How Will The Blockchain Change Venture Capital Investing?
Around April last year, I wrote an article called ‘Bitcoin, Blockchain and Self-Enforcing Contracts’. As you may have heard, a lot has changed in the blockchain space over the past months so I thought I’d take the opportunity to reflect on how my perception of the space has changed since, specifically focusing on venture capital investing which many believe is ripe for change due to its limited returns, absence of retail investors, illiquidity, aversion to social impact startups and overall lack of diversity and inclusion.
I first became interested in blockchain technology through the emergence of Bitcoin, and was given the opportunity to jump head-first into the space for my final year dissertation where I outlined a method to effectively store trades between fiat and cryptocurrencies on an improved version of the Bitcoin blockchain. To complement this, my career path has taken me toward the venture space with domain expertise in emerging technology startups and protocols (e.g. applied AI, blockchain and other distributed ledger technologies) that provide services to retail and other incumbent sectors, with a particular focus on digital lifestyle startups where user experience and the overall purchase process are improved.
The overall track record of the VC asset class is poor; most funds do not outperform the public markets — yet, investors usually claim that they can beat the market through network, access and cherry-picking early-stage companies.
The convergence of VC and the blockchain unwittingly led me to a conversation with David Siegel, long-term angel and venture investor and founder of blockchain community 2030, around Christmas time. He had a hypothetical solution to this asset performance problem called Global Beta Ventures which, based on the work of Right Side Capital, 500 Startups and Kima Ventures, theorised that it is possible to create a set of investable indices of early-stage startups grouped by startup growth phase and powered by smart contracts for an IRR significantly higher than public markets (22% IRR [UK], 35% IRR [US]). This immediately piqued my interest, and he went on to describe the 20|30 community and his broader aims to create a decentralised networked world that will be mainstream in 2030.
At present, VCs are unable to invest in blockchain startups due to legal commitments to their LPs and generally don’t invest in social impact startups for fear that revenue is not their most pressing concern.
Around the same time that I spoke to David, I came across Olaf Carlson-Wee and Polychain Capital — a new digital assets hedge fund that raised over $10 million from Andreessen Horowitz and Union Square Ventures to invest in application-specific tokens at protocol level, similar to equity investment except the value is in an intrinsic part of the software. Funds like this allow value to be distributed much more evenly to the makers, creators and innovators that build and grow the product and allow the curators of open source software protocols to avoid their broken fundraising models. I was fortunate enough to have a couple of conversations with General Partner Ryan Zurrer who concurred that ‘Sand Hill Road will be disrupted long before Wall Street’ — a statement that I believe to be true more and more by the day.
VC is an illiquid asset class whereby we try and cherry-pick unicorns and wait several years to see if we’re right — this means that our performance is essentially unknown for 5–10 years and we have little to keep us accountable.
A few months later into 2017 came a very informative article from Richard Kastelein going into detail on why VCs should care about initial coin offerings. Although it raised several important points, two jumped out at me: 1) ICOs could mean the liquidation of a significant portion of venture capital investing allowing for the democratisation of the space in a way that equity crowdfunding hasn’t quite done so yet, and 2) the return on investment is significantly higher. Hence, if adopted en masse, swathes of new retail investors could enter the market and price dynamics could change. This means that live indicators of startup performance will be in the public domain — by inference, LPs will have a much clearer idea on the performance of their investments.
Personally, I think that the intersection of VC and blockchain technology will result in the coming-of-age of liquid equity-style crowdfunding for blockchain innovations at the protocol level — this is being kicked off by projects like Ethereum, Tezos, Cosmos and Filecoin amongst others, and funds like Polychain. I’m completely sold on the idea that altcoins are here to stay and VC needs to get ready for it, but it’s important to remember that despite all the hype there is still a lot of noise around these tokens and many people still don’t understand what they are, how they work and why they have intrinsic value.
The market capitalisations and trading volumes of these coins will probably decrease before they increase strongly and sustainably and this is likely better in the long-run because there needs to be a serious regulatory shake-up and significant changes in the due diligence process to ensure a fair and agreeable process — ICOs will remain as people minting their own ‘currencies’ (read: ‘commodities’ or ‘global reserve currencies’ — most fiat currencies aren’t volatile enough to be replaced so cryptocurrencies act as better hedges to ‘the system’, cross-border payment facilitators and providers of utility value to protocols; however, the digitisation of fiat currencies makes total sense to me — I’ve only withdrawn cash once in the last six months) and attributing value to them through crowd investment until this happens.
This all plays into the wider VC mega-trend of democratisation through crowd investment, diversity and disintermediation resulting in a fundamental shift in the way we invest and what we invest in.
This blog post was written by Harry McLaverty, freelance emerging technologies and investment consultant to startups, VCs and other ecosystem players. I am also a c0-founder and trustee at WarwickTECH, and one of the four #poctech ambassadors at Campus London.
If you’re new to emerging technologies, are trying to find business use-cases for your existing tech, or want to converge different technologies together and raise investment from the right funds then feel free to reach out on LinkedIn.
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