It’s human nature to always be on the lookout for the next big thing. Whether it’s evolving as people, scrolling through endless social media feeds, or identifying new investment opportunities, we don’t like to stand still.
Technology is perhaps the fastest-moving aspect of our lives and an area brimming with exciting innovations across industries as companies recognize the importance of everything from clouds to analytics and data. And despite market turmoil, venture capital firms are still investing.
According to Morningstar’s PitchBook, emerging technologies account for about 11% of all seed and early-stage VC investments — and current favorites are areas like Web3, DevOps, and AI. But what makes these opportunities so exciting for VCs and when – if ever – will they have real relevance?
1, 2, Web3
The road from conception to actual adoption is long. For example, we are currently being bombarded with information about the Metaverse and how an alternate, digital universe is the future of everything from shopping to corporate conferences. But in reality we are still only Yes, really with the Oculus Quest for Beat Saber. In fact, research firm Gartner estimates that it will be at least a decade before the metaverse is a truly mainstream concept.
So back to the current favorites of the VCs. According to PitchBook’s Q2 2022 Emerging Technology Indicator (ETI), Web3 and decentralized finance, or DeFi, are by far the most popular among VCs.
Web3 generally refers to decentralized software protocols and blockchain-based products and services. DeFi is the term for the finance-oriented products in it. Companies that attract finance in this segment create everything from marketplaces and platforms, networks, custodial services, identity and privacy tools to payment services.
The concept differs from the current Web or Web2 by the “decentralized” blockchain aspect, but beyond that Web3 is more of a generic term than a fixed technology. For example, by operating on open-source public blockchains, DeFi services eliminate the need for intermediaries by existing as peer-to-peer smart contracts.
The Web3 and DeFi segment became the largest recipient of emerging tech capital in Q3 2021 – surpassing fintech and biotech – and has dominated ever since. Investments have been reduced by more than half to $874 million from over $2 billion since peaking in the fourth quarter — but the amount is still significant given the crypto winter and rising regulatory risk.
Is the hype right?
PitchBook’s deal analysis shows that interest in Web3 is at an all-time high, but according to Gartner, it could be heading for a pretty significant bottom. The company has developed an analytics model called the Hype Cycle (although it’s not a cycle at all) to track technology development, popularity, and adoption.
Of course, the growth of a major innovation is neither linear nor guaranteed, but the model offers some insights into the journey from inception to mainstay. Technologies go through five stages: Innovation Triggers, Culmination of Inflated Expectations, Breakthrough of Disillusionment, Slope of Enlightenment, and Plateau of Productivity.
In other words, when a new technology is discovered, the cycle begins with inflated attention, expectations, and funding — before crashing as investors realize there may not be enough applications, weak performance, or bad press. Then companies find ways to adapt the technology to their business, and over time it becomes mainstream.
Garter places Web3 in the inflated expectation phase, along with related technologies like NFTs, blockchain, and decentralized identity. This is where the mass media hype begins and a wealth of new companies are emerging beyond the early adopters. And indeed, the sectors get a lot of attention.
But there are signs that everything could collapse for Web3. Plunging cryptocurrency valuations have certainly provided a reality check, and bitcoin alone still consumes more energy than Finland annually, resulting in a huge cost to the environment. One software engineer, Molly White, even started a blog called “Web3 is Going Great,” which details some of the not-so-great developments in this space. For example, over $10 million has been lost to Web3 handles and scams so far.
through the trough
Take autonomous vehicles, also known as self-driving cars. A few years ago its arrival was supposed to be revolutionary, but it has turned into a very expensive and sometimes dangerous project that has plunged technology into the “valley of disillusionment”. Driverless cars, for example, have received a lot of bad press about “not living up to the hype” and the space has also started to consolidate. But as of September 2021, three companies are licensed to operate autonomous vehicles in California: Cruise, Nuro, and Waymo.
This is the future of Web3? Not yet, judging by the number and size of deals made. The largest investment in the second quarter included a $175 million Series A for Lightspark, a startup looking to improve the Bitcoin network and reduce its transaction times. The next largest deal was a $148 million Series B raised by CertiK, which offers blockchain security, monitoring and auditing technology. Other big deals are focused on NFTs, crypto wallets, identity and tokens.
And while the roadblocks are certainly still ahead, some will be ironed out. Ethereum, the blockchain used by many Web3 developers, “finally” transitioned from emission-heavy proof-of-work system to proof-of-stake system (see our glossary for a refresher on all crypto). But proof-of-stake has been criticized for not upholding the idea of decentralization; It doesn’t rely on computers for security, but on individuals or companies using their own tokens – and they will be the new verifiers, not the decentralized servers.
Nothing new under the sun
But the idea of decentralization and zero censorship were fundamental web tenets in the first place, and Web3 has seen many projects centralized in ways similar to BigTech, White continues Web3 runs great. Additionally, there are also instances where “uncensorable” or “unmodifiable” platforms have removed or altered data.
“[Sceptics] Also, mention often that a great many Web3 projects sound a lot like Ponzi or pyramid schemes, and question the lack of regulation, oversight and taxation that makes fraud, tax evasion and other criminal behavior particularly rampant in the space,” she writes.
Gartner believes it will take between five and 10 years for the technology segment to mature. In an analyst note, PitchBook’s Robert Le says that while developments have been significant over the past few years, “many projects and digital assets are highly speculative and have not yet progressed beyond the concept phase.” For DeFi, there are technological, fraud, regulatory, and centralization risks, to name a few.
But right now, Web3 is riding the funding wave, and who knows, 15 years from now we might be in the back seats of our driverless cars conducting blockchain transactions from the Metaverse and laughing at crypto’s history as a serial polluter. But I doubt it.