VC’s Dilemma: Liquidity Change and Trust Mechanism Reshaping

Author: YettaS Source: X, @YettaSing

The biggest feeling I had when I went to Consensus HK this time was that VCs had a very difficult time. It was no exaggeration to say that there was widespread grief, which was in sharp contrast to Marshal P. Some VCs could not raise the next round of funds, some VCs had half of their people leave, some VCs turned to strategic investment instead of independent investment, and some VCs even considered sending memes to raise funds...

Many VC peers also chose to leave, some joined the project side, and some transformed into KoL, which seemed to be more cost-effective options. In the changing situation, everyone is looking for a new way to survive. And I am also thinking, what is wrong with VC? How to break the situation?

First of all, we have to admit that the best era of VC as an investment asset class has passed, both in China and the United States. The following figure shows the return data of several Lightspeed funds. The best fund invested in Snap, Affirm, and OYO in 2012 and achieved a DPI return of 3.7X (DPI is the distributed return multiple, which does not rely on valuation and measures the actual return on funds exited). Of course, it is completely incomparable with directly buying BTC, and even recovering the investment has become a problem since 2014.

China's VC has also experienced a similar trajectory. Relying on the demographic dividend, the rapid growth of mobile Internet and consumer Internet has spawned hundreds of billions of companies such as Alibaba, Meituan, and Byte. 2015 was the last highlight. Subsequently, stricter regulation, tighter liquidity, declining industry dividends, changes in the industry cycle facing growth bottlenecks, and limited IPO exit channels caused a sharp decline in the return rate of VC institutions and a large number of practitioners to leave the market.

Crypto VC is no exception. With the changes in the macro environment, the evolution of market structure and the decline in capital returns, VCs are facing huge survival difficulties.

It's all about cost and liquidity

In the past, the value chain of VC investment was clearly visible: the project party brought innovative ideas, VC provided strategic support and resources, KoL amplified the market voice at critical moments, and finally completed value discovery on CEX. Everyone provides different values ​​and bears different risks at different stages, and obtains matching returns. This is a "relatively fair" value chain.

For example, as a VC, the value we provide is never as simple as investing a sum of money in the early stage. How to help the project party quickly connect to the key resources in the ecosystem to promote business development, provide timely advice when the market changes suddenly, help the project party adjust the strategy, and even help build the core team. In addition, in order to make a long-term binding with the project party, let’s not talk about when the TGE can be held. Even after the TGE, we generally face a one-year lock-in and 2-3 years of vesting. To a large extent, we all hope to play a non-zero-sum game of PVE with the project party.

However, in the current market environment, the core contradiction lies in the extreme lack of liquidity, intensified market competition, and the VC model is unsustainable.

The change of capital flow: Where does the dilemma of VC come from?

The main driving force of this round of bull market is the strong entry of US Bitcoin spot ETFs and institutional investors. However, the transmission path of funds has changed significantly:

1. Institutional funds mainly flow to BTC, BTC ETF and even Index, but never spread to the wider altcoin market;

2. Without real technical/product innovation support, altcoins are difficult to maintain high valuations.

This directly leads to the VC model being highly FUD in the current market environment. Retail investors believe that VCs enjoy unfair advantages, can obtain chips at a lower cost, and have access to key market information. This information asymmetry leads to a collapse of market trust and further depletion of liquidity. In a PvP environment, retail investors demand "absolute fairness". In contrast, the strategy of secondary funds will not be in strong opposition to market sentiment, because retail investors can also enter the market with the same chips, after all, they have been given an absolutely fair opportunity.

The current huge Fud against VC is a counterattack of "absolute fairness" against "relative fairness" under the shortage of liquidity.

The rise of the Meme financing model

If I regarded Meme as a cultural phenomenon last time, then this time, we need to regard it as a new way of financing. The core value of this financing method lies in -

• Fair participation mechanism: retail investors can track information through on-chain data and obtain early chips under a relatively fair pricing mechanism;

• Lower entry threshold: During the DeFi Summer period, we supported many solo devs who relied on product innovation to drive value capture. Now, the Meme model has further lowered the threshold, allowing developers to "have assets first, then products."

There is nothing wrong with this logic itself. Looking back, many public chains have conducted TGE without a mature ecosystem or main network. Why can't Meme use the same method to attract enough attention first and then promote product development?

In essence, the evolution of the path of "asset first, product later" is the sweep of the entire financial ecosystem by the wave of populist capitalism. The prevalence of the attention economy, catering to the public's desire to get rich quickly, breaking the monopoly of traditional financial institutions, lowering the threshold of funds, and making information public and transparent are all unstoppable trends in the new era of populism. GameStop retail investors fought against Wall Street, and the evolution of fundraising methods from ICO to NFT to Meme are all financial interpretations under the wave of the times.

So I said that Crypto is just a microcosm of this era.

The role of VC in the new model

No financing model is perfect. The biggest problem with the Meme financing model is that the signal-to-noise ratio is extremely low, which brings unprecedented trust challenges——

• The signal-to-noise ratio is extremely low: fair launch makes the cost of asset issuance extremely low, and a lot of garbage will be flooded in it.

• Insufficient information transparency: For high-liquidity Meme projects, everyone in the market can enter at an early stage, which means that whether the project is built for a long time has become less important. What is important is how to make a profit in the game.

• Trust costs soar: high liquidity means high game. The first day of circulation means that we have no mechanism to bind interests with the Founder to achieve long-term win-win results. Everyone will become a counterparty at any time and become each other's exit liquidity. This trust structure is dangerous and unsustainable.

I agree very much with @yuyue_chris's article on the differences in mindset among different participants:

• People who play Meme think: narrative > chip structure ~ community or emotion > product technology;

• The primary market thinks: narrative > product technology ~ chip structure > community or emotion;

The Meme model is essentially a darker on-chain world than the VC model. Due to the lack of product and technical support, "absolute fairness" is often just a cover. Look at Libra. Every time the cabals behind the market carefully plan public benefits, we will eventually become the object of precise harvesting. They can always predict your predictions. In a highly gamed environment, the real long-term Builder becomes difficult to distinguish.

I don't think VC will disappear, because this world is full of huge information asymmetry and trust asymmetry. For example, cooperative resources like ARC are definitely not available to an ordinary Dev.

But in the face of such a wave of populist capitalism, it is unrealistic for VCs to simply use information asymmetry to make money as in the past. It is never easy to adapt to changes, especially when the market paradigm is completely reconstructed and the effective methodology in the past is quickly eliminated. The rise of Meme financing is not accidental, but the result of deeper liquidity changes and the reshaping of trust mechanisms.

When the high liquidity and short-term game thinking of Meme meet the long-term support and value empowerment of VC, how to find a balance between the two is a problem that VC must face now. On the one hand, Primitive is very fortunate to have the freedom and flexibility to respond to market changes, but it is not easy to recognize structural changes and change its investment strategy.

But no matter how the market changes, one thing remains unchanged - the real long-term value is those excellent founders who have foresight, strong execution, and are willing to continue to build.