AI Is Killing Crypto Venture Capital Interest

The venture capital space has lost significant momentum over the last few quarters. Global venture funding is nearly half of what it was last year. Whatever remains of the market is now being directed toward AI funds. AI has become the golden goose for VC firms after the turbulence in crypto in the last year.

Chris Coll–Beswick is the Founder and Managing Partner at Transcend Labs.

Although AI has picked up pace, the VC market is nowhere close to where it was in 2021-22. With higher interest rates and a sustained supply chain shortage, the global market isn’t “ideal.”

In my field of startup incubation, I have experienced the shift firsthand. Back in 2020-21, Investors were much more likely to fund lofty ideas with very little supporting evidence. But today, even the most promising startups have a hard time gaining the attention of top VCs.

According to Crunchbase, “Global venture funding in Q2 2023 fell … 49% compared to the second quarter of 2022 when startup investors spent $127 billion.”

The overall deal volume has also decreased significantly by 37%.

“More than 6,000 startups raised funding this past quarter, compared to more than 9,500 for the same time period a year ago.”

The primary cause of this shakiness is the radical increase in interest rates from near zero to 5.5% – a high number for investors making risky decisions. Investors are also not happy with the IPO drought and the lack of exit opportunities in the market.

Kevin Colleran, co-founder at early-stage firm Slow Ventures, an investor in crypto companies, told VCCircle, “I haven’t written any checks in the past 18 months. I have 30 portfolio companies that I need to help figure out how to survive. There is no point for me to add to the misery.”

For crypto, the situation is worse.

The entire crypto industry made 382 deals in Q2 2023 for a net total of just $2.34 billion. Compared to Q1 2022’s $12.14 billion, these are meager numbers.

Crypto and Web3 startups specializing in various spaces raised a total of $29B and $33B in two consecutive years ‘21 and ‘22.

However, since Q1 2022, we have seen five consecutive months in the red.

What caused this collapse?

After a hype-fueled bull run starting in 2020, a slew of disastrous events discouraged even the most pro-crypto VCs.

The failure of Celsius, Voyager, 3AC, Luna/UST, and, of course, FTX made 2022 a crypto investing nightmare.

The latter caused the most damage as the FTX CEO Sam Bankman-Fried was revered by all the prestigious VC funds and was the primary representative of the new asset class to regulators in Washington.

The FTX fiasco destroyed whatever investor confidence was left in the crypto industry, resulting in major investors moving away to greener pastures. Big VCs like Sequoia, an investor in FTX, are slashing their crypto funds.

The AI dominance started the same month FTX collapsed, filling the vacuum created in the market. Since then, AI has been unstoppable.

AI projects have been commanding huge VC rounds with valuations that are difficult to justify. Generative AI startups raised $1.6-plus billion in Q1 2023. Companies like Anthropic raised $450 million; Adept AI raised $350 million.

That number nearly doubled when Inflection AI alone raised $1.3 billion in June at a $4 billion valuation.

While AI is one of the most promising spaces in tech, these numbers are mind boggling, to say the least. And with the recent GPU shortage, most of this money will be spent on securing computation tools rather than actual innovation.

VCs chase the hot trends — it’s not a disputed fact. And the hot AI trend, however unsustainable, is working to the detriment of crypto.

I’ve been seeing this trend up close. In November 2022, a metaverse startup in my network had almost confirmed pre-seed funding from one of the big four VCs. A week after, FTX crashed and the firm rescinded the term sheet.

This is just one of many incidents that have been taking place since last year. AI has received almost $28 billion so far in 2023 —  almost 20% of global VC funding.

Companies like Meta, which changed its name to signal its metaverse ambitions, have cut down considerably on its vision.

To work around the general crypto phobia, a lot of crypto projects are adding AI components to the core product. Projects like Jada are much more likely to gain mainstream VC interest today than pure crypto projects.

In my experience running Transcend Labs, I have seen this work out in two ways. Some projects actually find a way to innovate and integrate AI functionalities, strengthening the core product.

But the majority is just banking on the AI trend to gain traction. The AI part doesn’t play any crucial role in the core crypto product. And, sometimes the AI component impacts the shift to decentralization.

So is there a way out for crypto founders? Of course, there is!

Unlike mainstream AI which isn’t even a year old, crypto has been present for more than a decade. Thanks to the cyclical movement of the crypto economy, we can confidently predict more innovation and investor interest as the bear market ends. Lower interest rates, globalized crypto regulation, Bitcoin ETF approvals, and more TradFi involvement in crypto could all reignite VC flows.

In the meantime, founders should focus on building in stealth mode with a small community. Consequential projects like Ethereum or Aave have faced several bear markets and managed to get out of it with a better product and user experience. Other projects can do the same.