Crypto VCs face a harsh reality in the bear market

The tokens, known as BTRST, serve as a currency and reward system for Braintrust users. But the Silicon Valley startup also sold hoards of them to investors like Tiger on the condition they agree to multi-year lock-up periods—an arrangement designed to ensure investors don’t dump their holdings and depress the price. 

During crypto’s recent bull run, token strategies paid off handsomely as digital assets soared. But in early 2022, the market took a dramatic turn. The collapse of industry mainstays like Terra and FTX sent cryptocurrencies into a free fall, dropping crypto’s total market cap by as much as 70%. Meanwhile, venture capital firms and their limited partner investors grew reluctant to open their wallets as interest rates began to skyrocket.

For Tiger, the broader meltdown translated into hefty losses in its venture investments, prompting the firm to reportedly look into selling some of its holdings to pacify LPs. Ordinarily, this would entail seeking buyers for shares on the secondary market, a laborious process compared with dumping tokens. In the case of Tiger’s BTRST tokens, however, the firm could simply sell them directly on crypto exchanges as soon as a lock-up period expired.

According to on-chain data reviewed by Fortune, Tiger wallets have been dumping Braintrust tokens since January, tapping institutional investment firm FalconX to sell hundreds of thousands, contributing to the price slumping over 20%. Tiger declined to comment.

Cratering token prices create a dilemma for venture investors: Unlike private companies, where a decline in valuation isn’t immediately apparent during a bear market, losses at token-based projects like Braintrust can be seen by everyone right away.

Adam Jackson, Braintrust’s cofounder, said that he sticks by the company’s crypto-based strategy, arguing that the price of the token has no impact on its utility for the Braintrust platform. Even so, he acknowledged that prices impact sentiment. “Token projects have to eat that shit every day,” he told Fortune.

The Braintrust episode highlights the fraught new frontier of crypto venture capital. Liquid tokens can create a massive and immediate upside during a bull market but an outsized wallop when the good times end—underscoring how the challenge of climbing out of a bear market is even greater for crypto-based venture capital. Fortune spoke with investors, analysts, and entrepreneurs to discover how the new industry is adapting.

‘Juicing up those numbers’

Unsurprisingly, the volatility has been distressing for those new to the rollercoaster of crypto. 

“There’s no way to hide behind the opaqueness of the private markets for a crypto fund with token holdings,” said Robert Le, a crypto analyst at industry data provider PitchBook. 

While crypto projects have raised money with tokens for years—most notably in the initial coin offering explosion of 2017—the model took off with mainstream venture firms during crypto’s most recent bull market. VCs no doubt observed the early success of projects like Solana Labs, which sold nearly 80 million Solana tokens to investors, including Multicoin Capital and 500 Global, before launching in 2020, and netting some of its early backers a reported $1 billion in returns as of late 2021.

In recent years, most crypto venture deals involved some combination of equity and so-called token warrants, which entitle VCs to a certain number of tokens at a future date. Crypto startups often raise money to build out their project—often a new blockchain, as was the case with Solana—before launching a public token.

The huge potential returns from tokens spurred the rise of crypto-focused funds such as Pantera and Polychain Capital, followed by later players like Haun Ventures and Paradigm. The promise of token riches also attracted the attention of generalist venture firms, including Sequoia Capital and Bessemer Venture Partners. In an era of zero interest rates and tons of cash in the private markets, many VCs latched onto crypto—and tokens in particular—as the next hot thing. 

Lilita Infante, a former Department of Justice special agent who founded the crypto crime-fighting startup CAT Labs, told Fortune that she had trouble raising money in the heady days before FTX’s collapse. She felt a major roadblock when she approached VCs was that the project didn’t offer tokens—only old-fashioned equity. “I didn’t have the pump-and-dump element, so they weren’t interested,” she said.

The allure of publicly traded, liquid tokens also attracted hedge funds like Tiger and Brevan Howard along with VCs trying their hand at hedge fund-like plays.

One crypto VC, who spoke on the condition of anonymity, told Fortune that hedge funds that later launched venture strategies, like Jump Trading and Brevan Howard, typically “have more hedge fund DNA than venture DNA”—a situation that would prove troublesome for crypto firms like Braintrust since hedge funds like quicker exits, and, unlike their VC counterparts, are reluctant to wait years for a project to bloom. The crypto VC said they would sometimes try to persuade other participating firms to have longer lock-up periods, with the assumption that some other firms were just interested in short-term liquidity. 

“Money has been really misallocated,” argued Alyse Killeen, founder of the Bitcoin-focused fund Stillmark. “You’ve seen projects get funded that can produce a return via tokens without producing a sustainable product.”

Despite the risks, the strategy still reaped benefits during the bull market. Both 2021 and 2022 saw record fundraising for crypto-focused VC firms, including Multicoin, which raised a $430 million fund in July of last year, and Electric Capital, which raised a whopping $1 billion in March of 2022. 

“I would say some portion of that is because they had very good metrics by getting liquidity super early and juicing up those numbers,” said Le, the Pitchbook analyst, explaining crypto firms’ fundraising prowess.

In the world of venture capital, firms must use an accounting practice known as mark to market for equity investments, a process that assesses the value of their startup shares every quarter. As a result, LPs have limited insights into the value of their VCs’ holdings.

In the case of token holdings, crypto VCs are likewise obliged to mark to market. But since token markets are much more liquid—trading publicly 24/7— their investors can gauge the value of their portfolios on a daily—or even hourly—basis. 

The upshot is that, following the recent meltdown in the crypto market, funds couldn’t hide from the real-time performance of their token holdings—and what they revealed often wasn’t pretty.  

‘What the hell did you do? You were 6x up!’

The numbers so far tell a bleak story. 

Several crypto VC firms have seen their assets under management, or AUM, fall considerably over the last year: Multicoin’s AUM fell from roughly $8.9 billion at the start of last year to around $1.4 billion as of the end of 2022; Paradigm’s dropped from over $13 billion to around $8.7 billion over the same period, according to Newcomer and independently verified filings. Although AUM isn’t a perfect measure of a firm’s success and can fluctuate for reasons other than a fund’s performance, it’s a gauge for its well-being.

Multicoin also told its investors in an annual letter that the firm’s token-focused hedge fund lost over 90% in 2022, Coindesk reported, though the fund was reportedly still up nearly 1,400% net of fees since inception. Multicoin declined to comment. Paradigm, meanwhile, began this May to downplay its crypto emphasis on its website. 

“We remain as excited and committed to crypto as ever,” Alana Palmedo, Paradigm’s COO, told Fortune in a statement.

Because token transactions occur on publicly viewable blockchains, it’s also possible to review the holdings of VC firms if their wallets are identified—another quirk of the crypto ecosystem. By cross-referencing token investment announcements with on-chain transactions, the analytics company Nansen tracks prominent VC wallets.

Nansen’s wallet findings suggest the U.S. dollar value of VC firms’ token holdings has decreased substantially from mid-May 2022 through mid-May 2023—24% for Andreessen Horowitz, 37% for Paradigm, and nearly 70% for Polychain.

Nansen’s data is limited to Ether and ERC-20 tokens, which excludes widely held tokens including Solana and Bitcoin, and so its findings often reflect a fraction of firms’ total holdings—but given the drop in the value of tokens of all sorts, the ETH numbers are likely indicative of a broader trend. A Nansen analyst added that declines could also be caused by wallet transfers or tokens being staked. Paradigm and a16z declined to comment to Fortune on the research firm’s findings, while Polychain and Dragonfly did not respond.

Kavita Gupta, the founding managing partner at the crypto-focused Delta Blockchain Fund, told Fortune that at the height of the bull market, her fund was up 600%, buoyed by its token investments. Today, it’s up just 18%. Like many crypto-native VCs, Gupta said she’s not concerned.

“If you believe in those projects and you hold them long enough, there’s going to be a bull market again,” she told Fortune. 

Some like Vance Spencer, a cofounder of the VC firm Framework, even argue the lower value of liquid tokens presents better deals than private valuations, which are still in the process of adjusting to the market. 

The tricky part is convincing LPs to remain calm. Gupta’s investors include crypto founders but also high-net-worth individuals, family offices, and institutions—and not all of them are accustomed to the cyclical whiplash of the industry.

“We continuously have to educate the family offices who are, like, a shipping family industry from Vietnam,” she said. “They’re like, ‘What the hell did you do? You were 6x up!’”

Meanwhile, interest in crypto among family offices, which invest in many VC firms, is waning. According to a Goldman Sachs survey of 166 institutional family offices from mid-January through late February, only 12% expressed potential future interest in investing in crypto, down from 45% in 2021. 

Some crypto-native funds told Fortune that they self-select for LPs who understand the cyclical nature of the market and won’t get squeamish. 

“You want to scare off the people that aren’t aligned in that way,” said Alok Vasudev, a cofounder of the venture fund Standard Crypto. “You want to make sure that the folks that are in the boat are the ones that really believe in the strategy.”

The LPs of crypto-focused VC firm CoinFund “have brought a lot of questions to us and we have tried to over-communicate through this period,” Seth Ginns, who manages the firm’s liquid investments, told Fortune. The fact that the crypto VC space has “multiple different types of investable assets” across liquid tokens and venture investments is valuable, he says, and that’s apparent to their LPs.

Some LPs understand the unique dynamics of token investing, including Jackson, the Braintrust founder, who’s also an investor in Multicoin, Polychain, and ParaFi. He argues token prices are down because of a relative lack of liquidity, and that valuations will recover during the next bull market.

“Everyone walked out of the room at the same time,” he said. “Whatever music was playing when we left is what we think is still playing.”

Even so, the stark drop in token prices, along with the general downturn in the venture industry owing to macroeconomic factors, has hurt crypto firms’ ability to raise new funds. 

Fundraising for crypto VC has fallen off a cliff in 2023, according to PitchBook data provided to Fortune. Though the data is only through mid-May, it’s not off to a good start: Crypto firms globally have raised just $500 million—98% less than in all of 2022—over eight funds—90% fewer. Those fundraising hardships have also been felt, to a lesser degree, among venture capital firms across the board.

At the recent Medici conference in Los Angeles, an invitation-only crypto event in Beverly Hills for top investors, VCs “were all saying it’s the hardest fundraising environment they’ve ever seen,” Jackson, who attended the conference, told Fortune. “You’re eating shit, things are oversold, and there’s no liquidity.”

The final innings? 

While enticing LPs back into crypto may not be easy, there are signs token-based investing is here for the long term.

“Around FTX, there was definitely an increased hesitancy, particularly among LPs that were new to the space, around deploying” into crypto funds, CoinFund’s Ginns says. “I think we’re in the final innings of that.”

In recent months, cryptocurrencies have made a comeback: Solana’s token is up over 100% year to date, while Bitcoin is up 63%—though both far below their highs of 2021. “On the Bitcoin side, I think you can expect to see larger funds raised this year,” Killeen from Stillmark told Fortune. 

Token strategies remain popular among crypto-focused VCs. In early April, the venture firm Dragonfly invested $10 million in Bitget, a Seychelles-based trading platform. Data from Nansen shows that Dragonfly received around 60 million Bitget tokens in return—at the time, worth about $24 million. 

Bullish investors reference trends like the rise in developers working in the crypto space and the passage of crypto regulation in markets from the European Union to Brazil as reasons to be excited about the space. 

And ever the optimistic crowd, VCs like Ginns are taking a rosy view: “We actually pretty definitively believe that we’re in the next bull market right now.”

Generalist VCs can, and have, shifted attention to more buzzy areas like artificial intelligence to invest unspent cash. Some crypto firms have followed suit, including Foresight Ventures and Paradigm. According to one LP, who spoke on the condition of anonymity, Paradigm had not communicated any changes to its investors. Alana Palmedo, Paradigm’s COO, emphasized that the firm is not pivoting from crypto. 

But many crypto VCs are standing by their strategy. “They don’t really have a choice,” PitchBook’s Le said. “I mean, it’s in their mandate.”