Crypto Startups Face An Uphill Battle Amid Market Pessimism, Regulatory Hurdles

The funding boom in the Indian startup ecosystem, and even globally, in 2021 resulted in investors lining up to invest in cryptocurrency startups. Crypto startups were the flavour of the season and everyone wanted a share in them.

According to Inc42 data, investors pumped in $513 Mn across 32 crypto/Web3 deals in 2021. India also got its first crypto unicorn in August 2021 when CoinDCX raised $90 Mn at a valuation of $1.1 Bn. A few months after this, CoinSwitch also joined the unicorn club. 

At that time, it seemed nothing could go wrong for Indian crypto startups. The momentum of 2021 continued in the first half of 2022 as well, with crypto/Web3 startups raising over $773 Mn across 39 deals. Polygon alone raised $450 Mn in February 2022, while 5ire, a fifth-generation Layer-1 (L1) blockchain network, raised $100 Mn in its Series A round in July 2022 at a valuation of $1.5 Bn.

However, by this time, the initial signs of the Russia-Ukraine war, rising inflation and tightening monetary policies had started appearing in the form of decreased funding in the Indian startup ecosystem. This funding winter, which continues even today, proved to be too strong for the crypto wave as well.

Besides the funding winter, the sharp fall in prices of cryptocurrencies, collapse and controversies at major crypto exchanges, and regulatory ambiguity, among others, hit crypto startups hard. These startups are now struggling to come to terms with the drastic change in the market sentiment.

Crypto Startups Shut Shop

Many crypto startups decided to bide their time and wait for the hard times to pass away. This resulted in the likes of Polygon, CoinDCX, and WazirX laying off nearly 250 employees over the last year or so.

However, not all crypto startups could afford to do this and many of them decided to shut their operations. Pillow, Flint and WeTrade are such startups which decided to wound down their business over the last few months. 

Accel-Backed Pillow

Earlier this week, Pillow became the latest Indian crypto startup to fold up amid the challenging operating environment.

“We regret to inform you that the Pillow team has made the decision to no longer provide our current services through the Pillow app due to regulatory uncertainty, and will be closing operations on July 31,” an in-app notification on Pillow app recently read.

Founded in 2021 by Arindam Roy, Rajath KM, and Kartik Mishra, the startup raised $18 Mn in its Series A funding round co-led by Accel, Quona Capital, Elevation Capital, and Jump Capital.

Peak-XV Backed Flint Money

Last month, Bengaluru-based Flint Labs also decided to discontinue its Flint Money app owing to regulatory challenges and unfavourable market conditions, among other issues.

“The combination of regulatory hurdles, negative market sentiment, and other challenges substantially limited our growth potential. With the mounting pressure from these factors and the responsibility to protect our users’ interests, we reached the difficult decision to sunset the Flint Money app in November 2022,” Flint Labs said in a blogpost.

Flint was founded in 2021 by former product managers of CRED – Anshu Agrawal and Akshit Bordia. It launched Flint Money in January 2022. The startup raised $5.1 Mn in seed funding round led by Sequoia Capital India, GFC and a clutch of other investors in January 2022.

Bengaluru-Based WeTrade

In February this year, crypto platform WeTrade announced that it would be shutting its operations amid the funding winter and the uncertainty in the crypto market.

“WeTrade started in 2022 with a vision to make trading in cryptocurrency easy and rewarding. However, with the crypto winter deepening and the ambience turning increasingly hostile, we have decided to pause our services,” the startup said.

In 2022, WeTrade reportedly raised INR 15 Cr from external investors, including VCs and angel investors.

Regulatory Uncertainty Casts A Dark Cloud

Besides the funding winter, the lack of clarity on cryptocurrencies in India and the contradictory statements from the government and the Reserve Bank of India (RBI) have also affected crypto startups.

For the first time in the 2022 Budget, Finance Minister Nirmala Sitharaman introduced crypto taxation by announcing plans to tax virtual digital assets (VDAs), including private cryptocurrencies. Under a new section, the government introduced a 30% tax on profit from crypto transactions, which became effective on April 1, 2022. In addition, 1% TDS (Tax Deductible at Source under section 194S of the Income Tax Act) was also levied on crypto transactions above INR 10,000 with effect from July 1, 2022.

The taxation announcements brought temporary relief to the industry as it was perceived as official recognition for cryptocurrencies. While the taxation announcement resulted in a sharp decline in crypto transactions, the industry was hopeful that it would pick pace soon. 

However, the Terra Luna crash, the suspension of operations by Vauld, and the collapse of FTX earlier this year only added to the troubles of the crypto ecosystem. Meanwhile, the RBI has been a staunch opponent of private cryptocurrencies, with its top officials calling for a ban on cryptocurrencies at different times.

However, the government has not spoken about a blanket ban on cryptocurrencies. The Economic Survey 2022-23 highlighted the pervasive nature of cryptos and called for global regulations. But, the finance minister has refrained from commenting on legality of crypto, indicating that the government may want to buy time and observe the space carefully before taking any action.

Although this could be a positive for the industry, the delay by the government in making its stance clear is accelerating the uncertainty and negative market sentiment. 

Commenting on the situation, a crypto startup founder, who didn’t want to be named, said, “Fundamentally crypto and Web3 space saw the emergence of good ideas and innovation. All the good ideas that everyone has been working on, cannot be implemented without the blessings of the governments.Governments giving a blessing essentially means giving up control and making things a lot more anonymous and autonomous, which is something that no government would want to do. Fundamentally, everyone wants decentralisation, but it’s just not aligned to the incentives of those who are in power.” 

Legal Troubles & Controversies

As if the regulatory uncertainty in the space were not enough, a number of major Indian crypto startups, including CoinSwitch and CoinDCX, also came under the scanner of the Enforcement Directorate (ED) over the last couple of years for their alleged involvement in money laundering. A number of crypto scams also emerged in the country over the last few years, adding to the industry’s woes.

As of January 31, 2023, the ED had seized proceeds worth INR 936 Cr in relation with various cryptocurrency frauds, as per the government.

Besides, the infamous verbal spat between the founders of WazirX and Binance over the ownership of the former further eroded trust in cryptos. It was a peculiar situation in which neither of the parties was willing to claim ownership of WazirX. 

If the crypto industry felt that only India was the problem, the developments in the US over the last few months, post the collapse of FTX, proved them wrong. The Securities and Exchange Commission (SEC) of the US recently sued Coinbase and Binance, two of the world’s largest crypto exchanges, for allegedly bypassing regulations. This is likely to further affect the market sentiments towards cryptocurrencies.

Other Factors Troubling Crypto Startups

According to Rajagopal Menon, vice president of WazirX, the sentiment-driven nature of crypto markets is akin to stock markets. “During Bitcoin’s peak at $67,000, our servers struggled to handle the overwhelming demand. However, with Bitcoin currently experiencing a significant price drop of over 50%, people have become more cautious and adopted a wait-and-watch approach,” he said.

The negative market sentiment is the biggest factor troubling crypto startups. According to the founder quoted earlier in this story, investors like to focus on trending technologies where they can see maximum upside. Unfortunately, crypto space is not such an attractive proposition right now.

“Right now, we are obviously at that stage where things would be difficult in the next two years. And the hottest topic right now is AI and most of the investors are doubling down there aggressively when it comes to emerging tech. There are a few crypto-centric funds but it would take time for industry interest to come back ” he said.

How Crypto Startups Can Stay Afloat

According to Menon, crypto startups should focus on trimming unnecessary costs and streamlining operations. This would involve re-evaluating their budget, reducing non-essential expenses, and optimising resource allocation.

“Relying solely on one revenue stream can be risky during times of regulatory uncertainty. Crypto companies should explore partnerships and collaborations to diversify their income sources,” he added.

CoinSwitch seems to be doing exactly this. Earlier this week, it was reported that the crypto exchange plans to enter the wealthtech space by launching a stock trading vertical. CoinSwitch is planning to apply for a stockbroker’s licence with the Securities and Exchange Board of India (SEBI). While it remains to be seen how successful it would be in the space, which has  presence of established players like Zerodha, Groww, and Upstox, the move seems to be an attempt by CoinSwitch to diversify its revenue stream and not only depend on the crypto space. 

Besides, there are some areas within the cryptocurrency space where startups can continue to innovate.

According to the aforementioned crypto startup founder, startups focused on fundamental infra layer solutions can continue to operate the way they did earlier as technology will keep evolving. “I think we are still not there where decentralised apps can be mass-marketed, so the technology needs to be built further,” he said.

Apart from that, exchanges form the backbone of the crypto economy and they should continue to operate and innovate.

“I think we are still at a nascent stage and there’s a lot happening there in terms of technology… It is not just a space which is driven by FOMO. But products which are dependent on the returns they give to users will continue to suffer,” the founder added.

Note: We at Inc42 take our ethics very seriously. More information about it can be found here.