Original author: 0xLouisT
Original translation: TechFlow
Altcoins are bleeding — why? Is it because of high FDV, or CEX listing strategies? Should Binance and Coinbase just use TWAP (time-weighted average price) to put their money into new altcoins? The real culprit is not new — it all goes back to the 2021 crypto VC bubble.
In this article, I will analyze how we got to this point. In the following articles, I will explore the impact of this phenomenon on projects, liquidity markets, possible future trends, and provide some advice for entrepreneurs in the current environment.
ICO Mania (2017-2018)
The crypto industry is inherently a highly liquid one — projects can issue tokens at any time, and those tokens can represent anything, regardless of the stage they are in. Prior to 2017, most trading activity took place in the open market, where anyone could buy tokens directly through centralized exchanges.
Then came the ICO (initial coin offering) bubble: an era of wild speculation that was quickly exploited by scammers. It ended like all bubbles: with lawsuits, fraud, and a regulatory crackdown. The Securities and Exchange Commission (SEC) stepped in and made ICOs all but illegal. To avoid the U.S. judicial system, founders had to find other ways to raise money.
Venture Capital Frenzy (2021-2022)
As retail investors were forced to exit, founders turned to institutional investors. From 2018 to 2020, the crypto VC space grew and expanded - some firms were pure VCs, others were hedge funds that allocated a small portion of their assets under management (AUM) to VC bets. At the time, investing in altcoins was a contrarian move - many believed that these tokens would eventually go to zero.
Then, 2021 came. The bull market sent VC portfolios soaring (at least on paper). By April, many funds had seen returns of 20x or even 100x. Crypto VCs suddenly looked like money-printing machines. Limited partners (LPs) flocked in, eager to ride the next wave. VCs raised new funds that were 10x or even 100x the size of the previous ones, confident that they could replicate these astonishing returns.
Source: Galaxy Research
Additionally, there are some psychological reasons why VCs are so attractive to LPs, which I analyzed in detail in a previous article: The Real Reason Why There Are More VCs Than Liquidity in Crypto.
The Hangover Period (2022-2024): Dilemma and Transformation of Crypto Venture Capital
Then, 2022 came along: Luna collapsed, 3AC (Three Arrows Capital) went bankrupt, FTX closed down - billions of dollars in paper gains vanished overnight.
Contrary to popular belief, most VCs did not cash out at the market peak. They rode the market crash down like everyone else. And now they face two major problems:
Disappointed Limited Partners (LPs): LPs who once cheered for 100x returns are now asking for a quick exit, putting pressure on funds to reduce risk and lock in returns in advance.
Too much money: There is a lot of unused venture capital (dry powder) in the market, but the demand for high-quality projects is insufficient. In order to meet the investment threshold and pave the way for the next round of financing, many funds choose to invest funds in economically unreasonable projects instead of returning capital to LPs.
Today, most crypto VCs are in a dilemma: unable to raise new funds, holding a bunch of low-quality projects that are destined to develop according to the high FDV to zero script. Under pressure from LPs, these VCs have transformed from supporters of long-term visions to pursuers of short-term exits. They frequently sell large VC-backed tokens (such as alternative L1, L2, and infrastructure tokens) whose high valuations they themselves artificially pushed up.
In other words, the incentives and timeframes for crypto VCs have changed significantly:
2020: VCs are contrarian, cash-strapped, and focused on the long term.
2024: VC becomes crowded, overfunded, and more short-sighted.
I think that VC funds will mostly underperform expectations in 2021-2023. VC returns follow a power-law distribution, where a few winners make up for the majority of losers. But forced early selling will break this pattern, leading to weaker overall performance.
If you want to learn more about average VC returns, I wrote an article about that a while ago.
It’s not hard to understand why more and more founders and communities are skeptical of venture capital. The incentives and timelines of venture capital are not aligned with the goals of founders, and this misalignment is driving the following shifts:
Community-driven financing: Projects tend to raise funds through community power rather than relying on venture capital.
Liquidity funds for long-term support: Compared with venture capital, liquidity funds are gradually becoming the main force for long-term support of tokens.
Assessing liquidity/VC cycle
Tracking the flow of capital between venture capital and liquid markets is critical. I use a metric to assess the state of the venture capital market. It’s not perfect, but it’s a good guide.
I assumed that VCs would deploy 70% of their capital linearly over three years — which seems to be the trend for most VCs.
VC 3 y Linear Deployment Visualization
Based on VC fundraising data provided by @glxyresearch, I applied a weighted sum model, combined with 16 quarters of deployment rates, to estimate the dry powder remaining in the system. In Q4 2022, ~$48B of VC funding was undeployed. However, as new rounds of fundraising have stalled, this number has at least halved and continues to decline.
VC unfunded funds visualization chart
Next, I compared the remaining VC funding each quarter to TOTA L2 (the total crypto market cap minus Bitcoin). Since VCs typically invest in altcoins, TOTA L2 is the best proxy. If VC funding is too high relative to TOTA L2, 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.
Crypto Venture Capital and Liquid Markets: Cyclical Patterns and Future Prospects
Typically, when the risk-adjusted returns of liquid markets tend to outperform those of VCs during the “VC euphoria” period, the “VC capitulation” period is more complex—it can mean that VCs are giving up, or it can indicate that the liquid market is overheated.
Like all markets, crypto VC and liquidity markets follow cyclical laws. The excess capital accumulated in 2021/2022 is being quickly depleted, making it more difficult for founders to raise funds. At the same time, VCs with running out of money are becoming more selective in their deals and terms.
I will stop here and the next article will delve deeper into the impact of this phenomenon on liquid markets.
Summarize
Venture capital funds have performed poorly in recent years, and venture capital firms are turning to short-term selling to return capital to LPs. Many well-known crypto venture capital firms may not survive in the next few years.
The misalignment between VCs and founders is driving founders to turn to other funding channels.
The oversupply of venture capital has led to an irrational allocation of resources, which I will analyze in detail in a subsequent article.
To be continued...
