Restoring VC investor confidence will push the crypto revolution forward

One of the most used terms at the end of last year was ‘polycrisis’. The World Economic Forum’s Global Risks Report 2023 uses the term to explain how, “present and future risks can also interact with each other to form a ‘polycrisis’ – a cluster of related global risks with compounding effects, such that the overall impact exceeds the sum of each part”. This has certainly been true in crypto, which has faced its own polycrisis in 2022 – with a series of events impacting the sector and severely testing investor confidence.

One of the knock-on impacts has been a sharp decline in VC funding for early-stage projects. The shift in central banks’ macroeconomic policies to combat inflation worldwide, coupled with the collapse of the UST stablecoin, the bankruptcies of numerous crypto companies, and most notably the second largest cryptocurrency exchange, created a series of Black Swan events on the crypto market, eroding its value and credibility, and brought in the bearish sentiment among investors. While 2022 was a record year in terms of investments in the crypto and blockchain industry (over $26bln, based on Pitchbook data), Q1 2023 recorded just a little over $2.2bln of new capital raised in the sector, sending us precipitously back to 2020 levels. With nearly $100bln raised in 2022 by VC funds specifically targeting blockchain and crypto investments, there is, however, a generous amount of dry powder on the market waiting to be deployed wisely, prudently, and not irrationally hectically.

So how will crypto and blockchain start-ups attract investment now and what should potential backers be looking for in terms of opportunities?

DeFi and consolidation

“History does not repeat itself, but it often rhymes”, claims Mark Twain. Likely, the market will see funding return to areas that were attractive before the tumult of 2022, and smart money is already positioning itself for the beginning of the next bull cycle. The innate usefulness of distributed ledger technology will undoubtedly see blockchain gain traction, with NFTs, gaming-related tokens and the wider Web3 ecosystem plausibly being the winners. 

Meanwhile, major players are continuing to follow suit, with Amazon’s Alexa Fund, the venture capital arm of the tech giant, leading a $20 million Series A-4 funding round for the 3D character studio Superplastic, which creates “synthetic celebrities,” vinyl toys,  coupled with NFT collections on Ethereum and partnered with big brands like Gucci and Epic Games’ “Fortnite.” 

Consideringthe above, the crypto space is about to enter a phase of mass consolidation which has already begun with the remaining solvent players, like Nexo, expressing their readiness to acquire the assets of companies with solvency issues to supply immediate liquidity to their clients and relief to the entire industry.

As a result, we have been through a year where crypto M&A deals have hit a record high, despite the downturn. Where before many start-ups in the digital assets space could rely on healthy investments from leading VC funds, this year has been marked by the growth of acquisitions.

Beyond M&A, the demise of a multitude of crypto exchanges and companies has also significantly shifted the investors’ focus away from centralised exchanges towards decentralised finance (DeFi). Fundamentally, DeFi removes third parties and centralised institutions from financial transactions. As with crypto, it uses blockchain, enabling businesses and customers to conduct peer-to-peer financial transactions without intermediation. DeFi will create secure asset-based crypto lending platforms that have applications in lending, borrowing, trading, and investing.

A meeting of worlds

These platforms will include the ability to transmit money anywhere in the world and deposit funds in crypto wallets, and although DeFi is often seen as an alternative to traditional finance, there is definite potential for the two systems to work in tandem which is the rationale for and endgame of many companies when making strategic investments into these projects. For example, while we at Nexo believe and have invested broadly in DeFi, we began our journey with a CeFi offering that ultimately brings people from regular fiat currencies to DeFi.

We may well see more integration between DeFi applications and traditional financial institutions, as well as the development of hybrid systems that combine the best of both worlds. At Nexo, our recently launched Nexo Wallet empowers users to benefit from this trend, enabling them to create their own Web3 identity, aggregate crypto and NFTs in a single wallet, and trade NFTs.

DeFi applications are still relatively complex but as technology develops and user interfaces improve, we will see a more user-friendly experience that makes it easier for people to access the DeFi ecosystem. Also, an increasing familiarity with distributed ledger technology will help accelerate take-up. Moves by the Financial Stability Board (FSB) to develop regulation for DeFi will add confidence among institutional players, which will in turn improve trust in the technology.

In February of this year the FSB published a report, ‘The Financial Stability Risks of Decentralised Finance’, which confirmed that “TradFi players are beginning to enter the market”. The report states that the FSB will explore how its proposed policy recommendations for the international regulation of crypto-asset activities could be enhanced to take account of DeFi.

Learning from the past and building for the future

The initial coin offering (ICO) craze of 2017-18 was crypto’s first real investment round rodeo. Of course, projects like Nexo that released working, sustainable and profitable solutions after an ICO were scarce (under 10% of all ICOs).  But things have changed. The ICO rush has been replaced by a more traditional approach, where crypto companies are increasingly reliant on conventional venture capital (VC). This not only helps create stability, but it also brings in a higher level of institutionalisation and the expertise inherent amongst traditional VC investors, which sit alongside ‘authentic’ crypto activities such as token generation events (TGE).

Through Nexo Ventures, Nexo’s $150 million Web3-focused investment arm, we take an active incubator role, strategically as well as financially supporting fast-growing  Web3 start-ups, like MetaQuants, a valuation and risk manager for NFT assets, who are at the cutting edge of NFT portfolio management. As an incubator, we provide strategic guidance to MetaQuants’ team and having Nexo become their first client, we are committed to support them on their risk management and upcoming fundraising round.

Looking back through recent history, we can see that after many crises there is a raft of new innovations that can transform the landscape and shape the future. We believe that blockchain technology can radically transform the web, the financial system and money in a way that brings greater freedom, privacy, and prosperity for all. To make this a reality, we need to restore investor confidence and create an environment that gives support to entrepreneurs so they can continue to push the crypto revolution forward.