Digital Asset Market Evolution

Throughout history, evolving markets were subject to evolution and de-evolution cycles. The nascent market for digital assets is no exception. Since its inception in 2009, the rapid proliferation of the digital asset market in 2016-18 was followed by significant downward corrections in 2018-19 (called the “crypto winter”).

Digital assets cover all types of virtual and electronic assets, regardless of how they are otherwise named or categorized by regulatory agencies, including cryptocurrencies, security tokens, utility tokens, virtual assets, virtual collectibles, stablecoins, and altcoins, among others. Digital assets can be distinguished from stock because stocks are not inherently digital (think of Wall Street before computers) and have strong ties to the world of hard assets. Bitcoin is a purely digital asset because it only exists in the virtual world.

Digital assets and decentralized cryptocurrencies are different from fiat currencies. Key differences include what their values attach to, the supply level, and the storage methods. The value of fiat currency, no longer backed by gold, is tied to the trust citizens have in their country’s economy, government, and central bank. In theory, decentralized cryptocurrencies, such as Bitcoin, are different. They are often designed with a fixed supply to be anti-inflationary. Cryptocurrencies can be stored and transferred without any involvement from a central entity. They are designed to bypass existing financial intermediaries.

The nascent digital asset market presents an opportunity for the establishment of a new asset class that attracts mainstream investors. The global consensus record of information and transactions that is created through blockchain technology enables the much-needed transparency in finance.  At the beginning of the 2020s, investors in the digital asset market range from retail to institutional; it includes exchanges, broker dealers, investment banks, custody providers, IT firms, and other players in the ecosystem. Furthermore, blockchain technology opens truly global access to finance, including in areas of the world where the banking system is not readily available and the unbanked constitute large parts of the population.

The funding sources for digital asset startups have an impact on the digital asset market. Since 2016/17, the funding sources for digital asset startups and blockchain startups have moved from equity funding to initial coin offerings (ICOs), to equity offerings, and initial exchange offerings (IEOs), just to return back to equity funding in the early 2020s. Because equity investments in blockchain startups make it less likely and less necessary for the respective startups to issue digital currencies, at least as a funding source, the market for digital currencies and the total volume of issued digital currencies is likely to recede when the funding market moved from ICOs back to equity funding.


In the aftermath of the ICO boom and bust, the decentralized finance community continued to expand financial products and services that are based on digital assets. This continuing expansion and attempts to disrupt existing legacy finance via decentralized finance products gave rise to what became known as Decentralized Finance (DeFi).

The emerging market for decentralized finance (DeFi) has the potential to impact the overall digital asset market. Proponents of DeFi often claim that it involves the development of an upgraded monetary system built on public blockchains. The expected customer base of such an upgraded and distinguishable monetary system could involve the 1.7 billion unbanked individuals plus the crypto communities of the western hemisphere. In the early 2020s, most DeFi applications are built on open source networks such as Bitcoin and Ethereum which enable such decentralized applications (Dapps) to disintermediate financial activities via permissionless and censorship-resistant blockchains.

The historical evolution of DeFi begins in early 2018. It was then that the teams behind Set Protocol, 0x, Dharma, and DyDx started working together to build an alternative financial system. The teams hoped they would be able to address the fairness, transparency, and equity issues that afflict the existing system. As it evolved, the DeFi movement became an open community for decentralized finance platforms to work toward these goals together to achieve open source interoperability, collaboration, and transparency. Telegram and Reddit channels were subsequently created, followed by meetups and eventually conferences called “DeFi Summits.” In the early 2020s, DeFi’s total value had risen to around $500 million. DeFi applications became more robust and the community started launching second-generation protocols. DeFi became the leading sector of the cryptocurrency market. Any FinTech project can become part of the DeFi community if it builds a service for or is based on blockchain, follows general standards and is compatible with other DeFi projects.

The Ethereum platform enabled the evolution of DeFi. Ethereum enables an open financial system with little to no involvement from financial institutions.  In the early 2020s, Ethereum is the leading DeFi platform for smart contracting and is used by the overwhelming majority of DeFi protocols. Transactions on the Ethereum blockchain are valid, meaning that network participants (“nodes”) verify, validate, and audit transactions before and after they are executed. Such transactions are immutable and verifiable through a smart contract. Ethereum’s network technology can thus eliminate the need for intermediaries in financial transactions and expand transaction possibilities by increasing the scope and efficiency of peer-to-peer transactions through distributed trust and decentralized platforms. Less intermediary involvement reduces transaction cost, broadens financial inclusion, empowers open access, encourages permissionless innovation, and creates new business opportunities.

Evolving DeFi platforms keep increasing the financial products and portfolio of services that are available for network participants. For example, DeFi platforms include prediction markets, distributed corporate governance, and trade finance. Banking services have also employed blockchain technology in order to mitigate credit risk for exporters and importers. DeFi platforms allow users to convert fiat currency into a stable currency, store this stable currency in an interest-bearing account, and use future contracts to hedge against financial uncertainty. In addition, DeFi platforms go beyond traditional banking and financial services. Parties in the supply chain can view inventory records and effect payments in real-time, and can utilize a seamless system of lending and repayment using smart contracts.

Despite its impressive gains, the evolution of the DeFi market and its new monetary system depends on higher levels of stability in DeFi products and in the market for digital assets overall. Thus, the instability of most cryptocurrencies today undermines the stability and wider adoption of DeFi.

Factors Influencing the Evolution and De-Evolution of the Market in Digital Assets

Several factors have contributed to the evolution and de-evolution of the market in digital assets. First and foremost among those factors is the persistent legal uncertainty that afflicts the market for digital assets. Regulators around the world have struggled with developing a coherent approach to regulating digital assets. For example, in the context of ICOs, only a very small minority of countries has banned ICOs and cryptocurrencies altogether. Regulatory efforts in the context of digital assets have included attempts at regulating cryptocurrencies, regulating distributed ledger technology (DLT), mandating compliance programs, regulating ICOs, regulating exchanges, securities regulation, prohibiting exposed financial institutions, and publishing government guidance discouraging consumer participation.

Other factors that influenced the evolution of the market in digital assets included the changes in the market for ICOs. ICOs morphed from mostly unencumbered direct fundraising, albeit not regulatorily supported, to more restricted fundraising efforts. Such restrictions were mostly taken voluntarily by token issuers in anticipation of regulatory scrutiny. For example, in 2018 and 2019 “lockup” of ICO token investments became the norm: in an effort to curtail the market frenzy of 2017 and 2018, many ICOs required their investors to hold the tokens for 1 to 3 years before selling. Moreover, the ICO fee structure, despite typically offering large discounts (up to 30%) for early investors, was in many ways more expensive for issuers, especially in comparison with the fees charged by investment banks in an initial public offering of stock. Underwriter fees charged by investment banks could range from 4 to 7% of gross proceeds, plus an additional $4.2 million of offering costs directly attributable to the IPO.

Finally, the market maturity and investor experience continue to play a role in the evolution of the market for digital assets. Immature markets, such as the market for digital assets in 2020, often struggle to attract institutional investors and venture capitalists that have sufficient operating experience in that market. Without significant operating experience, investors are less likely to make successful decisions in the market for digital assets, especially in an environment of market turbulence. This, in turn, can limit institutional investor access at scale, which is only partially offset by the larger possible profit margins attainable in such emerging markets.


Wulf A. Kaal is a Professor of Law at the University of St. Thomas School of Law in Minneapolis, MN

This post is adapted from his paper, “Digital Asset Market Evolution,” which is forthcoming in the Journal of Corporation Law and available on SSRN.

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