How Falling Crypto Prices are Good for the Space

Blockchain, Investing | October 29, 2018 By:

 The blockchain industry is at an important juncture. During the past two years, a nascent technology with a few fledgling use cases has erupted into a global phenomenon, attracting an estimated $28.4 billion in investment dollars, the covers of world-renowned publications, and significant mindshare amongst some of the world’s leading entrepreneurs and technologists.

Despite the industry’s unquestionable growth, the lack of proven, real-world value plus macroeconomic conditions have dampened the influx of investment dollars and caused cryptocurrency and token prices to decrease significantly in recent months.

The methods through which capital was raised, coupled with unconventional capital management strategies, could leave these blockchain projects with less defense against a down market than traditional tech companies, leading to an inevitable industry retraction.  While all projects inevitably feel some near-term pain from these market conditions, projects with a long-term focus should drive the industry as a whole, benefiting from a renewed focus, a new class of value-added investors, and a charter to add real-world value.

A New Type of Investment

In addition to the compelling nature of blockchain technology, the influx of investor dollars during this period was heavily driven by ease of access and liquidity.  Traditional seed or venture investing requires privileged access to deal flow and patience, with money often locked-up for 5-10+ years.  Additionally, during those 5-10+ years, valuations are set infrequently and price discovery is opaque at best.

Investment in blockchain project tokens, on the other hand, has been a perfect fit for investors with shorter attention spans and lack of access to blue-chip deals.  These investors could enjoy extraordinary returns from finding a project online and entering/exiting positions with a few clicks of a mouse.

While momentum hasn’t fully ceased and strong projects are still raising capital, the industry is clearly going through a sizable retraction.  The most popular tokens have seen precipitous decreases, with BTC, ETH, and XRP decreasing 65%+, 83%+, 85%+ since peak pricing around the start of 2018.  Smaller “altcoins” have seen similar or even more dramatic decreases during the same period.

The factors that bolstered the market over the past 24 months, namely near-instant liquidity, ease of access to deals, and perfect price discovery, created a virtuous cycle that led to rapid and precipitous growth.  Those same factors, however, could create a vicious cycle for blockchain projects, which are likely less resilient in a downturn than traditional tech companies that raised from venture investors and are more insulated from the market backdrop.  This article explains the reasons why blockchain projects could prove especially susceptible to the current market retraction.  It also outlines why a market retraction could be a strongly positive development that will allow companies to focus on creating value and delivering on the multitude of promises made by the blockchain industry to-date.

Blockchain Projects are Heavily Susceptible to an Industry Downturn

The fundraising and capital management functions of blockchain projects and companies are unique compared to their counterparts in other technology sectors. By appealing to liquidity-driven investors, many of whom were less experienced than traditional seed or venture investors, projects were able to raise capital quickly from a broader base of investors.  Additionally, many projects created early enterprise value by holding investment capital in volatile cryptocurrency assets, which were often unrelated to the core business.  These strategies, once accretive but fallible in the long-term, could have potentially terminal consequences for projects.

The Double-Edged Sword of Liquidity

Exchange-traded blockchain projects were able to attract capital from investors interested in short-term investments with high liquidity and transparent price discovery. Unfortunately, these investors are able to more easily exit token positions than traditional equity positions, creating a cascading downward effect on token prices. Projects that raised in equity, or that had sizable token lockups, should be able to keep investors more deeply involved in the long-term, adding value, and not adversely impacting prices through bear markets.

Lower Operational Purchasing Power

Holding token sale proceeds in ETH (or other cryptocurrencies) was extremely value-added in the short-term and proved tolerable in hindsight for projects that raised in Q3 2017 or earlier.  For projects that had the misfortune to raise near peak prices, especially in Q4 2017 or Q1 2018, this widely-adopted strategy could prove disastrous.  Projects that converted a sizeable amount of token sale proceeds into fiat have retained purchasing power to invest in employees, technology, or other operational necessities without selling additional tokens (either their own or ETH) at depleted prices.

A Fixed Token Supply Will Limit Subsequent Fundraising Options

“Down Round” is a painful word for both existing investors and for founders and early employees.  Both parties hate the outsized dilution that comes with a lower valuation; however, these types of rounds are part of a toolbelt available to startups facing suboptimal market conditions. Projects with a fixed token supply must sell some of the original supply allocated to the team and employees at lower prices to bridge operational costs until market conditions improve.  This issuer dilution represents a similar idea to a “down round”, but with likely compounded negative implications.

A Market Retraction Will be the Foundation for a Brighter Future

Taken together, a combination of poor timing and volatile capital management could cause an imminent cash crunch for even projects that raised enormous sums of capital.  This market retraction will likely represent a death knell for projects with little underlying substance that took advantage of unsophisticated investors and market hype.  Unfortunately, it may also cause problems for extremely credible projects that were unlucky with timing and denominated capital in cryptocurrency because of conviction rather than impulsive instincts.

Either way, it’s likely that a market retraction creates a great opportunity for projects that have been focused on long-term value creation since the beginning, slowly building great teams and solving real problems amidst the volatile market backdrop.

Projects will use this “down market” to focus on solving the industry’s most challenging problems.  Many great use cases for blockchain technology have been proposed, but most of those are limited by factors like network scalability, performant private computing, and the lack of reliable core infrastructure and developer tools.

The “golden age” of blockchain technology is almost certainly in the future rather than the past and will be owned by projects and companies focused on long-term value creation rather than near-term speculation.  Many of these projects have existed under-the-radar thus far, shirking ICO conferences and 100k Telegram channels for steady value creation.

A prediction for the future of blockchain can be drawn from the “dot com” bubble and its subsequent recovery.  More than 5,000companies (an estimated 52%+ of the industry) were shut down or acquired in the years immediately following the bubble burst.  These 5,000 included some of the most well-capitalized and hyped companies in the industry.  Internet giants like Amazon, Google, and eBay, however, were survivors that lost value but subsequently focused on long-term growth and, in aggregate, built giant businesses that dwarf the $1.7 trillion lost when the bubble burst.

If blockchain companies prove to be less resilient than internet companies due to the compounding effects of rapid liquidity, flighty investors, and poor fundraising capital management, then the retraction could affect much more than 46% of today’s companies, including some of the most well-known and well-capitalized projects.  I fully expect, though, to see the survivors continue to focus on the long-term and deliver the unprecedented enterprise and social value we’ve been promised all along.