Zhang Mingjing from Chain Capital: There may be a wave of VC investment opportunities in blockchain in the second half of the year

This article was published on July 21, 2019, on the Chain Catcher WeChat public account and organized by Gong Quanyu.

Since the beginning of 2019, there has been a stark contrast between the booming secondary market and the quiet primary market in both traditional financial markets and the blockchain market. While this is certainly influenced by funding and policy factors, VC firms will not miss out on genuine investment opportunities. How does Chain Capital view the investment opportunities in the blockchain field in the primary market for the second half of the year?

Recently, Mr. Zhang Mingjing from Chain Capital shared insights on the current blockchain investment and financing market from the perspective of mainstream VCs as a guest at the "Catcher Academy Phase II" hosted by Chain Catcher. He pointed out that there may be a wave of VC investments in blockchain in the second half of the year and elaborated on four underlying logics and three considerations for this judgment. Below is the text整理.

**▏ Session One: ** Community Sharing ▕

Hello everyone, I am Zhang Mingjing, the founder of Chain Capital. Today, I will mainly share some research and practical insights on the blockchain investment and financing market.

First, let me talk about my understanding of blockchain.

Blockchain is actually a collective term.
Before 2014, there was only "Bitcoin"; after 2014, we had "blockchain." Blockchain is a term that abstracts and combines two parts of Bitcoin: one is the technical part, such as distributed ledgers, encryption technology, consensus algorithms, etc., and the other part is the token economic model of Bitcoin. Together, they are called blockchain.

In essence, blockchain is a new type of database, a distributed database, but the distributed attribute may explain 80% of its characteristics, not all. We should know that distributed databases have existed for a long time, such as Oracle and MySQL databases, which also have distributed technology.
However, their previous distribution only had multi-point backup and fault tolerance characteristics, which could not solve the problem of subjective malice, because they operated under specific patterns set by computers and did not involve malicious tampering.

The essence of this new type of database is its consensus algorithm, such as the Byzantine algorithm, which prevents subjective malice. This has led to large-scale collaborative distributed databases like the Bitcoin network, enabling multiple mutually distrustful entities to collaborate on the internet. Today, when we look at various public chain projects, they all revolve around issues such as how to improve the computational speed of such databases, increase their capacity, or solve interconnectivity issues between different databases, etc.

Next, I will explain why many VCs do not pay much attention to blockchain, as they still view blockchain as merely a database investment logic.

Looking back to around the 1980s, the database industry was in its early development stage. At that time, American VCs were investing in various databases, relational databases, non-relational databases, and how to synchronize between different databases; from DB2 to Oracle, from MySQL to MongoDB, and so on.

Of course, if we only see blockchain as a database, that would be too narrow a perspective. The database essentially represents a ledger, and bookkeeping equals recording value.
The difference between this blockchain database and many previous databases is that it can record very granular values and allow for in-market transactions. Blockchain enables all valuable transactions to be recorded, securitized, and traded, which is why it is often referred to as the value internet.

So how should we understand the financial attributes of blockchain?

I abstract it into two aspects: one is crowdfunding, and the other is the early listing and circulation of equity for startups. Considering current regulatory factors, I will briefly elaborate on these two attributes. For example, equity crowdfunding is not allowed in our country, but it is permitted in the United States, and crowdfunding has its rationale.

For instance, if you want to become an LP of a VC firm, you cannot do it without a million. If you want to become an LP of top VC firms like Sequoia or Matrix, you need tens of millions in assets, so we can say that ordinary people do not have smooth channels to invest in VC firms.

Blockchain provides us with opportunities to invest in quality assets. For example, an engineer with an annual salary of one million, if he is optimistic about the development of AI and wants to invest in some quality projects early on, can easily do so through crowdfunding, without needing to become an LP of a VC or being an outstanding fund manager. This also explains why you can see some ordinary engineers suddenly becoming wealthy in the blockchain industry, as they are early investors in some cryptocurrency projects.

Based on the previous explanations, it is not difficult to understand why most VCs do not invest in blockchain + e-commerce or blockchain + tourism projects,
because VCs still see them as e-commerce or tourism projects, which require you to have distinctive features in those industries.

If blockchain is merely used for recording and trading, then fundamentally, it is no different from using MySQL or Oracle databases for recording. How can one say that using a different database for recording can change the project's fundamentals? Many projects are just using the concept of blockchain to raise funds. Of course, in the past, these projects found a lot of money using the concept of blockchain because there is a lot of long-tail money in the realm of inclusive finance.

After frequent communication with investment institutions during this period, I have formed a judgment—there may be a wave of VC investments in blockchain in the second half of the year.

The main reasons are as follows:

First, the secondary market is improving. From the current coin prices, the industry has broken through the previous slump and entered a phase of vigorous development, although there will be adjustments along the way.

Second, we can see that the national policy on blockchain is gradually loosening.
For example, in the first half of this year, we rarely heard very negative news; previously, there were often rumors that a certain leading exchange was about to be investigated. Additionally, the entry of giant companies like Facebook has undoubtedly had a significant impact on regulators.

Third, the industry's infrastructure is expected to accelerate its improvement.
I have seen a lot of discussions about Facebook's cryptocurrency in the financial sector, and I believe Facebook's entry can enhance the improvement of industry infrastructure and engineering-level applications.

I believe everyone has seen some blockchain products, most of which are not software engineering-level or scalable industrial products; they are basically demo versions. With Facebook's entry, it will certainly organize a large number of talents with software engineering capabilities to develop, which will greatly help the improvement of the entire blockchain industry's infrastructure and the quality of practitioners.

Fourth, VCs lack investment themes, and there are not many good investment opportunities this year.
According to my research and observation, many VCs have been focusing on learning and research in the past two months, all looking for new breakthroughs. Therefore, as long as the cryptocurrency market can stabilize, blockchain will definitely become a good direction for some VCs to seek breakthroughs.

If everyone agrees with my judgment, then I will talk about the considerations for financing in the second half of the year.

First, it is essential to strategically value this opportunity window, but the window period will not be too long.

For VCs to enter an industry on a large scale, they need to talk about penetration rates, and without a 10-20% penetration rate, they will not enter on a large scale. Currently, the penetration rate of the blockchain industry is too low, with only a few million cryptocurrency users in China. Therefore, the financing opportunities in the second half of the year can be understood as a small rebound in the market, so everyone must seize this opportunity window and quickly secure funding.

Second, financing must adhere to a strategy of small steps and quick runs, without getting bogged down by valuation, but rather aiming to secure funding.

Once you secure some funding, proceed with the business, and continue to raise more after making certain progress. Never think that you won't raise funds if the valuation does not meet expectations. Additionally, do not be overly picky about investors; everything should be aimed at securing funding.

Third, be cautious in using blockchain financing methods.

Choosing blockchain financing means you will face various long-tail investors, and in the end, the money you raise may be from gamblers, which can lead to various group incidents if not handled well.
My suggestion is that project parties should try to secure funding from institutions and middle-class individuals in the primary market; as for becoming a public project in the secondary market, constantly negotiating with investors is a matter for later.

**▏ Session Two: ** Dialogue Session ▕

Question: Mr. Zhang is an expert in investment and financing. I would like to ask a macro question: what cycle do you think the current capital market is in?

Zhang Mingjing:
Let me first share a set of data from the broader technology sector. According to Qianlong's statistics, in the first five months of 2019, the fundraising amount for PE and VC in China was 440 billion RMB, a year-on-year decrease of 29%; the investment amount for VC and PE in the first five months was 200 billion RMB, a year-on-year decrease of 54%, with the number of investment cases at 2418, a year-on-year decrease of 50%.

From these numbers, we can see that the entire capital market is still very sluggish, which is related to the end of a wave of information revolution dividends represented by mobile internet.
Currently, everyone has not found a systematic opportunity that combines new traffic and technology, which can resonate with both.

Now, investors are looking at lower-tier markets, overseas markets, enterprise services, aerospace, and life sciences, but their focus is quite scattered, unlike the past 3-5 years when everyone had a consensus that the biggest opportunity was only in mobile internet. This is a broader background.
Although investors are trained in value investing every day, they still prefer opportunities that emerge from the bottom and move to the right side, as investing in a rapidly growing market is more comfortable.

Fortunately, the blockchain industry has completed a wave of craziness and downturns and is now in a new positive and healthy upward channel, so we blockchain entrepreneurs should be increasingly confident.

Question: You have encountered many projects, what common characteristics do you think good projects have?

Zhang Mingjing:
One characteristic of good projects is rapid growth, whether in users, revenue, or profit growth, because the capital market is not a completely fair game; everyone bets on growth, so it is essential to grow quickly.
Therefore, we entrepreneurs must think of ways to achieve rapid growth.

Question:
I feel there is a trend where native blockchain investment institutions tend to look for undervalued projects directly in the market, while being less enthusiastic about some new projects. Some equity investment institutions either invest in underlying technical infrastructure or in projects closely related to money, such as exchanges. What do you think about the current investment characteristics of these two?

Zhang Mingjing:
The so-called native blockchain investment institutions investing in severely undervalued projects refers more to projects in the secondary market where the token price was once high but is now severely undervalued; or projects that have improved their fundamentals after being listed.

Blockchain investment does not have PS and PE values, but they do have a value center (which everyone has not yet found). We can tentatively use "private placement rate" to replace it. This private placement rate used to be 100 times, now it is 10 times, but once the market picks up, everyone believes this ratio will rise, so native blockchain investment institutions are betting on changes in the private placement rate.

Equity investment institutions generally hope that the projects they invest in can last longer, and they believe the industry is still in its early stages, so most investors will invest in some underlying projects, essentially still viewing blockchain through a high-tech logic.

In fact, I believe many VCs are still operating under the original logic, not considering the close integration of blockchain projects with finance, or not seeing the reflexivity of the financial market on project fundamentals (Editor’s note: Reflexivity theory is a theory proposed by Soros about the interactive influence between investors and the market. Soros believes that investors act based on the information they have and their understanding of the market, which in turn affects and changes the market's original trends, with both continuously influencing each other).

Because they do not see this point, they still follow the original method to only look at the linear growth of fundamentals.
If some VCs value the trading attributes of blockchain, they may invest in projects like exchanges that are closer to money, or Fintech projects, similar to the early wave of electronic direct connections, algorithms, and high-frequency trading system vendors that appeared on Wall Street. I think there may be quite a few blockchain projects of the aforementioned types that will receive VC investments in the second half of the year.

Question: How long does the current financing cycle take?

Zhang Mingjing:
Not to mention blockchain, based on my understanding of the overall situation of technology projects, it generally takes about 3-6 months. In fact, starting this year, it has become rare for technology projects to complete financing within 6 months; most have extended to 6-9 months or even longer.

So for each financing, everyone must be well-prepared in terms of time. For blockchain entrepreneurs, if you do not take less than half a year to raise funds, it is very likely that you will not succeed.
We blockchain entrepreneurs, having experienced the charm of token financing, may not be able to endure the wait and feel that this time is too long, but if you want to secure VC funding, you need to make long-term preparations.

If you are determined to take traditional VC money, it is best to find a good financial advisor. On one hand, they can help you find the right people in the institution; on the other hand, a financial advisor can help you create a systematic organization, making the financing process very tight.

We often see some projects that are very happy to chat with investment institutions, but due to a lack of close follow-up, they end up falling through. Or when an investment institution shows interest and immediately wants to conduct due diligence, the project cooperates with the institution for a round, and then several other institutions come for due diligence, causing the project to be repeatedly tossed around. In such cases, I suggest entrepreneurs definitely find a financial advisor; this financial advisor does not have to be from Chain Capital, but you need such a role.

Question: Recently, some people said that now is a good time for equity investment institutions to enter and buy at the bottom because many blockchain projects have seen their valuations drop. Do you think the current valuations of projects are reasonable overall?

Zhang Mingjing:
Currently, the value of blockchain projects is definitely underestimated. Just look at the bubble in the AI sector, which may be much larger than that of blockchain. An AI company founded by a well-known professor may have a valuation of tens of millions of dollars in the angel round, and VCs flock to it.

In our blockchain industry, there are also some clearly excellent technology innovation companies with products, users, and outstanding and diligent teams, but currently, there are very few projects in the market with absolute valuations above 200 million RMB. Therefore, there are many projects in the blockchain industry whose values are severely underestimated. Based on this, we at Chain Capital have also established our own equity investment fund, hoping to help some quality entrepreneurs.

Question: I would like to follow up with a question: is there any consensus judgment or calculation method for valuations in the industry currently?

Zhang Mingjing:
Actually, there is none. Based on my experience, I will share some observations for reference. Generally speaking, we observe that globally leading projects can have valuations of tens of millions or even over a hundred million dollars; nationally leading projects may have valuations of 30-50 million dollars; and vertically leading projects are generally around 20 million dollars. If it is a very ordinary project, the valuation is usually between a few million to 20 million dollars, and the valuation is related to the degree of recognition of the project.
We observe that the valuation center for tokenization is still declining, but once a project is listed in the secondary market, its performance can vary significantly, which is related to the operational level of the team.

Question: The last question comes from an online inquiry. I would like to ask whether VCs are more interested in technology or application-type projects in the second half of the year? What is a reasonable exit strategy for VCs investing in blockchain projects currently?

Zhang Mingjing: I have also been frequently visiting various VC institutions recently, and they are still focusing more on underlying technologies, hoping to find some unique projects in that area.

Regarding reasonable exit strategies, I believe a more optimized comprehensive method is to invest in equity while giving tokens, provided that VCs accept this method. The essence of investing in equity while giving tokens is that you invest in this enterprise while also holding parallel rights associated with the actual controlling person of this enterprise, which may be a foundation rather than a company, and this is very easy to understand. However, currently, many VCs have not crossed this hurdle.