Traditional venture capital funds drive valuations through multiple funding rounds. Startups aim for initial public offerings or other exits. Then the sharemarket decides upon a more realistic valuation.\u00a0<\/strong><\/p>\n But in cryptoland, tokens introduce market capitalization while a company is being built.<\/p>\n This means there are a lot of competing interests and agendas. Token sales for Web3 startups can be the bastard child of a personality cult leader founder and a bunch of VCs, raised by a group of Discord-dwelling degens manning a DAO, while speculators trade 24\/7 and the media circles.<\/p>\n So, how do founding teams get the balance right between the needs and wants of the VCs and what\u2019s best for the community? Are the interests of VC funds aligned with the interests of token holders?<\/p>\n \u00a0<\/strong><\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n Let\u2019s start with LUNA\u2019s collapse<\/a>. Who did the due diligence? VC funding can have a big impact on whether the community invests or thinks a project is legitimate or not. The stamp of big-name funds carries credibility and traction before retailers can invest.<\/span><\/p>\n Retail investors got rekt when Terra\u2019s algorithmic stablecoin project and ecosystem collapsed in May. The stories of homes and life savings being lost and suicide hotlines being posted on Reddit were alarming. Memes of Squid Games<\/em> and Bernie Maddoff\u2019s 150-year prison sentence were <\/span>mashed up next to Terra founder Do Kwon\u2019s attempt to save the ecosystem with a phoenix-like token called Luna 2.0.<\/span><\/p>\n Perhaps representative of retail investors in general, one retail investor who lost a substantial amount when the algorithmic stablecoin collapsed told me, he \u201cdidn\u2019t really get it but thought it was too big to collapse overnight.\u201d<\/span>\u00a0<\/span><\/p>\n On the other hand, some funds that<\/span> trade<\/span> complex financial products for a living made a killing.<\/span><\/p>\n Who did the due diligence? Who said pegging two related coins via complex math was a good idea? Most were just plain confused.<\/span><\/p>\n One very senior risk analyst at a crypto VC fund told me he held grave reservations regarding the \u201calgorithm stablecoin.\u201d But his team was assuaged by the cap table having some big names in crypto capital.<\/span><\/p>\n And he actually read LUNA\u2019s filings from the United States Securities and Exchange Commission.<\/span><\/p>\n VCs look at cap tables and see who else invested. LUNA was widely considered a \u201cblue chip\u201d by then, leading among crypto analysts and then reputable institutions, such as Three Arrows Capital, Pantera Capital, and Coinbase Ventures. Pantera notably got its LUNA exit timing right, while Three Arrows Capital is in liquidation and has filed for bankruptcy.<\/span><\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n Three Arrows Capital bought 10.9M locked LUNA for $559.6m \u2013 it’s now worth $670.45.<\/p>\n Ouch<\/p>\n \u2014 Crypto Maxi (@cryptoMaxi420) June 14, 2022<\/a><\/p>\n<\/blockquote>\n \u00a0<\/p>\n \u00a0<\/p>\n Everyone wants to be the smartest guy in the room. \u201cWith the LUNA example, VC backers must be seeing something you don\u2019t, was the thought,\u201d according to that risk analyst.<\/span><\/p>\n \u201cIt always was a Ponzi, no point mincing words,\u201d he tells Magazine.<\/span><\/p>\n He argues that \u201cVCs can distort everything, even in who supports what L1 chains. It\u2019s a PR war; VCs turbocharge the machine. I call it the VC hunger games.\u201d<\/span><\/p>\n This is one high-profile example of the perils of VC funding for crypto communities.<\/span><\/p>\n There is a difference between VCs and the retail investor community, and Web3 blurs the lines. Traditional VC fund managers often push for large capital deployment, a board seat, rapid growth and expedited exits. But Web3 VCs are often early investors who first engage as active community members, providing liquidity and governance to build out a project.<\/span><\/p>\n \u201cCommunity\u201d itself is a vexed concept, as participants can literally \u201csell out,\u201d and institutions are part of the community too, having been involved from early on. Ethereum had 3,000-odd participants, a mix of individuals and institutions.<\/span><\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n First, we need to understand who VCs are and where they come from, which will help us understand the dilemma of building an organic Web3 community.<\/span><\/p>\n The first crypto native funds emerged from investors who got lucky and made a killing on early crypto projects and were suddenly flush with cash. Many had worked on exchanges in the early days and, consequently, were on first-name terms with every token project that tried to get listed. So, they know pretty much everyone in the ecosystem and usually get the first bite at the early funding rounds of any decent project trying to raise capital.<\/span><\/p>\n Coinbase<\/span>, Ethereum, Consensys and others produced some extremely wealthy individuals who went on to become investors in many projects. Some launched<\/span> their own<\/span> VC funds or firms, while others have stayed low-key to investing. But<\/span> they all know each other<\/span>, so they can get early access to deals.\u00a0<\/span><\/p>\n Many exchanges also established incubators or accelerators, such as Binance Labs and Huobi, that incubate super early projects and take a percentage of tokens for funding. They can leverage their network for funding and promises of support, such as listing on their exchanges and social media help.\u00a0<\/span><\/p>\n More recently, individuals have pooled capital to become institutional investors \u2014 e.g., coordinated capital investing through investment DAOs. Legally pooled funds management and taxation laws generally lead to these conversations around creating a DAO and\/or legal investment vehicle structure.\u00a0<\/span><\/p>\n So, Web3 VC firms now include a spectrum from 20-something degens who have established their own funds, <\/span>electricians mining Bitcoin since 2013 to Softbank.\u00a0 <\/span> \u201cWhat do we even mean by community versus a VC firm? People love a villain and hate the man, but at the end of the day, they are all just people. VC in Web3 is a messy, amorphous concept in Web3. Is a group of 20-year-olds with a website an entity, a VC firm, or is that just a bunch of 20-year-olds? VCs also could just be a few whales.\u201d<\/p>\n Yet, there is always a trade-off between an organic community and exit horizons when dealing with tradable liquid tokens.\u00a0<\/span><\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n wild chart pic.twitter.com\/g0xbkWjgCy<\/a><\/p>\n \u2014 Turner Novak 🍌🧢 (@TurnerNovak) June 7, 2022<\/a><\/p>\n<\/blockquote>\n \u00a0<\/p>\n \u00a0<\/p>\n As liquidity is a key aspect of crypto investing, exit time preferences constantly vary compared to traditional VC investments. Liquidity refers to the ease with which an asset or security can be converted into cash at market price.<\/span><\/p>\n One of the clearest ways in which VC interests collide with the community\u2019s is in token lockups.<\/span><\/p>\n VCs often buy a huge chunk of tokens at an early stage at a very low price, and these tokens are often time-locked, so they can\u2019t be sold for one or two years. When the time is up, VCs face the dilemma of dumping their tokens \u2014 which makes them a fortune but tanks the price of the community\u2019s holdings \u2014 or hanging on. Typically, VCs are perceived to choose the former.<\/span> \u201cI wish they could rank VC firms by whether they engaged in quick flips \u2014 so founders are aware if they are really dealing with a VC or more of a hedge fund.\u201d\u00a0<\/span><\/p>\n<\/blockquote>\n The capital cycle is different in Web3 compared to traditional VC. Bear and bull cycles also mean that cash preservation can distort investor markets. Exits may need to be expedited in a bear market.<\/span><\/p>\n VCs may face conflicts between their own cash position and helping an invested company. Web3 lock-ups of a year or so, for example, are famously shorter than in the traditional VC realm, of, say, seven years.\u00a0<\/span><\/p>\n \u00a0<\/span><\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n Staking (especially in a bull market) may attract VC funding away from riskier seed VC plays. Staking a retail investment once a token lists on a retail exchange can provide better cash returns than a \u201ccheap\u201d seed deal pre-token launch, locked up for 12 months, that tanks when it lists as a token.\u00a0 Crypto VC firms invest at various stages and, at times, act like crypto hedge funds. <\/span>Venture capital invests in startups to accelerate their growth and generate high returns for investors. Hedge funds traditionally invest in a variety of investments, ranging from stocks, bonds, commodities and currencies using complex structures and leveraging in order to boost returns more rapidly.<\/span><\/p>\n David Mack, managing director of Koji Capital, tells Magazine, it\u2019s a <\/span>continuum:\u00a0<\/span><\/p>\n \u201cCrypto VCs are effectively hybrids: When teams are raising seed capital to get resourced to deliver a product, our approach is the same as most venture investors. However, when we realize our investment and hold liquid crypto assets, we start to resemble a hedge fund, often using that liquidity to support the early product we invested in.\u201d<\/span><\/p>\n<\/blockquote>\n \u201cThis kind of approach is an emergent feature of crypto-focused firms, and founders are really in search of this capability when selecting their investors,\u201d says Mack.<\/span><\/p>\n If assets are tokenized and liquid, then VCs become hedge funds in the long run. A shift to tokenization, from passive to active assets, is more like hedge fund activities. This can create enduring conflict.<\/span><\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n \u201cThere is a massive conflict between VC liquidity and long-term community building,\u201d opines <\/span>Jonathan Allen, who started his first VC fund out of college. He now runs<\/span> Mirana Ventures<\/span>, is a core contributor to<\/span> BitDAO<\/span>,<\/span> zkDAO and<\/span>\u00a0eduDAO,<\/span> and sits on the<\/span> PleasrDAO<\/span> board.\u00a0<\/span><\/p>\n Liquidity allows VCs to think about short-term profits in conflict with communities building for the long term.<\/span><\/p>\n \u201cLiquidity raises a bunch of new issues. Quality communities mean people who are there for the long haul. We have barely scratched the surface of a healthy community that incentivises better community members,\u201d argues Allen.<\/span><\/p>\n Allen was also a U.S. Army <\/span>Explosive Ordnance Disposal (EOD) <\/span>Technician (bomb disarmer) who got into crypto after an injury suffered in Afghanistan in 2012. T<\/span>he EOD motto is perhaps suited to being a crypto VC, too: \u201cInitial success or total failure.\u201d\u00a0<\/span><\/p>\n He argues that crypto VC has \u201cevolved over cycles \u2014 with increasing community exposure and less VC funding now favored.\u201d <\/span>The alternative is fair distributions of tokens to the most active community members and project users to ensure the most valuable people to the project are motivated by the correct incentives.\u00a0<\/span><\/p>\n \u201cWe don\u2019t want a lot of VCs to own a lot of tokens. A lot of VC funds are maybe not as helpful as individuals or communities. We often advise our portfolio companies to save 30% for angels. Individuals who we feel need to, and can be, more helpful.\u201d<\/p>\n<\/blockquote>\n Angels are typically the investors who first write a small cheque in return for equity when the company is at a very early stage and the company\u2019s valuation is still low.\u00a0<\/span><\/p>\n While the exit cycles in crypto are a key difference from traditional VC, founders can also determine the lock-ups so good-faith investors cannot dump their profits.<\/span><\/p>\n Nonetheless, for Allen, community building is key. \u201cWith a lot of invested projects, we let the code stand for itself,\u201d he says. \u201cIt\u2019s about building authentic community missionaries versus mercenaries \u2014 first movers at scale. VC funding in the form of blitzscaling can grow the wrong kind of community.\u201d<\/span><\/p>\n \u201cToo often, people are free riders \u2014 they hold tokens and don\u2019t do anything.\u201d<\/span><\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n While there\u2019s certainly an increasing hostility to VCs in the industry, some founders reject this angst.\u00a0<\/span><\/p>\n Josh Tobkin dropped out of a large economics scholarship to play professional poker and \u201clearned to think in probabilities.\u201d By the last crypto winter of 2018, he had founded Unity Chain, a crypto lab in Taiwan. He has some well-known investors, including FTX, United Overseas Bank, Coinbase and Razer.<\/span><\/p>\n He is now working on a novel blockchain consensus algorithm: the creation of an intralayer that bridges all layer 1s, layer 2s and decentralized apps across all ecosystems.<\/span> \u201cA more secure infrastructure to prevent instances like the Ronin Bridge hack or the liveness faults of Solana.\u201d His current project, <\/span>SupraOracles<\/span>, plans to have a token, with the infrastructure launching soon.\u00a0<\/span><\/p>\n He believes a VC lead investor adds great value, as the \u201ccomplication is taking a check from everyone. VCs make it much easier to close deals both with other investors as well as social proofing for large corporate partners.\u201d<\/span><\/p>\n Tobkin tells Magazine, \u201cDecentralized retail raises are great, but it helps to find (VC) funds who are passionate about your project when it aids their entire portfolio. Projects need a mixture of both types of funding for their growth whilst balancing decentralization.\u201d<\/span><\/p>\n \u201cNever go full VC, and never go full retail.\u201d<\/p>\n<\/blockquote>\n Tobkin says VCs played an important role in SupraOracles: \u201cVCs were necessary to get started. The cap table [table of investors] amounts are very balanced. We didn\u2019t oversell. 1% max for each investor on strict vesting terms.\u201d <\/span>Vesting refers to when equity can be cashed out.<\/span><\/p>\n Tobkin also values the Web2 introductions that more traditional VCs can offer. <\/span> \u201cWith one integration, we\u2019re bridging Web2 to Web3 and vice versa. We have VCs to thank for it.\u201d<\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n Are you a traditional VC who wants to enter into Crypto VC? or a founder who wants to study thought patterns of VCs?<\/p>\n Here are 14 great threads on Crypto VC that will explain you the whole crypto VC landscape and what daily life looks like as a crypto VC 🧵 \u2193<\/p>\n + some alpha..<\/p>\n \u2014 Meet Barvadiya (@meetbarvadiya) June 19, 2022<\/a><\/p>\n<\/blockquote>\n \u00a0<\/p>\n \u00a0<\/p>\n Tara Fung i<\/span>s another Web3 founder grateful for VCs. She is a<\/span> Harvard graduate who \u201ctransitioned to tech with <\/span>finance skills <\/span>and a general curiosity.\u201d<\/span>\u00a0A former chief revenue officer at two \u201ccentralized\u201d fintechs, she \u201cwanted to build on the new frontier.\u201d Her startup, <\/span>Co:Create,<\/span> seeks to help successful NFT projects scale.<\/span><\/p>\n Becoming a founder in 2022, she received $25 million in VC funding led by a16z. Her \u201cthinking was that the resources would help us deliver faster, and I could focus on building (as I was) feeling like this would be a rocky year.\u201d\u00a0<\/span><\/p>\n A16z <\/span>closed a $4.5-billion crypto fund<\/span><\/a> in May 2022 despite treacherous market conditions. <\/span>She met a16z partner Chris Dixon four times before meeting the other partners. She notes there\u2019s \u201cnot a ton of diligence at seed. It\u2019s a diverse cap table, and obviously, the fundraising timeline sped up due to a16z\u2019s participation.\u201d She also hand-selected Web3 native angels to be included on the cap table.\u00a0<\/span><\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n She highly values that \u201ca16z has an in-house research team that I can go to with a problem, such as best practice for tokenomic design.\u201d That\u2019s a huge value add. Tokenomic design is an emerging, complex and sometimes arbitrary science. <\/span><\/p>\n This is an important theme. How the companies are structured early on has important ramifications. \u201cWhat we do now can set us up for success \u2014 VCs offer a level of professionalism.\u201d\u00a0<\/span><\/p>\n \u201cToken sales too early can be a double-edged sword.\u201d Fung explains that one challenging aspect of building in Web3 is that founders must \u201cbuild publicly, not behind closed doors.\u201d<\/span><\/p>\n When and if to form a DAO is now another vexed question alongside \u201cwen\u201d to have a token sale?\u00a0<\/span><\/p>\n \u201cDAOs offer great promise, but what does the timeline look like? You have to be thoughtful and create clarity at the start and let the community evolve.\u201d\u00a0<\/span><\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n Lurie<\/span>, founder <\/span>of <\/span>Shipyard Software<\/span>, <\/span>agrees that VCs can work hand in hand with decentralized governance and bring major benefits to the community.<\/span> He argues that in crypto, it\u2019s \u201cnecessary to decentralize governance because the community demands it. It is also a necessity to make the VC model work.<\/span>\u201d VC funding is a competitive and a regulatory necessity to building a viable company, argues Lurie.<\/span><\/p>\n \u201cTo me, a defining characteristic of a VC firm is that it steps up to ensure investor protections and good governance,\u201d says Lurie.\u00a0<\/span><\/p>\n Lurie started out at VC Bessemer Venture Partners, and he has seen both sides of the VC spectrum, raising several VC rounds, \u201csome hard, some easy,\u201d for his startups. This includes an early NFT protocol ICO in 2017.<\/span><\/p>\n \u201cDecentralized governance is a trade-off with nimbleness. It\u2019s tough to start a fully decentralized company from day one. You need to strike a balance. Startups are in a constant battle, and few people make it to the end of that journey.\u201d\u00a0<\/span><\/p>\n \u201cOne of the best reasons for VC-backing is governance \u2014 a partner on a deal will hold founders accountable,\u201d he says.\u00a0<\/span><\/p>\n We\u2019ve noted how a VC\u2019s interests can work against those of the community, but sometimes, the community can work against the interests of VCs. And communities can vote in a way that totally disregards the law or their obligations.<\/span> In mid-June, <\/span>Merit Circle DAO<\/span>, a gaming DAO, voted to return the investment of a major play-to-earn guild turned early-stage investor Yield Guild Games (YGG)<\/span> instead of paying out the 30x return it was owed.<\/span><\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n It’s sort of funny how deeply this whole web3 thing set the hook with VCs.<\/p>\n They’re squirming a little bit now \u2014 lashing out at skeptics in a way usually reserved for CEOs of fraudulent companies.<\/p>\n How did we get here? \u2014 Travis.web1 (@coloradotravis) June 7, 2022<\/a><\/p>\n<\/blockquote>\n \u00a0<\/p>\n \u00a0<\/p>\n What will this mean for VC investing in DAOs in the future if the community can simply overturn a contractual agreement with a vote? Who\u2019d stump up the funds in the first place?<\/span><\/p>\n As it happened, a reasonable deal was hammered out whereby YGG got a 10x return instantly, with no more vesting or risk of a lowered valuation. But it highlights that there are perils, too, for VC investors with the evolving and sometimes flaky nature of crypto communities.\u00a0<\/span><\/p>\n \u00a0<\/p>\n \u00a0<\/p>\n If a DAO successfully renegs on a SAFT, it will embolden other DAOs to do the same resulting in greater levels of politics and a chilling effect on future investments into DAOs.<\/p>\n \u2014 Galois Capital (@Galois_Capital) May 26, 2022<\/a><\/p>\n<\/blockquote>\n![\"VC](\"https:\/\/cointelegraph.com\/magazine\/wp-content\/uploads\/2022\/07\/magazine-Perils-of-VC-funding-for-crypto-community-building-1024x576.jpg\")
Even VCs were LUNAtics<\/h4>\n
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What is a crypto VC anyway?<\/h4>\n
![](\"https:\/\/pbs.twimg.com\/media\/FSdx3kcUUAAbcBt.png\")
<\/span>
<\/span>Mark Lurie, <\/span>a VC turned Web3 founder, <\/span>says:<\/span><\/p>\n\n
Crypto VC firm to a hedge fund is a continuum<\/h4>\n
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<\/span>Lurie thinks the crypto community should create VC review systems for better community building. \u201cThe community is aware of the quick flip. On-chain vesting is the only thing holding VCs to that vesting schedule,\u201d he says.<\/span><\/p>\n\n
![\"a16z\"](\"https:\/\/cointelegraph.com\/magazine\/wp-content\/uploads\/2022\/07\/a16z-twitter.jpg\")
<\/span><\/p>\n\n
![\"VC\"](\"https:\/\/cointelegraph.com\/magazine\/wp-content\/uploads\/2022\/07\/vc2.jpg\")
Liquidity vs. long-term community building<\/h4>\n
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VCs add investor network effects and tokenomics advice<\/h4>\n
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<\/span>\u201cCrucially, the leads for our rounds have worked for it. They have a massive list of traditional Web2 in need of our exact solution, and they are making introductions. They sell for us \u2014 it\u2019s a win-win. Retail generally can\u2019t do that unfortunately.\u201d<\/span><\/p>\n\n
Wen token sale?<\/h4>\n
![\"Building\"](\"https:\/\/cointelegraph.com\/magazine\/wp-content\/uploads\/2022\/07\/vc3-1024x682.jpg\")
Investor protections<\/h4>\n
Are faceless DAOs not accountable to investors?<\/h4>\n
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1\/https:\/\/t.co\/Tj3OtUUl3J<\/a><\/p>\n\n