Locked-up “paper wealth” VCs encountering a “hell difficulty” cycle

Author: Mia, ChainCatcher

Retail investors attributed the reason for losing money to the token issuance strategy of "high FDV (future discounted value), low circulation", and believed that VCs and project parties colluded to unlock a large number of tokens, which impacted the crypto market.

VCs "crying out for injustice", defining the primary market of this cycle as "hell difficulty". Li Xi, partner of LD Capital, said that this year's books are profitable, but it's all paper value, because the shares belonging to VCs are still 0 unlocked. In addition to the VCs who "assembled the game", most VCs are "big leeks" who took over.

ChainCatcher interviewed many representatives of the VC industry, trying to explore the current survival status of VCs.

Many VCs said that 6 major reasons have led to the current VCs facing exit difficulties. Some VCs said that in the current market environment, not investing has become the best strategy.

VC’s “paper wealth”

In the current market cycle, the “high FDV, low circulation” token issuance method has gradually become a mainstream trend, and “VC tokens” have been labeled as “dangerous” in the secondary market.

Previously, hitesh.eth, the co-founder of the data analysis platform DYOR, posted a set of data on X, counting the top ten typical “VC tokens” on the market.

The data shows that even in the case of a continuous decline in the market, the major VCs still have a floating profit of dozens or even nearly a hundred times the book value of their investments in these tokens.

For VC institutions, "book profit" has always been common sense and objective. Early investors usually receive a certain proportion of tokens as a reward, and these tokens will be locked according to a specific time limit structure. This phenomenon has always existed for both web2 and web3 investments, but the proportions will be very different in different development stages.

However, the uncertainty of unlocking also makes this part of the income become "paper wealth".

LD Capital partner Li Xi publicly stated that although the projects invested by LD Capital and listed on the trading platform have shown a profitable trend in the financial statements, behind this series of seemingly glamorous figures is actually "paper wealth", "because the shares belonging to VC have "high FDV and low circulation", resulting in zero unlocking of tokens".

For retail investors in the secondary market, there are still a large number of VC shares that have not been unlocked, which has caused new panic.

Common token lock-up parameters include: allocation ratio, lock-up time and unlocking cycle. All these parameters only play a role in the time dimension. At present, the unlocking period is a one-size-fits-all rule set by the project party and the exchange. For the current market environment, "unlocked tokens" have become VC's "book profit".

Faced with "book profit", the market has also begun to produce a response strategy - "over-the-counter OTC".

CatcherVC investment partner Loners said: "If the deal you invest in is not bad, there will be some funds willing to buy the saft agreement in your hand, which is equivalent to risk transfer or early cashing out, but the current trading volume in the OTC market is still too small, and the trading is concentrated in a few particularly top projects."

Loners said that if over-the-counter trading gradually matures and matches funds with different risk tolerances, this problem will be partially alleviated. Or more extreme options can also choose the form of short hedging, but many institutions do not have management experience in this area and are not recommended to try.

Lock-up Dilemma

Faced with the unlocking of a large number of "VC tokens" in the current market, unless market demand increases, it may bring potential selling pressure.

Loners also holds the same view: "The unlocking period of project tokens and related resources is relatively long. If the market's expectations for project development are not met during this period, coupled with market sentiment and liquidity fluctuations, and the high premium caused by the peak of project popularity usually concentrated in the listing stage, the price of tokens is prone to fall if there is a lack of new funds injected after the project is unlocked."

Hack VC partner Ro Patel said, "If the proportion of locked tokens is too large, which in turn affects the available liquidity of tokens, this will have an adverse impact on the price of tokens, thereby damaging the interests of all holders; conversely, if contributors are not properly compensated, they may lose the motivation to continue building, which will ultimately damage the interests of all holders."

Similarly, SevenUpDao partner Nathan believes that "for some underlying infrastructure, the unlocking can remain unchanged, giving them time to develop across cycles. But for projects on the traffic side and the application side, the same unlocking should not be adopted. You need to encourage them and motivate them to quickly unlock and continuously innovate the next one."

Loners also holds the same view as Nathan, believing that the design of the unlocking terms should be based on the specific project type. "For important infrastructure in the industry, longer-term unlocking can be accepted, while many application projects should not design particularly strict terms. Instead, they should focus on the product itself and exchange relatively good unlocking conditions for financing efficiency."

6 reasons for the difficulty of the primary market hell

As market liquidity becomes increasingly exhausted and the return cycle of the primary market is extended, more and more small and medium-sized VCs affiliated with large VCs have chosen a conservative wait-and-see attitude.

Nathan confessed, "For small and medium-sized investment institutions, the more flexible they are, the less likely they are to suffer losses in this matter, because you don't need to invest in 30 or 50 projects a year for the sake of brand and to spend LP's money at a rhythm, and there are not so many high-quality projects in the market for everyone to share."

Some small and medium-sized VC institutions also said that due to overvaluation and strict investment terms, they did not participate in too many primary investments this year.

They believe that some new projects on the market are not endorsed by large VCs and the concepts are not innovative enough. In addition, too high FDV may also make the price of TGE exceed expectations, "many institutional investments are actually facing losses."

As more and more small VCs withdraw, the market has become a battlefield for large VCs to "fight alone."

Due to the pressure of LP's investment, large VCs still need to invest despite the difficult investment environment.

Faced with the current difficulty of investment in the primary market, Nathan optimistically defines it as "temporary and a reasonable existence of phased development."

VCs believe that the challenges of this round of investment "hell difficulty" mainly come from the following 6 aspects:

• Valuation bubble and market turbulence:In early 2022, affected by the dollar's water dividend, North American VC institutions successfully raised huge funds, pushing the valuation of the primary market to an irrational level. Subsequently, events such as FTX's thunder and Binance CZ occurred one after another, seriously disrupting the market's financing and listing rhythm, further exacerbating market uncertainty.

• Industry narrative and application lack:Although technical narratives and new asset issuance narratives emerge in an endless stream, the market generally lacks application narratives that can attract users and generate actual utility. This leads investors to be skeptical about the long-term value of the project, which in turn affects their investment decisions.

• Limited capital flow and stock market:The market as a whole is in a stock capital state, and capital flow is limited. Although there is ETF inflow, it does not flow into the altcoin market, which directly affects the market activity and the financing ability of the project.

• The dilemma of altcoins and VC coins:The price of altcoins has fallen sharply, and VC coins are facing the dilemma of unlocking a large amount of money but no incremental funds to take over, which has led to the continuous decline of these currencies, further undermining market confidence.

• Fund concentration and exit difficulty:The capital end is highly concentrated in a few head CEXs, and most non-hot projects cannot meet the CEX listing requirements and are difficult to gain the favor of investment institutions, which in turn increases the difficulty of project exit.

• Lack of hot spots and hot money deviation:The current market lacks new hot spots to carry hot money. At the same time, when the market's attention is focused on memes with higher risks, the speculative atmosphere and volatility of the market are further exacerbated.

VCs that “assemble” and “big leeks” that take over

LD Capital partner Li Xi summarized the current VC situation by saying, “Except for VCs that “assemble,” most VCs are “big leeks” that take over, and this is indeed the case. Nathan defined it as “‘Assembly’ is a market adjustment phenomenon as the difficulty of exiting the primary market increases.” ”

Against the backdrop of increasing difficulty in exiting the primary market, “assembling a game” has quietly emerged. In the form of “banding together”, “assembling a game” reduces the risk of VCs losing money to a relatively controllable range at a lower valuation.

However, “assembling a game” is not without flaws. There are few excellent founding teams, serious narrative homogeneity, high trial and error costs, and a lack of direct capital exit channels. These are challenges that cannot be ignored.

Nathan said, “When the primary market is particularly prosperous, direct investment is a more efficient approach in terms of ROI; otherwise, ‘assembling a game’ will be considered.” For VCs that hope for long-term and stable development, “the action of ‘assembling a game’ is not necessary, but the ability to ‘assembly a game’ is necessary. ”

Regarding the “assembly” projects and “big leeks”, it is actually a process of market selection and self-healing. Loners said that whether it is a collection project or a serious project, from a financial perspective, the exit often depends on the performance of the secondary market. However, the core of the project still lies in whether its products or services can create positive value for the industry. If a project lacks substantial contribution, it will be difficult to maintain its market position in the long run even with a strong background and support.

Nathan said that if a large number of “assembly” projects are of poor quality, capital cannot exit, and they are swept up by public opinion, then naturally the “assembly” will lose motivation. If this project can obtain better resources and the valuation is reasonable, why not do it?