By Devika Mittal, Listings Lead at OKX
Crypto originally emerged as an alternative to the traditional financial system – not just to banks, but also to hedge funds, venture capital (VC) firms, and institutional investors. Decentralized ecosystems grew and let retail enthusiasts access investment opportunities that would otherwise have been limited to financial insiders.
Enter crypto venture capital (VC) firms.
ICOs: From public sales to private sales
Although there were some limited VC investments into crypto projects as early as 2013, it was only from 2017 that they began in earnest, mainly driven by the initial coin offering (ICO) boom. In 2017, crypto projects raised $5.5B in ICOs. In 2018, that figure amounted to $6.3B in the first three months alone.
Originally, ICOs came with public pre-sales of tokens for the general public. The process was pretty simple:
- Anyone on the internet could buy a certain amount of tokens to help fund a crypto project.
- Later on, that project would officially launch its token on an exchange. The pre-sale buyer community would have a vested interest in promoting the token and making its price increase.
Think of it as getting stock options in a company you work at, at a specified strike price, to be exercised at a later time when the company IPOs in the open market (and other circumstances), hopefully at a higher price than the strike price.
Later on, most ICOs switched to a private sale model, where only professional investors and a limited list of angel investors would get early access to token sales. And that changed a lot of things.
Benefits of private sales
Shifting to a private sale model was meant to allow for:
- Focusing on project building versus. public hype building
- Developing a longer term vision
- Allowing the U.S. community to get involved
Some examples of crypto projects that raised private funds include:
- EOS, which raised over $4 billion in a year-long ICO, with participation from several prominent VCs, including Peter Thiel's Founders Fund.
- Filecoin, which raised over $200 million in an ICO led by Sequoia Capital and other VCs.
- FTX, which raised $2B from 80 investors, including Sequoia Capital, Tiger Global, SoftBank, BlackRock and others.
In total, VCs spent $32B on crypto in 2021, and $29B in 2022. Top VCs such as Sequoia raised a $600M crypto fund and a16z crypto raised a $4.5B fourth fund. This increase in funding has allowed crypto projects to raise funds in a relatively streamlined process and focus on building technology. However, it has also meant that some crypto projects have started facing the pressures of fundraising that traditional startups face.
Unintended consequences
In recent years, the crypto industry has had access to large amounts of liquidity through VCs. This has led to a number of negative consequences that threaten to derail the promise of the ecosystem and harm it as a whole, such as:
- Skewed monetary incentives
- Easy money
- Prioritisation of hypes over strong fundamentals
These tendencies have led several crypto startups to focus on short-term goals at the expense of building long-term businesses.
The way forward
VC plays a crucial role in crypto but it has to follow a different path. Here are some of the important points we hope the future of crypto VC will build on:
- Equity raises over token raises: Despite lock-in periods, token raises can incentivize short-term pump and dumps. A shift towards equity raises would allow companies to build sounder businesses with strong equity value instead.
- Focus on the fundamentals: VCs should allocate more time for robust tech due diligence, and for asking the tough questions. Does this technology truly not exist yet? If so, why is this much better than the others? Does anyone want and/or need it? Does it have to be in crypto? If no one else has built it yet, why not?
- Small pre-seed and seed rounds: Projects should aim to raise the $1-5M required to test a proof of concept, and test it fast. Most projects do not require more than that to assess the technology and customer traction.
- Deeper industry knowledge: As more VCs get into crypto, new investors should leverage those with the industry business and technical expertise to ramp up and get an in-depth understanding of the ecosystem.
- Assessing valuations: For projects without product launch, VCs should negotiate valuations down instead of raising valuations due to competition in the market.
The future for crypto VC is bright. VC funding enables strong projects to hire the right talent, conduct outreach, and find their target audience. As we move towards a post-bear market, targeted and thoughtful VC investments will allow the crypto ecosystem to flourish and grow – provided it avoids some of its past excesses.
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