The History of VC Asset Bubbles: Why Does Every New Coin Seem to Be Heading to Zero?

Original Title: "The Great Crypto VC Bubble: Why Every New Token Trends to Zero (Part 1)"

Author: ++0xLouisT++

Compiled by: Deep Tide TechFlow

Altcoins are continuously bleeding out—why? Is it due to high FDV, or the listing strategies of CEXs? Should Binance and Coinbase directly invest their funds into new altcoins using TWAP (Time-Weighted Average Price)? The real culprit is not new—it all traces back to the crypto VC bubble of 2021.

In this article, I will analyze how we got to where we are today. In the following articles, I will explore the impact of this phenomenon on projects and liquid markets, potential future trends, and provide some advice for entrepreneurs in the current environment.

The ICO Craze (2017-2018)

The crypto industry is essentially a highly liquid industry—projects can issue tokens at any time, and these tokens can represent anything, regardless of their stage. Before 2017, most trading activity occurred in public markets, where anyone could directly purchase tokens through centralized exchanges.

Then came the ICO (Initial Coin Offering) bubble: a period of frenzied speculation quickly exploited by scammers. Its end was like all bubbles: lawsuits, fraud, and regulatory crackdowns. The U.S. Securities and Exchange Commission (SEC) intervened, making ICOs almost illegal. To avoid the U.S. judicial system, founders had to seek alternative ways to raise funds.

The VC Frenzy (2021-2022)

As retail investors were forced out, founders turned to institutional investors. From 2018 to 2020, the crypto VC space gradually grew—some firms were pure VC firms, while others were hedge funds allocating a small portion of their assets under management (AUM) to VC bets. At that time, investing in altcoins was a contrarian move—many believed these tokens would ultimately trend to zero.

Then came 2021. The bull market caused VC portfolios (at least on paper) to skyrocket. By April, many funds had achieved returns of 20x or even 100x. Crypto VCs suddenly looked like "money printers." Limited partners (LPs) flocked in, eager to ride the next wave. VC firms rushed to raise new funds, with sizes 10 times or even 100 times larger than before, convinced they could replicate these astonishing returns.

Source: Galaxy Research

Additionally, there are some psychological reasons explaining why VCs are so attractive to LPs, which I analyzed in detail in a previous article: The Real Reason Why There Is More VC Than Liquid Capital in the Crypto Space

The Hangover Period (2022-2024): The Dilemma and Transformation of Crypto VCs

Then came 2022: the collapse of Luna, the bankruptcy of 3AC (Three Arrows Capital), the failure of FTX—billions of dollars in paper gains vanished overnight.

Contrary to popular belief, most VCs did not cash out at the market peak. They, like everyone else, experienced the downward process of the market crash. Now, they face two major challenges:

1. Disappointed Limited Partners (LPs): LPs who once cheered for 100x returns are now demanding quick exits, pressuring funds to reduce risk and lock in profits prematurely.

2. Excess Capital: There is a large amount of unused VC capital (dry powder) in the market, but quality projects are in short supply. Many funds choose to invest in economically unreasonable projects to meet investment thresholds and pave the way for the next round of financing, rather than returning capital to LPs.

Today, most crypto VCs find themselves in a predicament: unable to raise new funds, holding a bunch of low-quality projects destined to follow the "high FDV to zero" script. Under pressure from LPs, these VCs have shifted from long-term vision supporters to short-term exit pursuers. They frequently sell off large tokens supported by VCs (such as alternative L1, L2, and infrastructure tokens), whose high valuations they themselves artificially inflated.

In other words, the incentive mechanisms and timeframes for crypto VCs have changed significantly:

• 2020: VCs were contrarians, facing capital shortages, focusing on long-term development.

• 2024: VCs have become crowded, over-capitalized, and more short-sighted.

I believe that the performance of VC funds from 2021 to 2023 will largely fall below expectations. VC returns follow a power-law distribution, where a few winners compensate for the majority of losers. However, due to forced early sell-offs, this model will be disrupted, leading to overall weaker performance.

If you want to learn more about the average data on VC returns, I previously wrote a related article.

It is not hard to understand why more and more founders and communities are skeptical of VCs. The misalignment between the incentive mechanisms and timelines of VCs and the goals of founders is driving a shift towards the following trends:

1. Community-Driven Financing: Projects are more inclined to raise funds through community efforts rather than relying on VCs.

2. Long-Term Support from Liquid Capital: Compared to VCs, liquid capital is gradually becoming the mainstay for long-term support of tokens.

Assessing the Liquidity/VC Cycle

Tracking the capital flow between VC funds and liquid markets is crucial. I use a metric to assess the state of the VC market. While it is not perfect, it is very informative.

I assume that VCs will linearly deploy 70% of their funds within three years—this seems to be the trend for most VCs.

VC 3y Linear Deployment Visualization

Based on the VC fundraising data provided by @glxyresearch, I applied a weighted sum model, combining the deployment rates over 16 quarters to estimate the remaining unused funds (dry powder) in the system. As of Q4 2022, approximately $48 billion in VC funds remained undeployed. However, with the new round of fundraising stagnating, this number has at least halved and continues to decline.

VC Undeployed Capital Visualization Chart

Next, I will compare the remaining VC funds each quarter with TOTAL2 (the total market cap of the crypto market excluding Bitcoin). Since VCs typically invest in altcoins, TOTAL2 is the best proxy indicator. If VC funds are too abundant relative to TOTAL2, the market will be unable to absorb future Token Generation Events (TGEs). Normalizing this data can reveal cyclical characteristics of the liquidity/VC ratio.

Crypto VCs and Liquid Markets: Cyclical Patterns and Future Outlook

Typically, during the "VC Euphoria" phase, the risk-adjusted returns of liquid markets often outperform VCs. The "VC Capitulation" phase is more complex—it may indicate that VCs are giving up, or it may suggest that the liquid market is overheating.

Like all markets, crypto VCs and liquid markets follow cyclical patterns. The excess capital accumulated in 2021/2022 is rapidly being depleted, making it more difficult for founders to raise funds. Meanwhile, capital-strapped VC firms are becoming more selective in trading and terms.

I will pause here, and the next article will delve into the impact of this phenomenon on liquid markets.

Conclusion

1. Recent VC fund performance has been lackluster, and VC firms are turning to short-term sell-offs to return capital to LPs. Many well-known crypto VC firms may not survive in the coming years.

2. The misalignment between VC firms and founders is driving founders to seek alternative financing channels.

3. The oversupply of VC capital has led to unreasonable resource allocation, which I will analyze in detail in subsequent articles.

To be continued…