The locked "paper wealth" faces the "hellish difficulty" cycle of VCs

Author: Mia, ChainCatcher

Editor: Marco, ChainCatcher

Retail investors attribute their losses to the "high FDV (Future Discounted Value), low circulation" token issuance strategy, believing that VCs and project parties are colluding, with a large number of tokens being unlocked, impacting the crypto market.

Meanwhile, VCs claim they are "wronged," defining the primary market of this cycle as "hellish difficulty." Li Xi, a partner at LD Capital, stated that while the financial statements show profits this year, they are all paper profits, as the VC's share remains at 0 unlocks. Apart from the "gathering" VCs, most VCs are merely "big retail investors" taking over.

ChainCatcher interviewed several representatives from the VC industry to explore the current survival status of VCs.

Many VCs cited six reasons that have led to the current exit difficulties faced by VCs. Some VCs indicated that in the current market environment, not investing has become the best strategy.

VC's "Paper Wealth"

In the current market cycle, the "high FDV, low circulation" token issuance method has gradually become a mainstream trend, and "VC tokens" have been labeled as "dangerous" in the secondary market.

Previously, Hitesh.eth, co-founder of the data analysis platform DYOR, posted a set of data on X, reviewing the ten most typical "VC tokens" currently on the market.

The data shows that even in a continuously declining market, major VCs still have paper profits of dozens or even nearly a hundred times on their investments in these tokens.

For VC institutions, "paper profits" have always been a common and objective existence. Early investors typically receive a certain proportion of tokens as a reward, which are locked according to a specific time structure. This phenomenon exists in both web2 and web3 investments, although the proportions vary significantly at different stages of development.

However, the uncertainty of unlocking has turned these profits into "paper wealth."

Li Xi, a partner at LD Capital, publicly stated that although the projects invested by LD Capital and already listed on trading platforms show profits on financial statements, behind this seemingly glamorous series of numbers lies "paper wealth," "because the VC's share remains at 0 unlocks due to 'high FDV, low circulation.'"

For retail investors in the secondary market, the large number of VC shares that remain unlocked has triggered new panic.

Common token lock-up parameters include: allocation ratio, lock-up period, and unlocking cycle. All these parameters only play a role in the time dimension, and the current unlocking period is a one-size-fits-all rule set by project parties and exchanges. In the current market environment, "unlocked tokens" have become the "paper profits" of VCs.

Faced with "paper profits," the market has also begun to develop countermeasures—"over-the-counter (OTC) trading."

CatcherVC investment partner Loners stated, "If the deal you invested in is decent, some funds will be willing to buy your SAFT agreements, which is equivalent to risk transfer or early cashing out. However, the current OTC market's trading volume is still too small, and transactions are concentrated on a few particularly leading projects."

Loners mentioned that if OTC trading matures gradually, matching funds with different risk tolerances, this issue will be partially alleviated. Alternatively, a more extreme approach could be to short hedge, but many institutions lack management experience in this area and do not recommend trying it.

Lock-up Dilemma

In the face of the massive unlocking of "VC tokens" in the current market, unless market demand increases, it may lead to potential selling pressure.

Loners shares the same view: "The unlocking period for project tokens and related resources is long. If the market's expectations for project development are not met during this period, combined with market sentiment, liquidity fluctuations, and the fact that project hype peaks are usually concentrated around the listing stage, leading to high premiums, if there is a lack of new capital injection after unlocking, token prices are likely to fall."

Ro Patel, a partner at Hack VC, stated, "If the proportion of locked tokens is too large, it will affect the token's available liquidity, which will adversely impact the token's price and harm the interests of all holders. Conversely, if contributors do not receive appropriate compensation, they may lose the motivation to continue building, ultimately harming the interests of all holders."

Similarly, Nathan, a partner at SevenUpDao, believes, "For some underlying infrastructure, the unlocking can remain unchanged, giving them time to develop across cycles. However, for projects focused on traffic or applications, the same unlocking approach should not be taken. You need to encourage and incentivize them to unlock quickly and continuously innovate."

Loners agrees with Nathan, stating that the design of unlocking terms should depend on the specific project type. "For industry-critical infrastructure, longer unlocking periods can be accepted, while many application projects should not have particularly harsh terms. Instead, they should focus on the product itself and exchange relatively favorable unlocking conditions for financing efficiency."

Six Reasons Leading to Hellish Difficulty in the Primary Market

As market liquidity continues to dry up, the return cycle in the primary market has lengthened, and more and more small and medium-sized VCs affiliated with large VCs have chosen a conservative wait-and-see attitude.

Nathan candidly stated, "For small and medium-sized investment institutions, the higher the flexibility of adjustment, the less likely they are to suffer losses in this matter, because you do not need to invest in 30 or 50 projects a year for the sake of branding or to spend LP's money at a certain pace. There are simply not that many quality projects available in the market."

Some small and medium-sized VC institutions also indicated that due to high valuations and stringent investment terms, they have not participated in many primary investments this year.

They believe that some new projects on the market currently lack backing from large VCs and are not innovative enough. Additionally, excessively high FDVs may lead to TGE prices exceeding expectations, "many institutional investments are actually facing losses."

As more and more small VCs exit, the market has become a battlefield for large VCs to "fight alone."

Faced with LP's funding pressure, large VCs still need to invest, despite the challenging investment environment.

In light of the current difficulties in the primary market, Nathan optimistically defines it as "temporary and a reasonable existence of phased development."

VCs believe that the challenges of this round of investment's "hellish difficulty" mainly stem from the following six aspects:

• Valuation Bubble and Market Turmoil: In early 2022, influenced by the dollar's monetary easing, North American VC institutions successfully raised huge amounts of capital, driving primary market valuations to irrational levels. Subsequently, events such as the FTX collapse and Binance's CZ incidents severely disrupted the financing and listing rhythm of the market, further exacerbating market uncertainty.
• Industry Narrative and Application Deficiency: Although technical narratives and new asset issuance narratives are emerging, the market generally lacks application narratives that can attract users and generate actual utility. This leads to investors holding skeptical views on the long-term value of projects, thereby affecting their investment decisions.
• Restricted Capital Flow and Stock Market: The market is overall in a state of stagnant capital, with restricted capital flow. Although there is some ETF inflow, it has not entered the altcoin market, directly impacting market activity and project financing capabilities.
• Dilemma of Altcoins and VC Tokens: Altcoin prices have plummeted, while VC tokens face a large number of unlocks without incremental capital to absorb them, leading to continuous price declines and further undermining market confidence.
• Concentration of Capital and Exit Difficulty: Capital is highly concentrated in a few leading centralized exchanges (CEX), while most non-popular projects cannot meet CEX's listing requirements and struggle to gain favor from investment institutions, further increasing the difficulty of project exits.
• Lack of Hotspots and Speculative Capital Shift: The current market lacks new hotspots to absorb speculative capital, and when market attention is focused on higher-risk meme projects, it further exacerbates the speculative atmosphere and volatility in the market.

"Gathering" VCs and "Big Retail Investors" Taking Over

Li Xi, a partner at LD Capital, summarized the current VC situation by stating, "Apart from the 'gathering' VCs, most VCs are just 'big retail investors' taking over," and this is indeed the case. Nathan defines it as a "market adjustment phenomenon under the increased difficulty of exiting the current primary market."

In the context of the increasing difficulty of exiting the primary market, "gathering" has quietly emerged. "Gathering" reduces the risk of loss for VCs by forming a "team" and lowering valuations to a relatively controllable range.

However, "gathering" is not without flaws; the scarcity of excellent founding teams, severe narrative homogeneity, high trial-and-error costs, and the lack of direct capital exit channels are all challenges that cannot be ignored.

Nathan stated, "During particularly prosperous times in the primary market, the more efficient approach from an ROI perspective is direct investment; conversely, only then would one consider 'gathering.' For VCs hoping for long-term stable development, 'gathering' actions are not necessary, but the ability to 'gather' is essential."

Regarding "gathering" projects and "big retail investors," it is essentially a process of market selection and self-repair. Loners noted that whether it is a gathering project or a legitimate project, from a funding perspective, exits often depend on secondary market performance. However, the core of the project still lies in whether its product or service can create positive value for the industry. If a project lacks substantial contributions, even with strong backing and support, it is difficult to maintain its market position in the long term.

Nathan stated that if a large number of "gathering" projects are of poor quality, making it impossible for capital to exit and being swept up by public opinion, it will naturally demotivate the "gatherers." Conversely, if a project can obtain better resources and has a reasonable valuation, why not pursue it?