The altcoin season is over. Is the crypto VC bubble to blame?

Author: 0xLouisT, L1D Partner; Translation: Golden Finance xiaozou

Why did altcoins plummet? Because of high FDV (fully diluted valuation)? Or because of CEX (centralized exchange) listing? Should Binance and Coinbase invest their treasury funds in new altcoins through TWAP (time-weighted average price) strategy?

The real culprit is nothing new, and everything can be traced back to the crypto VC (venture capital) bubble in 2021.

In this article, let's analyze how we got to this point.

1. ICO boom (2017-2018)

The crypto industry is essentially a liquid industry - projects can issue tokens representing anything at any time at any stage. Until 2017, most of the activity was concentrated in the open market, where anyone could buy directly through CEX.

Then came the ICO bubble, an era of crazy speculation, an era hijacked by scammers in an instant. It ended like all good bubbles: lawsuits, deception and regulatory shocks. The U.S. Securities and Exchange Commission (SEC) stepped in, making ICOs effectively illegal. Founders who wanted to avoid the U.S. court system had to find other ways to raise funds.

2. VC boom (2021-2022)

As retail investment was cut off, founders turned to institutional investors. From 2018 to 2020, crypto VC gradually grew - some companies were pure VCs, others were hedge funds that allocated a small portion of their assets under management (AUM) to VC investments. At the time, investing in altcoins was a contrarian idea - many believed that their value would eventually return to zero.

Then 2021 came. The bull market caused VC portfolios (book value) to soar. By April, funds had grown 20 to 100 times. Crypto VCs suddenly looked like money printing machines. LPs (liquidity providers) poured in, eager to seize the next wave of opportunities. Firms raised new funds that were 10 or even 100 times larger than before, confident that they could replicate those huge gains.

Of course, there are some psychological reasons why VCs are so popular with LPs, which I have discussed in previous articles.

3. Sequelae (2022-2024)

Then came 2022: Luna, 3AC, FTX and other events made billions of dollars of paper gains evaporate overnight. Contrary to popular belief, most VCs did not sell at the top. They experienced the plunge like everyone else. Now, they face two huge problems:

● Frustrated LPs: LPs who once cheered for 100x returns all asked to exit, forcing funds to reduce risks and take profits in advance.

● Overcapital: VCs have more idle funds than quality projects. Instead of returning funds to LPs, many funds are investing in projects that do not make economic sense, just to deploy the remaining funds to meet threshold requirements and possibly raise funds for the next fund.

Most crypto VCs are now in trouble - unable to raise new funds, holding a bunch of low-quality projects that are destined to "high FDV will eventually return to zero". Under pressure from LPs, VCs have shifted from long-term vision holders to short-term exit profit seekers, constantly selling large VC-backed tokens (Alt L1, L2, infrastructure tokens) at unreasonable valuations that they helped to create.

In other words, the motivations and timeframes of crypto VCs have changed significantly:

● In 2020, VCs are contrarian, cash-starved, long-term thinkers.

● In 2024, they are crowded, overfunded, and short-term profit-driven.

I believe that most VC investments in 2021-2023 will perform poorly. VC returns follow a power law distribution, with a few winners making up for the losers. But being forced to sell early will distort the final results, leading to weaker overall performance.

If you want to learn more about the average numbers for VC returns, I wrote the following article:

No wonder founders and communities are increasingly skeptical of VCs. Their incentives and timelines are not aligned with founders' goals, leading founders to turn to community-driven fundraising and liquidity funds to support tokens for the long term instead of VCs.

4. Evaluate Liquidity/VC Cycle

It is critical to track the flow of funds between VC and liquidity markets. I use a metric to evaluate the state of the VC market. This metric is not perfect, but it is very useful.

I assume that VCs deploy 70% of their funds linearly over three years - which seems to be the trend for most VCs.

Using Galaxy Research's VC fundraising data, I apply a weighted sum method that considers 16 quarters of deployment rates. This method allows for an assessment of the remaining idle funds in the system. In the fourth quarter of 2022, there is approximately $48 billion of VC idle funds. Next, I compared the remaining VC idle funds each quarter to TOTAL2 (crypto market cap excluding Bitcoin). Since VCs typically invest in altcoins, this is the best way to assess. If there is too much VC idle funds relative to TOTAL2, the market will not be able to absorb future token generation events (TGEs). Normalizing this data reveals the cyclical nature of the liquidity/VC ratio.

Typically, being in the "VC euphoria" area indicates that the risk-adjusted return rate of the liquidity market is better than that of VC. The "VC capitulation" area is more complicated - it may signal VC withdrawal or overheating of the liquidity market.

Like all markets, crypto VC and liquidity markets follow cyclical laws. The excess capital of 2021/2022 is quickly running out, making it more difficult for founders to raise funds. Cash-strapped VCs have become more picky in deals and terms.

5. Conclusion

●VCs have performed poorly in recent investments and turned to short-term selling to return funds to LPs. Many well-known crypto VCs may not be able to survive in the next few years.

●The misalignment between VCs and founders is pushing founders to look for alternative sources of funds.

●The oversupply of VC capital has led to poor allocation of funds.