VC 3.0 — How VCs position themselves in the world of blockchain

Eight months ago I wrote a post exploring ICOs and their implications for VCs. Since then, the ICO space has had a meteoric rise and one question I keep hearing along the way is “how do VCs position themselves in this new space?”

To answer the above, VCs are navigating a minefield of many other new questions with far fewer answers. That said, some things resembling answers are beginning to coalesce, and I’d like to share a few.

When I began surveying the state of the token world for institutional investors, I realized that directly investing in tokens is operationally challenging for a variety of reasons (custodianship, regulation, risk allocation… to name a few). Despite these challenges, many shops are investing. So, given that, let’s talk about positioning, specifically: how do these VCs position themselves to founders?

There seem to be a few common strategies and each comes with merits for founders and risks for VCs:

When I reviewed these approaches something stood out: they all felt effective in the short term, but less-so as the space matures. More importantly, many of these approaches aren’t uniquely helpful to founders. Sure, it’s nice to have an investor write a huge check, but in a space where capital is readily available, even from non-institutional investors, how much help is that really?

So I asked myself what most of the best VCs I know ask themselves: what keeps founders in this space up at night? After quickly not having an answer, I decided to go to the source. A few weeks ago, I had a chat with Doug Petkanics. Doug started a project called Livepeer and has been thinking about this space for a while. Prior to Livepeer, Doug started a company called Wildcard and another one called Hyperpublic, both of which were Lerer Hippeau portfolio companies.

Doug and I talked about these strategies and I asked him what the key driver is for his protocol’s long term success. His answer was simple: adoption. While having a steady market cap is great — and there’s certainly financial engineering that can optimize your ICO — the key driver for success is protocol adoption. The more people who build on and use your protocol, the more valuable your token becomes.

So how do you increase protocol adoption?

  1. Provide hard resources (money, real estate, computing power) to developers that are building on top of your protocol.
  2. Provide soft resources (guidance, community, support) to developers building on top of your protocol.

But how do you provide these two resources as a founder?

Hard Resources: One way you can provide hard resources is by raising a bunch of money and directly investing in those projects, but this presents a few issues:

  • Scope creep — How do you balance your focus while investing in other businesses?
  • Signaling — Do you alienate part of your community if you invest in one project over a competing one?
  • Structure — Are you issuing grants? Are these investments? If so, how are they structured and managed?

If you’re a VC, this should sound familiar (if you’re not, bear with me). This is exactly what VCs spend all day thinking about. VCs, not founders, are the ones well positioned to provide hard resources to projects.

The path forward is not totally clear. But there are some close analogues. VCs today often hold a portion of their funds in reserves to re-invest in companies. Usually these funds are used for defensive investments to protect their stake from the dilution of subsequent funding events.

In this space, VCs typically see one or two funding events, so holding half your fund to protect your investment is less helpful. But what if you used that portion of your fund as hard resources to be reinvested in these protocols? The beauty here is that instead of just defending your returns you could feasibly multiply them by investing in two assets that drive each other’s success.

For example, for a project like Filecoin, this may mean reserving capital dedicated to seeding an entrepreneur who wants to build the Dropbox killer on top of Filecoin’s decentralized storage network. For 0x this may mean investing in a team that wants to build an algorithmic market maker. Both of these businesses provide the double benefit of potentially providing great returns on their own as standard companies, while also providing adoption to the underlying protocols and their tokens.

Reserving 50% to reinvest in these projects might be too aggressive, but many other parallels (like fund recycling) exist that could be used instead. There’s still a lot to work out here, but this idea seems like a clear lane for VCs to enter, one which may be operationally challenging enough to differentiate them from other investors.

Soft Resources: This one feels much more straightforward. Every project relies on successful support networks for developers and business people building on top of these protocols. If you’re a new founder in this space, it’s possible that you haven’t built a network like this before. So you ask yourself: Do I launch a slack/discord channel? Do I host weekly hangouts / meet-ups? Do I blog? How exactly can I help these people? Is there a playbook for how to do this? Well, there is. VCs have platform teams that spend all of their time providing soft resources to their portfolio and they’ve learned what works and what doesn’t when it comes to building community. VCs with strong platform teams are uniquely positioned to translate their platform and community experiences into best practices for founders in this space.

Final Notes

To recap, my high-level takeaway is that successful VCs will find a way to differentiate themselves by doing a lot of things they already do: providing investment expertise as a service and managing the operational challenges of community building. On a more granular level, I still have plenty of questions. First and foremost, what’s the best way to economically structure a fund that does this?

Answering this question and others will take trial and error so I asked Doug if I could share this idea with other VCs and founders so that we can all learn best practices together. I’m excited to see that a few people I’ve talked to about this are already off and running with experiments of their own and I’m looking forward to seeing more in the future.

Thanks to Doug Petkanics for sharing this idea with me and editing this post. Thanks also to Taylor Greene, Stephanie Manning, Isabelle Phelps and George Mayer. If you’re interested in learning more or becoming part of the conversation drop me a line at julian @ lererhippeau . com or @julianmoncadany.

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