"This has been a very hectic period. It seems like 2021," commented David Nage, Arca's portfolio manager. "Deals in 2021 gave you the impression that you had a gun to your head; the market has somewhat recovered from that feeling." According to Nage, his company recorded around 690 agreements across all phases that happened in Q1, which is roughly 30 to 40% greater than the 2023 lows.

According to Alex Felix, co-founder and chief investment officer of CoinFund, "the crypto venture capital funding landscape was cautiously optimistic in Q1, rebounding from a challenging two-year period of fundraising difficulties for both companies and managers."

Felix noted that there has been a discernible increase in deal-making activity even with a notable year-over-year decline in both venture capital and cryptocurrency financing in 2023—roughly 65%.

However, why now?

The favorable outcomes of Grayscale and Ripple's court victories from the previous year, together with the optimism around decentralized finance (DeFi) on Solana, have contributed to the escalation of the cryptocurrency venture capital scene. Following the SEC's approval of the largest cryptocurrency, the demand for bitcoin ETFs in the United States has also increased.

"The fact that we survived also had an impact on the market," Nage remarked. "I know it's ironic to say this, but we were supposed to die after LUNA, BlockFi, FTX, and the banking crisis, but we survived."

And because of the crypto industry's macro validation, it could not end very soon. According to Mike Giampapa, general partner at Galaxy Ventures, "crypto venture will continue to heat up on the back of a bullish macro backdrop fueled by the launch of crypto ETF products, the BTC halving, and projected rate cuts in the U.S. ahead of the upcoming presidential election." Additionally, institutional interest is beginning to translate into actual funding and goods.

BlackRock, for instance, is launching its tokenized money market fund on the Ethereum blockchain, which may result in more adoptions and competitive pressure from conventional financial institutions.

where business is booming

Deal flow for cryptocurrency startups has generally increased in domains including DeFi, SocialFi, and Bitcoin layer-2 growth. Every week, we close 30 to 40 agreements, which represents an increase of 10% to 20% over the previous quarter. The pace of things is becoming more difficult to keep up with, Nage said.

According to Giampapa, there has been a surge in the number of newly established businesses entering the market as well as those who have been lean during the downturn and are considering financing again. "In 2024, the market will tell a story of the 'haves' and 'have nots,' with many other companies going out of business and newer companies building along popular narratives getting funded at rich valuations," he continued.

In the web3 world, SocialFi, which mostly refers to decentralized social media, is quite popular right now. Decentralized social network protocol Mask Network surpassed $100 million for its fund to help assist other similar applications, while Bi.social just closed a $3 million round. Decentralized social app networks like Farcaster, which are utilizing Web 2.0 strategies to attract new audiences, may be partially responsible for this industry's growth. The market for Web3 gaming is likewise growing quickly, and later this year hundreds of new titles are anticipated to be released.

Blockchain technology, artificial intelligence, and cryptocurrency are all "hot right now," according to Schmidt.

Tekin Salimi, the creator of dao5, stated, "We expect this trend to continue for the foreseeable future, given the grandiose expectations for AI's potential to impact the global economy."

Investors are particularly interested in blockchains that are modular and AI-enabled, such as 0G laboratories, which raised $35 million in a pre-seed round to debut.

Valuations in the founder-friendly market are rising.

According to Salimi, VC competition is fostering an atmosphere where founders have more clout when it comes to financing. As of late, "there is no shortage of hungry money," according to Framework Ventures co-founder Michael Anderson.

According to Marthe Naudts, associate at White Star Capital's Digital Asset Fund, "this is founder-friendly in the sense that, in oversubscribed rounds, investors are now reverse-pitching their value," which means that some investors must convince founders to select them. "With competitive rounds closing out before investors have time for thorough due diligence, founders now have flexibility and can set terms."

Felix, meanwhile, asserts that the power is "perfectly balanced" for both sides and hasn't actually moved from investors to entrepreneurs. "VCs are winning more advantageous and protective deal structures, and founders are benefiting from rounds that are catalyzed with more urgency and valuations ticking up slightly from their recent trough."

Schmidt noted that there is a significant disparity depending on the caliber of the team and industry. While some firms are new, others are going through a re-pricing through a down round or extension. These startups raised money during the last market cycle.

According to Schmidt, pre-seed rounds have valuations of around $10 million for cryptocurrency consumers but as much as $300 million or more for industries like AI and crypto. For example, according to Messari data, PredX, an AI-enabled prediction market, raised $500,000 and had a $20 million post-money valuation. A web3 AI social network called CharacterX earned $2.8 million in a seed round, valued at $30 million after money.

According to Nage, pre-money valuations for seed rounds range from $25 million to $40 million, with some businesses pricing themselves around the $80 million threshold. According to Schmidt, the typical seed investment is between $30 million and $60 million after appraisal.

"Valuations are up significantly, and founders still have plenty of options with others even when larger, more established firms pass on a deal," Anderson stated. "Considering how early in this cycle we are, some of the valuation we're seeing are already a little out of the ordinary."

If investors are forming their expectations solely based on headlines, there are misconceptions about the state of the private market because fundraising announcements are sometimes made several months or even a year after the actual raise, according to Schmidt.

Even for high-quality organizations, raises that would have taken months or never occurred at all last year are now occurring in weeks or less with better conditions for founders, according to Schmidt. "New teams are able to come out of the gate strong with larger raises and higher valuations, but teams that wasted time and money during the bear market are still raising bridge rounds."

As a result, Nage added, there has been a "massive sentiment shift" about the value of cryptocurrencies, with bitcoin reaching all-time highs, Solana topping $200, and ether approaching $4,000.

Since many angel investors and tiny funds are eager to write the first check at the lowest entry points, Felix stated that seed rounds are still the simplest for startups to raise. Nevertheless, the Series A graduation rate has dropped from the upper 20% level to the mid-teens, so I do not expect an instant recovery. Raise a round of capital over $10 million will remain suitably difficult.

While many venture capitalists are aware that they cannot just wait it out on their hands and knees, they are nonetheless striving to exercise caution so as not to get FOMO'd into greater values. According to Thomas Tang, vice president of investments at Ryze Labs, "it is common to see rounds get oversubscribed within days of coming to market and allocations being denied or shifted to subsequent rounds at higher valuations."

Return of the tokenomic

Nage claimed that since the end of 2023, he has been informed by peers and businesses that tokenomic plans for 2024 are being considered. Thus, a number of Arca's portfolio firms are focusing on developing that this year since there is a recent surge in token issuance. He noted that this is a change from the mid-2022 post-Terra/LUNA collapse period, when the majority of seed ventures were financed by warrants or Simple Agreement for Future Equity (SAFE).

Nage stated, "Valuations have shifted violently into this new issuance phase we're entering."

Since they anticipate that the tokens would be sold publicly at a large markup, this dynamic has led venture capitalists (VCs) to accept "lofty valuations in private rounds," Tang added.

Not that SAFE rounds have stopped occurring; rather, Schmidt stated that the market has come to revolve around them in addition to priced equity rounds and token formats "as a way to give teams flexibility, but also investor protection."

In addition, Clay Robbins, co-founder of Colosseum, an accelerator and venture capital firm, noted that it's more difficult for teams building around conventional business models. He continued, saying that generalist investors don't entirely trust in that market yet, whereas crypto-native VCs are strongly leaning that way since they see token transactions and early liquidity behind it.

Naudts stated that it is too soon to tell how well these tokens would function in the long run. Tokens meant to be used as a payment method as well as a speculative asset are something her company, White Star, is wary of. "However, tokenomics models are being experimented with much more here, and the innovation that is taking place is definitely exciting."

Considering the remainder of 2024

According to Robbins, the early-stage investment market will be hot for the rest of the year. I predict it will be inconsistent in the growth stage because of the "relatively anemic IPO market, lack of fundamentals-based underwriting of growth-stage crypto companies, and a (now confirmed) trial between the SEC and Coinbase."

Additionally, April will be a significant month for the sentiment of the cryptocurrency market. There's a lot of concern about how the next Bitcoin Halving, which only happens once every four years, will impact the business. The price of bitcoin has increased in the past due to halving occurrences, however past performance is not always indicative of future performance.

Salimi declared, "We expect the next three quarters of 2024 to be very bullish, while short-term market corrections may be on the horizon." Election years have often seen good advances in the financial markets. Furthermore, we believe that later this year the macro climate will start to improve, starting with interest rate reductions.

And in contrast to last year, a lot of venture capitalists are confident that the market will continue to experience the hyper VC activity it witnessed in Q1 assuming there aren't any significant fraud instances, litigation, or unfavorable regulatory implications. Giampapa stated, "Regulation remains the wild card here and could act as a catalyst for either another leg higher or a brake on growth."

According to Robbins, there may be "frenzy levels of deployment" if there is regulatory progress, genuine on-chain momentum, the introduction of additional institutional-based products, and an overall improvement in the macroenvironment.

"There is going to be increased activity and deal flow, with funds raising capital being the most important factor," Nage stated. Due to the fact that the sector "was a death knell and no interest was out there from LPs," many businesses were unable to seek capital from them last year.

As the market goes past FTX, LPs are also becoming more interested in the area again, but some are also starting to distinguish between "crypto" and "crypto venture," which might lead some to decide to simply allocate to Bitcoin and call it a day for their exposure to the market, according to Schmidt.

But according to Schmidt, conventional venture capitalists and crossover funds haven't "plunged head-first back into crypto, but they're slowly dipping their toes into a few more deals." "I wouldn't be shocked if the market gets even more frothy as those larger players return, cryptocurrency funds return to the market to replenish their capital from limited partners, and the space as a whole gains institutional appeal once more."

In any case, Nage continued, "the sentiment has changed significantly over the last quarter, so as that improves, it should also have positive effects on the venture market." "[Firms] won't hang on to their previous dry powder as tenaciously as they did last year if they can generate money in the following two to three quarters. As it subsides, more checks will appear.

According to Nage, most funds were only closing a few agreements every quarter or one to two deals each month last year. That has shifted significantly. We have completed six or more in December alone. This quarter, Nage was in negotiations for all agreements, all of which had timing constraints.

Felix said that CoinFund concluded four agreements in the first quarter of 2024 compared to 17 deals in 2023.

Based on statistics from PitchBook, the cryptocurrency and blockchain industries raised $10.18 billion in funding last year. When I asked each company how much money they anticipated raising by the end of 2024, the majority expected that it would be in the $10–$20 billion range, although some estimates were higher.

Felix estimates that VC financing for web3 may account for over 10% of total funds received worldwide; based on PitchBook's 2023 fundraising statistics, this might amount to as much as $16.2 billion by year's end. In any case, it is anticipated to fall short of the around $30 billion and over $33 billion that cryptocurrency firms raised in 2022 and 2021, respectively.

According to Robbins, "this market is in between the muted market of last year and the mania of 2021, 2022."

There's a catch: Giampapa believes that many managers would expedite deployments and seek funding in the upcoming six to twelve months. Some of the biggest capital deployers during the last bull market were now-defunct companies like FTX and Three Arrows Capital. "I find it difficult to see how money invested in cryptocurrency venture capital gets back to the 2021–2022 levels without these pools of capital."