This article was compiled and organized by BlockWeeks
In the second quarter of 2021, the prices of digital assets such as Bitcoin and Ethereum hit all-time highs, then underwent a significant correction; at the same time, venture capital flowing into crypto startups also set new records, with total funding surpassing the all-time peak just set in the previous quarter, although the number of deals remained below the peak of the first quarter of 2018. The gap between crypto VC valuations and the broader venture capital market continued to widen.
Market first surged then corrected, yet venture capital accelerated against the trend
The crypto market was overall hot in the second quarter of 2021. BTC and ETH respectively climbed to all-time highs above $60,000 and $40,000, with DeFi assets rising even more sharply. Despite significant downward volatility in the latter half of the second quarter, major assets remained at relatively high levels by the end of the quarter.
In the highly volatile market environment, venture capital continued to grow exponentially. The total amount of capital invested in crypto private companies this quarter broke through all previous highs, exceeding $5.6 billion. The quarter-over-quarter change in total investment from the first quarter to the second quarter of 2021 was close to $2.6 billion, the largest single-quarter increase in absolute scale in history.
Entering the third quarter, the market calmed down, with Bitcoin oscillating in the $30,000 to $40,000 range, a drawdown of about 35% to 53% from its all-time high. But since 2016, private investment in the crypto startup ecosystem has often lagged behind Bitcoin price movements, so even if the market remains below the second-quarter highs, venture capital activity is expected to remain elevated. If the bull market resumes, total private investment in the third quarter could even expand further.
A founder's market: fund size becomes a new dimension of competition
This is a typical "founder's market." As the crypto bull market materialized in the first half of 2021, competition in the crypto VC track became increasingly fierce. Against the backdrop of intensifying competition, fund size became another dimension of differentiation for investors: larger funds are less price-sensitive, and thus able to offer better terms and buy larger shares in each round.
The growth in fund size also marks the maturation of the ecosystem. Larger funds mean rising interest from institutional investors; at the same time, as companies grow in size, both the size of individual deals and the number of later-stage deals increase in tandem, and more capital is required to participate in meaningful financing rounds. These crypto-native investors will compete with large traditional late-stage venture capital and private equity growth funds for shares in later-stage companies, whose activity in this area is steadily increasing.
The previous quarter saw the entry or expansion of several large institutions. In the second quarter of 2021, multiple mega-funds completed fundraising, led by Andreessen Horowitz's record-setting $2.2 billion a16z crypto III; Blockchain Capital, ZVC Investment Partnership, and Dragonfly Capital also each completed fundraises exceeding $200 million.
Early-stage investment returns, pre-seed share falls to historic low
The sharp growth in VC financing for crypto startups last quarter made the second quarter of 2021 the quarter with the largest capital deployment in the history of the sector. Nevertheless, the total number of deals remained below the historic high of the first quarter of 2018.
In the first quarter of 2021, for the first time in the history of the asset class, the majority of capital flowed to later-stage crypto companies; the second quarter returned to normal, with most VC capital flowing back to early-stage companies. The massive capital raised by early-stage companies last quarter shows rising willingness to invest in the expansion of the crypto ecosystem, and also reverses the first-quarter trend of capital concentrating in later-stage companies.
Although capital allocated to the early stage grew quarter-over-quarter, the number of pre-seed deals continued to decline, accounting for only 23% of all deals, a historic low; at the same time, the share of later-stage deals continued to climb, reaching a historic high of 13%.
The distribution of investment by stage reflects the cyclicality of the crypto industry: private market activity is often correlated with public market sentiment. The impact of the bull market is also reflected in the continued rise in the number of deals across all stages.
However, although the share of capital flowing to early-stage companies rose this quarter, the share of later-stage deals by number also increased. This dynamic reveals two intersecting trends: the size of individual early-stage deals is growing, and the number of later-stage companies is increasing, both pointing to the maturation of the crypto startup ecosystem. At the same time, new founders have not yet flooded in on a large scale—the continued decline in pre-seed deals is evidence of this.
Valuations highly correlated with Bitcoin price
In the second quarter, both average deal size and valuations broke through historic highs, continuing the broadly sustained upward trend since the first quarter of 2019. Demand for allocation quotas exceeded the supply of investable projects, leading to an increasingly fierce market in which investors compete for shares.
Deal valuations remain correlated with Bitcoin price, a trend that has persisted across recent cycles. Given the large amount of dry powder awaiting deployment, and the fact that private investment often lags public market investment, valuations and investment amounts are likely to remain elevated next quarter even if public markets stall.
Crypto VC vs traditional VC: valuation premium continues to widen
Since the first quarter of 2020, valuations in the crypto sector have been equal to or higher than the broader market. In both the first and second quarters of 2021, crypto valuations experienced explosive growth, outpacing the rest of the market. At the same time, the average size of crypto deals is smaller than the overall average, indicating that crypto companies sell a lower proportion of equity than other companies.
As discussed in the first-quarter report, the fact that industry valuations remain higher than the overall market despite smaller individual deal sizes supports the judgment that "there is excess capital in this sector, thereby creating an environment extremely favorable to founders." As larger funds continue to enter, the situation for investors may first become more expensive, then cheaper.
In the second quarter of 2021, crypto valuations continued to outperform the overall market. Last quarter, crypto valuations exceeded the overall market by more than 50%, compared with a gap of 34% in the first quarter, showing a quarter-by-quarter acceleration. The difference in median valuations indicates that institutional capital is seeking allocation to the crypto ecosystem at a proportion far exceeding other industries. Because median crypto deal size remains slightly below the overall industry even as valuations rise, crypto founders are selling equity more efficiently than the overall market. In short, rising valuations are a signal of a founder-friendly market. As this trend continues, investors (especially large, well-connected, and highly specialized investors) will compete for shares in top startups, while allocators lacking differentiation will struggle to access top founders.
Fund sizes are exploding. Crypto VC funds are getting larger, and the ecosystem is diverging between large and small players. As the competition for shares heats up, fund size provides another dimension of differentiation for VCs: large funds have less elastic demand, and thus can offer better terms and capture larger shares. Large funds also provide additional value-added services, including security audits, design resources, media support and exposure, and recruiting assistance directly or through extensive networks. As prices for later-stage deals rise, large growth equity funds are accelerating their entry into this market.
Cyclicality remains: primary market lags secondary market
Crypto VC remains cyclical. Venture capital is tied to public markets in both scale and deal composition. There are more deals in bull markets, and early-stage companies can obtain capital they might not get in other environments. The second quarter reflected both trends: total investment and deal count accelerated sharply; early-stage investment rebounded from the relative trough of the first quarter and once again exceeded later-stage investment.
However, the number of pre-seed deals continued to decline, indicating that the wave of new founders has not yet arrived. As speculated in last quarter's report, the decline in pre-seed may reflect the growth of new decentralized protocols—whose financing may not be fully captured by the dataset; but the decline may also indicate that the increasingly mature crypto market lacks major infrastructure gaps. The 2017–2018 bull market exposed significant gaps in lending, settlement, brokerage, and other areas, and many founders started companies precisely to fill these opportunities.
Because private markets often lag public markets, and given abundant crypto VC capital, deal counts and valuations (especially for early-stage companies) are expected to remain elevated even if public markets move sideways.
