Crypto Venture Capital’s Rejection Of Venture Capital And “The Box”

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I really like Bloomberg’s “Odd Lots” podcast. The hosts are pretty good (Tracy and Jo) and they consistently bring in awesome guests (readers might recall the Zoltan Pozsar-inspired Reserve Asset 3.0 article on an “Odd Lots” podcast).

Well, in this Monday’s episode, “Odd Lots” had Sam Bankman-Fried (SBF). He is probably best known for his outstanding hair, but he also founded the crypto exchange FTX. He ranks among the wealthiest in crypto and, given that he studied physics at MIT, probably one of its brightest (whatever that means). On the podcast, he compared crypto “yield farming” to a “box” that allows you to take out more money than you put into it.

Magically.

This quote hit me like a ton of bricks, but then it added a blow to the venture capital investment approach that irritated me. His view on venture capital is shared by many, but that view has been clouded by the introduction of crypto. I’m not saying that SBF is necessarily wrong. What I’m suggesting is that crypto venture capital… it’s… just… not really… venture capital.

That (and maybe more…) below.

Georges Kaloudis

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I am a bitcoin. According to the internet purist’s set of rules, that means I have to avoid altcoins and “crypto” altogether. But honestly, it’s boring.

I’m not boring, so I pay attention to the hellish landscape of “crypto this, NFT that and all blockchain” inspired by Bitcoin. Part of that means I listen whenever SBF speaks. I want to zoom in on two specific things he talked about in the podcast mentioned in the intro: 1) The Box and 2) venture capital.

‘The box’

On the podcast, Matt Levin (every newsletter writer’s hero) asked SBF to provide “an intuitive understanding of yield farming”.

Sam responded with:

You start with a company that builds a box…they probably dress it up to look like a life-changing, you know, world-changing protocol that’s going to replace all the big banks in 38 days. Maybe for now, ignore what he’s doing and pretend he’s literally doing nothing. It’s just a box. You can then put a token in The Box and you take it out of The Box. Okay, you put it in The Box and you get an IOU token for putting it in The Box, then you can trade that IOU for the token.

Sam Bankman Fried

Ok… an oddly simple example using a somewhat cynical tone: The Box seems a bit meaningless, a tech-enabled piggy bank.

He continued:

In about five minutes with an internet connection, you could create such a box and such a token, and [decide] that it should be worth $180 depending on how much effort you put into it. In the world we’re in, if you do that, everyone’s going to be like, ‘Ooh, Box token. Maybe that’s cool. Then it pops up on Twitter, and it will have a market cap of $20 million…

Sam Bankman Fried

Then yield farming kicks in and The Box starts distributing tokens as interest payments to people who put tokens in The Box.

Let’s say the total amount of money in The Box is $100 million and it pays out $16 million per year in X tokens, a return of 16%. It’s rather good. So people put a little more. And maybe it’ll happen until there’s $200 million in The Box… And now all of a sudden everyone’s like, wow, people are putting $200 million in The Box Box! It’s a pretty cool box, isn’t it? For example, this is a valuable box, as evidenced by all the money people have apparently decided to put in The Box. And who are we to say they’re wrong about that?

Sam Bankman Fried

Uh… who turned up the heat here? This is a scathing take on yield farming that you would only expect from its harshest critics. That it came from the mouth of one of the wealthiest in crypto was surprising. SBF essentially stated that yield farming consists of:

Step 1: Put some money in the box.

Step 2: Wait.

Step 3: ???

Step 4: Profit.

I have nothing more to add, as I think these quotes are largely sufficient on their own. I wanted to write about these quotes to emphasize that individuals need to exercise caution when deciding whether or not to participate in yield farming. Your performance could simply be based on nothing but The Box. Which can be fine, as long as you understand that and are okay with it.

Read more: What is yield farming? DeFi’s Rocket Fuel, Explained

Crypto Venture Capital vs Venture Capital

After talking about yield farming in the episode, SBF answered a question about how he thinks “institutional money or quasi-kind of venture capital” found the next big thing in crypto. . SBF offered to take it further and respond to how he thinks venture capitalists have found the next “everything they’re going to invest in.”

He said:

You get a weird process. Venture capitalists see what all their friends are talking about. And their friends keep talking about this company or this token, and they start FOMO [fear of missing out-ing] then their LP [investors in the venture capital fund] are like, yo, have you ever made us a lot of money from this company or this token? And the answer is no, we haven’t invested in it. But that’s not a good answer considering the question your LPs just asked. So instead you’re like, oh boy, you’re gonna be excited about what we’ve done and/or will do. And then you find a way to get into that token and/or business.

It’s bizarre processes like that, ultimately, that are like shaping venture capitalists’ investments in traditional stocks and in cryptocurrencies.

Sam Bankman Fried

Again. Cynical. But for all my personal cynicism, I don’t completely agree with SBF here. I think even though he tried to take a stand on venture capital in general, he still offered his crypto venture capital take. Because crypto venture capital and traditional venture capital are different.

Venture capital is a form of equity investment that targets startups and start-ups in emerging industries. Once a venture capital investment is made, then begins the five to 10 year process of growing, developing and running the business. Only then do venture capitalists and their LPs make a comeback. Rinse and repeat. Venture capital funds have a long-term time horizon, just like private equity and private credit funds.

Crypto venture capitalists, when not investing in the equity of companies operating in the space (companies like Coinbase), are investing in tokens. And when they don’t step in early in presales, they step in later when their LPs ask if they’ve invested in certain projects (as SBF suggested).

This model is not really venture capital. If a token that a VC investor buys after an LP has requested it, its price increases, the VC investor can reap profits by selling in the open market, perhaps after years , but sometimes after months.

This is one of the places where crypto-token venture capital diverges from traditional venture capital. The illiquidity of traditional venture capital investment commitments is part of the reason why investors expect “good” returns; they take a risk by locking in their money for at least five years, and investors feel they should be paid for that risk.

With token investments, crypto venture capitalists can enter and exit trades as easily as hedge funds. That’s what I think SBF was describing, but it’s not venture capital.

And that’s just one of the differences. There is much more that can be written that deserves attention. For example, there is likely a level of FOMO’ in traditional venture capital that is driven by the immense amount of capital that has been raised in recent years in search of investments. There is also something to be said about the fundraising figures announced by token venture capitalists, but that’s for another time (and perhaps another author).



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Crypto Venture Capital’s Rejection Of Venture Capital And “The Box”


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