March 2020 may have been the worst month to be in blockchain-related ventures since February 2014. The last time I had observed so much fear and pain, Mt Gox was going down after months of reported insolvency. Ironically, six years later, another exchange (Bitmex) played just as crucial a role in the price of Bitcoin swaying drastically. We will not be looking at token prices in this piece. We stand at an odd juncture, where there are reasons to be bullish on Bitcoin's price given that halving is round the corner. But the macro-economic backdrop could not possibly look uglier. And that is what is truly in the minds of every founder I know. While venture capitalists may proclaim that they are "open" for business, deal closures announced are the only real measure of what is really going on in the ground. Given that the pandemic's news was out since January 2020, I figured it would be good to look at how funding has panned out today (March 31st) to get an idea of what is going on.
To understand where we stand in terms of the funding spectrum, I began comparing figures from Q1 2016 to Q1 2020. Each of these years is different because risk appetites for blockchain ventures vary depending on where the technology stands in the hype cycle. There is a noticeable lag in the availability of this data, and we may have to wait until Q3 2020 before we have a holistic picture of how the pandemic has affected financing, but based on numbers available as of March 31, 2020, here is where we are.
The Numbers Show What The Tweets Do not.
Q1 2020 has seen more equity raises in the blockchain ecosystem than any previous first quarters. A large part of the reason for that massive $686 million figure is the $300 million that Bakkt alone raised recently. Discounting that, we would be around ~386 million. The same levels of Q1 2018. This is interesting because Q1 2019 came after Bitcoin tumbled to the low $4000 range and a similarly bad macro-economic environment. In some sense, what we are seeing is the unpairing of token prices and investor activity in the space. It does not necessarily translate to a boom for early-stage financing. I believe the picture is rather ugly. To understand why, we need to look at the frequency of funding rounds that happens in the first quarter.
The past quarter saw a ~70 percent drop in terms of deal count. On its own, this is no cause for concern. As the boom and bust cycle within blockchains play out, we will see more early-stage ventures dying. Assuming a high number of ventures were birthed in Q1 2018 in the aftermath of the Bitcoin bull-run of 2017, a large number of them would be shutting shop around now due to the lack of viable business models. But the extent to which it has dropped is a little worrisome and something every founder in the space should be aware of as they speak to VCs for their financing.
Three key observations here. If we are to go by Q1 alone, seed and pre-seed financing has taken a drastic hit in terms of frequency. Seed stage saw a ~65% decline since 2019's Q1. At the same time, there is an extreme surge in the number of Series B's happening. My understanding here is that investors have been fleeing to safety for quite some time. It is not that there are no new ventures in the space. It is the fact that fewer of them are being funded in the early stages. Why is this the case?
- Two years since the rally of 2017, investor appetite for risky ventures without a clear business model has drastically declined. The reason for this is the difficulty in follow on rounds without measurable metrics. A "DeFi" venture cannot raise a series B or C on merits of being "decentralised" alone. It needs to measure up to traditional fintech alternatives. Similarly, NFT startups may raise their first few cheques on the merits of being a gaming or ticketing solution but as the cheque sizes evolve, so do questions around business modelling. The time for experimentation has gone and likely won't return until Bitcoin hits a new ATH
- The lower the price of Bitcoin, the higher the preference for investing directly in the liquid asset with a much lower price point than sitting duck in a token model that may not be planned out for years to come. While IEOs have come and gone, their ability to generate massive wealth for all stakeholders is not yet proven (albeit a bit too early to judge) and based on what we saw in the markets over the last few months, there will be even fewer buyers for tokens for the interim.
Investors have the upper hand at play here. During a bull market where options are few and growth is quick (due to rising public awareness), investors may be willing to agree to a higher valuation. If the tides turn to a recessionary environment, there will be venture capitalists that see prudence in taking longer to see how markets play out. Each additional day a VC gets is an added data point that indicates whether we will see a quick recovery in the public markets or a prolonged recession. The balance is no longer in favour of those building.
Median Raises Make A Fight To Quality Evident
Pre-seed and angel rounds were seeing healthy upticks after the rally of 2017. Investor sentiment and commitment towards the space had indeed not declined drastically on the basis of Bitcoin’s price alone. However, in Q1 2020, we see the exact opposite pan out. There are no angel rounds on record and pre-seed rounds have almost dropped by 50% in terms of amount raised. The underlying sentiment here may have been fuelled by the fact that a pandemic induced risk-off environment may have kept investors away from tying themselves up with too much risk in ventures without proven business models. One of the contributors to the uptick we saw in 2019’s Q1 Angel rounds may have been the surge of IEOs that happened around the time. In Q1 2020, there are no definitive pathways to liquidity. In addition, the two years of learnings that come from investing since 2017 may have made it clear that the paths to product-market fit are few. My reasoning for this is that if we observe the count and median raises at the seed level, we see a marked rise.
Investors are becoming more comfortable waiting it out until teams show their ability to get traction and revenue and entering at a higher valuation with reduced risk. One of the after-effects of this is that we will see certain themes becoming increasingly common. At the same time, high risk, early-stage, almost academic ventures may never proceed beyond their whitepaper. This belief is further cemented by the fact that Series A figures have also gone up substantially. The ecosystem is imitating the sentiments of the broader macro-economic environment. In a period where risk-off is the norm, flight to quality in venture financing would mean backing teams with product-market fit with larger checks.
What Does This Mean For Founders
The harsh reality is that the coming months will be tough, regardless of what VCs tweet. There will be fewer rounds being closed, at lower than preferred valuations and the extent of one's runways will determine who ends up shutting shop or being category leaders. There will be ecosystem funds that run the show for quite some time, but if history is indicative of anything - ecosystem funds have not birthed a unicorn yet. Yes, they keep the show running, but if massive outcomes (in terms of customers) is what a founder's focus is at, then the token grant ecosystem alone may not fuel the next big thing in this ecosystem. What will move the needle will be (i) teams that band together to solve for problems faster (ii) VCs and sectorial experts being more flexible in terms of valuation and remuneration and (iii) startups drastically cutting down on burn rates. There is no time for experimenting and pivots. Dollars spend on anything that does not extend your runway will be dollars wasted.
If as a founder, you speak to 40-50 VCs and do not close a round, it is essential to know that it does not reflect a personal failure. It is tough out there. Fundraising largely depends on macro-economic environment and consumer preferences. At a time when unemployment figures are at its highest in recorded history, users won't be spending on anything that does not go beyond bare minimum survival. There may be a billion dollars parked on exchanges to buy Bitcoin, but those dollars are going to take a long time before they funnel to the average startup. The upside is, the tourists are most definitely going to have to leave this market altogether. As it gets harder to build and sustain in the ecosystem, fewer teams will compete for emerging markets against fewer competitors. Survival of the fittest will become the norm. As venture financing seeks new avenues for risk as the macro-economic outlook becomes better- they will be the ones those dollars flow into. In other words, we are at a point in time where it is simultaneously the worst time to be building a venture (from a financing and userbase point of view) and the best to be competing against peers.
If you are in the early stages of venture building - Outlier Ventures is actively writing cheques and building alongside founders.
Tomorrow, we will take a deeper look at where venture financing dollars for blockchain in Q1 2020 went to understand investor sentiments better.
If you are an investor actively deploying in these environments, I would love to hear from you. Hit me up!