Crypto Investors Could Learn a Thing or Two From Venture Capital
By now I’m sure you’ve heard of Ethereum, the skyrocketing blockchain technology and its currency Ether (ETH), which have been hunting down Bitcoin’s market cap like a shark after blood. One of the main contributing factors to the 4,000% rise in ETH since January are the startups building upon Ethereum’s technology and utilizing the ERC20 token protocol. Through the protocol, these experimental startups can hold their own token crowdsale (TC) commonly referred to as a initial coin offering (ICO) similar to contributing to a Kickstarter campaign but instead of receiving the first version of a product or a perk, the investor receives a token to be used on the platform (at least that’s the pitch).
The rapid rise of TCs have given blockchain startups access to millions of dollars in a matter of days, hours, minutes and even seconds. Backed by a team, white paper, website, and rarely a workable prototype, companies like Golem, Aragon, and Iconomi have exploded onto the scene with the hopes of developing a decentralized world.
Historically, funding for private tech startups in the United States has been limited to accredited investors (angels, venture capital) or through an IPO on the stock market. While the implementation of the token crowdsale has greatly reduced the time to raise these funds and provide equal opportunity to those investing, the amount of capital some these companies are raising is quite alarming.
Let’s take a look at two startups:
Startup A
Startup — Pre-Seed: the two-person team of fraternity brothers fresh out of college released a functioning minimum viable product (MVP). With this, the team was able to secure $25,000 from a local accelerator. The team incorporated and created an option pool for all current and future employees with a 1-year cliff and 4-year vest.
Pre-Seed — Seed: to keep their burn rate low and conserve their modest funding, the team only paid themselves as much as they need to get by ($1,000/month each), right around the poverty level in the US. With no extra income for personal extracurricular activities, the team spent virtually all of their waking hours developing the product and acquiring users. After grinding away, Startup A finally gained momentum and grew 5% month-over-month between months 3–7. Upon entering the accelerator, fundraising for the next round began right away. A $750,000 seed round closed after angel investors saw Startup A’s minor but snowballing traction at the end of month 8.
Seed — Series A: With a seed round secured, Startup A began scaling up their team by adding three employees in development and two in sales. At this burn rate, the team had an 18 month window to find their next round of funding. During this time, new user growth skyrocketed and churn was minimal. With 4.5% growth month-over-month, Startup A secured a $3.5 million Series A round from a mix of venture capital and angel investors.
Series A — Series B: After using the new funding to ramp up the team, Startup A’s growth began to resemble that of a hockey stick. Their CEO was on the cover of Wired and the homepage of TechCrunch in-between raising for the next round. Everyone is talking about Startup A in Silicon Valley. Riding this massive wave of PR and organic growth, Startup A closed a Series B round just two years after their Series A round to the tune of $17.5 million.
Startup A Funding Recap
Pre-Seed: $25,000
Seed: $975,000
Series A: $3.5 million
Series B: $17.5 million
Total: $22 million after ~3.5 years of success
Startup B
Token Crowdsale: Startup B announces a token crowdsale after releasing a beautiful landing page, a 15-page white paper, a roadmap, a strong social media following, and a MVP planned to be developed over the next 6 months. During the crowdsale, Startup B sells 1 billion SBT (Startup B Tokens) in return for $10 million in ETH. At the time of the sale, 1 ETH was worth $100 USD but due to the exponentially growing market, the price per ETH rose to $300 USD in two months quickly turning that $10 million into $30 million USD.
The team has locked their allotment of tokens for the first 6 months.
Startup B Funding Recap
TC: $10 million in 30 minutes
Worth after 2 months: $30 million
While this TC seems insane, it is non uncommon with the TCs we have seen within the past two months.
The fund-raising process which previously took startups weeks or even months to find accredited investors has been greatly reduced and those providing the funding are able to receive fast liquidity if needed compared to waiting for an exit 7–10 years down the road, if ever. But will this process last? And if it does, will the death of traditional fundraising through angel investors and venture capital be close behind?
Will it work?
To look at the absurdity of these rounds, let’s look at some recent TCs compared to the funding rounds of some “unicorn” ($1 billion < valuation) tech startups:
Rounds are a popular form of fundraising because it is a method that has been tried with success. With seed money, the startups test their idea, find product market fit and if all goes well, scale up in Series rounds (A, B, C, etc.). To compensate for the risk, those that invest in earlier rounds are given more equity compared to later rounds. With TCs, investors are tossing in scaling-level money from the beginning with little or no testing and validation by the startups. TC investors are placing millions of dollars into the hands of these startup teams with the hope that they will follow through on their roadmaps and grand vision displayed in the white paper. With the growth of ETH in market cap, this funding explodes compared to the traditional route.
The good news is that these TC startups will not fail because of they have run out of funding or are spending too much time fundraising. 92% of traditional technology startups fail for a wide variety of reasons and very rarely in the early stages is it because the founders are too wealthy. While I like to be optimistic for the technology and its future, it is hard to imagine every single individual on a TC startup team will act in the best interest of the company after this new-acquired wealth.
Add the lack of monetary hunger to other common factors such as not achieving product market fit, having a weak team, poor business model, or an external market factor and the value of your crypto-portfolio could come crashing down faster than it rose.
How can you protect yourself? Ask the same questions an angel inventor or venture capitalist would prior to making an investment decision. At the end of the day it’s your money, a little due diligence can go a long way.
Note: this is in no way investment advice but instead a set of questions you should ask to protect yourself prior to pulling the trigger on a cryptocurrency or cryptoasset. These recommendations work not just for those participating in crowdsales but for those looking to invest in tokens post-crowdsale.
Idea
A great starting point would be the problem in which the startup is trying to solve. Read through the white paper and try to understand the idea on as deep a level as you can. Do your best to remove yourself from the FOMO (fear of missing out) hype you might see on reddit, Twitter or elsewhere.
What is being solved?
Is there a roadmap with different stages and release dates?
Is this a niche product or is this something you or your mother could use?
Which companies or individuals could benefit from this product?
Will the product run into any legal or political hurdles?
Where will the money raised in the token sale be spent?
Traction
Is there a Github available? How often is the team committing? If you’re less technical, recruit a friend’s help.
Is there a live product? How many are using the system?
If not, can you become a tester of an Alpha or Beta?
If not, is there a date that either will be available?
Team
You should be able to find the teams on the website or white paper. Understand the role of each team member and the benefit they bring.
Who is developing the product? Is it the core team or will it be outsourced?
Is this the team to solve the problem and deliver on the product? Do they have experience in the space-finance, computing, storage, etc.
Are the team members involved with any other projects as a team member or advisor?
Is the team accessible on Slack, Telegram or elsewhere?
Who are the advisors and how will they help? What else are these advisors involved with? Are the advisors legitimate? Ethereum co-founder Vitalik Buterin recently made the decision to no longer serve as an advisor on future projects after some startups were falsifying their advisor list.
Has the team handled a large amount of funding previously? These startups have tens of millions of dollars at their fingertips, make sure you trust them to handle this appropriately.
Token and Potential Returns
If you’re researching pre-TC, understand what the market cap and price per token will equate to after the sale.
Compared with other tokens will it be undervalued?
Is the TC capped?
What percentage of the total tokens will be available during the TC participants?
Will any of the tokens be locked up for a period of time following the TC?
Will the tokens be readily available for trade upon the TC’s closing?
How large is the addressable market? Try to compare the startup to an already established organization — ex. Golem’s decentralized computing with the current computing space.
Do you have the proper wallet for the tokens? MyEtherWallet (for ETH/ERC20) or a hardware wallet like TREZOR will work great. Never leave your assets on an exchange!
Buy with only that which you can lose and HODL
Yes, I meant HODL and not hold. Have confidence in blockchain as a whole and the token or tokens you select. It is highly recommended not to margin fund or day trade with the industry being as volatile as it is. You could end up losing your whole investment by being impatient.
Startups can help too
Some could argue the dot-com bubble of the 90s and the token crowdsale (TC) boom of today have similar paths. While investors were throwing money at any publicly-traded internet idea with a pulse during Web 1.0, those companies still needed to be fairly established and vetted. After that bubbled, Web 2.0 became smarter — while in their infancy, less tech companies went for public IPO money and instead went after private funding from accredited investors first through angels and then venture capital.
Web 3.0 has the chance to combine the best of both worlds — we can provide the average Joe with the opportunity to benefit from these potentially high-growth startups while also streamlining the speed it takes for the companies to receive the funding. Instead of weeks or months of searching, meeting and negotiating, they will instead be able to put their time into focusing on developing a great product.
Not that I believe cryptocurrency’s end is near, but the recent wave could come crashing with a massive correction at any moment. Back in November 2016 when Golem raised $8.6 million in ETH at ~$10.50/ETH very few would have imagined ETH would be sitting around $400 in June of 2017. Because of this growth, that $8.6 million in ETH is now worth $307.5 million with ETH at $375 (as of 6/17).
What can these companies do to prevent the dreaded “B” word (rhymes with double)?
I see two viable options.
One is simple, continue the current funding structure that has been done since Web 2.0 and go through the traditional VC and angel channels like the team over at Dharma.io is planning to do with their peer-to-peer lending platform built on Ethereum. While this process is much lengthier and the funds raised may be less than that of a TC, the lack of liquidity in the investment gives the investors an incentive to ensure the success of the company long-term by serving as advisors and oftentimes sitting on the board. It is also a fundraising method that has legal guidelines already established for companies and investors in the United States.
The other option is the crowdsale. However, the current structure needs improved upon if startups want this form of fundraising to last. While a lot of the ideas below will appear to benefit the investors more than the startups, the startups benefit greatly from the state of cryptocurrency and a crash would ultimately hurt everyone. Here are some ideas I have for the TCs moving forward:
Don’t raise prior to having a minimum viable product (MVP)
Add confidence to the market by providing some type of functioning prototype. Gain market validation prior to raising millions of dollars. Force yourself and your team to stay lean early on and test if this is even an idea worth pursuing or even possible. While it is still early on in the token crowdsale era, the weight and watchful eye of millions of dollars in funding may be too much pressure for some.
Split the token sales into different rounds.
Just as is common with traditional funding, break the token sales into multiple rounds aligned with specific milestones. Reward the earlier token buyers with greater percentages of tokens compared to those joining in future raises.
If you raise all funds at once, distribute only what you need.
Create a smart contract to lock up the funds for founders with a vesting schedule. Allow the token holders to vote when the locked tokens should be released for future funding. A startup doesn’t need more than $10 million to get their feet off the ground, anything else spent is a waste.
Conclusion
Remember at the end of the day these startups are experiments in an infant industry. It is best for all involved to understand the risks and the volatility of the space. Just as ETH has risen from $8.15 to $420 in 6 months, it could also just as easily plummet overnight (although many are bullish).
While you may have been introduced to blockchain by seeing an article about the TCs and the exponential growth of market cap, pay attention to the foundation of it all — the blockchain. Try the products, utilize the tools, offer your own unique skills, and contribute to conversations to help build upon blockchain’s success.
I’m starting ChainTrek, a newsletter to provide an insight into these innovative startups of Web 3.0 that have a live, working product today. While it is great the TC startups have gotten a ton of publicity, I think it is also crucial for the ecosystem to get use out of the products. ChainTrek will release its first newsletter in the upcoming week and we will soon be raising a $50 million dollar crowdsale — just kidding ;).
I would appreciate any feedback to this post and hope this can contribute to a larger conversation moving forward. Feel free to follow me on Twitter or email at kevin@chaintrek.com.
