I want to focus this post on the macro environment for tech, startups, web3, and climate because that is where my head is at right now.

I believe that sometime in the first half of 2023, the central banks around the world will start backing off the tightening that they have been engaged in as inflation continues to ease and the economy continues to cool. Interest rates will level off in the first half of 2023 and I think there is a good chance of a “soft landing” or a very mild recession in 2023.

With that macro view in mind, what would that mean for tech, startups, and web3?

The largest tech companies will emerge from this downturn leaner and more profitable and growing more slowly. They will be mature businesses that behave like the blue chips that they are. I think these companies, like Apple, Amazon, and possibly Google, will see their stocks come back into favor ahead of everything else in tech. I am hedging on Google because I believe the massive advances in AI/ML that we are seeing right now may be a threat to their core search franchise.

Startups are going to have a tough year in 2023. While many have gotten their burn rates way down, most startups still are losing money and will eventually need to raise capital in 2023. Because most startups avoided raising in 2022, there will be a glut of startup companies in the market for capital this year and while there is plenty of venture capital sitting on the sidelines waiting to be deployed, VCs will be much more selective, instead of funding everything that moves as we’ve done over the last few years.

Good businesses with product market fit, positive unit economics, and strong leadership teams will raise capital although it will be at the new normal in terms of valuation. I believe that “new normal” is more or less where we were in 2015 where seed rounds were done around $10mm, A rounds were done around $15mm to $25mm, B rounds were done around $25mm to $50mm, and growth rounds had a cap at 10x revenues. This new normal will lead to many flat rounds, down rounds, inside rounds, and rounds with a lot of structure on them. None of that is good, but the worst of those options is rounds with a lot of structure. I believe founders and CEOS and Boards should take the pain of a new valuation (flat, down, whatever) over structure.

But there is a huge number of startups out there that have not really found product market fit, have not created positive unit economics, and have unresolved issues in their founding teams and leadership teams. These startups will struggle to raise capital at any price and most of them will fail. This has already started to happen but because so much capital was raised in 2021 and the early part of 2022, it has taken longer for these companies to fail. I think we will see a lot of startups in this category go under or taken out in fire sales in the first half of 2023.

While all of that sounds gloomy and downright horrible, I do think the startup sector will end the year in a much better place. The good companies will have gotten funded, the bad ones will have shut down, and VCs will be back to competing with each other to win deals, which is where founders always want VCs to be.

I think web3 will behave similarly in some respects but different in others.

I think the large caps in web3 (BTC and ETH mainly) will start to attract more interest from investors and should do well in 2023. I am more bullish on ETH personally because it has the best underlying economic model of any web3 asset.

Like the startup sector more broadly, web3 will go through a triage of sorts in 2023. Projects and protocols that have found product market fit, have real token economics, and ship new features quickly will attract new interest and rise in value. But many web3 projects have not found product market fit, have weak or no token economics, and do not execute well and I think we will see many of them continue to flounder and fail in 2023.

There is a much larger overhang in web3 right now when compared to the broader startup and tech sectors. There are entities that are insolvent but have not been restructured. There are funds that are so far under water that they may be forced to liquidate. These kinds of activities will produce ongoing sell pressure on web3 tokens for at least the first quarter of 2023 and maybe for much longer.

While there are compelling values out there in web3, I am not convinced that it is safe to go back into the water just yet unless you have a very strong stomach and a very long time horizon.

Climate, where USV has been actively investing for the last three years and now has two funds dedicated to the sector, has mostly been spared the carnage that has hit the other parts of USV’s portfolio. 2022 brought largely good news to the sector in the form of the oddly named Inflation Reduction Act (IRA) that will flow billions of dollars of capital into the sector over the next decade. Many leading VC firms have dedicated climate funds now and we see huge amounts of capital available for climate startups with strong teams and novel approaches.

Last year I predicted 2022 would be a big year for carbon credits and while we saw a lot of growth in the market for these credits, particularly among the large tech companies, I was way too optimistic about how fast the market would grow. That said, I think 2023 will bring more growth in this market which provides the underlying business model to many of the new climate startups VCs are funding right now.

We are also seeing a noticeable movement of tech and startup talent into the climate sector in search of new problems to solve, more meaning in their work, and many more job openings too. I think 2023 will be a big year for this talent migration.

There is a pattern to much of this and it is that 2023 is going to be a tough year for most but those that get through it should find themselves in a good place, with leaner cost structures, less competition, and healthier employer/employee dynamics. Surviving is thriving in 2023.

So to everyone who is reading this, Happy 2023. Buckle up, hang tough, and be smart.

I like to bookend the New Year holiday with two posts, one looking back at the year that is ending and one looking forward to the year ahead. This is the first of these two posts. The second one will run tomorrow.

What happened in 2022 is the bottom fell out of the capital markets and the startup and tech sector more broadly.

Back in February 2021, I wrote a post called How This Ends. In it, I wrote:

I believe it ends when the Covid 19 pandemic is over and the global economy recovers. Those two things won’t necessarily happen at the same time. There is a wide range of recovery scenarios and nobody really knows how long it will take the global economy to recover from the pandemic.

But at some point, economies will recover, central banks will tighten the money supply, and interest rates will rise. We may see price inflation of consumer goods and labor too, although that is less clear.

When economies recover and interest rates rise, the air will come out of the asset price bubbles that have built up and the go go markets will hit the brakes.

I went on to say that I had no idea when all of that would happen, but I was confident it would.

Well, it happened in 2022.

The air came out of the asset price bubbles that had built up over the last decade and were accelerated/exaggerated by the pandemic. There have been a number of other factors at work, like a war in Europe, that made things even worse, but it is my view that most of what happened in 2022 was entirely predictable, expected, and necessary.

In the areas that USV works in; tech, startups, and web3, there have been a number of important downstream effects of the popping of the bubble and they are worth enumerating.

As the capital markets, including crypto/web3, came undone, companies reacted by adjusting their burn rates to reflect that the growth at any cost phase was over and it was time to get on a path to breakeven. That has meant layoffs across the tech, startup, and web3 sectors. The voracious appetite for talent has waned. Spending for growth has largely stopped and most tech companies and startups are growing more slowly but with better unit economics and lower cash burn.

Some startups have failed, particularly the ones with upside-down unit economics or with a lack of product market fit. I think we have just seen the start of this trend and I plan to talk more about this in tomorrow’s post.

The sector with the largest impact, obviously, has been web3. Many large centralized entities; lenders, exchanges, crypto funds, etc, blew up when the value of web3 assets declined 70-90% over the course of 2022. The carnage has been massive and reminds me of what happened to the web sector in 2000/2001. Some of this has been markets doing their thing, but not all of it was. There was fraud, mismanagement, irresponsible risk-taking, and more, at play in the web3 sector.

And yet, I am not aware of any leading decentralized protocols blowing up in 2022. The smart contracts that run these protocols did what they were programmed to do and they have come through intact. It is a testament to the power of decentralized protocols over centralized entities and, for me, the major lesson of 2022 in web3.

I used the word necessary a few paragraphs ago to describe what happened in 2022. I understand that this year has been painful for most and devastating for many. I am not immune to it. Our family’s net worth has taken a massive hit. The carrying value of USV’s assets under management has been cut in half this year. And yet, I am fine, my family is fine, and USV is fine. Many are not. I understand that and have a lot of empathy for those who lost so much, including their jobs, this year.

And yet, I know that the unwinding of an unhealthy and unsustainable growth at all costs/cheap capital environment was necessary and will be healthy in the long run. We already see many of our portfolio companies operating at much more sensible cost structures with clear paths to profitability at much lower growth rates.

The ending of the war for talent in tech also is incredibly healthy. Some leading tech company CEOs I know believe they can operate with much lower headcounts in product/engineering/design than they have been for the long term. That talent can move into new startups and new growth areas, like climate and healthcare, that need it.

Like all transitions, this is messy, painful, disruptive, and ugly. And this year has been all of that and more. I am happy to see it in the rearview mirror and looking forward to better things in 2023. Which will be my topic for tomorrow.

As usual, here are some songs that stuck with me this year.

I hope you enjoy it.

I have written many times about the Hour Of Code here at AVC.

It is the highlight of the annual Computer Science Education Week which is the first week of December, which is this week.

Yesterday Marco Argenti, Goldman Sachs’ CIO, and I went with NYC Schools Chancellor David Banks to the Hospitality Management High School in the Hell’s Kitchen neighborhood in Manhattan to do an Hour of Code with the students there.

In the class we attended students were using the Scratch programming environment to make a small robot move around a course while also navigating some real world problems.

In this photo you can see three young women with their robot and a laptop with Scratch on it:

At the end of that exercise, the students got the opportunity to ask Marco and his colleagues about working as a software engineer. This is a post the Goldman team wrote about the importance of this work.

Many AVC readers know that getting computer science education into every building in the NYC public schools has been a long standing passion project of mine. It’s hard work getting the business community engaged with this work and supporting it financially.

But every time I get the opportunity to go into the schools and see the teachers and students working on computer science problems, I get a boost of energy in my system to keep going and push even harder.

I was particularly excited and pleased to see Chancellor Banks so engaged and excited about what he saw yesterday.

Chancellor Banks and his team at the Dept of Education are very focused on creating pathways to rewarding careers for their students. The Chancellor calls it his “north star.” So they are a fantastic partner for this work I do and I appreciate everything the DOE, the school leaders, and the teachers do to help the young people of NYC become computational thinkers and be computer literate. It will make a big difference in their lives.

The advances in AI over the last year are mind-boggling. I attended a dinner this past week with USV portfolio founders and one who works in education told us that ChatGPT has effectively ended the essay as a way for teachers to assess student progress. It will be easier for a student to prompt ChatGPT to write the essay than to write it themselves.

It is not just language models that are making huge advances. AIs can produce incredible audio and video as well. I am certain that an AI can produce a podcast or video of me saying something I did not say and would not say. I haven’t seen it yet, but it is inevitable.

So what do we do about this world we are living in where content can be created by machines and ascribed to us?

I think we will need to sign everything to signify its validity. When I say sign, I am thinking cryptographically signed, like you sign a transaction in your web3 wallet.

I post my blogs at AVC.com and also at AVC.Mirror.xyz which is a web3 blogging platform that allows me to sign my posts and store them on-chain. This is an attestation at the end of last week’s blog post.

You can see that “author address” and click on it to see that it is one of the various web3 addresses I own/control. That signifies that it was me who posted the blog. It is also stored on-chain on the Arweave blockchain so that the content exists independently of the blogging platform. That is also important to me.

I think AI and Web3 are two sides of the same coin. As machines increasingly do the work that humans used to do, we will need tools to manage our identity and our humanity. Web3 is producing those tools and some of us are already using them to write, tweet/cast, make and collect art, and do a host of other things that machines can also do. Web3 will be the human place to do these things when machines start corrupting the traditional places we do/did these things.

When markets are in turmoil, like they have been for most of this year, I like to have a buy-and-hold mindset when it comes to making new investments. It is hard to know when you’ve reached the bottom and can start buying again, but if you think about a ten or twenty-year hold, then it becomes a bit easier.

The Gotham Gal and I buy and build a fair bit of real estate on the side and we generally use a “cap rate” of between 5 and 10 when we acquire and develop real estate. That means we want to generate an annual yield on our total investment (acquisition cost plus construction cost) of between 5% and 10%. If you think of those numbers as price/earnings ratios, then we are paying a PE of between 10 and 20 times earnings.

It is true that PEs and cap rates and most other “investment ratios” are impacted by current interest rates. When rates go up, like they have been for the last year, the value of capital assets goes down. That’s what we have been seeing this year, among other things.

But if you think about holding an asset over a very long time, like a building, then you will likely hold it through a number of different interest rate environments. And so what I like to think about is what a reasonable return is for a very long-term hold. And in real estate, that is between 5% and 10% per year in my view.

Riskier assets, like venture capital investments, would require a much higher return than 5 to 10% a year. At USV, we generally underwrite to at least 10x our investment if the company is successful and drop down to maybe 5x on more mature companies where we have a much better line of sight to an exit. A 10x return over ten years is roughly a 26% annual return compounded. A 5x return over ten years is around 17.5% compounded. So riskier assets command higher expected returns.

But if you are looking at a tech stock that is mature, like Google or Apple or Amazon, or even something a bit less mature like Etsy (where I am Chairman and own a lot of stock), or Shopify, or Airbnb, I believe it is appropriate to think about that investment more like real estate than venture capital.

Let’s look at Google. It is down about 30% in the last year to a market cap of about 1.25 Trillion. It generates about $70bn of net income a year (that’s what it generated in the last year). It generates about $80bn of cash flow from operations. So if you think of Google like a building, it is trading at a cap rate of 6.4% and a PE of about 18x. Google’s business is not quite as resilient as a building, which is a hard business to mess up, but it also could potentially grow its earnings significantly over the next decade or two, which is a bit harder to do with buildings.

Would you rather buy Google at a cap rate of 6.4% or an apartment building in your neighborhood for a 6.4 cap rate. I think it’s a tossup. At least it is to me.

Now let’s look at Airbnb. Airbnb’s stock is down 46% in the last year. It is valued at $62bn. In the quarter that ended in September 2022, it generated $2.9bn of revenue and $1.2bn of EBITDA and Net Income. I am not sure why Net Income and EBITDA are the same. Maybe Airbnb is not paying taxes yet. It could be using up loss carryforwards or something like that. But a fully taxed Airbnb would be generating Net Income of more like $1bn or maybe even a bit less per quarter. On an annual basis, Airbnb is likely to be generating about $5bn of EBITDA and maybe $4bn of net income. Airbnb’s cash flow from operations over the last four quarters is approaching $3.5bn. So if you think of Airbnb like a building, it is trading at a cap rate of 5.6% and a PE of 15.5x.

These ratios and numbers are all “back of the envelope.” What I mean by that is there is a much more rigorous analysis that could be done here. I am just trying to use some real companies as examples of what I am writing about today.

My point is that if you think Airbnb and Google will be around for the next twenty years and their businesses will be stable and/or growing, then the prices at which they trade in the market resemble what a real estate owner might pay for them if they were buildings.

And if you, like a real estate owner, want to own these assets for a long period of time and generate an annual return of between 5% and 10% on them, compounded over ten to twenty years, then today’s prices look pretty reasonable to me.

A 6.4% annual return compounded over ten years is about a double on your investment. A 6.4% investment compounded over twenty years is about 3.5x your money. So if you are saving for a retirement or college expenses or something else, you have a long-term opportunity and so thinking long-term can be very helpful.

To be perfectly clear, I am not recommending Airbnb or Google stock here. I like both companies very much and think they are dominant in their sectors (travel and search) and likely will continue that dominance for the foreseeable future. But all businesses are at risk of poor management, new competitors, changing market structures and technologies, and many other things. Return comes with risks. Buildings can be risky too. Neighborhoods can change. Tax and other laws can change.

What I am saying, however, is that many of the top tech companies have seen their stocks tumble between 30% and 80% in the last year. Shopify is down 75% in the last year. Twilio is down 83%. Cloudflare is down 75%. These are companies I am quite familiar with, know the CEOs, and admire. Again, I am not recommending these stocks. I am just saying that prices have come down a lot in the last year and fundamental analysis, at least on some, suggests they are in the range where a long-term buy and hold could make a lot of sense.

Does that mean the stock market has bottomed? Absolutely not. It may have. It may not have. But if you are investing for a very long time horizon, you may not want to think about trying to time the bottom, which is very hard to do anyway, and just think if investments you make now and hold for a long time make sense. And on that measure, I feel that the answer is starting to be yes.

If markets continue to tumble into next year, then we will have opportunities to buy great companies at even lower PE ratios and higher cap rates. And there is some chance that will be the case.

So another thing I like to think about is taking a long-term approach to making investments. If you decide to invest $100,000 into the stock market because you agree with my reasoning in this post, then it would make a lot more sense to invest $10,000 a month over the next ten months than invest all of the $100,000 this month. The markets may move up on you making the later investments more expensive. But they could also move down on your making the later investments more attractive.

Since we don’t know which way markets will move, it is best not to try to time them and just average into a position over a reasonably long time period.

Markets are not rational in the short run. They become overheated at times and those are excellent times to sell some of your investments and move to cash for a while. They also become overly beaten up at times and those are excellent times to deploy that cash back into the markets. Knowing when you are in which situation is critical and fundamental analysis using cap rates and PE ratios and expected returns can be very helpful in determining that.

We spent this past weekend in Mexico City at Bright Moment’s NFT Art CDMX. Bright Moments is the premier NFT art “gallery” in the world. I use that term in parentheses because Bright Moments is much more than a gallery but that word is well understood. USV is a member of the Bright Moments DAO.

Over the course of the weekend, eleven leading NFT artists minted new generative artworks one by one in minting rooms where the collector and the artist saw the work revealed together.

Because there were eleven artists minting their work and also the 1000 mexican cryptocitizens (called Mexas) being minted all at the same time, there was a “live feed” of all of this minting activity in the center of the space.

Hanging out in the main space and witnessing all of the fantastic art coming to life for the first time in real time and in real life was an amazing experience. We did it for two nights this weekend.

I’ve written before about Bright Moments and the in-person experience of experiencing the creation (minting) of generative art. Too much of the NFT experience for my taste happens online and in isolation.

Art is best when it is experienced by a group of people and displayed in a large format where everyone can appreciate it and discuss it together. When you experience generative NFT art that way, it is an aha moment.

Finally, I want to thank the entire Bright Moments team for putting together an incredible event where the artists were front and center along with their amazing work. I came away from it even more excited about where NFT art is going and what it will become.

This post was co-written by Katie Haun and Fred Wilson

The events surrounding FTX have shaken the confidence of many. How did one of the largest crypto exchanges collapse so quickly? Why do meltdowns like this seem to keep happening?

At times like this, it helps to have a long-term view of web3 as a sector, not just a forward-looking long-term view, but also some perspective on where we have come from.

As longtime investors in web3 and board members (also individual shareholders) of Coinbase, one of the oldest and best-known companies in the space, we thought we might share some thoughts.

Web3 is a software-driven innovation that has a built-in financial system. This has been both a strength and a weakness. On the one hand, tokens enable developers and users to contribute to open-source protocols and participate in the economic upside of doing so, leading to strong developer communities. That’s been a positive relative to how software has been developed, monetized, and governed in the past. On the other hand, tokens lend themselves to boom/bust cycles and a sense by many that web3 is simply a speculative endeavor with no real substance behind it. 

This perception is only reinforced by the companies and individuals who started web3 companies and projects with the exclusive intent of making a lot of money very quickly through leveraged trading and speculation, pumping and dumping, and, sometimes, outright fraud.

Most of the well-known meltdowns in web3, going all the way back to Mt Gox and including recent failures like 3AC, Celsius, and Alameda/FTX, have happened to centralized companies operating trading, lending, and speculating businesses. Many of the failures have been offshore and all of them were largely unregulated. These companies and their activities have given web3 a bad name. We have also seen high-profile decentralized projects, like Terra, fail due to flawed design but those failures happen out in the open in a transparent way that is much healthier than the way centralized companies fail.

Contrast that with regulated web3 businesses like Coinbase, Kraken, and Anchorage that operate in the US and you will see that the companies that have followed the rules and behaved properly have weathered these storms. Coinbase’s early innovation was creating a secure, easy-to-use, regulated bridge from fiat currencies to crypto and a safe place to store crypto assets. Coinbase provides a number of important services that have allowed the web3 ecosystem to grow and thrive. 

The most important software innovation of the last decade, which started with the Bitcoin white paper fourteen years ago, is the emergence of open-source software and decentralized protocols that are the foundation of web3.  These protocols have survived recent market volatility. It is the promise of software that is not controlled by a company, but instead by an open-source community with built-in safeguards and increased transparency relative to today’s tech and financial systems, that gives us so much confidence in the future of web3.

These web3 protocols are in active development for mainstream adoption and some key features are still missing. For example, blockchains as they were originally architected are public by default. This is not suitable for most applications. Imagine if your email, banking, and social data were public for everyone to see on a blockchain. Also, blockchains are slow and complex networks. Improvements to performance, scalability, and privacy are happening at the infrastructure level of the web3 technology stack. Emergent technologies like zero-knowledge proofs and rollups are starting to address these issues without compromising decentralization. These breakthroughs are still in the early stages of deployment among a small subset of developers. This is the kind of important work that happens behind the scenes without any coverage. But it is these developments that are preparing web3 for the mainstream.

Eventually, as the web3 infrastructure improves, the user experience gap between self-custody and storing assets on centralized entities will shrink. More users will feel comfortable self custodying their assets in software they control and managing the keys that provide access to their assets themselves. This is how many web3 users interact with decentralized applications, like NFT marketplaces, today.

When web3 becomes a credible alternative to web2 for the masses, large centralized companies like Facebook, Apple, Amazon, and Google will have to compete for access to our data thus redefining how we use the web. Software development will be more open-source and composable. And large financial institutions like banks and brokerage firms (which includes the FTXs of the world) will no longer control our assets and lend them out without our permission.

Ironically, web3 is about giving control of data and assets back to the people and taking it away from large centralized companies. But the transition from web2 to web3 has been slow and messy and many of the early web3 companies have been copycat versions of what came before them. That is where the risk has been in the web3 ecosystem and what we need to move away from.

The lesson of these recent events for policymakers should not be that web3 is bad and must be constrained. It should be that pushing innovation offshore is bad. We need trusted and well-regulated centralized entities to survive and thrive and we also need decentralized web3 protocols to flourish and provide a path to a fully decentralized web. Both are possible and the good news is we are already on a path toward both. We need to stay that course, provide for a healthy web3 sector in the US, and stop pushing US users to risky/shady offshore entities with unclear, uneven, and unfair policy actions.

This is another hard moment for web3 and we will see negative headlines about “crypto” for some time. But it’s important to remember that these headlines are all about the speculating/trading part of web3. The much more important underlying software innovation continues unabated. And that is what we remain so excited about and will continue to fund and champion. 

This post was also shared on the Haun Ventures blog.

I’ve previously written about The $1k Project for Ukraine, which was launched by my friend, Alex Iskold, five days into the Russian aggression. 

Since its inception, the project raised more than $10M and helped 10,000 families and 35,000 children. The AVC community has generously participated.

Last week, Russia announced its withdrawal from Kherson and The $1k Project crew is racing to help the next 1,000 families specifically focusing on the liberated territories. 

This coming winter is going to be absolutely brutal in Ukraine because of the energy crisis.

The Gotham Gal and I have previously made a donation to the project and we received this thank you page from the families we supported.

This past weekend we made another donation to support these families in the newly liberated territories.

If you are able to give and support a family please do so here.