The Future of Crypto Investing
If you look at last few years of crypto investing, VCs have largely looked at crypto companies effectively as decentralized companies -- as equities. But, as things have played out, value hasn’t accrued to equity in the parent company; it has instead accrued to the token network. Speculative value, to be sure, but value nonetheless.
So, VCs responded by amending LPAs to invest directly in digital assets via SAFTS. They figured out custody, etc...but blockchain is a little more complicated than that, and requires a little more thinking about what is the correct way to structure an investment.
With layer 2 technologies on the horizon, it’s important to note that layer 2 technologies don’t have tokens the way we’re used to. They don’t have investable equity--they are open source projects.
So, yet again, VCs have this investment conundrum: how do you capture the value of decentralized technologies directly?
Even more perplexingly: how do you participate as an investor when there’s no token or no equity…?
In this new world, you might have to be more technical to participate - might have to earn your way in by participating in the network.
Enter generalized mining.
Notation calls it Mining 2.0, Coinfund calls it “Generalized Mining” but the basic idea is that investors will actively participate in the networks in which they invest. They won’t just contribute capital; they’ll also serve as “miners, stakers, validators, bonders, curators, dispute resolvers, nodes, hubs, watchers, routers for networks, etc.”
To be sure, some of these projects will combine active participation with direct investing, but other projects will not present opportunities to invest--and direct participation in the underlying networks will be the only way one can capture the value of that particular technology.
Why does this matter?
Zooming back out, VCs always have tried to innovate: First Round came with the platform approach to venture, a16z brought the services model, Village Global I hope has helped usher the networked investing model.
I think Coinfund, Notation, Figment, Bison Trails, and others will bring the active participation model of investing -- the crypto native application of of the platform VC approach.
VCs always talk about value add - what’s unique about crypto is that you can make it tangible and measurable.
Firms that actively participate in networks are going to have unfair advantages in terms of deal flow, due diligence, and financial returns. These firms will theoretically be positioned to make more money earning through network participation than through investing alone.
In traditional VC your role was make an investment, then try to provide external guidance/value add to grow the company.
Now, you as a VC will have direct influence. When big changes need to be made to the protocol that will steer the end destination, investors essentially have a liquid board seat that directly impacts the course of the project. This is pretty fundamental.
Can VCs compete?
In this network participation approach there are new problems. You not only have the old questions (e.g what are use cases? is it a hedge fund is it a venture fund or hybrid? what’s the lock up? etc) You now also have the question of team: Do VCs have the team to do it?
Crypto investing teams are going to have to be multidisciplinary. It’s not just about having investors and sourcers anymore. Teams are going to have to have the tech chops, understand how game theory scenarios play out, deep legal expertise, and much more.
VCs are smart people, to be sure, but they don’t have deep knowledge of these proof of stake networks -- they’re not protocol designers, or consensus algorithm evaluators.
The kinds of issues we see in crypto native decentralized networks goes far beyond typical experience of analyzing companies.
It’s not just knowing how to invest, and it’s not just understanding the technology - it’s the combination of all of those things...I think VCs are better off partnering with existing funds like Notation, Coinfund, Figment, Bison Trails that are on the cutting edge, rather than building entirely separate teams internally.
VCs serving as LPs to these crypto funds could be the perfect role for everyone involved, since native crypto funds may have a tough time getting traditional LPs, who are still trying to wrap their heads around Bitcoin - let alone Generalized Mining. Indeed, it appears that VCs can get in on the action after all.