Crypto Funding Decline Raises Important Questions

Funding for crypto startups has fallen by three quarters in the space of a year. Data from DeFiLlama shows that 2023 H1 funding was just $3.7 billion, less than 25% of the levels seen in H1 2022.

Funding for crypto startups has dropped to the lowest since 2020. The decline is most likely due not only to the brutal bear market, which saw VCs burned with the collapse of FTX and other major organizations in the space, but also thanks to regulatory enforcement and the hostile attitude taken towards the sector by US authorities.

At Odds With Bullish Fundamentals

The low levels of funding do not align with the bullish sentiment and the new narrative that has infused the crypto world, thanks to the entrance of major players like BlackRock and the expectation that a spot bitcoin ETF will be approved. BTC has doubled in price from its bear market low around $15,500.

There may be at least two reasons why funding has not matched this trend.

The first is simply that funding for startups is a lagging indicator. It takes time for that money to filter through into working products, new users, and demand. As the chart above shows, VC interest tends to peak when the market cycle does, following the wider hype.

The second reason is arguably more concerning.

Institutions ≠ Innovation

The news that BlackRock, Fidelity, many, many other huge asset managers are seeking to launch ETFs is bullish for prices, but that goal requires very little innovation. The case for BTC has been made: It's an alternative asset that may serve as an inflation hedge and "Gold 2.0". But the effort these institutions are pouring into getting their applications approved has little to do with the wider blockchain space. Reducing it to its simplest terms, it's about custodying BTC and putting it into a TradFi wrapper, so TradFi processes can extract value from traders and investors.

There may be—and likely will be—second-order consequences. The surge of publicity and interest in digital currencies will bring additional funding and innovation to the wider blockchain sector. And the number of developers working in Web3 has grown 25% since the end of 2021, which is a promising sign.

However, the regulatory headwinds still exist in the US, which is off-putting to VC. While a significant percentage of total investment for Q1 and Q2 did come from the US, there's no question that it could have been more had the SEC not made it its mission to persecute the crypto sector. There are also new technologies coming of age, which are seen to offer less risky returns. Over the past 18 months, venture capitalists have plowed $15.5 billion into AI startups.

A Mixed Picture

Attention is firmly back on crypto after a year in the wilderness. But now, the picture is very different.

It remains to be seen how the decline in crypto startup funding will resolve. There has been a concerted effort to bring an end to the Wild West era for crypto, and TradFi is now firmly leading the charge. While the future is looking bright, there are questions about the lasting impacts of allowing TradFi so much influence over a sector that has traditionally relied on communities and grassroots funding.

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