Crypto Capital Tetralogy Part 2(B) —— The Battle between VCs and Token Funds


How should we treat the emerging token projects? How can retail investors quickly judge the rationality of token rights financing projects? How should regulatory agencies mediate from the technical and industry self-discipline perspective? How can traditional VCs participate in token interests as much as possible within their own equity legal framework? And as an entrepreneur, how do you choose from equity or token financing to help your project development?

This series of articles is about equity investment, equity financing, and token investments in the past, present, and future.

Part Ⅴ

What decides the victory in a poker game? Many people will say card skills. But many people overlook another crucial factor, the number of chips. Therefore, in the world of equity investment, those funds with massive amounts of capital often also get better deals. Of course, looking at the current VC industry competition, previously the RMB VCs competed in a red ocean, and now US dollar funds are also “rolling inwards.” Because, for VCs that are not at the megafund level, to grow and strengthen, they must inevitably go to two extremes, industrial capital or “influence capital.” In the investment industry, VCs, as products of the previous information asymmetry era, are no longer rare. Instead, it is more industry-dependent industrial capital and the core individual (entrepreneur/KOL) influence capital that has taken its place. This token investments and financing era is a new era of information symmetry, and anyone with a little bit of insight can participate in the token investments. However, the difference is that the threshold for participating in equity investment is relatively high, and the threshold for participating in token investments is relatively low. This has led to the emergence of a large number of token investments, and a large number of retail investors have also participated. However, due to the low threshold, the quality of these projects is uneven, and the risk is high. Therefore, it is particularly important to be able to quickly and accurately judge the rationality of these projects.

I cannot deny that token financing has a faster liquidation path. I advocate and adhere to long-termism, but when the short-term market bubble comes and there is a better exit path and higher exit valuation, why not let everyone make more money with you?

In addition, in terms of simply channels and means of exiting the financial market, the hot SPACs of the past two years and the token market are so similar, isn’t this just a prominent expression of this “liquidationism”?

Part Ⅵ

So, do we have to issue token? Before answering this question, I think there are three elements to issuing tokens – timing, location, and people. These three factors decrease in importance in that order.

Please note again that I am not talking about the project itself in the following, but rather the incremental value generated and the factors affected by issuing tokens on top of doing the project (company). I will not discuss basic factors of project development and other company operations.

The people factor is intuitively the “web3 gene” in the team, but the more important factor is actually the narrative behind the token1 issuance. In a sense, before 2021, web3 people were actually very exclusive and looked at web2 newcomers with skeptical eyes. However, since 2021, with the entry of a large number of “regular forces,” projects led by founders with web2 backgrounds already account for the vast majority. When considering future trends, we must recognize that projects combining hard skills & solid experience in web2 and methodology & insight in web3 will lead the industry.

However, many founders make the mistake of choosing the wrong approach to issuing tokens – for example, tools are not suitable for issuing tokens, as seen in The Graph and Dappradar. For tool-type projects, a to B business model is more suitable, which has a one-way, weak coupling relationship with the vast number of C-end users. This is not suitable for creating a good token model.

So – what kind of narrative is a good direction for issuing tokens, and what kind can be said to be a pitfall from the start?

Let’s give another example. As the general trading market of crypto, Price estimation is a really good business model and an interesting thing to do, and many projects have taken this as a starting point. If the main focus is on a valuator that uses its accumulated data and algorithms to build a model for price prediction, then it is a traditional business model, and even if it adds some trading functions such as smart trading, it is not suitable for the issuing token scenario. However, if we take one step further and open source the pricing model, establish an Oracle, allow users to participate in contributing data, and even have a certain impact on the final decision-making, and benefit from it to achieve a positive feedback loop (for example, first use the data barrier established by yourself to build algorithms and models, then open source the model, allow users to submit correct metadata, give a reference range for valuation, such as $5000-$10000, and then allow users to give their own valuation results based on the number of tokens in their hands within this range, finally take the weighted average. This valuation method can combine data rationality and market intuition), then the Oracle issuing tokens can almost be said to be a success.

Chainlink token price chart
Chainlink token price chart

A typical example is Chainlink. Although Chainlink’s circulation market value has fallen nearly 90% from its all-time high on May 8, 2021 to now, it is still ranked in the top 20 on the network.

The Graph token price chart
The Graph token price chart

To summarize, if you want to issue a token, you must be clear that the token must have “strong participation” and “strong liquidity”, that is, users must frequently use it to meet utility needs – if you just treat it as a voucher, then as a token attribute, it is basically “consumed” by users without much meaning; at the same time, its economic model is based on “deflation” or high-speed liquidity. For example, the Defi boom in 2020 began with yield farming of Compound, but it was the introduction of the concept of “machine gun pools” and the ability for users to create machine gun pools and trading strategies that really sparked more participation, creating more “gameplay,” improving the overall profitability of the project, and bringing in more users and new gameplay, forming a positive feedback loop.

Therefore, tokens need to have strong utility, or more worldly terms, “playability.” As for how to define “utility,” like “value,” it is a very difficult question, with a thousand Hamlets in the hearts of a thousand viewers. On this point, there will be an explanation in the follow-up of my series of articles – “Extra – Business, Investment Philosophy Sketch Talk.”

This is closely related to NFTs and is a question I am asked every day – how do you release an NFT that more people are willing to buy?

1.There should be a scenario for interaction with the user. If there is no interactivity, and continuous (not annual but weekly) new stories, it is just a digital product that does not have consumption or interactivity, then NFT as a digital product will be over after one wave of sales.

2.There must be a protagonist “strongly promoted”, in the case of a relatively high user threshold, only strong bonds and strong promotion are good, if you do not charge yourself, the user will not automatically convert, even if you are a star. Many people say that reducing the threshold can bring more users in, but even today, Buffett still does not like internet growth stocks, and it is still difficult for 60-year-olds to use computers, while for 90-year-olds, the internet is almost everything in life. “Lowering the threshold” is, in my opinion, not a man-made process, but a process of time sedimentation. In my opinion, the simple metamask is still not very familiar to web2 people who are used to the internet.

For this part, see the author’s another series of articles “On the Existence Value of NFT-Capitalization, Utility and Mass Adoption”.

Therefore, expanding the user base is the cornerstone of the future of the web3 project’s token monetization. The market is not limited to the English-speaking regions of Europe and the United States. There is huge potential for users in China, South Korea, Japan, Spanish and Portuguese-speaking South America, and Southeast Asia, where there are large populations but many languages. Even the most excellent projects need to break through language barriers. In the last period, when most of the world was still virgin territory for web3, top projects could easily occupy other countries’ markets, but as the industry matures, there are many local projects competing in every country, and it is no longer so easy to dominate. For a well-known American project, even if you are listed on Coinbase, it does not mean you will be able to make a name for yourself in other countries outside the English-speaking region.

In my opinion, the key to determining the success of a web3 project is not just the token price and the resulting profits for investors, but also liquidity. The liquidity of a project that is only listed on Coinbase is not comparable to the liquidity of a project that is listed on Coinbase and Binance, or on Coinbase, Binance, Upbit, Bitflyer, Kraken, Kucoin, etc. Therefore, if we are more accurate, the internationalization required for token issuance is not just about having an English-speaking team, or attending events and meetings in various countries, or finding a few market partnerships and KOLs to complete the task, but rather about being able to establish deep local connections in the main countries (more specifically, language regions) of the global web3. How do you judge this? For example, if you plan to issue tokens one year later and quickly expand to countries around the world, you should quickly think of who you can rely on in the local market of each country, at least one name that you can quickly get more relationship resources from in the local area. Because the schedule will become very tight after the token is issued, what you need to do is “persuade” and “confirm cooperation”, rather than just getting to know each other and lacking a trust foundation because there is no intermediary to introduce you.

The best thing is to establish a local team around a “anchor” and quickly gain more in-depth relationships as a resource center. Even the strongest teams, if they do not prepare early and find the right people, will fail miserably in localizing their efforts in South Korea, as Binance has learned. This is also true for NFTs. The globalization process of crypto in the past few years will be repeated, but faster. In my opinion, the three most critical countries for globalization are still the United States, China, and South Korea, in decreasing order of priority. Based on the willingness of the public to participate (impulsively), per capita purchasing power, and population base, I believe these three countries are the top contenders. This is also why NFTGo has established offices in these three countries and began corresponding local layout at the earliest stage.

The timing for preparing to issue tokens, including announcing the timing for issuing tokens, should be in line with the industry’s long-term cycle and industry iteration.

For example, the Defi bull market was mainly in the periods of July-September 2020 and January-April 2021. In fact, after May 2021, with the Bitcoin price reaching a peak of $58,000 and the attention and funds attracted by the Doge series such as Shiba token, Defi has been on a downhill slope until today. The reason is that few people realize that the meaning of Defi protocols is to serve as a “reservoir” for crypto assets. When the price of crypto assets such as Bitcoin and Ethereum rise, there will be a series of demand for capital overflow, and the financial opportunities such as lending for this part of the capital will flow into the “reservoir” the most. Once the price of the underlying asset shrinks, the “reservoir” of Defi will shrink rapidly or even be drained. The significance of Defi for the industry is the creation of new protocol forms, rather than the innovation of underlying assets or the driving role in the transformation of industry infrastructure.

Therefore, even if there was a bull market in the industry in the second half of 2021, especially in September-December, Defi still did not shine, but was overshadowed by NFT and Web3. This is mainly because, from the peak of $58,000 for Bitcoin in May 2021 to the all-time high of $69,000 in November 2021, the increase was only 20%, and the water was not big enough, or the water went elsewhere (such as emerging assets like NFT) instead of coming to you. Therefore, the timing for issuing tokens (I emphasize again, the timing I am referring to is the timing for issuing tokens, not the timing for starting the project build, which must be much earlier) should also be at the beginning of a bull market, finding the important turning point of the entire industry cycle, and issuing tokens slightly past the turning point will be the “perfect timing”.

I spent the longest section talking about people and only three paragraphs talking about timing. That’s because timing is really the hardest thing to control. We often say that the most scarce insights are often the ones that are the hardest to explain with language. Out of 100 Web3 entrepreneurs, there may be 10 who understand people, 5 who understand location, and only 1 who understands timing. And timing changes as the industry progresses. The first prophecy in my “Unlocking the New Code: From Blockchain to Digital Currency” written a few years ago, I now believe is relatively biased. Now, I tend to conclude that “Bitcoin’s market value will be surpassed, and most likely it will be Ethereum. When this moment arrives, it will mean that the industry’s four-year period led by Bitcoin’s halving cycle will end and the industry’s beta will no longer be as significant, and instead alpha will be used to achieve excess returns and become profit-oriented, which also means the beginning of the industry’s explosion in applications.” Four years later, the logic of controlling “timing” may undergo fundamental changes.

Part Ⅶ

So, the logic for issuing tokens is now clear. If you can really hit the timing, location, and people, it should be at least an average level of token investments.

But, as an entrepreneur, can we do better?

Yes, by combining equity and token financing.

Generally, equity financing is difficult at first and then easy, while token financing is easy at first and then difficult. In a bull market, token financing is a pursuit of the ultimate speed, often relying on relationships, experience, or even intuition to quickly respond in a situation of serious information asymmetry. This is a means of “quickly choosing a project that can make money based on previous successful experience, and through high turnover and exit speed, to achieve excess returns beyond the industry beta.” So, in practice, when the valuation of a company that is conducting token financing is lower than a certain “critical value,” and some basic conditions are met, it can even be determined that this will definitely make money.

But with equity, on the other hand, if the valuation of a project is not high enough in the early stage, it is not easy for the valuation to go up later, and in competition, it is likely to be suppressed by opponents forever due to lack of breath.

And more importantly, the proportion of token financing investors’ chips is often far lower than that of traditional equity companies. We generally believe that the early stage financing ratio of a token financing project should not be more than 15% or even 10%, and even if the token financing is re-financed through OTC or other means, the proportion should not be higher than 25% when the project is listed on an exchange such as Coinbase or Binance (meaning the project is close to maturity). For an equity project, at least 40% of the shares belong to various financial investors at the time of listing, and in some cases more than 60% is not uncommon. I have explained this in detail in the above “Crypto Capital Theory Quadrilogy, Part Two (Upper)” and will not repeat it here.

Algorand token supply graph
Algorand token supply graph
Didi Prospectus Shareholding Ratio Chart
Didi Prospectus Shareholding Ratio Chart

A classic comparison is between Algorand and Didi, both well-known projects in the Web3 and Web2 industries, respectively. The proportion of tokens belonging to external investors in Algorand ultimately did not exceed 20%, while Didi exceeded 60%.

As mentioned above, a good token project should have “high interactivity.” Here is a point that is often questioned by investors: There should be barriers to competition between businesses. If you pursue “interactivity” and allow users to participate, you will inevitably have to open source, which is equivalent to losing business barriers and allowing other protocols to copy and finish it.

I believe that many people do not understand the core meaning of equity investment, which is essentially a discounted expectation of future profit dividends, and a risk investment; but token financing is not the same. I understand it as a discounted expectation of future mass participation, and participation is strongly correlated with utility.

Correspondingly, debt investment is an investment based on the ability of future core assets to repay debt and cash flow, and must have a liquid asset. If you still cannot understand token financing and want to add the logic of equity investment and exit to token financing, then think about how much disappointment you would face if you invested in corporate bonds using the philosophy of risk investment.

Therefore, for token investments, what’s the problem with open sourcing and allowing other protocols to copy it? Let them copy it and then establish a connection with them, and the user base of each project will not decrease, but only increase.

This is similar to investing in a country. If you have the opportunity to invest in a country, you should not only look at GDP, but the greatest value is the circulation rights of its issued currency. If countries only look at competition from a competitive perspective, each country should not open up international currency circulation in order to “protect local industries.” In fact, only through more market-oriented international trade and currency exchange can a more robust “currency issuance market” be created.

From this perspective, why do we say that Web3 projects, especially public chains, are more like “countries” than purely traditional equity enterprises?

So, in order to truly transition from a equity-based company to an open protocol, we must transition from “having a self” to “having no self”. First, we must create core value, and in this stage, we must use traditional business management thinking. Then, through “having no self”, we can achieve exponential growth in financial value.

To summarize, I believe that in managing a web3 project, the best approach to choosing equity or token financing is to “be innovative while remaining true to our principles”. That is, first create a baseline by focusing on cash flow and using our product and global reach to reach as many users as possible. In this process, look for the most appropriate narrative for token issuance, and enter the market in search of an upper limit before the bull market arrives. Furthermore, I believe that issuing multiple tokens is not only possible, but is actually a better choice.

Someone asked, how can we issue multiple tokens?

Why not? Equity companies can still split and go public, and they can use a SPAC to transfer core assets, so why can’t token companies do the same? As long as you have a high-quality core asset, you can issue multiple tokens in different directions (obviously, you can’t use the same narrative for multiple projects) and at different times (obviously, you can’t issue multiple tokens densely within the same time period), as long as you maintain a good rhythm. What’s wrong with conducting several token issuances?

Equity financing and token financing can be used alternately if they are used properly. As for the legal issues that may arise from this, I will discuss them in detail in Part 4 of this series, “Token Financing and Legal Practices”.

As an example of “sense of rhythm”, Opensea’s high valuation (announced a $13.3 billion E round in January 2022) actually hinders its potential path to issuing a token. Such a high valuation corresponds to heavy profit expectations, so it is no longer possible for it to transform into an open protocol.

Coinbase market capitalization chart
Coinbase market capitalization chart

By comparison, Coinbase, which is also an exchange and has been around for almost 10 years, does not even have such a high market value on the stock market.

Of course, I don’t think it is a healthy performance for a web2 product based on the web3 world to have such a high valuation.

After all, my business values prioritize making investors money. Is it possible to continue to the next round of financing and exit at a reasonable valuation when the valuation is already so high at such an early stage, far from IPO?

On the positive side, I think Dapper Labs is a phenomenal example. This kind of fractional financing model leaves room for Dapper Labs to split and go public. Dapper Labs, the parent company, has consistently pursued equity financing for years, and its well-known sub-projects include Flow, CryptoKitty, and NBA Topshot. Flow is a well-known NFT public chain, CryptoKitty is the industry’s earliest native project to create the concept of NFTs, and NBA Topshot is an outstanding representative of the NFTization of real IP. All of these have brought good returns to Dapper Labs’ shareholders, and they have all been achieved through tokenization.

Dapperlabs’ financing journey is shown in the figure (deleted the financing that was spun off from its parent company in February 2018)。                                                              Refer to:
Dapperlabs’ financing journey is shown in the figure (deleted the financing that was spun off from its parent company in February 2018)。 Refer to:

I believe that in the background of VCs increasingly emphasizing DPI, companies like Dapperlabs, which achieve phased liquidation through currency rights while returning profits to equity investors and at the same time preserving the steady development of their core business, will strengthen the expectation of future equity liquidation and be emulated by many companies in the future.

Part Ⅷ

Now that we have discussed currency rights and equity, let’s move on to the next stage – how can we become more rational in token design when we decide to issue token? What is the rhythm of a reasonable “currency right operation” to ensure exchange and liquidity at the right time? In the actual operation process, how can we minimize conflicts between equity and currency rights through advance design? Wait, before that, shouldn’t we make a more precise definition of the word “token”, what exactly are we talking about when we mention cryptocurrency, token, and NFT?

The next article may be somewhat academic, but I hope you can still find answers to your questions.


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