Capital drought: Strategies for Web3 startups to sail through the funding winter

The events that rocked the crypto ecosystem last year have had a profound impact on the Web3 funding landscape. As easy money dries up across the startup ecosystem, crypto-focused venture capital funds are holding onto the dry powder. The slowdown has continued despite the rebound in crypto prices since the turn of the year.

As active investors in Web3, we have been meeting several founders, and the question that we’re asked most often is: How can Web3 startups sail through this period?

But first some context. This winter has many architects. The rising interest rates and the uncertain global macroeconomic conditions cause a “risk-off” sentiment among VCs. The slowdown in funding has impacted all major sectors—AI is an exception to this—and tech startups, in general, are facing down rounds. For crypto startups, there is the added heat from the US regulators, prompting many to consider their future at friendlier jurisdictions in Europe, the Middle East and most recently, Hong Kong.

According to the latest reports, overall, crypto VC funding plunged by 80% in the first quarter of 2023, to $2.4 billion—the lowest in two years—as against $12.3 billion for the same period in 2022.

There is a nuance here worth highlighting. What’s exited is primarily the “tourist capital” lured in by the price action. Traditional Web2 VCs that had entered the space simply on FOMO, rather than building a thesis for the long term, were easily disillusioned by the rough ride. Against this backdrop, the crypto and Web3 native funds continue to deploy capital, albeit with enhanced due diligence.

There’s been a marked slowdown in funding in the Indian startup landscape, too. Across sectors, the total VC funding in May 2023 stood at $948 million as compared to $1.68 billion in May 2022—a 44% year-on-year decline (as per some industry reports). Like in the global market, several traditional (or Web2) Indian funds that had jumped into the Web3 space during the bull run of 2020 and 2021 are now treading cautiously. T

he drying of these taps has an outsized impact on the Indian Web3 startups as the space lacks dedicated Crypto/Web3 funds. In other words, funds here are in want of “borrowed conviction and thesis” that tend to influence the traditional VCs in the West.

Growth-stage startups hit hard

Particularly hard hit by the new reality are growth-stage startups. These startups have raised their Series B funds and are scaling up rapidly. In better times, their rapid growth alone would have been viewed as a measure of their immense potential. But today, VCs are eager to see a road to profitability and are shying away from burning funds for growth alone.

Early-stage investing has had a milder impact as VCs continue to be in search of the next moonshot project. However, the recent regulatory pressure in the US is proving to be a dampener.

Even the themes that are garnering the interest of VCs have changed. As against the hype cycle of 2021 when NFT projects were in high demand, these days startups building on underlying blockchain infrastructure, data and analytics, and user onboarding solutions are on VC’s radar. These projects are focused on scaling the ecosystem, assuming that mass adoption will be driven by the next bull run in prices (BTC Halving anyone?)

Young startups are today more in need of support than ever before, especially in a nascent industry wrestling with teething issues. India’s Web3 startups need ramps to global capital with a conviction and investment thesis more aligned with this cutting-edge space. Which is to say, the trying times call for not just capital and mentorship, but a network enabler. 

Anecdotal evidence shows many pre-seed and seed rounds are on halt due to the lack of “lead investor” interest, which is the critical signal needed to materialise the ‘soft commits’ that these founders and startups would have received.

The night is darkest before dawn

The travails of funding winter should not discourage India’s young Web3 builders and innovators. The investment thesis that attracted capital into Web3 has not changed decentralisation and tokenisation will be adopted by more and more industries. Further, global VCs continue to sit on record levels of dry powder. Conviction in the projects—and, of course, easing of global macroeconomic conditions—could help untap this resource.

There is also the matter of BTC Halving, the scheduled reduction of mining rewards on the Bitcoin network—an event that has historically been a catalyst for positive price action.

The simple advice to Web3 builders in the current slowdown is to hunker down and build—and cut the flab. Expenditures need to be tamed; the burn rate needs to be of primary concern for the founders, making sure that they have at least 12-18 months of runway in sight. For very early-stage projects (pre-product or ideation stage), the focus should be on getting an MVP up and running to catch the interest of the VCs.

My advice for such projects would be to apply for accelerators and incubators, or to build hackathons. Another great avenue for funding could be ecosystem grants that are managed by several protocol foundations.

Despite the many challenges, the bear market is the best time to build, and history is filled with examples of several moonshot projects forged in challenging times. A first principles approach now will place the Web3 startups in a sweet spot for the bull run of tomorrow.

Parth Chaturvedi is Investments Lead at CoinSwitch Ventures.