Coinbase Ventures Q2 funding memo

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

TLDR:

• Coinbase Ventures deal exercise mirrored the general tempo of the enterprise panorama, down 34% QoQ. Activity remained up 68% YoY, reflecting the regular development of our enterprise apply over the previous 12 months
• Among the important thing developments noticed, we consider that Web3 gaming will onboard the subsequent huge wave of crypto customers, with skilled founders from Web2 gaming persevering with to pour into the area
• We’re enthusiastic about Web3 person functions working to upend the captive fashions of Web2 and provides customers management over their audiences and communities
• The Solana ecosystem continues to point out spectacular momentum and developer traction
• Massive UX enhancements are coming to crypto that can obfuscate away complexity and ship experiences on par with Web2
• The United States continues to be dwelling to the majority of corporations in our portfolio, with Singapore, UK, Germany, and India all establishing spectacular innovation hubs
• Where CeFi lenders faltered this 12 months, DeFi lending platforms had been resilient
• Current value motion apart, we stay satisfied that the chance inside crypto and Web3 are far better than most understand.

The first 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 12 months.

A core a part of the crypto market chaos stemmed from the collapse of the $60B Terra ecosystem in May. This contributed to the implosion of a $10B crypto fund (Three Arrows Capital) that had leveraged publicity to Terra together with a number of different trades that moved towards them (GBTC, stETH). Next, 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 compelled out of business.

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

Venture panorama

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

Crypto enterprise funding nonetheless noticed a report 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. Sure 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 in addition noticed deal place sluggish, with the full rely lowering 34% QoQ, from 71 to 47. Despite 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 development of our enterprise apply.

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 corporations are foregoing a fundraise until completely essential, and even then, provided that they really feel assured that they’ll present the expansion wanted to justify a brand new spherical.

Gloomy macro surroundings apart, there are nonetheless loads of top quality founders elevating on the seed stage, the place we’re most energetic. Looking 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 longer term: one with a vibrant array of Web3 person functions, improved UX, strong DeFi markets, scalable L1/L2 ecosystems, and all the instruments builders must construct the subsequent killer app.

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 coming 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 unfavourable ought to the fervor driving the sport die down, which is finally what occurred. Regardless, Axie posted almost $1B in gross sales in a single month and attracted 2M DAUs with basically zero advertising finances. 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 consider that Web3 gaming will onboard the subsequent huge 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 few quarters solely strengthens our conviction.

As we noticed in Q1, founders with robust monitor data in Web2 gaming proceed to embrace this class. For instance, Azra games*, was based by the creators of the $1.4B+ cellular blockbuster Star Wars Galaxy Heroes. Their aim is to construct a fight RPG recreation with a sturdy 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 property.

Companies like Venly* will add gasoline to the fireplace with a set of instruments that allow Web2 recreation builders seamlessly make the leap into Web3. Established gaming powerhouses are even beginning to come round, with Fortnite creator Epic Games now permitting NFT based games into its recreation retailer.

It will take a while for this sector to mature, however it’s rising more and more clear that blockchain gaming can be an enormous class sooner or later. Expect an elevated give attention to sustainable economics and gameplay that infuses NFTs with extra acquainted Web2 gaming experiences.

Rewiring Web2

Beyond gaming, the subsequent era of Web3 person functions 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, much like e-mail (SMTP). While Farcaster has constructed the primary social app on the protocol, different builders can construct competing shoppers, similar to we now have Gmail and Apple iCloud. While you possibly 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, however it additionally opens the door for extra aligned monetization. Where most promoting spend goes on to Twitter, Instagram, and many others, Farcaster customers with massive followings can monetize their audiences straight throughout platforms.

Another funding we’re enthusiastic about is Highlight.xyz*, which sits on the burgeoning intersection of Web3 and music. Highlight will let musicians create their very own web3-enabled fanclubs / communities (no coding essential), full with token gating, entry to NFT airdrops, merchandise and extra. Highlight 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. While 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.

Given that Solana sensible contracts are coded in Rust versus the EVM’s Solidity, founding groups typically select between constructing in a single or the opposite. Increasingly, we’re seeing groups choose 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 choose 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 nevertheless (the flexibility for Solana to stay on-line) stays a problem that’s paramount for the Solana group to clear up.

The UX of Everything

An total clunky and disjointed crypto person expertise has lengthy been a hurdle for adoption. Think of what a person 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. Soon builders constructing in crypto and Web3 will be capable to deploy all the transaction stack with a number of easy traces of code and customary set of APIs.

The finish end result can be a future the place, for instance, a person can execute a DEX transaction in a single click on. In the background, fiat can 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. All of the complexity can be obfuscated away and we’ll have person experiences on par with Web2 — an enormous unlock.

Where are the buidlers?

This quarter we took a take a look at the place the founding groups we’ve invested in are based mostly. While crypto is a world business, considerably unsurprisingly, the most important focus of our founding groups hail from the United States — dwelling to 64% of our 356 portfolio corporations; all of the extra cause 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. Meanwhile, the UK and Germany are dwelling 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 anticipate to play a significant position 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 staff, together with the aforementioned Coherent and Farcaster, in addition to three others not but introduced. We’re proud to proceed to assist staff who obtain a world class crypto training at Coinbase and go on to discovered world class corporations and tasks.

Wrapping up

While there’s lots to be enthusiastic about sooner or later, there are additionally loads of classes to be discovered within the current. The present crypto crises is much like these we’ve seen play out in conventional finance. The opaqueness that centralized lenders and Three Arrows Capital operated beneath resulted in an incapability for lenders to correctly consider the chance of their counterparties. Lenders didn’t understand how a lot the others had lent to 3AC, nor did they understand how a lot leverage and danger 3AC was taking over. Investors didn’t understand how a lot danger they had been uncovered to altogether. When the market moved towards each the lenders and 3AC, lenders had been left with huge holes of their steadiness sheets, and traders had been left holding the bag.

However in distinction to the centralized lenders dealing with insolvency, it’s essential to notice that blue chip DeFi lenders Aave, Compound, and MakerDAO operated with out a hitch. Every mortgage and its phrases remained transparently on-chain for all to see. When collateralization ranges fell under thresholds, collateral was offered by way of autonomous code and lenders had been paid again. This identical code additionally dictated that Celsius was compelled to pay back $400M in loans to Aave, Compound, and MakerDAO — no court docket order wanted (although overcollaterization performed a job). All advised, it served as a strong 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 most well-liked person utility was Crypto Kitties. These days, there are extra profound, impactful improvements than we will rely. DeFi, NFTs, a wealthy DAO ecosystem, all happened within the final two years, and even got here collectively to make a real impact on the world stage. Meanwhile, layer2 scaling solutions are lastly right here, and may take us from the dial-up to broadband part, able to supporting a wealthy array of person functions with easy UX to boot.

As in earlier downturns, detractors are as soon as once more confidently announcing crypto dead. However, from our seat within the business, 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 better than most understand.

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Coinbase Ventures Q2 investment memo was initially printed in The Coinbase Blog on Medium, the place individuals are persevering with the dialog by highlighting and responding to this story.