How Venture Capital Is Evolving with Web3

Five years ago, during boom time in the crypto market, investors chased wild returns on obscure digital assets that launched via so-called initial coin offerings (ICOs). Back then, it seemed, projects hardly needed more than a slick whitepaper and a vaguely plausible roadmap to raise seven- and eight-figure sums. Inevitably, though, the party ended as the market soured, and countless projects that were once at the center of oversubscribed rounds have since failed to deliver on their stated goals.

And yet, the capital raised via initial coin offerings in 2017 now seems positively modest. While around $4.9bn was generated in 2017, blockchain and crypto startups welcomed twice as much in the final quarter of 2021 for an annual total of $33 billion. Much of the influx is due to the rise of Web3 projects, the kind associated with non-fungible tokens (NFTs) and gamified finance (gamefi), as well as the participation of deep-pocketed funds supporting pre-product, pre-revenue companies at steep valuations. But do these crazy valuations reflect reality or fantasy?

Investing in the Infrastructure of the Future

There are certainly parallels to be drawn between the ICO boom and today’s Web3 gold rush. For one, the appetite of private equity investors is such that an elaborate pitch deck still goes a long way towards securing capital. Today, however, there is a greater focus on finding tangible protocols that can ship in the near-term: metaverse-based digital worlds, decentralized social networks, DAO tooling, inter-protocol bridges, and NFT marketplaces and collections.

In 2017, projects could skate by on a wing and a prayer, attracting capital with the promise of a groundbreaking protocol that would launch… oh, sometime in the future. But with the arrival of extremely large funds in the $100m to $1 billion range, such blandishments no longer pass muster. Fundamentals are back in vogue, with an emphasis on viable use-cases and strong communities. At the same time, projects themselves have become more judicious about vetting their investors, as founders seek to join forces with those they believe can bring the most value.

Whatever way you look at it, it’s a good time to be an early-stage Web3 startup: not only are institutional investors starting to enter the market, but crypto-native VCs have announced huge venture funds that must be allocated, setting the scene for frenzied deal activity. Back in January, Andreessen Horowitz announced the creation of a $1bn fund for Web3 seed investments, a figure subsequently trumped by Coinbase board member Katie Haun, whose $1.5bn is spread across two Web3-focused war chests.

The emergence of such funds is continuing to push up bids and inflate the valuations of startups that in many cases have yet to generate any revenue, never mind launching a workable product. Partly this is a consequence of frothy market conditions – there are now over 900 tech startups worth at least a billion dollars – and partly it’s a response to the mainstreaming of the metaverse, which has introduced new and exciting crypto use-cases: gaming, live events, enhanced customer experiences in VR, advertising opportunities, etc. What’s more, these use-cases are now being acknowledged by major brands: in December, Nike announced the acquisition of RTFKT, a creator of “virtual sneakers, collectibles and experiences,” a move it said would “accelerate the company’s digital transformation.”

Where Now?

Ultimately, asset managers and angel investors want to seize the day and ride the wave, convinced that they are involved in something special. The allure of the Web3 tech stack, with its promise to restore internet control and ownership to the little guy, is irresistible and the influx of talent from other sectors (game developers, artists, builders) has convinced VCs they’re at the forefront of its evolution. And yet, there remains a sense that the stampede towards Web3 projects is setting many investors up for a fall.

This is not simply due to the creeping sense that startups are being overvalued. Regulatory uncertainty still permeates the digital asset market, and concerns about the environmental impact of mining have not gone away. What’s more, if the market tanks an inevitable period of belt-tightening will surely follow: and projects may have to scale back their ambitions.

If Web3 can fulfill its promise by delivering greater privacy, stronger data security, and richer user experiences, there is a chance that, as with the ICO boom of 2017, we’ll eventually consider today’s investments small beer. But that’s a big if. As it stands, there is cause for both optimism and unease as the groundwork for the internet’s future is gradually laid.

Guest Posts

Author: Jared Polites

Jared is a partner at Rarestone Capital, an active Web3 fund, and Raresone Labs, the fund’s marketing arm. He often writes about Web3, technology, and entrepreneurship for sites like Entrepreneur, Benzinga, Hackernoon, and more. As a dual investor/marketer, Jared helps early-stage companies with everything from marketing and go-to-market strategy, as well as tangible PR execution and strategic consulting.