Analysing the Current State of Venture Capital in Crypto
- Posted: 07.09.23
Where did all the crypto venture capital go?
What’s going on with venture capital (VC)?
Start-ups generated $162 billion in VC investment in 2022. A year later, that figure is down to $76 billion – over 50% drop.
But the story with crypto is even worse.
True, there’s no year-on-year 50% drop. But that’s only because the VC market for crypto start-ups has been downright abysmal for years.
From the highs of January 2022 ($5.4 billion) to the crippling lows of August 2023 ($0.5 billion), VC investment in the crypto market has decreased by an order of magnitude.
So what’s next? Is anything happening at all in the VC market? Where does it go from here?
Where did it all go wrong?
VC investors play a high-stakes game. Venture capital firms sink capital into emerging and early-stage start-ups, giving those companies a major boost in the hopes of scaling things quickly and reaching profitability as fast as possible.
That’s where all the talks of “funding rounds” comes in. From pre-seed to seed, start-up, early stage, and expansion stage – funding rounds focus on attracting venture funds to keep a startup running prior to product launch and full profitability.
But because there’s no formal project, and therefore no track record, VC funding is a bit of a gamble.
Projects stall, never get off the ground, or collapse entirely, with VC investors losing out each time. Just looking at cryptocurrencies, over 2,300 crypto projects resulted in “dead coins” between 2013 and 2022. The months since then certainly haven’t improved those numbers.
That has led to an increasingly “risk-averse approach” by investors, according to Kyn Chaturvedi of DeFi (decentralized finance) start-up Minterest.
But even with coins collapsing, investment plummeting, and markets shrinking, there’s still room for some optimism.
“There is a discernible increase in investor interest” – Kyn Chaturvedi, Minterest
What happens next?
For starters, venture capitalists, and their money, follow the broader market. Here at Plexus, we’re seeing strong interest in developers and marketers for new projects. And with industry bellwethers Bitcoin and Ethereum having a banner year, there are good signs that sentiment in the broader market is beginning to turn.
That turnaround can also be seen in how the existing VC investment behaves. Despite the ongoing headwinds, “the latter half of 2023 has shown promising signs for Web3 start-ups,” Chaturvedi reports. “There is a discernible increase in investor interest.”
Key Events in Crypto Venture Capital Investment
Why the recent optimism?
It’s worth reviewing quickly how crypto got to be where it is. Three key events or trends have shaped the VC market as it stands today – it’s worth outlining what they are.
The fall of the FTX empire
FTX collapsed in November, 2022. At the beginning of the same year, FTX had announced the launch of a $2 billion VC fund of its own, FTX Ventures. FTX Ventures didn’t have time to develop into a major player in the crypto VC field; by the end of 2022, FTX had collapsed, Sam Bankman-Fried was a pariah, and the crypto rout was on.
Famously, investors had mostly ignored SBF’s own eccentricities in their rush to pour money into FTX. The result was a wildly over-hyped crypto exchange that eventually collapsed due to mismanagement, pulling down a number of other players along with it and leaving VC firms feeling the pain.
In the aftermath, other big players – from VC hedge fund Andreessen Horowitz and a16z, to industry players like Coinbase Ventures and Binance Labs – have started to play their cards close to the chest.
Why the caution? In large part because since FTX’s collapse, US-based regulators such as the SEC have turned increasingly close attention to crypto companies, both established players and emerging start-ups.
The threat (and promise) of looming regulation
SEC regulation is typically viewed as a threat; just ask Coinbase. But at the same time, any regulation, however harsh, would at least provide much-needed clarity for projects and digital assets – and, crucially, for the VC investors who might want to support those projects.
That expectation of clarity is driving some of the recent renewed interest. Projects that are well-run and closely managed are more likely to come out on top when the regulatory dust settles; those are the same projects attracting the most attention.
It may also explain why some VC funds are finding success focusing on early-stage start-ups in the crypto space, giving them more time to adjust to changing regulatory environments.
The AI potential
What’s changed since 2022?
In part, the continued explosion of AI.
Unsurprisingly, AI-focused start-ups outside crypto have taken a growing share of available VC capital. In the US, nearly $1 out of every $4 of VC investment went to AI-focused start-ups.
Not that crypto is without its own AI-based projects. There’s room for AI and crypto together – and future projects that blend generative AI and DeFi, NFTs, or cryptocurrencies are sure to draw strong interest.
Some projects are already capitalising on the trend; Cube3.ai recently raised over $8 million for a project leveraging AI algorithms to boost security.
File this one more under “potential” rather than “proven,” but at the very least, AI’s success demonstrates that VC money is still out there – for the right projects.
What today’s venture capital wants: strong fundamentals
Look long enough, and you’ll see VC success stories, even in today’s market. Recent raises show strong variety – blockchain scanners (Lore), traditional/crypto payments (Moneygram), and DeFi (Maple Finance, Kinza Finance), among many others.
What’s the common bond that VC investors are searching for?
Projects with a good framework and strong fundamentals.
The increase in investor interest means that certain projects “are starting to take a lion’s share,” Chaturvedi says, “particularly for projects that demonstrate strong fundamentals, which is evidenced by oversubscriptions in recent funding rounds.”
VC firms learned a painful lesson when the market dived. Blockchain companies built on max potential, but without a solid foundation and proven business models, failed hard.
Conclusion
For crypto firms, attracting VC investment certainly is a tougher game than it used to be, with smaller amounts of cash going around.
But the emphasis on solid fundamentals has led to a knock-on effect here at Plexus. Solid fundamentals require a top-notch team. The crypto market is increasingly mature, and that’s reflected in everything from vastly-improved design to an increasingly sophisticated pool of potential employees.
And according to Euan Wilson, Managing Consultant at Plexus,
A focus on customer acquisition and revenue generating products has led to a greater focus on usability, UX & customer experience. Similar to the traditional tech market 10-15 years ago, I think there will be a new appreciation of the discipline and what “good” looks like from a user perspective.
Projects need top-tier candidates who can deliver user-focused projects to dominate a rebounding market – and to attract VC investment.