As some reading this may know, I’ve spent a ton of time in the cryptocurrency business. I’ve spent years working in a variety of roles in the industry; from working at a market making firm/OTC desk in Asia (Eigen Capital), then at crypto asset manager Iconic Holding, and now as a VC. I’ve spent quite a bit of time conducting research about cryptocurrency through the Stanford Digital Currency Initiative, of which I’m a founding member, as well as with boots on the ground-esque primary research purveying the space: going to events, talking to as many founders/investors/researchers/policymakers/other relevant stakeholders as possible, being in as many group chats as possible, knowing SME experts, even helping stand up DAOs etc.

I’ve written previously about how I think the market for crypto VC is trending in terms of how funds themselves find ways to bring value to get into deals and the way that they “differentiate” themselves. In this article, I will seek to expand on that explanation of differentiation, and then give my two cents on a) why there has been so much inflow into crypto VC in the past 2 years b) what the result of these inflows will be and c) why the crypto VC market will NOT trend like traditional venture capital has, towards the law of large numbers, and instead remain a decentralized game that (almost) anyone can play – provided that they “do their reading” (i.e. do the research).

First, the amount of capital that has flowed into the crypto/blockchain space in the last 18 months alone is astounding. There was $6.5Bn in VC funding for crypto and blockchain startups in Q3 of 2021, which surpassed Q2 of 2021, which saw $5.2Bn. In the first nine months of 2021 there was 3 billion in funding, with early stage deals (pre-seed, seed, and Series A) accounting for nearly 80% of that funding. There ended up being $30bn worth of VC funding for crypto and blockchain startups total in 2021, up 445.5% as of late December 2021. This may seem like a lot of money, so it may be hard to believe that 2022 looks like it’s about to break this record: 4 billion was raised in January for crypto startups - if the trend holds, nearly 50 billion will be the number for this year. In terms of subject matter, 10% of early stage companies are working on blockchain technology (at least as of 2021).

Why is so much cash coming into the space? The growth rate for crypto has been astounding, in terms of adoption/sheer number of users, but the returns are equally mind boggling: if you had bought an index of the top 20 cryptocurrencies by market cap in 2018 and held it today, you would have nearly 30x your money. Most (good) crypto VCs have mirrored the market with 20-30x returns - the outstanding ones, like Multicoin, which marked about 200x at their height, do much better. I’ve heard rumors that the average 19-year-old/Gen Z-er in the United States has a crypto wallet but not a bank account (have never seen this substantiated, but it wouldn’t be shocking). Nearly 13% of Americans own cryptocurrencies. In places like Southeast Asia, where P2E is common, playing games has taken the place of other forms of labor.

These are all the obvious answers. But I believe that there are more reasons beyond the basic understanding we all have that should likely be discussed because they are relevant to what is happening in crypto and underscore aspects of the space that don’t get addressed often enough.

At Iconic Holding GmbH, I specialized in building out a platform that would cater to emerging crypto hedge funds. The reason that the company - which had originally found success as an accelerator with its own adjacent venture capital fund, once the most successful in Europe focused on crypto, with a 94% hit rate - was moving into hedge funds (having already launched the first regulated index fund for cryptocurrencies) was because it was hoping to build out its place as a full - stack crypto asset management firm (this included launching ETPs as well). The thought was that as an asset management company, Iconic would be able to weather any downturn by offering strategies on the hedge fund side that would perform irrespective of a bull market. As someone who was tasked with selling these hedge funds (after finding them, doing due diligence on them, and then servicing them), the pushback I would always get was that if you had just made a directional bet, you could outperform the index, so the preference towards VC was enormous (and ultimately one of the major contributing factors for my making the jump this way), even in cases where the hedge funds would outperform the VC returns. Why? Because being a good VC is a skill and can be replicated, whereas trading vol or making one-off 18,000% trades wasn’t necessarily replicable, since the funds themselves are so young (as were the people managing them) and it’s impossible to know who is the best trader by sheer skill.

But what makes VC returns so much better than those of crypto hedge funds? We can’t overlook how nascent the infrastructure for crypto buying/selling/trading actually is. This Washington Post article focuses on how Binance, the world’s largest cryptocurrency exchange, often struggles to service individuals during high volatility moments and has not honored executing their trades as a result – perhaps invidiously. Meanwhile, crypto exchanges charge *ridiculously* high fees relative to their non-crypto fees, averaging .05-.2% of volume in trading fees (some exchanges charge as much as 5% to retail for purchasing and selling while offering discounts to institutional traders), and their aggregate profits equate to tens of billions of dollars a year. Since VCs have a near monopoly on the cheapest tranche rounds, and sell down the road to retail, who are charged such high fees upon buying and selling that unless an aggregate return threshold is met, they usually HODL - sometimes to their detriment. But the retail capital props up both centralized exchanges and the VCs that put money into the tokens that eventually get listed on these exchanges. (Where this retail money in a country where the average person doesn’t have 300USD to their name comes from is another question, but let’s assume crypto has grown in part thanks to the influx of capital to consumers during the pandemic.) And the exchanges can take all the profit they’d like (theoretically) because they never have to be open during times when they would lose the most money - since no governing authority ever really seems to take fault for them doing this (@ the SEC, where are you?).

It would seem rational, if we were indeed in a rational market, that market participants would notice this major “glitch” in the product and proceed to price the company accordingly. But Coinbase, an exchange I’ve used that even this time last year would not allow me to log in during times of high volatility, was somehow still worth 40 billion as of a few months ago (not as of the date this was first posted, 5/12/22). It rose to over 100 billion at one point, which could be because certain types of investors were looking for crypto exposure and this was their answer. But as the market grows, true competition will hopefully flush out the malpractice that is unfortunately so common. Let’s just hope that the same retail users - 70 million in the United States for Coinbase, for example - are more forgiving.

The larger point, here, however, is that people who have never sold out of their positions (VCs included), opting instead to go long, have made the most money. I can’t help but to believe that part of the reason for this is - wait for it - because there has been no truly great, reliable way to trade cryptocurrencies irrespective of OTC, which itself has had historically insane fees. If you can’t log into your Coinbase account during high vol times, why ever sell? If there were truly ways to hedge your bets in crypto with counterparties you could trust, average hedge fund returns would squash those of VC (or at least mirror them more closely). (At Iconic, we used to have hedge funds present us with two results when reporting their returns: what their returns actually were, and what they would have collected if Binance, [insert other exchange], etc. had actually executed their trades.)

The problem, of course, is that now there is so much inflow into VC that there are certain cryptocurrencies/companies that seem to be propped up by the VC money itself (and not much else). Subsequently assessing value for projects has almost gotten murkier, not easier, over time because the market doesn’t always reflect true value creation, just capital influx [this trend has required active rails of communications with OTC desks, market making desks, whales, independent traders, hedge funds, VCs that are hedge funds, VCs that have a large liquid book, and others, to parse.]. (In fact, the hope of some VCs is that with enough capital and resource aggregation, they will be able to “put lipstick on a pig” and dress up companies that otherwise would have been hapless in the days of good ole VCs who did nothing for their companies and sat on the sidelines.) In crypto, because liquidity events happen preemptive to the (full) product, not upon a company going public, we are seeing almost reverse capital markets in real time: tons of hype will be generated for a product before it gets its product-market fit, leading people to stake (read: provide liquidity), which adds to overall Total Value Locked, which sometimes tokenomics reflect almost 1-1, which leads to the product becoming insanely valuable before ever seeing a true user base adopt it. Over time, the liquidity may be pulled, which leads to a value loss. The benefit to this structure is that over time, the market can still read how valuable the product is due to hyper liquidity, but the downside is that early on in a product’s life cycle the price can peak and trough. But because there is no dilution in tokens, meaning when VCs buy tokens in pre-seed, seed, or Series A investments, they are buying literal percentages of the overall supply, manipulation is much easier and ownership is much less democratic - BUT returns are much higher than in traditional VC.

Many people have written about the institutionalization of the crypto space, and how big money is going to change how business is done. Even if this influx of capital DOES change the way business is done, I don’t believe that the same players that have dominated traditional VC - A16Z and Sequoia - or the ones that have dominated crypto VC - please see reference to the Five Families here - will have the highest returns moving forward.

Part of this is because of the sheer size of their funds: at 2.5 billion USD, A16Z can’t 200x their fund. They can’t even 10x it, a potential 5x may be possible. Same with and Sequoia (or Paradigm/DCG for that matter).

We all know about the law of large numbers with regards to venture capital. The more bets you make, the more unicorns you’ll be able to seed. And the vaster your network, the better your deal flow. (The general thought is that as more capital flows in, deal flow gets more professionalized and less collaborative, leading to more corporate, staid ways for funds to gain deal flow, whether by creating their own pipelines or being more secretive.)

But more money does not necessarily denote smarter money, at least not in crypto. The funds that seem to be doing the best by returns lately are the most decentralized.

There are various reasons for this. Crypto is a global business: American funds do not necessarily have the same hegemony or prestige that they used to carry. As cryptocurrencies trade 24/7, there necessitates a different work culture for the teams that end up being successful (read: East or South Asian teams seem to flourish as founders in this space, not coincidentally, partially due to 9-9-11 culture). Third, there seems to be a much more decentralized process to teambuilding - many teams are virtual first, multi-ethnic and citizens of several countries as an aggregate. The traditional demaractors of a good team (a famous VC in the Valley once said his best investments were “white, male, Harvard dropouts”) have dropped by the wayside, as have moats and other hallmarks of traditional VCs. Welcome to crypto, where the only things that truly matter are execution, hustle, and the ability to build community and brand in tandem.

Subsequently, some of the best deals come from far reaches of the Earth that traditional VCs would never bother entering. A great example of a decentralized DAO that has sourced some of the best deals - and has the best returns for a debut fund that I’ve ever seen in crypto, having made 30x in the past twelve months - is Global Coin Research, led by Joyce Chang.

What can we learn from her success? What is she doing that other VCs aren’t? For one, Joyce has 30,000 subscribers, many of whom share deal flow and do due diligence as well as deal closings on behalf of the DAO. They also build out their own research and have pipelines to be full service value-add businesses. With 40 employees and 16 investments, Andreseen’s crypto network couldn’t touch hers (assuming founding teams of 5 people, who each bring their own network of roughly 200 independent people). She’s also starting to incentivize the users with tokenomics that payout 15% carry/percent of profit if DD on a deal is done, and tokens for the finding of the deal itself. With the token, she is able to employ a team of 20+ people.

We can’t help but to believe that the next great founder will be found by a wide ranging network of individuals who would never get hired at a white shoe fund.

In a follow up to this article, I will be trying to further discern what Joyce’s group can do that A16Z [insert other large fund] can’t, how the process for crypto VC is different from traditional VC such that it’s nearly impossible to capture value and an understanding of the market on a 6-person team basis, and whether or not (and if so, how) this trend towards decentralization been reflected in the current state of VC. ** **

Cheers!

As some reading this may know, I’ve spent a ton of time in the cryptocurrency business. I’ve spent years working in a variety of roles in the industry; from working at a market making firm/OTC desk in Asia (Eigen Capital), then at crypto asset manager Iconic Holding, and now as a VC. I’ve spent quite a bit of time conducting research about cryptocurrency through the Stanford Digital Currency Initiative, of which I’m a founding member, as well as with boots on the ground-esque primary research purveying the space: going to events, talking to as many founders/investors/researchers/policymakers/other relevant stakeholders as possible, being in as many group chats as possible, knowing SME experts, even helping stand up DAOs etc.

I’ve written previously about how I think the market for crypto VC is trending in terms of how funds themselves find ways to bring value to get into deals and the way that they “differentiate” themselves. In this article, I will seek to expand on that explanation of differentiation, and then give my two cents on a) why there has been so much inflow into crypto VC in the past 2 years b) what the result of these inflows will be and c) why the crypto VC market will NOT trend like traditional venture capital has, towards the law of large numbers, and instead remain a decentralized game that (almost) anyone can play – provided that they “do their reading” (i.e. do the research).

First, the amount of capital that has flowed into the crypto/blockchain space in the last 18 months alone is astounding. There was $6.5Bn in VC funding for crypto and blockchain startups in Q3 of 2021, which surpassed Q2 of 2021, which saw $5.2Bn. In the first nine months of 2021 there was 3 billion in funding, with early stage deals (pre-seed, seed, and Series A) accounting for nearly 80% of that funding. There ended up being $30bn worth of VC funding for crypto and blockchain startups total in 2021, up 445.5% as of late December 2021. This may seem like a lot of money, so it may be hard to believe that 2022 looks like it’s about to break this record: 4 billion was raised in January for crypto startups - if the trend holds, nearly 50 billion will be the number for this year. In terms of subject matter, 10% of early stage companies are working on blockchain technology (at least as of 2021).

Why is so much cash coming into the space? The growth rate for crypto has been astounding, in terms of adoption/sheer number of users, but the returns are equally mind boggling: if you had bought an index of the top 20 cryptocurrencies by market cap in 2018 and held it today, you would have nearly 30x your money. Most (good) crypto VCs have mirrored the market with 20-30x returns - the outstanding ones, like Multicoin, which marked about 200x at their height, do much better. I’ve heard rumors that the average 19-year-old/Gen Z-er in the United States has a crypto wallet but not a bank account (have never seen this substantiated, but it wouldn’t be shocking). Nearly 13% of Americans own cryptocurrencies. In places like Southeast Asia, where P2E is common, playing games has taken the place of other forms of labor.

These are all the obvious answers. But I believe that there are more reasons beyond the basic understanding we all have that should likely be discussed because they are relevant to what is happening in crypto and underscore aspects of the space that don’t get addressed often enough.

At Iconic Holding GmbH, I specialized in building out a platform that would cater to emerging crypto hedge funds. The reason that the company - which had originally found success as an accelerator with its own adjacent venture capital fund, once the most successful in Europe focused on crypto, with a 94% hit rate - was moving into hedge funds (having already launched the first regulated index fund for cryptocurrencies) was because it was hoping to build out its place as a full - stack crypto asset management firm (this included launching ETPs as well). The thought was that as an asset management company, Iconic would be able to weather any downturn by offering strategies on the hedge fund side that would perform irrespective of a bull market. As someone who was tasked with selling these hedge funds (after finding them, doing due diligence on them, and then servicing them), the pushback I would always get was that if you had just made a directional bet, you could outperform the index, so the preference towards VC was enormous (and ultimately one of the major contributing factors for my making the jump this way), even in cases where the hedge funds would outperform the VC returns. Why? Because being a good VC is a skill and can be replicated, whereas trading vol or making one-off 18,000% trades wasn’t necessarily replicable, since the funds themselves are so young (as were the people managing them) and it’s impossible to know who is the best trader by sheer skill.

But what makes VC returns so much better than those of crypto hedge funds? We can’t overlook how nascent the infrastructure for crypto buying/selling/trading actually is. This Washington Post article focuses on how Binance, the world’s largest cryptocurrency exchange, often struggles to service individuals during high volatility moments and has not honored executing their trades as a result – perhaps invidiously. Meanwhile, crypto exchanges charge *ridiculously* high fees relative to their non-crypto fees, averaging .05-.2% of volume in trading fees (some exchanges charge as much as 5% to retail for purchasing and selling while offering discounts to institutional traders), and their aggregate profits equate to tens of billions of dollars a year. Since VCs have a near monopoly on the cheapest tranche rounds, and sell down the road to retail, who are charged such high fees upon buying and selling that unless an aggregate return threshold is met, they usually HODL - sometimes to their detriment. But the retail capital props up both centralized exchanges and the VCs that put money into the tokens that eventually get listed on these exchanges. (Where this retail money in a country where the average person doesn’t have 300USD to their name comes from is another question, but let’s assume crypto has grown in part thanks to the influx of capital to consumers during the pandemic.) And the exchanges can take all the profit they’d like (theoretically) because they never have to be open during times when they would lose the most money - since no governing authority ever really seems to take fault for them doing this (@ the SEC, where are you?).

It would seem rational, if we were indeed in a rational market, that market participants would notice this major “glitch” in the product and proceed to price the company accordingly. But Coinbase, an exchange I’ve used that even this time last year would not allow me to log in during times of high volatility, was somehow still worth 40 billion as of a few months ago (not as of the date this was first posted, 5/12/22). It rose to over 100 billion at one point, which could be because certain types of investors were looking for crypto exposure and this was their answer. But as the market grows, true competition will hopefully flush out the malpractice that is unfortunately so common. Let’s just hope that the same retail users - 70 million in the United States for Coinbase, for example - are more forgiving.

The larger point, here, however, is that people who have never sold out of their positions (VCs included), opting instead to go long, have made the most money. I can’t help but to believe that part of the reason for this is - wait for it - because there has been no truly great, reliable way to trade cryptocurrencies irrespective of OTC, which itself has had historically insane fees. If you can’t log into your Coinbase account during high vol times, why ever sell? If there were truly ways to hedge your bets in crypto with counterparties you could trust, average hedge fund returns would squash those of VC (or at least mirror them more closely). (At Iconic, we used to have hedge funds present us with two results when reporting their returns: what their returns actually were, and what they would have collected if Binance, [insert other exchange], etc. had actually executed their trades.)

The problem, of course, is that now there is so much inflow into VC that there are certain cryptocurrencies/companies that seem to be propped up by the VC money itself (and not much else). Subsequently assessing value for projects has almost gotten murkier, not easier, over time because the market doesn’t always reflect true value creation, just capital influx [this trend has required active rails of communications with OTC desks, market making desks, whales, independent traders, hedge funds, VCs that are hedge funds, VCs that have a large liquid book, and others, to parse.]. (In fact, the hope of some VCs is that with enough capital and resource aggregation, they will be able to “put lipstick on a pig” and dress up companies that otherwise would have been hapless in the days of good ole VCs who did nothing for their companies and sat on the sidelines.) In crypto, because liquidity events happen preemptive to the (full) product, not upon a company going public, we are seeing almost reverse capital markets in real time: tons of hype will be generated for a product before it gets its product-market fit, leading people to stake (read: provide liquidity), which adds to overall Total Value Locked, which sometimes tokenomics reflect almost 1-1, which leads to the product becoming insanely valuable before ever seeing a true user base adopt it. Over time, the liquidity may be pulled, which leads to a value loss. The benefit to this structure is that over time, the market can still read how valuable the product is due to hyper liquidity, but the downside is that early on in a product’s life cycle the price can peak and trough. But because there is no dilution in tokens, meaning when VCs buy tokens in pre-seed, seed, or Series A investments, they are buying literal percentages of the overall supply, manipulation is much easier and ownership is much less democratic - BUT returns are much higher than in traditional VC.

Many people have written about the institutionalization of the crypto space, and how big money is going to change how business is done. Even if this influx of capital DOES change the way business is done, I don’t believe that the same players that have dominated traditional VC - A16Z and Sequoia - or the ones that have dominated crypto VC - please see reference to the Five Families here - will have the highest returns moving forward.

Part of this is because of the sheer size of their funds: at 2.5 billion USD, A16Z can’t 200x their fund. They can’t even 10x it, a potential 5x may be possible. Same with and Sequoia (or Paradigm/DCG for that matter).

We all know about the law of large numbers with regards to venture capital. The more bets you make, the more unicorns you’ll be able to seed. And the vaster your network, the better your deal flow. (The general thought is that as more capital flows in, deal flow gets more professionalized and less collaborative, leading to more corporate, staid ways for funds to gain deal flow, whether by creating their own pipelines or being more secretive.)

But more money does not necessarily denote smarter money, at least not in crypto. The funds that seem to be doing the best by returns lately are the most decentralized.

There are various reasons for this. Crypto is a global business: American funds do not necessarily have the same hegemony or prestige that they used to carry. As cryptocurrencies trade 24/7, there necessitates a different work culture for the teams that end up being successful (read: East or South Asian teams seem to flourish as founders in this space, not coincidentally, partially due to 9-9-11 culture). Third, there seems to be a much more decentralized process to teambuilding - many teams are virtual first, multi-ethnic and citizens of several countries as an aggregate. The traditional demaractors of a good team (a famous VC in the Valley once said his best investments were “white, male, Harvard dropouts”) have dropped by the wayside, as have moats and other hallmarks of traditional VCs. Welcome to crypto, where the only things that truly matter are execution, hustle, and the ability to build community and brand in tandem.

Subsequently, some of the best deals come from far reaches of the Earth that traditional VCs would never bother entering. A great example of a decentralized DAO that has sourced some of the best deals - and has the best returns for a debut fund that I’ve ever seen in crypto, having made 30x in the past twelve months - is Global Coin Research, led by Joyce Chang.

What can we learn from her success? What is she doing that other VCs aren’t? For one, Joyce has 30,000 subscribers, many of whom share deal flow and do due diligence as well as deal closings on behalf of the DAO. They also build out their own research and have pipelines to be full service value-add businesses. With 40 employees and 16 investments, Andreseen’s crypto network couldn’t touch hers (assuming founding teams of 5 people, who each bring their own network of roughly 200 independent people). She’s also starting to incentivize the users with tokenomics that payout 15% carry/percent of profit if DD on a deal is done, and tokens for the finding of the deal itself. With the token, she is able to employ a team of 20+ people.

We can’t help but to believe that the next great founder will be found by a wide ranging network of individuals who would never get hired at a white shoe fund.

In a follow up to this article, I will be trying to further discern what Joyce’s group can do that A16Z [insert other large fund] can’t, how the process for crypto VC is different from traditional VC such that it’s nearly impossible to capture value and an understanding of the market on a 6-person team basis, and whether or not (and if so, how) this trend towards decentralization been reflected in the current state of VC. ** **

Cheers!