Funding for crypto startups continues to grow more scarce. Venture capital flowing into the industry dropped for the fifth consecutive quarter since Q1 2022 to $2.34 billion globally as investors withhold their checkbooks, fearing risks from a severe regulatory stance and an uncertain economy.
The second quarter’s $2.34 billion tally was raised across 382 deals, according to PitchBook data, but it’s a stark decline from the $12.14 billion peak the industry hit in the first quarter of 2022. The biggest raises during Q2 2023 were LayerZero’s $120 million Series B round and Worldcoin’s $115 million Series C round.
“It’s a numbers game,” said Lydia Chiu, VP of business development at Ava Labs. In general, investors are seeing lower valuations, so they’re writing “smaller checks,” she told TechCrunch+.
This decline in capital deployment could be attributed to regulatory headwinds in the U.S., which have inclined a lot of crypto-related deal flows in Q2 to be structured like traditional venture structures, like raising equity, opposed to token investments or simple agreement for future tokens (SAFTs), Chiu said.
The Tiger Globals and Softbanks of the world aren’t going to invest in everything anymore. Lasse Clausen, founding partner, 1kx
Regulations have certainly stifled optimism around the industry, but there are also a number of other factors at play. A handful of popular crypto companies filed for Chapter 11 bankruptcy protection last year, squelching confidence in the industry, and a few traditional firms and entrepreneurs left the U.S. ecosystem altogether when the market turned. It also didn’t help when investors suddenly adopted a much more discerning approach that valued profits over growth.
According to Chiu, valuations in the industry dropped a stark 50% from the first half of 2022 to the second half of 2022. Since then, crypto startups’ valuations have dropped an additional 15% to the first half of 2023, totaling almost 70% year over year.
That’s a severe decline — startups that raised money in January 2022, for example, would be hard pressed to raise capital again today without taking a steep discount on their price tags.
But it’s not all doom and gloom, and crypto-native founders and investors are not yet giving up hope. “That trend is not necessarily going to reverse, but it may slow down in Q3 or be less severe,” Chiu said.
Indeed, there’s still “a lot of money being deployed,” said Lasse Clausen, founding partner at early-stage crypto investing firm 1kx. “[Funding] looks like it’s down, and it absolutely is, but comparing it to all time highs, those didn’t even make any sense.”
The promise of a better future
In the 2021–22 bull market cycle that saw crypto rising to historic highs, a lot of legacy, more generalist investors got into the space, driven by FOMO and hype. But few of those investors did their homework, Clausen pointed out, which caused the space to become overfunded with exaggerated valuations that were way too high.
“That’s the challenge of this market being so cyclical and momentum-driven,” he said. “There’s so much noise, and it’s easy to paint a picture that everything’s down 90% and this market is dead, but the goal is to find metrics that fight the cyclicality.”
Today, the market has shifted and the traditional players are more hesitant, resulting in fewer investors deploying capital. “The Tiger Globals and Softbanks of the world aren’t going to invest in everything anymore,” Clausen said. “The majority of actors invested in blockchain [follow] — if prices are up, they invest aggressively; if prices are down, they start to rethink theses about the space.”
Now it’s just “the true believers left,” said Vance Spencer, co-founder of Framework Ventures. “It’s those who believe in crypto for the right reasons versus those who were trying it out.”
Several investors feel there might be some breathing room coming in the near future.
While the crypto market is incredibly volatile, Clausen is fairly confident the bottom is in and believes the worst is over for this cycle. “We’re not in a bull market, but we’re not crashing every day,” he said.
The investment landscape also doesn’t feel meaningfully different between Q1 and Q2 this year, said David Pakman, managing partner at CoinFund. “It feels like this half of the year is thematically similar or the same — more non-U.S. projects and higher quality.”
The quality of crypto startups has increased this year compared to the second half of last year, Pakman added. The collapse of crypto exchange FTX and market changes helped “weed out entrepreneurs who were here to get rich quickly,” he noted.
The competition for crypto deals is also way weaker, several investors said. But that’s not necessarily a bad thing.
Overall, the market will be “friendly to the right type of investors and strategies,” Spencer said. “Being liquid is important. Venture is going to take longer and you’re looking for the outliers.” For the right investors, it’s going to be a great market going forward, he added.
That means there’s a “lot of softness” for pricing and room for negotiation in deals, Pakman said.
Regardless, it appears the old venture adage that goes, “Great companies can always raise,” seems to apply to crypto, too, regardless of how the U.S. regulatory system feels about the sector. A lot of projects that have “superstar teams and amazing use cases will always be competitive,” Chiu said. “Deals that everyone wants will continue to be wanted.”
“It’s been a long time of this bear market, and psychologically, it’s not easy,” Clausen said. “We’re left with entrepreneurs who want to build whether they raise money or not. There’s not a lot of people like that, going against the odds and taking risks.”
But in the long-term, Clausen believes the sheer determination of those few founders will pay off.