Crypto winter or crypto spring?

Since the beginning of 2018, scepticism has been prevalent in the blockchain space (for an accessible introduction to blockchain, please see our full report). Negative press has become an almost daily occurrence (e.g. WIRED, Forbes, FT). This period of reckoning, referred to as the ‘crypto winter’, should be interpreted in a positive light — the build-up of hype across the ecosystem in 2017 has given way to a more grounded, pragmatic and business-case-first approach to product development. Our analysis of the UK blockchain ecosystem suggests the underlying activity remains healthy. We expect an acceleration in business investment and entrepreneurial activity due to: improving capital dynamics, more efficient deployment of resources, greater focus on infrastructure development, and accelerating adoption by enterprises, partly driven by the urgent need for digitisation highlighted by the Covid-19 crisis.

Over 2,700 blockchain companies have been created in the UK since 2008

There has been an explosion of entrepreneurship activity with over 2,700 blockchain companies founded in the UK since 2008 (the year when the Bitcoin whitepaper was first published). More than 70% of those have been launched in the last three years. This acceleration is partly due to the technology maturing but is also an artefact of the price-induced hype that surrounded the space in 2017.

Figure 2: The number of blockchain companies has been growing rapidly. Source: MMC, Beauhurst, Crunchbase, Dealroom, Tracxn. *2019 totals might change due to a lag in reporting.

Having a live price feed for a new technology is unusual and has created unhelpful swings in sentiment. Hype and disillusionment cycles are customary in the adoption of new technologies but, in the case of DLT (decentralised ledger technology), the live price feed has accentuated the effect. The bull run in the value of Bitcoin during 2017 fuelled a gold-rush mentality that attracted many opportunists to the space. Thus, the rally catalysed growth in entrepreneurship activity.

Figure 3: Entrepreneurship activity is impacted by bitcoin price. Source: MMC, Beauhurst, Crunchbase, Coinmarketcap, Dealroom, Tracxn. *2019 totals might change due to a lag in reporting.

While price cannot alone explain the swings in entrepreneurship activity, the chart above suggests it certainly played a role. Another key contributor was the easy access to capital enabled by the initial coin offering model.

Capital raised through ICOs in the UK is 2.2x the equity funding

An Initial Coin Offering (ICO) is a funding mechanism in which companies sell their tokens in exchange for other crypto (typically Ether or Bitcoin) or fiat currencies (a fiat currency is a legal tender whose value is backed by the government that issued it). It is similar to crowdfunding because it enables an individual to finance a company in exchange for an asset that can appreciate/depreciate in value. Unlike crowdfunding, there was almost no regulatory oversight when ICOs first appeared.

With the explosion of tokens, ICOs quickly became the ‘go-to’ source of funding for blockchain companies, replacing traditional startup financing routes (VC and Angel funding). Lack of regulation, technology hype, open access and rapidly increasing prices of cryptocurrencies contributed to creating an ICO boom in 2017 and early 2018. Between January 2017 and December 2019, UK blockchain companies raised £1.2bn via ICOs (ICObench.com). This compares to £525m invested in equity to fund startups in the space (Beauhurst).

Figure 4: ICO funding has declined significantly in 2019. Source: MMC, ICObench.com, Beauhurst.com.

ICOs represent a valuable funding source for open-source projects. But, the cheap access to capital combined with the lack of in-depth understanding of the esoteric concepts involved in most crypto projects generated, the perfect conditions for a bubble. This created an environment where entrepreneurs were focused on the price action rather than the business proposition. Thus, the majority were not interested in creating long-term value (e.g. New Study Says 80 Percent of ICOs Conducted in 2017 Were Scams by Cointelegraph). As a result, ICO funding considerably decelerated towards the end of 2018. We believe this trend will continue in the short to medium term.

As the ICO funding model becomes increasingly difficult, companies are shifting back to traditional capital raising strategies. This has prompted founders to place more focus on company fundamentals. Thus, our review of the UK ecosystem focuses on startups that have raised equity financing. Companies that have used both equity and ICO funding are also captured but ICO-only plays aren’t.

Only 9% of the startups have raised equity financing

Starting with the 2,700 startups above and excluding companies that have no equity funding or are no-longer active, we are left with c.230.

We’ve individually researched these early stage UK blockchain companies (those using the technology or selling crypto products/services) and spoken to more than a quarter of them so far. We’ve developed a map (see Figure 1 at the top) to place the startups according to their:

• Purpose: Is the company focused on improving a business function (e.g. compliance or human resources) or a sector (finance, media)? Or does the company develop new protocols or core technologies with cross-domain application?
• Customer Type: Does the company predominantly sell to other businesses (‘B2B’) or to consumers (‘B2C’)?
• Funding: How much funding has the company received to date? We bracket this from ‘angel’ investment (under $500k) through to ‘growth’ capital ($8m to ~$100m).

We apologise if we’ve omitted or mis-classified your company. Please get in touch (asen@mmc.vc) with additions or corrections.

Our analysis focuses on equity-funded startups and, as such, might not cover very early stage companies that have not raised financing yet. While the work focuses on the UK, most of the conclusions are applicable more broadly due to the global nature of the blockchain ecosystem.

UK’s blockchain ecosystem is still nascent but…

The UK ecosystem is home to a higher proportion of seed and pre-seed blockchain companies compared to the global average and other markets such as the US. More than 60% of the UK companies have raised less than $2m in capital. While the UK has 5x fewer blockchain companies than the US, the equity investment has been 10x lower. The discrepancy comes from later stage companies as the average Angel/Pre-seed startup in the UK and the US has raised similar funding. It is difficult to pinpoint the main driver behind these dynamics — it could be that companies are not successfully scaling or it could be related to less capital being available for later stage financing. Further, European late stage investors are more conservative than the US and thus require more traction before committing to large raises. This is what a lot of blockchain companies lack.

Figure 5: UK’s blockchain ecosystem is nascent compared to global peers. Source: MMC, Crunchbase.

…availability of capital remains healthy despite the crypto winter

Despite the negative sentiment surrounding the blockchain space, equity capital dynamics have remained robust. Since 2013, UK blockchain startups have raised £525m in equity funding with 85% occurring since 2017. 2019 is on track to become the second strongest year for equity capital raising with £168m announced so far (funding rounds could be announced with a lag).

Figure 6: Equity funding remains healthy. Source: Beauhurst, MMC.

While equity funding likely declined year-on-year in 2019, the quarterly progression presents an optimistic picture. Capital raised was hire year-on-year in both Q2 and Q3. Deals are announced with some lag, so we expect the Q4 gap between 2018 and 2019 to narrow. The number of rounds in the first nine months of 2019 was lower year-on-year, meaning that investors still active in the space are not shying away from putting forward larger checks. Consequently, blockchain/DLT entrepreneurs in the UK maintain adequate access to capital.

Through 2020 and beyond, the Covid19 crisis is likely to impact funding activity for all early-stage companies. That said, the increasingly pragmatic, business-case-first approach of the teams in the blockchain/crypto space makes them relatively well-positioned to weather this downturn, compared to previous periods of weakness in the funding environment.

Figure 7: Equity funding is recovering. Source: Beauhurst, MMC.

8 in 10 blockchain startups in the UK target business clients

8 in 10 blockchain businesses in the UK target business customers. This is not hugely surprising given we are early in the adoption cycle of the new technology.

Figure 8: UK equity-funded blockchain companies mostly have a vertical focus and target business clients. Source: MMC, Beauhurst, Crunchbase, Dealroom, Tracxn.

The shift from centralised to decentralised architectures is highly complementary to the ‘offline’ to ‘online’ transition. We are still in the early phases of this and there are significant opportunities for young B2B companies to support traditional businesses on this journey. The Covid-19 crisis has shone a spotlight on the inadequacy of existing information systems and demonstrated the need for true digitisation across all industries by showcasing the vulnerability of the current system. Blockchain technology is compelling as an enabling architecture for digital transformation, especially when combined with other technologies such as IoT and machine learning. Hence, the current shock could further increase enterprise interest in DLT/digital assets and accelerate adoption.

At the same time, decentralised architectures are still not mature enough to power the majority of consumer use cases. Most platforms suffer from poor user experience, lack of scalability, and difficult deployment. As a result, the value creation potential for entrepreneurs, focusing on developing the blockchain infrastructure stack, is significant.

Somewhat counterintuitively, the proportion of equity-funded startups focusing on infrastructure projects, headquartered in the UK, is significantly lower than those pursuing a vertical. Our conversations with startups point to several factors contributing to this dynamic:

• Monetisation: Most infrastructure projects (such as Radix and Medicalchain) are open-source. As such, entrepreneurs have chosen to use tokens as a value transfer mechanism instead of directly monetising the activity in their ecosystems through traditional rent-seeking models. ICO funding is well-suited to companies in this space and many might not be pursuing equity capital.
• Business case: Blockchain deployments that are use-case specific find it easier to monetise their products. With ICO funding drying up, entrepreneurs are increasingly adopting a narrower, vertical focus in order to demonstrate ROI in a short period of time.
• Regulation: Infrastructure projects tend to be geographically distributed but headquartered in jurisdictions with favourable regulatory regimes. Examples in Europe include Malta and Switzerland. These provide greater legal certainty, government support and easier access to capital.

The growing share of ‘live’ blockchain (or ‘blockchain-inspired’) deployments suggests we are seeing first signs of maturity in the technology. While it took the internet approximately 30 years to become ‘usable’ by businesses (early 1960s to early 1990s), DLT has made that transition in a third of the time.

Higher focus on infrastructure development during the crypto winter

Technology nascency is widely considered an impediment to blockchain adoption. Successful decentralised Web 3.0 applications and services are conditional on solving the scalability, transaction throughput, and speed challenges hampering public DLT networks.

The majority of the capital attracted during the ICO frenzy focused on the application layer. These projects, however, lacked a strong infrastructure foundation and strong business case. During the crypto winter, there has been a rebalancing of developer effort . Analysis of global Github activity by Electric Capital reveals that smart contracts and infrastructure open-source projects have been gaining developers, while applications have been net losers (see Electric Capital’s H1 2019 Developer Report). The space is also becoming increasingly rigorous when it comes to debugging, code checks and audits. This has led to the emergence of strong ecosystems with powerful network effects. For example, Ethereum is continuing to gain full time open-source developers that work across the stack, resulting in Web 2.0-grade experiences such as user-friendly wallets to access the innovation occurring in the decentralised finance (DeFi) space. While capital is less abundant than it was during the ICO bubble, resources are being deployed more efficiently and targeted at fundamental areas of the technology stack.

Consumer businesses are mostly focused on cryptocurrency products

Despite the clear skew towards B2B models in the UK (see Figure 8), there is a sizeable proportion of entrepreneurs with a B2C focus. Most of these start-ups offer products facilitating easier access to and management of cryptocurrencies.

Figure 9: Financial services is a core focus for UK equity-funded blockchain companies targeting consumers. Source: MMC, Beauhurst, Crunchbase, Dealroom, Tracxn.

This is hardly surprising given Bitcoin, a cryptocurrency use case in itself, was the genesis of blockchain technologies. A decade on since the launch of Bitcoin, there are tens of other cryptocurrencies available (thousands have been launched but the vast majority are not used regularly). Accordingly, a suite of services has been developed to allow the public to exchange, store and trade these assets. In the UK, 6 in 10 startups provide such services:

• consumer wallets for storage of currencies (e.g. Argent, Luno, Samourai Wallet),
• exchanges (e.g. Coinfloor, Bitstamp),
• payment services (e.g. Wirex), and
• current accounts serving both business and consumer customers (e.g. Cashaa).

With crypto users numbering tens of millions already (see the 2nd Global Cryptoasset Benchmark Study by the Cambridge Centre for Alternative Finance), the need for safe and user-friendly bank-like services will only grow.

Figure 10: Exchanges, Wallets & Payments account for the majority consumer equity-funded blockchain businesses in the UK. Source: MMC, Beauhurst, Crunchbase, Dealroom, Tracxn.

The high volatility of most cryptocurrencies makes them a poor replacement for fiat. Stablecoins are a promising development towards a more effective transactional asset but their adoption is still nascent. Therefore, currently, cryptocurrencies are mainly viewed as an investment vehicle. New trading and asset management solutions (e.g. Revix and AiX) are emerging to help consumers access these investments with greater ease. Other products (such as tax services platform Recap) that help with portfolio management are also being developed to cater to the growing ecosystem of cryptocurrency users.

Good examples of startups that have been funded in non-crypto consumer space are Uhive, a social network, and Aurovine, a music service. While these are not fintech focused applications, both of them are using utility tokens to provide additional functionality to their users. These tokens are not considered currencies but they require similar basic infrastructure to enable storage and trading. Therefore, user friendly, secure and regulated ‘gateway’ products such as wallets and exchanges are critical in further accelerating the adoption of the technology.

6 in 10 B2B focused startups serve the financial sector but…

Most B2B startups that have raised equity funding focus on addressing sector specific challenges. Fewer companies are focusing on business functions. This could indicate that entrepreneurs consider blockchain use cases that are applicable across industries harder to develop or monetise currently.

Figure 11: Most B2B equity-funded blockchain businesses in the UK target the financial services sector. Source: MMC, Beauhurst, Crunchbase, Dealroom, Tracxn

As with B2C, the financial services sector dominates entrepreneurial activity among business-focused startups. Being a key financial services centre and a fintech powerhouse, London is an ideal launchpad for startups targeting the industry. We see three broad groups of offerings:

• Facilitating issuance, investment and management of digital assets. These include custodial services, exchanges, and tokenisation platforms. This category contains ‘gateway’ products that are key to improving the institutional adoption of digital assets. The growing evidence that crypto assets are increasingly being considered an institutional asset class but better infrastructure is required to facilitate access underpins our thesis behind the recent investment in Copper. Other examples include Globacap, Lacero, Trustology.
• Providing blockchain products to improve the back-end processes powering the capital markets and the legacy banking infrastructure. These range from automating trade settlement to offering new platforms for commodity trading and improving the insurance claim management process. Data providers also fall in this category. Examples include Acre, Agora, Blockclaim, Nivaura.
• New financial products. There is substantial opportunity in this space to reimagine the SME lending market through innovative trade financing, asset financing and other working capital offerings. Services based on tokenised assets also hold great promise as we move towards a world of programmable finance. The burgeoning DeFi ecosystem is particularly important in this respect. DeFi is the movement to open source financial product building by using Ethereum protocols to design composable financial architectures. The creativity enabled and fostered by DeFi could result in an explosion in the number of financial products. Examples include CrediCar, DAG Global, Superfluid.Finance.

…adoption is challenging

Despite the high entrepreneurial and enterprise activity, financial services (FS) presents some key adoption challenges. A study of over 800 enterprise projects by Gartner suggests that only 10% of the FS pilots get into production. Corporates site regulation, implementation complexity and stakeholder involvement as significant impediments: “creation of ecosystem participants was a challenge,” “… challenge in getting internal buy-in” and “technology considered not feasible” (Gartner). Our conversations suggest that most enterprise projects with a blockchain component start with a substantial consultancy-like pilot phase that is not easy to monetise, resulting in longer sales cycles and poor capital efficiency.

Regulation is also often cited as barrier. Regulatory certainty is slowly coming to blockchain and digital assets with both regulators and entrepreneurs taking a more proactive approach. The UK’s FCA has been one of the pioneers in the space with DLT companies representing 30% of the participants in its Sandbox programme since 2015. This process is a crucial step towards broader adoption of the technology, just as the development of the internet legislation in the early to mid 1990s paved the way for the growth in the years leading up to the dot-com bubble.

Beyond Financial Services, Media, Compliance and Supply Chain are emerging as early adopters

More than 50% of global enterprises consider the technology a strategic priority and are investing in developing their capabilities (Deloitte’s 2019 Global Blockchain Survey). From an enterprise perspective, decentralised technologies are no longer just the remit of financial services. The survey by Gartner established that the proportion of DLT projects focused on the financial industry has decreased to 30% from 75% two years ago. The media, manufacturing and government sectors are conducting various exploratory projects that leverage core DLT use cases such as asset tracking and shared record keeping.

As reflected in Figure 11, the Media & Advertising vertical in the UK is seeing high levels of activity. Shared record-keeping and identity management delivered through blockchain solutions could significantly reduce challenges faced in digital advertising and IP management:

• Advertising: The digital advertising value chain is inefficient and fragmented. More than 60% of the money paid by the advertiser in a typical programmatic campaign are captured by middlemen instead of going to the publisher, the so-called ‘tech tax’ (World Federation of Advertisers). In addition, fraud and non-transparent behaviour are costing advertisers billions each year. Blockchain could address these issues by creating cryptographically-secured digital assets/identifiers (e.g. digital ads) that can be tracked across the ecosystem to provide higher transparency. A decentralised network, which leverages smart contracts to programmatically control the flow of data and ad inventory in the digital advertising supply chain, should, in time, also reduce the number of intermediaries required. Companies such as Fenestra are working towards providing such alternatives. Others like Glimpse have the ambitious goal of putting consumers at the centre of the advertising ecosystem by giving them control over the monetisation of their personal data.
• Media and IP Management: The current system of rights management was set up to cater to a much more centralised world with tight control on distribution. New consumer behaviours present new opportunities for content monetisation but outdated rights management systems prevent content creators, IP holders and artists to fully benefit from those. Blockchain could address these issues by enabling efficient traceability via digital asset management and micropayments. Blockchain can enable content registries that can quickly and autonomously identify assets and establish ownership every time the content is consumed. This will disrupt the business model of the intermediaries involved in the value chain and better align the rewards to the value created. Further, a potential new system should generate structured data that could later be fed through AI algorithms to enable additional upside (e.g. more effective discovery for artists, recommendations for consumers and revenue forecasting for distributers/artists). Startups tend to specialise in specific verticals. For example, Blokur and Delic are working in the music industry, Filmchain is targeting the film industry, and Aggregion is targeting the software licensing space.

Figure 12: Most B2B equity-funded blockchain businesses in the UK, focusing on functions, target supply chain use cases. Source: MMC, Beauhurst, Crunchbase, Dealroom, Tracxn

Regulation & Compliance is a focus area for startups serving business functions. Blockchain delivers ‘out-of-the box’ capabilities that are fundamental building blocks in regulatory use cases:

• Immutability by design
• Transparency and auditability
• Proof of ownership

Most of these attributes are currently provided by additional overhead. For example, large financial institutions are often required to (semi-)manually reconcile customer data across business unit silos and public databases to satisfy know-your-customer (KYC) and anti-money laundering (AML) requirements. Separately, organisations need additional processes to demonstrate compliance with regulations. Blockchains could provide a transparent, immutable, and auditable single source of truth ledger that both streamlines operations and serves as a record of compliance. DLTs could also provide regulators with real-time-monitoring capabilities. Companies such as AID:tech and Zamna aim to build such personal identity records shared among organisations to provide efficiency and reduce regulatory burden. Others such as ByzGen are sitting at the intersection of enterprise data, security and compliance, showcasing the unique capabilities a blockchain-based architecture can deliver in the context of digital transformation. While the benefits are promising, deployment is non-trivial due to lack of common standards, legacy processes, legacy infrastructure, and reluctance from companies to share data with competitors. Enterprises also often choose the easy but ineffective shortcut of moving current processes to DLT instead of devising new ways of working that are native to the new paradigm.

Provenance is another core use case for blockchain technologies. Therefore, it is no surprise that supply chain management attracts relatively high activity. Everledger, for example, helps clients track the provenance of diamonds, art and wine, helping customers reduce business risk and enhance customer value. The fashion and retail industries are increasingly focusing on improving transparency for their customers, as well as reducing counterfeits. Provenance (the company) is working with brands such as Martine Jarlgaard, Unilever, and Sainsbury’s to track the journey of raw materials and prove sustainable sourcing of products. In fashion, tracking products through the supply chain and enabling consumers to prove authenticity could supercharge the resale markets, which are seeing as much as $23bn worths of goods transacted (ThredUp). Provenance use cases, however, often depend on successfully and reliably linking the physical goods to digital identifiers — a solution is as strong as the weakest link in the chain. Ongoing research in IoT technologies should help solve outstanding issues in this aspect.

Conclusion: The UK blockchain ecosystem is primed for growth

While sentiment in the blockchain space remains volatile, the underlying activity in the ecosystem is considerable:

• Focus on infrastructure: the number of full-time developers continues to grow and effort is focused on key areas of the infrastructure stack.
• Enterprise activity: Adoption and experimentation of blockchain technology is accelerating in large sectors beyond financial services.
• Stronger fundamentals: Entrepreneurs are adopting business-case first approach to product building while also prioritising UX.

The ecosystem is emerging stronger from the crypto winter and this presents significant opportunities in the years ahead.

I’d like to thank Mike Stokes and David Kelnar, whose work and guidance contributed to the above. Also, special thanks to Ana-Maria Yanakieva, Francesco Renzi and Thomas Klocanas for their feedback.