In the last few months I’ve spoken with a number of traditional investors who have heard of cryptocurrencies and ICOs, but haven’t quite grasped the new breed of investors supporting the cryptocurrency ecosystem. In this article I’ll try to articulate my own experiences within the ecosystem.

Introduction to traditional angels and VC investors

If you’re already an investor, then you can skip this section.

In traditional technology investments, there are angel investors who invest in the very early stages of a company, and the Venture Capitalists (VCs) who invest after the angels but before the company reaches IPO. The commonality between the angel investors and VCs is that they generally invest on long time horizons, since it takes about 5 to 10 years to build a technology company that can create a lot of value. Once enough ‘value’ has been created by the company, then there is a liquidation event where the investors can make a return on their investment. These liquidation events are usually in the form of a sale/acquisition, IPO, or by ‘taking money off the table’ by selling their shares to another investor in future rounds of funding. This is important as these investors make their money from the equity they hold in the company, which may or may not be related to the performance of the company’s products.

For the companies that these investors are supporting, they also provide access to their own network and expertise, which in some cases may be more valuable then the money they are providing.

How the dynamics change with crypto-investors

When comparing crypto-investors to traditional investors, the dynamics behind their investments are quite different. For crypto-investors, they can invest like an angel investor by investing in a pre-sale, ICO (Initial Coin Offering), or TGE (Token Generation Event), or they can invest in later stage companies by buying the tokens when they are available on the ‘markets’. However the largest difference is that crypto-investors do not need to wait for a liquidation event after 5–10 years. They can decide to liquidate their investment shortly after they invest, or they can hold onto them for as long as they believe in the project.

The primary value for crypto-investors is not equity in the company, the primary value is the liquidity and utility that the tokens have.

Crypto-investors don’t need or necessarily want equity in the company, since from a crypto-investor perspective, equity is slow, illiquid, requires a lot of paper work, and will take years before they are able to be liquidated.

Similar to traditional investors, crypto-investors do not just invest their money into the projects. They invest their time by engaging with the company, founders, and community, tell their network about the project, and essentially become cheerleaders for the project if it is performing well.

For traditional investors, the more investors you have on board, then the smaller your equity stake becomes and the smaller your potential return becomes. You want great investors investing in the company, but you don’t want too many investors on board (i.e. the relative pie gets smaller with more investors).

For crypto-investors, the more crypto-investors that are on board, then the more liquidity and support the tokens will have. Therefore crypto-investors want many more crypto-investors on board, as that increases the value of the network and increases the usage of the tokens (i.e. the relative pie gets bigger with more investors). These are the network effects of crypto-investors, something that traditional investors do not have.

When a crypto-investor looses faith in a project or needs to liquidate their investment, they can easily liquidate by selling their tokens. If the crypto-investor is actively involved in the community (described below), then at worst the crypto-investor will lose part of their initial investment, but not their entire investment. Comparing this with traditional investors, when the investor looses faith in the company, they essentially need to write it off as a total loss, as there is usually no way to liquidate the equity they hold in the company.

The advantages for the companies being funded

Besides what you hear in the media about ridiculous amounts of money being raised for young companies in record amounts of time for no equity, I believe the dynamics are so dramatically different from traditional investments that it requires a new way of looking at the companies being funded.

Crypto-investors interact with the company and surrounding community, sometimes on a day to day basis (Slack, Telegram, Discord, Reddit, etc), keep track of the companies progress and deliverables, and track how the company is executing. If the company fails to execute on its roadmap without proper communication, then the crypto-investors (sometimes hundreds or thousands of them) will show their dissatisfaction by liquidating their investments, reducing the token price, and reducing the funds available to the company — since the company usually holds a certain amount of tokens to fund its development, a reduction in token value results in a reduction in total value of the company’s token holdings. Therefore the company has a strong financial incentive to communicate clearly with the community of investors and execute on its promises.

Compare this with traditional companies, who do not have the same level of interaction with their investors, who usually update their investors during board meetings, and where once the money is given to the companies, the investors do not have any direct way to change the amount of funding already raised by the company.

The background of a lot of crypto-investors is also highly technical (I’ll go into why this is in a future article), so the companies also gain a small army of crypto-investors who support their product based on the fundamental technical aspects of their vision, and may also want to contribute directly to the code base or build on top of the technology they are building. Similar to the initial ethereum investors, a lot of us purchased ethereum as we wanted to build applications on top of the ethereum blockchain, which required ETH to execute the apps we wanted to build. The technical crypto-investors have an economic incentive to further build on top of their investments, to add more value to their investments. Compare this with traditional investors, who are usually full time investors and who (to my knowledge) are not known for building products on top of their portfolio companies.

The disadvantages and some potential solutions for crypto-funded companies

Like most things in life, too much of anything can be disadvantageous. With a community of hundreds or thousands of investors monitoring how the company is performing, this can apply a lot of pressure on the company to satisfy the community and communicate, when they could (or should) be spending time on building the product. Highly technical teams are generally not known for their great communication abilities, so the requirement of also being great community builders needs to be considered seriously by companies, either by hiring a firm that specialises in community engagement, or building out their own internal community engagement team.

Since the tokens will eventually be on the open markets, humans can and will act irrationally. The token price can be tied to the emotions of the community, which may or may not be justified. Therefore the initial execution of the presale/ICO/TGE needs to be carefully planned to ensure the correct distribution of tokens to the ‘right’ people, with the right incentives created for longer term token holders. Preventing ‘first day dumps’, ensuring proper liquidity, and having clear communication is an important requirement, which requires quite specialised knowledge in crypto-economics, game theory, and network engagement.

Agree or disagree? Let me know in the comments.

P.S. I understand that there are also a lot of ‘unsophisticated’ investors who are throwing money into questionable projects, and either making or losing a lot of money. I’ve conveniently skipped this class of ‘investors’ in this article, but may dive deeper into their economics in the future.

P.P.S. My wife and I created Truong.vc, where we use our own money to invest and contribute to cryptocurrency and decentralised projects. This year we’ve made more than 40+ crypto investments and consult on select cryptocurrency projects.