How are cryptocurrencies, ICOs impacting the VC market?

Some ICOs leverage historical venture funding to raise capital they probably shouldn’t be receiving, according to Aberdeen Standard Investments co-head of global venture capital Kirsten Morin in a research interview with FinTech Global.

Interest from more mainstream venture capital firms in the blockchain and cryptocurrency sector is a relatively recent phenomenon. A few years back there were only handfuls of firms that were exploring opportunities in the space, such as Sequoia. However, with the recent cryptocurrency and ICO market ‘explosion’, Aberdeen has seen many more early-stage VCs turn their attention to the space.

Morin said, “We are hearing from the managers we work with that they’re seeing a lot of the top entrepreneurial talent in Silicon Valley refocus their time and attention on blockchain related projects. Whereas, if you had asked them where they were seeing the best opportunities a year ago you would have heard buzz words like AI, machine learning, autonomous driving.” While these areas are still a key area for development, there has been a dramatic expansion in blockchain.

However, there are various issues that have been caused by this sudden growth of the market. Morin said, “The biggest concern is the volume of capital these projects are securing in their infancies.” Some of the most notable ICOs have been able to pull in hundreds of millions of dollars, such as Bankera which has raised over €100m in its sale. ICOs bring the ability for some companies to potentially raise colossal levels of money, before even launching a network.

She added, “I think VCs have been operating in an environment where the companies they have been working with have also had a lot of access to growth capital and that creates a set of challenges. It’s hard to be disciplined with your burn if you have access to a lot of capital. So, you have very early stage companies with a tremendous war chest of capital at their disposal and its going to take a lot of discipline. I think VCs are probably cognisant that they don’t have the same governance or control of how entrepreneurs are planning on spending that money with ICOs.”

One of the other problems ICOs bring is the risk of adverse selection, particularly those that have previously raised venture funding from a reputable firm. An issue could be that companies that normally wouldn’t get funding, can now access it through an ICO. Having had an involvement from VCs, even if it is no longer active, can serve as an endorsement. Morin added, “There is adverse selection of companies that have previously raised venture funding, who no longer can raise incremental funding from their VCs, but can pen a whitepaper and tap into the ICO market and can leverage the historical involvement of strong-brand name VCs to success in attracting capital from new outside ICO investors.”

Investments in to the blockchain and cryptocurrency sector nearly tripled last year, compared to 2016 according to data by FinTech Global. In 2017, companies developing these technology solutions pulled in a combined $1.8bn, while in 2016, the sector only raised a total of $573m. While the deal value has risen, there has been a big fall in the volume of transactions, with 63 less being completed in 2017.

Cryptocurrencies future with VC

When crowdfunding was starting to pop-up, there was a question of it disrupting VC funding, and this is similar to ICOs. Crowdfunding didn’t replace it, instead it served as complimentary source of capital that widened the opportunities available to venture firms, and Morin thinks it will be the same with ICOs.

An area Morin likes about the cryptocurreny and blockchain market is that it is a global opportunity where there isn’t a specific geography that is better for building a network. However, regulators are almost definitely going to come in and create some governance and regulation for the market, which is going to be welcomed by VCs.

Morin said, “I think yes we have seen a plethora of new fund offerings that are focused on cryptocurrencies and I think it is evolving very rapidly. We are seeing more funds being marketed with more private equity fund characteristics, less liquidity, longer hold periods and the view is that can help with volatility as they can offer investments to entrepreneurs that are more stable and long term.”

Some VCs are even looking to accept and invest in crypto assets, but this brings new difficulties. Most are not ready to take them, with there being question marks around how they are stored, moving them around, security risks.

“We’re seeing many established venture firms adapt their fund structure to allow for token-based investing. Most venture firms have some sort of definition of a security in a limited partnership agreement, and some are expanding that to include token related investing.”

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