Is the recent influx of crypto VCs good for the ecosystem?

Photo by Nikola Đuza on Unsplash

There has been a lot of fuss recently in the crypto world around product market fit and what crypto’s use cases are. In our view most of this is 100% valid. As we have been telling everyone who wants to listen for a long time now, there are nearly 20,000 listed crypto tokens out there (we’re told there are actually millions but only about 20k make it to the public lists, but you get the point) and at least 95% are smoke and mirrors. Some deliberately so but most are just bad business ideas. However, the rest are full of promise and excitement and our view is that as time goes on, more and more real-world use cases will emerge. Out of the ashes of this bust will come some world changing businesses and that’s why we are here.

One aspect of the crypto boom and bust that is perhaps unappreciated is that of crypto venture capitalists. We have a somewhat nuanced view on what has unfolded and believe that a key issue is the skeuomorphic nature of VCs in the world of crypto. The model from the traditional world has been transplanted and dumped into the crypto world with an accelerated exit timeline and we don’t believe it works. Now before we go into this, we want to make it clear that some of the best investors in the world are in crypto. These are VCs who understand exactly how crypto works and what its promise is who have been around for some time, and they are key innovators and supporters in the space.

This piece is not aimed at them. But over the past 18 months or so everyone seemingly became a VC, and likewise it seems almost every VC went into crypto.

Early life, tick by tick

The first issue that the crypto VC model poses is a structural one, regardless of the source of the underlying funds being deployed.

Consider this – traditional VC investments are made into early-stage businesses, often on the basis of a little more than a slide deck, a wireframe or (at best) and a minimum viable product. These might be great ideas, but once funded, these startups are bestowed with a generous amount of capital with which they go on to build their businesses.

Of course, these funding rounds aren’t one-off: multiple rounds of funding occur, often at increasing valuations (another “not a given” point), but in general, the share price is a number that is typically updated at the point when a round happens, marked to the valuation of the most recent round.

In between rounds, no one knows what the value of the company is. No one is watching – not the founders, not the employees, not their investors. Marking a VC book to market is most certainly not a daily affair.

As a result, the value of the business doesn’t even feature in decision making. Of course, a founder needs to take into consideration the entire plethora of matters that need to be handled, but fortunately, being judged and valued on a frequent basis isn’t one of those concerns.

Founders in the private space have a precious luxury: the ability to build in peace, including the ability to make (and hopefully correct) any mistakes in execution and strategy without having to deal with any opinions other than those of a handful of rather sophisticated investors and partners.

Contrast this with a company with listed stock: for sure, these are typically much more mature companies with businesses that have typically proven some sort of commercial viability.

The game is different when a company is public: the scrutiny is incessant (at least results are only filed once a quarter, thank the heavens!), the impact of the stock price on employee, management and (where relevant) founder morale is profound and managing the fluctuations of the stock price, not to mention queries from investors, is a full-time job requiring an entire department called “Investor relations”.

It’s no wonder that the overlap between “private” stage investors, mostly PE and VC funds, and the “public” world, mostly mutual funds and hedge funds, is tiny. And rightly so: the handover point is the point at which a company goes public, moving from the realm of the private to the public. It is also at this point that the cap table of a company profoundly changes: out with the PE/VC crowd, perhaps with some vestiges remaining in the form of lockups that expire in the quarters following the IPO, and in with the public investment cohort. The veil of “peace and tranquillity” accorded by being private is pulled back, and suddenly the scrutiny is real.

This is the way things have been for a long time: new companies grow quietly in peace. If they don’t make it, they die silently, their passing mourned by only their employees, founders and a small number of private market investors. Once companies hit the public realm, they have more or less proven their worth – of course, they can still fail, but they are exponentially (typically) more viable than most private enterprises (with a handful of exceptions of course), and better able to weather the life of being public.

Crypto flipped all of that on its head.

We have often said that crypto projects are early-stage ventures with a ticking stock price.

VC/PE investors, accustomed to the peace and quiet of the private markets, now have to face the chaos of publicly traded asset prices that fluctuate to the whims of the market. Likewise, founders have to contend with the already huge challenges of running and growing an early-stage business, ALONGSIDE the stress of managing a plethora of investors (not just institutional and sophisticated) and a live ticking token price which can move 24/7 – that’s more hours and more days of volatility than the average stock.

In the face of these challenges, founders have nowhere to turn for help: their VC/PE advisors aren’t “public market” people, and from what we’ve seen from our conversations with a number of these startups, that lack of experience in public markets leads to some rather concerning advice being given. And when we start seeing crypto VC managers opining on the direction of Fed policy and what that means for crypto tokens, we can only wonder where they get that confidence in future outcomes which even multi-decade veterans like Stan Druckenmiller are reluctant to express. Public markets are complex systems that even decades of experience trading a live price cannot decode. We struggle to believe therefore that our private market counterparts have been secretly housing the secrets to the universe, and nor should they be expected to.

To be clear, there are some of greatest private market investors involved in private rounds in many crypto projects, and we have no intention of belittling their experience and achievements. But they’re in a different game now, and the implications of receiving advice for the wrong sort of game are immense for their investee companies.

Evidently, the standard playbook for private companies doesn’t work for crypto businesses – the life of a crypto startup brings forth the best AND the worst of BOTH public AND private markets, AND more.

To say that it’s “not easy” for founders is a gross understatement.

Show me the money

To make things worse, consider the difference in provenance of funding for many crypto VCs. With the exception of a16z, which is probably one of the most adventurous, forward-looking VCs around, almost every other crypto VC was formed by partners who made their money in crypto.

Therein lies the next issue: prior to this particular market cycle in crypto, the only way anyone made money in crypto was in trading. No surprise, then, that the first instinct of any VC advisor in crypto is to make a better trading solution.

It’s an even smaller surprise therefore that the majority of products and solutions developed in this stage of crypto’s life cycle are geared towards the speculation and trading of markets. When the advisors to these new companies pick the ideas they like and choose to back, it is understandable that they choose what resonates best with them, and there’s nothing that resonates with a trader than a better trading experience.

Giving advice that is born of real-life experience isn’t wrong in and of itself, but as markets people (ourselves included) sometimes forget, life isn’t all about just flipping paper instruments for a profit. There is an entire set of industries and business models out there which are in need of improvement, but with the idea generation process for creating crypto-driven products dominated by a desire to find product-market fit in the comfort zone of speculation markets, it is no surprise how the industry has panned out so far.

Taking the applications of crypto to the next level is going to require founders to venture way outside the comfort zone of speculation markets and apply their technology to solving bottlenecks in other industries, perhaps even spawning new industries that don’t yet exist.

What is the way?

Investing in early-stage ventures, especially in private markets, is hard. The focus has traditionally been one of business building, coaching these nascent businesses in the ways of the world and helping them to realise their business plans as they go on their journey towards a public listing. As a result, we’ve typically stayed out of this sphere, deferring to the experts in the field and only “taking over” as minority investors when a company’s stock lists in public markets.

It is in public markets where we thrive.

But crypto’s normalisation of an instantly-listed token for projects that are merely days old – sometimes even having the token come BEFORE the project starts trying to operate – fundamentally changes the game. Having a live ticking price impacts the dynamics of decision making. Most of the time, it makes an industry whose focus on product-market fit is already largely focused on financial solutions EVEN MORE FINANCIALISED.

And it is this confluence that risks causing founders to detract from their original purpose which is to build a business that is potentially world-changing.

The deflating of the market’s ebullience is by no means a bad thing for businesses either: notwithstanding “numba go down” on token prices, the reality is that there is now an abundance of talent in the market which can be employed. For projects who successfully raised in time, that cash in treasury is sacrosanct: to be protected as the means of fulfilling the promises of the business plan pitched to investors.

It doesn’t need to make any extra return, it doesn’t need to be put at risk and most importantly, it mustn’t be used as buyback money, regardless of what your friendly neighbourhood crypto VC says. Tokenholders have their perennial choice: either they buy, or they sell, at the prevailing market price.

Founders on the other hand have only one responsibility: grow the business, continue to search for product market fit and grow towards long-term sustainability, regardless of what the market says about the token price. That’s how they will create value.

Having investors who understand what it’s like to build in public is very important. Perhaps lockups to investors should be longer dated and more aligned with the team members. After all, alignment of interest is probably the most important box to tick when it comes to business building.

And its business building that is going to matter here.

Not token price management.