Keeping tabs on performance should be easy for venture capitalists in crypto. The bulk of their bets, if not all of them, are denominated in liquid tokens that can be marked to market at any time.
There’s just one problem: A growing number of VCs are reporting that at least half their portfolio projects are holding back the launch of their tokens, citing fears over price, exchange fees and increasingly aggressive regulation.
Take Spartan Group, one of the more active investors in decentralized finance.
Of the 108 projects that Spartan has backed through its $110 million DeFi fund, less than 40% have listed on exchanges, according to an investment report for the third quarter of 2022 obtained by The Block. Kelvin Koh, managing partner at Spartan Labs, said the fund in question invests in early-stage ventures, and that part of its returns — even for projects that have launched tokens — are unrealized.
It turns out that many crypto VCs are in the same boat.
“Around 60% are yet to launch, and due to FTX exposure around 3% are on life support,” Oliver Blakey, partner and co-founder of Ascensive Assets, said in an email. His firm has made 89 investments across two different funds.
Sitting on the sidelines
Listing a token can be a liquidity event for the founding team and early investors, allowing them to cash out some of their stake or update valuations in their portfolios, a source with experience in both venture investing and market making said. Perhaps more crucially, it also allows a project to build a token economy into its product.
“I would say a lot of tokens got launched early (pre-product) in the bull market because it was [a] marketing and adoption tool, whereas now it’s more of a distraction,” Blakey said. “Projects will wait until the token is an integral part of the project before launching them now.”
White Star Capital is in a similar position. About half of its DeFi portfolio companies are still to launch, said Sep Alavi, a general partner. And Rich Rosenblum, co-founder and president of market maker and venture heavyweight GSR, estimates that the majority of the DeFi and infrastructure investments it made in 2022 have yet to float their tokens.
Even offerings from projects within Outlier Ventures' token ascent program, which is dedicated to startups in the final stretch of a token launch, are paused.
“Most of them are still in this holding pattern because they don't need to launch the network; it would be helpful from a product and technical perspective,” said Jamie Burke, founder and CEO of Outlier Ventures. “They can't delay it indefinitely, but they can wait a little bit longer.”
About 10 projects from Outlier’s token advisory program are planning to launch this year, but they can afford to wait if needed, he added. It currently has 25 projects in the program.
Facing the gale
Appetite for token launches among founders and investors had been dwindling for most of 2022, a year marred by May's failure of the Terra/luna stablecoin ecosystem. Then it came to a screeching halt following the collapse of crypto exchange FTX and its sister trading firm Alameda Research.
The retreat came down to a combination of factors, from a worsening macro environment, which zapped market liquidity, to increased regulatory scrutiny on topics like whether tokens could be viewed as securities.
Pantera Capital’s early-stage token fund was down by about 71% year-to-date in September 2022. The Wall Street Journal reported that Andreessen Horowitz's flagship crypto fund fell by 40% in the first half of the year. In the third quarter, Spartan’s DeFi fund had returned just 4.5% year-to-date, according to the investor documents.
FTX’s collapse in November only exacerbated the existing problems. Since the crisis, many crypto exchanges have moved into a defensive posture, protecting existing liquidity over listing new tokens, said Michal Benedykcinski, a senior vice president at venture firm Arca.
“Many of those venues quite frankly will not take on new listings for the time being, especially the onshore centralized exchanges,” Benedykcinski said.
David Chreng-Messembourg, founding partner of LeadBlock Partners, said exchanges are currently focused on “cash preservation and customer retention” after a painful year.
“Any cash intensive initiatives, including strategic, or marketing campaigns have been paused. New token listing is no exception — most exchanges have paused/delayed for now any token listings they had in their pipeline,” he added.
FTX's demise has also made it harder for startups that do want to launch a token to find a market maker.
“Alameda was the go-to market maker for most projects, so founders now have to make a decision on who they trust, because a lot of them are still to announce they have been, or are close to being, wiped out,” Blakey said.
Even in such grim market conditions, some startups may be forced to list whether they want to or not.
“Being a founder these days, you are dealing with different investor perspectives. Some who are token-only investors are pushing their projects prematurely to launch,” said Paul Hsu, founder and CEO of Decasonic, who is seeing some founders being pressed into launches.
GSR’s Rosenblum, meanwhile, foresees attention on projects who sold investors on the idea that tokens would be a core component.
“I don’t think there was much pressure in the second half, given the one-two punch from luna and FTX, and nor will there be if the market appears to be in liquidation,” he said. “But if the market appears to be healthy, those that get close to the one-year mark are likely to get pressure, as most of them sold their investors on the idea that the token is crucial for optimal operation, so naturally they’ll need to make excuses up if they don’t have a timeline once conditions are favorable.”
A SAFE bet
One of the biggest lessons for Outlier Ventures from this cycle is how much more successful companies with a hybrid structure of both equity and tokens have been at raising money, compared with projects that have focused only on the token side of the business.
An equity raise with a token warrant structure means startups can focus on developing their product-market fit in the short term, parking designing a token economy until later, Outlier's Burke said.
“One-hundred percent at our company token-only deals have different risk parameters,” Decasonic's Hsu concurred. “Equity-only companies have different risk parameters. The most anti-fragile companies are those with SAFE [simple agreement for future equity] plus token warrants.”
The widespread delays to token launches may even prove beneficial for venture firms that have only just started dabbling in crypto, Benedykcinski said.
“A lot of venture capital that has entered the game with the potential liquid token going live, many of those funds are not fully set up to handle and have the internal risk management of an actively traded token out there in the wild,” Benedykcinski said.
Many will welcome delays as they get the proper infrastructure in place, he added.
Disclaimer: Beginning in 2021, Michael McCaffrey, the former CEO and majority owner of The Block, took a series of loans from founder and former FTX and Alameda CEO Sam Bankman-Fried. McCaffrey resigned from the company in December 2022 after failing to disclose those transactions.
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