The Maturation of the Cryptocurrency Industry: The Role of Venture Capital and Private Equity

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Its valuation having inflated to nearly $20k per unit at the end of 2017 and having fallen to below $4k a year later, Bitcoin now appears to have, however temporarily, stabilised at a valuation of $10.2k (28th August 2019). Regardless the price of bitcoin, however, across this period there has been a distinct maturation in the cryptocurrency industry.

Throughout this tumultuous time search demand for the cryptocurrency industry has tumbled with little sign of making a full recovery. As of July 2019, monthly searches for the industry sits at 45.5m globally. While this sits above the lowest observed value in March 2019 (23.2m), it is a far cry from the industry peak in December 2017 which hit 257.5m searches. Existing research highlights that this demand across the second half of 2017 was predominantly driven by retail investors (non-professional investors who buy and sell securities, mutual funds, or exchange-traded funds) who tended to perceive cryptocurrency to be akin to a “get rich quick scheme”. While this bares the hallmarks of an immature market driven by speculation, which might signal a lack of optimism for the industry, different data sources paint another picture.

Source: Google

There appears to be evidence of a growing interest in the cryptocurrency industry from institutional investors. The GrayScale Bitcoin Trust (GBTC), a publicly traded investment product solely available to institutional and accredited investors (investors whose net worth exceeds $1m excluding their primary residence), is an over-the counter security whose value is solely derived from the price of Bitcoin. By purchasing shares in this trust, investors can partake in Bitcoin investment without directly owning the high-risk asset.

The value of this investment product has sky-rocketed this year. While the security traded at $3.84 per share in February, as of the 27th August 2019 it is currently trading at $12.76, an increase of over 230%. As reported in Forbes, from February 2019 to the end of June 2019, this investment product drastically outperformed many other assets including gold, oil, the USD, and the S&P 500.

While institutional investors made up 56% of investments into GrayScale products in half 1 of 2018, this figure has risen to 84% in the second quarter of 2019. It has been reported that a large number of these institutional investors are hedge funds. Despite a decline in growth over the past 2 months, a likely consequence of GrayScale Bitcoin Trust being closed to new investment from May 1 2019 to June 30 2019, it appears that there is a growing interest in from institutions in this space. This might be taken as a sign for potential growth and optimism for the future of cryptocurrencies.

Source: Yahoo Finance Data

Venturing out of purely direct investments in cryptocurrencies, data from Crypto Fund Research highlights that there has been a sustained increase in the number of dedicated crypto funds (otherwise referred to as cryptocurrency / blockchain / digital asset funds). These are largely venture capital or hedge funds, with crypto PE funds representing a much smaller figure. This expansion of investments into blockchain and cryptocurrency start-ups signify a distinct optimism for further growth in the industry.

Source: Crypto Fund Research

This same source highlights the near exponential growth in the number of crypto assets that are located under such funds. As reported by Crypto Fund Research, these price increases are a likely consequence of new funds being launched, increased capital being allocated into existing funds, and price fluctuations in portfolio values.

Data from Pitchbook, corroborates the inherent growth of venture capital deals in this sector. They have reported that investment into this industry climbed from $14 million to $628 million over the period from 2012 to 2017. Despite an isolated spike in funding in 2018, venture capital investments in blockchain based companies appear to have resumed their healthy growth rates in 2019, with $108 million in venture capital invested so far this year as of February 18th.

While it is uncommon for venture capital and private equity funds to directly hold cryptocurrency, although this is not completely unheard of, many are becoming more highly involved in start ups in this field. Most notably, Kakao, developer of South Korea’s biggest mobile messaging app KakaoTalk, raised a staggering $90 million from venture capital and private equity funds including IDG Capital, Cresendo Equity Partners, and Translink Capital to develop what they have termed as Ground X. This blockchain subsidiary seeks to develop a blockchain platform that aspires to encourage the widespread adoption of blockchain technology and cryptocurrency by removing some of the less user-friendly dimensions of cryptocurrencies such as private keys, wallets and cryptographic addresses.

In a similar effort to bring a greater audience to cryptocurrencies, Bain Capital Ventures, a subsidiary of private equity firm Bain Capital, have invested into cryptocurrency exchange CoinCDX who are seeking to upscale their technology infrastructure and build new projects to attract a wider consumer base.

Research produced from Circle suggests that this trend will be ongoing, with a number of new start-ups securing venture capital funding in 2019, including companies such as Fnality ($50 mil), Cambridge Blockchain ($3.5 mil), Coda Protocol ($15 mill), Flexa ($14.1 mil), and Crowdz ($5.5 mil).

What does the future look like for cryptocurrency?

With many new start-ups seeking to remove the technical barriers that prevent the widespread usage of cryptocurrency and blockchain technology, the future looks bright for cryptocurrency. Most potently, the launch of Bakkt in late September 2019, a bitcoin futures exchange and digital assets platform founded by Intercontinental Exchange, the parent company of the New York Stock Exchange, is expected to increase participation in this space. With backing from partners including the Boston Consulting Group, Microsoft and Starbucks and a goal of Bakkt serving as the backbone of digital payments infrastructures from 2020, it is likely that we may see further investments into start-ups in this space.

Put simply, with a lot of growth in this sector and as start-ups begin to mature into established companies, private equity funds will want to monitor this space.