Author: Suvashree Ghosh, Ryan Weeks, Emily Nicolle, Bloomberg; Translated by: Wuzhu, Golden Finance

News of the detention of Telegram founder Pavel Durov has sent shockwaves through the crypto venture capital world, with some of the sector’s biggest players having invested in digital tokens closely tied to the messaging app.

Pantera Capital Management, Animoca Brands and Mirana Ventures are among more than a dozen firms that have invested in Toncoin, a blockchain used by Telegram to process instant payments, among other things. Pantera, one of the largest crypto venture capital funds, invested more than $100 million in Toncoin earlier this year, people familiar with the matter said.

The funds were lured by a hyped-up cryptocurrency idea: Telegram would become a digital asset “super app” akin to China’s WeChat, with its 900 million users relying on Toncoin for everything from payments to playing blockchain-based games. The token surged fourfold from February to early July, with assets locked on its blockchain, TON, briefly exceeding $1 billion.

But the risks were exposed by Durov’s detention, accused of not doing enough to combat crime on Telegram. Durov was charged Wednesday with participating in the distribution of child pornography and other crimes such as drug trafficking on the app. Telegram said in a statement on Sunday that it complies with European law.

Toncoin plunged about 20% after Durov was arrested outside Paris on Aug. 24, before recovering some of its losses. The total value locked in TON has fallen to $573 million, according to data provider DefiLlama.

The total value of assets locked on the TON network has dropped significantly this year

“Most investors believed that the app itself would clearly facilitate and drive adoption of the Toncoin network, or at least sow the seeds,” said Lasse Clausen, founding partner at crypto venture capital firm 1kx. “Now that we have a black swan event, the company itself and its founders may have some questions about the future.”

Total value locked (TVL) is a metric of how well a blockchain is being used for its intended purpose, whether that’s gaming or decentralized finance applications.

Venture capital investors who poured money into Toncoin — often with agreements not to sell for at least a year — are now trying to assess whether France’s move against Mr. Durov will cause users to flee Telegram, an app that became popular in crypto circles in large part because of a lax regulatory approach that got him into legal trouble.

Pantera called Toncoin its largest investment, but did not disclose the amount. A spokesperson for the Menlo Park, California-based company, which manages nearly $5 billion, did not respond to emails and phone calls seeking comment. The TON Foundation, which manages the blockchain, said in an email that it has never raised funds. Animoca Brands did not comment on its investment, and Mirana Ventures did not immediately respond to inquiries.

Some Toncoin backers saw an opportunity. DWF Labs, a cryptocurrency market maker that invested in the token, spent “millions of dollars” buying Toncoin on the open market after prices crashed over the weekend, said co-founder Eugene Ng.

Token Trading, Liquidity

OTC investments in projects like TON by venture capital firms and other crypto funds are called “token deals” because investors receive tokens rather than traditional equity and are unique to the cryptocurrency space. To conduct these deals, venture capitalists often set up separate vehicles, called liquidity funds, designed to hold assets for shorter periods of time. Because many token deals are conducted bilaterally, there are no reliable estimates of their popularity.

Tokens have several advantages for venture capital firms and their investors, the most obvious being that they tend to involve faster exits. A common structure is for tokens to unlock after 12 months, after which investors can gradually sell them. The volatility of tokens also gives backers more timely information about the progress of a project, Clausen said.

“If you’re a traditional venture investor with equity, the maturity period is about eight to 10 years, so you really have a lot of years where companies are just doing their thing,” he said.

Token sales can also involve deep discounts. Pantera paid 40% below market price for Toncoin at the time, according to a person familiar with the matter, who asked not to be identified because the terms are confidential. At the average price of $6.32 when the deal was announced in May, the investment would still be easily profitable.

Toncoin has reversed some of its gains this year

The person said Pantera has a one-year lockup period, after which it can sell the Toncoin in batches over several years.

The flip side of token investing is that the assets are extremely volatile — when an investment goes bad, it’s immediately apparent. Funds typically mark their holdings to market on a regular basis, meaning big declines show up immediately in reports to limited partners.

Few examples better illustrate this risk than the collapse of Do Kwon’s TerraUSD stablecoin project in May 2022. Just a few months earlier, investors including Three Arrows Capital and Jump Crypto had purchased more than $1 billion of Luna, a token used to stabilize TerraUSD. When TerraUSD collapsed, Luna became worthless. Three Arrows went bankrupt shortly after, setting off a series of failures across the crypto industry.