Why crypto start-up founders struggle to raise cash now

4 views 12:17 pm 0 Comments November 22, 2023

The prices of cryptocurrencies may be returning, but a sore spot for crypto start-up owners is that they find it challenging to raise fresh capital to start or run their businesses.

“Raising capital is increasingly becoming an uphill battle in crypto-related endeavors now as venture capital investments are significantly declining,” explained Dr. Rashid Hammad, a UAE-based entrepreneurship coach who avidly invests and trades cryptocurrencies.

“Although the entire cryptocurrency market significantly recovered from the 2022 price slump brought on by what is referred to as the ‘crypto winter,’ investors’ interest in crypto startups remains low amid prevalent risks from regulatory pressure and an uncertain market.”

According to data aggregator AltIndex.com, crypto startups raised $2.1 billion (Dh7.7 billion) annually, 80 percent less than last year. So, what is causing this crunch in crypto financing, and is it reshaping the industry? Also, should crypto start-up founders stay concerned?

Young crypto start-ups struggle for funds.

“Along with increasing regulatory scrutiny and skeptical investors, capital deployment has pulled back significantly from the highs of 2021, which has left many young startups struggling to raise funds,” agreed Brian Deshell, a UAE-based cryptocurrency trader and analyst.

“With the broader funding crunch, crypto waters are getting choppier, and a market that saw impressive investments in the past few years, has come under pressure, startling investors. Not to mention, this is also affecting the underlying cryptocurrency ecosystem as well.”

Even with investors pulling back from the market, crypto startups have raised impressive amounts of money in funding rounds. As per data, companies in the crypto space have raised nearly $30 billion (Dh110 billion) so far, with two-thirds of that from deals in 2021 and 2022.

According to data from US-based corporate analytics firm Crunchbase, crypto startups raised $1.1 billion (Dh4.04 billion) in 2019. A year later, this figure jumped to almost $1.7 billion (Dh6.24 billion). Still, that was nothing compared to investment growth in 2021, when the crypto market boomed.

Along with increasing regulatory scrutiny and skeptical investors, capital deployment has pulled back significantly from the highs of 2021, which has left many young startups struggling to raise funds.

– Brian Deshell, a UAE-based cryptocurrency trader and analyst

Crypto funding drops for third straight quarter

In 2021, crypto startups raised $11.1 billion (Dh40.77 billion) in funding, six times more than a year before. Raising funds in 2022 was just as impressive, with $10.1 billion (Dh37.09 billion) worth of investments, pushing a two-year total funding amount to over $20 billion (Dh73.45 billion).

However, with crypto startups raising five times less this year than last year, the data showed that venture capital flowing into the industry has fallen for three straight quarters. In the first two quarters of the year, crypto startups raised over $800 million (Dh2.9 billion), 80 percent less than a year ago.

Between July and September this year, the total funding amount dropped by a further 90 percent to $426 million (Dh1.6 billion), with crypto startup funding continuing to grow more scarce, with only $75 million (Dh275.5 million) raised in the past month and a half.

“The scarcity in funding for crypto start-ups has turned the current quarter into potentially one of the worst quarters in years. As it’s essentially a game largely run on numbers, investors write smaller cheque amounts as they see lower valuations. It’s that simple,” said Hammad.

What’s driving this decline in crypto financing?

According to Deshell, crypto startups’ valuations in the industry dropped a stark 50 percent from the first half of 2022 to the second half of 2022. Since then, valuations have dropped an additional 15 percent to the first half of 2023, totaling almost 70 percent year over year.

“That’s a severe decline — startups that raised money in January 2022, for example, would be hard-pressed to raise capital again today without taking a steep discount on their price tags,” he added. “While regulations have stifled optimism around the industry, other factors are at play.

Deshell went on to list how confidence in the industry squelched after a handful of famous crypto firms filed for bankruptcy. Top crypto entrepreneurs like Samuel Benjamin Bankman-Fried (SBF) and Changpeng Zhao (CZ) found themselves in regulatory trouble in the US.

“It also didn’t help when investors adopted a more discerning approach valuing profits over growth. But it’s not all doom and gloom, and crypto founders are not yet giving up hope. That trend will not necessarily reverse, but it may slow down or be less severe,” added Deshell.

Why else do startups fail to convince investors for funding?
When an investor decides to pass up on investing in a crypto startup, aside from the above-mentioned general concerns surrounding the cryptocurrency market as a whole, it may also be because of the combination of a lot of other reasons:

“Investors are in the business of taking risks to aim for astronomical returns. If your target market is too niche and doesn’t look big enough, that dampens the spirit of the investors fast,” added Hammad. “Another reason would be there isn’t a strong enough founding team.

“This is crucial in early fundraises. Investors are mostly investing because of the founders. Why would I even consider investing if the founding team doesn’t fill me with the confidence that they can undertake such a difficult assignment?”

Also, if you don’t have a business model that doesn’t work, then you are planning on building a business that would be constantly guzzling in the money, added Hammad. “Trust me, no investor wants to fund your growth in perpetuity when the cash flow looks red in all perpetuity.”

Verdict: Should crypto start-up owners continue to be concerned?

While there is no denying that the majority of investors in crypto join with the hopes of making a lot of money, another group of people also join crypto and enter the market purely to bet on the technology.

“There will always be a percentage of investors who believe in the science behind cryptocurrencies and are willing bet their savings on it, which includes the use of blockchain in smart contracts, decentralized finance (DeFi), or earn a passive income with play-to-earn,” Deshell added.

(Decentralised finance is an emerging technology that removes third parties from financial transactions. It offers financial instruments without relying on intermediaries such as brokerages, exchanges, or banks by using smart contracts on a blockchain.)

“They view this market as the next big thing just about to increase adoption. Similar to what the internet did in the early 2000s. They invest in the future or want to be a part of it. As such science-centric groups will not cease to exist, so shall their investments,” Dunn added.

Although the crypto market is volatile and never without risks, it’s still worth considering if you want to expand your crypto business, given its advantages for companies and consumers. “But any exposure in the industry when it comes to your savings should be limited,” cautioned Hammad.

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