Some crypto startups were already scrambling to raise money. The coronavirus made their struggles worse

The global pandemic has put the flow of venture capital on ice, a situation that is impacting early-stage crypto startups especially hard.

"Within the past week and a half, we have three VCs that pretty much we are in final stage of due diligence with come back and say, look it's not you, but we are not deploying capitals within six months given what just happened in the market," early-stage crypto onramp startup Yellow Card CEO Chris Maurice told The Block.

Although the full effect of the virus is yet to manifest, the number of reported deals globally in 2020 already dropped by almost half from the same period last year, according to Crunchbase data.

The broader crypto ecosystem is proving to be no exception. Since the beginning of the year, a total of 125 venture deals in blockchain and cryptocurrency startups have been reported, which is just slightly over half of what was announced in 2019 (326 deals) or 2018 (363 deals), per PitchBook data. Prior reporting by The Block also showed that the pandemic stalled fundraising efforts for some major Indian exchanges. 

To a certain extent, the crypto space is particularly sensitive to the venture funding slow-down, since most crypto startups are early-stage companies sustained by small VC checks that were doled out one or two years ago.

According to PitchBook, approximately 87.7% of the total funding rounds from 2017 to 2019 have a disclosed size of less than $5 million,  while many deals were closed in 2018 and 2019 with no follow-up rounds.

By this point, some of those crypto firms have burned through most of their funding. As such, they either need to raise new funds or face the danger of bankruptcy and closure.

Indeed, news of closed venture deals and companies looking to fundraise in crypto piled up over the first three months of 2020. Those deals range from Amber's $28 million Series A from backers such as Coinbase Ventures and Pantera to the $900,000 small checks for two early-stage agricultural startups. 

Meanwhile, other companies have reported shutting down (Sparkswap and Paradigm Labs), claiming that a lack of capital or user traction was the main cause of their demise.

As Outlier Ventures' Jamie Burke noted: "By the end of last year the number of VCs investing in anything crypto-related, particularly in Europe (and even the US) had dramatically reduced."

"This is the epitome of a Black Swan which has side-blinded an already struggling crypto industry," he said.

First victim – DeFi? 

In terms of which sector in crypto might take the biggest hit, existing evidence suggests that decentralized finance (DeFi) – a nascent ecosystem that is still largely in an experimental phase – may be one of the first victims claimed by the funding freeze. 

As previously reported, the DeFi sector, in general, suffers from the lack of a clear path to profitability, as it struggles to balance between decentralization and revenue generation. Even before the pandemic, those who couldn't generate user traction have already lost investor interest.

For example, Paradigm Labs, a liquidity aggregation protocol for decentralized exchanges, successfully raising a seed round in 2018. However, it failed to identify product-market fit in the evolving decentralized exchange landscape and shut down recently, according to the company's founder Liam Kovatch in a blog post. 

In a recent interview with The Block, Pantera Capital's Paul Veradittakit also warned that deals in DeFi could slow down as VCs become more selective about the sectors in which they choose to invest.

"A lot of DeFi projects, either they don't have too many users or it's really hard to monetize. We have been brainstorming on how they can either make a transition or do something else that can generate a revenue source. A couple of teams have been asking us," Fenbushi Capital managing director Peter Yang told The Block.

However, not all DeFi projects are tightening their belts to survive the current environment. Some with healthier balance sheets might be in the mood for some shopping.

Zerion, a platform for tracking different DeFi protocols, recently acquired MyDeFi, which offers a similar service. The former raised $2 million from Placeholder, Blockchain.com Ventures, and Gnosis in December, which leaves the company with a more comfortable runway and some additional cash for acquisition.

"We currently have quite a bit of runway and we're holding on cash for investment… So that allows us to be a bit more opportunistic," said Zerion CEO Evgeny Yurtaev.

Although some DeFi projects may be struggling to obtain funding, Yurtaev noted that the space as a whole was able to retain user and developer interest, leaving possibilities open for startups to generate traction.

"I think people who are building in DeFi, people who are heavily invested in DeFi, they didn't lose interest. So it's mainly the influx of people for the short-term will probably decline," he said.

Narrative shift 

While some startups are settling for smaller checks and lower valuations in their funding rounds to weather through this difficult time, others are worried about long term survival. Such concerns center around whether to tweak their products to fit into a post-pandemic world that brings different tech narrative and shifting investor interests.

"What some of the conversations we've been having with investors is, look, there's money to be made when you've got massive change. And rather than a slow evolving market, you're going to see massive amounts of compression and pent up demand and then a release. That's the change in our market and we want to be in a position to accelerate out of that," said Justin Banon, who runs an Ethereum-based voucher redemption platform Redeemeum.

The urge to carve out a narrative that will suit a post-pandemic climate is especially imminent for crypto startups, according to Yurtaev, since bitcoin's price fell alongside other asset classes had already driven some potential investment interest away.

"What's definitely going to be more complicated for them [DeFi projects] is future fundraising because crypto didn't prove that it's like this uncorrelated asset as a lot of people wanted to be so potentially a lot of like the other companies got more thinking about putting more money into the assets or DeFi," he said.

Not all hope is lost

While some investors have chosen to keep a low profile during the market turmoil, others have decided to step forward.

An open-source spreadsheet has been circulating between investors and founders, which lists over 250 venture capital firms that are still accepting pitches, including Accel, Index Ventures, Kindred Capital, and Techstars. Most of the firms on the list said they are looking to back early-stage startups, with some disclosing that they made their last investments as recently as last Friday.

Additionally, as The Block's Frank Chapparo recently pointed out, a number of crypto VCs, such as a16z and Polychain Capital, have recently finished fundraising or have been sitting on a pile of cash. As the market downturn squeezed startups valuations, they are ready to deploy that dry powder.

However, venture funding, M&A and even company shutdowns are events that take a long time to conclude and may not occur in the public eye. In fact, some deals that were closed prior to the market downturn were only recently announced. Therefore, what's being seen now might just be the tip of the iceberg.

As such, Burke said he expects many startups to "break-even next quarter and become profitable within 6 months" in order to survive the virus and its aftermath.

"Crypto startups are going to find it hard, but good startups are good startups," he told The Block.

Editor's Note: Pantera Capital is an equity investor in The Block.