How will Venture Capital be affected by Crypto and ICO? | KoinOK Blog

Before the emergence of ICO as a way for raising startup capital, VC used to be the predominant route. In VC model, startup location matters a lot and a majority of Venture Capital Funds are still concentrated in Silicon Valley in the US.

However, with the emergence of ICOs, the locational advantage has eroded to a great extent because of availability of global pool of investors who just need an internet connection to invest. Unlike VC model where only accredited investors can participate, here even retail investors can get in and infact retail investors have been dominant.

So, if the idea stands out, a crypto startup in Peru can now raise millions of dollars from global investor pool via internet in which maybe one of the investors is a 23 year old young graphic designer from New Zealand who has put in just $200 and another is a senior government official from South Korea who has invested her $2000 worth of capital.

However, apart from ICO turning into a competitive and disruptive force for VC model, a number of traditional VCs have been quick to adapt their approach and have already started allocating a portion of their portfolio into ICOs themselves.

Some of these VCs include Sequoia Capital, Bessemer Ventures, SoftBank, Tencent, Union Square Ventures etc. And more and more are getting in with time.

Why? Because ICOs offer “venture capital fund economics with public market liquidity”. This means that while the economics is same — there would be winners and losers in ICOs but a minority of big winners are enough to compensate for the losses in a majority of losers; additionally here the capital isn’t locked for 7–8 years, rather VCs get public market liquidity when ICO projects get listed on crypto exchanges (usually within a few months of ICO completion), enabling them to exit early or hedge their positions.

Not only this, dedicated crypto-focused funds have also emerged which include Multicoin Capital, Pantera Capital, Polychain Capital, Placeholder, Blocktower Capital, Blockchain Capital, Grayscale Investments etc.

Sizhao Yang (FarmVille Co-founder) had a very interesting perspective to share on this topic on Twitter back in 2017 and we wanted to share it with you all. Please find it below in bullet points:

1. First, we have to see what is the underlying mechanics behind venture capital.
2. Historically, most money for businesses is lent out through relationships, collateral, or a track record of profits.
3. Relationship capital is known as the friends and family round. People who trust you as a person in anticipation of the future. They have a record of your habits and character and “trust” for the payback sometime in the future.
4. This capital runs out fairly quickly (unless you have rich friends) and you have to scale using stranger’s money. The stranger or institution can only lend you money based on your track record of paying it back (credit), existing assets (collateral), or existing profits (DCF).
5. If you don’t have a track record, how do you get capital? The early days of venture capital were funding the ships that would explore the “New World” (North America, South America, India) and an investor would invest in anticipation of future profits from the trade.
6. We now know this as venture capital backing promising technology companies concentrated in tech hubs (SF, Boston, Beijing) and expecting 80% of the companies to go to 0 and one or two companies to go up 100x. This process takes 7 to 10 years to play out to liquidity.
7. So the model is to invest in future revenue 10 years out, future profits 15 years out and then get liquidity through an IPO. Why profits so late? Because these unicorns have to build defensible networks and then profit much later. This is the legalized monopoly business.
8. This model was made profitable by the proliferation of seed capital and the declining cost of software such that there was an explosion and eventually a implosion in early stage financing.
9. What venture capitalist and angel investing do is 4 stages: sourcing, deciding, closing, and helping. The investor has to do all 4 stages and convince you as the entrepreneur that his/her money is better than the other guy.
10. So the reality is that the VC is selling a bundled service that includes: network, advice, experience, and operational help. After the VC sells you then he/she have to squeeze in your deal to justify her fund. The larger the check the better.
11. However, the entrepreneur only wants a certain amount of money due to dilution so he/she will be picky on who to let in and why. It’ll be usually a combination of perceived value from the “bundled” service mentioned previously.
12. As a proportion of time, VCs spend a lot of time on sourcing investments. A lot of a VCs job is to say no. However this changes with crypto.
13. Venture capital is local. Crypto is global. Venture capital reads deck. Crypto reads white papers. Venture capital is illiquid. Crypto reads github code and is always liquid. Venture capital’s rounds are small. Crypto’s rounds are large.
14. What is the implication of this? Well, it means there are a lot more crypto projects and you can always get in if you want, which means developing local relationships matter less than reading and deciding on the right whitepaper.
15. Relationships still matter to get into the private pre-sales or being an advisor, but with regard to getting into the deal in ICO or even after the token has been trading, you always have a chance.
16. Which means the whitepaper reading and building a community or telegram and discord groups is so important and this is why there is a proliferation of them. Exactly to support this function. A decentralized community doing global due diligence.
17. Also because of the liquidity, most crypto funds in this area behave more like crypto hedge funds rather than pure breed buy and hold venture capital investors. So is this a venture capital or a hedge fund model, not clear yet, but it will be a combination of the two for sure.
18. What is the implication of all this? It means: reading whitepapers, building quantitative tools, and reading 24/7 us and asia crypto news from forums, messaging services, and building relationships globally in US/Japan/Korea/China is just the standard modus operandi.
19. The further implication is that the winners will likely not look like the traditional venture capital guys but will be a hybrid. Whether the Two Sigmas, De Shaw, Sequoia, or Benchmark dominate will be unclear, but it will be interesting to see it play out.
20. As tokenization and securitization move toward all aspects of “dry” and “wet” law you will see it consume more and more fundraising services. Not just venture capital, but potentially junk bonds, peer to peer lending, private equity. Impossible?
21. You’re already seeing it out with early signs of prime brokerage use cases subsumed by Tzero and other startups. The tokenization lowers costs enough such that it can facilitate more and more of the joint “finance” and “law” use cases.
22. In conclusion, because crypto affects “law” and “finance” and is “global.” The dynamics will overwhelm a lot of the traditional mechanism of venture capital. A new breed will emerge being a hybrid of quant hedge funds and traditional venture capitalist powered by global messages.