Dialogue Tangent Co-founder: Liquidity Funds vs Venture Capital, Who is Really Driving the Crypto Market

Original Title: VC vs. Liquid Fund & Inside Friend.Tech's Exit - The Chopping Block

Podcast Source: Unchained

Translation: Deep Tide TechFlow

Guests: Jason Choi, Co-founder of Tangent

Hosts: Haseeb Qureshi, Managing Partner at Dragonfly; Tom Schmidt, Partner at Dragonfly; Tarun Chitra, Managing Partner at Robot Ventures

Release Date: September 14, 2024

Background Information

This episode of the podcast features DeFi experts Tom, Tarun from Gauntlet, and Jason Choi, co-founder of Tangent. They discuss the challenges of venture capital in the crypto market and the limitations of airdrops, while also emphasizing the potential of DeFi protocols to improve market efficiency. As the market continues to evolve, enhancing investment quality and the actual value of projects will become a focal point for the industry.

Tangent is a company focused on blockchain technology and decentralized finance (DeFi) solutions. It aims to provide innovative financial services to users, leveraging the transparency and security of blockchain to improve the efficiency of traditional financial systems.

Key Takeaways

Friend.Tech Token Crash: The price of Friend.Tech's token plummeted by 96%, highlighting the risks of launching tokens without sustainable product planning and user retention strategies.

Project Exit and Ethics: Early token issuance has raised concerns about the ethical responsibilities of teams when abandoning projects, with increasing accusations of "rug pulls."

Impact of Airdrop Farming: Airdrop farming distorts real user engagement, leading to inflated metrics that inaccurately reflect product-market fit and genuine user growth.

Venture Capital in Crypto: Low barriers to entry have led venture capital firms (VCs) to inflate project valuations, often resulting in overhyped and unfulfilled crypto projects.

Challenges of Early Token Issuance: Early token releases often harm long-term project potential by confusing market signals and damaging user retention.

Debate on VC Value Extraction: The debate continues over whether venture capital extracts value from the crypto market or if liquid funds can enhance market efficiency.

Hedge Funds and Market Efficiency: Hedge funds may improve market liquidity, but their impact on long-term crypto growth remains under scrutiny.

Speculative Market vs. Long-term Value: The crypto market continues to struggle with balancing short-term speculative behavior and creating sustainable long-term value.

Impact of U.S. Politics in Singapore

General Attention to U.S. Politics

• Jason pointed out that U.S. politics occupies a significant place in discussions in Singapore. Almost daily, people are focused on developments in the U.S., especially political debates. He mentioned that during this time, their work has felt like a macro fund, as they have been closely monitoring political events, which he finds somewhat unpleasant.

Focus on Trump Family Projects

• Haseeb mentioned the Trump family's DeFi-related projects, and Jason stated that his understanding of the project is limited to some surface-level information, mentioning its relation to Aave token prices.

Social Media Reactions

• Tarun noted that his previous comments on certain projects sparked significant reactions, especially when he referred to a project as a "rug pull" or "poor people's exit scam," receiving intense feedback. Therefore, he chose to avoid further comments on such projects to prevent more controversy.

Current Status of Friend.Tech

• Haseeb mentioned that the Friend.Tech project has recently garnered widespread attention. Friend.Tech is a social finance project that allows users to support creators by purchasing their tokens and joining creator chats. Although the project generated buzz in the summer of 2023, its token has performed poorly since launch, currently down 96% from its historical peak.

• Haseeb also noted that the project team transferred contract control to an invalid address four days ago, which has led to accusations of an "exit scam."

Team's Explanation and Market Reaction

• Despite the team stating that they did not sell tokens and that the issuance was fair, the market's reaction has been strong, with many believing the project is "exiting" or "abandoning." Haseeb raised the issue of broader discussions about the responsibilities that crypto product teams should bear.

• Jason mentioned that he was an active user of Friend.Tech, and despite the token price crash, he believes the project initially attracted a large user base.

Views on Team Responsibility

• Tom further analyzed the scope of team responsibility, suggesting that compared to some obvious "rug pull" projects, Friend.Tech's situation is more complex. He pointed out that while the team did not retain tokens, they profited from platform transaction fees, which has caused dissatisfaction among users, as these earnings did not translate into token value.

• Haseeb also added that there is a gap between user expectations for the token and the actual situation, leading to disappointment.

• Jason concluded that Friend.Tech may not have executed the timing of the token release well and failed to establish an effective value accumulation mechanism. They also faced issues with product-market fit, as the project initially performed well but did not sustain user engagement. Overall, this incident has sparked profound discussions about the responsibilities of crypto project teams and provided important lessons for future similar projects.

Future of Friend.Tech

Limitations and Challenges of the Platform

• Jason mentioned that the design of Friend.Tech results in a very small user base. Due to the token price curve, users quickly find themselves excluded, making it difficult for the platform to expand to more users. Additionally, creators' earnings on the platform primarily come from users purchasing their tokens, and once users join the group, creators have no incentive to continue providing value. This mechanism leads many creators to be less active after joining, as they do not hold their own tokens.

Timing and Impact of Token Release

• Haseeb believes that while the token release of Friend.Tech attracted a large number of users in the short term, the platform's infrastructure and user experience did not improve. He pointed out that although the token release brought users back, the platform still has many issues, resulting in a poor user experience.

• Haseeb likened this situation to a comedian's first appearance on television; if the performance is poor, there may not be another opportunity.

Reflections and Suggestions for the Future

• Tarun expressed that he has little emotional connection to Friend.Tech but believes the project did indeed try to innovate in certain aspects. He mentioned that Friend.Tech attempted to incorporate elements of meme tokens but failed to effectively implement these ideas.

• Haseeb further added that the Friend.Tech team did not iterate sufficiently on the core product, leading to stagnation in platform innovation.

Decline in User Experience and Content Quality

• The discussion highlighted that over time, user questions have become monotonous, and creator interactions have gradually decreased. Tarun even stated that creators' performance on the platform has been affected, leading to a decline in content quality.

• Haseeb believes that Friend.Tech has not found a good balance between user engagement and content creation, ultimately leading to a sense of fatigue in the user experience.

How to Shut Down a Startup

Norms and Challenges of Startup Closures

• Haseeb mentioned that shutting down startups is a common phenomenon, especially in the crypto industry. Many early-stage startups may realize they cannot achieve their initial goals and need to consider exit strategies. Unlike traditional industries, the crypto sector lacks clear exit norms or processes, leaving founders confused when shutting down projects.

Founders' Exit Strategies

• Jason believes that in the early stages of a startup, the shutdown process is relatively straightforward, as there are no tokens involved at that point. Founders can work with lawyers to gradually liquidate the company and proportionally refund investors. However, once tokens are released, the situation becomes complicated, as founders must deal with thousands of token holders rather than just a few investors.

Timing of Token Release

• Jason emphasized that founders must be cautious when deciding to release tokens. The token release should occur when the project has achieved some degree of product-market fit, rather than as a "desperate move" when the project is in trouble. He mentioned that some projects are considering how to gradually shut down tokens and proportionally refund investors after undergoing legal processes.

Successful Closure Cases

• Haseeb and Tarun mentioned some successful token closure cases, such as Vega and Fei, which used community voting and buyback mechanisms to handle the closure process. These methods not only allow the community to participate in decision-making but also provide some compensation for investors.

Decentralization and Open Source Possibilities

• Tom suggested that ideally, founders should consider open-sourcing the project, allowing the community to continue operating it. This approach could somewhat alleviate users' disappointment over the project's closure, as users could maintain and manage the project themselves. However, fully decentralized products are rare, and many projects still rely on centralized infrastructure.

Venture Capital Funds and Liquidity in the Crypto Market

• Haseeb raised the topic of recent heated discussions on Twitter regarding the dynamics between venture capital (VC) funds and liquidity markets. A tweet from Arthur Chung sparked this discussion, claiming that in the current crypto market, venture capital funds are effectively "net extractors," meaning they extract more funds from the crypto ecosystem than they invest. The crux of this viewpoint is that venture capital funds typically invest in new projects at low valuations and then sell tokens through exchanges once the projects mature, thereby withdrawing funds from the ecosystem.

Different Types of Venture Capital Funds

• Jason believes this perspective is overly simplistic and cannot be generalized. He pointed out that the barriers to entry for venture capital funds in the crypto industry are relatively low, resulting in a wide variance in project quality among many funds. While some funds do buy tokens at low prices and sell them at high valuations, this does not represent the entire state of the venture capital industry. He emphasized that the excess of funds in the market has intensified competition for quality projects.

Investment Opportunities in Early Stages

• Jason further explained that Tangent aims to focus on early-stage investments, as many large funds often cannot effectively support these startups. They hope to fill this gap by providing small investments. Additionally, he mentioned that the price discovery mechanism in liquid markets is relatively insufficient, leading to a lack of consensus on token valuations, which is also an issue raised by Arthur.

Uniqueness of the Crypto Market

• Tarun pointed out that the crypto market blurs the lines between private and public investments, with venture capital having a greater influence in the crypto space compared to traditional markets. He believes that investors in the crypto market can directly influence project liquidity and market pricing, whereas in traditional venture capital, investors have relatively less control over the final public price.

Pricing Efficiency in Private Markets

• Tarun also noted that pricing efficiency in private markets may be lower than in public markets. Due to competitive pressures, investors often need to transact at prices higher than they deem reasonable, and this auction mechanism makes pricing in private markets more unstable and inefficient.

Winner's Curse

• The "winner's curse" mentioned by Haseeb is a well-known phenomenon first identified in the 1960s during the U.S. government's auction of oil leases in Alaska. In the auction, oil companies could sample the land and then decide how much they were willing to bid. Since each bidder only sampled a specific area, some bidders might overestimate the value of the entire land, leading to overbidding and ultimately resulting in the "winner's curse."

Winner's Curse in Crypto Venture Capital

• Tarun believes that the winner's curse exists not only in crypto venture capital but that all venture capital may face this phenomenon, though it is more pronounced in the crypto space. He pointed out that private investors in the crypto market are often also public market investors, participating in the liquidity formation process at token release and trading with market makers. This participation allows them to exert more influence when assets go public.

Impact of Market Intervention

• Haseeb further analyzed that Tarun's point is that competitive venture capital transactions often lead to inflated prices, and the eventual winners may suffer losses in expected value.

• Tarun added that while they may appear to have won the transaction on the surface, if no intervention occurs, the final value may be lower than they anticipated. Private funds in the crypto market can intervene more in the process of assets becoming public, which is in stark contrast to the pricing mechanisms in traditional public markets dominated by intermediaries like banks.

Dynamics Between Public and Private Markets

Value of Brands and Liquidity

• Tarun believes that in tech venture capital, brand value is higher because investors are more willing to pay a premium for well-known brands before liquidity. In the crypto market, however, the brand premium is relatively low. Haseeb countered that in the early stages of crypto projects, brand influence is crucial, as many projects have not yet launched products, making branding an important signal.

Stage Differences and Investment Strategies

• During the discussion, Haseeb and Tarun also talked about the differences between the crypto market and traditional tech investments. Haseeb pointed out that while brand influence is significant in the early stages, its effect may diminish in later stages. Tarun argued that the crypto market lacks later-stage financing rounds, making brand influence more pronounced in the early stages.

Liquidity Events and Market Speculation

• Jason mentioned that public markets in the crypto space often give projects a premium far above their actual value, allowing venture capitalists to reap substantial returns when projects go public. For instance, if a venture capitalist invests in a new Layer 1 project at a fully diluted valuation (FDV) of $30 million, and the project's market valuation reaches $1 billion three months later, this creates a "fiduciary duty" for the venture capitalists—under these circumstances, they are almost obligated to sell their held tokens.

Impact of Rapid Listings

• Jason further pointed out that the liquidity window in the crypto market allows projects to secure funding in a short time frame, contrasting sharply with the traditional market, where it typically takes seven to ten years for a startup to go public.

• While Haseeb expressed skepticism about projects launching tokens in such a short time frame, arguing that no one can launch a token in two months, Jason countered that even if it isn't two months, the time frame is still significantly shorter compared to traditional markets.

Market Speculation and Valuation Pressure

• Jason believes that this rapid listing dynamic prevents projects from truly realizing their potential, partly due to the immense speculative premium the market places on new projects. Almost all projects entering the crypto market, even with minimal potential, are accepted by the market at inflated valuations, but these projects often struggle to achieve these high valuations in their early stages.

Self-Correcting Market

• Jason proposed that the market will eventually self-correct. As ordinary investors begin to realize that purchasing tokens at several hundred million in fully diluted valuation could lead to losses, this speculative behavior in the market may gradually diminish. He noted that the token issuance situation over the past six months shows that, aside from a few highly liquid "meme coins," almost all newly issued tokens have seen price declines. This indicates that investors are gradually recognizing this pattern, which may lead to adjustments in future market behavior.

Hedge Funds and Market Efficiency

Market Volatility and the Role of Venture Capital

• Haseeb pointed out that the market has seen a significant decline over the past six months, with nearly all assets dropping by 50%. He emphasized that while he is a venture capitalist, he does not agree with the view that liquidity funds are beneficial to the market while venture capital funds are harmful. He believes this perspective implies that the projects they build lack real value, which is not the case.

• Haseeb stressed that many projects funded by venture capital (such as Polymarket, Solana, Avalanche, Circle, Tether, and Coinbase) have actually driven the development of the crypto market, making it more valuable.

Role of Liquidity Funds

• Haseeb further discussed the effectiveness of liquidity funds, arguing that their performance in the market does not necessarily promote the long-term development of projects. He believes that the goal of liquidity funds is to achieve short-term profits through frequent trading rather than providing funding for new projects. The operational model of liquidity funds makes them more inclined to extract value from the market in the short term rather than support long-term technological development.

Market Efficiency and Liquidity

• Haseeb mentioned that the efficiency issues in liquidity markets are also worth noting. He questioned whether the entry of liquidity funds into the market would mean that their performance would be poor. He pointed out that the goal of liquidity funds is to make quick profits rather than long-term investments, which may lead them to extract more funds from the market rather than support the development of new projects.

Comparison of Venture Capital and Traditional Finance

• Tarun also participated in the discussion, pointing out that similar doubts about venture capitalists exist in traditional financial markets. He mentioned that many people believe venture capitalists merely inflate each other's valuations, which actually reflects the tension between long-term investments and short-term profits in capital markets. He believes this tension is one of the core conflicts of capitalism, leading to frequent trading activities.

Airdrop Farming and Wash Trading

(Deep Tide Note: Wash Trading is a market manipulation behavior where traders frequently buy and sell the same asset without actual transfer of ownership to create a false trading volume. This behavior can mislead other investors into believing that there is high demand for a particular asset, thereby attracting more investors. Wash trading not only affects market transparency but can also lead to inflated prices, negatively impacting the healthy development of the market.)

Lack of Market Financing Efficiency

• Tom pointed out that the public cryptocurrency market performs poorly in providing and raising funds for teams issuing tokens. He noted that unlike traditional stock markets, teams cannot easily issue new tokens through the public market when they need more capital; in most cases, teams are actually selling tokens to venture capitalists rather than trading directly in the public market. This makes the crypto market inefficient in providing funding for teams.

Relationship Between Hedge Funds and Ordinary Investors

• Haseeb further discussed the relationship between hedge funds and ordinary investors, noting that discussions on crypto Twitter often tend to support hedge funds, which contradicts the interests of ordinary investors.

• Tarun mentioned that, similar to the GameStop situation, ordinary investors have a complex attitude towards hedge funds, especially during market volatility.

Quality of Venture Capital and Market Perception

• Jason noted that different qualities of venture capitalists can significantly affect the market's perception of venture capital. He believes that projects supported by high-quality venture capitalists typically attract more capital, while low-quality venture capitalists may lead to market misjudgments about projects, fostering a pessimistic attitude towards venture capital.

Value of Liquidity Funds

• In discussing liquidity funds, Jason emphasized that different liquidity fund strategies may have varying impacts on the market. He pointed out that high-frequency trading funds may provide more liquidity to the market, while some thematic funds may improve market efficiency by sharing their investment ideas, thereby shifting capital from inferior projects to higher-quality ones.

Impact of Wash Trading

• Regarding wash trading, Tarun and Haseeb discussed its prevalence and impact on the market. Tarun mentioned that wash trading may be legal in some cases, but it can distort the true state of the market, and in the crypto market, the costs of wash trading may not be sufficient to deter such behavior.

Controversy of Airdrop Farming

• Jason noted that systematic airdrop farming could negatively impact projects, as these behaviors lead to a false inflation of the project's user base, affecting founders' judgments about product-market fit. He believes that such behavior is not conducive to the long-term development of projects.

Future of the Market and Strategies

• In discussing market strategies, Tarun expressed concerns about the current market's lack of mid-frequency trading strategies, believing this deficiency limits the market's maturity and efficiency. He argued that the market needs more mid-frequency trading strategies to better facilitate price discovery under different market conditions.