The altcoin season is over. Is the crypto VC bubble to blame?

Why did altcoins plummet? Because of high FDV (fully diluted valuation)? Or because of CEX (centralized exchange) listings? Should Binance and Coinbase invest their treasury funds in new altcoins through TWAP (time-weighted average price) strategies?

The real culprit is nothing new and can all be traced back to the 2021 crypto VC (venture capital) bubble.

In this article, we will analyze how we got to where we are today.

1. ICO boom (2017-2018)

The crypto industry is essentially a liquid industry - projects can issue tokens representing anything at any time at any stage. Until 2017, most of the activity was concentrated in the open market, where anyone could buy directly through CEX.

Then came the ICO bubble, an era of wild speculation that was hijacked by scammers. It ended like all good bubbles: with lawsuits, deception, and regulatory shocks. The U.S. Securities and Exchange Commission (SEC) stepped in and made ICOs effectively illegal. Founders who wanted to avoid the U.S. court system had to find other ways to raise money.

2. VC boom (2021-2022)

As retail investment was cut off, founders turned to institutional investors. From 2018 to 2020, crypto VC gradually grew - some companies were pure VCs, and others were hedge funds that allocated a small portion of their assets under management (AUM) to VC investments. At the time, investing in altcoins was contrarian thinking - many people believed that their value would eventually return to zero.

Then 2021 arrived. The bull market sent VC portfolios (book value) soaring. By April, funds had grown 20 to 100 times. Crypto VCs suddenly became like money printing machines. LPs (liquidity providers) poured in, eager to seize the next wave of opportunities. Firms raised new funds that were 10 or even 100 times larger than before, confident that they could replicate those huge gains.

Of course, there are also psychological reasons why VCs are so popular with LPs, which I have discussed in previous articles.

3. Sequelae (2022-2024)

Then came 2022: Luna, 3AC, FTX, and others, which wiped out billions of dollars in paper gains overnight. Contrary to popular belief, most VCs did not sell at the top. They experienced the crash like everyone else. Now, they face two huge problems:

● Frustrated LPs: LPs that once cheered for 100x returns are now asking to exit, forcing the fund to reduce risk and take profits early.

● Excess funds: VCs have more idle funds than quality projects. Instead of returning funds to LPs, many funds invest in projects that do not make economic sense, just to deploy the remaining funds to meet threshold requirements and possibly raise funds for the next fund.

Most crypto VCs are now in a dilemma - unable to raise new funds, holding a bunch of low-quality projects that are destined to "high FDV will eventually return to zero". Under the pressure of LPs, VCs have transformed from long-term vision holders to short-term exit profit seekers, constantly selling large VC-backed tokens (Alt L1, L2, infrastructure tokens) at unreasonable valuations that they have helped to create.

In other words, crypto VC motivations and timeframes have changed significantly:

● In 2020, VCs are contrarian, capital-starved, long-term thinkers.

● In 2024, they are crowded, overfunded, and short-term profit-oriented.

I believe that VC investments in 2021-2023 will mostly underperform. VC returns follow a power law distribution, with a few winners making up for the losers. But being forced to sell early will distort the final results, leading to weaker overall performance.

If you want to learn more about the average VC return numbers, I wrote this article:

It’s no wonder founders and communities are increasingly skeptical of VCs. Their incentives and timelines are misaligned with founders’ goals, causing founders to turn to community-driven fundraising and liquidity funds to support tokens long-term instead of VCs.

4. Evaluate liquidity/VC cycle

Tracking the flow of funds between VC and liquid markets is critical. I use a metric to assess the state of the VC market. It’s not perfect, but it’s very useful.

I assume VCs deploy 70% of their funds linearly over three years — which seems to be the trend for most VCs.

Using VC fundraising data from Galaxy Research, I applied a weighted sum that takes into account 16 quarters of deployment rates. This approach allows for an assessment of the remaining idle capital in the system. In the fourth quarter of 2022, there is approximately $48 billion of VC idle capital.

Next, I compared the remaining VC idle funds each quarter to TOTAL2 (crypto market cap excluding Bitcoin). Since VCs are typically invested in altcoins, this is the best way to assess. If there is too much VC idle funds relative to TOTAL2, the market will not be able to absorb future token generation events (TGEs). Normalizing this data reveals the cyclical nature of the liquidity/VC ratio.

Typically, being in the “VC euphoria” area indicates that the risk-adjusted returns of liquid markets are better than those of VCs. The “VC capitulation” area is more complicated—it can signal VC withdrawal or overheating of liquid markets.

Like all markets, crypto VC and liquidity markets follow cycles. The excess capital of 2021/2022 is being depleted quickly, making it more difficult for founders to raise funds. Cash-strapped VCs are becoming more selective in deals and terms.

5. Conclusion

● VCs have performed poorly in recent investments and turned to short-term selling to return funds to LPs. Many well-known crypto VCs may not be able to survive in the next few years.

● The misalignment between VCs and founders is driving founders to seek alternative sources of funding.

● Oversupply of VC capital leads to poor allocation of funds.