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Venture capital (VC) investment in the Web3 space has been hot this year, with several established VCs launching Web3 and encryption divisions. Paradigm’s $2.5 billion fund and Electric Capital’s $1 billion fund are just a few examples.
So why are these companies so optimistic about their Web3 investments?
The token economy that underpins many web3 projects can deliver outsized returns compared to Web2 investments. This is especially true in the current environment of soaring inflation, rising interest rates, falling startup valuations and market volatility. While the cryptocurrency market has seen its ups and downs in 2022, its total market capitalization has grown by nearly 200% in 2021, with Bitcoin and Ethereum returning around 60% and 400%, respectively. Other cryptocurrencies have had impressive returns, such as Avalanche up around 3,300% and Solana up around 11,000%.
more industry-specific, The market cap of DeFi (decentralized finance) in 2020 is only $2 billion, while open one $160 billion market cap in 2022 — an 80-fold increase in just two years.Many well-known investors and institutions are making bold predictions that DeFi, which currently makes up a small percentage of the traditional financial markets of the S&P 500, may be worth it 100 times more in just five years.
Related: 3 Steps to Web3: The Ultimate Guide to Navigating Web3 for Non-Technical Founders
The NFT industry is also experiencing explosive growth, becoming a $40 billion market by 2021, a 21,000% increase over 2020! The NFT market is almost on par with the traditional art market, and for good reason. If you’re an early investor in a specific project like CryptoPunks or Bored Ape Yacht Club, you’ll get a staggering 100x return in less than a year.
Of course, for every big winner, there are countless losers. Given that your typical VC fund’s target annual rate of return is between 20-30%, VC funds just need to pick some solid investments. As we’ve seen, there are plenty of opportunities to invest in potential unicorns early on, earn 100x returns and cover countless failures. This particular period of Web3 represents an opportunity reminiscent of the early days of the internet boom that spawned many of today’s most prominent VCs.
Traditional equity investments in startups are illiquid. Investors often need to wait for a liquidation event such as an IPO or acquisition to cash out. Of course, there is a secondary market for private stocks, and acquisitions by private investors have been around for some time. However, this is a very complex process and is not considered a liquid investment.
On the other hand, most of the early Web3 projects issued tokens that could be traded on exchanges at any time. Suppose, if an investment hits 100x in a short period of time, investors usually have the opportunity to realize returns faster because there is no lock-up period.
Furthermore, a startup relying on its token economy essentially means it is built on-chain. “On-chain” (data stored publicly on the blockchain) means that startups and their key metrics are much more transparent than private markets. This is because investors in Web3 projects can see how much money they have, how the money is allocated, and so on.This information is usually available on the platform with just one or two clicks, e.g. Ether Scan.
Rather than just making a traditional equity investment and hoping for a capital gain on exit, tokens offer a unique opportunity for VCs to generate passive income from their holdings.
This can be done by either:
- The most popular are Stake your tokens. This means using your assets to support a blockchain network utilizing a proof-of-stake consensus mechanism.
- Another way is Yield Agriculture. You can deposit tokens into the liquidity pool and earn interest.
- Finally, you can take advantage of Liquidity mining. This means you can provide liquidity to DeFi protocols and earn rewards.
Related: 9 Trends Shaping the Blockchain Industry
The rewards of these passive income mechanisms can be quite dramatic.they often range from 2 to 25 Percentages, or for some higher-risk projects, more than 1000%. Additionally, these rewards are typically distributed daily, a dramatic change from the interest-bearing term deposits or dividends we’re used to.
This ultimately means that venture funds can generate attractive passive returns for themselves and their partners ahead of any liquidation event, thereby incentivizing them to not only maintain their position, but further contribute to the success of the project.
The Internet and its subsequent innovations have enabled startups to take advantage of near-zero marginal cost solutions and unprecedented economies of scale. This makes the former internet company look seriously capital inefficient.
Let’s take Netflix as an example. Netflix has thousands of employees and a market cap of more than $100 billion in 2022. By comparison, its brick-and-mortar predecessor, Blockbuster, had a peak market capitalization of just $5 billion, with more than 60,000 employees and a lot of real estate.
What does this have to do with Web3? Web3’s token economics and base-layer infrastructure, which underlies how projects pool funds, coordinate, and incentivize holders, can make web2 companies appear as inefficient as their pre-web predecessors.
Chris Dixon of a16z wrote He said he “has never been involved in a project that spends a lot of money on sales and marketing. You don’t need to spend money on marketing when the user is the real owner, loves what they do, and loves telling other people.” Web2 companies typically spend millions on aggressive marketing to accelerate consumer acquisition, while Web3 startups can expand the network through token incentives.
UniSwap is a leading decentralized exchange with a market cap of $6.2 billion and 50 employees. The market value per employee is a staggering $124 million.From this perspective, the most successful company of all time, Apple, is located at approximately $18 million per employee.
This proves that startups no longer need to hire too much talent. Instead, they can strategically leverage their token incentivized network to help them build, scale, and thrive, essentially becoming a low-cost model for fundamental talent acquisition.
Bottom of the S-curve
As mentioned, this is an incredible new space, largely defined by a sense of urgency and excitement reminiscent of the early days of Web1.Similar to Web1, there are many Hype and stupid money is coming into the space, so we should proceed with caution.
Most major financial institutions predict that the wider web3 industry will grow at a compound annual growth rate of approximately 50% over the next decade to become a multi-trillion dollar industry. Despite early criticism of cryptocurrencies, JPMorgan, Goldman Sachs and Citi recently launched crypto research units to take advantage of the fast-growing opportunities.
Today, we are at the bottom of the S-curve, which means this is likely to be a once-in-a-lifetime opportunity.
Related: Are Investors Realizing the Potential of Web 3.0?