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Venture Capital Meets CryptoAssets

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Whether or not we are at the early stages of another CryptoBoom is to be determined. But one thing is clear – major VC and Hedge Funds alike are already positioning themselves and preparing to deploy capital accordingly. Simultaneously, blockchain technology is getting better, network effects are taking hold, and Crypto is moving up the S-Curve.  Venture is now shifting into Crypto, it’s time to place your bets!

A decade ago, an anonymous computer scientist named Satoshi Nakomoto and a band of brothers known as Cypherpunks  launched the now famous Bitcoin cryptocurrency.  With the launch of Bitcoin, Satoshi et al began unsettling the guardians of the financial establishment (ie. Jamie Dimon) who have famously labeled it a fraud and predicted its death hundreds of time (see the Bitcoin Obituaries).  But Bitcoin has not only survived, it has grown in scale and seen 1,000s of copycats, all claiming to be better, faster, more secure, etc. Bitcoin started a movement, and here are 10 years later looking at the beginning of not only a new asset class and potentially financial system if Crypto innovations continue to scale.

CryptoLexicon

Crypto Lexicon

While Bitcoin remains number one, there are still many opportunities within the space for building exchanges, core infrastructure, wallet technology, and ‘decentralized’ financial institutions.  That’s why Venture Capitalists and Hedge Funds alike are raising huge funds, changing their organizational structure, and preparing the masts for the next wave of Bitcoin and other Crypto technologies.

Venture Capital goes Crypto Capital

Venture is becoming Crypto, and vice versa.

Andreesen Horowitz, one of the most prominent and recognizable Venture Capital (VC) firms has restructured their entire corporate model, rescinding their VC exemptions to become a financial advisor.  The main motivation for the move is to expand their ability to invest in Cryptoassets sans limit, assets which would otherwise be limited to 20% of their VC portfolio under SEC regulations.  Now they can go big and invest across asset classes (Cryptoassets and currencies, private companies, public companies) and not have their purview be limited by asset class.

“By renouncing venture capital status, Andreessen Horowitz says it’ll go deeper on riskier bets: If the firm wants to put $1 billion into cryptocurrency or buy unlimited amounts of shares in public companies or from other investors, it can.” Forbes

@A16Z – as they are known in the Twittersphere – have gained notoriety for making early-stage bets in companies like Airbnb, Pinterest, Slack, and a host of enterprise companies.

a16z bets

Forbes

They have had their share misses; perhaps the most recent notable flop would be their $12mn Series A in Cryptokitties at the peak of the Ethereum-boom in early 2018.  But these misses are part of their model and are more than made up for by their massive gains on some of the above-mentioned companies.  Despite their controversies as a firm – and there are many – they deliver where it matters most to their LPs (Limited Partners), exponential ROI (return on investment).

“The formula worked. The firm’s first and third flagship funds, $300 million and $900 million, respectively, are already expected to return five times their money to investors, sources say. Its $650 million second fund and $1.7 billion fourth fund are expected to return three times their investment capital, good for the top quartile of firms, and are expected to climb.” Forbes

Clearly, they see the big opportunity to scale their returns in the Cryptoassets class. Despite flops like CryptoKitties, they have made very successful Crypto bets in companies like Coinbase and Polychain Capital.  As a result, they will look to place massive amounts of financial and human capital behind more Crypto companies who could be 1 of the 15 that they look each year to continue to drive returns for their recently announced $2bn fund. 

“Horowitz’s well-publicized view, one it still holds, was that what matters is not how many companies you back that fail but how many become massive, outlier successes. Andreessen argues that only 15 deals per year generate all the returns, and he’s intent on seeing all the hot deals first.” Forbes

Bitcoin

A16Z Portfolio

And of course, VCs like A16Z and others will likely continue to buy up Bitcoin itself.  Peter Thiel’s Founders Fund famously made a fortune on Bitcoin in the last runup, and there will undoubtedly be more VCs using their venture dollars to get into Bitcoin, which itself has the ability to produce asymmetric returns as a standalone asset.

“Founders bought around $15 to $20 million in bitcoin, and it has told investors the firm’s haul is now worth hundreds of millions of dollars after the digital currency’s ripping rise in the past year.” DowJones

Hedge Funds

On the other side of the coin, you had many hedge-fund managers begin to open funds in the early stages of the last Crypto boom in 2015-16.  One example is Mark Yusko with Morgan Creek Capital Management who started Morgan Creek Digital Assets in 2014  as a way to gain exposure to the Crypto market. In its current format, the fund contains a mix of 10 Cryptocurrencies, predominantly Bitcoin; however, institutional investors can invest fiat currency directly into the fund to gain exposure, they are not required to invest cryptocurrencies directly and have the hassle of managing/securing those digital currencies/assets.

Fund Composition

Morgan Creek Digital Assets Index

Similar to the founders of Andreesen Horowitz (Mark Andreesen and Ben Horowitz), Mark Yusko has built his reputation on a series of unconventional views that have eventually led him towards exponential returns.  In this case, his origins as a hedge-fund manager with Tiger Asset Management led him to be introduced to Bitcoin through a former colleague, which led to the creations of Pantera’s Bitcoin Fund and then  Morgan Creek’s own Bitcoin Infrastructure Fund.  These funds returned even more X than A16Z’s VC Funds.

“It’s about a 9.6X. We’d all say that’s awesome. I should have put the money in Bitcoin fund. That’s like 86X including the crypto winter. It’s the best performing hedge fund of all time.” The Block

As opposed to targeting the LP audience like A16Z, Mr Yusko is targeting the broad finance/fund manager community, many of whom generally hold the view that Bitcoin is a fraud:

“What we told people was we should do 1 percent in crypto itself because of the asymmetry of it and then you should put another couple percent in infrastructure related to it. So a couple, 2-3 percent, not crazy allocations but we thought the asymmetry was really high. And when you look at traditional assets today, one of our big themes right now is get off zero #getoffzero from Twitter. And the key is that 0, 10 years from now you look back it’s going to be the wrong answer. As a fiduciary, no exposure crypto assets are going to be the wrong answer.” The Block

What’s the thesis for future returns in Crypto? 

The S-Curve – a traditional barometer for measuring innovations – and crossing the Tipping Point on the curve towards an exponential adoption rate. The Tipping Point in the Crypto context is where one or more protocols will become dominant, and a new wave of financial applications will be built on top of those protocols.  These are exactly the types of situations that Hedge Funds like to traditionally identify, and now that blockchain technology and Crypto protocols are readying for the mainstream consumer, we expect to see many more Funds like Morgan Creek launch, using traditional discipline and risk-weightings in the brave new world of Cryptoassets.

“For Bitcoin to have truly asymmetric returns like the the 50X, 100X returns that some people believed. From this point forward, I think what you have to have is network effect continue and start to move out of, S curves are really interesting. So S curves, you start with the innovators, the 1 or 2 percent then you go to the early adopters and then you go to the late majority or the early majority rather than the late majority than the early adopters and then the masses.”

S-Curve

Based on a combination of historical returns, the moves of VCs like A16Z, and funds like Morgan Creek, it’s clear that the Cryptoasset category will continue to be one of the hottest sources of investment in the years to come.  The Cryptoasset class is likely set to outperform traditional asset categories over the next decade, potentially generating those once-in-a-lifetime returns for those who play it right.

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