Previous quarterly update:
Fund Update Q3 2022
In Q4 2022 we made 2 pre-seed investments in stealth startups – one in crypto and one in AI. When these startups come out of stealth mode and announce, we will post more about them in following updates.
We've also added a few advisory positions in existing portfolio companies which we will discuss in future updates. Our primary focus in the bear market has been on supporting founders on product, sales/business development, and various data & analytics initiatives.
Venture and Macro Outlook
Early stage venture rounds continue to slow down in pace and quantity, with many valuations reverting back to ~2019 levels on average, with some exception. The occasional crypto deal is still overvalued as if it were 2021, but most teams and investors have come to terms with new valuation ranges and expectations. Rounds are also moving much slower, though we expect this to pickup towards the end of 2023.
There have been a ton of AI deals lately off the back of hype around OpenAPI, Stable Diffusion, Lensa, etc. My previous career was in big data and ML for about 10 years and we've invested in half a dozen data/AI startups over the last few years prior to the current hype (e.g. Accern, Cribl, Turing, etc). We had always planned to continue investing in good AI startups where it makes sense. Just because these deals have a level of FOMO right now will not change the pace of our deployment however. Despite technological breakthroughs, there is a lot of noise in AI right now, reminiscent of crypto hype cycles but without the liquidity. Business models, real adoption, and value capture are questionable in most of these new AI startups and valuations will run to untenable levels (sound familiar?) Generally, we will try to invest where open-source values exist and crypto will remain our core specialty regardless.
Since our last update, we've had inflation come down slightly, which will likely continue dropping month over month. The question remains, what is the extent and speed of this monthly drop (timeline) and what's the catch (repercussions)? Does it have to come with recession and heavier de-growth or can the balancing act occur? There have been some relatively positive numbers around jobs and economic growth recently. Is this the beginning of a recovery or more financial engineering into the end of a fiscal year (plus one with midterms)? If the latter, that can only last so long, and the true colors of the state of the economy will emerge in 2023. There are undoubtedly core economic metrics that will come to a head in 2023, that were perhaps ignored or delayed indicators last year (e.g. individual household net worth).
Generally, we have seen quite good cases for both outcomes (softer landing vs. full on recession) which is why we became buyers in Q4. However, we are still leaning towards another equities shakeout being required to really reset things towards ~3,000 S&P levels. In a historical lens, it would be rather unprecedented if the market were to recover here and it would be a very shallow correction in hindsight – but stranger things have happened of course. The market also weathered COVID which could have skewed typical cyclicality and create an outlier case where things moved differently due to the panicked oversold levels back in March 2020. Clarity should finally come over the next 3-6 months. Until then, it's the usual silly monthly Fed song and dance.
Crypto Update and Outlook
Much of our crypto outlook was covered in our last blog post "What's Next for Crypto". We probably sound like broken records on this, but over the last 9-12 months, our process has remained similar in terms of slowing capital deployment down in liquid markets and waiting for the market to unwind and for dust to settle. Our liquid portfolio has been optimized to be as simple as possible in this climate, with only a few active positions (mostly BTC and ETH), lots of dry powder, and various longer term vesting/illiquid token investments for the next eventual cycle.
We did end up buying more Bitcoin at ~$16,000 levels in the weeks following the FTX blow-up when these levels were re-tested (late November/early December). We also purchased some SOL under $10 recently, as calls for its demise have been vastly over-exaggerated in our opinion. The fundamentals and community will stick around and most of the negative baggage has been priced in and offloaded.
From here, we see our book activity picking up in the coming months and quarters. We are aching to get back to active crypto buying again as conditions slowly improve. We are still quite skeptical a bottom has been met, but in deploying at various levels around and below ~$18,000 levels, we are well-positioned in either scenario. The focus has been more on supporting existing portfolio companies and gearing up for various network launches in the coming months and year+.
In terms of event-driven selloffs, we believe crypto has bottomed in its own right, if it were its own compartmentalized, uncorrelated market. The primary cause of concern for further downside at this point hinges on equities and broader slowdown and recession risk, which crypto and risk in general will correlate to. There will be more contagion here and there (e.g. potentially DCG, other smaller exchanges, etc), but it will not cause a high volume selloff in our opinions – the FTX meltdown has priced that in.
While it's true the magnitude of economic slowdown has been relatively light and manageable so far aside from the damage inflation already caused, these things typically have delayed onsets. This is why we have decided to take a drawn out approach in capital deployment over many months, as cash is still king for now (only over-deployed folks or bagholders will tell you otherwise).
The bull case for crypto is still undoubtedly intact and narratives will evolve and sentiment will improve over time. There are still many first principles use-cases around ownership, data, privacy, and provenance that are here to stay for the long haul and we will continue backing teams building in these areas and being active market movers.
Stay tuned for more updates and Happy New Year!
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