By Connor Dempsey

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TLDR: 

Venture landscape: 

• Venture funding conditions tightened for another quarter, with Coinbase Ventures making 9 new investments; our slowest quarter since Q2 2020.

• In this environment, we narrowed our focus and wrote larger average checks on a fewer number of investments while doubling down on existing portfolio companies. 

• Capital availability has declined, traditional VCs have taken a step back from crypto, and deals are taking longer to come together. High quality founders are still able to raise, while others struggle to close rounds.

• VC “dry powder” remains at all-time highs, however there’s a chance some of the funds get returned to LPs should fund managers deem it the fiduciary responsible thing to do. 

Themes; investments: 

• Web3 developer activity is showing healthy growth alongside a more robust developer toolkit; we invested inThirdWeb which is building a range of developer solutions and exhibiting impressive traction.  

• Proof-of-stake networks are generating $8B in annual staking rewards with estimates of that figure hitting $40B by 2025; we backed Alluvial, which is an institutional-grade liquid staking protocol that can unlock more institutional inflows into crypto. 

• “Application-specific” chains on Cosmos are growing in popularity due to the customizability they afford teams; we added DeFi focused Sei protocol to our stable of Cosmos portfolio companies in Q3. 

• Move is the programming language developed by Facebook’s Diem. When Diem shut down, the core teams productized Move in the form of Aptos and Sui (Mysten Labs); we’re excited about the potential of the Move ecosystem and have backed each of these new layer-1s. 

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Overview

Worries surrounding the overall health of the economy have set in and continue to weigh on the venture funding landscape. Similar to Q2, both global venture and crypto funding conditions slowed considerably in Q3.

Despite sideways token prices and the slowing pace of venture funding, the broader industry pressed forward. Developer activity remains healthy and the tools available to web3 developers grow more robust by the day. Ethereum’s “merge” signified a monumental technological achievement, and set the stage for the next era of ETH applications, including a massive institutional business around proof of stake. Cosmos and “application-specific” chains are picking up momentum while new layer 1’s that evolved out of Facebook’s Diem (Aptos & Sui) are coming to market. The quarter also saw large players like BlackRock and Google make inroads into the space while NFTs garnered more mainstream adoption. 

In this quarter’s recap and market outlook we’ll provide an overview of what we’re seeing in the venture landscape, along with on the ground observations from the Coinbase Ventures team. 

Venture landscape  

In Q2, total venture funding dropped 23%, which at the time marked the largest dip in a decade. Then in Q3, total venture funding dropped another 34%, from $112B to $74.5B, setting a new record for quarterly decline. 

According to data from The Block, crypto venture funding slowed in lockstep with the broader venture landscape over the past two quarters. Following a 22% drop in Q2, total crypto funding dropped another 35% in Q3, from $9.5B to $6.2B.

Coinbase Ventures made 9 investments over the quarter; our lowest quarterly total since Q2 2020. In this slower environment, we took the opportunity to narrow our near-term focus areas and concentrate activity on a fewer absolute number of investments. We also doubled down on support for existing portfolio companies. 

This resulted in a notable increase in our quarterly average check-size and follow-on investments in Messari, Mysten, and WalletConnect.   

Crypto venture landscape observations 

Capital availability has declined, and as a result, there’s a lower number of companies actively raising and deals getting done. While crypto-native venture firms remain active, capital from more traditional firms has dried up considerably as they shift to a more incremental and measured approach to crypto.   

Deals are still getting done, but we’re in an environment of “haves and have nots.” Highly sought after founders are able to raise at lofty valuations while others are having trouble pulling together a full syndicate and have been forced to reset valuation expectations. Some of these teams are resorting to raising smaller bridge financing rounds at flat or down valuations.   

The deals that are getting done are taking longer to come together; particularly when compared to the fervent pace observed in 2021. In an uncertain macro environment, investors across the board are being more patient in deploying capital. There’s also been fewer VCs stepping up to lead deals due to pricing uncertainty, further contributing to the overall slowing pace. 

While the amount of capital firms are willing to deploy in this environment has declined, there’s still a record amount of “dry powder” that needs to find a home eventually. However, there’s a chance we see some of it returned to LPs if fund managers decide that’s the responsible thing to do as a fiduciary. In the meantime, funds are dedicating more time and resources to supporting their existing portfolio founders and building out their own operational functions.

Now before we get into some of the things we’re excited about from Q3, some brief housekeeping matters. 

Evolving our venture practice 

Coinbase Ventures was launched in 2018 as a passion project run by a few dedicated employees in addition to their full time roles at various corners of Coinbase. Over the years, we’ve added full time staff and have matured our Ventures practice – establishing deeper connections between our portfolio companies and product teams within Coinbase. Additionally, we’ve begun staking and earning yield from our liquid token investments while recently launching new media channels (subscribe to our newsletter and follow us on Twitter!). 

Going forward, this continued evolution may include reducing our positions in certain companies or projects that we believe have reached maturity and are beyond our investment mandate. This will allow us to focus our efforts and reinvest capital in new companies and projects that we feel we’re best positioned to support. 

With that, let’s get into some themes we’re currently excited about, including: web3 developer activity, institutional staking, and the Cosmos and Move ecosystems.

Web3 dev rising  

Prices are down, but looking at web3 developer activity you wouldn’t know it. As Alchemy’s* Q3 Web3 developer report showed, despite a 70% drop in the price of ETH, smart contract deployment on Ethereum increased 40%. Further, Q3 showed sizable year-over-year gains in metrics measuring developer activity on the industry’s largest smart contract blockchain. 

Beyond Ethereum, the report also shows healthy growth in developer activity across Polygon*, Solana, Arbitrum*, and Optimism*. Key infrastructure projects like The Graph*, Alchemy*, ENS*, and WalletConnect* are all showing increased usage and installations as well. We think this is all a sign that the buildout of the web3 developer stack is bearing fruit. While it’s still not as easy to build in web3 as web2, it’s getting easier by the day, leading to a rise in web3 developer activity. 

One company building on that front that we backed in Q3 is Thirdweb - a platform that provides developers with libraries of pre-built and battle tested smart contract templates, software development kits (SDKs), and dashboards for monitoring deployed contracts. These solutions can be leveraged to launch everything from marketplaces, token-gated clubs, DeFi protocols, DAOs, NFTs, and blockchain based games across seven chains.  

Thirdweb is showing impressive traction with developers, including many inside Coinbase. Thirdweb SDKs already power NFT drops on Coinbase NFT, like this recent drop with the Chicago Bulls. With this partnership, Thirdweb joins 0x as CBV portfolio companies helping power Coinbase NFT. 

Liquified stake 

Blockchains need to come to “consensus”, or agree on the state of the blockchain at any given time to function. Participants who commit resources to validate new transactions and help bring a network to consensus through a process called staking are rewarded in a network’s native token.

Staking is already a multi-billion dollar business, and with the completion of Ethereum’s Merge, the industry’s largest smart contract blockchain is now secured by Proof-of-Stake consensus. Rather than commit electricity to proof-of-work mining rigs, validators simply lock or “stake” tokens into the network to participate in consensus and earn token rewards. Staked digital assets in PoS networks are now generating $8B in annual revenue with some estimating that figure will hit $40B by 2025.

Staked tokens are locked up for a certain period and are essentially illiquid. Liquid staking protocols have risen to address the capital inefficiency of traditional staking. These protocols issue receipt tokens that represent a claim on staked digital assets (like Coinbase’s cbETH for example). Receipt tokens accrue rewards, but can also be sold and can be used to actively participate in compatible DeFi protocols. At present, there is nearly $10B in ETH locked in liquid staking pools offered by Lido, Coinbase, Rocket Pool and others. 

While both staking and liquid staking are already big businesses, it’s presently difficult for institutions to participate. This stems from the higher levels of security and compliance standards they need to satisfy. Enter Alluvial’s Liquid Collective: an enterprise-grade liquid staking protocol launched with support from industry leaders including Coinbase Cloud, Figment, Kraken, and others. At maturity, stable, liquid staking rewards could be viewed as web3’s risk-free rate of return, presenting a compelling opportunity for institutions, while unlocking massive inflows into the cryptoeconomy. 

Cosmos & the App-chain Gang

Today, “monolithic” L1s like Ethereum and Solana have thousands of Dapps operating on a single blockchain. This allows Dapps to interoperate, but Dapp teams sacrifice the ability to fully customize and control their own domains, and must compete with other Dapps for blockspace. But what if you could launch your own fully customizable “application-specific” chain while still remaining interoperable with other Dapps?  

The idea isn’t new, but has been picking up momentum, particularly on Cosmos. Instead of being a one-stop-shop blockchain, Cosmos is a collection of tools for launching standalone blockchains capable of interoperating with one another. Today, there are over 60 Cosmos chains. Some of the largest exchange chains and tokens, such as Binance, Crypto.com, and Huobi, as well as the now defunct Terra have also been built using elements of the Cosmos toolkit.

Electric Capital showed that at the end of 2021, Cosmos had the third most active developer community after Ethereum and Polkadot. Since then, it seems more developers are seeing the light. Popular DeFi applications like DYDX have recently opted to launch an  “app-chain” on Cosmos, citing the customizability they’re afforded. Following the collapse of Terra, we’re also seeing former Terra projects opting to relaunch on Cosmos (Delphi Labs, for example). There’s also excitement around “ATOM 2.0” - an update of Cosmos’ tokenomics which should lower the cost of launching app-chains, as projects can leverage existing validators rather than have to bootstrap their own network.  

Coinbase Ventures has backed many Cosmos-based projects to date including  Axelar, Evmos, Kyve, Polymer, Umee, and in Q3, Sei. We’re excited to see Cosmos’ introduction of EVM and SolanaVM (Nitro) modules, which will pave the way for existing Ethereum and Solana applications to be deployed in Cosmos. Further, it’s been interesting to see IBC - the tech that enables Cosmos interoperability - adopted by ecosystems like Polkadot and Near, led by Composable Finance*.  

More broadly, Cosmos’ momentum underscores, that between L2s and app-chains, that the future is multi-chain (if that weren’t already clear).

MOVE’in on up 

Remember Diem? The blockchain-based payment system headed up by Facebook. While Diem ultimately never fully got off the ground (mainly due to regulatory complexity), a key piece of the project lives on in the form of Move. 

Underlying every smart contract blockchain are computer languages that developers write programs in. Ethereum has Solidity. Solana has Rust. Diem had Move. Before Facebook (now Meta) had to shutter the project, they poured a tremendous amount of resources into the development of Move to create a blockchain capable of supporting Facebook levels of users activity. Once Diem shut down, rather than call it a day, the core teams spun out to productize Move. 

The two new L1s leveraging Move that you’ve likely been hearing about lately are Sui and Aptos. The Move language has been touted as highly developer friendly, well-suited for designing software around data and objects (i.e. tokens & NFTs), allowing for maximum code reusability and developer efficiency. Given that Move was inspired by Rust but with built-in decentralized storage capabilities, it’s becoming increasingly popular among Solana developers.  

We participated in the early rounds of both Aptos and Sui and have been investing in Move infrastructure projects to be announced at a later date. Becoming a dominant general purpose L1 remains one of the largest prizes in crypto and with the emergence of Aptos and Sui, it's clear that the incumbents will continue to be challenged by new competitors innovating at the programming layer.

Concluding thoughts 

It’s a bit of a crypto cliche that, “bear markets are for building”; but some cliche’s exist simply because they’re true. Much of the madness associated with bull markets subsides, tourists leave, and those that remain can put their heads down and build the next cycle of innovation. 

The 2018 bear market in which Coinbase Ventures was founded yielded projects like Uniswap*, USDC, Polygon*, Solana, and OpenSea*. These all played major roles in the subsequent bull cycle, paving the way for DeFi, NFTs, DAOs, and web3 gaming. We expect this down cycle to birth similar innovations that come together in new and unpredictable ways. 

The key difference now, however, is that the industry is standing on a much stronger foundation. User experience has vastly improved, L2s are ready, developer tooling is more robust, and key infrastructure has matured. On top of that, as evidenced by Coinbase’s recent partnerships with both Google and Blackrock, the size and sophistication of participants continues to grow. Meanwhile NFTs continue to make mainstream strides with adoption from Starbucks and most recently, the successful launch of Reddit NFTs, which quickly reached 3M active wallets. 

This all sets the stage for the next cycle of innovation to make a far greater impact than any before it. 

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Disclosures

* denotes Coinbase Ventures portfolio company

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