28 June 2018

Are cryptocurrencies the future of venture capital?

Alexander Tkachenko and Nigel Green discuss the potential impact of cryptocurrencies on the future of venture capital

‘Crypto and blockchain are technologies that are revolutionising many markets. It’s truly on the level of the internet and mobile, and so it’s very disruptive. It may disrupt entire industries. As VCs are focused on disruptive companies, they are taking note of technology developments in the cryptocurrency marketplace’

To many, cryptocurrencies and blockchain are the latest trend in venture capital markets. Founder of Venture Exchange (VNX-io), Alexander Tkachenko, doesn’t agree though. He explains that cryptocurrencies, such as Bitcoin and Ethereum, are often being used to fund established companies and start-ups through initial coin offerings (ICOs).

However, these aren’t strictly venture capital investments, but crowdfunded ones and alarmingly, a small number of theses have been marked as scams, and education in the market is desperately needed to protect future investors.

“My view is that crypto investments won’t replace traditional VC investments as they have very little in common, other than the early stage of projects being supported. Investors should view ICOs as another way of crowdfunding (or crowd investing) only to be accomplished via blockchain using cryptocurrencies as a means to transfer value. ICOs are very short-term by nature, because profits are often made long before any product is build or the business is established,” says Tkachenko.

Most crypto investors gamble on the success of tokens they buy, without performing due diligence in researching the market.

“One of the ways venture capital investment is different to ICOs, is that you have to “sweat” investments, understand the business service offering, the target markets, as well as analyse the strengths and weakness of the development teams. It’s a major investment of time and resource to understand the entire proposition and it doesn’t’ finish when you wire the money, it’s only the beginning,” Tkachenko continues.

He thinks that only 10-15% of venture capitalists are investing in crypto investments at the moment. Many more have looked into it, though. “VCs are at the forefront of new technology innovation, but many are not willing to invest in cryptocurrencies or crypto assets, because most ICOs simply lack standardised qualifications. However, with the emergence of blockchain technologies, crypto is now impacting a diverse range of traditional markets, creating equity opportunities for traditional investors and new investors alike.”

Mainstream expansion
Nigel Green, founder and CEO of deVere Group, comments: “Mainstream expansion is clearly evidenced by the fact that more than 35% of wealthy individuals around the world – who are already likely to be successful investors – are telling us that they already have exposure to crypto or that they will have by the end of this year.”

deVere Group surveyed 600 clients across the globe and found that there is now a significant amount of evidence to show that high net worth individuals should not ignore investing in “the huge potential of cryptocurrencies.”

“There’s now surging public awareness of the value, need and demand for digital, global currencies in a digitalised, globalised world”, claims Green. He therefore thinks that a broader understanding and awareness of the crypto sector will “grow exponentially in the next year as technology improves, where major corporations and financial institutions embrace it, and as regulations are further developed.”

Traditional challenges
Tkachenko goes further to explain that the traditional challenges of venture capital investment are about defining the team that can deliver the product according to the market fit. “ICOs don’t necessarily solve these issues, but they help venture funds and accelerators to attract funding because they make it borderless; enabling global attraction for funding.”

“Crypto and blockchain are technologies that are revolutionising many markets. It’s truly on the level of the internet and mobile, and so it’s very disruptive. It may disrupt entire industries. As VCs are focused on disruptive companies, they are taking note of technology developments in the cryptocurrency marketplace.”

“I’ve heard about VCs looking at opportunities to invest and I have heard about them using ICOs to raise additional funds. Raising funds through ICOs and the blockchain is still considered a rare occurrence, but it’s an opportunity growing in influence and platforms are coming to market to take advantage of this great potential.”

Average ROI
In 2017, European venture capital firm, Mangrove Capital Partners (MCP), highlighted the performance and the disruptive potential of ICOs in a report. In a press release of 19th October 2017, the company claimed that ICOs “delivered an average return of over 1,000%.”

In the report ‘Tokenisation: Implications for the venture capital industry’, MCP states the performance of ICOs ‘has been nothing short of outstanding’. It also claims the research found the majority of large-scale ICOs (i.e. those over $10m) is focused on either the blockchain economy or the financial services industry.

Regulatory protection
“This is the beginning of the crypto and blockchain economy, which has begun in a not-so- traditional way”, Tkachenko stresses. There are, therefore, bound to be challenges that need to be overcome – including those pertaining to due diligence to make sure that whatever is invested in is above board. Regulations may help to address many of the issues, but the problem is that innovations are often unplanned. When they do occur, the regulations often struggle to catch up.

“The first phase of the internet wasn’t smooth,” Tkachenko explains. “Innovations run ahead of time. Whether regulations can strengthen and straighten the playing field is certain, at the moment, but blockchain now presents an opportunity for professional investors and innovators to attract capital, and to solve the traditional issues that have hampered VC investors in the past; such as low liquidity.” He also thinks regulation would help venture capital and crypto industries to attract big money by providing a high degree of protection for first time investors.

Creating partnerships
Creating partnerships with a wide range of players within the market can help, too. “I think all the established players would be well advised to embrace and look out for the changes”, argues Tkachenko. “This is because the pace of change is so fast that you have to run to remain in the same place. “Technologies are so disruptive that you could be forced out of the market, and so by partnering with banks and financial services companies it’s possible to get a competitive edge against any rivals”, he says.

Trading platforms
So, how can a cryptocurrency trading platform, based on blockchain and distributed ledger technologies (DLTs), help to regulate transactions? Well, firstly Tkachenko thinks the phrase ‘cryptocurrency platform’ should be dropped. In his opinion, it’s more important to look at how the platform is built on blockchain, which is in itself a distributed ledger technology:

“The blockchain is a DLT and so the elements in an original contract can’t be changed. An action occurs automatically. It’s hard to stop it, even if one party doesn’t want the transaction, it is still paid. The automatic execution of the contract is something we use. If you have a claim on a particular revenue, you will automatically have the revenue that is part of that claim. This means that the “smart contract” executes automatically.”

“Contracts are revised from time to time, and the different parties must agree to it. However, with blockchain it’s hard to do as it is a security measure. In our particular case it’s hard to execute, but if the smart contract is written in that way, then you can change it. This could require more than 3 parties.”

DLT technology and the acceptance of it will change over the next 5 years. It will look very different. Venture Exchange is therefore “working hard to provide VCs with the ability to use the technology to gain additional liquidity and access to the capital.”

Small ticket value
“My personal view is that the VC model has been focused more on larger ticket investments, but for society, small tickets are more beneficial as they create new workplaces. Yet, at this level it is difficult to get access to the funding. We hope that, by focusing on the mid-tier, our platform will dramatically change the early stage funding of the smaller ticket investments by allowing better access to investors over the next 5 years and beyond.”

For now, the venture capital industry remains closed in character. There are some very professional players, some with the sophistication to handle very long documents, such as limited partnership agreements. The trouble is that many of these documents are inaccessible, and complex. Not everybody will be able to understand certain aspects, such as fee structures and how they work – particularly the non-professional investor.

“The amount of capital required to be a VC is a barrier, and it may take up 10 years to achieve a return on investment”, Tkachenko claims. So, over the next few years, he wants to address these issues with a platform to enable professional and non-professional investors to invest in the most promising companies.

This will make access to liquidity easier and enable investors to focus on what they know best, while giving the non-professional investors access to the asset classes they didn’t have never been given access to before. Returns are in double percentage figures, and this will drive economic growth and innovation from a societal perspective.

Over the next few years Tkachenko hopes that more people will become ‘venture capitalists’, more able to invest in new and growing start-up innovation by opening up the traditional investment market.

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