He offers a framework to help better define and assess the health of the industry holistically, understand what’s different between 2018 and now, as well as provide insights into where he thinks we are headed.
Firstly, what is a Technology Winter?
A winter, in the context of a technology cycle, was first used in reference to the AI community back in 1984 in a public debate as ‘a chain reaction that began with pessimism in its technology community, followed by pessimism in the press, a severe cutback in funding, followed by the end of serious research’.
Using this definition it is safe to say that all of these things were objectively true for crypto in 2018, and throughout 2020, until DeFi Summer renewed interest and capital began to be deployed back into the industry. Like AI, Crypto as an information technology, is expected to experience several hype cycles, followed by periods of disappointment and criticism, funding cuts, only to be followed by renewed interest years later. In the case of AI, decades later.
So to objectively measure if we are or aren’t in a Crypto Winter we would need pessimism in the community and press followed by a severe cutback in funding and no continued serious research. Whilst I think there is clearly a sense of pessimism in parts of the community, and definitely in the media, let’s unpack all these points and try and find objective answers to help qualify if we are or aren’t currently experiencing a technology winter.
No Continued Research?
Firstly, I believe, unlike AI during its Winter in 1984, Crypto has already been enjoying 8+ years of commercialisation and would argue has already broken out of a purely R&D stage. However, in that context we could look at the levels of R&D funding by the capitalization of major protocols as well as the number of new Web3 primitives, layer ones and twos being launched or continuing development by their github repo activity. We continuously analyze web3 development activity for all major protocols as part of our Development Trends reports, and those activity metrics show continued, and in many cases increased, code commits.
Equally, from another viewpoint from that of our accelerator; we are seeing record levels of startups being launched to bundle and commercialize blockchain infrastructure, and have received 2,000+ applications since Q1. And have not (yet) seen any slowdown as to the number of founders and developers joining the space, or indeed the level of hiring at the early stage. Our jobs board alone has 200+ open vacancies and anecdotally we have seen those let go from the redundancies at the larger firms making cuts like Coinbase, both publicly and privately, receiving dozens of job offers the same day. Equally, we are seeing Web2 executives crossing over at record levels from Big Tech partly from redundancies because their share schemes are less of a talent lock than in the past.
Severe Cut Back In Funding?
Which leads us into the next requirement for this to be classified as a winter, a severe cut back in funding is required. And it’s here where I believe many are jumping the gun and making the mistake of only looking at one part of the story rather than the holistic whole.
Obviously it is true that in the more visible part of the market, publicly listed crypto assets, there has been a significant decline in market capitalization. At the time of writing (16.06.22) we are down from all-time highs of $3 Trillion + to just under $1 Trillion, with 72 of the top 100 tokens suffering hair cuts of up to 90%. Using traditional capital market definitions of a ‘bear market’; where there are declines in an overall market, index like the S&P 500, individual securities or commodities of 20% or more over a sustained period of time (typically two months or more) it is safe to say we comfortably qualify for a bear market, but that alone does not qualify for a Winter.
For a more holistic view for overall funding you can’t just look at listed assets in the secondary market but also need to understand activity in primary venture funding. And it’s here perhaps where we at Outlier, with the support of tools like PitchDeck, can offer some greater insights into the health of the industry.
Whilst the funding of early stage startups from Pre-Seed to Seed up to Series A appears to be slowing down relative to even just to Q1, funding is still being actively both allocated to new crypto specific funds and deployed. There has been more than $15 billion in total capital raised this year by funds alone explicitly allocated for Web3 investments, up from $12 billion during the same period in 2021, with a new fund being launched almost every week.
Through our later stage token launchpad Ascent, and when combined with recent data from exchanges and listing platforms like CoinList, Kucoin and Huobi; the number of new listings are down significantly, with some platforms pausing all primary listings altogether due to heavy reductions in returns, however many others are for now just pushing back tentatively back on average 6 months. Those that are continuing to list are focused on smaller market caps and low circulating supply projects as the market can’t support more demand. However, in the context of a TGEs (Token Generation Events) there has already been a long-term trend, since 2017, away from them being fundraising events but rather network launches from a product and community perspective.
Although of course the Primary and Secondary markets are linked, the former needs the latter to serve as a liquidity event to realize gains for their LPs or recycle profits back into the market. Whilst in crypto this cycle has been historically short relative to classic equity venture they still require healthy secondary markets made up of a mix of retail and more actively managed institutional money, such as hedge funds. And it’s here where we have seen the most damage with demand all but drying up and hedge funds native to crypto like Three Arrows Capital under significant strain, alongside other high profile implosions.
So how can we create an objective framework?
Based on the above the question is; does the venture capital being deployed in the space dry up before renewed demand in the secondary markets returns for it to sustain or do both eventually disappear for several years.
One possible way of creating an objective measure of a Crypto Winter could be as follows:
Where Secondary Markets; need to be down more than 90% from ATHs for 6 consecutive months + in combination with;
Primary Markets; VC / Privates Sales also down 90% from ATHs inflows for 6 consecutive months +
How likely is this and what happens next?
The sentiment when we surveyed our co-investor network was the expectation the bear market in the Primary Markets would be relatively short lived (on average between 6-12 Months), with only 20% thinking it would be beyond 12 months. Furthermore, the expectation was valuations would on average only be down up 25%, and less so in the top decile of projects. If this is a correct assessment, it would be fair to suggest there is more than enough patient venture capital allocated to the space that will bridge us safely into another bull market.
But then the question is; how will that bull market come about? And where will that new money and demand come from?
Typically in crypto bull cycles are driven by a combination of an emergent innovation that creates a new form of native asset and / or yield. In 2017 it was ICOs, in 2020 DeFi and 2021 NFTs. It is difficult to say exactly what the next innovation trigger will be, but one thing is for sure there is a big enough brain trust with a strong incentive to figure it out, and our guess at Outlier is either a native form of Social Graph and / or a growing range of programmable Digital Consumables.
But with this said, all previous crypto cycles were supported by a backdrop of a more beneficial macro environment; typically quantitative easing drawing new capital in. Many, myself included, believe that the current state of the secondary market in crypto is largely being driven by a deteriorating wider macro environment, similar to the downturn in the equity markets. However, because crypto is universal, permissionless, 24/7 and has shallower liquidity, it exaggerates the macro mood. On the one hand this is positive as it means crypto is widely enough held that it is mainstream but it also means there are drivers outside of the industries control and the same kind of supporting environment for a cycle isn’t here yet.
However, unlike periods when hot retail money floods into crypto where fundamentals are ignored, because they are no longer the primary drivers of price, funding today will be driven by more professional money trying to find actual value. This means during this relative period of calm the industry will hopefully begin a process of developing fundamentals that will sustain into the next bull market. This increasing maturity, when combined with a growing range of industry applications beyond DeFI, will potentially reduce the future correlation of crypto with traditional asset classes making it more resistant to pure external macro moods.
When all of this is considered together, whilst incredibly bearish in the short to mid term, I can tell you this doesn’t look to me to qualify as a Crypto Winter, perhaps more like Summer Sale.