How Venture Capitalists Evaluate Blockchain Startups

Baozou Commentary : Many entrepreneurs hope to join the blockchain development boom, develop their own blockchain projects and obtain financing. However, the author believes that this behavior is too blind, and communicated with three senior venture capitalists in the blockchain field to understand what kind of enterprises venture capital favors. Finally, summarizing the opinions of experts, it can be seen that our common investment object evaluation is not applicable to the blockchain field. The restrictions of the scale of the blockchain industry and regulatory policies require companies to reach a high level of consensus and technical cognition. Therefore, the evaluation criteria for venture capital investment objects are the recognition of the risks of the blockchain industry, the explanation of the reasons for choosing blockchain, and whether there is a high-quality business plan.

Translation: Annie_Xu

With more than $1 billion invested in bitcoin companies and even more invested in blockchain overall, everyone from seasoned entrepreneurs to casual enthusiasts are looking for ways to apply the technology and get investment in blockchain projects. The 2014 investment frenzy for bitcoin startups may have faded, but companies and venture capitalists are still enthusiastic about blockchain technology. So I recently discussed blockchain investing with three veteran venture capitalists in the blockchain space.

While raising $760,000 for Bitwage, I met a lot of venture capitalists. I discussed her thoughts on investing in the space with venture capitalist Alyse Killeen; she leads a group of venture capitalists that include some of the earliest investors in blockchain and bitcoin startups.

Alyse Killeen

Killeen explained that there is a big difference between evaluating bitcoin and public blockchain companies.

"Market dynamics are closely tied to regulatory policies and the way businesses interact with the various third parties they rely on for survival. For example, let's assume you develop a social application. You can operate it independently without relying on key data, gateways or the development speed of core underlying technologies provided by third parties. However, the existence of regulation makes blockchain companies have development dependencies and development barriers. The development speed of blockchain companies needs to be consistent with the third parties they rely on, and is influenced by the perception of other Bitcoin and blockchains."

Alyse said that Bitcoin and blockchain investment requires more than just team execution. The negative impact of early media coverage has caused traditional industry participants to be wary of blockchain, and the current small industry ecosystem needs to rely on each other to build a globally distributed network effect, so emerging companies in the blockchain field need to balance their relationship with them all the time. So Alyse pointed out that generally blockchain-based companies have no connection with standard channel partners, and the issue that companies are concerned about has changed from "who are your channel partners and what is the revenue distribution model" to "can you get smart channel partners." I interpreted her to mean that instead of seeking to cooperate with well-known companies that were scared by early media, startups should choose small channel partners who understand the value of blockchain. Because these channel partners are only temporary, it is more important to maintain a good relationship with other members and companies in the blockchain field.

Building relationships with other players in the space is key to reducing corporate risk because “as investors, we know that our investments in these companies will be respected by core developers, peers, channel partners, etc.” The core developers of public chains are independent of the institutions that build infrastructure and applications on top of the protocols; therefore, the respect of these institutions and individuals for a company’s needs and perspectives has a significant impact on the company’s ability to apply and adapt specific blockchain technologies.

Pamir Gelenbe, partner at European Hummingbird Ventures and major investor in Kraken, one of the world’s top three cryptocurrency exchanges, said:

“We should always remember that we are still at the starting line of this industry, and it is very dangerous to start too early. Therefore, ignoring the immaturity of the industry, I choose to focus on those companies that have the potential to expand revenue within a reasonable period of time. In many cases, companies with large markets are chosen to invest, but this does not apply to the Bitcoin field, which is a rapidly developing small market; therefore, the key to investment is to ignore the initial small market and identify companies that can expand rapidly.”

Although the immaturity of the blockchain market has led to new counterparty risk issues, Pamir pointed out that the market's growth rate requires companies that can seize opportunities for enterprise expansion. At the beginning of this year, the price of Bitcoin hovered around $400, but from April 1 to June 16, the price jumped from $420 to $730. A team that can respond quickly and correctly to market changes is as important as the relationship with each counterparty.

Pamir Gelenbe

So what should bitcoin or blockchain startups ignore when seeking venture capital? Pamir said:

“Most venture capitalists don’t understand the transformative nature of cryptocurrencies and all the hype around blockchain technology; so don’t consider them as your first choice investors as you’re wasting your time and won’t benefit from educating them.”

Likewise, Tim Draper of Draper Associates, a partner at DFJ (Draper Fisher Jurvetson) and an investor in Bitwage, noted that the biggest fear in bitcoin or blockchain fundraising is “someone who thinks blockchain is trendy and is interested in including it in their pitch.”

While you can quickly launch into a conversation with the buzzword “blockchain,” you should also be aware of the importance of a good business plan, understanding the industry-specific risks, and why you’re choosing blockchain. Without these three elements, you should look elsewhere.

Due to the immaturity of these technology markets, Alyse pointed out that capital mainly favors two different areas.

“Given the current state of the blockchain space, it’s great to see companies like Blockstream and Netki working on building infrastructure; and companies like Bitwage solving key pain points to drive growth in the number of end users.”

From the perspective of venture capitalists, the smart approach in the short term is to build the protocols required for widespread technology adoption in businesses or individuals, or applications that allow users to directly reap the benefits of the technology. Companies that focus on medium-term gains rely on assumptions about the market penetration of blockchain and cryptocurrency, so it is not clear in the short term to determine the winners and losers.

Tim Draper

So how will blockchain change the way we invest in the future? Tim Draper predicts a big change:

"A company that only uses Bitcoin relies entirely on accounts on the blockchain. If all accounts are in Bitcoin, the company does not need accounting. All accounting calculations are done automatically in the blockchain. I hope that in the future, investments will not require lawyers or accountants, and everyone can participate in frictionless transactions, all with smart contracts, so that there will be no ownership issues in corporate distribution or mergers."

These big changes aren’t as unrealistic as they sound. The DAO raised $150 million in May, roughly in line with Draper’s predictions. They expected to raise $5 million, and Pamir believes their increasing pain points are a sign that they’re coming too soon.

So are you planning to raise money or invest in a blockchain startup? Remember that this is not your average everyday fundraising pitch.