AI Is Dampening Crypto Venture Capital Enthusiasm

FTX-like scandals caused VCs to exit, resulting in a venture funding downturn. Now, in an uncertain macro setting, artificial intelligence is absorbing the remaining capital, according to Chris Coll-Beswick of Transcend Labs, a startup accelerator.

The venture capital landscape has unquestionably faced a significant downturn over the past few quarters. Global venture funding has dwindled to nearly half of its 2022 levels, with the remaining focus now shifting towards AI funds. AI has emerged as the undisputed gem in the eyes of VC firms, especially following the turbulence in the crypto market last year.

While AI is on the rise, it’s important to note that the VC market is still far from its robust state in 2021-22. The presence of higher interest rates and an ongoing supply chain shortage has created a less-than-ideal global market environment.

In my domain of startup incubation, I’ve witnessed this transformation firsthand. In the not-so-distant past, investors were more inclined to back ambitious concepts with minimal supporting evidence. However, in the present climate, even the most promising startups face formidable challenges in capturing the attention of top-tier VCs.

According to Crunchbase, “Global venture funding in Q2 2023 plummeted by a staggering 49% compared to the same quarter in 2022 when startup investors poured $127 billion into ventures.”

Furthermore, the overall deal volume has also seen a substantial 37% decline.

“During the last quarter, over 6,000 startups secured funding, in contrast to the more than 9,500 that did so during the same period a year ago.”

The primary catalyst behind this turbulence is the dramatic surge in interest rates, which have surged from nearly zero to a substantial 5.5%. This is a significant concern for investors engaging in riskier ventures. Additionally, the prolonged IPO drought and the dearth of exit opportunities in the market have left investors discontented.

Kevin Colleran, co-founder of the early-stage firm Slow Ventures, an investor in crypto companies, expressed his perspective, saying, “I haven’t written any checks in the past 18 months. I have 30 portfolio companies that I need to help navigate through these challenging times. There’s no point in me contributing to the existing challenges.”

For the crypto sector, the situation appears even more precarious.

In Q2 2023, the entire crypto industry was involved in just 382 deals, amounting to a meager total of $2.34 billion. Compare this to the $12.14 billion seen in Q1 2022, and the contrast is stark.

Crypto and Web3 startups, which excelled in various domains, had raised an impressive $29 billion and $33 billion in two consecutive years, 2021 and 2022. However, since Q1 2022, we’ve observed a consecutive five-month decline in performance.

What caused this collapse?

Following the tumultuous surge that began in 2020, even the most ardent crypto venture capitalists were disheartened by a series of calamitous events in 2022. The failures of Celsius, Voyager, 3AC, Luna/UST, and, notably, FTX, turned 2022 into a veritable nightmare for crypto investors.

FTX’s downfall had the most profound impact, as CEO Sam Bankman-Fried was revered by esteemed VC funds and served as the primary liaison between the new asset class and regulators in Washington. The FTX debacle shattered what little confidence remained in the crypto industry, prompting major investors to seek greener pastures. Notably, heavyweight VCs like Sequoia, which had invested in FTX, are scaling back their crypto investments.

Enter artificial intelligence (AI). AI’s ascent coincided with FTX’s collapse, swiftly filling the void left in the market. Since then, AI has been on an unstoppable trajectory.

AI projects have been securing substantial VC funding rounds, often with valuations that defy easy justification. Generative AI startups alone amassed over $1.6 billion in Q1 of 2023. Companies like Anthropic raised $450 million, while Adept AI secured $350 million. These numbers surged further when Inflection AI alone raised a staggering $1.3 billion in June, sporting a $4 billion valuation.

While AI unquestionably ranks among the most promising frontiers in technology, these figures are nothing short of mind-boggling. Moreover, the recent GPU shortage is diverting much of this capital toward securing computational resources rather than fostering genuine innovation.

VCs invariably chase the hottest trends, and the fervent pursuit of AI, regardless of its sustainability, has come at the expense of the crypto sector.

I’ve observed this shift firsthand. In November 2022, a metaverse startup in my network was on the verge of securing pre-seed funding from one of the top four VCs. However, a week later, following FTX’s collapse, the VC firm rescinded the term sheet.

“This is just one of many incidents that have been taking place since last year. AI has received almost $28 billion so far in 2023 — almost 20% of global VC funding.”

Such incidents have become increasingly commonplace since last year. In 2023 alone, AI has attracted nearly $28 billion in funding, constituting almost 20% of global VC investments.

To circumvent the prevailing apprehension toward crypto, numerous crypto projects are now incorporating AI elements into their core products. Projects like Jada are considerably more likely to pique mainstream VC interest today compared to purely crypto-focused ventures.

In my capacity as the leader of Transcend Labs, I’ve witnessed two distinct outcomes. Some projects successfully innovate and seamlessly integrate AI functionalities, thereby fortifying their core crypto products. Conversely, the majority merely ride the AI trend in hopes of gaining traction, with the AI component often impeding the shift toward decentralization.

So, is there a way forward for crypto founders? Undoubtedly.

Unlike mainstream AI, which is still in its infancy, crypto has been in existence for over a decade. Thanks to the cyclical nature of the crypto economy, we can confidently anticipate renewed innovation and heightened investor interest as the bear market subsides. Factors such as lower interest rates, globalized crypto regulations, approvals for Bitcoin ETFs, and greater participation from traditional finance in the crypto space could all reignite VC inflows.

In the interim, founders should concentrate on stealth-mode development within a close-knit community. Prominent projects like Ethereum and Aave have weathered numerous bear markets and emerged with superior products and user experiences. Other crypto projects can follow suit.


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