Where the Money Goes When Digital Currency Startups Raise Capital
With venture capital investments in FinTech startups booming, at a record US$315 million raised in 2014 and more in 2015?
With venture capital investments in FinTech startups booming, at a record US$315 million raised in 2014 and more in 2015, we wondered: Where is all this funding being spent, and why are those in the digital currency business not living a more “FunTech” lifestyle?
Stories from Silicon Valley commonly tell of newly minted tech startups splashing millions of dollars of investors' cash on lavish offices, expensive parties and high salaries. For the digital currency sector, however, the funds are visibly rolling in, but it's not always as clear where these startups spend their capital.
There's certainly a lot of money to go around. Digital currency companies raised a record breaking US$315 million in various funding rounds in 2014. This growth trend has continued in 2015, with Coinbase raising a US$75 million series C funding round almost immediately in January. More recently, digital currency startup 21, Inc. raised a record-smashing US$115 million in March.
One example of a high-spend startup going quickly through their cash is Ethereum. The decentralized web application platform raised US$18.5 million through the ICO of its Ether work units in late 2014. Despite this success, only 198 days after the crowdsale ended, the company had run through nearly all of its cash.
Users at /r/bitcoin noted that the company had been burning its funds at a rate of US$100,000 per day. This was largely because the company decided to keep its capital in BTC and then received a near 50% worse exchange rate when it came time to cash out to USD and pay their bills.
We spoke to Gerald Cotten, CEO of QuadrigaCX.com, the first publicly digital currency exchange in Canada, about the issues facing FinTechs when raising capital. Quadriga CX raised over US$670,000 (CA$850,000) in April this year, doubling the figure they had initially set out to achieve. We asked Cotten what it was like to sell the ideas of digital currency and innovative FinTech to some quite traditional investment houses and brokerages. He said:
“I explained the blue sky potential of digital currencies to the brokers and potential investors. They interviewed my team thoroughly as well as our product. They were curious about comparables, so the public major VC investments into our competitors did help us there. The combined blue sky of our trading platform, merchant platform, and remittance program is stratospheric.”
For Quadriga CX, raising US$670,000 has eased some of the day-to-day pressures experience by a small business. Cotten explained that the injection of cash meant he's been able to grow the team, while increasing the pace at which the company itself is growing.
“Our funding has allowed us to increase the size of our team and to scale at a sustainable pace. It has also allowed for the opportunity to facilitate key partnerships which will be announced during the next few months.”
Raising funding has also created the possibility of opening their fully-regulated exchange offering outside of Canada and into the European market. Cotten stated:
“Quadriga also plans on expanding our services in a very direct manner into Europe later this year.”
For other startups, such as the Internet bank Circle, a round of funding coincides with a shift in the focus of their business. When a company pivots to bring their work in line with a potential investor's interests and expectations, the core business offering can change too. For Circle, their US$50 million investment round in April coincided with such a move, as the Wall Street Journal explained:
“The funding news coincides with Circle’s move to allow consumers to hold traditional currencies in their accounts in addition to bitcoin. Chief Executive Jeremy Allaire said Circle will start with dollar offerings but then provide Chinese yuan accounts and other currencies once it can do so practically and compliantly.”
The burden of regulations and compliance can be both complicated and expensive for companies operating in these financial roles. To obtain a Money Services Business license, which is necessary to transmit customer funds, FinTech startups may have to wait until they receive their initial seed investments before they can afford the license.
In the case of Quadriga, the challenge of facing completely different EU regulations will likely consume a good deal of their latest funding round, although Cotten was keen to point out that, “The raise provides us with the working capital needed to continue to scale and expand at this rate. We have seen over 500% growth during the last few months.”
The legislative costs around many digital currency businesses mean that the excessive lifestyles or work styles that investment capital sometimes triggers in the normal tech world are more limited because FinTech startups face greater regulatory challenges and the associated costs that go with them.
With this common drain on FinTech startups’ capital reserves, they experience perhaps less competition between them over which company has the fanciest offices, or the best employee perks. Without this competitive one-upmanship that pervades the Silicon Valley scene, FinTech businesses can exist at the leaner end of the VC funded world, spending the majority of their raised funds on their core financial products.