Nine VCs Reflect on Q1 Crypto Funding: Rebounding but Falling Short of Previous Bull Market

Tom Schmidt, a partner at Dragonfly Capital, said, “If the cryptocurrency venture capital landscape of 2023 was a pot of cold water, then the first quarter of 2024 is when the water starts to boil and bubbles begin to form.”

According to PitchBook data, the cryptocurrency and blockchain sectors raised a total of $2.52 billion in the first quarter of 2024. This is about 25% higher than the $2.02 billion raised in the fourth quarter of 2023.

David Nage, portfolio manager at Arca, stated, “It's an unusually busy period right now, feels like 2021 all over again. 2021's fundraising was like having a gun to your head, you had to do it, and that feeling is back.” Nage said his firm tracked over 690 cross-stage financings that occurred in the first quarter, which is about 30% to 40% higher than the low point of 2023.

Alex Felix, co-founder and chief investment officer of CoinFund, commented, “In the first quarter, the financing outlook for crypto venture capital is cautiously optimistic, and companies have moved past the financing difficulties of the previous two years.”

Felix added that despite a significant year-over-year decline in venture capital and cryptocurrency financing in 2023 (about 65%), trading activity has clearly increased.

Why is the Primary Market Recovering Now？

One of the reasons for the warming of the cryptocurrency venture capital market is the positive impact of last year's legal victories for Ripple and Grayscale, as well as the positive sentiment towards DeFi on Solana. Additionally, demand for Bitcoin has increased following the SEC's approval of a spot Bitcoin ETF.

“Another thing affecting the market is that we are still alive,” Nage said. “I know it sounds funny to say, but after the crashes of LUNA, BlockFi, and FTX, and the banking crisis, people thought we would die, but we didn't.”

Considering the macroeconomic background, this trend in cryptocurrency is unlikely to stop soon. Mike Giampapa, General Partner at Galaxy Ventures, stated, “With the launch of cryptocurrency ETF products, Bitcoin halving, and expected interest rate cuts before the U.S. presidential election, the investment in cryptocurrency will continue to heat up. We also see institutional interest in cryptocurrencies beginning to translate into actual actions.”

For example, BlackRock is launching a tokenized money market fund on the Ethereum blockchain, which could intensify competition pressure on traditional financial institutions and bring about more adoption.

The Place Where Funds are Pouring In

Overall, financing for crypto startups across various sectors, from DeFi to SocialFi and Bitcoin L2, is on the rise. “We see 30 to 40 transactions per week, which is a 10% to 20% increase from the last quarter,” said Nage.

Giampapa noted that the number of new companies and legacy companies that have underperformed during the bear market and are now restarting their financing has increased. “The market in 2024 will be a story of 'haves' and 'have-nots', with new companies developing around hot narratives to secure high valuations and many other companies going under,” he added.

Currently, SocialFi primarily refers to decentralized social media in the Web3 world, and it's very popular. Bi.social recently completed a $3 million financing round, and the decentralized social networking protocol, Mask Network, raised $100 million to further support similar applications. Some of the success in this field can be attributed to decentralized social app networks like Farcaster, which are using Web 2.0 technology to attract new audiences. Web3 games are also expanding rapidly, with hundreds of new games expected to launch later this year.

Schmidt said that cryptocurrency, along with artificial intelligence, blockchain, and anything related to zero-knowledge proofs, “are all the rage right now.”

Tekin Salimi, the founder of dao5, said, “Given the huge expectations people have for the impact of artificial intelligence on the global economy, we expect this trend to continue in the foreseeable future.”

For example, blockchain projects that integrate modular and integrated artificial intelligence, such as 0G Labs, which raised $35 million in seed funding, are also attracting the attention of venture capitalists.

Founder-Friendly Market

Salimi stated that the competition among venture capital firms is creating an environment where project founders have more leverage in financing negotiations. Michael Anderson, the co-founder of Framework Ventures, said, “Recently, the market is not short of greedy capital.”

Marthe Naudts, a partner at White Star Capital's digital asset fund, said, “This is advantageous for founders because in oversubscribed financing rounds, investors are now reverse-pitching their value.” This means some investors have to show founders why they should choose them. “Founders now have the choice and the ability to set terms.”

However, Felix believes that power hasn't truly shifted from investors to founders but that there is a “perfect balance” between the two. “Founders benefit from more urgent financing rounds, and valuations have slightly rebounded from their recent lows, while venture capital firms are getting more protective and favorable deal structures.”

“It's worth noting that valuations vary greatly depending on the quality of the team and industry,” Schmidt said. Some startups that successfully raised funds in the previous market cycle are repricing through down rounds or delaying financing, while others are new faces.

Schmidt pointed out that, before seed rounds, valuations for projects in the cryptocurrency consumer sector were usually less than $10 million, but valuations for industries like cryptocurrency and artificial intelligence can reach $300 million or even higher. For example, according to Messari's data, the AI prediction market PredX raised $500,000 and had a post-investment valuation of $20 million. Additionally, Web3 AI social network CharacterX raised $2.8 million in seed funding with a post-investment valuation of $30 million.

For seed rounds, Nage expects pre-investment valuations to be between $25 million and $40 million, with several startups having seed round valuations of $80 million. Schmidt said that the average seed round valuation is between $30 million and $60 million.

“Valuations have skyrocketed, and even though larger, more mature companies have already completed financing, founders still have plenty of choices,” Anderson said. “Given that we are in the early stages of this cycle, some of the valuations we see are a bit crazy.”

Schmidt stated that since financing announcements typically come months to a year after the actual financing, if market participants judge the state of the private market based solely on headlines, they would misunderstand the current private market situation.

“Last year, even high-quality teams took months to raise funds or couldn't raise funds at all, but now it only takes a few weeks or even less time, and the terms for founders are also better,” Schmidt said. “Teams that wasted time and money during the bear market are still in transitional financing, but new teams can start strong with larger funding amounts and higher valuations.”

Valuation shifts are also driven by the sentiment in the cryptocurrency market, with Bitcoin hitting historic highs, Solana breaking $200, and Ethereum approaching $4,000, which is a “huge sentiment shift,” Nage said.

For founders, seed round financing is still the easiest, as many small funds and angel investors are willing to write the first check with the lowest threshold, Felix said. “However, I don't expect the completion rate for Series A financing to improve immediately, which has dropped from over 20% to around 15%. Raising more than $10 million in financing will still be a quite challenging task.”

Many venture capitalists are still trying to avoid falling into the trap of overvaluation due to excessive hype, while also realizing they cannot just sit back and wait. Thomas Tang, the Vice President of Investments at Ryze Labs, said, “Financing rounds being oversubscribed within days, and investments being rejected or shifted to higher valuation subsequent rounds, is quite common.”

Token Economy Makes a Comeback

Nage said that since the end of 2023, he has been hearing that companies and peers are researching the token economic designs for 2024. As a result, there has been a new growth in token issuance, with many of Arca's portfolio companies striving to achieve this goal this year. He added that this is different from the period after the mid-2022 Terra/LUNA crash when most seed round transactions were funded through Simple Agreements for Future Equity (SAFE) or warrant financing.

“We are entering a new phase of token issuance where there is a drastic shift in valuation,” Nage said.

Tang stated that this trend leads venture capital firms to accept “high valuations in private fundraising, as they anticipate significant appreciation of tokens in public trading.”

This doesn't mean there is no longer SAFE financing, Schmidt said. The market has evolved around priced equity round financing and token structures, “as a way to protect investors while also providing flexibility to the team.”

Clay Robbins, the co-founder of accelerator and venture capital fund Colosseum, said that for teams adopting traditional business models, fundraising is more challenging. He added that crypto-native venture capitalists see token trading and early liquidity as the driving forces behind it, leading to a significant bias in this direction, while other investors are still skeptical of this market.

On this point, Naudts said that the long-term performance of these tokens remains to be seen. Her company, White Star, is cautious about tokens that can be used both as speculative assets and as a means of payment. “But we see a lot of experimentation with token economic models here, which undoubtedly excites us about the innovation within,” she added.

What Will Happen Next？

Robbins indicated that early-stage funding will continue to heat up for the remainder of the year. Given the “relatively soft IPO market, lack of fundamental underwriting for growth-stage crypto companies, and the trial between the SEC and Coinbase, I expect the situation for growth-stage crypto firms to be inconsistent.”

April will be a crucial month for the sentiment in the cryptocurrency market. With the Bitcoin halving, which occurs once every four years, looming, there's a lot of uncertainty in the crypto industry. Past halving events have propelled the price of Bitcoin upwards, but historical data doesn't always predict the future.

“While short-term market adjustments might be imminent, we expect the next three quarters of 2024 to be very optimistic,” Salimi said. “Historically, financial markets tend to make positive progress in election years. Additionally, we anticipate the macro environment to start improving later this year, initially reflected in interest rate cuts.”

Compared to last year, many venture capitalists are convinced that the market will continue to see the high of the first quarter in the coming quarters, barring any major fraud cases, lawsuits, or negative regulatory impacts. “Regulation remains an uncertain factor that could either be a catalyst for the market to rise again or hinder growth,” Giampapa stated.

Robbins said that if there are positive developments in regulation, strong momentum in real on-chain developments, the introduction of more institutional-based products, and continued improvement in the overall macro environment, we might see a “frenzy of capital deployment.”

“There will be more activity, more transactions, and most importantly, funds are raising capital,” Nage said. Last year, many companies couldn't raise funds from LPs because the industry had “reached its end, and LPs were not interested.”

Schmidt said that as the industry recovers from the FTX incident, LPs are beginning to return to the field, but some are also starting to differentiate between “cryptocurrency” and “crypto venture capital,” which may lead some to only invest in Bitcoin.

Traditional venture capital firms or cross-border funds didn't “plunge into the cryptocurrency field headfirst, but they are slowly trying more transactions,” Schmidt said. “With those larger market participants returning, cryptocurrency funds re-entering the market, and raising capital again from limited partners, the entire field is becoming more institutionally attractive. I wouldn't be surprised if the bubble intensifies again.”

In any case, the sentiment has undergone a huge change in the last quarter, so with the continuous improvement of sentiment, it should also have a positive impact on the venture capital market, Nage added. “If companies can raise funds in the next two to three quarters, they won't hold onto the funds like last year. With this situation easing, you will see more checks being written.”

Nage mentioned that last year, most funds conducted only one to two transactions per month or several per quarter. “Now the situation has changed drastically. In December alone, we completed six or even more transactions.”

In contrast, CoinFund completed 17 transactions in 2023 and 4 transactions in the first quarter of 2024, Felix said.

According to PitchBook data, the entire cryptocurrency and blockchain industry raised a total of $10.18 billion last year. Several companies expect the industry to raise over $10 billion by the end of 2024, with some even forecasting up to $20 billion.

Felix believes that venture capital investment in Web3 could account for more than 10% of the global financing total. Therefore, based on PitchBook's 2023 financing data, this number could reach as high as $16.2 billion by year-end. In any case, this figure is expected to be lower than the nearly $30 billion raised by crypto startups in 2022 and the over $33 billion raised in 2021.

Robbins said, “The current market situation is somewhere between the frenzy of 2021 and 2022 and the downturn of last year.”

While Giampapa also believes that many managers will accelerate deployment and fundraising in the next 6 to 12 months, there is one thing to be cautious about. In the last bull market, some of the largest capital deployers were companies like FTX and Three Arrows Capital, which have since gone out of business. “Without these participants, it's hard for me to imagine the funds deployed into crypto venture capital returning to the levels of 2021 to 2022.”