A bear market may signal a change in the way institutional investors view crypto investments, and this is not necessarily a bad thing for an asset class that is sometimes mistaken for only volatile currencies.
“There is a misconception around the crypto space that there is only one thing — cryptocurrency — to allocate to, but that is far from the truth,” says Scott Armey, Managing Director, CIO at Galaxy Digital. “There is massive segmentation and specialization. The early days of a multi-contract technology map are often good for monetizing customizations, and this is the easiest way for organizations to get into the field.”
In other words, the true potential in crypto is on a longer time horizon than many investors may realize based on the history of the asset class. In 2018, ICO [initial coin offering] The bubble burst as investors essentially lost faith in cryptocurrencies. That is not the case today, and institutional investors eyeing the space with fear of headlines may reconsider opportunities that could be scarce.
“The longer the time horizon, the easier it will be to focus on building great technology and useful products,” says Ben Furman, founder and managing partner, ParaFi Capital, a company focused on investing across the crypto ecosystem. “We are long-term focused, and investors are taking a multi-decade look at cryptocurrencies. However, near-term cryptocurrencies have evolved into a volatile macro-driven asset class.”
Changes for the better in early stage investments
The cryptocurrency ecosystem has developed by leaps and bounds in a relatively short time, attracting massive amounts of venture capital and private equity. In its short history, the space has demonstrated a knack for innovation – particularly during challenging times, highlighting projects that have longevity and the ability to grow.
“During moments like these, there are select opportunities to make investments in large companies with time-sensitive funding needs,” Forman says. “It is normal in times of fear to freeze until you know the markets will go up again, but if you look back at the last cycle, the classic 2018/2019 turns out to be the best.”
As noted by the Army, being an early adopter of crypto-related technology evolving over many years is a natural fit for institutional investors. But early-stage venture investment has evolved from “early days” deals (think five years ago) that were structured as simple agreements for future tokens (SAFTs). The owner of a SAFT is not the owner of the shares, which makes him vulnerable and without the protections normally provided to stock holders.
More common today are structures that make up a SAFE – a simple agreement for future shares – with a token security attached.
When the tokens are expected to comprise most of the value in an equity investment, the pre-existing SAFE formula determines the number of tokens issued in proportion to the equity holders. This provides protection for investors (backed in particular by important case law).
The use of tokens is one area that can contribute to separating high-quality investments from less desirable opportunities. It is not uncommon for token maturity schedules to allow the founder to fully dispose of the risk of his token stake within 18 months. This can quickly become messy for a decentralized autonomous organization (DAO), making it a major obstacle for those communities to reach their full potential. Some argue that such actions are detrimental to the creation of high-quality companies and products.
“The maturity schedules for the token are very short and not aligned with the long term,” Forman says. This is one of the reasons for the selling in the market. Capital formation is the basis of capitalism. If you are a founder and setting up a business, you don’t have the option of eliminating risk – you have to build to the final exit. This long-term incentive alignment with investors and builders is very important. Neither side can really sell. Instead, it must create value.”
Another consideration in looking for quality investments is anonymous founders or team members, especially in decentralized finance. This goes against the investors’ need to be comfortable with the management team. Investors should insist that everyone in the management team knows about themselves for audit purposes. Of course, claims about the effectiveness of technological innovations must also be accurate.
For savvy investors who understand how to deal with the nuances of space, however, there is an abundance of opportunity in cryptocurrencies, and the asset class has an ever-improving track record.
“The best crypto assets and crypto companies are real products that really work,” says Haseeb Qureshi, Managing Partner, Dragonfly Capital, a global crypto asset management firm that has strategies for investment funds and hedge funds. “A huge number of people have interacted with them and understood what encryption is and why it would be useful,” he says. “DeFi [decentralized finance] It’s real. NFTs [non-fungible tokens] real. Investors continue to interact with them despite the economic downturn. Most of the shocks affecting cryptocurrency prices were exogenous.”
Focus on early stage strength
While it’s easy to get caught up in red flags while conducting due diligence on early stage investments, Qureshi suggests turning the lens and staring in the opposite view.
“In the early stages, we tend to invest more in strength than lack of weakness,” Qureshi says. “It is easier to plug a hole than to build a world power where there is no power at the moment. We tend to invest in something amazing that has a glaring flaw than it is to invest in something that has no flaws but that doesn’t get us excited.”
Can the early stage opportunities that develop today eventually be considered a mythical antiquity? It’s impossible to say for sure, but the military has benchmarked wines that provide something like a rear-view mirror for the future. The work wasn’t limited to coding either.
“The best antique returns have come from investing during previous bear markets,” he says. “Many of the generic assets that have become household names are early stage venture investments when things look dark. 2021, early 2022, and maybe even 2023 could end up becoming a classic for their crypto investment.”
With the amount of technology accumulation taking place in the space, huge stores of capital to be directed towards, and the growing realization that blockchain-related products are more than viable, the space appears set to produce highly desirable types for many years to come.