In a year that saw venture dollars invested ($33 billion) in crypto/blockchain startups outpace all other years combined, 2021 opened eyes to new opportunities beyond the basics of the market. Venture capital poured into the crypto space at record clip in 2021, but where it was directed changed.
If anything in the nascent world of digital assets can be said to be the “same old same old,” it was that investments typically targeted crypto market infrastructure for trading, holding, lending, and borrowing. Now, NFTs, the metaverse, blockchain gaming, and the concept of Web3 have potentially large total addressable markets that are very appealing to technology venture investors.
“VC firms are always looking for an emergent technology, and even better than a technology is an emergent ecosystem of technologies – and that is what the blockchain offers. Growing demand and interest in crypto assets and blockchain are connected to the evolution of several new application-level ecosystems,” says Alex Thorn, Head of Firmwide Research at Galaxy Digital, a financial platform for a digitally native world.
Clarity around the role for institutional investors
Fueling the demand noted by Thorn is, of course, the growing adoption of digital assets and blockchain ecosystems by users. In addition, as institutional investors now routinely incorporate significant amounts of alternative investments in their portfolios, they are motivated to explore less crowded spaces. To some degree, crypto now plays the role of an institutional risk asset.
“Many institutional funds may not be able to hold liquid crypto assets – doing so may bump against their mandate in general or their LP agreements,” says Thorn. “But they see the potential for large growth in digital assets and related companies, and VC is something they already know, so that’s where the money has been going. Q1 2022 was the largest ever for VC investment in crypto.”
Today’s growing demand for crypto-related assets comes after significant portions of market infrastructure have already been built. Market infrastructure investing in 2021 tended to focus on later stage companies rather than lots of little startups.
“There are more early-stage startups in verticals like NFTs and gaming, but overall current valuations tell us that it’s a founder-friendly environment with significant demand to allocate into fewer deals. That means heated competition among allocators to get into those deals, and that pushes the deal terms in favor of the founders and drives up valuations,” says Thorn. “Right now, it’s very hard to get into deals. Venture firms are having to offer bells and whistles, such as help with marketing and HR, to get a foot in the door.”
More than 40 crypto/blockchain companies raised capital at over a $1 billion valuation in 2021. If even a small number of those companies go public in the next two years, public equity investing in crypto will be energized and more diversified.
“We’re going to see a lot of highly valued private companies go public,” says Thorn. “Today, there is one big exchange, a couple of adjacent companies, and then a bunch of Bitcoin miners. That’s really it. And those adjacents are mostly fintech companies that also do something in crypto. Companies that could go public in the medium term include gaming companies, more exchanges, maybe something in the metaverse, and probably some true pick and shovel endeavors – compliance, accounting, and tax software, for example. An increase in the number of companies in the public equity space that deal directly in crypto assets should interest investors.”
Along with this shift to more public offerings, Thorn sees valuations “normalizing” in the world of digital assets, cooled by inflation and geopolitics. Lower valuations and a lot of capital looking for a home create an intriguing dynamic.
“Private market valuations will lag any kind of public valuation correction, but I still think it will happen,” says Thorn. “Gaming, metaverse, and NFTs are all quite new in the scheme of things. We’ll get more information over the next year as to how durable those businesses are, and that will shape a lot of where investment goes in the future as well.”
Thorn is also taking note of the decoupling of venture capital following Bitcoin’s price on a slightly lagged basis. He sees this as a good development and a powerful statement on the crypto landscape.
“You need people building new stuff and innovating for a technology-driven space to grow and move forward,” he says. “That was a concern for a few years when VC money wasn’t flowing at the tempo it is now, and there was a question of how new ideas to propel new use cases would be funded. Clearly, we’ve broken out of that mode.”
Just as clear is that after initial hesitancy by some institutions about crypto in general, there is now an appetite to at the very least learn more and discuss how digital assets might be a part of their investment strategy.
“A few years ago, one person at an institution might have been interested enough to take a meeting. Now, there are entire teams and committees focused on digital assets at many institutions, and almost all the larger and more innovative thinking ones,” says Thorn.