The Takeaways:

After the 2018 crypto crash, up to 90 percent of blockchain-focused Chinese venture capital firms left the market.

Now, as China’s central government pushes for greater blockchain adoption, some are returning and deal-flow is increasing.

Surviving funds are retooling and diversifying into fields such as secondary trading and bitcoin mining.

Chinese venture capital firms are taking another look at blockchain. After the 2018 crypto crash, up to 90 percent of blockchain-focused VCs left the market. Now, as China’s central government pushes for greater blockchain adoption, some are returning.

During the first six months in 2019, Chinese blockchain startups raised $368 million via 71 funding deals, according to Chinese financial data tracker 01Caijing.

VCs are finding it easier to raise money. Hong Kong-based Kenetic, which started in 2016 with a few partners trading their own capital, is on track to close an eight-figure fund next month, said managing partner Jehan Chu. NEO Global Capital, a fund backed by the NEO crypto project, has also been raising a second fund of about $50 million since June.

It is among numerous funds that are raising new vehicles this year because of a renewed sense of optimism. At the same time, VCs firms are diversifying away from equity plays in startups towards areas such as secondary trading and bitcoin mining.

These include Sora Ventures, an early-stage blockchain investment firm that entered the secondary market trading earlier this year. Its trading activities include swap, futures of mostly mainstream cryptocurrencies, which takes up about 20 percent of its asset-under-management, said founder and managing partner Jason Fang.

Fundamental Labs, a $500 million-under-management blockchain fund that has backed Coinbase, Canaan Creative and Binance, invested $44 million in bitcoin miners in May that could increase the bitcoin network’s total hash rate by at least 1,000 peta hashes per second (PH/s).

And Parallel Ventures, a blockchain VC founded by Yizhou Zhu, a former investment director at FreeS Capital, also invested in bitcoin mining equipment this year via a separate unit. The investment boasts a computing power of about 300 PH/s that’s worth about $15 million. FreeS has backed Chinese and U.S. tech startups including Uber. It also manages assets for other investors who are interested in the crypto space and completed raising a 200 million yuan ($28 million) new blockchain fund in August.

Big crash

Still, the deal flow is not what it was in 2018. The 71 deals in 2019 represent a drop of 67 percent in deal dollar value compared to 2018, and a 47 percent fall in deal volume. And there are far fewer firms than there used to be.

“Probably less than 10 percent of Chinese crypto investment funds have survived today [since early 2018],” estimates Howard Yuan, managing partner of Fundamental Labs.

By Yuan’s count, there were probably nearly 1,000 early-stage blockchain investment funds during the peak in 2018, including non-institutionalized individual vehicles and informal cryptocurrency capital pool. Of those, 150 to 200 were of a significant size and focused on early-stage investments, according to research from Frank Li, who was an investment director at blockchain venture firm Node Capital that backed the Huobi exchange.

“There are [now] probably around 20 to 30 blockchain venture funds today [in China],” estimates Ren of Consensus Lab, adding:

“At blockchain parties in Beijing last year, you could see people from over 50 funds mingling. Now, I can count all the funds in Beijing with less than my two hands.”

Fundamental Lab’s Yuan echoed that sentiment, estimating there are only “dozens of funds” left. Bonnie Cheung, a venture partner of 500 Startups, told Coindesk “less than 50” blockchain early stage funds are based in China while Parallel Ventures’ Yizhou Zhu puts the number at “around 20.”

Many funds were established by blockchain veterans who made money from mining, trading, and operating exchanges. Their venture vehicles tended to be add-on capabilities. Shifting back to mining, trading and exchanges is natural for them.

Other investors are simply staying on the sidelines. Junfei Ren, founding partner of Redbank Capital and formerly founder of Huobi Labs, said her newly established investment fund is just storing value in bitcoin, rather investing in any startups making use of the underlying technology.

Blockchain investment firm Consensus Lab is focused on incubating just five to six projects right now. “We don’t think of venture investment as an isolated business any more. It must be combined with other businesses to leverage our unique resources, creating a product matrix that can endure the bear market,” said the firm’s partner Kevin Ren.

Funds are struggling to find good investment targets, despite falling valuations for blockchain startups. Simply relying on equity or token investments this year would mean funds are likely in a standstill.

“We only invested in a handful of new token projects in the past two months. At the peak last year, we were doing one to two investments per week,” said Kenetic’s Jehan Chu.

Deal size is shrinking too as startup valuations nosedived and investors are becoming more cautious. Consensus Lab’s Ren told CoinDesk that the average deal size in China is around $100,000 this year, while deals worth half a million dollars are rarely found. Token deals, on the other hand, have mostly become quiet except a few bright pockets like those issued by exchanges.

Age of maturity

After the baptism by fire of the last market cycle, Chinese blockchain venture firms are maturing and evolving to find more sustainable paths, investors say. Valuations are becoming more reasonable and speculative players have left the market.

Funds are becoming more professional, said Jason Fang, managing partner at Sora Ventures. When his fund started in late 2017, it was among the first institutionalized funds in China with a recognized fund administrator and auditor. Now that practice is more standard.

“Before the market crash, investors didn’t evaluate projects carefully because token prices kept going up,” said Xin Jiang, an investment manager at Fenbushi Capital, one of the earliest and biggest venture funds in China established in 2015. “Now investors need to truly find value through more vigorous research and due diligence.”

Expectations for returns are becoming more realistic. “Analysts are spending much more time researching and checking with each other about startups,” said Frank Li, who worked at Node Capital previously and recently joined Parallel Ventures. He added:

“Investor mentality is also more long-term as nobody [now] expects to realize return in a matter of months. The horizon is more likely years ahead.”

Building sustainable future will take time. “We struggle to define a reasonable investment logic and it’s difficult to explain how we should value startups,” said Ren of Consensus Lab. “It’s a deep paradox, because as we invest, we are unsure where future direction lies.”

Kenetic’s Chu is more optimistic. “Equity in blockchain startups will never be cheaper than it is right now,” he said. “We are excited about the companies in China, especially in crypto trading platforms, infrastructure, and defi [decentralized finance] space.”

Chinese yuan image via Shutterstock