IF 2023 IS LIKE 2001, WHAT WILL THIS YEAR BE LIKE?
Blockchain Coinvestors Newsletter
Vol. 5, No. 1, January 2023
IF 2023 IS LIKE 2001, WHAT WILL THIS YEAR BE LIKE?
In Blockchain Coinvestors Investment Newsletter Vol. 1, No. 3, November 2022 "WHAT WE LEARNED FROM THE DOTCOM BUBBLE AND WHY IT MATTERS TODAY," we outlined the parallels between the 2001 Dotcom Crash and the 2022 Crypto Crash, and made some broad observations about what we should take from that past as thought starters for 2023 and beyond. We concluded that newsletter by outlining some tailwinds for Blockchain specialists such as ourselves.
Tailwinds for Blockchain Specialists
We believe the tailwinds behind blockchain specialists are even more substantial today than they were at the beginning of this year:
Digital monies, commodities, and assets are inevitable
Digital natives are now in their 40’s and 30’s and are digitally reliant
Downturns will wash away FOMO opportunists (as in 2001, 2009)
Superior returns in venture are highest following downturns
Distressed opportunities will present themselves (selectively)
Investors will need growth and FANG mega trend coming to an end
Those bullet points inspired a lot of you to comment, and broadly there was agreement that 2023 may be a time of great opportunity given that the global financial system and all of our transactions are in need of a comprehensive overhaul.
However, a number of you also sent us challenges to our thesis, and most often you asked - "can you be more specific about what we should expect in 2023 based upon the experiences of 2001?"
So here is some additional food for thought about how 2023 will play out, and what it will feel like to be an early stage innovation investor throughout 2023.
Confusion Will Persist in The Macro Environment
First, the macro environment will not resolve quickly.
As in 2001 (and 2008), economic downturns take time to surface, and while the press will be full of actions that Economists are recommending, and Central Bankers and other decision makers are taking, in practice, countering inflation, cooling down markets, chilling irrational exuberance, right sizing spending to lower levels of taxation, shrinking deficits, enabling the redeployment of workers, and so on don't happen fast.
Even without additional black swans (such as 9/11 and the ushering in of the war on terror and the patriot act and all that followed), 2023 is sure to be a year of continuing fear, uncertainty, and doubt, and the macro environment will be unpredictable, and most probably not helpful to investors. The average US recession lasts just less than 12 months, and corporate earnings, prices and valuations don't typically come back until the GDP line starts going up again. Which also means that exits (corporate acquisitions and going public events) are also slow to rebound back. Impacting valuations and investor sentiment back up to the early stage.
Lawmakers Will Beat Their Drums, But Not Much Will Happen in 2023
We remember the aftermath of the dotcom crash and that many lawmakers issued firm statements regarding how they planned to regulate everything including:
Internet sales tax collection, including local taxes on global Internet players, who were moving their earnings to low tax jurisdictions
Enhancement and enforcement of copyright and content ownership rules and approaches
Establishment of new rules regarding privacy online, the right to be forgotten, and the heuristics about the use of personal data
Reduction of Darkweb activity including online fraud, phishing, scamming, chargeback schemes, illegal activity online, etc.
And so on
Now we are entering 2023, and most of those same issues are still unresolved globally with regard to digital communications and content, and we have big new issues such as fake news, fake identities, and deep fake characters and content which need new fit-for-purpose regulations, but are complex and unlikely to be resolved quickly.
So by the time we get to the regulation of a new world of digital monies, commodities, and assets, the one thing we are sure of is that regardless of how much local jurisdictions and lawmakers will want to move quickly, the global financial system will take many years to get to grip with the new innovations that have come out of Pandora's box. To make matters worse, innovators won't stop innovating, so lawmakers will be chasing a moving target, which only further aggravates the challenge.
So expect lots of words, quite a lot of action, but very few tangible results in 2023.
Failure Will Be Accelerated Everywhere
In our book, Build Your Fortune in the Fifth Era, we laid out the realities of early stage investing, which may be the highest performing asset category in the world, but which also has very clear risks associated with it. Some important points included:
While the expected return of early stage venture is exceptionally high, more projects fail than succeed
The average early stage venture capital fund makes between 25 to 30 investments:
50 to 60% fail to return 1x the capital invested
10% provide a return of 5x or better which returns 80% or more of the capital the VC gets back
The remaining 30 to 40% of investments get a 1x to 5x return which, while attractive, does not return the fund; The 5x and better do
Diversification is a must in early stage venture capital as a result of its hit driven nature
There is evidence that the best investors get the best opportunities, and top quartile funds are highly persistent in the asset class, unlike in most others.
What we consistently see in the downturns like 2001 and 2008/9 is that:
The portfolios of venture capital funds see a wash out of many of the 50 to 60% of companies that will eventually fail
Failure is accelerated because follow-on financing is reduced and flows to the 10% of the companies where VC's have the highest conviction
There is a flight of capital and quality entrepreneurs to the best investors, and marginal players find it harder to get a positive return
Furthermore, the bad news comes first since the 5x and better companies take longer to get to their higher valuations
So in 2023, we will all read about failing blockchain companies everyday, and we may be confused into thinking that all of the companies will go that way too. Of course, it's not true, and some of the most valuable companies in the world are also being formed and backed in the downturn, but you don't know it for another five to ten years.
As a strategy, you have to invest with, and through, the best investors in the category.
Best Teams Focus on Building What Users Will Pay For
There is an old adage from the dotcom crash - in the years after the builders focused on building, the day traders went back to being employees in other people's businesses. The truth of it is that in the two or three years after a downturn, and especially in the year of the downturn (eg. 2023), the teams and companies that do get support are the ones that can demonstrate that real users are paying real money for their products and services. Demonstrable economic success gets funded, while visions and plans are much less likely to receive investment.
So in 2023, expect investors to want to really dig into the details of who is buying what and why, and quality and comprehensive due diligence will win out - as it always does.
The Late Stage and Speculative Investors Will Depart Stage Right
When the market was booming in 1999 and 2000 it was true that a lot of value could be captured by investing at high valuations in the late stage and then selling into public markets that were hungry for new IPO stocks and to strategic investors who were willing to pay very high prices (think AOL sale to Time Warner). It is just as true that all the mass of capital that arrived on the scene in those years (and in 2006/2007 and 2021/2022) can leave just as quickly. The speculators typically exit the scene all together.
The mega rounds will be rare in 2023, the valuations will be much lower and much more fiercely negotiated, and it is not obvious that the IPO window will reopen, or that the strategic acquirers will come back until post-recession - the exception being in the distressed market including acquihires.
So 2023 will feel very different from 2022 and for us, as blockchain specialists focused on the early stage, that is mostly a good thing.
The Best Specialist Investors Will Stay the Course with Some Adjustments
By 2000 most general purpose investment firms were making Internet investments, most often with teams who were repurposed from other technology areas or even other asset classes. Once the dotcom bubble burst, with the carnage it created in the portfolio's of those general purpose players, many of them exited the space for a few years until the inevitable rise of digital communications and content forced them to throw their hats back in the ring in the mid to late 00's. However, in 2001 through 2005 it was the best specialist Internet investors who stuck to their knitting, with some adjustments such as:
More aggressively negotiated valuations as the market became an investor, not entrepreneur friendly, one
More pro investor terms and conditions in every term sheet
Small initial capital commitments, often with milestone based financing
Clear expectations around metrics and what good needs to look like
And so on
We fully expect that firms like Tiger, to name but one, which by all accounts invested into 300 plus blockchain companies in 2022, will do much less in 2023, while the blockchain specialist VC's that we back have no choice but to continue to invest behind their thesis, even if they make alterations as noted above.
It Will Take Courage To Dollar Cost Average Into The Downmarket, But It Is The Right Strategy
All the academic research consistently shows that dollar cost averaging through the cycle is the best strategy, and in early stage ventures the evidence shows that an investor should heavy up on their allocations during the downturns since the returns are superior for those vintages. This is what the statistics show for 2001, 2002, and 2003 as examples.
However, it is psychologically very hard to invest more, when you feel you are worth much less, and in practice, many investors remain on the sidelines at exactly the wrong time. Warren Buffett explains this very well. You may feel poorer going into 2023, but it is not because you have less of what you bought before, it is rather that the price of what you bought before has gone down. It may eventually go back up so your feeling of being poorer can be illusory. More importantly, it is during the downturn, when prices are low, that you should be loading up on the units of the stocks you admire. You get more for your money (more shares) because the price per share is lower. That is good for the investor.
But it takes courage to put in more capital, and 'dollar cost average' into a downmarket, even though it is the right strategy.
Implications for Blockchain Coinvestors
So what are the implications of this for us, and blockchain specialist investors.
We expect 2023 to be:
A year of macro economic fear, uncertainty, and doubt with no rapid resolutions likely, and certainly no return to the 'normal' of cheap and boundless capital availability
A year of regulatory confusion, with many lawmakers calling for rapid change, but change taking many years to come, and decades to become globally harmonized
A year full of failure, bad news, and pessimism, with a broad washing out of venture portfolios, and the press full of the announcements of the bad news that comes first
Conversely, a year in which the builders and entrepreneurs will refocus on what always matters most - meeting the current and future needs of users with outstanding solutions that are much better than the status quo, and which they are willing to pay for
A time in which many players will exit the blockchain space, and less capital will come into it. Even more importantly, speculators will leave the scene and that will be a good thing.
Those specialist investors that remain, will find it more of a buyers (investors) market, and will be able to negotiate better valuations, better terms, and milestone driven funding to their advantage
Despite the challenges, real and psychological, some investors will do the right thing and allocate more capital into the sector at the bottom, and gain the super returns that downturns yield. However, even more investors will be chilled and will regret it later.
Did we miss anything important? If so, please share your thoughts back to us.
Alison Davis
Matthew Le Merle
ABOUT BLOCKCHAIN COINVESTORS
Launched in 2014, our vision is that digital monies, commodities and assets are inevitable and all of the world’s financial infrastructure must be upgraded. Our mission is to provide broad coverage of the emerging unicorns and fastest growth blockchain companies and crypto projects. Our investment strategy is now in its 9th year and has to date invested in more than 40 pure play blockchain venture funds in the Americas, Asia and Europe; and in a combined portfolio of 400+ blockchain and crypto projects including approximately 55% of all blockchain unicorns. Our funds rank in the top decile amongst all funds in their respective categories on both Pitchbook and Preqin. Headquartered in San Francisco with a presence in Grand Cayman, London, New York, Zug and Zurich, the alternative investment management firm was co-founded by Alison Davis and Matthew Le Merle.
FUND PERFORMANCE
Blockchain Coinvestors Fund III (Fund of Funds) was created to provide diverse coverage of the best blockchain 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 4.82x with an IRR of 67%. Fund II shows equally impressive early results with Net TVPI of 1.42x and an IRR of 42%. Almost all of our fund investments are performing as top quartile against the Cambridge Associates Venture Benchmark.
BLOCKCHAIN COINVESTORS FUNDS
Blockchain Coinvestors’ goals are to provide broad coverage of the emerging unicorns and fastest growth blockchain companies and to capture superior returns from investing in the leading blockchain venture partnerships. Our funds are open to investors that meet the Qualified Client definition with a minimum subscription level of $250,000 at the discretion of the Manager.
Blockchain Coinvestors Fund IV (Early Stage Token) provides direct access to promising private stage token projects accessing our relationships with many of the world’s leading blockchain investors. We leverage asymmetrical information from our 40+ VC Funds to pick the most attractive opportunities. This is a continuation of the direct token investing strategy of the Fund Manager that has included private stage investments in Acala, Filecoin, NEAR, Polkadot, Structure, and others.
Blockchain Coinvestors VI (Mid Stage Growth) provides direct exposure to the emerging category leaders in the blockchain and crypto ecosystem. The fund leverages our unique sustainable competitive advantage (USCA) in blockchain, web3, and fintech to create a concentrated portfolio of between 20 and 30 investments with attractive return profiles and visible paths to liquidity. The fund assesses the more than 400 blockchain and crypto projects in which we are direct and indirect investors and employs a robust investment framework to select investment opportunities into the leading mid stage growth rounds - typically Series B, C and D. This is a continuation of the mid stage investing strategy of the Fund Manager that has included investments in Bitwise, Brex, InfiniteWorld, Securitize, Uphold, Wyre, and others.
Please visit the Blockchain Coinvestors website to learn more about our offerings. You can also reach our Investor Relations team directly at ir@blockchaincoinvestors.com.
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.
BLOCKCHAIN COINVESTORS ANGELLIST SYNDICATE
Continuing the theme of the democratization of investing, we have a rapidly growing Blockchain Coinvestors syndicate on AngelList providing access to selected coinvestments. Please join us and our partner Lou Kerner on AngelList.
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REGISTER NOW FOR UPCOMING WEBINARS AND CALLS
Our investment team hosts regular webinars and calls to help educate our community about the Fifth Era, fintech, blockchain, and crypto. We discuss important trends, tailwinds, and investment themes including what we have learned and how we are using our knowledge to inform our own investment thesis and actions. Below is a list of upcoming webinars for which you can register by clicking the links:
Blockchain Coinvestors Investment Thesis
- January 23rd, 7:00am PT
- January 23rd, 12:00pm PT
Direct Investing in the Mid Stage
- February 6th, 7:00am PT
- February 6th, 12:00pm PT
Why Digital is Inevitable
- February 13th, 7:00am PT
- February 13th, 11:00am PT
Recordings of past webinars and calls can be found at www.blockchaincoinvestors.com/webinars.
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