on-chain facilitation of the global remittances market will help make the international transfer of money more efficient and fair for the growing number of migrant workers who rely on it.

Introduction to Global Remittances:

Remittance payments are defined as money that is sent from migrant workers to friends and family in their home countries. Due to the increase in global trade, and increasing free flow of human capital throughout the world, developed countries are relying more and more on migrant workers as a source of labor. Between 2005 and 2015, the migrant population in the United States jumped from just over 39 million to over 46 million and went from being 13.26% of the population to being 14.49%.

This increase was not limited to the United States however and indeed the same trend has played out across Europe as well. Between 2005 and 2015, the immigrant population of France jumped from 6.7 million to 7.8 million, the immigrant population of Germany jumped from 10.3 million to 12 million, and the immigrant population of the United Kingdom jumped from 5.9 million to 8.5 million.

This influx of migrants from developing countries has in turn led to an increase in the total remittance payments across the world. In 2019, before the widespread outbreak of COVID-19, the total flow of global remittances to developing countries was 548 Billion USD, which is larger than Foreign Direct Investment (FDI) and Official Development Assistance (ODA). This number declined during 2020 as the world stayed home and most countries adopted stringent immigration policies, but has since recovered as people began returning to work. By the end of 2021, global remittances to developing countries totaled roughly 589 billion USD, and that number is expected to increase by another 2.6 percent by the end of 2022.

The following chart shows the total worldwide remittance market from 2018 and predicts its expected growth until 2026. As shown, worldwide remittances are projected to maintain steady growth over the next couple years which indicates a steady demand for simpler transactions and cheaper fees.

Remittance transactions are typically handled in three steps:

1. Migrants send money to a third party sending agent.

2. The sending agent tells the paying agent in the recipient’s country to deliver the money

3. The paying agent makes the payment to the recipient

The use of third party agencies means a portion of the payment is lost to transaction fees as well as exchange fees between the two currencies. Since these third party agencies are profit driven organizations, these fees can end up totalling a considerable amount of money, especially for low-income migrants. According to the IMF, “transaction costs rarely affect large remittances (for the purpose of trade, investment, or aid): as a percentage of the principal amount, they tend to be small… But for smaller remittances — under $200, which is often typical for poor migrants — fees typically average 7 percent, and can be as high as 15–20 percent in smaller migration corridors”. Additionally the World Bank has previously stated that, in regards to transaction fees, “costs tend to be higher when remittances are sent through banks than through digital channels’’. Sending money around the world can also be painfully slow, with wait times ranging anywhere from a few days to a few weeks before a payment arrives.

For some countries in the developing world, remittance inflows represent sizable portions of national gross domestic product (GDP). The following chart shows which countries received the most remittance payments as percentages of their GDP in 2020. It is important to note that for all ten of the top countries, over one fifth of their GDP consists of remittances, meaning improvements to the system would have drastic real world impacts to their economies.

The Perks of Permissionless Networks:

Before discussing how blockchain technology can improve the remittances market, it is important to understand what a blockchain is. Simply put, a blockchain is an alternative way to store and update data. However, unlike traditional databases where data is stored in a central location and controlled by a single entity, blockchains are maintained and updated by individuals known as validators. A blockchain validator can be anyone willing and able to perform the validation procedure and there is often no rule on the maximum number of validators a blockchain can have. Public blockchains are thus considered to be decentralized since there is no one individual or company managing the data. While different blockchains may implement various consensus mechanisms and permissions, the technology itself has allowed developers and users to completely revolutionize the way that we think about money, the internet, privacy, financial markets, and a whole host of other industries.

One of the most common and popular use cases for blockchains is to support the existence of cryptocurrencies, which act as digital stores of assets. Popular cryptocurrencies include Bitcoin, Ethereum, and Solana, and range widely in both value and utility. Cryptocurrencies do not depend on the monetary policies of central banks due to their decentralized nature and allow holders to make transactions and send money without third party intermediaries. For the purposes of remittance payments, cryptocurrencies are unique in that their transaction fees are ubiquitous regardless of the geographic location of the recipient. In other words, there are no restrictions on sending money internationally. In cases where the sender/recipient is wary of volatility the option to use stablecoins, digital currencies backed by fiat currency or other assets, is also a favorable choice.

As discussed earlier, the major problems with the current remittances system is that transaction fees are high and money transfers are settled over long periods of time, relying on intermediaries. Sending remittance payments via blockchain would bring the system one step closer to solving these problems as payments and remittances have been a crucial use case of blockchain tech since its inception. Blockchain technology proposes distinct advantages over current systems and aims to make these types of transactions more efficient.

Three main advantages blockchain has over current systems include:

1. The need for intermediaries is removed which results in a large reduction of fees and losses from fluctuating exchange rates

2. The ledger provides significant improvements to settlement assurances, transactions settle within minutes at most

3. Transactions can be settled at any time and money can be sent anywhere in the world

In addition, blockchain technology provides a new opportunity for those who do not have access to traditional financial services. As of 2018, over 20% of the world’s adult population, mostly centered in the developing world, did not have access to typical banking services. That number, while on the rise, has been slowed by the lack of infrastructure in emerging economies where having a network of physical bank locations isn’t always practical. In these areas, use of the internet provides an important alternative as many banking services can be performed digitally. The advantage of having internet access is that, by connecting to a blockchain, one has access to all the main features of a bank (checking, saving, online payments, ect) on their phone or computer and can transact at any time across any time zone. As an added benefit of the technology, people will no longer have to travel to financial institutions to send or withdraw funds, which saves time for people in rural environments.

Internet access in developing countries is also on the rise. As stated in an article published by PewResearch in 2018, the percent of adults in emerging economies who used the internet grew from just 40% in 2015 to 60% in 2018. With sustained growth, some analysts predict that 90% of the world’s population could be using the internet by 2030. Below is a chart published in 2021 comparing internet penetration to banking access in a number of developing countries. What is noteworthy, is that in almost every country, more people have access to the internet than to a bank and a large percent of transactions are made using cash. In these areas, blockchains would give users access to much broader markets and provide more secure transactions than are possible with cash.

Key Players:

Traditionally, a number of companies have handled all global remittance and other international payment services. Most dominant among these is Western Union, which currently sends over 5 million online money transfers every month, although other legacy players include Moneygram, Transferwire, and Xoom.

Global remittance flows to middle and low income countries totaled 508 billion dollars in 2021, the majority of which were processed by a third party service. However, as demand for cheaper payment services has increased, many new service providers have begun to chip away at the legacy remittance market share, a number of which are turning to cryptocurrencies as an alternative to traditional currency exchanges.

A prominent example of an emerging player is the Stellar protocol. Stellar is an open source crypto currency that allows money to easily be moved and stored. The main difference between Stellar and other cryptocurrencies is its consensus protocol which allows transactions to be approved without confirmation from the entire miner network, allowing for faster transaction speeds. Stellar’s goal is to unite the world’s financial infrastructure so that money can flow quickly and cheaply between banks, businesses, and people. Stellar is currently supported by a non profit organization that handles every currency and speaks to every payment system in its native language. This allows both people and businesses to move money globally in seconds.

Telcoin is another cryptocurrency player in the Global Remittance space. Telcoin is integrating blockchain and the telecommunications industry to create a user owned decentralized financial platform. Telcoin allows for instantaneous money transfers by integrating blockchain technology with mobile devices via an application you can download on your phone.

Currently 31% of the global population is unbanked while 83.72% of the global population have smartphones. Creating an attractive and easy to use application may bring in a large volume of new blockchain users.

Another blockchain company that has shown previous interest in improving the remittance market is Circle. Circle is a payments infrastructure company that enables businesses to harness the power of blockchain and cryptocurrencies in their day to day operations. It started in 2013 as a peer-to-peer cryptocurrency exchange platform but has since expanded into other areas, notably producing its own stablecoin. The stated goal of Circle is to create a world where there is no distinction between international and domestic money transfers.

A more in depth diagram of the emerging blockchain companies entering the remittance market, provided by Blockdata, is listed below:

There is also a growing interest in traditional institutions partnering with blockchain startups to implement their technology to handle remittance payments. A key example is Ripple, another peer-to-peer cryptocurrency payment network, that partnered with Western Union and MoneyGram in 2018. Ripple has also partnered with SBI Remit, the largest remittance provider in Japan and Siam Commercial Bank to provide support for international payments in Thailand and Southeast Asia.

Though these are just a few of the emerging players aiming to change the remittances market, they are not the only ones. As the infrastructure surrounding cryptocurrencies improves it becomes ever simpler, safer, and faster to send money via the blockchain as opposed to traditional means. As new competition enters the market, the future of remittances appears to be decentralized.

Advantages of Blockchain Tech for Remittances:

The actual benefits of blockchain are displayed in the reduction of transaction costs for consumers conducting remittance payments as well as faster transaction speeds. Europe has a large portion of the world’s immigrants at 20%, and many of them send money home. This caused a remittance outflow of $165 billion in the continent, which is 25% of the world’s market. Africa is the largest destination of European remittance with 2019 numbers for remittances reaching around $48bn in Sub-Saharan Africa alone. Somalia’s remittance inflow in 2020 was estimated at 24.9% as a share of GDP, meaning that remittances are a large source of income and economic growth for citizens there.

However, the cost of sending this money is very expensive in comparison to other parts of the world. The percentage cost of sending $200 to most countries in Sub-Saharan Africa is about 9%, while Southern Africa has one of the highest costs of over 20%. Blockchain technology reduces these costs and makes them fairly consistent regardless of the destination. Traditional fees are broken up into four categories: 1.5% payment fee, 3.4% bank card fee, 0.3% bank account fee, and 0.7% pay in-store fee. Conversely, blockchain transactions consist solely of a mining fee and a gas fee. These fees can vary in percentage based on blockchain gas prices as well as the complexity of the transaction, but can be as low as a hundredth of a percent of the total transaction volume. Below is a comparison of fees as a percentage of transaction volume for sending money internationally via traditional means as opposed to a few popular blockchains.

Cryptocurrency is gaining popularity, especially among a younger demographic of users. According to a survey by PYMNTS, 23% of respondents who made remittance payments to friends or family in other countries used at least one kind of cryptocurrency. 13% of consumers also said that cryptocurrencies were their most used payment method for online cross-border remittances. As crypto adoption increases, so do the incentives for remittance providers to incorporate them as part of their service.

Sending money on the blockchain is also exceedingly simple in comparison to the complex process needed for traditional remittance payments. To send money from one crypto wallet to another, one simply needs to confirm the wallet address of the person they wish to send money to, state the amount they wish to send, and sign the transaction using their personal wallet keys. The transaction is then recorded automatically and the money is sent. There is often still a fee associated with the transaction, which is sent to the miner/validator, but, depending on the blockchain, this number can be as low as a fraction of a percent of the amount being sent and isn’t dependent on the geographic location of the recipient. In virtually all regards, blockchain transactions are faster, cheaper, and simpler than traditional global payment methods.

Risks and Limitations:

As described above, decentralization provides many benefits through cryptocurrency and other blockchain-related services. However, as with any technology, there are a few drawbacks. As a result of this decentralization, scams, stolen funds, and lost wallet addresses result in billions of dollars worth of losses or locked funds.

Lost addresses are one of the most prominent issues that come with the decentralized nature of cryptocurrency. Unlike money stored in a bank, which can be reclaimed even if a user forgets their credentials, money stored on the blockchain is effectively lost should a user forget their private key. This is because there is no third party organization taking partial custody over a wallet’s contents. The stories of crypto-wallets worth millions of dollars being lost are plentiful. As of 2017, a report estimates that between 2.78 million and 3.79 million Bitcoin tokens have been lost and are unrecoverable. At the time of writing this paper, the current price of a single Bitcoin is $29,401. With the total supply of Bitcoin capped at 21 million, the number of lost Bitcoins constitutes a sizable portion of the market.

There has been progress made to minimize the risk of lost wallets and make them more secure, such as multisig wallets, which require multiple signatures from different devices to approve transactions, as well as social recovery wallets19, which recruit trusted third parties to help manage wallet security. Argent, for example, is a company that has already shown promise with their social recovery wallet platform and is currently working to make the process cheaper and more available to the average crypto user. However, for crypto beginners and less technically adept users, forgotten seed phrases and lost wallets are still an issue as adoption of newer crypto wallet designs, while promising, has yet to become mainstream.

That being said, the user is not the only exploitable link on the chain. According to a crypto crime report done by Chainalysis, 2.7 billion dollars worth of crypto was scammed from 7.3 million users in 2020 alone. This came through hacks involving wallets, and exchanges, as well as the users themselves. For example, in 2020, the lending platform Bzx had 8.1 million dollars worth of crypto stolen through exploitation in the code of smart contracts. In 2021, the same platform was hacked again, resulting in 55 million dollars worth of losses. This occurred after a hacker sent a Bzx developer a phishing email that ran a script which gave access to private keys.

At the end of the day, however, when interacting with smart contracts, it is up to the user to audit the smart contracts directly or review an audit at the very least as smart contract vulnerabilities are always in the realm of possibility but less likely with credible audits. There is an element of risk that comes with purchasing and use of cryptocurrency, but it can be greatly mitigated through sufficient knowledge and operational security (opsec).

Looking Forward:

Blockchain technology holds potential to cut down settlement periods, fees, and intermediary involvement from the remittance industry among others. As blockchains are beginning to take off in terms of adoption and use, it is still unclear what degree of impact the technology will have over the long term or which players will emerge as industry leaders. Additionally, government regulation has yet to come out decisively in favor or against blockchain and cryptocurrencies leading to uncertainty regarding their implementation. Ripple, which has shown itself to be instrumental in crypto adoption in the remittances market, is currently embroiled in a legal battle with the Securities and Exchange Committee (SEC), the outcome of which would set much needed precedence for the industry within the United States. Other countries like Germany and Israel have moved to become more “crypto friendly” with their regulations which encourages innovation and investment. Germany for example, announced in May of 2022 that earnings from cryptocurrencies would be tax free making the country especially attractive to crypto investors within the EU. Israel, for its part, was one of the first countries to seriously consider creating a central bank digital currency (CBDC), and has been working hard towards its implementation, which, while centralized, would provide citizens many of the advantages of digital currencies, like speed of transaction and low fees.

Crypto support has not been unanimous however, and some countries have taken to rejecting the technology entirely, weary of the financial freedom it provides their citizens. Notably among these is China who was the world’s largest Bitcoin mining nation in 2019 before outright banning the use of cryptocurrencies in 2021. The Chinese government has instead chosen to invest in the creation of its own centralized digital currency which would allow it to maintain much greater control over the finances of its people. This kind of aggression towards the crypto industry not only limits the financial freedoms of its citizens, but also alienates would-be innovators and investors. Thus, as the cryptocurrency market continues to grow, China may find itself missing out on some of the benefits the new industry has to offer.

While the future still seems unclear, what is clear is that blockchain technology has many distinct advantages over the current system of remittances and global payments. By highlighting the shortcomings of legacy services, like high transaction fees, slow transaction speeds, and the reliance on third party intermediaries, it has allowed new players to enter the market as well as forced existing ones to become more receptive to blockchain and other forms of digital payments. This increased competition is already leading to a more efficient process for the end user, and will hopefully improve the lives of migrants around the world wishing to send money back home. A system where those with the least are affected the most is a system in need of change, and the user benefits ranging from settlement to costs are leading the way for innovation in the remittances industry.

Written By: Alexander Beaudry (Co-Director of Events), Chandler Otterbein (Executive Vice President), Mark Barry, Vendant Bhagat, Ashwin Kasargode

Chandler Otterbein (Executive Vice President)

Joan Yang (Co-Director of Expansion at WiBlock)

Cooper Duschang (Vice President of R&D, Co-Director of Governance)

Introduction:

With the spread of the global Coronavirus pandemic (COVID-19), the relationship between Bitcoin and equity markets has expanded. In 2020 the cryptocurrency market had a market capitalization of $826.6 million. During the 2021–2028 period this market is expected to grow at a compound annual growth rate of 11.1%. Cryptocurrencies offer a number of benefits over traditional forms of money. This includes faster, cheaper, and more secure transactions, as well as the opportunity to interact with decentralized finance applications and smart contracts. Despite the significant applicative potential and growing adoption of these digital assets, both cryptocurrency and the traditional markets have experienced a decline in value in 2022. No one market is significantly outperforming the other, suggesting that there may be a significant correlation between the two. To test this hypothesis, this article examines a variety of macroenvironment and overarching industry themes that may be entwining the growing cryptocurrency market with traditional financial markets.

Market Crypto Adoption:

Despite the recent bear market, global adoption of cryptocurrencies remains well above the levels that preceded the 2020 bull market. Consistent institutional investment, partnerships with cryptocurrency projects, and development on popular blockchains show there is a flood of new users with capturable value. Those who invest in cryptocurrency during times of price growth tend to stay even when prices decline, allowing the ecosystem to consistently grow across market cycles.

Companies are investing in cryptocurrency in order to diversify and take advantage of benefits such as faster, decentralized, transparent, secure, and reliable transactions. The adoption in those high remaining closing prices portray the trend of the market. For example, Tesla purchased $1.5 billion worth of Bitcoin in 2021 for more flexibility to further diversify and maximize returns on their cash. In another example of cryptocurrency adoption, nearly 3,000 Chipotle restaurants across the U.S. now accept 98 cryptocurrencies as payment through the chain’s partnership with Flexa. Other companies are likely to follow suit adopting cryptocurrency usage and contributing to the growth of the market.

Current Market:

Bitcoin has been trading steadily around $17,000. Cryptocurrency prices remain depressed with Bitcoin down more than 70% from its all-time high from nearly a year ago.

Similarly, the S&P 500 has seen recent decline, down from its own all-time high by over 22.5%. The traditional markets have not receded as much as the cryptocurrency markets; however, there are a variety of factors that affect both markets and are reason to examine the correlation between traditional indexes and stocks, and large cryptocurrencies.

Current Macro Environment:

Both cryptocurrencies and traditional risk-on asset markets reflect depressed valuations along with worrisome economic conditions. High inflation, the Federal Reserve’s interest-rate policy, the U.S. dollar’s strength, and the Russian invasion of Ukraine have all affected various aspects of both traditional and innovative markets.

The annual inflation rate is 6.5% for the twelve months leading up to December 2022. This general increase in prices and the fall of purchasing power is a significant factor that market players are taking into account. The Fed has been significantly raising interest rates, making it more expensive to borrow money inorder to combat inflation. As of January 17, 2023 the federal funds rate is 4.3%, one of the highest interest rates in over 10 years. This is a drastic change from the frothy low interest rate economy associated with the last bull market. The war between Russia and Ukraine is yet another factor influencing the current market downtrend. This conflict has had global ripple effects on prices for energy, food and other commodities. The U.S. Bureau of Labor Statistics recently reported a Consumer Price Index increase of 6.5% (Over the 12 months ending December 2022 before seasonal adjustment), accounting for major changes in areas including Food at home index up 11.8%, the index for electricity up 14.3%, and the energy index up 7.3%. Ultimately, this conflict has created hurdles and cost inefficiencies across the value chain, making it more difficult for businesses across the globe to generate profit.

To combat some of these economic problems, the Federal Reserve is establishing interest rate hikes in an attempt to reset the economy. By raising the cost of borrowing money, the central banks are suppressing the demand for goods and services. Historically, interest rate hikes tighten financial conditions, causing credit spreads to fall, stock and equity prices to fall, and the strength of the U.S. dollar to increase.

Despite rapid inflation, the personal savings rate data shows that investors are not holding onto the U.S. Dollar. However, the performance of equity and cryptocurrency markets shows that investors are also not flocking to those locations. Both markets are considered risk-on assets and investors and not increasing their personal savings, but are currently looking at risk-off assets to invest in.

Market Correlations:

Prior to 2022, the top 10 cryptocurrencies were relatively uncorrelated with the S&P 500 and characterized with significant volatility. However the increasing participation of traditional financial institutions in the cryptocurrency market led to a change in this trend. Traditional institutional participation not only influenced the significant growth of the crypto ecosystem in the last bullish investment cycle, but increased the correlation of the top 10 cryptocurrencies and the S&P 500 to the highest level ever recorded with these cryptocurrencies trending similarly with stocks against volatility. The relative immunity to broader macro conditions that cryptocurrency once maintained, has significantly diminished.

When looking at the price action between the SPY, NDQ and the top five cryptocurrencies in the current market downtrend, it is apparent that cryptocurrencies follow the same market trend as the traditional market and experience an amplified movement. Despite the significant adoption of cryptocurrencies and their promise going forward, this market is not exempt from the same factors.

In the last uptrend, the top crypto assets appreciated in value significantly more than traditional assets compared to the dollar. The cryptocurrency markets’ seemingly leveraged movements are representative of their speculative nature and market size. Currently, cryptocurrencies are associated with growth tech stocks and high volatility. A lot of this volatility is a result of the market size delta. The total size of the cryptomarket is $981 billion as of January 15th, 2023 while the total market cap of the S&P 500 is 32 trillion as of January 15th, 2023.

Looking at Bitcoin’s price correlation with three FAANG stocks, we see similar trends in the duration of specific correlations. Meta Platforms (NASDAQ: META) has only had an inverse correlation with Bitcoin from February 2015 to February 2016. Apple, Inc. (NASDAQ: AAPL) has experienced a few negative correlations with bitcoin in 2013, 2015 to 2017, and a few months since 2019. Alphabet, Inc. (NASDAQ: GOOGL) Class A Common Stock has experienced negative correlation in 2012, 2015, and 2019.

Despite occasionally experiencing negative correlations between Bitcoin and various large cap tech stocks, the positive correlation has been apparent for longer periods of time.

META Correlation:

• Periods Negative: 12 months
• Average Negative Correlation over sum of Months = -0.521
• Periods Positive: 96 months
• Average Positive Correlation over sum of Months = 0.682

AAPL Correlation

• Periods Negative: 30 months
• Average Negative Correlation over sum of Months = -0.656
• Periods Positive: 100 months
• Average Positive Correlation over sum of Months = 0.433

GOOGL Correlation:

• Periods Negative: 13 months
• Average Negative Correlation over sum of Months = -0.205
• Periods Positive: 117 months
• Average Positive Correlation over sum of Months = 0.635

Conclusion:

It is evident that the cryptocurrency market offers significant value, however this does not make it exempt from the same factors that influence traditional markets. Cryptocurrency prices are highly correlated with growth tech stock performance within the traditional market. Cryptocurrency and the traditional markets are highly correlated in terms of market trends. The same factors that affect the traditional markets affect the cryptocurrency market. Due to their speculative nature and a significantly smaller market capitalization, crypto assets experience an amplified movement correlated to the trend of the traditional market.

Written By NEU Blockchain Alpha Research:

Chandler Otterbein (Executive Vice President)

Joan Yang (Co-Director of Expansion at WiBlock)

Cooper Duschang (Vice President of R&D, Co-Director of Governance)