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The Rise of Native Protocol Funds ... And their role in the emerging decentralised funding stack.

Burgess COMMENTARY

Peter Burgess

The Rise of Native Protocol Funds And their role in the emerging decentralised funding stack.

Over the past couple of weeks Tezos and Blockstack have both announced the launch of ‘native’ venture funds aimed at building out their respective ecosystems by funding projects built on the underlying platforms.

The funding stack for decentralised projects is taking shape and so is the role that VCs will play in it.

The idea behind platform funds isn’t new of course. Slack, Twilio, Amazon Alexa and Stripe are all relatively recent examples of corporates deploying own or third party capital to stimulate developers activity on their own platforms. Whether those funds will ever generate attractive financial returns is a different matter, although a mere IRR probably only captures a portion of the overall value creation (and that’s kind of the point).

It is worth noting that Blockstack haven’t actually raised a proper fund: they will just facilitate $25 million worth of investments from a select group of VC funds into decentralised projects built on top of the Blockstack infrastructure that apply for funding. Tezos instead, for what I understand, will carve out $50 million from their recent token sale to invest in Tezos-based companies via “venture capital partners to be announced, as well as through a direct venture arm”.

The key difference with traditional platform funds though, other than structure, is that this is not traditional venture capital to equity-fund operating companies. It is capital to fund the development of a network, whose value is intrinsically linked to its community: governance in decentralised projects now includes financiers deploying capital to grow the network, to paraphrase cburniske.

What’s in it for the platforms?

With the ultimate goal of building up network value, platforms can expect the following from a native fund:
... Driver of developer adoption (critical given scarce supply)
... Boost to community / ecosystem
... Support in protocol roadmap and new features development
... Testing, bug fixing etc.
... Financial return (secondary).

A cynic may see a platform fund as an attempt to subsidize otherwise weak organic growth.

What’s in it for the platform VC-funded projects?

Beyond the initial capital, platform-funded projects can expect: Preferential access to the native VCs and their wider networks Preferential platform developer support for product build Early access to early platform features and releases Day-1 distribution to platform user base and community Implied legitimacy to new users, other investors and the press

What’s in it for the platform VCs?

By associating themselves to a protocol platform, VCs can expect: First look at projects emanating from the platform “Insight with some of the best minds in the space”, according to Max Mersch from OpenOcean (one of the Blockstack fund VC partner) Collaborative due diligence

There has been lots of chatter about whether the traditional VC model will still exist 10–20 years from now and about how ICOs are disrupting it. We are in a moment in time where projects are abusing of the tokens sale model purely to raise capital in irrational quantities, and we all know that’s not sustainable in the long term. ICOs, in their purest form, can bee seen as a way to maximise token distribution amongst *actual users* to kickstart or boost network effects, with capital being optional (think Numerai: they issued a token via an airdrop to their existing users, without raising any capital).

So, as the greed evaporates and token issues revert closer to their core function, traditional venture capitalists will try hard to carve out an valuable role for themselves. Most VCs are very keen to adapt to this new world and partnering up with protocols seems like one way of doing it.

So, what may the funding stack look like in a decentralised world?

If VCs will still play a role in this new world, one question that has been up in my mind is what may the ‘funding stack’ look like and how can they adapt to it.

I’ve tweeted this out the other day as I was thinking through the answer to the question. It was a little vague and rough, so I will try to add some colour to each point below.

🔑 Protocols as tech hubs

Historically developers gravitated towards physical hubs where risk capital was abundant, creating a vicious hard to break cycle. This has led to the emergence of the hotbeds of tech such as Silicon Valley, London and Berlin more recently, and their tech behemoths. What started off with the gravitational pull of web 2.0 centralised development platforms (e.g. AWS, S3, Azure), is only going to get exacerbated by the growth of decentralised protocols: remote developers will continue to cluster around open source protocols first, capital becoming just a feature attached to the protocol via native platform funds such Blockstack and Tezos, and/or token sales. Will we see a Filecoin or an Aragon platform fund in the future?

Protocols will thus become dealflow gatekeepers: investors will have to be talented enough to embrace the winning ones and bold enough to go a little off-piste.

🔍 Community for due diligence

We’ve talked a lot about this on Token Economy, so I’ll just link to Stefano’s post below. The TL;DR is that as decentralised projects get built out in the open, due diligence will also be open sourced.

We need more public due diligence for ICOs

It’s a new world out there.

medium.com

Both founders and investors will have to pay closer and closer attention to public scrutiny and adopt it to supplement their own.

🔮 VCs for “expertise”/capital

As access to capital is largely getting commoditised and supply of capital is virtually infinite, access to expertise isn’t: the smartest people in the room still only have 24 hrs in the day and they come in scarce supply.

As the venture capital suite of services gets unbundled, investors will have to focus hard on the ‘value-add’ to remain relevant, which may come with or without hard capital attached.

⛓️ Blockchain for deal execution

This relates to every legal process from company creation to share / token issuance and transfers. No more middle-men here, all out there on a blockchain, executed by a smart contract.

Investors may have to familiarise with source code, rather than legalese.

♻️ Token airdrop/sale for distribution/capital

This is about structuring and designing token issuances, monetary policies and economic incentives in such a way that maximises network effects. This can take the form of a Numeraire-like airdrop, a token sale for capital or mining token rewards.

Some new hires investors may have to think about soon: “Head of CryptoEconomics & Token Design”, “Head of Compliance & Structuring for Token Issuances”.

💰 Exchanges for liquidity

No more long-winded M&A processes and late-night negotiations. The asset class is fully liquid from day one.

Investors will need to think about rebalancing portfolios over time, hedging, complex custody, when to get out, when to return capital to LPs, while being prepared to stomach volatile NAVs. A whole new skill-set.

Conclusion

Protocol funds are starting to emerge in different shapes and forms, they may end up playing an important role in the evolving funding stack for decentralised projects and offer VCs willing to adapt a seat at the table.

Thanks to Yann Ranchere.

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