Investing in Lightning Network Startups. Part 1
This is an adapted transcript of the Kevin Rooke Show Episode 25 podcast originally made and published by Kevin Rooke in May 2022.
Oleg Mikhalsky, a partner at Fulgur Ventures, joined the podcast by Kevin Rooke to discuss why Fulgur is excited about Lightning and the ways in which the technology can disrupt existing institutions, payment processors, create new markets and enable monetary transfers that were never before possible. Kevin and Oleg also discussed different business models in Lightning, how to get more founders and project ideas in its ecosystem. One of the interesting topics was whether Lightning adoption comes from a top-down approach, like we see from El Salvador’s Bitcoin law or with Square’s Cash, or whether it comes from a bottom-up organic adoption, like we see in Bitcoin Beach or PlebNet.
This is the first part of the series of two articles based on the podcast episode. Here you can quickly grasp the main ideas discussed and find out more about the Bitcoin and Lightning ecosystem and its development in the future. In this part, Kevin and Oleg discuss the development of the Bitcoin and Lightning ecosystem in the past years, differences between Lightning investors and other crypto investors, their role in Lightning startups, and how they evaluate such projects.
Kevin Rooke: Let’s start things off with a little background on your history in Bitcoin and why you decided to start Fulgur Ventures.
Oleg Mikhalsky: I used to do angel investing between my enterprise career stints in software. My enterprise background is mostly software product management and business development. After one of my career tracks, I became an angel investor in a software company that shared a co-working space with Andrey Samokhvalov who at the end of 2017 was working for Lightning Labs as a remote software engineer. And on the other side of this picture, I also had someone who learned about Bitcoin a little bit earlier than I did. When Andrey decided to create his own project we became angel investors in probably one of the first Lightning network startups in early 2018. And I spent most of my time hanging around in conferences and trying to help with product development, strategy and networking. When we became a bit more experienced and connected, we started the VC fund in 2019. (You can learn more about the history of Fulgur Ventures here.)
Kevin Rooke: What do you think about the Lightning Network in the last four years, has it grown as fast as you expected it would back in 2018?
Oleg Mikhalsky: What is really interesting is the cyclicality of the Bitcoin space and going through the ups and downs and volatility. Cyclicality and volatility accelerate learning because learning is facilitated by change and healthy stress. I think we are at the beginning of the next learning cycle after the previous year’s bull run. And there is definitely a lot of momentum in the Lighting ecosystem which we are seeing that wasn’t there before. We know that Twitter is doing work with Lightning, Cash App introduced support for the technology. There are some quite substantial fundraisers happening recently: OpenNodes announced a significant fundraise. The metrics such transaction numbers and volume growth as in the recent research by Arcane and overall ecosystem review in Fulgur research also show progress on the Lightning Network. [The announcement of David Marcus project to build on Lightning came out after the podcast was recorded].
I think the main difference between this year and a couple of years before is that then we had a hypothesis based on a holistic understanding of what innovation in payments means and what micro payments could mean in the future. But now we really have tangible examples, such as Lighting Network applications in the gaming or content industry, like with your podcast, for example, on fountain.fm (disclosure Fulgur is as investor in Fountain). And we’re seeing that some of the metrics are very convincing, they prove the value proposition of the technology stack and specific business models in given domains, such as podcasting or gaming.
Kevin Rooke: Do you think the adoption in Lightning and some of the learnings that companies are going through right now is also tied to that cyclicality of the price of Bitcoin that you mentioned earlier?
Oleg Mikhalsky: The top of the cycle usually creates a somewhat abundance of capital that gets redistributed back into startups. It also creates additional excitement that drives innovation and startup activity in the space. These are two aspects where the cycles overlap. But if we think of Lightning as payment rails, which can eventually be used even to transfer an asset other than Bitcoin itself, that would make Lightning more independent and developing in its own cycle. Bitcoin is more like an asset and with Lighting you can build applications outside of the trading and asset accumulation space. So, it’s a bit of both, but we’re probably going to see more activity on Lightning regardless of the Bitcoin cyclicality. However, there is definitely an overlap.
Kevin Rooke: What is the divide between Lightning investors and broader crypto investors? What are some of the key beliefs or ideas that you have that give you conviction to invest in Lightning companies where other people would rather stick to crypto?
Oleg Mikhalsky: First of all, our thesis is built on ideas which we believe have strong fundamentals behind them. So, we believe in Bitcoin as the monetary system and Lighting as payment rails and enabling technology for innovation in fintech. Next, we also want to be adding value to the early stage startups we invest in and we believe our background in software can create value for such startups by really going into the weeds of how things work and actively engaging and brainstorming about business models, even sometimes about product implementation as well as by finding some synergies between different projects within the ecosystem. Finally, we’re just technically curious people. It’s important for us to learn continuosly to be more helpful to founders and also to make better decisions.
On the other hand, there are definitely generalist funds that invest across multiple domains. I think founders can always look for having the best of the two worlds. It’s important to create synergy between Bitcoin investors and investors from outside of this space. They could bring value in domains where they are experts, for example in content monetization and distribution as for fountain.fm. They could be investors from media industry or with connections to or experience from Spotify, Anchor.fm, Youtube etc. There could also be highly value adding investors for later stages when the project is scaling.
Kevin Rooke: If I’m a founder and I’m looking for capital, how much does it matter that the investors that I’m taking on are also going to help build and help get connections and iterate on the product that I’m building versus just handing me capital and letting me go run and do my thing? Has that changed over time? It seems like capital is not a constraint for a lot of startups right now.
Oleg Mikhalsky: In the past days the VC space has been hyperactive [The article was written right before the general VC slowdown started to show up in May-June 2022]. And we could definitely see an excess of capital in certain sectors of the blockchain space. But I wouldn’t say Bitcoin and Lightning is a capital-rich space as of yet.
If you have capital on the startup captable that just sits passively, you’re basically missing out on the added value that you could have had. And in the worst case, if you have capital with negative value, for example, with people who would say that you should issue a token no matter what, that will distract from being on a mission to build something great based on technology that has a fundamental value proposition. With time, investors will realize that Lighting has a precisely proven technology-product value proposition match. It’s instant, low cost, counterparty risk-free settlement, which helps to address several of the major bottlenecks in any fintech payment system and also enables true innocation by disintermediating payment settlement.
People are never going to refuse to buy things for cheaper. There’s always going to be payments. And by making payments more efficient, a lot of value can be created. Lightning and Bitcoin are exactly the right software stack and the ecosystem to build such things, because they have the technology that in a very simple and efficient way addresses the inefficiencies of payment stack and also creates potential for other applications, like Bitcoin native finance or the Internet of money, payments and transactions for digital content and entertainment and so no.
Kevin Rooke: Which side do you think Lightning is going to be more impactful: in disrupting current intermediaries or creating new markets?
Oleg Mikhalsky: It’s not so easy to disrupt something like fintech, payments, and the financial system because there are a lot of regulatory moats and incumbent inertia. Creating new products and new markets or augmenting existing products and existing markets and gradually improving them may be another area where we can see traction while we’re still working on creating a major disruption. Again, a great example is actually fountain.fm. It can actually change the monetization model for content in podcasts to the benefit of podcasters and their listeners, which is a very fast-growing industry.
But there could potentially be native Lighting or Bitcoin-focused experiences such as trading with options on Lightning or peer-to-peer trading in a non-custodial way. That’s a new market that has not existed before. We will see more examples like this.
Kevin Rooke: Are there any particular Lightning applications or use cases that you think are waiting to be disrupted?
Oleg Mikhalsky: One thing that I’m really excited about is the overlap between Lighting and energy payments. The first time I heard about it was from Nayuta, a company in Japan that is building on Bitcoin and Lightning. I believe that in general Bitcoin can play a great role in renewable energy and building sustainable new energy projects.
The other thing is, of course, digital entertainment and content monetization. Commerce in digital space is almost infinite. You’re not constrained with delivery of physical goods, low speed of cross-border payments, foreign exchange conversion overheads. It would be interesting to see some digital content platform that allows creators, listeners and viewers from all over the world to interact with each other with less friction than current systems and current platforms do.
Kevin Rooke: When you’re thinking about making investing decisions today and you’re looking at businesses, are there any particular business models in Lightning that you know are proven and you can confidently back?
Oleg Mikhalsky: Infrastructure is essential in Lighting and Bitcoin — different wallets and types of nodes and tools to support their operations. These are all the necessary building blocks as well as developer tools to create applications for Bitcoin and Lightning monetary system and payment rails. And then there are many opportunities on the interconnection between better user experience and technology itself for making user experience really smooth and for paving the way from custodial to non-custodial user experience.
Infrastructure and business-to-business services are models that are known to work in Internet projects and software in general. And obviously Lightning is going to have new business models around micropayments and Bitcoin-native financial products that we are yet to see. It’s just important to thoughtfully think about how technology delivers value and how to distribute this value between the user and the provider of a solution. We’re going to see business models around liquidity management. We could see some analogs of banking ecosystem, correspondent bank relationships and moving and reallocating liquidity between Lighting network nodes in a way that leads to creating a more efficient routing ecosystem and a more robust network. So, this is probably an area that will employ business models that have not existed before.
Kevin Rooke: How do you try and predict how much value a startup with a new business model could create and capture for investors?
Oleg Mikhalsky: We believe that for an early stage startup in an emerging industry it’s really important to be cognitive, cognizant of what is actually happening in the real world and to be agile and rational about how the founders view the world and their mission and how they take into account the inputs that are coming along the way. Value creation will follow when thoughful rational decisions are at the foundation of the business and there is a good risk management in place.
In Conclusion
The Lightning Network ecosystem is a new and promising space where you can build many interesting and innovative projects and create a lot of value by solving problems through innovation based on strong business and technical fundamentals. It’s hopefully going to become one of the most interesting topics for investors in the industry, as it provides huge opportunities for creating new business models as well as improving existing ones in the broader space of monetary value transfer. If you are thinking of starting your own project, you can also read more about different ways to funding Bitcoin projects in this article.
The second part of this article can be found here.
