(3,3)

One overriding sentiment of the last year or so has been “the evil VCs have an unfair advantage, they are dumping on us”. Such sentiment became popular enough that it became an effective marketing and community building tool for crypto projects.

You can hardly blame retail investors for resonating with this populist rhetoric. It feels a bit like the VCs have cheat codes. First, of course, the VCs get access to the best deals and making money is easy for them. And some VCs have a different cheat code — they are simply in the right place at the right time with the right amount of shame tolerance or audaciousness. Finally, the SEC gave all of them the greatest cheat code: they scared founders into only raising from professional investors.

Regular retail investors can only really buy an overpriced IDO or buy on the market. And a lot of the markets look like this.

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There’s been enough charts where close to zero retail buyers had the opportunity to win that it’s clear the game is rigged against normal people somewhere in the system.

They don’t even try to hide it. They proudly stick their portfolio on their website, boasting about the 100x gains they made funding Fuck You token without the sentience to recognise that the chart is a straight line downwards and only insiders won.

But in many ways, the frog nation retail trader has the same incentives as a crypto VC who has the same incentive as a Crypto Youtuber: they want to make money. They’re buying something with the goal of selling it to someone else later for a profit. Crypto VCs, anons, retail frogs, whatever. They are human beings existing within adversarial markets, impacted by the same incentives.

VCs

There’s two ends of the spectrum on crypto VCs: the first are legitimate co-builders and crypto native long-term thinkers. They are the ones that keep building alongside their portfolio cos and kept builders alive through bear markets.

The other end of the spectrum are spin-up shops that exist only in frothy bull market conditions. They have no thesis, vision or conviction. They fund short-vesting projects with a goal to quickly flip and extract value from a bull market. They invested in “Polkamon” and shit. They funded technically unsound projects to buy relationships with important market actors.

It’s a spectrum, so it’s fuzzy, and sometimes VCs or funds move along the spectrum in one way or another. The latter type are, in my opinion, demonic entities staffed by sociopaths that would probably steal from their disabled grandma. The first type are quite rare.

Thanks to the wonderful transparency of the blockchain, you can often see which VCs still hold %s of their positions. Lots of “reputable” VCs sold their L1 competitor coins far too early, for example. Some longer-term diamond handed VCs still own 100% of positions established years ago and are almost price-agnostic for now.

You can also see which VCs funded fundamentally or technically meritless projects. Some reputable VCs funded projects that to me look more like a joke than an investment because they knew they’d profit when it got listed on Binance. Others opted to only fund things they believe have long-term merit and are accretive to progress of the industry.

The main incentive structure difference between these two ends of the VCs spectrum is time horizon.

If you want to maximise your returns on a 20-year timeline, you need to be able to access the top 1% of deals for at least the next decade and a half. This means your reputation with founders is extremely important.

Since everyone can see which funds are dumping in real-time, VCs conviction becomes a metric that retail investors can gauge. Since retail investors are also the core users of crypto protocols, a VC’s reputation with founders is also influenced by what these retail traders think.

If a VC is known for regularly backing down-only dump tokens then retail investors will become skeptical of projects backed by such investors.

However, if a VC wanted to maximise their returns on a 2-year timeline, reputation becomes immediately less important. You no longer need access to the top 1% of deals for two decades. You no longer need to care about what founders think of you, and you don’t really care if retail investors learn you dump everything on them in a single market sell as soon as your tokens unlock.

It’s not a surprise that late-entrant VCs are more often in the latter category. These get-rich-quick type VCs entered the market inspired by the $ returns that they saw others were winning, with no long-term conviction in the industry, and thus no need for a long-term reputation.

The origin of the scam: fundraising

In a bull market, founders can almost virtually guarantee investors profits by creating hugely predatory tokenomics that favour only early backers.

This means virtually any project can raise money.

The visionary and high-conviction side of the investor spectrum are willing to take long-term risks: they accept long vesting periods and pay well for founders and projects that they think are important to shape the future. Receiving backing from these investors is usually somewhat difficult.

But raising money from mercenary investors is much easier. A project has several levers available to them. If a founder wants to raise $5m, they could do it tomorrow with just a deck and no other preparation.

Think about it like this.

Imagine you’re given the opportunity to invest in a project and its valuation is $250m, and your tokens are locked for 4 years. They will do a large airdrop, so lots of the supply will be given away for free and used as incentives for the first ten years. If you look at comparative project valuations, there’s maybe 20x upside for your investment. But you have to accept a lot of risk: who knows what state the market is in 4 years down the line, who knows if the team can deliver, the airdrop recipients may just sell it down, and a $250m valuation is still quite high for a pre-product protocol.

Now imagine you’re given the opportunity to invest in a project and its valuation is $10m. Most of your tokens are locked for 3 months, but you get 20% of them on day 1. By market comparison, $10m market cap is really small. In fact, you only need a $50m fully diluted valuation on day 1 and you can sell your 20% to recoup your initial investment. Great news, the project will do an IDO priced 20x higher on a popular Youtuber’s launchpad. This is a great deal. Not to mention, this project has secured an advertising video on another popular Youtube channel, and three top influencers are also buying the seed round! The risk is smaller, since it’s easier to imagine the state of the market in 3 months than it is in 4 years and everyone that has this token on the market will have a higher cost basis than you.

In the former example, you need to make a high-conviction bet that this team can execute and their product is important.

On the second project, it feels like you’re almost being given free money. All you need to do is hope there is enough liquidity to sell your 20% to make it risk free, no conviction necessary.

Founders can offer these “free-money deals” to investors to guarantee that they can raise capital. There is zero signal offered to the market on the team nor the project quality. Investors have just deployed simple math and decided the odds are sufficiently in their favour.

The common man

It is not a surprise, then, that populist rhetoric starts to connect with market participants. Now, projects can appeal to disillusioned market participants in order to effectively build a community. Come, join us instead. Fuck the suits and the VCs and the banks and the exchanges, the system is rigged. You can make money with us.

Community, users and attention is the most important part of building a crypto project. Founders learned they have a cheat code of their own.

But since the incentives are the same, you can apply the previous spectrum mental model from VCs to basically any other market actor, too. They are all just people trying to make money with different time horizon goals.

Some anons treat their anon identity as a highly valuable multi-decade pseudonym. Others treat it as a mask for the next couple of years until they have enough $ that they can bail.

Some builder-personalities are high-conviction long-term market participants and others are dollar-whores that end up effectively pumping tokens.

Projects using anti-VC rhetoric as a community growth mechanism are not immune to the market’s adversarial incentive structures. You’re not allowed to be surprised when your favourite anon twitter account is dumping on you after telling you to fuck the suits.

And certainly you shouldn’t be surprised when that YouTuber that you like doesn’t have your best interest at heart. They are certainly not taking symmetrical risk in the markets on the coins they promote to you. It’s free: you are the product.

Incentive structures

Explicating the incentive structures behind financial products and complex crypto schemes is a foresight-superpower in a market populated by retail investors and increasingly obfuscated tokenomics.

“Show me the incentive and I will show you the outcome’ — some old guy, probably Buffett

Most crypto projects, regardless of their sector or style of marketing, can be reduced to simplistic variables that are useful to inform your choices in the market. If you know the other participants in the market and you understand their incentives, it is unlikely that much will be surprising.

Yet crypto market participants seem to have quite a (3,3) mindset implicitly. It’s the only financial market where somebody exercising their right to sell an asset is seen as a betrayal to a community.

Perhaps it comes from the same place that “wagmi” or “hodl” came from. Perhaps it is rooted in the reason we ended up in these markets: all in it together, escaping from the tyranny of the old power structures that held us down.

But this ideological opposition to adversarial incentives often leaves retail holding bad investments way too long. It enables bad actors to abuse these ideals as they tweet “wagmi” while funding the seed round of Let Them Eat Cake Coin — which they don’t actually believe in but they know the tokenomics will allow them to profit anyway.

There is a reason “don’t trust, verify” became a popular Bitcoin phrase way back when. Think many market participants would benefit from adopting this mindset and trusting individual market actors much less than they currently do.

If you are making decisions without understanding the financial incentives of those playing on the same field as you then I hope you’re not betting more than you can afford to lose.