Mayur Polani

Venture Capitalist Cryptocurrency Investing

Venture capitalists’ firms consist of institutional investors, pension funds, and angel

investors who provide financing for startup companies in exchange for equity in the business.

The number one goal of these VC firms is to make a profit. A profit is made when the venture

capital fund sells the shares that it owns, for more money than it originally paid for them.

Venture capitalists look for a well-rounded team, a growing market and a unique product or

service with a strong competitive advantage. This requires VC’s to stay up to date in the hottest

market trends when investing in new companies. In 2017 the world was blown away by the fast

growing crypto currency market and the Initial Coin Offering (ICO) scene. One of the biggest

supporters behind new ICO’s and crypto were the opportunistic VC’s. We are able to see a

direct correlation between the increase in funding towards blockchain startups and a decrease

in funding by VC’s towards all other projects.

Financial analysts have been surprised at the shift of financing from traditional startups

to crypto startups that has taken place in the VC industry. 1 In 2017 more than $5.6 billion of

capital was raised in 2017 in ICO funding according to the metrics used by the TokenData team.

Compared to 2016 where crypto currencies only raised $240 million from VC’s. 2Already

through 10 months of 2018 ICO’s have raised over $7.1 billion. This shows the massive interest

by VC’s and accredited investors invest in the rising blockchain space. What is the reason for

1Williams-Grut, O. (2018, January 31). Only 48% of ICOs were successful last year - but startups still managed to
raise $5.6 billion. Retrieved from https://www.businessinsider.com/how-much-raised-icos-2017-tokendata-2017-
2018-1
2 ICOdata - ICO 2018 Statistics. (n.d.). Retrieved October 24, 2018, from https://www.icodata.io/stats/2018
investing so much money in an unproven asset class? 3 In 2017 the average return from each

ICO investment was 1,320%, which trumps all bonds, traditional equities, and average stock

returns. Clearly Venture capitalist firms attempted to capture the incredible return rate in 2017.

4 The companies that raised the most money were projects that attempted to create their own

blockchain. This is because other applications can be built on top of blockchains which increases

the value of that project. Besides just return on investment, VC’s also prefer how they receive

ownership in Crypto currencies versus traditional equity. When participating in an ICO, the VC’s

receive a set number of tokens that are seen as ownership part of a company. With tokens,

VC’s are able to trade them on the open liquid market, where as equity that is not in stocks has

a relatively illiquid market and sale of ownership is usually a lengthy process. Also, when

transferring ownership to someone else the transaction cost is very cheap; in most instances

under a dollar.

3Williams-Grut, O. (2017, October 18). No wonder investors are rushing into cryptocurrencies - average ICO
returns are 1,320%. Retrieved from https://www.businessinsider.com/ico-mangrove-capital-average-returns-
crypto-icos-2017-10
4Venegas, P. (2017). Initial Coin Offering (ICO) Risk, Value and Cost in Blockchain Trustless Crypto Markets. SSRN
Electronic Journal. doi:10.2139/ssrn.3012238
 Even with the record amounts of capital raised by VCs worldwide, there has been a

quiet, implosion in early-stage VC activity worldwide. This may explain why VC’s are so eager to

get their money into these crypto projects. A few reasons VC’s are spending less on projects on

the ground floor include new era of apps and heavy competition in fintech industry. Because

the smart phone app ecosystems are so well established now, every segment has seen many

improvements and innovations in lifestyle, health, finance, and all other categories. At the same

time, we have seen great maturation of the fintech market, where winners have already

emerged and new entrants in many fintech categories are fighting a costly battle to grow

quickly. This has caused VC’s to back off early stage companies and focus on funding proven

winners that need more capital. Companies such as Airbnb, Spotify, and Lyft have raised billions

while being in the top spot amongst their competitors.

While VC’s are enjoying their current venture in the crypto currency space, they have

many threats that could slow down investing. 5 The first is that the SEC may rule the use of

5
Disparte, D. (2018, July 21). Beware Of Crypto Risks - 10 Risks To Watch. Retrieved from
https://www.forbes.com/sites/dantedisparte/2018/07/21/beware-of-crypto-risks-10-risks-to-
watch/#266f78275f17
ICO’s as illegal security sales. The SEC has not laid out a true guideline that can be applied to

token ownership and sale. Therefore, many ICO dealings violate the Howie test and can be

considered as securities. The SEC could force these VC’s to return their token ownership to the

company, be refunded their money, and fined large amounts for buying unlicensed securities.

The second threat is that these tokens that prove ownership are digital assets. This is a problem

because firms are susceptible to hacks and in case of a data breach a criminal would be able to

send your tokens to his wallet address. Blockchain transactions are irreversible so there will be

a 0% chance of getting your ownership stake back in the company. This could lead to millions of

dollars worth of losses for VC’s. Lastly VC’s are investing in an asset class that is only 9 years old

and for the most part, the technology is unproven. There are very few companies making a

profit off their business model, most VC’s are simply profiting off the sale of their ownership

rather than recouping annual payments. In a new asset class VC’s can expect most of these

companies to fail.

With the traction blockchain startups are generating, do these companies represent the

future of VC investing? 6 Founder of Venture Exchange, Alexander Tkachenko believes that “10-

15% of venture capitalists are investing in crypto investments at the moment, and many more

have looked into it, VCs are at the forefront of new technology innovation.” It is clear that there

will be a lot more money that is funneled into to this market once regulations are clear for

investors and there are proper custody services offered to handle tokens and keep them safe

from hackers. One of the things VC’s are doing to establish themselves for the future crypto

6Do cryptocurrencies represent the future of venture capital? (2018, June 25). Retrieved from
https://www.information-age.com/cryptocurrencies-venture-capital-123472942/
scene is partnering with trading platforms. This is because when a VC invests in a company,

they will be able to get that token listed on a trading exchange instantly to maximize its early

value in the market. Another driver in the commitment to invest so heavily in these early stage

projects a potential of the third stage of the internet, is past result from major tech revolutions.

We saw many private investors become wealthy with early tech stocks in the 1990’s, VC’s then

have done very well in the 2010’s providing funding for apps and ecommerce businesses, and

now decentralized applications and blockchain technology is the next possible technological

shift in society. VC’s are willing to pay a heavy price now and help build the infrastructure for

the future.

After evaluating the current VC trends, it can be expected that more money will

continue to be invested into blockchain startups and less will be invested into other traditional

startups, based off average return on assets and ease of ownership and transactions. Factors

that may hinder the success of these investments will be regulations set in place by the SEC and

lack of trustworthy custody services provided by digital asset managing platforms. With all of

the resources and time VC’s are placing in this new industry, it is reasonable to assume that

investing in blockchain startups will be the new standard for firms all across the world. VC’s will

be financing the ability of developers to build this disruptive technology and will be seen as

pioneers in the space. They are providing credibility to small projects and controlling the

investment scene by the use of their dollars. By investing less in traditional startups over the

last couple of years, the financial sector has received a message that there is a new market to

keep an eye on, and VC’s will have a major part in the blockchain ecosystem going forward.