Cryptoverse: After Bitcoin 'Winter', Investors Hunt Risk in Virtual Worlds

As Bitcoin drifts towards mainstream maturity in 2022, daring crypto investors are eyeing up new sources of explosive action: "altcoins" that power online games and worlds.

But, be warned, the foothills of the unformed metaverse are no place for the faint-hearted.

Bitcoin, which like the rest of the market had been largely sinking since late 2021, has risen about 16 percent over the past two weeks to push above $41,000 (roughly Rs. 30 lakh), prompting many market players to declare an end to the "cryptocurrency winter".

Yet newer and smaller coins linked to virtual platforms have enjoyed stronger rallies amid the buzz around the metaverse.

Those used on gaming platform Axie Infinity and 3D virtual environment Decentraland, for example - the Axie and Mana - have gained 35 percent and 57 percent respectively in the same period since January 24. The token of the Gala gaming platform has jumped 125 percent, according to CoinMarketCap.

"When people think of crypto they tend to think of Bitcoin," said Ed Hindi, chief investment officer of Swiss-based cryptocurrency hedge fund Tyr Capital. "But this ignores the fact that crypto is not a one-risk asset class."

To give an idea of scale, though, the combined market cap of Axie, Gala and Mana is about $12.7 billion (roughly Rs. 94,950 crore), a fraction of the $800 billion (roughly Rs. 59,81,240 crore) -plus for Bitcoin, which commands 40 percent of the market.

Some investors are looking to altcoins to diversify their holdings as 13-year-old Bitcoin and No. 2 player ether increasingly move in step with traditional stock markets and become more sensitive to macroeconomic developments.

In a possible sign of this drive, multi-asset funds managing a combination of coins saw inflows totalling $32 million (roughly Rs. 240 crore) in the week ending on January 28, the largest since June 2021, according to data from CoinShares.

Yet the sheer novelty of many of these coins and the consequent lack of track records significantly ups the danger stakes for investors in an already risky and nebulous crypto world. Furthermore the fortunes of the likes of Axie and Gala are tied to the success of their gaming platforms, as well as the wider virtual economy.

Bottom of the blockchain

Nonetheless, delving deeper into the virtual plumbing, some market watchers say the growing interest in the metaverse is also benefiting altcoins that are on the "Layer 1" protocol of the blockchain - the base level on which smart contracts between buyers and sellers are written in code, and upon which virtual games and worlds are built.

They include Ether of the Ethereum blockchain, and its challengers Solana and Polkadot, which have risen 27 percent, 28 percent and 23 percent over the past two weeks.

"A lot of people are sensing this as a buying opportunity and what they are purchasing is overwhelmingly high-quality blue chip alts over Bitcoin right now," said Hany Rashwan, chief executive officer and co-founder of crypto fund manager 21Shares based in New York and Zurich, referring to coins on the Layer 1 blockchain, also including, Avalanche, Polygon and Terra.

"If you've developed a thesis around smart contracts, it's a wonderful buying opportunity right now."

Where's Bitcoin heading?

Back with Bitcoin - even though the dominant cryptocurrency is rallying after nearly halving in value between early December and January 24, its upward trajectory is far from assured, according to indications from hedging and other data.

Will Hamilton, head of trading and research at Trovio Capital Management, cites futures funding rates, which have remained negative since early December and suggest people are paying to be short. And he also points to options data showing options to sell Bitcoin versus buying, the put/call ratio, has hit 58 percent, a level last seen in the May-July 2021 selloff.

"Throughout this period of consolidation, changes in the derivatives market indicate traders continuing to bet on further downside," he said.