In my first article, I’ll write about three counterintuitive lessons I’ve learned over the past few years as a cryptocurrency VC. In the future I will cover more hot topics, such as politics, in my articles.
Portfolio construction is more important than picking the right target
This lesson is the most counter-intuitive, but it’s actually quite simple from a data perspective: if you only invest 0.5% of your money in something that’s 100x return, you’re not going to get your money back . Since VC returns follow a power-law distribution, 100x winners are uncommon, so every time you come across one, you have to make that investment more valuable. Concentrated investing > Prayer-style diversification .
A VC collects a bunch of pretty logos on the portfolio page of their fund website, that doesn’t mean their returns are really good looking, but that’s what portfolio construction is all about, and that’s why I’m on $400 million+ Funds are still getting confused by writing seed checks.
Some believe that small initial investments are for “shooting” opportunities and are prepared to massively double down on winners in subsequent rounds. But what actually happens is that in the later stages, the bigger foundations come in with a stronger stance and get almost all of the shares (ie, the later you invest, the zero-sum chance) Also, if you’re not the seed The main investor in the round, you will most likely not get your share in proportion, and the ownership will be diluted a lot (I have seen an example of 90%).
If you take this lesson to its logical limit (i.e. picking the right company doesn’t matter at all), then the optimal portfolio structure is to put 100% of your USD in ETH – this is called beta investing.
But let’s be honest, one of the darkest secrets in crypto VC investing is that at the beginning of the last cycle, most funds didn’t outperform DCA (Dollar Cost Averaging, also known as ETH). called the fixed-term fixed investment method).
Assuming a reasonable cost base for ETH of $200, if you invested in ETH at USD cost between 2018 and 2020, your fund TVPI (fund return multiple) would be 15x today.
As a counterexample, many will point to a well-known study done by AngelList, which showed that, on average, foundations that invest more have better returns . But I think cryptocurrencies are different. Because equivalent benchmark returns in the open market (eg DCA into ETH) are already high, you need to focus on asymmetric returns to have a chance of outperforming most.
Otherwise, over time, the average return on cryptocurrency VCs will be lower than just buying ETH. In the long run, it is very difficult to outperform the performance of ETH.
So with every new investment you should be thinking ” Will this exceed my ETH bags, will it pay for itself? ” and make a high confidence investment.
Before product-market fit, there was little correlation between the “hotness” of a funding round and the final outcome
When you look at who the biggest winners have been in the past cycle, you’ll see that they’re hardly seed round hits.
- DeFi : Uniswap may have been a hot spot in the market at one point, but Aave, back in the days when it was called ETHLend, was available to any retail investor for pennies on the open market. In fact, all Ethereum DeFi wasn’t attractive enough to invest in until DeFi Summer happened (and the new BitMEX competitor was the super hot spot).
- NFTs : SuperRare Cryptoart is still in a completely ignored situation when DeFi is hot with Degen yields of liquidity mining. The floor price of XCOPY and Pak pieces is still in single ETH.
- L1s : Ironically, Solana was one of the only “VC chains” and wasn’t a hot deal at the time (unlike Dfinity, Oasis, Algorand, ThunderToken, NEAR, etc.), but now it’s the top performer of Alt L1 investments.
This is why the control over valuation at the seed stage is very tight. I see more and more VCs going into seed rounds for products with valuations between $60 million and $100 million . The only reasonable exception I can think of is L1s, due to their high TAM (Total Addressable Market Available Market) cap. But beyond that, you can even buy some publicly traded tokens with potential but cheaper FDV (fully diluted valuation) for cheaper than those product seed rounds.
After product-market fit, however, the opposite is true: the best investments are those that are the clearest winners. This is because humans naturally have a hard time internalizing the feeling of exponential growth – we tend to underestimate how much the winner can really win and become a monopoly.
OpenSea’s pre-Series A valuation of $100 million seemed high at the time, but given how fast their deal volume was growing, it quickly turned into a cheap value proposition.
This is a good example of dialectics (extremely opposed truths). The best venture-return investments are either cheap ex-PE firms or expensive post-PE firms, no difference between the two.
It’s hard to pick a winner in the crowded space of trending narratives
One trend I’ve seen over the past year is that Web2 founders tend to build those Web3 narratives that are the hottest, and the most crowded spaces.
Many VCs point out that this is a sign of great talent entering the crypto space, but I think it’s more of a good school talent coming into the space, not necessarily a good founder-to-market fit.
Cryptocurrencies can be different from other industries, and historically, almost all of the most successful cryptocurrency projects were founded by people who didn’t have Ivy League/Silicon Valley ancestry.
I have some concerns about investing with obvious ideas:
- These ideas appeal to mercenary founders who are mercenary. These founders are good at replicating what has been successful (eg Ethereum DeFi to other L1 chains, existing web2 SaaS products for web3 DAOs) and aggressively market their products. But inevitably, as cryptocurrencies rotate to the next hot narrative, founders will shrink in size. For example, we are now seeing this situation where Ethereum DeFi tokens are down 70-80% from their all-time highs and DeFi on other chains becomes the new hot narrative. Among the Ethereum DeFi projects launched at DeFi Summer 2020, the mercenary founders who are mercenary have turned to angel investing, while the missionary founders have a product vision and continue to build and innovate.
- A good way to gauge mercenary versus missionary founders is to walk through the thought maze with them — just to see if the founders can talk about all the ways they’ve done before and the better way they’re doing it now. If a VC firm knows a lot more about a field than the founders, that’s a red flag.
- These ideas are highly competitive. Picking a winner is even harder when there are a dozen projects trying to build the same thing (like the Solana loan agreement). Each category remains largely a winner-take-all or duopoly-take-all business. If you take a concentrated approach (as per point 1 above), you cannot pray prayerfully diversify against its competitors due to conflicts of interest.
- These ideas have high pre-product valuations. what i see nowThe lowest valuation to the X chain is the first 40-60 million US dollars of the product, sometimes reaching 1-200 million US dollars. This risk/reward might be fine for traders looking for everything from a quick pre-sale to a token launch, but not for VCs looking for asymmetric investment returns.
I can’t give a complete conclusion, so I’ll end this post with a hot topic. Funds that show their paper returns to LPs to raise large funds will all underperform ETH once their paper returns are realized.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/1confirmation-partner-three-counterintuitive-lessons-from-crypto-vc-investing/
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