3 Counterintuitive Experiences in Cryptocurrency Investment

3 Surprising Cryptocurrency Investment Experiences

Good morning, readers! This article will introduce three counterintuitive experiences I have learned while serving as a cryptocurrency investor over the past few years. Of course, I will also explore more interesting topics in future articles.

1. Building an investment portfolio is more important than choosing the right company.

This experience is most contrary to our intuition, but the mathematical logic behind it is actually very simple. Suppose you invest 0.5% of the fund in a company with a return rate of up to 100 times. Even if the company achieves such a return, your fund cannot get a return. Since the distribution of venture capital returns follows a power law distribution, winners with returns up to 100 times are actually very rare. Therefore, every time you encounter such an opportunity, you must ensure that your investment is more valuable. To succeed, you need to focus on investment rather than just praying for good luck.

If you do not build the investment portfolio correctly, but only have a bunch of beautiful company logos on the fund website, it does not necessarily mean that the VC can get a good return. This also explains why some venture capital funds with over 400 million US dollars in assets are still engaged in seed investment business.

Some people believe that making small initial investments is to seize the opportunity of “scoring”, and then plan to make larger-scale investments on this basis. However, in actual situations, larger funds will enter the market in a more sensitive way and obtain the vast majority of returns (that is, the later you invest, the closer your rounds are to zero-sum). Most importantly, if you are not the main investor in the seed round, you may not be able to obtain proportional equity, so all your ownership shares may be heavily diluted (I have seen an example where the dilution rate is as high as 90%).

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If you consider the extreme case of this experience (that is, completely ignoring the importance of choosing the right company), the best investment portfolio construction is 100% dollar cost averaging, also called “beta”. To be honest, the unwritten rule of cryptographic investment institutions is that most of the funds launched in the previous cycle did not outperform the above investment portfolio construction. Assuming that the average ETH dollar cost from 2018 to 2020 is 200 US dollars, your fund’s TVPI may reach 15 times today’s price.

Many people use AngelList’s famous research as a counterexample, which shows that usually more investments by funds will bring better returns. However, I believe that this statement does not apply in the cryptocurrency field. Since the public market equivalent benchmark return (such as investing in ETH through DCA) is already very high, you need to focus on asymmetric returns in order to have a chance to outperform the market. Otherwise, over time, the average return of cryptographic investment institutions will be lower than the return of using only the ETH purchase strategy. In the long run, it is not easy to surpass ETH.

Therefore, for every new investment, you should ask yourself, “Can this surpass my ETH returns and return my capital?” At the same time, you should have enough confidence to bet on it.

2. The correlation between the “hotness” of funding rounds and the final outcome is minimal before product-market fit

If you look back in history, you’ll find that almost none of the biggest winners of the last cycle were seed-round hot projects.

DeFi: Despite Uniswap being a hot trading platform, Aave was only a few cents when it was known as ETHLend and available on public markets for any retail investor to buy. In fact, none of the investments in the Ethereum DeFi space were very attractive (new competitors to BitMEX were the hot ticket at the time) until the arrival of DeFi summer.

NFT: SuperRare’s digital art market was completely overlooked last year during the DeFi craze for “risk-reward farms.” The works of XCOPY and Pak were still priced at single ETH amounts.

L1: Ironically, Solana wasn’t one of the hottest “VC chains” at the time (unlike Dfinity, Oasis, Algorand, ThunderToken, NEAR, etc.), but it ended up being the best-performing alt L1 investment.

That’s why it makes sense to be very strict about valuations in the seed round. I’m seeing more and more VCs also starting to chase $60 million to $100 million valuations in seed-round deals. The only exception I can think of is L1, where the market size/upside is so high. Additionally, you can even buy publicly traded tokens with market recognition for less than the FDV of some seed-round deals.

However, after product-market fit, the opposite is true: the most successful investments are usually those that are most obviously poised for success. This is because humans are naturally bad at perceiving exponential growth (e.g. look at how many people dismissed COVID-19 in early 2020); we tend to underestimate the potential of winners and the likelihood of becoming monopolists. OpenSea was valued at $100 million in its A-round, which may have seemed high at the time, but quickly became a bargain as their transaction volume grew rapidly.

This is a good example of “dialectical” (extreme relative truth). In terms of investment risk and return, the best option is either a company that is cheap before product market fit or one that is expensive after product market fit, with no good options in between.

3. It’s hard to pick good projects in hot narratives and fierce competition

Over the past year, I’ve noticed a trend among Web2 founders building in the hottest and most fiercely competitive areas of Web3. Many venture capitalists view the influx of talent into crypto as a positive sign, but I believe that newcomers may have good credentials but not necessarily the specific needs and requirements of the crypto market. Unlike other industries, in crypto, heroes matter regardless of their background. Historically, almost all of the most successful crypto projects have been founded by people without Ivy League or Silicon Valley backgrounds.

I have some concerns about some of the “obvious” ideas in investment.

These ideas attract profit-seeking founders. These founders are good at copying existing things (such as copying ETH DeFi to other L1 chains, copying existing web2 SaaS products to web3 DAOs), and then aggressively marketing their products. But as the crypto hotspots shift, the industries these founders are in are bound to suffer some decline. For example, we are now seeing this happen as ETH DeFi tokens have fallen 70-80% from their all-time highs, while DeFi on other chains has become the new hot spot. In 2020, profit-seeking founders of ETH DeFi projects have turned to angel round investments, while mission-driven founders have continued to adhere to their product visions and innovate.

A good way to distinguish between “profit-seeking” and “mission-driven” founders is to discuss ideas with them. Can founders explain in detail the attempts of their predecessors and the better methods they are currently using? If venture capitalists have much more knowledge of a particular field than founders, this is usually a warning sign.

These ideas are highly competitive. When a dozen projects are trying to build the same thing (such as Solana lending protocols), it is much harder to choose the right project. In each industry or category, only a few dominant companies occupy market share. If you adopt a concentrated investment approach (according to the first point above), you are not suitable for investing in their competitors because of conflicting interests.

These ideas are highly valued before the product launch. We can see that the lowest valuation for DeFi clones on X Chain is 40-60 million US dollars and can even reach 100-200 million US dollars. While this may be profitable for traders who hope to make quick profits by buying tokens during the presale and then selling them after the token is launched, it may not be attractive to venture capitalists seeking to invest in projects with the potential to generate substantial returns and excess income to reward funds.

I have not come to a conclusion, so I will end this article in a controversial way: those funds that raise large amounts of funds by showing paper investment returns to LPs may not perform as well as Ethereum once these paper returns become actual returns.

Author: Richard Chen

Translation: Theseus Wu

Proofreading: jomosis1997

Layout: Bo

Review: Suannai

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