The VC-dominated crypto funding model needs a reboot

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Does the cryp­to industry’s fund­ing space need an over­haul? This is one of many ques­tions swirling in the wake of FTX’s down­fall: When the promi­nent exchange col­lapsed, it left behind a long line of help­less cred­i­tors and lenders — includ­ing many promis­ing projects depen­dent on funds promised by Sam Bankman-Fried and company.

But there is a big­ger prob­lem at the heart of the cur­rent fund­ing pic­ture, where­in deep-pock­et­ed ven­ture cap­i­tal firms throw their weight around in the low-liq­uid­i­ty Web3 mar­ket, heav­i­ly back­ing ear­ly-stage projects before cash­ing out at a prof­it once retail has FOMO’d into the market.

For all the talk of how blockchain and cryp­tocur­ren­cies rep­re­sent a crit­i­cal fiat off-ramp and a whole­some path­way towards greater decen­tral­iza­tion, trans­paren­cy, fair­ness and inclu­sion, this notion is tru­ly pie-in-the-sky when it comes to how projects are cur­rent­ly financed.

The prob­lem starts with a project’s pre-sale/­closed sale, which nat­u­ral­ly favors the sort of wealthy ven­ture cap­i­tal firms that are in a posi­tion to inject sub­stan­tial cap­i­tal, typ­i­cal­ly in return for sig­nif­i­cant­ly dis­count­ed tokens. At this junc­ture, VCs invari­ably pro­mote their port­fo­lios and the token of choice, caus­ing many retail investors — buoyed by the fact that a rep­utable name is back­ing a project — to grab a bag for themselves.

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When retail enters en masse, liq­uid­i­ty nat­u­ral­ly goes up, enabling the ear­ly back­ers to exit their posi­tions while in the green. You might ask: Well, what else are they sup­posed to do? The rai­son d’etre of a VC is to make mon­ey for its lim­it­ed part­ners, and if that is achieved by dump­ing on the mar­ket, most won’t bat an eye­lid. To quote Omar Lit­tle in The Wire: “The game is out there, and it’s either play or get played.”

Some unscrupu­lous play­ers actu­al­ly go one step fur­ther, manip­u­lat­ing prices so they can bor­row against their hold­ings to make even more bets, in turn increas­ing sys­temic risk in the indus­try. It’s pos­si­ble to rinse and repeat this process many times over, but if macro head­winds emerge, even VC bell­wethers can turn into dis­tressed sell­ers forced to dump every token in their port­fo­lio. We are see­ing this play out right now as Solana (SOL) pays a heavy price for its links to FTX Ven­tures and Alame­da Research.

When VCs dump their coins and col­lapse the price, all but the most reac­tive retail investors are left with tokens that are worth a mere frac­tion of what they paid. So, what’s the solution?

The bot­tom line is that dis­trib­uted, com­mu­ni­ty-based fund­ing mod­els will lead to a health­i­er, more resilient mar­ket. Projects that entice a spec­trum of con­trib­u­tors from the ear­li­est days, back­ers who are fair­ly remu­ner­at­ed for their sup­port, are not vul­ner­a­ble to the sin­gle point of fail­ure that comes from hav­ing one large, often over-lever­aged VC boot­strap­ping operation. 

And, of course, the mar­ket val­ue of said tokens is not at the mer­cy of VCs aggres­sive­ly pur­su­ing their own goals. If reg­u­lar folk are the ones buy­ing into a project, its lifeblood will be organ­ic: Some will own more than oth­ers, but none has the pow­er to sin­gle-hand­ed­ly bring the ship down. What’s more, new­er investors get access to tokens at a fair mar­ket rate.

Relat­ed: Dis­as­ter looms for Dig­i­tal Cur­ren­cy Group thanks to reg­u­la­tors and whales

Flaws in the exist­ing sys­tem are not exclu­sive to VCs and the mul­ti­ple ear­ly-sale rounds in which they par­tic­i­pate. Often­times, project founders them­selves col­lect out­sized ear­ly rewards, putting con­sid­er­able dis­tance between them­selves and the com­mu­ni­ty con­trib­u­tors to whom they invari­ably preach a “We’re all in it togeth­er” message.

The implo­sion of FTX and Alame­da was a black swan event, but it will sure­ly give many projects pause. Although receiv­ing an influx of cap­i­tal from a seri­ous Web3 investor is a water­shed moment for a start­up, at what cost? How many of these ser­i­al investors are gen­uine sup­port­ers with a long-term vision for the projects they back? And if a VC col­laps­es, it could bring your project down with it.

We often read about the wis­dom of the crowd and the ben­e­fits of com­mu­ni­ty gov­er­nance in cryp­to. Yet such sen­ti­ments are com­plete­ly for­got­ten when projects chase fund­ing. It is time to think long and hard about how cryp­to projects should be financed. 

As investors, we must become mind­ful of the many down­sides of typ­i­cal VC-backed coins. Rather than copy­ing the Sil­i­con Val­ley suits, we must learn to look the oth­er way — at the projects grow­ing from the bot­tom up, pro­pelled by gen­uine excite­ment from a com­mu­ni­ty of diehards who are in it for the long haul.

Justin Giu­di­ci is a co-founder of Telos, a third-gen­er­a­tion blockchain plat­form for build­ing scal­able dis­trib­uted appli­ca­tions with fee­less trans­ac­tions. He’s also the CEO of Infin­i­ty­bloc, a decen­tral­ized gig econ­o­my plat­form. He holds a bachelor’s degree in com­merce from Curtin University.

This arti­cle is for gen­er­al infor­ma­tion pur­pos­es and is not intend­ed to be and should not be tak­en as legal or invest­ment advice. The views, thoughts, and opin­ions expressed here are the author’s alone and do not nec­es­sar­i­ly reflect or rep­re­sent the views and opin­ions of Cointelegraph.

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