Institutional Top-of-Mind #16

Keep up with the top industry updates as we present bi-weekly market insights that are valuable to traders in the institutional space.

In this week's edition, Kelvin Lam, CFA, Institutional Research for OKX, analyzes the recent trends in crypto venture funding and explores what the data suggests about the sustainability of current cryptocurrency market valuations. Despite new all-time highs for Bitcoin, venture capital investment remains well below previous peaks. This divergence between funding activity and price appreciation raises key questions about current market valuation.

TL;DR

• The crypto venture funding market has seen renewed interest, with the total amount exceeding $1 billion for two consecutive months – the first time since late 2022. The capital has been primarily allocated to three key sectors: crypto infrastructure, GameFi, and decentralized finance (DeFi). Leading the charge are investors such as OKX Ventures, making significant investments across these areas.

• Historically, there's been a strong correlation between the total market capitalization of cryptocurrencies and the amount of funding raised by crypto ventures. However, the current data suggests a disconnect compared to trends observed three years ago. This divergence could be a critical factor in determining whether the current valuation of the cryptocurrency market is sustainable.

• Looking ahead, the crypto venture funding outlook will be shaped by a mix of headwinds and tailwinds. The prevailing high-interest-rate environment and venture capitalists' preferences could pose challenges. Meanwhile, the increasing involvement of institutional investors, particularly in emerging areas like real-world assets (RWAs) and decentralized physical infrastructure networks (DePINs), can serve as a positive catalyst for the industry's long-term growth and development.

Unveiling the latest crypto venture funding market

The recent headlines on crypto venture capital funding are encouraging. In April 2024, the funding amount exceeded $1B, marking the first time since late 2022 that the crypto industry has seen two consecutive months of funding surpassing this milestone. This data shows a positive indication of sustained investor interest in the crypto industry.

Out of the total $1.02B raised in April, it was distributed across 162 investment rounds, slightly lower than the $1.09B recorded in March from 186 rounds. Despite the slight decrease in the number of rounds, this still represents a significant improvement in funds raised. Notably, the venture funding market has experienced a period of cooldown, with a monthly average of $780M over the past 15 months. Therefore, this recent surge in funding showcases a positive shift and renewed confidence in the crypto industry.

Source: Rootdata, May 9 2024

Looking into the categories of projects that received funding between March and April 2024, we observed that the majority of capital was allocated to three key sectors. Crypto infrastructure projects received an impressive $664M, followed by GameFi projects with $158M, and decentralized finance (DeFi) projects with $125M.* From an investor perspective, OKX Ventures emerged as one of the leading investors, making 30 investments across different sectors in the first quarter of 2024. They were closely followed by Cypher Capital and Cogitent Ventures.*

In addition to the funding provided by crypto-native venture investors, we have also witnessed traditional financial giants entering the scene. Securitize, a platform specializing in tokenizing real-world assets, successfully secured a $47M investment round. BlackRock led the investment, with contributions from Hamilton Lane and Tradeweb Markets.** This signals a notable shift as these traditional investors begin to invest in and drive innovation across the blockchain ecosystem.

*Source: Rootdata, Apr 29 2024

**Source: The Block, May 1 2024

The link between crypto venture funding and market prices

Looking at the chart below, there's a strong correlation between the amount of funds raised from crypto ventures and the market cap of both Bitcoin (BTC) and the overall cryptocurrency market. The correlation between venture funding and crypto market performance reflects the growing willingness of institutional investors to commit substantial capital to this still-nascent crypto space, as venture capitalists serve as key indicators of institutional interest and confidence. Examining the previous bull cycle, the market cap of Bitcoin and the cryptocurrency market reached their peaks during the same period when the quarterly funds raised also reached their highest point in the fourth quarter of 2021.

Meanwhile, it's noteworthy that the market cap of altcoins (represented by the white line) has exhibited robust growth and surpassed that of Bitcoin (represented by the red line) during periods characterized by significant fund raised amounts in the previous bull market. This phenomenon is commonly referred to as the "altcoin season," when numerous new projects secure funding, list their tokens, and experience relatively high valuations during the market cycle.

In 2023, the cryptocurrency market rebounded from the lows of the previous period, with both Bitcoin and the broader crypto assets rallying throughout the year. However, a divergence became apparent - while the market valuations were soaring to new heights, the crypto venture funding landscape remained relatively sluggish, only gaining significant traction until Q4 2023.

This market paradox becomes even more intriguing when we examine the funding dynamics in greater detail. Despite Bitcoin reaching a new all-time high in the first quarter of 2024, the magnitude of venture funding during this period was merely a fraction, amounting to approximately one-fourth of the levels witnessed at the peak in the fourth quarter of 2021.

The disconnection between the two poses a critical question: is the current market valuation sustainable, or is it being propped up by factors that may prove temporary? While the approval of spot Bitcoin ETFs and the Bitcoin halving narrative have unarguably contributed to the strong Bitcoin rally, the current market valuation may need to find a new equilibrium. The question remains whether venture funding will finally start catching up to the current market prices, or if the valuation is at risk of a correction.

The outlook for crypto venture funding

The venture funding outlook is highly governed by the prevailing interest rate environment, also known as the cost of financing. The current high interest rate regime isn't helping, with the 10-year Treasury yield hovering around 4.5% – a significant 3.5% increase from the beginning of 2021. The future path of interest rates, heavily influenced by the Federal Reserve's policy decisions, is a critical factor shaping the funding outlook. With a record $6T in "cash on the sidelines" according to Morningstar, the amount of venture funding available can be highly sensitive to the interest rate environment.

On the crypto-specific front, cryptocurrencies have been voted the most overinvested area of technology in PitchBook's 2023 VC Tech Survey. Meanwhile, the rise of the AI sector compared to 3 years ago has introduced additional competition for venture capital. Investors are playing more cautiously after navigating the 2022 crypto winter, as evidenced by smaller average ticket sizes per funding round (refer to Rootdata's crypto funding table above).

Even so, there are some positive catalysts on the horizon. The industry is welcoming more institutional involvement, particularly in areas like real-world assets (RWAs) and decentralized physical infrastructure networks(DePINs). These sectors are bringing blockchain technologies to real-world use cases, potentially viewed by institutions as strategic investments into the infrastructure side to boost productivity and drive future value creation. As the crypto venture funding landscape evolves, traders will need to closely monitor macroeconomic and industry-specific trends to gauge the broader market outlook.