‍Venture Capital Adventures In Web3—Same-Same, But Different 

Editor's note: This article is based on BFF's Twitter Space, Venture Capital In Web3. Listen to the full recording.

Web3 is poised to shake up many industries through its innovative and disruptive nature. The values of self-ownership, decentralization and tokenization drive an aspiration towards trustless systems and community-oriented business models. But how does this affect the circulation of venture-capital (VC) funding?

Some critics of the ecosystem claim that Web3 is built by venture capitalists because of the significant VC investments that have fueled the industry to date. A16Z, one of the leading venture funds in the tech space, famously announced their $4.5 billion fund entirely dedicated to Web3 back in May of 2022, signaling their continued commitment to the sector. However, the sentiment has shifted dramatically since then, rapidly fading against the backdrop of recent macroeconomic headwinds and multiple crypto collapses of yesteryear. To put this in perspective, earlier this year Crunchbase reported a year-on-year drop of 82% in VC funding in Q1 2023. 

Despite the investor narrative shifting sharply from Web3 in 2023, there remains a group of VC investors whose conviction to the space has not wavered. BFF spoke to three of them to learn about the present-day VC landscape.

How is VC different in Web3?

Broadly speaking, VC funds are in the business of taking asymmetric risks on innovative, disruptive and highly scalable businesses, in the hope of equally asymmetric returns. But the VC industry itself is being disrupted by Web3. Traditionally, VC investment would be in the form of equity, meaning shares in a private company, which required a liquidation event such as an acquisition or an IPO in order for the VC to realise the return on their investment. In practice, this means that the money invested can be locked up for anywhere between five to 10 years. 

In contrast, investments in Web3 startups are often in the form of tokens rather than equity, which gives the investor an opportunity to crystallize their investment much earlier, as long as there is a liquid market for the tokens.  

This tokenized environment also means that the startups have more options when it comes to fundraising. Rather than seeking VC funding, a startup may choose to launch a token and raise funding in the public market, which essentially creates a competing source of capital to that of a VC.

“Venture Capital in general is a business of navigating high levels of uncertainty, but in Web3 it is navigating high levels of uncertainty plus a lot of depth, breadth and shifting of ideas all at a very rapid pace,” says Hanan Nor, program manager at Outlier Venture’s Web3 startup accelerator.

Despite the higher levels of uncertainty, the potential for outsized returns in Web3 is what investors find appealing. “This is a rapidly growing space, and we do see there are a lot of blank spaces and opportunities, where teams can validate their product market fit even before they introduce VCs into the mix, which accelerates the product life cycle,” says Sunny Guo venture manager at New OrderDAO, an investment and incubator community for Web3 projects. 

What are VCs looking for in Web3 projects?

Although Web3 is a new domain, the decision making process for VCs remains largely consistent to what it looks like traditionally. The VCs we spoke to pointed to the following foundational qualifiers:

A clear thesis

Web3 offers a broad range of products, services and related verticals, so the funds are looking for projects that best align with their investment thesis and their convictions in the space. “Some of the core areas we are interested in are B2C2C and B2B2C," says Vera Li, special council at ApeCoinDAO and advisor at Synergis Capital a New York based VC fund investing in Web3. "We are looking at blockchain-based solutions that can be integrated with traditional enterprise solutions, which we believe will ultimately drive greater adoption. This could be, for example, in UGC or the personal identity space, which we see as increasingly important as we anticipate further blending of the real life and virtual experiences in the years to come."

Commercial viability

One of the additional layers of complexity in Web3, driven by the nascent stage of the industry, is that commercial viability becomes a bit of a theoretical concept. For many products, the market or the demand does not yet exist, so investors are betting not only on the idea of the product but also on the fact that the Web3 space as a whole will see greater adoption in the future. 

“We look at the assumptions that the founder is working with respect to the potential market, and then it becomes a matter of validating each assumption,” says Guo.

Other considerations that might come into play are more fundamental ones like if this particular solution needs to be on-chain or whether it serves as a feature rather than a standalone product. 

Founder fit

The earlier the stage of investment, the more the investors are betting on the founder. In the early stages, when there is not much traction or data, founder fit is one of the key elements when it comes to assessing a deal.

“You assess a founder's past performance as a projection of future success, but a lot of the time you are also betting on the qualities that they have. Like grit, determination, communication and ability to execute,” says Nor. She works with more than 40 teams that go through OV’s Web3 accelerator every quarter, helping them to navigate through the early stages of their Web3 entrepreneurial journeys. Nor also flags ability to follow through and resilience as other important qualities, particularly in the current stage of the market. 

For Sunny Guo from New OrderDAO a good founder fit is also characterized by a founder who has a unique insight and a deep understanding of the pain points that they are solving for. 

What are the regulatory risks of venture in Web3?

VC is inherently risky, however operating in Web3 adds another layer of risk as the space is largely unregulated in most jurisdictions. Projects building crypto exchanges and DeFi protocols are all navigating the space without clear regulatory guardrails. Lack of regulation does not mean that innovation should not move forward, it does however mean potential headwinds in the future. 

“The regulation risk we cannot control. But history shows that the very successful founders that we've seen are the ones that drive their mission while being aware and respecting the regulatory parameters, rather than aggressively operating at the edge,” says Li.

Building community-driven investment

Community is a major pillar of Web3 and it translates nicely into new community based investment vehicles. Investors come together to form decentralized autonomous organizations (DAOs), leveraging a broader range of both skills and capital in order to fuel the new ecosystem of builders.

The concept of a DAO is not too dissimilar to an investment syndicate or a venture capital fund, but this new format uses token and voting mechanisms to organize activities. 

“New Order is a community-led incubation DAO that builds startups in decentralized finance and Web3. We launch early-stage protocols through strategic internal incubation and our accelerator program,” says Guo. The DAO essentially acts as a co-founder in these projects and supports them through their network of developers, researchers and strategists, with a percentage of the incubated project’s token supply going into the DAO’s treasury. 

Other examples include founder DAOs such as Orange DAO, seeded by Y Combinator alumni and the Australian-based Upside DAO that counts some of the Synthetix protocol OGs as members. Both aim to use not just capital but also unique skills and experience of its members to grow the Web3 ecosystem and encourage more building in the space.

Where to from here?

After a tumultuous 2022, the Web3 landscape has become a lot more quiet. The valuations have come back to more reasonable levels and while the capital is not flowing as easily, the good teams and projects are still being funded. Accelerators and incubators are humming along, and shameless self-promotion has been replaced by a studious build phase. One thing remains clear, no one really knows the extent of the possibilities of this new era of the internet or what the final destination looks like but many are still willing to bet on it. 

Read More: Tesla And Walmart Have Registered Web3 Domain Names—Here's What That Means

Liya Dashkina is a VC, contributor to a number of DAOs, Web3 consultant, chapter lead at the Australian DeFi Association and an advocate for women in Web3.

This article and all the information in it does not constitute financial advice. If you don’t want to invest money or time in Web3, you don’t have to. As always: Do your own research.

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