From industry frenzy to rational return: Reexamination of the role of crypto VC

Author: Jademont, CEO of Waterdrip Capital

Recently, there has been a lot of discussion about the role of venture capital (VC) in the cryptocurrency space. On the one hand, the community has a lot of criticism about the so-called "VC coin", and on the other hand, there are many reports about VCs defending their rights and closing down. In fact, the elimination rate in the VC industry has always been high, and this is not a recent phenomenon.

A joke: VCs under the ICO boom

Let's start with a joke. In 2018, Mars Finance held a contributor conference in Chongqing to award industry practitioners, and almost all the participants won awards. At that time, there was an award for "Excellent Token Fund", and the top 40 were selected, but there was almost no room for all the winners on the podium. Why are there so many winners? Because 2017 was the ICO boom and the first year of VC in the cryptocurrency circle. At that time, the number of VCs in Shanghai exceeded 100, and the threshold for establishment was extremely low. As long as there was an offshore entity that could sign and stamp and transfer money outward, it could call itself a Token Fund. Nationwide, there may be hundreds of VCs. In this case, it is not bad to be able to squeeze into the top 40, and our fund is just an ordinary one. When we moved to the office in 2022, we saw the award information of that year and unexpectedly found that we had changed from the top 40 in the list to the top 10. This is by no means a self-satisfaction, but because more than 30 VCs are no longer active. I estimate that if we persist for a few more years, we may be able to enter the top 5. Of course, new institutions continue to emerge in the industry, but every time I see that award list, I can feel the cruelty of the industry.

Community misunderstanding of VC

In fact, retail investors have many misunderstandings about VCs, and their evaluations of VCs are often polarized. On the one hand, when the community sees that VCs are involved in popular projects, they often think that cryptocurrency VCs are very profitable. But in fact, VCs still have many failed projects that are not noticed by the market at all. It is precisely because of such a high failure rate that individual projects must have high profit expectations. Often, when project founders come to me for financing, they will say, "My project is very stable and will not lose money. At most, I will make less money." I will always reply, "I will not invest in projects that guarantee capital. You have to convince me that this project can help me make 10 times the profit. If it can't make money, it will be completely zero. If the founder does not have a lofty goal, it is meaningless to find VC financing. You can live by slowly doing business and making a little money."

On the other hand, when the community sees that VCs have invested in a failed project, they will criticize VCs and project owners for "cutting leeks" together, but forget that VCs are also victims and may even lose more than retail investors.

How to evaluate whether a VC is good

To evaluate whether a VC is good, I think two standards are indispensable.

The first standard is of course to look at performance. VC is not a charity, and the interests of LP (limited partners) are the first priority. There are several large and well-known funds in the industry, but their performance is actually very average. I personally don’t like this kind of fund. Recently, a mother fund came to us to discuss cooperation and said that they had invested in ten US cryptocurrency VCs before, and found that the worst performance was the "letter plus number" fund, and the best performance was a small fund with only 20 to 30 million US dollars. This is completely opposite to the intuitive feelings of most people, so don’t be superstitious about the nonsense that "you can rush in if a big institution stands on the platform."

The second criterion is to look at the best projects that VC has invested in and have a greater impact on the project party without competing on performance, whether there is technological innovation, and whether it has a promoting effect on the industry. In other words, whether VC has made contributions to the industry through investment projects. An institution that only invests in a bunch of empty projects to help LP make money cannot be called excellent. And an institution that invests in a bunch of seemingly star projects, but enters at a high valuation in a later round and does not provide substantial help to the project, can hardly be called excellent. The latter is what many wealthy institutions with Web2 backgrounds often do in the past two years.

Challenges faced by Cryoto VC

The criticism of the community is not without reason. The biggest problem at present is that the valuations of projects pushed to the market by some wealthy institutions are too high. In the ICO era, it is easy for retail investors to make money because they have the same entry opportunities as institutions. What everyone competes for is courage and cognition, not connections and the ability to gather.

Take an ordinary "star project" listed on Binance as an example. First, there is a 10 million round of friends and family rounds, and a 30-50 million round of seed rounds. If there are large overseas institutions involved, the next round will jump directly to 300-500 million US dollars. Then we start to negotiate with the exchange. After negotiating with Binance, there will be a pre-list round of more than 1 billion US dollars. When the market opens, the market value is 30 to 50 billion or even 10 to 20 billion. Only at this price can retail investors have the opportunity to buy. But how much room for growth is left at this time? There is a lot of room for decline. In the long run, it is no wonder that retail investors are reluctant to follow up. In the past two years, we have rejected many star project financing requests of hundreds of millions of dollars or even higher. On the one hand, it is because of limited funds, and on the other hand, we do feel that these projects are not worth such a high price before they are launched and prove themselves.

I suggest that the top exchanges should set up a price limit mechanism within a certain period of time after the Token is launched. When the market opens, the price can only be bought and sold within a certain price (such as the price of the last round of financing). This will allow institutions to sell reasonably without causing retail investors to suffer from excessively high prices. Or simply return to the ICO era and let institutions treat themselves as large retail investors. The currently popular community fair sale is a variant of ICO.

Another challenge is that as the industry becomes more and more mature, almost all tracks are occupied by giants. Before a new narrative comes out, the previous investment method of throwing money and letting the project party fend for itself may become ineffective. Now it is more required that VC and project parties start a business together. On the one hand, the rights and obligations are more clear, and there are more constraints on the project party; on the other hand, the project party can also use more resources from VC. In other words, VC also needs to take a professional route. The VC with one person and one brand in the past may only be able to do angel investment.

Finally, I hope that as the cryptocurrency industry develops, VC will no longer be needed, just as I have always hoped that there will be no CEX (centralized exchanges) in the industry. A more decentralized world is what everyone should pursue.