Venture Capital Sector Facing Challenges in the Era of Cryptocurrency

In the past couple of years, cryptocurrency has experienced a sudden boom and is now making news in every sector. In the beginning, when bitcoin was in its initial stages, everybody was talking about Venture Capital (VC) and how it is going to benefit the small businesses.

So many venture capitalists made money by investing in innovative ideas that eventually materialized into unicorns. Instead of investing in the digital currency like bitcoins, investors preferred to invest in the companies, such as Coinbase or 21.co.

Bitcoin Price at All Times High

Some of these firms performed better than the other. For example, Coinbase ended up being in the first place in the app store of Apple last December as a result of hype over bitcoin. On the other hand, 21 kept changing its names and business plans. Back when Coinbase got its first round of funding from VCs, its price was about $110. However, recently, it has managed to reach $19,000.

An investment associate in the Digital Currency Group, Travis Scher, was of the opinion that had investors invested in the cryptocurrency instead of investing in digital currency firms, they would’ve gotten much higher returns by now.

VCs and the Increasing Trend of ICOs

This isn’t easy to grasp as it complicates the core idea of VCs.

The conventional way of making an investment was to find out the rising trend in technology, identify the targets that were in line with those trends and were in a better position to make it big, and then taking a profitable exit as soon as those companies were either sold out or went public.

But it won’t be an effective strategy for digital currencies like bitcoin. In fact, as more and more cryptocurrencies have entered the market, it has become even more confusing and complex. The community of dreamers, and entrepreneurs have been raising money via ICOs (Initial Coin Offerings), wherein, they create their own digital currencies, sell them for money and trade them in the open market.

When it comes to venture capital firms, they offer the investors an unrestricted access to private companies that are not publicly listed. Therefore, the question is, where will these venture capital companies go, if ICOs become a strong medium for people to get a bit of hot technology.

Venture Capitalists and their New Tactics

Venture capitalists have been devising new tactics to deal with the frenzy of cryptocurrency. Instead of seeking a stake in the digital currency firm, they have started purchasing the rights to acquire tokens ahead of initial coin offerings via legal contracts. In addition to that, they are improvising conventional equity deals, offering guarantees to investors in terms of getting tokens if a startup company goes for ICO in the future.

Some investors have also invested directly in bitcoin for years. The founder of VC firm Social Capital, Chamath Palihapitiya, said that he, along with his partners, invested in 5 percent of the bitcoin in circulation and still hold a reasonable stake in the currency.

Increasing Risks Faced by Investors in the Digital Currency Market

Although, the cryptocurrency market is rapidly growing, yet, it is not without risk. In fact, so many investors have suffered from hacking attacks and have also been threatened physically.

Threats are very real and harmful, because bitcoin will be lost forever if somebody steals it.

Cryptocurrency Hedge Funds and Futures Tokens

So many VC firms, including Sequoia Capital, Union Square Venture, and Andreessen Horowitz have made an investment in digital currency hedge funds in order to benefit from the boom without worrying about managing these currencies. They earn profits by trading dabble, litecoin, ethereum, and bitcoin in the ICOs market.

Some of the big names in the world of VC, including Bain Capital Venture, Union Square Ventures, and Sequoia Capital, have entered the deals to acquire digital tokens. For that, they are using legal agreements called “Simple Agreements for Future Tokens” also known as SAFT. Andreessen Horowitz is also taking steps to include provisions in standard contracts for investments in order to properly address ICOs.

According to a research website, in 2017, startup companies made about $3.6 billion in ICOs. This, however, is nothing in comparison to the $52.6 billion earned by VCs from around the world, as stated in the report by CB Insights and PricewaterhouseCoopers. Despite that, investors are inclined toward ICOs as it enables them to make millions in short span of time as compared to VC investments, which take years before you can reap the return.

National Currencies last breath?

The world of digital currency has gained massive popularity in the past couple of years.

Bitcoin has moved over $19,000, whereas, Ethereum is increasing in value every day and its price has crossed over $700. The continuing boom of cryptocurrencies might eventually lead to the next big step, i.e., the end of cash currencies.

Yes, you heard it right. Even the director and founder of Bitt, Gabriel Abed, is of the opinion that cash has been in the market for too long, and all the currencies will eventually be digitized.

Rise of the New Economic Age

All the cryptocurrencies, including Ether and Bitcoin, are basically issued by private organizations, groups, and individuals, they mine it through cryptographic protocols and more and more countries are gradually heading in that direction.

Russia has recently announced its plans for a national digital currency called Crypto-Ruble.
China and Kyrgyzstan are following the lead.
In Japan, over 200,000 stores have been accepting bitcoin as a legal tender and some of the big banks are planning to create their own version of these cryptocurrencies.

In a highly innovative environment, efforts are being made to circulate digital currency in various economies. The Federal Reserve in the United States however, has no such plans of nationalizing the cryptocurrency.

Crypto-Ruble – A New Start for Better Russian Economy?

Putin is very strict about following law and order and despite the advantages of having a national digital currency, it has gray areas when it comes to its legal status. This is why he is a little skeptical about cryptocurrencies. Therefore, the aim of Russian official crypto-policy is to eliminate the chances of illegal transactions such as, human-trafficking, terrorism financing, and money laundering, while at the same time using this technology to modernize the internal capital management of Russia. This is the main strategy behind crypto-ruble.

The crypto-ruble will serve as a connection between the real world and the crypto-world, which would enable the efficient tracking of capital flow in the Russian economy. Those who won’t be able to provide a paper trail of ownership will have to pay tax on crypto-ruble at the capital gain rates. It will encourage the development of low-cost crypto-payment systems, which allows the exchange of rubles for goods only in digital currencies where ownership can be tracked.

China Taking a Step to Cryptocurrency Implementation

People’s Bank of China has already created a prototype of a digital currency that may be circulating in the market in times to come, alongside Yuan. The country is testing possible scenarios in a simulated environment and running dummy transactions using digital currency with a few commercial banks in China.

Making Quantitative Easing Easier with National Cryptocurrency

The rise of new economic age with cryptocurrency as a national currency will make quantitative easing much easier. Quantitative easing is an economic concept, whereby the central bank purchases predefined amount of financial assets and government bonds to give a boost to the economy. By having a national cryptocurrency, it will be easier to execute the concept of quantitative easing.

Why is National Digital Currency a Better Idea?

Abed further added that nationalizing the digital currency is a better option as it is more transparent, immutable, and efficient. In fact, there have been talks between the Central Bank of Jamaica and Bitt to enable testing this technology. At the same time, the company has been running the active pilot programs in other Caribbean countries.

Jamaica is encouraging the FinTech startups by enabling them to operate in the country. The main reason behind these efforts is to foster innovation. A representative of the Caribbean Development Bank said that they do not want to be in a situation where regulatory authorities have a strong and dominant hand initially. He further said that the Caribbean can be used as a virtual space to test the new technology in a secure environment. These efforts will eventually enable them to take bigger steps in the future.

Rising Trend of Initial Coin Offerings

According to a report by Mangrove Capital, 204 ICOs have made a return of about 1,320 percent.

At the same time, investment banks and hedge funds have shown increasing interest in the digital currency with over 55 crypto-specific hedge funds. Before diving deep into why investors are showing greater interest in cryptocurrency, let’s take a look at what ICO is.

What is ICO?

Unlike conventional financial system, ICO or Initial Coin Offering is an alternative and unconventional way of crowdfunding. It has enabled a number of successful firms and projects to get the finance to start their business. New businesses and startups around the globe are getting millions of dollars in funds by issuing digital coins. The rising trend of digital currency has made people both worried and excited.

In ICO, the coins bought by investors are for businesses and marketplaces that are not developed yet. By purchasing these coins, they make a bet that a firm or startup will end up becoming successful and as a result, the coin will increase in value.

In average it takes about six months or a year to raise money with conventional venture capital (VC) system, but it is different when it comes to ICOs. In this token crowdfunding, you get to have a large crowd of engaging supporters who want to see you succeed. Not only do they campaign for you, but they are also your early adopters.

Growing Trend of ICO

Startups have raised more than 2 billion dollars since the start of 2017. It is a huge amount of funding, given the fact that not many people knew about it a few years ago. Businesses are making money via this mode of funding faster than usual.

In April this year, Gnosis (prediction market for Ethereum) managed to raise 12 million dollars in just ten minutes. In June, Mozilla’s founder raised 35 million dollars by selling Basic Attention Tokens in under 30 seconds for his new web browser startup called ‘Brave’.

ICOs have become the name of the game as they have left the venture capital market behind and are the biggest source of funding. It is a great option for those companies that are pursuing the application of blockchain technology.

Concerns by the Regulators

Despite the increasing trends of ICOs, regulators have shown serious concerns. They are warning investors that it is a high-risk investment.

Although, some coins value has dramatically increased, a very high volatility cannot be ignored. Some have also considered it a ‘speculative boom’, but that did not stop investment banks and hedge funds from showing their interest by making an investment in cryptocurrencies and ICOs.

Reason behind the Increasing Interest of Institutional Investors in ICOs

The digital currency market has made massive profits in the past one year or so. Initially, institutional investors were curious about what this is all about, but they started getting a hang of it gradually and became less apprehensive and more interested in this alternative investment. It is a kind of chain reaction that started with the rising interest among venture capitalists and now institutional investors, including mutual funds, investment banks, and hedge funds are following their lead. They have shown growing interest and are making an effort to estimate and grab the opportunities in the cryptocurrency market.

The reason why they are more interested in the new and unconventional currency is that it promises a higher return as compared to market averages. According to a fintech analytics firm, there have been at least 55 cryptocurrency hedge funds and a former manager at Fortress, Mike Novogratz, has recently announced a plan to use 500 million dollars for a new digital currency hedge fund. Blockchain Capital also made an announcement of raising 150 million dollars; a part of this fund will be for cryptocurrencies.

Goldman Sachs’ Approval

Goldman Sachs is planning to set up a bitcoin trading desk, as they believe that institutional investors are interested in cryptocurrency more than ever. The firm has reported it to be ‘a major milestone’. They believe that the investors need an over-the-counter brokerage platform where they can sell or buy as much cryptocurrency as they want. Goldman Sachs is of the opinion that it can take up this role, but there will be other issues, including market infrastructure and serious concern by the regulators.

If, however, ICOs becomes regulated, it will change the way how businesses raise money and will also impact the venture capital market.

ICOs Surpassed Early Stage Venture Capital Funding

New startups that raised funds through Initial Coin Offerings (ICOs) have now surpassed the early stage VC Funding for internet firms.

But before diving into it, it is important to know what ICOs are.

What is Initial Coin Offerings?

This is another way of raising cash.

Cryptocurrency and blockchain startup companies raise capital through ICOs by selling tokens of investors in exchange for equity funds. It is somewhat the same as Initial Public Offering in which stocks are issued in exchange for equity. Just like crowdfunding, ICOs provide a way to get funds from users by enabling them to have a share of the business. They get digital currency in exchange for the money they invest in the business.

Rising Popularity of ICOs and VC Funding

ICOs have gained massive popularity in the last few months among blockchain and cryptocurrency startups. In April this year, the total capital raised via these offerings was around $100 million and in May, the amount went up to about $250 million. The month of June turned out to be the biggest surprise when the total funding exceeded $550 million. According to Goldman Sachs, it was the first time that it performed better than seed and angel venture capital funding. Early stage and angel venture capital funding was less than $300 million in June.

In July, the offerings were a little more than $300 million, whereas, early stage and angel funding was just a bit higher than $200 million.

Popularity Among the Celebrities

ICOs have become so popular that even the celebrities, including Paris Hilton and Floyd Mayweather, have started jumping on board. In fact, Paris has been involved in it for over a year now and also met the COO of Ethereum last year.

Total Value of ICOs in 2017

The total value raised by 92 ICOs in 2017 is $1.25 billion. This is a really good number, given the recent boom of such offerings in the VC sector. There are so many firms that have used these offerings to raise money. For example, Tezos managed to get the capital of over $200 million by creating a new blockchain, whereas, another firm, Bancor secured $153 million via ICO.

Criticism and Scrutiny from Regulators

Despite the boom, this phenomenon has been under severe criticism and scrutiny from regulators and other authorities. For example, the Monetary Authority of Singapore (MAS) released a statement in which it was mentioned that these offerings are exposed to money laundering and other terrorist financing risks, because the nature of these transactions remains anonymous. Another concern raised by the MAS was the collection of large amounts of capital in such a short time frame, which makes ICO vulnerable to high-level risk.

On the other hand, the Security and Exchange Commission (SEC) said in July this year that the security law of the U.S. will be applicable to this cryptocurrency. The experts are also showing concern over its legitimacy. They have highlighted that the sale of a cryptographic token makes the investor entitled to a certain share of profit in the firm, which can be considered as a violation of financial rules and regulations. The People’s Bank of China and a lot of other government departments have released a joint statement that people and firms that have raised money through ICO should also make arrangements to return that capital.

Firms Facing Increasing Risk of Getting Hacked

Despite all the boom and criticism, the risk of ICOs cannot be ruled out. A clear example of this is CoinDash that initiated an ICO, but ended up getting hacked in July. As a result, all of its funds got stolen. Although, it has gained popularity in the past few months, yet, the risks cannot be ruled out entirely.

Future of ICOs

The Chief Information Officer of UBS, Oliver Bussman, raised his concern and said that strict regulations and measures, as applied to IPO businesses, are required in ICO to safeguard the interest of investors. However, he is quite confident about this new mode of raising funds and expressed that such offerings will continue to happen in future. He said that as a new business model that is benefiting the blockchain technology, ICO will continue to sustain by combining hybrid equity ownership/currency and crowd funding.