Monday, February 08, 2021 / 06:00
PM / by James Thorne of PitchBook / Header Image Credit: iStock
Coinbase Ventures launched in 2018 on the heels of an unprecedented boom-bust cycle for bitcoin, which saw the currency's price peak at nearly $20,000 before losing half its value in a little more than a month.
As a cryptocurrency trading platform, that short-lived frenzy was good for Coinbase's business. But the decision to launch a crypto-focused VC firm had less to do with the price of bitcoin than what the market fervor meant for entrepreneurs.
"We recognized in early 2018 that there were a ton of new startups that were leveraging blockchain technology," said Shan Aggarwal, the fund maestro Coinbase hired from Greycroft.
Coinbase Ventures believed that it would benefit in the long run by investing in the ecosystem, Aggarwal said. Soon, the firm would become one of the industry's most active investors, with deals backing game maker CryptoKitties, stablecoin startup Terra and crypto exchange Bitso.
Coinbase Ventures was part of a phenomenon that has repeated since the first bitcoin was mined a dozen years ago. Whenever the price of the world's best-known digital currency has hit new highs, firms have stepped up their investments.
Blockchain startup deals gain momentum after bitcoin rallies
Long after the bitcoin buying frenzy subsided in early 2018, VC investors continued to pump money into cryptocurrency and blockchain startups. In 2018, such financing rounds totaled $2.8 billion across nearly 400 deals, the highest on record, according to PitchBook data. A similar phenomenon followed a smaller bitcoin price rise in mid-2019.
Andreessen Horowitz's Chris Dixon has dubbed this the "crypto price-innovation cycle." It works like this: Bitcoin and other digital coins rise in value, sensational news reports follow, entrepreneurs and developers take an interest, and venture capitalists invest in them.
For the past month, bitcoin has managed to trade above $30,000. How long that will last and what the impact might be on startups is unclear, but investors are hopeful that history will repeat itself.
"We're going to see a lot of entrepreneurs coming into the space," said Paul Veradittakit, a partner at blockchain investor Pantera Capital.
Already, momentum appears to be building. The recent spike in bitcoin has coincided with the strongest quarter for cryptocurrency and blockchain startups since the end of 2018, totaling $702 million in Q4 2020, according to PitchBook data. Since October, the price of bitcoin has more than tripled, from less than $11,000 to more than $37,000 as of Friday.
Because the products of many blockchain startups are tied to the value of cryptocurrencies, the rise of bitcoin, ether and other coins can directly improve the outlook for those startups, Veradittakit said.
Traditional VC firms appear keen to increase their exposure to the blockchain ecosystem. A16z launched its second crypto fund with $515 million last year. Union Square Ventures plans to dedicate 30% of its recently closed $251 million fund to crypto startups.
Specialist investors Polychain Capital, Pantera, Pithia and Blockchain Capital have each raised funds totaling more than $100 million to invest in blockchain and cryptocurrency startups since 2018.
Public investors will soon be able to get in on the action too. Coinbase has unveiled plans for a direct listing, and rival exchange Bakkt is going public through a $2.1 billion SPAC merger with VPC Impact Acquisition Holdings.
The recent surge in bitcoin follows heightened interest among institutional investors and wider access to the crypto market in general. Retail investors can now buy digital currencies on platforms like Robinhood and PayPal, eliminating the need for people to create accounts through dedicated cryptocurrency exchanges.
Bitcoin's price spiked to more than $44,000 on Monday to set a new record after Tesla revealed that it has purchased $1.5 billion worth of the cryptocurrency. The carmaker joined other large investors to recently venture into digital currencies, a group that reportedly includes the endowments of Harvard and Yale, as well as Square, which announced in October that it had purchased $50 million worth of bitcoin.
Looking ahead, some crypto investors say the new crop of startups stand to benefit from recent technological improvements and emerging applications.
"The infrastructure that existed [in 2018] was really, really nascent," said Coinbase's Aggarwal. "There's been tremendous progress in developing core infrastructure for crypto."
Those advances resulted in part from past cryptocurrency market spikes that forced developers to find ways to improve the scalability, cost and speed of transactions.
Decentralized finance, or DeFi, is one emerging area that had gained a strong following among investors who are betting that traditional banking services can be securely provided based on blockchain ledger technology.
"DeFi was a nascent, unsure thing a few years ago," said Steve Jang, a Coinbase investor and managing partner of Kindred Ventures, which recently closed a $100 million fund. "Now it's much more established."
BlockFi, which lets users take out loans or earn interest on digital currency holdings, became one of the most-funded startups of the decentralized finance trend after raising $50 million last year led by Morgan Creek Digital Assets with Valar Ventures, Winklevoss Capital and others.
Another hot area has been non-fungible tokens, or NFTs, a class of tradeable digital assets that often take the form of digital artwork or collectibles.
CryptoKitties founder Dapper Labs has generated buzz following the 2019 launch of NBA Top Shots, a game that uses NFTs to store tradeable video clips from professional basketball games-essentially virtual trading cards.
Already, the ethereum-based game has seen users spending tens of thousands of dollars on individual game highlights. NBA players including Andre Iguodala and Spencer Dinwiddie have joined Warner Music, Samsung NEXT and a host of VC firms in backing Dapper Labs.
Jang said the most promising blockchain applications tend to have both an intuitive user experience and a clear technological edge, adding, "There has to be an advantage that you get by using crypto."