PitchBook tips VC investment in cryptocurrency to rebound in 2023

VC interest in cryptocurrency is tipped to bottom out in the first half before rising again. Investor interest could be boosted by regulatory action to improve transparency in the digital currency market.

VC interest in the cryptocurrency sector detonated in the aftermath of the Covid-19 crisis. Company funding hit record levels in 2021 as investors considered the leading role that these cutting-edge currencies could play in our increasingly digitalised society.

Yet VC investment in digital currency start-ups plummeted as 2022 progressed thanks to a flurry of industry scandals that began last spring. The scale of the collapse is laid bare by fresh data from PitchBook.

Between October and December last year the deal count fell to just 345, the venture capital data provider says. This was down almost 40% from levels recorded in the previous quarter. It was also the lowest number since the final quarter of 2020.

Meanwhile, the amount invested by VCs in 2022’s fourth quarter also dropped to its worst figure for two years. At $2.5 billion, this represented a whopping 72% quarter-on-quarter decline.

Another record year for cryptocurrency

2022 still proved to be a record year for crypto start-up investment. But this was thanks to a bumper start in which total of $11.4 billion was spent by VC investors in the first quarter. The number of deals between January and March came in at 917.

For the year, total investment of $26.2 billion beat the all-time high recorded in 2021 by more than a billion dollars. Furthermore, the number of deals rose to 2,541 from 2,490 a year earlier.

Deal sizes increased across all funding stages in 2022, with seed rounds enjoying the highest year-on-year increase, up 53.8%. Early stage and late stage funding rose 50% and 22.2% respectively.

Explaining the downturn in cryptocurrency last year

It’s perhaps no shock that VC funding in crypto crumbled as last year progressed. In fact the scale of the downturn is so severe that it’s been described widely described as “the crypto winter.”

The collapse of algorithmic stablecoin terraUSD fired the starting gun on the panic last May. The fall of the stablecoin — a type of cryptocurrency whose value is tied to a type of asset (in this case the US dollar) — also brought its sister token luna crashing down.

Prices of digital currencies slumped in the aftermath and major cryptocurrency hedge fund Three Arrows Capital went bust shortly afterwards. Fears of a liquidity crisis have continued to sap investor confidence.

A bad year for cryptocurrencies got even worse in November when cryptocurrency exchange FTX filed for Chapter 11 bankruptcy protection. It is estimated that more than one million individuals and businesses have been left out of pocket after what was the third-biggest exchange by volume went under.

Things could be looking up

The last 12 months is a period that the crypto market will want to forget. However, there is optimism in the air that VC interest will improve as the new year progresses.

PitchBook believes that the “market fear, uncertainty, and doubt” that plagued VC activity last year will gradually improve later on in 2023. It says that the funding will bottom out during the first half of the year before recovering.

The data business reckons that investors could become more confident in digital assets towards the end of the year “as we lap 2022’s failures and see more regulations, better risk management, and real-world use cases.”

Interestingly PitchBook notes that “there is meaningful VC dry powder that is earmarked for new crypto startups.” Haun Ventures, CoinFund and Paradigm are a few of the crypto-dedicated VC firms that have decent levels of capital to invest following recent fundraising, it says.

Regulatory action tipped to underpin recovery

So what could prompt a rebound in VC crypto funding in 2023? Well PitchBook has identified improved regulatory clarity has been identified as perhaps a major catalyst for investor appetite.

It notes that “the lack of regulatory clarity has been a constant source of friction for crypto markets since crypto’s inception” but added that “that is starting to change.”

Possible ratification of the European Union’s Market in Crypto-assets Regulation (MiCA) bill could help this along, it says. The legislation — which is expected to be ratified early this year before being introduced in 2024 — will “give industry stakeholders the most comprehensive, clear set of rules to date,” PitchBook says.

Meanwhile in the US, a likely increase in the number of congressional hearings “will help legislators fast-track their understanding of crypto risks and opportunities,” it notes.

These hearings will probably involve industry participants, regulators and people involved in failed crypto businesses, PitchBook predicts. It reckons these could lead to “at least” a couple of bills being passed by legislators this year.

Investors will demand greater transparency

Unsurprisingly PitchBook predicts that VCs will be seeking better risk management and transparency in the cryptocurrency sector in 2023 following last year’s troubles.

It says that “there will be less tolerance for centralized, opaque operating models” and that certain activities like trading, leverage or yield generation will shift to “more transparent decentralized finance (DeFi) protocols.”

Crypto businesses whose products and services have real-world use cases will also be in high demand amongst VCs this year, it predicts. This is because “these businesses should be more sustainable than those that seek only to serve crypto users and other crypto companies.

Interested in the latest crypto valuations? Our Blockchain & Crypto Valuation Multiples report will be updated next month with the latest data.