Silicon Valley bets on cryptocurrency projects to disrupt finance

Uniswap isn’t even three years old, but it has already turned millions of dollars into billions for venture capitalists betting on a new kind of cryptocurrency exchange.

Instead of acting like a traditional broker, Uniswap is automated software that allows users to trade cryptocurrencies directly with each other, without any middleman.

Last year, venture capitalists who had invested a total of $ 12.8 million in the company behind the project received a sweetener: Uniswap began distributing one billion digital tokens to users , giving investors 18% of the total.

The tokens, which give holders the right to vote in the project, jumped to a price of $ 28, rewarding investors with a stake of around $ 5 billion if all the tokens were issued. Uniswap presented a four-year acquisition schedule for the tokens, which currently have a market capitalization of around $ 16 billion, according to data from CoinMarketCap.

Uniswap has a lot of company. Over the past year, the fastest growing cryptocurrency startups have been those aiming to abolish financial intermediaries. They have also brought in a new generation of venture capitalists, producing returns that are the envy of their more conservative peers.

Decentralized Finance (“DeFi”) projects aim to replicate basic financial services such as lending and commerce using software called blockchains, removing traditional middlemen.

In the span of two years, and aided by the recent cryptocurrency boom, what started out as a curiosity gained momentum, ushering in a new model of technology investing in the process. Private investors have backed 72 DeFi companies this year, according to PitchBook data, already exceeding last year’s total by more than a quarter.

Uniswap facilitated over $ 1 billion in transactions over the majority of days in May, rivaling traditional cryptocurrency exchanges such as Coinbase for business in the ether and other related tokens.

Meanwhile, the value of cryptocurrency used as collateral for loans, transactions, and other transactions in DeFi applications has grown over 60-fold in the past year, reaching the equivalent of over $ 67 billion. dollars, according to website data. DeFi Pulse.

Supporters of DeFi projects are convinced that in the long run applications have a good chance of rewiring the financial system.

Gray area

But traditional venture capitalists, including Sequoia Capital, have largely avoided investing directly in DeFi projects, in part because of concerns about how they would be treated by regulators, according to people familiar with their business. thought.

Lawyers and venture capitalists have said DeFi inhabits a largely unregulated gray area that could face pressure from the new chairman of the Securities and Exchange Commission, Gary Gensler. Some investors have drawn comparisons between DeFi and the boom in initial coin offerings four years ago, which collapsed following intervention by regulators.

“The fundamental structure of US financial regulation goes through intermediaries,” said Jai Massari, partner at the Davis Polk law firm which advises on cryptocurrency transactions. “Here you don’t have these middlemen.”

Instead, Sequoia and other traditional venture capital firms have invested independently through specialist cryptocurrency funds, which often have more flexible structures allowing them to accumulate larger stakes in digital assets. Paradigm and Polychain Capital, two large investors in DeFi projects, both received investments from Sequoia.

Endowments from Harvard and Yale universities have also supported Paradigm, which is led by Coinbase co-founder Fred Ehrsam and former Sequoia partner Matt Huang. After raising $ 740 million as of 2018, the company’s assets had reached $ 3 billion by the end of last year, according to regulatory documents.

More funds are on the way. Andreessen Horowitz, an investor in several of the biggest DeFi projects such as the Compound and Maker loan programs, recently sought to raise $ 1 billion for the next version of his cryptocurrency funds, nearly doubling the size of its most recent version. more recent.

Not everyone at DeFi welcomed venture capitalists, who often have preferential terms for investing early. One project, PoolTogether, changed the terms of a planned token deal after some community members complained about the rebate investors would receive in exchange for quick funding, according to the group’s online forums.

Governance rights

“The signal that would otherwise be very valuable to have a level A investor – it has a reverse effect on DeFi,” said Haseeb Qureshi, managing partner of Dragonfly Capital, a cryptocurrency venture capital firm.

While DeFi groups often start out as businesses that raise traditional venture capital, the real payoff comes when projects issue large pools of tokens.

Distributions, which reward users with effectively free assets for their participation in networks, are intended to extend governance rights to a large group, thereby reducing the power of founders over time. They also paid generously for venture capitalists.

If Uniswap’s tokens continue to trade at current levels, venture capitalists will have returned nearly 400 times their original capital to the project by the time their shares are fully vested.

Paradigm, who led a $ 1.8 million fundraiser in the company behind Uniswap, was the largest outside investor when the project began issuing tokens last year, two people familiar with the matter said. The company had received the rights to its share of all tokens issued by the project when it invested, one of the people said. Paradigm and Uniswap both declined to comment.

Some investors have already started betting on alternative sites for DeFi developers. Ethereum, the blockchain underlying most of the projects, faced high transaction costs as volume increased, frustrating traders.

Multicoin Capital managing partner Kyle Samani said investors had placed too much faith in Uniswap to become the dominant market maker and Ethereum to remain the most important computer program for DeFi.

Solana, a new blockchain backed by Multicoin in 2019, has appreciated by a factor of more than 150 since its IPO on Binance last year, giving it a market cap of $ 9.1 billion. Multicoin is the biggest outside investor in the project, the two groups said. Solana claims to have faster speeds and lower transaction costs than Ethereum.

“By the end of the year, the smartest money that isn’t a full-time crypto will say Ethereum hasn’t won,” Samani said. – Copyright The Financial Times Limited 2021

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