Written by Jean-Luc Shorey, or @JeanLuc_Koji on Twitter.

Global venture capital (VC) funding reached an all time high in November 2021. Last year saw a sharp increase in VC funding - which saw a doubling in capital funding in some months compared to its 2020 counterpart. Early 2022 saw the start of a decline in all types of VC funding - reducing in line with a global drawdown in equity valuations. Interestingly, however, funding of crypto projects bucked this trend. Funding for crypto projects soared to an all time high with firms embracing the Web3 narrative, driven by a search for premium yields (previously earned by early adopters). 

DAOs, NFTs, metaverses, and DeFi entered the common vernacular, becoming buzzwords of 2021, as investors turned their focus to understanding these novel applications of blockchain technology. This entrance into the market may have proved poorly-timed for some with the recent market downturn. Specifically, the fallout associated with the collapse of the Terra-Luna ecosystem.

Irrespective of the recent downturn, it is important to analyze the paradigm shift in VC funding we’ve seen over the last 12 months and understand the underlying forces that drove this shift. 

This analysis will enable us to gain insight into which sectors of the market investors have the most conviction in, and how investment theses may have evolved in the last year.

In brief, although we are in a wildly different market to where we were a few months ago, the funding commitment data illustrates a compelling picture of the fastest growing sectors in the industry that are driving the realization of a blockchain based future. 

Gaming was undeniably the winner over the last 12 months, with a seismic shift in funding being directed towards the blockchain gaming industry.

VC Investment by Sector: Gaming a clear winner

Firstly, a look at VC investment by sector for the previous six month period. Note that all the data below was collected from the blockchain funding database Dove Metrics. 

It is clear to see that in the last six months, gaming has been the major focus of venture investors with over $5b being committed to that sector. After gaming, the following five categories with the strongest funding are consistent performers in the crypto VC space: trading, tooling, exchanges, L1s and payments. These categories are all maintaining a significant  early funding market share.

It’s important to note how the venture sector has changed in the last year. The following chart displays the net change in funding per sector compared to the previous six months.

Gaming has had the largest net increase in funding - experiencing a $3.3b increase compared to the previous six months. Tooling, liquidity, and metaverse specific investments also experienced a large increase in early stage funding. Experiencing the inverse trend, exchanges, security, funding vehicles, banking and stablecoin categories saw a decrease in funding from the previous six months.

This chart shows the relative increase in funding (%) from the previous six months. It’s clear that Infrastructure saw the largest relative increase in early stage funding. 

CEX to DEX Volumes

As DeFi has grown in adoption, it can be seen that trading on decentralised exchanges are slowly eating into CEX’s spot market share. This graph is important because it shows that Trading volume for defi-native tokens is increasingly taking place on-chain, indicating an increased demand for on-chain participation. Further, liquidity (TVL) on DEXs, graphed below, highlights the appetite for on-chain spot transactions as a decentralized alternative to CEXs.

Analysis

Funding Trends

From the above trends, it is clear that gaming has been the dominant category of early stage investment in the past six months. This indicates general investor consensus that gaming will experience the largest comparative growth in the blockchain sector. This does not necessarily indicate that gaming will be the most valuable category of blockchain company in the future, rather that investors believe it has the largest growth potential relative to other categories. Investor theses that gaming will be a strong onboarder of users into DeFi and or crypto more generally are well documented on the public record, making it an interesting category to examine over the next 12-18 months.  

Infrastructure investments experienced a large relative increase compared to the previous six months. This is most likely due to an oversaturation in application layer investments as many new application layer protocols became minimally iterative reincarnations of previous innovations by the end of 2021.

DEX’s share of spot trading volume has consistently increased over the past three years, which indicates sustained attraction of capital and activity on-chain. As this ratio increases, token price volatility should suppress given that the (relative) share of off-chain derivatives will decrease, and reduce the effect of liquidations and the general volatile effects on leveraged markets.

The DEX total value locked (TVL) is still dominated by Curve and Uniswap, yet other exchanges are retaining and have captured a significant portion of the market.

Gaming

Gaming in DeFi has seen an enormous influx of users, functioning as a key onboarder to DeFi to increase mainstream adoption. On the backdrop of a bullish cryptocurrency market, we’re seeing money flow into the gaming industry, creating an intersection between DeFi and gaming that will play a huge role in the next generation of online experience..

Within the past 6 months, the gaming category has seen the largest influx of funds from institutional investors, with >$5.2bn worth of funds raised during this time period. Some of the largest raises were Sorare, raising $680m at a $4.3B valuation for its fantasy sports NFT game, as well as Forte raising $185m at a $1B valuation for its blockchain game platform building new kinds of game economies, and Axie Infinity developer Sky Mavis taking part in a $150m Series C raise giving it a valuation close to $3B. Other big names within the industry such as Mythical Games, who brought P2E and playable NFTs to the mainstream throughout 2021, also raised $150m at a $1.25B valuation, and the likes of Sandbox who raised $93m to accelerate the development of its open metaverse (at the time, the token had a market cap of $2.46B).

Currently, the video gaming industry is valued at $175 billion, with one in three people participating in gaming. The DeFi space is currently sitting on roughly $80bn in total value locked (down from almost $100bn in Nov 2021. Innovations that effectively leverage the intersection of both industries could be a game-changer. As the gaming industry pivots its focus to in-game assets, blockchain could potentially solve a number of related problems: eliminating fraudulent items, creating scarcity, and incentivizing more purchases by making items transferable across games.

In the traditional gaming industry, gamers cannot redeem assets after the novelty of the game has worn off, and yet users are willing to spend large sums in virtual worlds without any potential asset ownership. This is particularly attractive for such users when their purchases become productive assets, providing tangible value to users for all in-game interactions. In this new model, economic value no longer just accrues to the game developer and publisher:

The implications of blockchain gaming doesn’t stop there. The size of the blockchain enabled gaming industry could dwarf the size of gaming as it currently exists. This is because games are evolving how we interact online and curating the next generation internet experience. How we interact and consume information online is being transformed by video game companies who are pioneering world class graphics and visuals that are increasingly visceral and immersive.

For the last couple of decades, the internet has developed to enable social and content interaction like never before with multimedia consumption and creation reaching new heights. 

Games are taking this immersion a step further, with 3-Dimensional, interactive virtual worlds creating new and increasingly life-like experiences for users. With the added value blockchain technology unlocks via attaching verifiability, immutability and interoperability to assets in this immersive environment, it enables full economies and societies to be hosted in these virtual worlds. Understood through this lens, it’s not unreasonable to suggest that blockchain games and ‘metaverse’ protocols could be the hosting environment for the future internet.

Gaming environments will be the hosting platform of the internet and DeFi will provide the valuable ‘in-game’ financial tools. Specifically, this new breed of sophisticated gaming not only allows users to collect, buy and trade, but also:

• Interact with all features of DeFi, including yield farming, lending/borrowing, or token minting through a gamified front end 
• Influence the direction of a game, either through building part of a virtual world that other users can interact with, or gaining governance rights through the accumulation of native tokens both earned in-game or bought on the open market

Already, blockchain-based collectible and trading games such as Axie Infinity and Splinterlands demonstrate that a play-to-earn business model not only has the potential to disrupt the gaming industry but also change how users learn and interact with DeFi platforms.

When you have an environment that is sensory, as well as financially and socially immersive, it becomes an entirely new reality. In this scenario, not only does ownership over assets need to be secured and verified on the blockchain, the actual state of reality also needs to be secured on-chain. For this reason, gaming engines and virtual environments themselves will be natively hosted on-chain as the technology scales to handle more throughput (without sacrificing security).

Hosting of entire digital realities creates digital industries that were nascent or non-existent previously:

1. Amalgamation of gaming and real-world luxury brands: Real-world companies are already set to release NFTs, with luxury brands increasingly releasing branded clothes for game characters. “Gamification is going to influence many things, but there's an obvious application for fashion. Fashion is meant to be this playful arena where you should be able to express yourself and you should be able to experiment,” Michaela Larosse, Head of Content and Strategy at The Fabricant, said. We’re seeing the likes of Prada and Riders Republic, Balenciaga and Fortnite, and Louis Vuitton and League of Legends. It will no doubt help to contribute to an even richer space as it progresses within DeFi gaming, driving engagement among people that may have never thought of interacting with DeFi before.
2. Increased sophistication: With GameFi attracting and holding attention, it seems that more engaging and sophisticated games will be produced, bringing a greater number of backers and investors to the DeFi space. The Walking Dead is another major brand that has secured a plot in The Sandbox, where players will be able to enter a virtual zombie world.
3. Metaverse: With the Metaverse complimenting emerging technologies such as blockchain, IoT and AR, its adoption has soared and is now mainstream technology, offering a life-like gaming experience. The vision for Metaverse gaming platforms will be interoperability, technically this is very challenging, but allowing players to move their gaming items from one space to another without any major changes will deliver immense utility to the sector. With big tech giants like Microsoft and Facebook coming into the industry with their insulated Metaverse projects, existing futuristic gaming projects like Decentraland and The Sandbox will see huge developments of an enhanced version of the Metaverse in the future.
4. Profit sharing communities: we’re seeing projects offer new opportunities for gamers and investors by providing a platform where investors who are not interested in playing games can invest and provide NFTs for players who would not otherwise be able to afford them. From there, players earn rewards for their gameplay, while investors earn a share of the profits. One example of this type of protocol is Yield Guild Games (YGG), a P2E gaming guild and decentralized autonomous organization focused on creating a community that lets players earn via blockchain-based economies. The DAO generates revenue through the sale of NFT assets or by renting them out to gamers as part of a profit-sharing model known as a scholarship. Some of the current games and investments that YGG is involved with include Axie Infinity, Illuvium, Guild of Guardians, Star Atlas, Splinterlands and The Sandbox.
5. Communities with education support: Another trend emerging out of the gaming and NFT sectors are communities that focus on educating community members on how to earn money through gameplay, even seeing protocols providing apprenticeships for players. Merit Circle is a DAO project focused on developing its P2E economy by helping gamers transform their hobby into a steady stream of income.

As our social and economic interactions increasingly take place online, the environment within which that interaction takes place becomes ever more important. This is reflected in the dominance of gaming venture funding over the last year. Gaming has been the pioneer of online immersive experiences for decades and the industry is now being integrated with retail and economic components through blockchain technology. The incorporation of novel economic and social systems with immersive virtual environments will usher in the future of online interaction.

If you liked this analysis of venture investment trends watch out for the next article in this series, which will focus on the trends in the Trading category.

References and sources used throughout this article: