Crypto startups are becoming VCs. Their backers are not amused

Launching a venture capital arm is a kind of rite of passage for technology firms, and crypto has been no exception. Just as Microsoft and Google have venture capital arms, so too do the big beasts of crypto, like Coinbase and FTX.  

What’s unusual about crypto firms dabbling in venture capital is that some have started doing so at a much earlier stage in their own development. 

And now the real venture capitalists — the ones for whom investing is a day job — are growing concerned. So how early is too early for a firm to start investing? 

Everyone’s a VC 

In early July, privacy startup Mask Network announced the launch of a new venture capital arm named Bonfire Union, for which it had raised $42 million. Mask Network reportedly took inspiration for launching Bonfire Union from Tencent, the Chinese tech giant whose investment exploits have seen it referred to as the “SoftBank of China.”

But Mask Network is no SoftBank. The Japanese conglomerate’s Vision Funds have ploughed hundreds of billions of dollars into tech startups in recent years. Mask Network only launched in July 2019. In February this year, it raised $3 million from well-known venture capitalists such as Digital Currency Group and Animoca Brands — four months after bagging $2 million in a round led by HashKey. Binance and Alameda Research are also backers. 

CyberConnect, the web3 data startup, raised $15 million in a Series A round in May. The Palo Alto-based company then participated as an investor in Particle Network’s $1.5m seed round earlier in May, and in Project Twelve’s $8 million raise in June. CyberConnect only launched its own social networking platform Link3 on July 19. 

Then there’s Biconomy, the software development firm for decentralized apps that raised around $9 million from venture investors in July 2021, followed by another $11.5 million through a token sale. The startup then participated in DeFi startup Pillow’s $3m seed round in February this year. 

The list goes on and on. 

Oliver Blakey, managing partner at Ascensive Assets, said this approach implies that a startup is focused on the wrong things. “If you raise money as a startup to build a company, and then a month after you’re using that money to invest into other projects, you’re just a gambler,” he said. “You’re not focused on actually building a product for the company, you’re just trying to benefit financially from the hype of the cycle.” 

Blakely says his team is finding that numerous projects invested large amounts of their money during the bull market. “And we’re now finding a lot of those companies or projects are like, ‘Holy shit, what are going to do now? We’ve invested all the money we raised, and don’t have any money to pay salaries.’”   

The nature of crypto venture capital, much of which takes the form of token purchases, incentivizes crypto startups to invest when prices are going up, said Marc Weinstein, head of platform at Mechanism Capital. Partnerships forged through investment often drive token prices more than product launches.  

“We recommend that founders focus on their product, ignore token price and trust that when product market fit is found, the market will adjust to the fundamental improvement, especially as more sophisticated investors are able to invest directly in tokens,” Weinstein added.  

FTX Ventures’ lead Amy Wu has seen some portfolio companies get into investing, but doesn’t necessarily see that as a problem. “The teams who venture invest effectively typically use it as a tool for business development and often has someone focused on it,” she said. “Teams get into trouble when it materially impacts cash runway or when it distracts from the core business.”

CyberConnect, Mask Network and Biconomy were contacted for comment, but did not respond by press time. 

A matter of timing 

Still, there is an important distinction to be drawn between crypto founders making personal investments, which, according to multiple venture capitalists, is less of an issue. Indeed, angel investing is seen by one venture capitalist as a route to creating “a cabal” around a given protocol.  

There are countless examples of high-profile crypto founders going on to invest in earlier-stage startups. But some get into the venture capital game earlier — and more wholeheartedly — than others.  

Decentralized cloud storage startup Cere Network raised $31 million from investors including Polygon and Republic, the investment platform, in September 2021. Before that, it had raised $5 million from the likes of Binance Labs and Arrington XRP Capital. Cere’s mainnet only launched in May this year. Yet since November 2021, Cere co-founder Kenzi Wang has been working on a venture capital fund named Hyperedge Capital that has backed a dozen web3 projects, according to his LinkedIn profile. He is listed as a partner at Hyperedge on the company’s website.  

Wang told The Block that he and Sandeep Nailwal, a co-founder of Polygon, launched the fund together because, in Wang’s view, most venture investors in crypto today are either run by “web2” founders or traditional finance executives.  

“There’s not really a native web3 founder led fund,” said Wang. “That’s one of the main reasons we wanted to create a fund — to be super founder friendly and for the purposes of building up a founder network.” He said both he and Nailwal believe Hyperedge will provide opportunities to “fund companies that might have integrations” with their respective companies, helping to grow those ecosystems.  

Whether the subject is angel investing, becoming a partner at a separate fund or investing through a corporate vehicle, the question that underlies this trend is simple: when is the right time for early-stage founders and startups to turn investor?  

Few batted an eyelid at Crypto.com’s decision to launch what is now a $500 million venture capital fund — it began at $200 million — in March 2021. Blockdaemon and BlockFi are another two later-stage firms that have started venture investing recently, but that are unlikely to raise eyebrows (the latter’s present liquidity struggles notwithstanding).  

“There are a number of corporate VCs that have been very successful, there are many that ended up spinning out,” said Oksana Tiedt, head of funds and co-investment at Lennertz & Co, a fund of funds. “I think the trend is absolutely fitting to the blockchain ecosystem as it creates a closed loop of creativity and growth.” 

But how soon is too soon? Is Nansen, the Singapore-based analytics startup founded in 2020, at the appropriate point in its development to start investing? The company closed a $75 million Series B round in December last year, with backing coming from blue-chip investors such as Accel, Tiger Global and a16z. Since then, it made two of its own investments in ZeroDrop and APY Finance in April and May, respectively, as well as acquiring ApeBoard in May.  

“I wouldn’t characterise this as venture capital investing,” said Alex Svanevik, Nansen’s CEO. “The investments are made to take us closer to the vision of the information super-app of web3.” 

The closer Nansen gets to that vision, the less such qualifying statements about its investments will be necessary.