THE IMPACT OF ASSET TOKENIZATION ON VENTURE RISK AND RETURN
THE IMPACT OF ASSET TOKENIZATION ON VENTURE RISK AND RETURN
Dear Readers,
As we navigate through an unpredictable economic environment, blockchain technology shines brightly as a beacon of potential and promise. At Blockchain Coinvestors, we firmly believe that the upgrade of the world's financial infrastructure, enabling monies, commodities, and assets to journey on digital tracks, will be a significant value creation catalyst in the coming decades.
Historically, early-stage investing has a track record of outperforming other asset classes, a trend that becomes even more pronounced in the wake of economic recessions.
However, early-stage investing has hitherto been hampered by one major drawback: compared to public market investing or late-stage private investing, the journey to liquidity and therefore, the return of capital for limited partners, is typically longer than other asset classes. The nature of early-stage investing makes it one of the most illiquid asset classes, albeit also the one with the most asymmetric upside.
This is now changing in important ways.
The Journey of Traditional Early-Stage Investing: A Slow Path to Liquidity
The trajectory of a venture investment is well-illustrated by its 'J-curve'. This curve is a graphical representation of the lifecycle of the investment, presenting venture investment dynamics as follows:
Venture funds endure an investment period during which the Multiple on Invested Capital (MOIC) drops below 1x.
Within a venture portfolio, failing investments usually surface quicker than successful ones, decreasing returns in the initial years.
Over time, the successful portfolio companies begin making larger exits, which causes the upward trend of the typical venture portfolio J-curve.
The most substantial exits often take the longest to materialize, meaning the expected high return for an early-stage venture fund is usually driven by outcomes in the second half of the fund's lifespan.
This ‘typical’ set of dynamics is being impacted by other powerful forces in private investing:
Most venture exits are corporate acquisitions, highly sensitive to economic conditions. In times of recession, large corporations decelerate their acquisition activities, particularly those involving mega-exits ($1bn+). These large exits play a crucial role in shaping a venture portfolio returns and the J-curve. If delayed during recessions, investors must show patience, as their eventual liquidity events are postponed.
Since the implementation of Sarbanes-Oxley (SOX) in 2002 a key route to liquidity – the Initial Public Offering (IPO) – has become much more difficult for high growth technology companies. SOX, which aimed to increase transparency and financial auditing for public companies in the wake of the Enron scandal, heightened the compliance burden for companies seeking to go public. While the key aim of SOX reporting is to help protect investors from fraudulent financial reporting, an indirect impact has been a ‘chilling effect’ on fast growing companies seeking to access the US public markets. Consequently, companies that typically would have gone public are choosing to remain private for longer durations. For instance, the average age of US tech companies that went public in 1999 was four years, which increased to eleven years by 2014 (source: SEC).
$10bn Market Cap Software Companies
Notes: Only lists companies founded after 1980; 2015 data are preliminary; some companies excluded from analysis if bankrupt or acquired.
Source: McKinsey & Company
There are several consequences from this shift in private investment market dynamics:
Greater value creation of technology companies is being captured in the private phase by investors who can access the best opportunities within this asset class.
Venture capitalists are raising larger funds to provide late-stage capital, capturing more value creation in the private phase before companies go public, implying that the value creation in public equity markets is likely to be less than in previous eras.
Large investment firms, including pension funds, sovereign wealth funds, and big asset managers, are reallocating more capital into private markets in search of growth exposure. This movement has led to a rise in late-stage private market valuations.
Family offices, high net worth and retail investors, who previously had access to growth stocks in public markets, find these opportunities increasingly out of reach until they carry substantial valuations.
Investors who can secure early-stage access alongside the best investors in a sector tend to capture most of the private phase value creation, providing they can maintain a long-term, patient view.
Considering blockchain is a unique technological innovation, we might expect similar dynamics in the private investment phases. However, some idiosyncratic characteristics of blockchain projects are leading to earlier exits and liquidity.
Tokens: Accelerating the J-Curve with Fast and Liquid Exits
Amid the turmoil of the Global Financial Crisis, Satoshi Nakamoto's groundbreaking 2008 whitepaper introduced a revolutionary technology and financial paradigm: a decentralized peer-to-peer form of digital cash, underpinned by a transparent, open-access, and distributed blockchain. We believe this transformative innovation not only possesses a broad range of applications but also has significantly expanded the frontier of early-stage investment opportunities.
Bitcoin, while primarily a digital store of value, has paved the way for a proliferation of tokens serving numerous purposes in the years since its inception, from utility to governance to asset backed tokens. While the nature of these tokens and their value proposition vary widely, they share a common characteristic: tokens are digital manifestations of value, safeguarded, held, and transferred via blockchain technology.
This paradigm shift has empowered early-stage investors to mitigate the drawn out 'J-curve' shown above by providing (i) a quicker route to exit and (ii) increased probability of achieving immediate liquidity upon exit.
Many projects see their token as an integral component of the product itself. Therefore, tokens are typically launched early in a project's development, during the formation phase. Like equities, tokens often go through multiple private funding stages (formation, seed, private rounds) before having a public listing event. However, the period between token creation and public debut is often only 2-3 years, in contrast to approximately 7-10 years for a typical early-stage equity investment.
But it's also crucial to note that all exits are not created equal, especially in the realm of traditional equity investing. When an equity investment is exited via an acquisition, early-stage investors typically receive a combination of cash and equity in the acquiring company, with some deals even involving a complete equity swap. If the acquiring company is already publicly traded, liquidity is readily accessible. However, if it is privately held, investors find themselves waiting until the acquirer goes public: only then can they fully liquidate their investment. This detail is particularly important considering the vast majority of equity investment exits are achieved via acquisitions.
Contrastingly, token investing has a unique advantage: nearly all exits occur through a public token listing. This means that upon achieving a successful exit, early-stage investors gain immediate liquidity - a feature that, though commonly subject to standard lock-up provisions, is not typically seen in traditional exits.
Implications for Investors
Token investing’s significantly expedited exit timeline, in conjunction with the immediate liquidity upon exit, dramatically alters the trajectory of the J-curve for an early-stage investor.
Nonetheless, this promising new asset class does not come without risks. As with all early stage investing, failure rates can be high. In traditional equity-based venture investing, failure rates are typically near 60% (start-ups that return less than the capital invested in them). While comprehensive data sets are lacking, it’s plausible that failure rates in tokenized projects are even higher. Research published by Deloitte suggests that as many as 80% of tokenized projects fail, with surviving projects often subject to 'public market failure'. In other words, it appears that the enterprise risk is higher in the public token asset class than in the public equity asset class.
Despite its inherent risks, private early-stage investing consistently holds the crown as the asset class yielding the highest historical returns. This trend becomes even more profound following recessions. We firmly believe that a strategic approach of investing into the downturn can lay the groundwork for exceptional returns in the subsequent recovery period.
At Blockchain Coinvestors, we've honed a strategic approach to traverse this complex terrain in each of our investment strategies – fund of funds, early-stage token, and mid-stage growth:
We collaborate with top-tier investors, leveraging their specialized knowledge to identify promising teams and projects, encompassing both equities and tokens.
We build an early stage, diversified, global portfolio that combines traditional venture investments (standard preferred equity rounds) with the innovative characteristics of tokenized projects.
We assemble a focused selection of tokenized projects that combine the asymmetrical upside of early stage investing with a quicker liquidity profile.
Our strategy has already begun to reap rewards. According to Preqin and Pitchbook, our inaugural fund of funds has emerged as a top-performing entity in its category, with a 4x Net TVPI return. Notably, it has consistently maintained an MOIC (Multiple on Invested Capital) above 1x and has returned 100% of Limited Partner (LP) capital, validating the asset class’s ability to accelerate capital return and, as a result, accelerate the J-curve.
There is more to find in our early-stage token investing webinar. If you are interested in leveraging our access to leading investors and top-tier investment opportunities, we invite you to book a meeting with our team.
Thank you for reading.
Best,
Mitch Mechigian
Partner, London
ABOUT BLOCKCHAIN COINVESTORS
Launched in 2014, Blockchain Coinvestors’ vision is that digital monies, commodities and assets are inevitable and all of the world’s financial infrastructure must be upgraded. The mission is to provide broad early stage coverage of the emerging unicorns and fastest growth blockchain companies and projects. Blockchain Coinvestors’ investment strategies are now in their 10th year and have to date invested in 40+ pure play blockchain venture funds in the Americas, Asia and Europe; and in a combined portfolio of 750+ blockchain companies and projects including 70+ blockchain unicorns. Blockchain Coinvestors’ first fund of funds ranks in the top decile amongst all funds in its category on both Pitchbook and Preqin. Headquartered in San Francisco with a presence in London, New York, Grand Cayman, Zug and Zurich, the alternative investment management firm was co-founded by Alison Davis and Matthew Le Merle.
FUND PERFORMANCE
Blockchain Coinvestors’ Fund of Funds strategy provides diversified early stage coverage of the best blockchain opportunities by partnering with leading pure play venture funds in the Americas, Asia, and Europe. Blockchain Coinvestors Funds I and II have already experienced significant appreciation. Fund I Net TVPI is 4.04x with an IRR of 51.4% and is one of the highest performing fund of funds in the world according to Pitchbook and Preqin. Fund II shows impressive early results with Net TVPI of 1.18x and an IRR of 16.3%. Fund III closed at the end of 2022 and will begin reporting this year, while Fund V is preparing for its final closing in the next quarter. The newest fund of funds - Fund VII - is now in formation. Blockchain Coinvestors also manages two direct funds; Fund IV (Early stage token) and Fund VI (Mid stage growth).
BLOCKCHAIN COINVESTORS CURRENT OPPORTUNITIES
Our funds provide investors with global, diversified exposure to early stage investing into the blockchain space. Our Fund of Funds allows an investor to make a single investment to access global, diversified exposure to leading early stage blockchain venture investments on an institutional platform, while our direct funds provide concentrated early stage exposure. We also provide regular coinvestment opportunities to our investors.
Funds are available to accredited investors, with minimums of $250,000 or more at the discretion of our managers.
Blockchain Coinvestors Fund VII (Fund of Funds). The Blockchain Coinvestors Fund of Funds strategy provides diversified early stage coverage of the best blockchain opportunities by partnering with pure play venture funds in the Americas, Asia, and Europe. A single investment accesses global, diversified exposure to leading early stage blockchain venture investments on an institutional platform. The newest fund of funds - Fund VII - is now in formation.
Blockchain Coinvestors Fund IV (Early Stage Token). This direct fund accesses early stage tokenized projects in their formation and seed stages through relationships with other leading blockchain investors. The Fund leverages asymmetrical information from 40+ VC Funds to pick the most attractive opportunities.
Blockchain Coinvestors Fund VI (Mid Stage Growth). This direct fund provides exposure to the emerging category leaders in the blockchain ecosystem. The Fund assesses the 750+ blockchain companies and projects in the portfolio and employs a robust investment framework to select investment opportunities in their mid stage rounds - typically Series A, B, C.
Coinvestments. The Blockchain Coinvestors' coinvestment program offers investors the opportunity to increase their exposure to emerging category leaders in the blockchain space.
Contact our Capital Formation team at IR@blockchaincoinvestors.com to learn more about any of these opportunities
INTERESTED IN MORE? REGISTER NOW FOR UPCOMING WEBINARS AND CALLS
Our investment team hosts regular webinars and calls to help educate our community about our investment thesis focused on the inevitability of digital monies, commodities and assets and the role that blockchain technology plays in enabling them. We discuss what we have learned and how we are using our knowledge to inform our own investment thesis and actions. Below is a list of our upcoming webinars for which you can register.
Meet the Blockchain Unicorns - Mid-Year Update
Our bi-annual report which includes the most comprehensive list of blockchain unicorns globally - including private blockchain enterprises and projects whose valuations exceed $1 billion. Blockchain Coinvestors uses proprietary data sources and its own database of its combined portfolio resulting from its blockchain venture fund of funds to track emerging unicorns.
Recordings of past webinars and calls can be found at www.blockchaincoinvestors.com/webinars.
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BLOCKCHAIN COINVESTORS SWISS
We are excited to announce that Blockchain Coinvestors Funds are now available through Swiss certificates for those of our non-US investors who prefer this approach. The underlying fund is the same, however, our Zurich-based team at Blockchain Coinvestors Swiss, who will introduce in future weeks, can provide detailed information regarding this investment option. Email us at mlemerle@blockchaincoinvestors.com to learn more.
"THE BEST WAY TO INVEST IN BLOCKCHAIN BUSINESSES"