Coinbase Ventures Q2 funding memo

Around the Block sheds mild on key tendencies in crypto. Written by Connor Dempsey, sourced from the work and insights from all the staff at Coinbase Ventures & Corp Dev

TLDR:

• Coinbase Ventures deal exercise mirrored the general tempo of the enterprise panorama, down 34% QoQ. Exercise remained up 68% YoY, reflecting the regular progress of our enterprise follow over the previous yr
• Among the many key tendencies noticed, we imagine that Web3 gaming will onboard the following large wave of crypto customers, with skilled founders from Web2 gaming persevering with to pour into the area
• We’re enthusiastic about Web3 consumer purposes working to upend the captive fashions of Web2 and provides customers management over their audiences and communities
• The Solana ecosystem continues to indicate spectacular momentum and developer traction
• Large UX enhancements are coming to crypto that may obfuscate away complexity and ship experiences on par with Web2
• The US continues to be house to the majority of firms in our portfolio, with Singapore, UK, Germany, and India all establishing spectacular innovation hubs
• The place CeFi lenders faltered this yr, DeFi lending platforms had been resilient
• Present value motion apart, we stay satisfied that the chance inside crypto and Web3 are far higher than most notice.

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 yr.

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 couple of different trades that moved in opposition to 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 into chapter 11.

The macro market downturn seeped into the enterprise panorama as nicely.

Enterprise panorama

The broader enterprise market started to indicate indicators of cooling in Q1, with whole funding dropping for the primary time since Q2 2019. That development continued in Q2, with whole enterprise funding dropping 23%, marking the most important dip in a decade. The quarter additionally noticed later stage firms like Klarna raising down rounds; an extra signal of the instances.

Crypto enterprise funding nonetheless noticed a file Q1, however as we wrote in our last letter, we’d already begun seeing indicators of a slowdown that we anticipated to floor in Q2. Positive sufficient, data 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 active investors in crypto, but additionally 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 progress 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, notably on the later levels. We’re seeing that many firms are foregoing a fundraise except completely vital, and even then, provided that they really feel assured that they will present the expansion wanted to justify a brand new spherical.

Gloomy macro setting apart, there are nonetheless loads of top quality founders elevating on the seed stage, the place we’re most lively. 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 purposes, improved UX, sturdy DeFi markets, scalable L1/L2 ecosystems, and all the instruments builders must construct the following killer app.

Right here’s how our exercise broke down over Q2.

Now, let’s take 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 optimistic suggestions loop that might flip detrimental 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 price range. This put all the gaming world on discover to the ability of this new vertical.

With an estimated 3.2B+ gamers on the earth, we strongly imagine that Web3 gaming will onboard the following 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 couple of quarters solely strengthens our conviction.

As we noticed in Q1, founders with robust monitor information in Web2 gaming proceed to embrace this class. For instance, Azra games*, was based by the creators of the $1.4B+ cell 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 area has additionally attracted Justin Kan, co-founder of the sport streaming platform Twitch, which was sold to Amazon for $1B. Kan’s new firm, Fractal*, is constructing a market for NFT gaming belongings.

Corporations like Venly* will add gasoline to the hearth with a collection of instruments that allow 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 based 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 shall be an enormous class sooner or later. Count on an elevated give attention to sustainable economics and gameplay that infuses NFTs with extra acquainted Web2 gaming experiences.

Rewiring Web2

Past gaming, the following technology of Web3 consumer purposes are working to upend the captive fashions of Web2 and to provide customers management over their audiences and communities. One firm we’re notably 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 e mail (SMTP). Whereas Farcaster has constructed the primary social app on the protocol, different builders can construct competing purchasers, identical to we’ve got Gmail and Apple iCloud. Whilst you can’t take your Twitter followers with you to TikTok, somebody might 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 so on, Farcaster customers with massive followings can monetize their audiences straight throughout platforms.

One other funding we’re enthusiastic about is Highlight.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 vital), 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 advised, 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 development in early groups putting 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 assist each the EVM and Solana from the onset — like current additions in Coherent and Moralis. We’ve seen others begin on EVM and decide to completely 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 massive funds have publicly expressed assist 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 staff to unravel.

The UX of Every part

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 alternative, after which lastly execute a transaction.

In Q2, we’ve invested in a number of groups (not but introduced) engaged on streamlining and verticalizing all the retail transaction journey. Quickly builders constructing in crypto and Web3 will have the ability to deploy all the transaction stack with a couple of easy strains of code and normal set of APIs.

The top consequence shall be a future the place, for instance, a consumer can execute a DEX transaction in a single click on. Within the background, fiat shall 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 alternative. The entire complexity shall be obfuscated away and we’ll have consumer experiences on par with Web2 — an enormous unlock.

The place are the buidlers?

This quarter we took a take a look at the place the founding groups we’ve invested in are primarily based. Whereas crypto is a worldwide trade, considerably unsurprisingly, the most important 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 relatively 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 the direction of regulatory clarity. We proceed to be impressed by founding groups in India, who we count on to play a serious function 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 assist 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 discovered 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 incapacity for lenders to correctly consider the chance of their counterparties. Lenders didn’t know the way a lot the others had lent to 3AC, nor did they know the way a lot leverage and danger 3AC was taking over. Buyers didn’t know the way a lot danger they had been uncovered to altogether. When the market moved in opposition to each the lenders and 3AC, lenders had been left with large holes of their steadiness sheets, and traders had been left holding the bag.

Nevertheless in distinction to the centralized lenders going through insolvency, it’s essential to notice that blue chip DeFi lenders Aave, Compound, and MakerDAO operated with no hitch. Each mortgage and its phrases remained transparently on-chain for all to see. When collateralization ranges fell beneath 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 back $400M in loans to Aave, Compound, and MakerDAO — no courtroom order wanted (although overcollaterization performed a job). All advised, it served as a robust proving level for decentralized finance.

That’s simply to say that it could be simple to get discouraged by the present value motion whereas forgetting simply how far we’ve are available a brief interval. When the final bear market hit, the preferred consumer utility was Crypto Kitties. Lately, there are extra profound, impactful improvements than we will rely. DeFi, NFTs, a wealthy DAO ecosystem, all took place within the final two years, and even got here collectively to make a real impact on the world stage. In the meantime, layer2 scaling solutions are lastly right here, and may take us from the dial-up to broadband section, able to supporting a wealthy array of consumer purposes with easy UX as well.

As in earlier downturns, detractors are as soon as once more confidently announcing crypto dead. Nevertheless, from our seat within the trade, we’re invigorated by the good founders we see working tirelessly to maneuver this expertise ahead. As all the monetary system and world digitizes itself, we stay satisfied that the chance inside crypto and Web3 are far higher than most notice.