Nine VCs Discuss Q1 Crypto Funding: Emerging from the Slump, but Not as Strong as the Last Bull Market

Original Title: “Nine crypto VCs on why Q1 investments were so hot and how it compares to previous bull market”

Author: Jacquelyn Melinek

Translation: Luffy, Foresight News

Dragonfly Capital partner Tom Schmidt told TechCrunch that if the cryptocurrency venture capital landscape in 2023 was a pot of cold water, then the first quarter of 2024 is when the bubbles start to form before the water boils.

He was not wrong; according to PitchBook data, in the first quarter of 2024, a total of $2.52 billion was raised in the cryptocurrency and blockchain sectors. This is about 25% higher than the $2.02 billion in the fourth quarter of 2023.

Arca portfolio manager David Nage said, "It’s an unusually busy time now, it feels like 2021. The fundraising in 2021 felt like being held at gunpoint; you had to do it, and that feeling is back." Nage noted that his company tracked over 690 cross-stage financings that occurred in the first quarter, which is about 30% to 40% higher than the low point in 2023.

CoinFund co-founder and Chief Investment Officer Alex Felix stated, "In the first quarter, the fundraising outlook for crypto venture capital is cautiously optimistic; companies have moved away from the fundraising struggles of the previous two years."

Felix added that although venture capital and cryptocurrency fundraising fell sharply year-on-year in 2023 (about 65%), deal activity has noticeably increased.

Why the Recovery Now?

Part of the reason for the warming of the crypto 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, but after the collapses of LUNA, BlockFi, and FTX, and the banking crisis, people thought we would die, but we didn't."

Considering the macroeconomic backdrop, this trend in cryptocurrency may not stop anytime soon. Galaxy Ventures general partner Mike Giampapa stated, "With the favorable macro backdrop of cryptocurrency ETF products launching, Bitcoin halving, and anticipated interest rate cuts before the U.S. presidential election, cryptocurrency investment will continue to heat up." "We are also seeing institutional interest in cryptocurrencies begin to translate into actual action."

For example, BlackRock is launching a tokenized money market fund on the Ethereum blockchain, which could intensify competitive pressure from traditional financial institutions and lead to greater adoption.

Where the Deals Are Flowing

Overall, financing for crypto startups across multiple sectors, from DeFi to SocialFi to Bitcoin L2, is on the rise. "We are seeing 30 to 40 deals a week, which is a 10% to 20% increase from the previous quarter," Nage said.

Giampapa noted that both new companies and established firms that have underperformed during the bear market are beginning to raise funds again. "The market in 2024 will be a story of 'the rich' and 'the poor'; new companies will develop according to popular narratives and secure funding at high valuations, while many others will go under," he added.

Currently, SocialFi, which primarily refers to decentralized social media in the Web3 world, is very popular. Bi.social recently completed a $3 million funding round, and the decentralized social network protocol Mask Network raised $100 million to further support similar applications. Some successes in this field can be attributed to decentralized social applications like Farcaster, which is attracting new audiences using Web 2.0 technology. Web3 gaming is also rapidly expanding, with hundreds of new games expected to launch later this year.

Schmidt said that cryptocurrencies, artificial intelligence, blockchain, and anything related to zero-knowledge proofs "are all hot topics right now."

Dao5 founder Tekin Salimi stated, "Given the enormous expectations people have regarding the potential impact of artificial intelligence on the global economy, we expect this trend to continue for the foreseeable future."

For instance, modular and integrated AI blockchains (like 0G Labs, which raised $35 million in seed funding) have also attracted the attention of venture capitalists.

Founder-Friendly Market

Salimi noted that competition among venture capital firms is creating an environment where project founders have more leverage in fundraising negotiations. Framework Ventures co-founder Michael Anderson said, "Recently, the market has not lacked greedy capital."

White Star Capital digital asset fund partner Marthe Naudts stated, "This is favorable for founders because, in oversubscribed funding rounds, investors are now reverse pitching their value to founders." This means some investors must show founders why they should choose them. "Founders now have the power to choose and set the terms."

However, Felix stated that power has not truly shifted from investors to founders; rather, both sides have reached a "perfect balance." "Founders benefit from more urgent funding rounds, valuations have slightly rebounded from recent lows, and venture capital firms are getting more protective and favorable deal structures."

It is worth noting that there are significant valuation differences based on the quality of the team and the industry, Schmidt said. Some startups that successfully raised funds in the last market cycle are repricing through down rounds or deferred funding, while others are new faces.

Schmidt pointed out that before the seed round, projects in the cryptocurrency consumer space typically had valuations of less than $10 million, while industries like cryptocurrency and artificial intelligence could see valuations reach $300 million or even higher. For example, according to Messari data, the AI prediction market PredX raised $500,000, with a post-investment valuation of $20 million. Additionally, the 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 stated that the average seed round valuation is between $30 million and $60 million.

"Valuations are rising sharply; even larger, more mature companies that have completed funding rounds still have many options," Anderson said. "Considering we are in the early stages of this cycle, some valuations we are seeing are already a bit outrageous."

Schmidt noted that since funding announcements often come months to a year after the actual funding, market participants could misunderstand the current state of the private market if they only judge based on news headlines.

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

The shift in valuations is also driven by sentiment in the cryptocurrency market, as Bitcoin hits all-time highs, Solana breaks $200, and Ether approaches $4,000, which Nage described as a "huge sentiment shift."

For founders, seed round funding remains the easiest, as many small funds and angel investors are willing to write the first check with the lowest barriers, Felix said. "However, I expect the completion rate for Series A funding will not improve immediately; that rate has dropped from over 20% to around 15%. Raising over $10 million will still be quite challenging."

Many venture capitalists are still trying to avoid the trap of overvaluation due to excessive hype while also realizing they cannot just sit back and wait. Ryze Labs investment vice president Thomas Tang stated, "A funding round can be oversubscribed within days, and it is quite common for investments to be rejected or shifted to higher-valued subsequent funding rounds."

Token Economics Making a Comeback

Nage said that since the end of 2023, he has been hearing companies and peers exploring token economic designs for 2024. As a result, there has been a new surge 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 mid-2022 era following the Terra/LUNA collapse, when most seed round deals were financed through Simple Agreements for Future Equity (SAFE) or warrants.

"We are entering a new phase of token issuance where valuations are undergoing dramatic shifts," Nage said.

Tang stated that this dynamic is prompting venture capital firms to accept "high valuations in private rounds because they expect tokens to rise significantly in public trading."

This does not mean that SAFE financing is no longer available; Schmidt noted that the market has centered around pricing equity rounds and token structures "as a way to protect investors while also providing flexibility for teams."

Clay Robbins, co-founder of the accelerator and venture capital fund Colosseum, stated that teams adopting traditional business models are finding it harder to raise funds. He added that crypto-native venture capitalists believe that token trading and early liquidity are the driving forces behind this, so they have a significant bias in this area, while some other investors are still skeptical about this market.

In this regard, Naudts stated that the long-term performance of these tokens remains to be seen. Her company, White Star, takes a cautious approach to tokens that can serve as both speculative assets and payment methods. "But we see a lot of experimentation with token economics models here, which undoubtedly excites us about the innovations within."

What’s Next

Robbins stated that early-stage financing will continue to heat up for the remainder of this year. Given that "the IPO market is relatively weak, lacking fundamental underwriting for growth-stage cryptocurrency companies, and with the trial between the SEC and Coinbase, I expect the situation for growth-stage crypto firms will be inconsistent."

April will be a crucial month for sentiment in the cryptocurrency market. With the Bitcoin halving, which occurs every four years, approaching, there is much uncertainty about how this will affect the crypto industry. Past halving events have driven up Bitcoin prices, but historical data does not always predict the future.

"While a short-term market correction may be imminent, we expect the next three quarters of 2024 to be very optimistic," Salimi stated. "Historically, financial markets tend to make positive progress in election years. Additionally, we expect the macro environment to start improving later this year, first reflected in interest rate cuts."

Compared to last year, many venture capitalists are confident that, barring large-scale fraud cases, lawsuits, or negative regulatory impacts, the market will continue to see venture capital peaks similar to the first quarter in the coming quarters. "Regulation remains an unknown factor that could either catalyze the market to rise again or hinder growth," Giampapa stated.

Robbins indicated that if there are positive developments in regulation, real on-chain development momentum is strong, more institution-based products are launched, and the overall macro environment continues to improve, there could be a "crazy deployment of funds."

"There will be more activity, more deals, and most importantly, funds are raising capital," Nage said. Last year, many companies struggled to raise funds from LPs because the industry "had reached its end, and LPs were not interested."

Schmidt noted that as the industry recovers from the FTX incident, LPs are also starting to return to the space, but some are beginning to differentiate between "cryptocurrency" and "cryptocurrency venture capital," which may lead some to choose to only invest in Bitcoin.

Traditional venture capital firms or crossover funds have not "dove headfirst into the cryptocurrency space, but they are slowly trying more deals," Schmidt said. "As those larger market participants return, cryptocurrency funds are coming back to the market, regaining capital from limited partners, and the entire space is becoming more institutionally attractive again. I wouldn't be surprised if the bubble inflates again."

In any case, the sentiment from the last quarter has changed dramatically, and as sentiment continues to improve, 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 hoard cash like last year. As this situation eases, you will see more checks being written."

Nage noted that last year, most funds only completed one or two deals per month or a few deals per quarter. "Now, the situation has changed dramatically. In December alone, we completed six or more deals."

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

PitchBook data shows that the entire cryptocurrency and blockchain industry raised $10.18 billion last year. I asked each company how much they expect to raise by the end of 2024, and most estimates were above $10 billion, with some even expecting as much as $20 billion.

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

Robbins stated, "The current market situation is between the frenzy of 2021 and 2022 and the lows of last year."

While Giampapa also believes many managers will accelerate deployment and go out to raise funds in the next 6 to 12 months, one thing to watch out for is that in the last bull market, some large capital deployers were companies like FTX and Three Arrows Capital, which are no longer in business. "Without these participants, I find it hard to imagine that the funds deployed into crypto venture capital could return to the levels seen in 2021 to 2022."