Crypto VC Major Retreat: Those rushing into AI are doomed; only those who stay can reap the rewards

Author: Regan Bozman

Translation: Deep Tide TechFlow

Deep Tide Guide: The crypto venture capital market is shrinking rapidly. Investors are either leave, shift to AI and deep tech (high difficulty and fierce competition), or continue focusing on crypto. The key is that the growth potential of stablecoins and global financial applications remains huge—we may have only traveled 5% of the way. This article is based on observations by investor Regan Bozman from Lattice Fund, indicating that Crypto VC is contracting. This is a fact, but it’s not necessarily bad news. After the bubble deflates, the real opportunities often just begin to surface.

This week, a popular topic on Crypto Twitter seems to be a common concern: does the shrinking of available funds mean the crypto industry is losing its appeal?

Crypto venture capital is clearly contracting—there’s no doubt about that. But why is this happening, and what does it mean? There’s much debate. Rob Hadick’s view is that crypto VC is consolidating around the best founders and top funds, which signals industry maturity. Meltem believes the contraction is due to (a) a lack of quality early-stage founders, and (b) a surface area too small compared to other high-growth industries.

I have nothing to add to this specific debate.

It’s obviously still possible for outstanding founders to start in crypto. But it’s equally clear that there are far fewer founders starting in crypto than in 2021, while there are many more starting in AI and other fields. Is this because of a lack of capital, or has this caused the gap? Both could be true.

Undoubtedly, this work is much harder than before. As funding floods into the space, returns are compressed. Tokens are structurally more challenging than in 2017-2021. Since the AI boom, fewer allocators are interested in funding crypto VC funds. If you don’t genuinely love crypto VC, now might be a good time to do something else.

Last week, I attended Disciplus’s Demo Day in El Segundo, focused on industrial technology. I was surprised to see so many crypto investors there. It felt like meeting another married friend at a bar—you both probably shouldn’t be there. Industrial tech isn’t Lattice’s main focus (I personally invested in Disciplus), but I wanted to better understand what’s happening in the non-crypto VC market.

Understanding how crypto investors respond to market conditions is the most interesting question because it directly impacts the future of the crypto capital markets. Clearly, some are heading to El Segundo. But not everyone. Currently, I see three main responses among crypto investors:

The first is to leave and do something entirely different. This could be operational roles within crypto, or completely unrelated ventures. It’s increasingly common for people to leave established funds, as many zero-interest-era funds continue to disappear. Yes, the assets under management of large funds are growing, but the rate of personnel growth is unlikely to offset the number of bankruptcies.

Some crypto managers are doing well enough that they can invest in whatever they want, unconstrained by fund mandates. Kyle Samani is the most publicly known example. Samani reminds us that poor performance might push people down this path, but there are also investors with exceptional track records who simply choose to focus on more interesting problems elsewhere.

The second is to continue doing venture at your firm but expand your investment scope. This is easier for some than others. Not all active crypto companies are explicitly focused on crypto. My sense is that Meltem’s mission is broader than just crypto, so people like Crucible can simply choose to focus on other areas. Paradigm, when launched, positioned itself very clearly as a crypto fund—now they’re doing “frontier tech.”

Many firms (including ours) have a clear mission to invest in digital assets and related businesses. Fund documents often broadly define this, but I believe most crypto fund managers have a very clear understanding with LPs that they represent “crypto exposure.” So these managers either modify their LPAs to do non-crypto businesses, get verbal approval from LPs, or do it secretly. It’s clearly a spectrum—you could argue that all AI businesses will eventually use stablecoins, so they’re all “crypto businesses.” I’m not saying this view is correct, just that the boundaries can be blurry.

The third option is to stay the course. If you believe this industry will grow 100x from here, with less competition and lower valuations, it’s a good time to invest. We’ve chosen this route.

What door leads to wealth?

I understand the appeal of the second option, but I remain skeptical. Venture capital is an extremely competitive industry and a power-law business. There’s a reason Y Combinator accounts for about 90% of global accelerator returns. The top 10% of VC funds often participate in the best deals, which generate most of the returns. This means that unless you’re among the best, playing this game is really not worth it, and becoming the best is damn hard.

The most common side hustle in crypto is shifting to AI. AI is large, growing, and will change the world. It’s also arguably the most competitive VC market of the past two decades. More money is being invested at higher valuations (with significant questions about business models). You’re competing against AI-focused funds, generalist VC funds, and basically every VC source on Earth. So I highly doubt most crypto funds have any real advantage here. Of course, there are exceptions—some crypto managers are very thoughtful about AI. But my assumption is that most will face tough losses.

Deep tech/industrial tech (like those found in El Segundo) might be less competitive, but it’s not without challenges. You’re leaving perhaps the most capital-efficient business in history (open-source protocols) for a highly capital-intensive one. These businesses also require specific technical skills to analyze.

Opportunities remaining in crypto

This brings us back to crypto, which in some ways reflects broader trends in the VC market. Fewer companies are raising larger shares of available capital. The market is polarizing. In the past, there were many crypto funds of $100-200 million. Now, it’s mainly early-stage specialized funds under $70 million and large platform funds. The main difference between crypto and traditional VC is that crypto VC is shrinking, while traditional VC is growing very rapidly.

Our focus remains on “seed opportunities in industries or categories not yet recognized by large institutional firms.” The current crypto market obviously faces challenges, but I believe there are just as many opportunities. Crypto-driven financial applications are rapidly expanding in many markets worldwide. Non-USD stablecoin circulation is still just a drop in the ocean. We may have only completed 5% of the upgrade to the financial system—there are still vast opportunities ahead.