over 2 years ago • 9 mins
This is the edited transcript of an interview with David Chreng, co-founder of the blockchain-focused venture capital firm LeadBlock Partners. Tap the 🎧 button above to listen to the audio version.
Crypto markets have been booming this year, sending stalwarts like bitcoin to fresh highs and introducing a whole new audience to novel products such as non-fungible tokens (NFTs) and decentralized autonomous organizations (DAOs).
With interest in the space increasing with every passing week, we wanted to pick the brains of a professional who invests in crypto and blockchain projects professionally: David Chreng, co-founder of the blockchain-focused venture capital (VC) firm LeadBlock Partners.
David explained how blockchain-based investments differ from traditional VC investments and how smaller retail investors can get involved. He also explained why the next generation of the internet – known as web3 – is getting him so very excited.
David began by telling Finimize analyst Andrew Rummer how he goes about identifying promising blockchain-focused investment opportunities.
David Chreng: So number one still remains the team – and initially the founding members, with their vision, their experience, their network, their ability to execute, but also to attract, train, and retain talent. Because that's a massive bottleneck to growth.
Number two is the market need and maturity, but also the product that will address it. So for instance, you can have the most innovative product, but if it is actually “nice to have” instead of “must have”, I can almost guarantee that you will have a hard time selling it. And the second element – market maturity – I think is a critical factor. Because if you’re looking at the blockchain and crypto space, back in 2017 or 2018, the funding environment for those businesses was not necessarily there. So even though you can have great talents behind the startup and the product, if the market isn't ready for it – and by market, I mean customers and investors – there's going to be some trickiness in finding external capital to fuel your ship.
Andrew Rummer: In the classic VC setup, there's only really one way to invest, which is taking an equity stake in the company. But it strikes me that in the blockchain or crypto ecosystem there's two ways of investing: you could take an equity stake in a company that’s building a project or you could invest in the crypto tokens that sit at the heart of one of these projects. So do you invest in both equity and tokens – or just one or the other?
David: With LeadBlock Partners’ Fund One, we are only investing on the equity side. We are going to create a hybrid model, where we'll have the ability to invest also in tokens at early stages, but applying the same methodology, the same assessment, the same metrics that we do for traditional VC investing.
Andrew: Is there a different process to assessing an investment in startup equity versus a startup crypto token?
David: It's quite different, to be honest. There are some factors that remain the same – for instance, as I was mentioning, on the quality of the team – but I'll say the number one difference between the two will be liquidity. So when you're investing in tokens, even taking into consideration the vesting, and the lockup period, you still tend to have a liquidity event earlier than in a traditional equity investment environment.
But it also means that you need to think about the liquidation avenues for your token, because if the market cap – the value of your project – is very low, with low liquidity pools in the system, you would have what is called a slippage. Which means that, let's say, you have 10 euros worth of token and there's only five euros worth of demand. That means that if you're looking to sell at a specific point in time – where there is actually an imbalance between buyers and sellers – you could have an impact on the price at which you're going to be selling your tokens.
So that's something that you need to consider, which is not necessarily what most private investors would have in mind – especially when you're investing early. Because the reality is that if you're looking for equity investment and there is a liquidation event – for instance a public listing or trade sale – there is already an idea of the price at which you're going to be selling your ownership.
And the second element I'd like to highlight is the business models: they are very distinct. If you're thinking about an equity investment from a pure, standard, simple definition, an equity investment into a company gives you a legal ownership of the company, which then entitles the investor to some right over investment. If you're thinking about a token investment, this applies as well, but this applies through a smart contract. And the token in most cases has a utility, that then derives economic value. So the dynamics are quite different. I think that the mindset for identifying the business need and the team in early premises tend to remain the same. But on the token side, there's additional consideration that you need to bear in mind as well.
Andrew: I’d like to dig into that a little bit further. If you're investing in a company’s equity, then the ultimate goal is that you hope that company becomes profitable and generates a cash flow that is somehow returned to you as an investor. But how does that work in a token-based investment? Where are the cash flows generated? What are you looking for when you judge these token investments?
David: If you're looking specifically on the token side, there are revenue streams that are generated on the back of those token-denominated projects. If you're taking the example of decentralized exchanges, like Uniswap or SushiSwap, that enable you as an individual to convert one token into another token, when you do that, you need what is called a “liquidity pool”. That is effectively a contribution from either third parties or individuals like yourself or myself, and for every transaction made a percentage of the fees taken is going to be redistributed back to the founders of the product, but also to the community, ie. the token holders. So there are actually revenue streams that are generated.
And then if you want to compare in very simple terms between being a shareholder of a private company and being a token holder of a crypto project doing the same thing, I'd say that if you are an equity owner, and the company hasn't decided to distribute dividends, your return will be based on the share price appreciation over time, right? Despite the fact that the revenues can go up and down, at any single point in time if the company doesn't want to distribute dividends, then the only way for you to materialize your value or your loss is when you actually sell your shares.
On the token side, if there is already an incentive baked into the smart contract of the project to redistribute a portion of the revenue generated by the platform, as a token holder, you would already get that effectively. So you would expect to get that sometimes a bit earlier.
And the second element is, as a token holder, you also have what is called “governance” rights. So let's say there is somebody behind a project that would like to give 10% of the revenue stream back to the community, you can, in theory, always submit that request to the project for a governance vote. And that's the beauty also of that decentralized ecosystem, which is effectively the DAO type of mechanism – a decentralized autonomous organisation – where control is moving from a centralized counterparty into a decentralized system where the community have their say.
Andrew: So, moving on a little here, there are a few terms that come up whenever I start talking about crypto investing at the moment: one is web3 and the other is the metaverse – the idea that we’ll increasingly interact in immersive online environments. What’s your take on web3 and the metaverse? And what are the opportunities for investors in this whole area?
David: On the metaverse side, I have to admit that that's one area where I'm very excited – especially how web3 is unlocking new models and market dynamics. So just to define a bit what web3 is: if you go back a few decades, in the 1990s, we have moved from the world of web 1.0 with the emergence of the Internet, where we were mostly in a read-only mode. So people were consuming content, but there were significant barriers to entry for people to actually code or create a website, for instance.
And then, over a decade later, we moved progressively to web 2.0, which effectively is a read-write type of mode. And there's been a lot of new businesses that enable people to, for instance, create websites or create ecommerce businesses online very simply without the actual need to learn how to code. And gradually we're trending towards the web 3.0, which is read, write, and own. So the key about web3, to me, is around the ownership and control that is moving back from centralized parties to individuals. And that has been unlocked by blockchain technology.
So, to answer your question: yes, I'm actually investing in the metaverse and some of the related crypto projects – but on a personal basis. We're looking a lot into it from a fund standpoint as well. But if I'm thinking about what's currently happening on the crypto universe, you have seen a massive growth in terms of the number but also the maturity of the play-to-earn type games. And given how geeky I am, and how much I used to play when I was younger, games like World of Warcraft, seeing that when you are playing, the content, the experience, or even the character that you have invested in from a time and also a capital standpoint – meaning that he's actually yours – is changing everything to me.
So what I think has changed today from a decade ago, there are three main elements that are changing the landscape and why we are moving towards a more pronounced interest in the metaverse. So, number one is how accessible the powerful computation firepower is becoming. Number two is the variety of VR and AR equipment accessible to the broader public. And number three is blockchain technology creating new economic models – for instance the play-to-earn models. So I'm actually very excited to see how fast we're gonna get there, but we're clearly seeing big institutions across verticals that are looking into the metaverse but also looking at how blockchain technology could enhance that.
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