At the beginning of the year, we saw the insatiable appetite of the cryptocurrency and blockchain space from new investors all over the world hitting a near $800 billion market cap. Now in the second half of 2018, the industry has seen a significant pullback to the tune of $200 billion, yet the underlying blockchain technology has nevertheless caught the attention from nearly every Fortune 500 company.
The beginning of 2018 started out strong for initial coin offerings (ICO’s), and the general sentiment around investing in distributed ledger technologies, to the point that individuals were questioning how long traditional venture capital could survive. Seemingly overnight, we saw ICO’s and crypto backing funds hold off on investing as the market pulled back drastically. As this Gartner Hype Cycle trajectory continues, VC investment will almost certainly rise in prominence, potentially overshadowing Initial Coin Offerings (ICOs) as institutional investors consider blockchain-powered integrations for mainstream products.
Over the course of the next several years, cryptocurrency as a fundraising vehicle will continue to usher in a new bucket of investors and technology enthusiasts, something akin to the emergence of new investors in 2011 under the accredited investor rule 501 of Regulation D of the U.S. Securities and Exchange Commission (SEC). However, institutional venture capital will play a pivotal role in guiding these companies to maturity by providing corporate governance, additional funding mechanisms, and a network of professionals that cross nearly every vertical.
Although ICOs technically outperformed traditional VC funding in the second quarter of 2018, raising more than $7.3 billion across more than 90 ICOs, it’s been a closer race than ever before. Under the same timeline, VC investments for crypto companies reached $4.3 billion in cumulative funding, with $1.1 billion executed across nearly 178 deals (Coindesk, 2018).
For the past couple of years, ICOs and pre-sales (pre-sales of the coins before they are minted) have served as the main crowdfunding function for blockchain projects that have a tokenized asset attached to the project.
This novel method of fundraising opened the door to a new persona of global investors, ultimately creating a new “accredited investor” and enabling new projects to take flight. By doing an ICO or pre-sale, many of these companies raised a non-diluted round of funding because the token offered a quicker path to liquidity and the value was held in the token with hopes of utility in the distributed network. The vast sums of money raised for these companies have given crypto and blockchain companies runway to build out cryptocurrency relations (exchange listing, custodianship, community building) and teams to build vastly complicated distributed networks.
Now that we’re seeing (and expecting) more formalized regulatory policy appear concerning the buying, selling, and utility of crypto assets, we need to rethink fundraising strategies and mature as an industry.
There is an incredible opportunity for blockchain technologies that have navigated the cryptocurrency markets to combat and mitigate against traditional institutional investor sentiment about the space: what it takes to establish scale and manage an active crypto community, launch and distribute a currency/token, and provide custodianship of those assets. Furthermore, blockchain companies can then appeal to institutional investors by focusing on articulating applications of distributed ledger technologies to real-world use cases and scaling of an organization rather than crypto economics (which was mainly the focus of ICO’s over the past year).
In the United States, in particular, VC investments are fast becoming a best practice to ensure compliance with formalizing designations under the U.S. Securities and Exchange Commission (SEC).
We’re already beginning to see this take shape in the startup capital of the world: San Francisco and Silicon Valley. Silicon Valley insiders have already tapped into the opportunity to capitalize upon the native talent pipeline and address one of the industry’s most significant obstacles — the blockchain brain drain of developers.
At present, San Francisco has the highest number of registered Simple Agreement for Future Token (SAFT) – a derivative of the familiar SAFE (simple agreement for future equity) documents in the United States. SAFE contracts are primarily considered to be the most cited playbook for formally registering an early stage investment where valuation of a company can be pushed off until a later date when the company has matured.
To compete with crypto epicenters in Zug and Singapore, executives from Silicon Valley are overwhelmingly electing to seek VC funding to remain both competitive and compliant in the global market. Sand Hill Road is waking up to the idea of tokenized infrastructure and transactions, given the real-world benefits blockchain proffers, but are still primarily doing equity and debt rounds of fundraising to appease limited partners (LP’s or investors in venture funds) and the terms of their existing funds. Additionally, traditional investors will continue to sit on the crypto investing sidelines until regulation is more clear-cut, utility or purpose is adequately conveyed, the volatility of crypto begins to stabilize, and custodianship is understood.
When Constellation was founded, we sought to combine the unique mechanism of a token sale with the undeniable power of VC influence. We raised nearly $33.7 million in a private sale, comprised mostly in the form of ETH (Ethereum cryptocurrency), appealing primarily to the global cryptocurrency investor as the appetite for this technology was mainly in this new class.
For many growing crypto companies, it can often be confusing to attract the evolving cryptocurrency investor, let alone draw the attention of institutional investors that are naive to this new industry. It is for this reason that we are establishing a roadmap/playbook for crypto companies looking for a more secure ICO-alternative — a knowledge base that we believe institutional investors will find highly compelling, as crypto can serve as an excellent crowdfunding solution for many businesses in the near future.
Some may argue that the presence of VC investors contradicts the true nature of decentralization in blockchain and alternative governance structures, yet this would be a short-sighted assumption. While traditional VCs have certainly fostered the creation of some of the largest brands in the world, their investment in no way infringes upon the founding principles of either blockchain or cryptocurrency. On the contrary, VCs are already proving to be an essential resource for grassroots crypto advocacy and will continue to serve as a critical bridge between cryptocurrency and traditional enterprise in the eyes of potential investors.
Granted, crypto companies should not see either VC or crypto as a fast track to easy fundraising. Prior to reaching out to potential investors on both sides of the fence and to usher in more accountability into the space, companies should make sure that they’re laser-focused on their value proposition, express a detailed plan of action to growing the team, management of a large community (think of them as your fans, technology enthusiasts, and shareholders), and can navigate an engineering roadmap. As the space matures, it will be critical to articulate easily-digestible business model will undoubtedly attract more attention from VCs than vague promises, and will likely mitigate the risk of inadvertent infringement with government agencies.
It’s hard to imagine what the future of cryptocurrency will look like in a year’s time (a lot has happened in a short amount of time), but the sector is professionalizing quickly. With formalizing regulatory standards, rapidly-expanding use cases, and burgeoning mainstream appeal, there’s near limitless potential for the widespread adoption of blockchain technology. However, without the support of traditional investors, most notably VCs, many of these companies, regardless of their value, will never get off the ground and scale into the technology brands we are familiar with today.
The days of fat Ethereum wallets indiscriminately investing into projects with a ton of hype are growing less frequent; conversely, the days of remarkably sound investments are becoming more common. Full credit where it’s due though – many young tech gurus that believed in cryptocurrency in the early days, particularly in Bitcoin and Ethereum, have paved the way for a new breed of investors that will continue to drive innovation from new angles.
A new era in cryptocurrency is upon us, and it will include participation and insight by both institutional and cryptocurrency investors, while ultimately requiring blockchain technology companies and the applications built on existing technologies to behave like mini-IPO’s being accountable to a myriad of personas from tech enthusiasts, crypto communities, users and enterprise organizations, and investors.
