The prospect of investing in China is suddenly brightening as the country phases out its draconian zero-COVID policy, which has caused business disruptions of all kinds and kept the country’s borders closed for the past three years.

For venture capitalists, the pandemic has been a tumultuous ride. Tony Wu, a partner at Northern Light Venture Capital, a China-focused venture capital firm with $4.5 billion in assets under management, calls 2022 the “toughest” in his 15 years of investing in Chinese startups.

“Now spring is finally bringing new life to the dry trees. There is a lot of optimism for 2023,” says Wu, who focuses on the consumer internet space in the enterprise, in an interview with TechCrunch. NLVC’s broad portfolio includes China’s on-demand services titan Meituan; BGI, the country’s genetic giant; and Black Sesame Technologies, one of the few local auto chip makers.

What went wrong in 2022? And what makes Wu more hopeful about next year?

herald of spring

In recent years, China’s regulatory crackdown on its internet industry, coupled with COVID restrictions that caused great uncertainties in the economy, has drastically affected investor confidence. Venture capital deals fell 44% year-over-year to $62.1 billion in the first 10 months of 2022, according to research firm Preqin. Equity investments fell 33.9% in the first three quarters of the year, another report by Chinese market researcher Zero2IPO shows.

The bearish mood of 2022 “was on par with 2008-2009,” Wu acknowledges. But unlike the 2008 financial crisis, he argued, this round of recession “fundamentally undermined the vitality” of the country’s venture investing. “Money fled, talent left, and a lot of internet bosses moved to Singapore.”

Regulations are nothing new in China’s tech space, as authorities are always rushing new legislation to curb the reckless growth of emerging sectors. But the recent wave of clampdowns, beginning around 2020 when the government suspended Ant Group’s colossal IPO, is widely seen as the harshest in decades, forcing tech companies left and right to rethink their policies. strategies.

Companies operating in heavily regulated areas such as social media, gaming and the web3 saw a narrowing window of opportunity domestically, so many of them packed up and headed to culturally familiar and geographically Singapore. near. Its investors, especially those who raise money from international limited partners, followed suit and established outposts in the city-state. An era of rising tensions between the United States and China further prompted Chinese companies with ambitions abroad to cut ties with the country.

The abrupt end to the zero COVID policy and the first signs of regulatory easing are giving investors hope that some aspects of the tech industry may finally return to normal. At the very least, investors can meet the founders in another city informally without worrying about being quarantined on the way back.

The clouds also seem to slowly disperse in the regulatory space. In December, China granted a batch of licenses to 44 foreign games, ending an 18-month hiatus that hit gaming giants like Tencent. Wu believes regulators will also start to lift some of the restrictions on Ant Group, which overhauled its fintech business at the behest of regulators to act more like a traditional financial group.

chasing web3

Even if the darker days of regulations are behind us, the renaissance has limitations. The reckless, high-growth era of social media, ride-sharing, and other consumer-focused businesses has come to an end. At web3, one of the few remaining areas in technology that was still generating impressive returns for venture capitalists until the recent market crash, “there is no discernible future for China for now,” Wu suggests.

That’s a conclusion shared by many founders and investors. Over the years, China has moved to ban much of the underlying infrastructure of web3, most importantly, cryptocurrency trading. As a result, many serious web3 projects have moved abroad.

Despite the brain drain, Wu continues to support web3 entrepreneurs from China. In 2023, he plans to allocate at least 60% of his “power” to web3, which he believes is as bad for venture capital as it is for the Internet.

“Web3 has fundamentally changed the way investments are made,” observes the investor. “In the past, you were investing in Chinese founders with operations in China. Now, a web3 startup might have their R&D in China, but their product is global, and the rest of their team might be in Singapore or the US. They’re taking capital as well as token investment. And instead of 10%, we only take 1% of your share.”

Like others who remain bullish on web3 despite the drop, Wu believes the bear market is a good time to “build” when people finally don’t see cryptocurrencies as a speculative asset class. “We should see how many users and new developers are accumulating on web3,” he says.

China also remains central to the global development of web3 despite the fact that there is no national market for the decentralized technology. Two decades of frenetic growth at tech giants like Tencent, Alibaba, and ByteDance have spawned a group of skilled software engineers who are known for delivering results under pressure and tight deadlines, and who, on average, they cost only a fifth of their US counterparts.

China’s Internet talent also has experience running large-scale and rapidly expanding Internet services, Wu argues. “Solana is known for being fast and cheap, right? But she’s also had a few cuts. The blockchain alone manages over a thousand nodes. But name any major Chinese Internet company: it easily runs hundreds of thousands of servers.”

He continues. “The question is how to unleash China’s developer supply for the global web3 industry.”

electric car race

While Wu follows China’s web3 founders abroad, he is also betting on domestic players in another exciting area: electric vehicles. Even in the relatively new EV industry, he sees the race as having entered “the second half” and the competition becoming “fierce.”

China shipped about 20 million vehicles in 2022, 6.5 million or 32.5% of which ran on “new energy” such as electric or hybrid, according to the China Passenger Car Association. “More or less, the EV penetration rate reaches 60-70%, because there will still be some gasoline cars. [a 30% penetration means] the industry is moving into the second half,” says Wu.

So far, none of the Chinese EV companies are remotely close to the level of brand recognition enjoyed by German luxury carmakers. But each offers its unique selling point. Upstart Nio puts a lot of effort into customer service and rival Xpeng prides itself on advanced technologies like autonomous driving.

Wu singles out BYD, the 28-year-old EV and battery giant, as the pioneer in the globalization of Chinese EV companies due to its incredible affordability. In December, BYD’s overseas sales exceeded 10,000 units, which doesn’t sound like much. But the automaker is already well established in China, often battling Tesla for the top spot in the world’s largest electric vehicle market.

“The globalization of Chinese electric vehicles is inevitable. We have a complete supply chain, and our price advantage is already quite obvious,” Wu argues, noting that BYD is the only Chinese EV maker that controls the entire supply chain like Tesla, giving it leeway to cut prices. “You have to remember that these Chinese automakers are coming out of an extremely competitive environment.”