While the 2021 venture cycle was still booming, every startup sector felt hot. Every geography set records. Founders ruled supreme, venture capitalists lined up to pay steep prices for startup shares, and new business models flourished.
Now, halfway through 2022, we’ve seen a bracing reversion to the mean. Most startup sectors appear to be busier digesting last year’s excesses than attacking the future, while geographic startup investing trends have reversed. Even more, the pendulum of relative power has swung back toward venture capitalists away from founders, startup prices are falling, and some ideas that ruled the roost in 2021 are in disarray.
It’s worth noting that none of this should be a surprise; the business cycle always turns.
But it didn’t turn all at once. Looking back, it appears that the feedback loop between falling public market prices and reduced startup activity first linked up in the software market. The shellacking of SaaS companies on the public markets led to a retreat in investing velocity and price of software startups; something that is still being digested today among upstart tech companies of all maturities.
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Crypto held on longer to its period of cheer. Sure, Coinbase’s stock had seen some of the air come out of its value in the first quarter, but by late March the U.S. crypto exchange was still worth north of $40 billion. Coinbase kept losing ground as April saw its shares commence their current slide, but as recently as May, this column was writing that “no one told the crypto world that startup megadeals aren’t as plentiful anymore.”
The pain of the current downturn set in more slowly in the crypto market, perhaps because the blockchain domain is something of a parallel economy to the one we interact with every day. Sure, they are directly linked, but perhaps not as closely as, say, traditional startups and the Nasdaq.
No matter, the period when crypto companies appeared able to avoid the downturn simply by working on their own vision for the future is over.
Growth, layoffs, M&A
A few weeks back, Coinbase announced that it was pausing hiring to rethink its priorities. That alone was a shock, as the company was busy boosting its technology investments as recently as the first quarter of the year. As the company said in its Q1 earnings report concerning its cost structure:
Technology and development expenses were $571 million, up 24% compared to Q4, and were driven by technical hiring related to our continued investments in product innovation and platform infrastructure.
Even more, the company set a steady tone, saying that it planned to keep spending within reason:
Our outlook for 2022 is largely unchanged. We plan to invest significantly, yet prudently, throughout this year to continue building the future of crypto. While we are navigating uncertain and volatile markets, we have a decade of experience to draw from and will continue to invest wisely to drive long-term growth.
Why? Because the company said that it saw “seemingly endless opportunities” in its market. Coinbase continued:
That’s why it’s as important as ever for us to keep investing across our three strategic pillars — crypto as an investment, crypto as a new financial system, and crypto as an app platform.
We are at a point in our evolution where we need to continue investing to drive growth and help grow our sector. At the same time, we will closely monitor market conditions to ensure we are investing our resources as responsibly and wisely as possible. We took steps to strengthen our balance sheet last year, and while the near term may be choppy, we plan to invest prudently to drive long-term shareholder value.
After announcing a hiring freeze in May, Coinbase said yesterday that it was not only extending its “hiring pause for both new and backfill roles for the foreseeable future,” but also taking the extreme step of rescinding “a number of accepted offers.”
Two things: First, it’s never good to renege on a hiring agreement, just as it is bad to change one’s mind on a signed term sheet. This goes in both directions, from company to employee and employee to company, just as it impacts both startups and investors when it comes to canceling an effectively done deal. The only way to ameliorate the type of action is to be open about it, so we must award Coinbase one point for its candor.
That said, the company’s radical decision to yank accepted offers shows the stress that it is under. And Coinbase is not alone in its suffering. Gemini, another well-known crypto exchange, is cutting around 10% of its staff, and Bloomberg reports that Rain Financial recently laid off dozens.
Of all the companies in the crypto ecosystem, the centralized exchanges were the best understood by non-crypto folks. Their model is simple: Users trade and the exchanges make huge fees from their activity. And the companies proved incredibly lucrative last year, with Coinbase growing from $1.6 billion in Q1 2021 revenue and $771 million worth of net income to $2.0 billion in top line and $1.6 billion worth of net income in Q2. At the time, Coinbase looked like a bloody genius, having ridden out downturns only to get crowned when retail investors turned their attention more closely to the crypto market.
Then the reason why video game companies have long been considered lackluster venture capital bets reared its head. Video games can be highly profitable products. They can also flop and have a tendency to generate uneven revenues over time. VCs, who covet consistently expanding top line that is both predictable and durable, have often proved leery of investing in businesses that can vary so greatly in performance terms.
You can see the connection to the crypto marketplace business: Consumer attention led to growth, and the model kicked out profits for a time. Now, Coinbase is stuck with falling revenues and a cost basis that it likely viewed as a competitive advantage until recently — more spending means more people on staff building a better product. Hence the hiring freeze and just-kiddings for some hires. Other exchanges are also looking to reduce their costs.
The party is over. Not simply because Coinbase is doing its damndest to get its top and bottom lines in sync, but also because Coinbase and similar companies have been hugely active corporate venture capitalists. Coinbase was the most active corporate venture capital player in the world in the first quarter, taking part in a known 37 deals, per CB Insights data. Surely that pace must slow as the company looks to reduce spending, right?
If Coinbase is pulling back on CVC activity, we can infer that its competitors are as well. Competitors like FTX also have active investment arms. In a sense, strong, profitable consumer activity in the crypto space allowed marketplaces to recycle user cash into their own ecosystem in a loop that once drove even more consumer activity. The connection between investment and eventually rising consumer activity — and thus fee-based income — now appears less clear.
So the party is over for technology generally, and crypto in particular. Narrowing our vision, the party is over for crypto in general, and for crypto marketplaces in particular. As marketplaces cut costs, we can anticipate that some of their externally facing work to also slow or halt. That will reduce capital in play and slow the pace of deal-making in the crypto market.
The other side of the business cycle always turning from good to bad in time is that it inevitably turns back later on. Let’s see who makes it to the other end in good shape.