Crypto slump leaves VCs eying startup bargains, but they're facing tighter pocket books

Crypto venture capitalists are looking around at the carnage in the industry and licking their lips at the deals on offer. The only problem is that it's not clear if anyone will give them money to invest. 

Valuations are down, competition for deal allocation is easing and the crypto market has — at least partially — been cleansed of bad actors, so the VCs say. Yet many Limited Partners, burned from months of crypto freefall, are too fed up to care.  

And as a global banking crisis compounds crypto’s homegrown problems, established venture firms and brand-new teams alike are trying to raise billions of dollars to invest in the crypto sector — an insatiable demand for capital meeting lukewarm supply.  

“Broader appetite for venture is slowing down, yet crypto [VC] firms are raising again, hoping to capitalize on a cheaper market,” said Lior Messika, managing partner at crypto VC firm Eden Block.  

The list of VCs fundraising is long.  

In August 2022, filings showed that former executives from Galaxy Digital and Genesis had set about trying to gather $500 million for a fund named DBA Crypto. Animoca Brands said it would try to raise $2 billion for a metaverse fund in November 2022, before scaling back its target to $1 billion. Hedge fund heavyweight Dan Tapiero is currently trying to obtain $1 billion for a new crypto-focused private equity fund. And The Block reported in recent weeks that Polychain Capital is trying to raise $400 million for its fourth fund.  

New crypto players

As well as these established names, new venture funds are being touted by a diverse array of managers. Mysten Labs CEO Evan Cheng wants to raise over $100 million for web3 venture bets. The hosts of popular crypto podcast and newsletter Bankless are reportedly seeking $35 million to do roughly the same thing. Meanwhile, web3 gaming guild Yield Guild Games is raising $75 million for its first fund, according to a pitch deck obtained by The Block. 

Several other firms have also staged “first closes” of what are, ultimately, supposed to be larger investment vehicles. LeadBlock Partners announced a first close of its $150 million fund in November last year; former Binance strategy lead Gin Chao’s No Limit Holdings announced a first close for its planned $100 million first fund in December; and DeFiance Capital secured “eight figures” of a targeted $100 million liquid token fund last week.  

In short, every man and his (NFT of a) dog wants to raise a VC fund. But, as so often in crypto, there's a debate among potential backers as to whether the current crypto market weakness represents a cyclical trough or the beginning of the end for the industry. 

Still early? 

“It’s a polarized fundraising market for crypto funds now but overall much more difficult than pre Q1 2022,” said DeFiance Capital founder Arthur Cheong, contrasting the attitude of crypto native investors with that of non-expert LPs who had been drawn to crypto during the boom times but are now “almost in full retreat.”   

“We see sophisticated LPs who have been through cycles maintaining their conviction and see this as a good opportunity and timing to deploy to managers that proven themselves in navigating this market,” he said.  

The idea that bear markets are a good time to invest is a core tenet of the crypto psyche. So too in the crypto venture capital scene.  

“Blockchain has a history of going through cycles,” said Ken Seiff, managing partner at Blockchange Ventures. “You’d much rather invest when there’s a rising tide of valuation for a new technology, you’d much rather invest at the bottom of the cycle. But of course investors run at the bottom of the cycle because investors have just lost money.”  

Cyclical bets

A lot of the venture capitalists’ focus in the depths of bear markets goes towards seed-stage startups — which give the best chance of seeing the cyclical bet play out. “When LPs are scared, it’s best time to sign early-stage checks, a proven strategy over and over,” Kenzi Wang, co-founder of Symbolic Capital, said in a recent tweet about how the perception that there is “easy LP money” to be had in the Middle East is nothing but a mirage.  

Seed-stage investing is a good fit for bear markets. The availability of venture capital contracts, in part because some of its biggest distributors disappear. Alameda Research, the failed hedge fund founded by Sam Bankman-Fried, still sits third on The Block Pro’s list of crypto’s most active venture capital investors with 218 deals. Three Arrows Capital is another prominent example of a prolific sprayer of capital that went up in smoke last year. While at large, these types of investors have a distorting effect on the market, inflating startup valuations to unrealistic levels.  

Andrei Brasoveanu told The Block in a previous interview that the crypto VC market in 2021 was “overly transactional,” with backers constantly in “catch-up mode.” Former FTX Ventures lead Amy Wu, as recently as Nov. 5 last year, described how term sheets were often signed within 24 hours during the bull market. She resigned less than a week after making those comments.  

LPs who stick around and back crypto VCs today can expect much better terms for smaller checks, Seiff said.  

Proof-of-returns 

But venture capitalists will still need to persuade LPs that they’re the right group to navigate a sea of seed-stage deals — the majority of which will fail — in an unforgiving market.  

Eden Block’s Messika said LPs have become much more discerning and will look for distributors with “strong Distribution to Paid-In Capital on previous funds, a recognized brand and deep specialization in the market.” DPI is a measure of how much money a VC has sent back to an LP divided by what that LP paid into the fund. Paper gains in the form of locked up tokens or illiquid equity are not factored in. 

If hard returns are the order of the day, venture firms that rose to prominence during the fastest-finger-first climate of the last crypto bull market may struggle. 

“The 2021 vintage is notoriously problematic for many venture funds, even more so in the crypto sector. With private equity reaching record numbers in 2021, crypto-venture firms funded companies at extremely high valuations in comparison to today’s markets,” Messika said.  

“While the best companies successfully raise and scale further, the dramatic decrease in venture funding has led to a very high incidence of companies failing to raise or having to raise at flat/lower valuations. Due to lower funding, valuations have also been lowered across the board and investors today are buying more with their money. Therefore, the performance of many funds that deployed aggressively before the events of last year is expected to be severely impaired compared to other vintages.” 

Disclaimer: The former CEO and majority shareholder of The Block has disclosed a series of loans from former FTX and Alameda founder Sam Bankman-Fried.