Capital Formation in Crypto: Analyzing the role of Crypto VCs
Since the start of the 21st century venture capital (VC) has been the most profitable asset class to invest in. According to Cambridge Associates, the average VC return returned 23.1% per annum for the trailing 25 year period ended December 2023. Well ahead of the S&P 500s 8.3% per annum. Web2 venture capital gave us the most profitable companies we see today such as Google, Meta, and Nvidia. Since 2000, roughly 60% of IPOs were from venture-backed companies. VCs not only provide strong returns for their limited partners (LPs) but take the risks that help build the companies that drive our lives everyday.
Within crypto, Venture Capital, to date, has produced a similar number of success stories. Almost every major crypto protocol had some level of VC funding along their journey. Crypto VCs were celebrated the past few cycles for helping bring these companies to market. Recently there has been a pushback against the number of crypto VCs, the value they add, and the aggregate amount of capital they have to deploy compared to their counterparts in the public markets (ie. hedge funds).
Crypto VCs have been called predatory, irrelevant or unnecessary by projects and the community at large. Is this true? What role do crypto VCs and other investment vehicles play in crypto more broadly and what value do they add? In this brief piece we explore the landscape of the crypto investment spectrum and discuss what value crypto VCs actually provide.
Capital Formation in Crypto
In Web2 there is a very clearly defined line between venture capital funds and hedge funds. Venture capital funds invest in illiquid private equity with liquidity opportunities many years in the future, often through a purchase by a larger private entity / fund or an IPO. Hedge funds focus on allocating to a range of assets (stocks, bonds, currencies) that often have daily liquidity. Within crypto, investment time horizon delineations are often extremely blurred.
If you are a dedicated crypto venture fund, for example, you likely have a number of protocols that will have a public token launch. Once that token is launched you likely have some level of liquidity either immediately or at some point in the future. As a manager, that necessitates a hold or sell decision just like a hedge fund would have with a position. If you are a crypto hedge fund you will likely have discretion to purchase some level of private assets, or simply OTC deals of liquid assets that have a lock-up period of one plus years (ie Solana (SOL) for a 40% discount with a one year vest and three year lock up). This looks very much like something a venture capital fund would invest in. Most if not all private investment vehicles within crypto allow broad discretion for investing in both illiquid and liquid assets, unlike traditional finance. The lines between hedge funds and venture funds in crypto are very fluid but they both have a distinct role to play in the capital formation process for new protocols.
Crypto VCs take the initial risk of funding these early stage start-ups. They are first movers to get the company off the ground and continue to help fund it during key inflection points. This is a much higher risk profile than later or public stage investing and they should certainly be compensated for this risk; 50–70% of early stage investments go to zero. Crypto VCs have the unique challenge of managing both stages, illiquid and liquid, of the investment process effectively. This is something their Web2 counterparts don’t have to manage. Therefore they do have to manage a liquidation into the market at some point.
Does that mean they have to dump day one on unsuspecting retail? No (they often have lockups anyway). Are there bad actors who take advantage of retail through predatory marketing or other means? Unfortunately, yes. Should there be more transparency on agreements? Absolutely. But overall crypto VCs are here to support capital formation across the ecosystem or very frankly they simply wouldn’t have jobs when it came time to raise their next fund. Once this exit process is facilitated is where the hedge funds and other liquid market participants come in to do their jobs and find true price discovery for these assets.
VCs take risk through capital deployment to fund early stage projects. But should a startup take a check from just anyone? What value do VCs actually provide early stage startups?
What is the Role of Crypto VCs?
Attention
Every investment in crypto is some percentage fundamentals and some percentage attention. Some hardcore defi protocols like Maker may skew almost 100% towards fundamentals and some esoteric assets like meme coins will skew all towards attention economy. In 2021 there were roughly 400k tokens available for purchase, today there are over 2 million (thanks pump.fun). We are seeing an average of 15k new tokens launched per day. Additionally we have a number of tokens unlocked from previous previous cycle launches and dozens of token generation events from projects that raised capital in 2022 and 2023. In July alone there are $350m worth of token unlocks and hundreds of millions in new token launches. With the huge increase in the number of tokens and expanding number of verticals, attention is more paramount in crypto than ever.
Attention also brings more capital, both on the private side and once launched on the public side. Large VCs like Pantera, Paradigm, Coinfund and Dragonfly have billions to deploy and rarely write checks under at least a few million dollars. Their Investments create a flywheel because all else equal more capital means more potential to succeed through spend in talent, marketing, infrastructure, etc. Even more than in Web 2, crypto, smaller crypto VCs and community VCs are pack animals. For better or worse they follow these big investors and quickly fill out the rounds once one of these bigger VCs leads.
Connections
Bringing a protocol to market takes a very unique set of experiences and connections. There is no playbook you can find on Amazon or a guide you can Google. Launching a token requires connections to launchpads or other listing services to bring your token to market. It may require connections to accelerators who can help you refine your business plan or go to market strategy. It requires connections with exchanges to list your token once it is live. It requires connections with market makers who will facilitate order liquidity and trading of your token. VCs have all these connections from their experience and can help projects as they navigate this part of their journey.
Credibility
All else equal venture projects are more highly vetted than projects not funded by VCs. There are obvious glaring exceptions (see anything FTX invested in) but a venture backed project will have the capital to get a number of audits and the VCs will likely have done their own set of due diligence on the technology, business plan and founders before making an investment. All of this helps make VC funded projects much more credible and less likely to be suspect in an industry rife with illegitimacy and scams.
Advice
Most VCs have invested across numerous cycles and have the hard earned knowledge of how to operate in this space. They often bring experience from other industries that can prove useful. They can provide advice from prior experience on best practices on what to do in regards to tokenomics, go to marketing, hiring, and more. They also can provide perspective on evolutions in these best practices overtime. For example tokenomics and allocations have markedly changed the past handful of years, and have solidified for what established best practices are for certain cohort allocations and vesting schedules.
Recruitment
Crypto VCs can help either directly or indirectly with talent acquisition. Directly through the job boards that many larger VCs have for their portfolio companies, or through their connections in the space. Indirectly through the signaling mentioned above. Talent is always interested in the new recently funded startup flush with cash and publicity. This signaling provides potential employees more comfort in making the leap into a risky startup.
Initial and follow on capital
The most obvious advantage VCs provide is capital to risky ventures. They are willing to take the risk of deploying capital into often pre-product market fit and pre-revenue startups with the hope that they will one day succeed. These VCs were writing millions of dollars in checks during the bear markets when many others were not willing to take the risks. There are of course other avenues to get initial capital but VCs are the most prominent. If you could bootstrap your own company, great(you would eschewing all the advantages above), but there are certainly advantages to self-funding. The bottom line is 99% of projects can’t do it. Finally, VCs provide follow-on capital or connections for follow-on capital as these projects continue to grow.
Wrapping up
There is a wide range of benefits crypto VCs can provide projects. While we are eyes wide open that all VC crypto are not good actors nor provide all of the benefits listed above, the large majority do. We think the overton window has swung a bit too far in the opposite direction in completely writing off crypto VCs.
At MV Global, we strive to be not just investors but partners. We work daily to help projects have not only the best go to market possible but to strive and thrive after TGE. If you are looking for funding the pre-seed or seed stage we would love to discuss your project.
We hope this piece can further the discussion on the value of crypto VCs and welcome your feedback and discussion on X (@buildwithMV, @dunleavy89) and on Linkedin.
About MV Global
Established in 2019, MV Global has emerged as a force in the Web3 landscape focused on early-stage investments and venture building. Our mission is clear: to partner with mavericks, visionaries and free thinkers to leverage blockchain-enabled technologies to build for the future.
