Last year, crypto founders had it easy: all they needed was an idea and a mediocre team that could put together a semblance of a crypto project. Then bam! Startups could raise $10M in seed rounds and notch $100M valuations, even before they had an actual product.
“The VC market for crypto was ridiculously red-hot, and so you saw outlandish valuations, outlandish seed rounds,” Corbin Page, the former head of fintech products at Consensys, told The Defiant.
That world is now a distant memory.
A sell-off in crypto that began late last year turned into a free-fall in May, with bearish investors vaporizing $1.6T in market capitalization over the last six months. The sudden shift has forced crypto entrepreneurs to adapt to a new reality — the days of easy VC money are over.
Venture capitalists that were so quick to cut checks over the past two years are now becoming far more careful when choosing where to invest their money, according to interviews with VCs. Funding rounds that used to close in weeks will probably now take months. Devs won’t land deals with just an idea. They will have to show they have a functioning product that people will pay to use.
“The last two years, I think, the bargaining power was on the entrepreneur side,” SY Chan, a former investment banker and venture capitalist, told The Defiant. “Now, I think that the VCs are getting back the bargaining power, so they should be able to invest on very good terms.”
What’s bad for the many might be good for the few. VCs are sitting on billions of dollars raised during last year’s bull market and they will be under pressure to deploy that dry powder or risk having to hand it back to their investing clients. Company founders with a clear vision, strong track record, talented team, and path to profitability will become even more attractive to VCs searching for promising investments.
“At the end of the day, the capital is there and it needs to be deployed,” Eitan Katz, founder of the Israel-based Diversify, said. “Maybe due diligence is slightly longer. Maybe [VCs] are more picky, maybe valuations are more sane and conservative. … I cannot say that, you know, everything is dry and the sky is falling and we’re in the winter.”
There are signs things are about to get tougher for VCs, too. Clients decreased their investments into crypto funds by 40% between April and May, according to data compiled by Dove Analytics, dropping to $6.8B. Still, VC crypto funding in May was double what it was a year earlier.
It’s important to keep in mind that the crypto crash was sparked by macroeconomic factors, said Lee Smallwood, chief operating officer at venture firm Hivemind Capital, which raised a $1.5B crypto fund last year.
Consumer prices have soared to 39-year-highs in the wake of trillions of dollars deployed by Washington to address the Covid-19 crisis. As a result, the Federal Reserve is raising interest rates and investors are pulling their money from risky assets like crypto and stocks. Russia’s invasion of Ukraine added geopolitical risk into the mix.
Keeping this in mind should bolster the confidence of investors that crypto will work its way through this tough cycle. When it emerges, the market should be largely cleansed of the unsavory projects that have sprouted in the last two years and given the industry a reputation for being a lawless haven for scammers and rug-pullers, according to those who spoke to The Defiant.
‘Hitting the Desk’
The failure of businesses built on shaky foundations should make it easier for more disciplined companies to secure financing in the current lull, according to one founder, who asked not to be identified so as not to jeopardize his own fundraising.
“There’s less of that BS,” he said. “And so it’s easier to stand out for just a strong, quality infrastructure startup like ours.”
Smallwood, who previously ran the digital assets business at Citi, recalled hearing a pitch for a crypto startup that included nothing more than a slide deck. The founder had already raised money that put its valuation at more than $10M.
“And my jaw is hitting the desk, and I’m pulling my hair out because that’s not the fundraising environment that I was exposed to,” he said. “It always comes back to those business fundamentals, right? Are you actually building something that has utility that people want to use and has a demonstrated case for making a big impact?”
This year, Page, the former head of fintech at Consensys, founded a pair of companies, Paymagic and DustSweeper, the latter of which won several awards at the ETHDenver buildathon. He and his team raised money through the first three months of the year “relatively easily.”
But founders and builders he’s spoken to lately have found money much harder to come by.
“So the people that kind of dragged their feet and delayed fundraising are having a much harder time now,” he said.
SY Chan knows this first hand. Earlier this year, he raised $1.5M in pre-seed funding for his startup, Sumeria Labs, a liquidity protocol for NFTs and one of several companies selected for a “DeFi base camp” run by Outlier Ventures and New Order DAO. He had hoped to raise between $4M and $5M in seed funding, but has since preemptively cut that by about $1M.
For entrepreneurs, they may find the priorities of this new era jarring. “We’ve had multiple VCs that won’t even get on a call unless they see that we have a product up and running,” said the founder who asked to remain anonymous.
Meanwhile, investors who’ve already allocated money are telling companies to tighten their belts.
A slideshow presentation prepared by Sequoia Capital and shared with companies said founders should, at a minimum, cut any fat from their companies; better yet, they could start earning more revenue from existing customers.
“The supply of talent has increased, but (founders) have to manage their costs,” Chan said. “The past couple of years, the cost of hiring engineers has increased quite substantially. Especially for us, because we’re a web3 startup, web3 talent is kind of scarce at the moment.”
In this market, some projects are more likely to get attention from investors than others.
“This year, I pulled a lot of money out of the primary market and my focus shifted from dApps to projects more of long-term value – such as web3 infrastructure,” an angel investor who spoke on the condition of anonymity said.
Builders have taken note.
“We are lucky to have an infrastructure project, and that is perceived as something that is more resilient to the market moves,” Katz said. “I think that the investors, the VCs, do understand that we’re still very early and infrastructure is still needed (in crypto). I believe that application projects may have a different experience.”
“If you’re just another, you know, NFT marketplace, or Metaverse-type play, people are really struggling at this point,” he said.
Venture firm a16z recently announced a new, $4.5 billion fund, with $1.5 billion set aside for seed funding. The fund adds to an enormous pool of capital that has yet to be allocated, meaning those with good ideas are “still getting the money,” Page said.
“This is a cycle where people realize that they have to keep focused on their burn rate,” Smallwood said, “on the unit economics, on the things that ultimately will build enduring value and a sustainable business. And I actually think it’s a great time to be building.”