I hope you are doing well through the pandemic scare. I recently moved to Dubai. It has been welcoming so far, although I am still in the process of exploring the place. Please send recommendations for good spots and old libraries if you know of any. I need to figure out things to do on the weekend.
For today's piece, I wanted to look at how equity raises in the blockchain ecosystem have evolved over the past year. I intentionally excluded raises made through token sales, debt and grants to understand the behaviour of longer-term investors. A small caveat before we begin: I wrote this piece from the point of view of someone actively deploying money and helping founders raise. So, all of the figures you see here are likely on the conservative side compared to other industry reports. With that out of the way, let's dig in.
$17 Billion Deployed This Year
2018 saw a cumulative $3.7 billion deployed compared to $1.3 billion in 2017 for equity raises. This uptick was partly due to the vacuum left by a lack of market interest in initial coin offerings. In 2019 and 2020, cumulative equity-based raises hovered around $2.7 billion. Guess how much has been deployed so far in 2021? $17 billion! The average day in 2021 saw blockchain-related ventures raise $20 million. The trickle-down nature of this capital explains why we have seen a significant uptick in the number of advertisements in prominent outlets such as stadiums and cricket leagues. However, here's the irony about the whole situation: Although we saw much higher amounts of capital flowing into the space, the frequency of rounds has not increased in the industry.
If the numbers are to speak, 2018 had more equity rounds (1289) than 2021 at 1278. While more capital is coming into the industry, fewer firms are being funded through the year. Seed-stage financing saw a boom in 2017 and 2018 as the industry was still nascent. Venture funds were smaller in size, and naturally, they invested in early-stage organisations. The story of 2021 equity financing is one of that early crop of early-stage financiers getting their exits. As larger venture firms enter the space through acquiring positions in ventures with sufficient traction, early-stage funds will have liquidity and an enormous appetite to deploy capital. There is a gap between when exits occur and when newer capital is deployed. This is more to do with the legalities of practising exits and creating new entities to deploy as a fund. So if the numbers are indicative, we should likely see an explosion in early-stage financing going into Q2 2022. In the interim, however, the market is signalling that early-stage raises for blockchain ventures are as tricky as they have always been. To understand why we dig into the frequency and distribution of capital deployed in ventures over the years.
Trickle Down Effects
Consider the graph below that breaks down frequency and capital deployed into the ecosystem over the years. There is a massive uptick across stages for money deployed in 2021, but Series B and Series C raises have commanded the bulk of it. A jump of roughly ten times from $695 million to $6.692 billion in capital deployed in Series B stages. Series C saw a similar uptick- $421 million to $3.1 billion. Growth stage equity is where the bulk of the capital went this year, but seed and series A raises spiked up roughly five times over the year in terms of amount of money deployed.
That's a lot of numbers, so let me summarise what may be happening:
(1) Larger, well-established funds like Tiger and Sequoia are aggressively entering the stage through late-stage equity. Instead of playing small games, they have built portfolios through deploying large cheques to projects with meaningful product-market fit.
(2) Returns generated on previous investments and public markets in crypto are going back to newer seed-stage financing rounds. So while the frequency (as mentioned above) has remained flat, seed-stage organisations are raising more capital when they manage to raise.
(3) Early-stage raises are still consensus-based. Part of the reason for this is that founders give smaller allocations to multiple funds to build a healthier cap table. So we may be seeing a case of funds taking signals from other funds to co-invest and put together larger raises in the seed stages. This point is somewhat supported by the fact that the size of an average seed raise has risen from $1.5 million in 2020 to $3.3 million this year.
You may refer to this link if you are looking for a better graph that summarises how capital has flowed into different stages over the past few years.
Side note: I had issues embedding that data in the website, so do reach out if you can help me fix it!
This massive influx of capital has changed how venture building has historically occurred within the industry. Founders are often quick to point out that employees increasingly seek higher wages due to gains made through public market trading. We may have hit a new high for how wages in the industry will remain. Because more institutional forms of capital increasingly back early-stage ventures. These organisations will likely have the mandate to burn money for growth. As a result, they will continue to acquire top talent at higher rates regardless of what is happening in the public market. The counter-balance most founders have at the early stages is the possibility of offering equity/token offerings to employees joining the organisation. Explaining that partial ownership of ventures they work on can translate to millions down the road will be crucial for founders to onboard strategic employees. This trickle-down aspect of how capital affects founders applies to service providers such as audit firms and the media. Any service-oriented agency likely sees that they cannot scale human hours exponentially in the face of rising demand without diluting capital. Onboarding and training new employees take time, so naturally, as more founders seek these services, the price they demand will go higher. In such market conditions, it becomes more pertinent for bootstrapped founders to explain their vision if they cannot compete on large paycheques because the opportunity cost is too high for skilled labour in the market. The alternative is to take longer and upskill an early-stage team instead of looking for the best talent. There is a sea of hungry, driven individuals looking to break into the space if founders are willing to be patient and train them. (I really want to explain how DAOs are changing the dynamic here but that is a long article in itself - does not fit in with the vibe of this piece.)
We will dig further into where capital is going shortly – but before that, in case you are wondering, here are the totals for how much has gone in equity financing to different stages over the years.
Where is the money going?
Close to 50 ventures raised north of $100 million in 2021. In contrast, 2018 saw just eight venture raises that had north of $100 million deployed. 2019? Five! Part of the reason for this uptick is that firms take time to mature. One way to think of it is like this: The number of firms that started in ~2015 is likely a small fraction of the number that launched around ~2018. Given three years to find PMF, it is natural that 2021 had a much greater number of organisations raising larger rounds. What I did find interesting is the number of retail-oriented ventures that are now raising significant sums. Historically, blockchain funding was dominated by fintech, exchanges or institutional servicing platforms. That remains the case, with FTX, Celsius, Gemini and Fireblocks being the top ten most significant raises. Also in that mix are Sorare, Moonpay, Forte and Dapper Labs. Each of them is focused on onboarding the next billion users to the digital asset ecosystem. From a founder's perspective, this is a key inflexion point. Much of the capital went towards finance-related startups in the last three years. It will become a common theme for consumer-related founders to transition from traditional ventures to Web3 ones building unicorns. It is the reason why in the previous cycle, we mostly saw finance folks entering the space. In this cycle - it is musicians, artists and gamers. This transition is evident if we observe the venture funds involved in the largest raises.
The table below summarises some of the major investments made by the most significant venture funds deploying money in the space. In each of these cases, the funds mentioned were leads in the round.
As you can see, the crop of investors leading the largest venture raises in the digital asset space are no longer what used to be 'crypto-native' funds. They are traditional, well-established names that usually do late-stage equity with the hopes of delivering an exit through IPOs. To me, this distinctly shows an evolution of the ecosystem. Funds no longer make large investments and hope to make an instant exit on tokens alone. That does occur, but more patient, strategic capital moves in size in the industry now. This gives both the capital runway and time that late-stage businesses will need to establish themselves alongside their traditional peers going forward. Perhaps this is what makes the ecosystem fundamentally different from the 2017 cycle this year. Many individuals have been pointing out that multi-billion-dollar funds that have emerged in the last few months may provide 'support' to asset prices if we see a pullback on prices.
I don't think this analysis holds. These large funds will likely be playing the market in three ways. |
1. Instead of structuring discounted rounds in exchange for discounts (like Sushi) – they will buy assets in the spot market and work with protocols. In this case, the investment will be more similar to private equity.
2. If they deploy to layer 1s, they will complement that investment by supporting applications built on said layer 1. In this case, most new funds will take on the role Consensys did for Ethereum. It is no easy task without a large team and deep pockets.
3. Firms will skip tokens altogether and go the equity route, as you can already see with the large raises that are now trending. That requires patience, appetite for risk and the right network to access equity-based deals. Newer funds have good reason to invest large tickets in projects with PMF with the intent of exiting at IPO. Opensea is a likely candidate for a fund to try this model.
In the event of a full-blown regulator-induced bear market, these pockets of capital may choose to deploy in associated themes such as gaming, social trading, or, I don't know—the same thing VCs have been investing into in the last decade. Mobile applications and food delivery? They may not necessarily rush to buy your altcoins from the spot market. One of the added observations I had in this regard was the amount of capital deployed to each city over the past few years. Regional hubs such as Singapore and London attract money but have roughly half of what San Francisco and New York have drawn so far. Large Indian cities like Bombay and Bangalore are barely in the mix, with a mere $400 million raised by Indian blockchain ventures so far.
In my view, San Francisco and New York lead due to the obvious concentration of talent from both capital markets and technology in the area. The global boom in blockchain related unicorn ventures is not even here yet. There is a good case to believe the next few multi-billion dollar raises for blockchain related ventures will likely be in SEA and Europe given how the capital investment markets there tend to lag in the context of venture capital investments. As investors practise exits in the US (partly through IPOs), and traditional sources of capital in Europe and SEA form appetite to deploy money - they will look for underpriced opportunities in the industry. That is likely when we see other ecosystems ramp up in capital deployed.
So What's Next
Okay, so that's a lot of words and charts, so let me summarise things so that you have the key takeaways.
1. The frequency of seed-stage raises have not increased, but size has roughly doubled. The signal value of early-stage backers matters a lot more now.
2. ~75% of money deployed is concentrated in ~5% of deals this year. The power laws are getting brutal.
3. The crypto funds you see on Twitter are likely not determining the future of this industry at the late stages. The power brokers are slowly becoming the old guards with the human resources and capital required to do multi-billion dollar rounds.
4. We are transitioning towards an era of massive retail adoption of blockchain-based applications. The financialisation of the industry occurred in the past few years. It set the foundations for assets such as NFTs to be owned and traded. Now the users need to be onboarded.
This changes the game in many ways for fund managers and founders in the ecosystem. Earlier, it was 'enough' to understand how a token economy would evolve and do the basics around marketing, exchange listing, and what was perceived to be community building. Early entrants to the industry had little competition, given the risks involved in joining the industry. It is now a 'consensus' move towards Web3 like it was a smart move to build on the internet in the early 2000s. The game changes when a move turns from being risky to consensus. In financial terms, this may be the equivalent of a crowded trade with sufficient momentum for now. Venture building will get exponentially more competitive, including the source of capital that backs these firms. This friction between the old guard and newer entrants is most visible on Twitter when discussing VCs' role in the digital asset space. There is a crisis of identity around whether their sole role is to deploy money in the early stages and take a step back or keep adding value to the point where they are putting in more work than the founders. When players like Tiger Global are deploying money in $4 million rounds for play-to-earn games, you know the industry has evolved, and how you engage with it needs to change too.
In my article on the state of ecosystem funding in Q1 2021, I had hinted at how sectorial expertise will drive returns going into the year. That has indeed been the case.
Funds have been building differentiation with a focus on
1. Access to developers and governance know how- 1kx being an incredible example
2. Geo-specific access
3. Sectorial know-how (eg: building primitives for DeFi and helping them scale)
I think going forward, the biggest opportunities for early stage venture backers will be in cases where they are able to overlap some of these. For instance, a VC fund may not be the best fund to invest in India, but it could have the most know how on how to scale a DeFi primitive within the regulatory landscape of a a region. It may serve you well to draw these Venn diagrams and see where you fit best instead of pursuing every early stage deal because mortality rates for blockchain specific ventures are just as bad, if not worse than traditional startups.
(sidenote: I will release some numbers on that soon)
What about founders? As much as more capital is coming inward, things will only get more competitive. In 2021's frothy markets, being "on the blockchain" could help raise funding — but that may not be the case as the FOMO and burnout settle through the next year. As FOMO drops, capital will dry up, and as individuals come to grips with their burnout, the labor market will have upward repricing. We are transitioning to an era where the most prominent players in specific categories have effectively passed on partial ownership to their communities, Uniswap and ENS being the largest examples. Understanding how to hack growth by accommodating communities in a manner that generates wealth for all stakeholders involved will be the most significant lever for growth in 2022. Don't believe me? Think about why Axie Infinity is the most renowned play-to-earn brand in 2021.
I will see you guys next with a long-form on how mimetic theory forms the basis for most of what we see in web3.
P.s - If you'd like to discuss more about this piece or collaborate on research, join us here
Have a good day
We Need An Editor
I am looking for someone to help with editing and proof-reading research pieces. We have multiple bits of research that needs to go out. I take an incredible amount of time to edit and do a terrible job at it. If you are comfortable helping us churn these pieces out faster, please drop me a link to any of your portfolio and details on how to contact you to firstname.lastname@example.org. Preference would be given for crypto-native individuals. Time spent would be ±10 hours a week, remote and compensated in digital assets of your preference.