The primary half of 2022 was turbulent for all markets. The Dow and S&P had their worst first halves since 1962 and 1970. The NASDAQ had its worst quarter since 2008. Bitcoin had its worst quarter since 2011, DeFi TVL ended down 70% from its excessive, and June NFT gross sales slumped to ranges not seen in a 12 months.
A core a part of the crypto market chaos stemmed from the collapse of the $60B Terra ecosystem in Might. This contributed to the implosion of a $10B crypto fund (Three Arrows Capital) that had leveraged publicity to Terra together with a number of different trades that moved towards them (GBTC, stETH). Subsequent, it was revealed that Three Arrows Capital had borrowed closely from a number of the largest centralized lenders in crypto. Unable to recoup these loans, a number of of those lenders had been pressured out of business.
The macro market downturn seeped into the enterprise panorama as nicely.
Enterprise panorama
The broader enterprise market started to point out indicators of cooling in Q1, with whole funding dropping for the primary time since Q2 2019. That pattern continued in Q2, with whole enterprise funding dropping 23%, marking the biggest dip in a decade. The quarter additionally noticed later stage firms like Klarna elevating down rounds; an additional signal of the occasions.
Crypto enterprise funding nonetheless noticed a file Q1, however as we wrote in our final letter, we’d already begun seeing indicators of a slowdown that we anticipated to floor in Q2. Positive sufficient, information from John Dantoni at The Block confirmed that crypto enterprise funding {dollars} decreased 22%: the primary down quarter in two years.
In Q2, Coinbase Ventures continued to rank among the many most energetic traders in crypto, but in addition noticed deal place gradual, with the whole rely lowering 34% QoQ, from 71 to 47. Regardless of the slowdown in comparison with the fervent tempo of late 21 and Q1 22, our Q2 exercise nonetheless elevated 68% YoY; indicative of the general development of our enterprise follow.
The decline largely mirrored the general market situations — with volatility within the markets, we noticed many founders rethink or put their rounds on pause, significantly on the later phases. We’re seeing that many firms are foregoing a fundraise until completely essential, and even then, provided that they really feel assured that they’ll present the expansion wanted to justify a brand new spherical.
Gloomy macro atmosphere apart, there are nonetheless loads of top quality founders elevating on the seed stage, the place we’re most energetic. Wanting past the worth motion on the areas that we invested in exhibits the vary of actual utility that’s persevering with to be constructed and paints a promising image of the long run: one with a vibrant array of Web3 consumer functions, improved UX, strong DeFi markets, scalable L1/L2 ecosystems, and all the instruments builders must construct the subsequent killer app.
Right here’s how our exercise broke down over Q2.
Now, let’s have a look at some themes that stood out. (* denotes Coinbase Ventures portfolio firm)
The approaching period of blockchain gaming
With the meteoric rise and subsequent fall of Axie Infinity exercise, many pundits have been gleefully fast to dismiss blockchain gaming as a passing fad. As we wrote in September, Axie was experiencing a constructive suggestions loop that might flip destructive ought to the fervor driving the sport die down, which is finally what occurred. Regardless, Axie posted practically $1B in gross sales in a single month and attracted 2M DAUs with basically zero advertising and marketing finances. This put your complete gaming world on discover to the ability of this new vertical.
With an estimated 3.2B+ avid gamers on this planet, we strongly imagine that Web3 gaming will onboard the subsequent large wave of crypto customers. Web3 gaming remained a sector of heavy funding in Q2, with The Block estimating that $2.6B+ was raised. Our exercise over the previous few quarters solely strengthens our conviction.
As we noticed in Q1, founders with robust observe information in Web2 gaming proceed to embrace this class. For instance, Azra video games*, was based by the creators of the $1.4B+ cellular blockbuster Star Wars Galaxy Heroes. Their aim is to construct a fight RPG sport with a strong in-game financial system that may nonetheless garner mainstream enchantment. The house has additionally attracted Justin Kan, co-founder of the sport streaming platform Twitch, which was bought to Amazon for $1B. Kan’s new firm, Fractal*, is constructing a market for NFT gaming property.
Corporations like Venly* will add gas to the hearth with a collection of instruments that permit Web2 sport builders seamlessly make the leap into Web3. Established gaming powerhouses are even beginning to come round, with Fortnite creator Epic Video games now permitting NFT primarily based video games into its sport retailer.
It’s going to take a while for this sector to mature, but it surely’s rising more and more clear that blockchain gaming might be a large class sooner or later. Anticipate an elevated deal with sustainable economics and gameplay that infuses NFTs with extra acquainted Web2 gaming experiences.
Rewiring Web2
Past gaming, the subsequent era of Web3 consumer functions are working to upend the captive fashions of Web2 and to provide customers management over their audiences and communities. One firm we’re significantly enthusiastic about is Farcaster*: a sufficiently decentralized social community based by Coinbase alumns Dan Romero and Varun Srinivasan. Their early product resembles Twitter, however with the important thing distinction of letting customers personal the connection with their audiences.
Farcaster is an open protocol, just like electronic mail (SMTP). Whereas Farcaster has constructed the primary social app on the protocol, different builders can construct competing shoppers, identical to we’ve got Gmail and Apple iCloud. When you can’t take your Twitter followers with you to TikTok, somebody may construct a TikTok equal on the Farcaster protocol, and Farcaster customers can take their followers with them to a brand new, differentiated platform. Not solely can customers preserve higher possession of their viewers, but it surely additionally opens the door for extra aligned monetization. The place most promoting spend goes on to Twitter, Instagram, and many others, Farcaster customers with giant followings can monetize their audiences instantly throughout platforms.
One other funding we’re enthusiastic about is Spotlight.xyz*, which sits on the burgeoning intersection of Web3 and music. Spotlight will let musicians create their very own web3-enabled fanclubs / communities (no coding essential), full with token gating, entry to NFT airdrops, merchandise and extra. Spotlight joins different CBV portcos like Audius*, Sound.xyz*, Mint Songs*, and Royal*, all providing musicians new avenues for connecting with and monetizing their fanbases.
All informed, we stay enthusiastic about Web3’s potential to reimagine entrenched Web2 fashions for social media, music, and extra, and finally return energy to creators.
Solana dawn
Noticeable in our Q2 exercise was the continued momentum behind the Solana ecosystem. Whereas Ethereum and the EVM stay king so far as developer traction and suitable apps, we’re noting a transparent pattern in early groups inserting significance on Solana. All in, we did 10 offers constructing on Solana in Q2.
On condition that Solana sensible contracts are coded in Rust versus the EVM’s Solidity, founding groups usually select between constructing in a single or the opposite. More and more, we’re seeing groups decide to help each the EVM and Solana from the onset — like latest additions in Coherent and Moralis. We’ve seen others begin on EVM and decide to totally transition to Solana whereas the above talked about Fractal opted to construct on Solana from the onset.
Add in the truth that a number of giant funds have publicly expressed help for the ecosystem, and it means that Solana’s endurance is actual. Chain liveliness nonetheless (the power for Solana to stay on-line) stays a difficulty that’s paramount for the Solana group to unravel.
The UX of The whole lot
An general clunky and disjointed crypto consumer expertise has lengthy been a hurdle for adoption. Consider what a consumer has to do to execute a typical transaction: convert fiat to crypto, switch crypto to a pockets, bridge crypto to their community of selection, after which lastly execute a transaction.
In Q2, we’ve invested in a number of groups (not but introduced) engaged on streamlining and verticalizing your complete retail transaction journey. Quickly builders constructing in crypto and Web3 will be capable to deploy your complete transaction stack with a number of easy strains of code and normal set of APIs.
The tip consequence might be a future the place, for instance, a consumer can execute a DEX transaction in a single click on. Within the background, fiat might be transformed into crypto, moved to a pockets, bridged to an L1/L2, earlier than executing the swap and custodying the asset of their pockets of selection. All the complexity might be obfuscated away and we’ll have consumer experiences on par with Web2 — a large unlock.
The place are the buidlers?
This quarter we took a have a look at the place the founding groups we’ve invested in are primarily based. Whereas crypto is a worldwide business, considerably unsurprisingly, the biggest focus of our founding groups hail from america — house to 64% of our 356 portfolio firms; all of the extra motive for regulators to foster reasonably than inhibit this quick rising sector.
Singapore has established itself as the bottom of most of the groups constructing in Asia. In the meantime, the UK and Germany are house to rising hubs, with coverage makers proactively working in direction of regulatory readability. We proceed to be impressed by founding groups in India, who we count on to play a serious position in the way forward for crypto adoption (CBV portfolio firm Frontier, with 30 engineers in India has constructed an exquisite mobile-first DeFi aggregator supporting 20+ chains and 45+ protocols).
This quarter, we had been additionally excited to again 5 groups based by former Coinbase workers, together with the aforementioned Coherent and Farcaster, in addition to three others not but introduced. We’re proud to proceed to help workers who obtain a world class crypto training at Coinbase and go on to discovered world class firms and initiatives.
Wrapping up
Whereas there’s loads to be enthusiastic about sooner or later, there are additionally loads of classes to be realized within the current. The present crypto crises is just like these we’ve seen play out in conventional finance. The opaqueness that centralized lenders and Three Arrows Capital operated below resulted in an lack of ability for lenders to correctly consider the chance of their counterparties. Lenders didn’t understand how a lot the others had lent to 3AC, nor did they understand how a lot leverage and danger 3AC was taking up. Buyers didn’t understand how a lot danger they had been uncovered to altogether. When the market moved towards each the lenders and 3AC, lenders had been left with large holes of their stability sheets, and traders had been left holding the bag.
Nevertheless in distinction to the centralized lenders going through insolvency, it’s necessary to notice that blue chip DeFi lenders Aave, Compound, and MakerDAO operated with out a hitch. Each mortgage and its phrases remained transparently on-chain for all to see. When collateralization ranges fell under thresholds, collateral was bought by way of autonomous code and lenders had been paid again. This similar code additionally dictated that Celsius was pressured to pay again $400M in loans to Aave, Compound, and MakerDAO — no courtroom order wanted (although overcollaterization performed a job). All informed, it served as a strong proving level for decentralized finance.
That’s simply to say that it could be straightforward to get discouraged by the present worth motion whereas forgetting simply how far we’ve are available in a brief interval. When the final bear market hit, the most well-liked consumer software was Crypto Kitties. Nowadays, there are extra profound, impactful improvements than we are able to rely. DeFi, NFTs, a wealthy DAO ecosystem, all took place within the final two years, and even got here collectively to make a actual affect on the world stage. In the meantime, layer2 scaling options are lastly right here, and might take us from the dial-up to broadband section, able to supporting a wealthy array of consumer functions with easy UX in addition.
As in earlier downturns, detractors are as soon as once more confidently saying crypto useless. Nevertheless, from our seat within the business, we’re invigorated by the sensible founders we see working tirelessly to maneuver this know-how ahead. As your complete monetary system and world digitizes itself, we stay satisfied that the chance inside crypto and Web3 are far higher than most understand.
