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Maybe old-fashioned venture capital wasn’t so bad after all
As the founder of a layer 2 blockchain focused on consumer cryptocurrencies, i.e. user-friendly applications that can achieve mass adoption, I’ve spent a lot of time thinking about why it’s more popular to talk about consumer cryptocurrencies rather than invest in them. It’s a common complaint among builders that infrastructure not only gets all the love, but he also gets all the money.
While this may seem rich coming from the founder of an infrastructure project, since our success should technically depend on consumer adoption of cryptocurrencies, it is an important problem to solve. The more I thought about it, the more I realized that I needed to take a step back to understand the incentives of people investing in these potential consumer applications.
Azeem Khan is the founder of Morph, an Ethereum Virtual Machine (EVM) layer 2 blockchain in testnet.
It often seems that cryptocurrency investors are not aligned with the projects they invest in. Perhaps it’s because tokens are changing the way venture capital works as a whole. On the other hand, venture capital is not a monolith.
If we want consumer applications to receive investment, more honest conversations will be needed about what project founders and their funders want to achieve.
If you were to ask someone who knows about venture capital or your favorite search engine how it works, you would probably see more or less the same answer: private equity financings in which investors provide money to startups, take shares and traditionally try to see returns exceeding 10 years. To date, this is how venture capital has worked.
So when you go to a cryptocurrency venture capitalist, that’s what you would expect, right? Not so fast. The token launch changed everything.
Take Ethereum. It is not only one of the most well-known blockchains but also the one where most of the builders are located. But Ethereum’s real innovation was becoming a platform where anyone could launch a consumer crypto application and its utility token.
VCs saw another opportunity here, organizing multibillion-dollar token drives for so-called “Ethereum killers.” While many of these projects have failed, leaving behind dormant ghost chains, it has been a profitable endeavor for many of the investors who put money into them. And this is part of the nature of how tokens work.
Before the introduction of token launches, venture capitalists used to invest in companies where they only received shares – think Meta, Airbnb, Roblox and so on. The way to get their investment money back was to have another company acquire the startup they invested in or have the company do an initial public offering (IPO) on the stock market. This is one reason why it has taken venture capitalists so long to see returns on their investments.
Since the advent of blockchain-based tokens, investors willing to fund crypto projects have found another avenue to earn their returns, often much faster.
The way venture capital deals work with Web3 startups these days is that investors take a percentage of tokens, shares, or both depending on the investment deal. One of the main things investors need to understand is how token allocations work. This is a new problem, never seen in traditional venture capital.
The two main aspects to consider are the “lockup” period, i.e. how many months after the launch of the token an investor must wait before starting to contribute their tokens, as well as the duration of this maturation period (the total allocation of tokens will be based on investment as a percentage of total token supply).
The last thing to consider is that the tokens these investors get have liquidity, meaning they can easily be sold for cash on an open market. This contrasts sharply with the equity-only model where it is much more difficult to sell your stake.
Going back to the beginning, if investors had to wait nearly a decade to see if their investments were successful, but can now start cashing out within a year thanks to token deals, perhaps it’s time to start rethinking venture capital.
Maybe it’s time to start looking at which investors are looking to earn less than 100x-1000x returns on their investments over a decade, and which are looking to earn smaller returns over a shorter period of time. The first is what will lead to consumer adoption, because we need to educate people about why blockchain is better for consumers, build the products, launch them, get the regulators involved, and actually be in a place where blockchains can handle traffic. , all operations that take time. The latter will only continue to further enrich already rich VCs, which is the opposite of what we need.
Hopefully, an honest dialogue about the evolving nature of venture capital will pave the way for more investment in the right infrastructure and consumer applications in the cryptocurrency world.
Note: The opinions expressed in this column are those of the author and do not necessarily reflect those of CoinDesk, Inc. or its owners and affiliates.