Transparency, sidecars and crypto winter

by Jeff Davis

From the very beginning, venture capital has had two silos. In a silo, management makes day-to-day decisions about the fund’s investments. Second, limited partners – investors who provide funds to managers.

LPs in venture capital funds are passive. They are not involved in the day-to-day management of investment choices or portfolios. Fund managers receive management fees and carried interest for their active, hands-on fund investment construction. This opaque investment process works for bull markets, and positive returns keep LPs happy. When the market turned red, however, investors began to wonder why they were paying managers and began questioning investments for which they had no say in their choices.

But now, thanks to the rise of Web3, the pattern of passive investors and active managers is starting to change. Web3 challenges how traditional venture capital structures work in tandem with the creation of decentralized autonomous organizations known as venture DAOs. Venture DAOs are investment vehicles, and DAO members actively choose the projects they support. DAO members participate in the procurement and due diligence of projects they see as promising. When an investment is needed, they pool their own funds to support the project. The result is the same as in the traditional venture capital model, where targeted projects are identified and funded, but the level of engagement is very different. DAO investors choose which projects they will support, not the general partner and investment committee of the fund. Decision-making has become decentralized, so the result is transparency on what, how and when investment decisions are collectively made.

Venture capital investors are watching and seeking similar transparent investment opportunities. One type of transparent investment is the sidecar, where investors provide additional funding in a project and ride with pooled funds. It allows for larger investments in a single known opportunity than is often blinded to pooling capital. However, sidecar opportunities are limited and are usually reserved for the most senior investors in the fund. The Venture DAO is offering sidecars — lots of sidecars — and they don’t have to play favorite roles either. More traditional investors are looking for these known (see: transparent) sidecar opportunities. We should expect funds of all types to start heeding this growing mandate to satisfy their investors and to look elsewhere if their mandates are not met.

Decentralization in risk DAOs is not limited to the financial realm. Web3 has decentralized applications (dApps) for art and collectibles, games and technology. People liken Web3 to the dial-up modem stage of the Internet. But the Internet today is nothing like it was 20 years ago. Web3 follows the growth trajectory of the early Internet as new utilities are created. Mass adoption of Web3 will emerge as more use cases are developed; the speed of this adoption will depend on the funds available to creators during this “crypto winter.”

Many experts liken the current “crypto winter” to the bursting of the dot-com bubble. I would say they have a good argument, except this isn’t the only crypto winter we’ve had. There are multiple crypto winters; as the name suggests, they are seasonal. We have seen new highs after every previous crypto winter. People in the space have come to expect these seasonal valuation changes. The internet crash was unexpected, and many investors were exposed when the tide went out.

Also, the internet era ended when people suddenly realized that all projects with lots of cash are unlikely to be profitable in a few years or even a decade. If they do have a business plan or product. There is so much speculation in this day and age that almost any concept ending in .com can be funded. What we’re experiencing right now is a correction relative to other risky assets. These other risk assets, especially tech stocks, are adjusting to rising interest rates — not because these projects have no value or avenues to profitability. Web3 has businesses that make money, and businesses that will make money soon.

Yes, just like 20+ years ago, there is a lot of money chasing Web3 deals and valuations have become volatile. But these Web3 valuations will soon be using a 12 EBITDA multiple, rather than the dot-com-era projections.

Leave a Comment

Your email address will not be published.