Author: Jademont, CEO of Waterdrip Capital

There has been a lot of discussion recently around the role of venture capital (VC) in the cryptocurrency space. On the one hand, there has been a lot of criticism from the community about so-called “VC coins”, and on the other hand, there have been a lot of reports about VCs defending their rights and shutting down. In fact, the elimination rate in the VC industry has always been high, and this is not a recent phenomenon.

A joke: VCs in the ICO boom

Let's start with a joke. In 2018, Mars Finance held a contributor conference in Chongqing to award industry practitioners, and almost all participants received awards. At that time, there was an award for "Excellent Token Fund", and the top 40 were selected, but there was almost no room for all the winners on the podium. Why are there so many winners? Because 2017 was the ICO boom and the first year of VC in the currency circle. At that time, the number of VCs in Shanghai exceeded 100, and the establishment threshold was extremely low. As long as there was an offshore entity that could sign and seal and remit money, it could call itself a Token Fund. There may be hundreds of VCs nationwide. In this case, it is not bad to squeeze into the top 40, and our fund is an ordinary one among them. When we moved to the office in 2022, we saw the award information of that year and unexpectedly found that we had changed from the top 40 in the list to the top 10. This is by no means a self-satisfaction, but because more than 30 VCs are no longer active. I estimate that if we persist for a few more years, we may be able to enter the top 5. Of course, new institutions continue to emerge in the industry, but every time I see the list of winners, I can feel the cruelty of the industry.

Community Misunderstandings about VC

In fact, retail investors have many misunderstandings about VCs, and their evaluations of VCs are often polarized. On the one hand, when the community sees that VCs are involved in popular projects, they often think that cryptocurrency VCs are very profitable. But in fact, VCs still have many failed projects that are not noticed by the market at all. It is precisely because of such a high failure rate that individual projects must have high profit expectations. Often when project founders come to me for financing, they will say, "My project is very stable and will not lose money. At most, I will make less money." I will always reply: "I will not invest in projects that guarantee capital. You have to convince me that this project can help me make 10 times the money. If it can't make money, it will be completely zero. If the founder does not have a lofty goal, it is meaningless to find VC financing. You can live by slowly doing business and making a little money."

On the other hand, when the community sees that VC has invested in a failed project, it will criticize VC and the project owner for “squeezing leeks” together, but forget that VC is also a victim and may even lose more than retail investors.

How to evaluate whether a VC is good

To evaluate whether a VC is good or not, I think both criteria are indispensable.

The first criterion is of course performance. VC is not a charity, and the interests of LPs (limited partners) are the first priority. There are several large and well-known funds in the industry, but their performance is actually very average. I personally don’t like this kind of fund. Recently, a parent fund approached us to discuss cooperation, saying that they had previously invested in ten US cryptocurrency VCs and found that the worst performance was the "letter plus number" fund, while the best performance was a small fund with only 20 to 30 million US dollars. This is completely contrary to the intuitive feelings of most people, so don’t be superstitious about the nonsense that "you can rush in if a big institution stands on your platform."

The second criterion is to look at the best projects that VC has invested in and have a greater impact on the project party, without competing on performance, whether there are technological innovations, and whether they have a promoting effect on the industry. In other words, whether the VC has contributed to the industry through investment projects. An institution that only invested in a bunch of empty projects to help LPs make money cannot be called excellent. And an institution that invested in a bunch of seemingly star projects, but entered at a high valuation in a later round and did not provide any substantial help to the projects, can hardly be called excellent. The latter is what many wealthy institutions with Web2 backgrounds often do in the past two years.

Challenges facing Crypto VC

The community’s criticism is not without reason. One of the biggest problems at present is that the projects pushed to the market by some wealthy institutions are overvalued. In the ICO era, it is easy for retail investors to make money because they have the same entry opportunities as institutions. What everyone competes on is courage and cognition, rather than relying on connections and the ability to organize a game.

Take an ordinary "star project" listed on Binance as an example. First, there is a 10 million round of friends and family rounds, and a 30-50 million round of seed rounds. If there are large overseas institutions involved, the next round will jump directly to 300-500 million US dollars. Then we start to negotiate with exchanges. After negotiating with Binance, there will be a pre-list round of more than 1 billion US dollars. When the market opens, the market value is 30 to 50 billion or even 10 to 20 billion. Only at this price can retail investors have the opportunity to buy. But how much room for growth is left at this time? There is a lot of room for decline. In the long run, it is no wonder that retail investors are reluctant to follow up. In the past two years, we have rejected many star project financing requests of hundreds of millions of dollars or even higher. On the one hand, it is because of limited funds, and on the other hand, we do feel that these projects are not worth such a high price before they are launched and prove themselves.

I suggest that the top exchanges should set up a price limit mechanism within a certain period of time after the Token is launched, so that trading can only be done within a certain price (such as the price of the last round of financing) when the market opens, which can not only allow institutions to sell reasonably, but also prevent the price from being too high to hurt retail investors. Or simply return to the ICO era and let institutions treat themselves as large retail investors. The currently popular community fair sale is a variant of ICO.

Another challenge is that as the industry matures, almost all tracks are occupied by giants. Before a new narrative emerges, the previous investment method of throwing money and letting the project party fend for itself may become ineffective. Now VCs and project parties are required to start a business together. On the one hand, the rights and obligations are more clear, and there are more constraints on the project party; on the other hand, the project party can use more resources from VCs. In other words, VCs also need to take a professional route. The VCs of the past, who were one person and one brand, may only be able to do angel investment.

Finally, I hope that as the cryptocurrency industry develops, VC will no longer be needed, just as I have always hoped that there will be no CEX (centralized exchanges) in the industry. A more decentralized world is what everyone should pursue.