Many retail investors complain that the projects supported by venture capitalists (VCs) are all “high FDV and low liquidity,” leading to significant unlocking risks for tokens. However, VCs also find it challenging as they are facing “hell-like difficulty” in the primary market, and they are also just paper rich. How will this game of wealth and risk develop in the future?
Summary:
Don’t be foolish: VC dominance is not the problem; the market fears projects without wealth effects.
Background:
Is the surge of VC tokens on exchanges the culprit for the market downturn? Restoring the truth with data.
Table of Contents:
The “Paper Wealth” of VCs
Impact on Retail Investors
Lock-up Dilemma
6 Major Reasons for the Hell-like Difficulty in the Primary Market
VCs “Pooling” and Retail Investors Left Holding the Bag
In this current cycle, some retail investors attribute their losses in altcoins to the token issuance strategy of “high FDV and low liquidity.” They believe that VCs and project teams conspired to unlock a large number of tokens, which has impacted the crypto market.
On the other hand, VCs are crying foul, defining the current primary market as “hell-like difficulty.” Li Xi, a partner at LD Capital, stated that although they have been profitable on paper this year, it is all just a paper value because the portion belonging to VCs has not been unlocked. Apart from “pooling” VCs, most VCs are just “big retail investors.”
ChainCatcher interviewed several representatives from the VC industry to explore the current state of VCs. Many VCs stated that there are six major reasons why VCs are facing difficulties in exiting the market. Some VCs also expressed that not investing is the best strategy in the current market environment.
In the current market cycle, the issuance of tokens with “high FDV and low liquidity” has gradually become a mainstream trend, while “VC tokens” have been labeled as risky in the secondary market.
Previously, hitesh.eth, the co-founder of data analysis platform DYOR, posted a set of data on X, listing the top ten typical “VC tokens” in the current market.
The data shows that even in a continuous market downturn, major VCs have seen dozens or even hundreds of times gains in the book value of these tokens.
For VC institutions, “book profit” has always been a common and objective existence. Early investors usually receive a certain proportion of tokens as rewards, which are locked according to specific time structures. This phenomenon exists in both web2 and web3 investments, but the proportions differ in different stages of development.
However, the uncertainty of unlocking also turns these profits into “paper wealth.”
Li Xi, a partner at LD Capital, publicly stated that although the projects invested in by LD Capital and already launched on trading platforms show a profit on financial statements, behind this seemingly glamorous digital world is actually “paper wealth” because the portion belonging to VCs has not been unlocked.
For retail investors in the secondary market, the large number of unlocked VC portions triggers new panic.
Common parameters for token lock-ups include distribution ratio, lock-up time, and unlocking period. All these parameters only work in the time dimension. Currently, the unlocking period is determined by project teams and exchanges with a one-size-fits-all rule. In the current market environment, “unlocked tokens” have become VC’s “book profit.”
To cope with “book profit,” the market has also started to develop a solution — “OTC (over-the-counter) trading.”
Loners, a partner at CatcherVC, stated, “If you have made good deals, some funds will be willing to buy your saft agreements, which is equivalent to risk transfer or early cash-out. However, the trading volume in the OTC market is still too small and concentrated in a few top projects.”
Loners believes that if the OTC market gradually matures and matches funds with different risk tolerance, this problem will be partially alleviated. Alternatively, a more extreme approach would be to engage in short selling for hedging, but it is not recommended for many institutions without experience in this area.
With the increasing unlocking of “VC-related tokens” in the market, potential selling pressure may arise unless market demand increases.
Loners also holds the same view, stating, “For some fundamental infrastructure projects, the unlocking can remain unchanged to give them time to develop across cycles. However, for projects on the traffic and application side, the same unlocking should not be adopted. You need to encourage and motivate them to unlock quickly for continuous innovation.”
Nathan, a partner at SevenUpDao, also believes that “for some fundamental infrastructures, the unlocking can remain unchanged to give them time for development across cycles. However, for projects on the traffic and application side, the same unlocking should not be adopted. You need to encourage and motivate them to unlock quickly for the next innovation.”
Loners and Nathan share the same opinion that the design of unlocking clauses should be specific to the type of project. “For important industry infrastructure, longer unlocking periods can be accepted, but for many application projects, overly strict clauses should not be designed. Instead, the focus should be on the product itself, exchanging relatively better unlocking conditions for financing efficiency.”
As market liquidity continues to dry up and the return cycle in the primary market extends, more and more small and medium-sized VCs that rely on large VCs have chosen a conservative and wait-and-see attitude.
Nathan candidly stated, “For small and medium-sized investment institutions, the higher the flexibility in adjustment, the less likely they are to suffer losses in this matter because they don’t need to invest in 30 or 50 projects in a year for the sake of branding or spending LP’s money at a certain rhythm. There can’t be that many high-quality projects in the market for everyone to share.”
Some small and medium-sized VC institutions also stated that they did not participate in many primary investments this year due to high valuations and stringent investment terms. They believe that some new projects on the market do not have major VCs’ endorsements and lack innovative concepts. Additionally, the high FDV may cause the TGE price to exceed expectations, resulting in many institutions actually facing losses.
As more and more small VCs exit, the market has become a battlefield where large VCs are fighting alone.
Despite the challenging investment environment, large VCs still need to invest due to the pressure of LP’s capital. Nathan optimistically defines the current difficulty in the primary market as a “temporary and phase-based rational existence.”
VCs believe that the challenges in this round of investment’s “hell-like difficulty” mainly come from the following six aspects:
1. Valuation bubbles and market turbulence: In early 2022, influenced by the flood of US dollars, North American VC institutions successfully raised large amounts of capital, driving the valuation in the primary market to irrational levels. Subsequently, events such as the FTX scandal and Binance CZ have occurred one after another, severely disrupting financing and listing schedules, further intensifying market uncertainty.
2. Industry narratives and the lack of applications: Despite the abundance of technical narratives and new asset issuance narratives, the market generally lacks application narratives that can attract users and generate practical utility. This leads to investors being skeptical about the long-term value of projects, which further affects their investment decisions.
3. Restricted fund flow and a stock market: The market is in a state of stock funds, with restricted fund flow. Although there is ETF inflow, there is no inflow into the altcoin market, directly affecting market activity and project financing capabilities.
4. Dilemma of altcoins and VC tokens: Altcoin prices have plummeted, and VC tokens are facing the dilemma of a large number of unlocks without incremental capital reception. This has led to continuous price declines in these tokens, further undermining market confidence.
5. Fund concentration and difficulty in exiting: Funds are highly concentrated in a few top-tier CEXs, and most non-popular projects fail to meet the listing requirements of CEXs and struggle to gain the favor of investment institutions, thereby increasing the difficulty of project exits.
6. Lack of hotspots and speculative capital shifting: The current market lacks new hotspots to carry speculative capital. At the same time, when market attention is focused on riskier memes, it further intensifies the speculative atmosphere and volatility in the market.
Li Xi, a partner at LD Capital, summarized the current state of VCs as “most VCs are just big retail investors, except for those ‘pooling.’ However, this is indeed the case.” Nathan defined it as a “market adjustment phenomenon under the increasing difficulty of exiting the primary market.”
In the current environment of increasing difficulty in exiting the primary market, the “pooling” phenomenon quietly emerged. “Pooling” reduces the risk of losing money for VCs through “grouping” at lower valuations, making it relatively controllable.
However, “pooling” is not without flaws. The lack of excellent founding teams, severe narrative homogeneity, high trial and error costs, and lack of direct capital exit channels are all significant challenges that cannot be ignored.
Nathan stated, “When the primary market is particularly prosperous, it is more efficient in terms of ROI to invest directly. Otherwise, ‘pooling’ will be considered.” For VCs that hope for long-term and stable development, the ability to “pool” is necessary, but the action of “pooling” is not.
Regarding “pooling” projects and “big retail investors,” it is actually a market choice and a process of self-repair. Loners stated that whether it is a “pooling” project or a serious project, from a funding perspective, the exit often relies on the performance of the secondary market. However, the core of a project lies in whether its product or service can create positive value for the industry. If a project lacks substantial contributions, even with a strong background and support, it is difficult to maintain its market position in the long run.
Nathan stated, “If a large number of ‘pooling’ projects cannot exit due to their poor quality, the inability of capital to exit, and being influenced by public opinion, it will naturally discourage ‘pooling.’ However, if this project can obtain better resources and have a reasonable valuation, why not?”
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