Everything You Need To Know About Venture Capital Financing In The Crypto Space

Venture capital funds and other institutional investors are increasingly monitoring cryptocurrency companies to see if their funding can generate a profit. Crypto startups have a lot of equity, and the mainstream is starting to see them as viable investment vehicles.

Everything You Need To Know About Venture Capital Financing In The Crypto Space | Coinscreed
Startups often go down the Venture Capital funding route when they are not yet ready to go public

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The cryptocurrency industry is maturing quickly, with many comparing it to the gold rush of the 20th century. And as the industry matures, users are witnessing a surge of traditional and retail investors flocking to the crypto space.

The DeFi space and the non-fungible token (NFT) market are some of the most popular areas in the cryptocurrency industry to attract venture capital. In this article, we will examine venture capital funding in the cryptocurrency industry.

What is venture capital funding?

Venture capital funds consist of a pool of investors who want to make a lot of money quickly. Fund managers send prospective investors a prospectus inviting them to participate. Essentially, a prospectus is a document that sells you in the mutual fund.

VC fund managers spend a lot of time reviewing thousands of projects to determine growth potential. Despite being prudent investors, venture capital firms like to diversify their bets. That way they don’t run the risk of putting all their money in one basket.

Startups often go down the Venture Capital funding route when they are not yet ready to go public. Alternatively, they may not be able to raise funds from retail investors. Because of the former, cryptocurrency startups have not sought venture capital funding, but that is changing fast.

Venture capital funds no longer limit their interest to cryptocurrency unicorns — rare companies valued at $1 billion or more, as determined by venture capital firms.

Many VCs are adopting “pick and shovel” business models as they recognize emerging opportunities. Pick and shovel organizations are cryptocurrency-related businesses that offer derivative services to the same user base. These companies include cryptocurrency tax reporting startups, cryptocurrency charting software, and many others.

Stages of venture capital funding

Everything You Need To Know About Venture Capital Financing In The Crypto Space | Coinscreed

Venture capital funding is generally divided into five phases. However, additional steps can be added later if funding goals were not met in previous rounds or if founders wish to apply for additional funding.

We will cover these five stages below.

Stage 0: Pre-seed

The pre-seed phase is the idea generation phase. It is often not included as an official step because the team members involved in this step want to determine if a founder’s idea can be translated into a product. The financing usually comes from a close circle of family and friends and does not include any equity.

If the founder knows the right people at this point, business angels can get involved. Compared to venture capital funds, angel investors are very wealthy individuals who typically run them alone. And unlike venture capitalists, angel investors can ignore the soundness of a project when they have complete confidence in a founder’s abilities.

Stage 1: Seed capital

The seed round is short and should be the shortest round of all. In this step, the marketability of the product is tested. The startup determines the viability of the market using a tool like the market potential analysis. As the name suggests, the market potential analysis tool helps provide a framework for conducting market research and verifying whether the product is worth bringing to market.

The startup may also need to convince the VC fund that their product is worth investing in, using tools like pitch decks and financial documents like income statements, cash flow forecasts, project roadmap, and so on. It’s worth noting that angel investors may still be involved at this stage.

Series A: Startup capital

Things are getting serious in Serie A. Then equity comes into play. Startups do not need to apply as this round is reserved for cryptocurrency companies that are already in the growth phase. You have a validated product and a strong community with stable cash flow.

What these companies are looking for is capital that will help them iterate their product and continue to expand. At this stage, investors are at much less risk because the company’s product or service is already validated. In addition, the focus of the business is on customer acquisition as well as marketing and advertising.

Series B: Early stage

The Series B funding round is dedicated to new iterations, sales, and marketing. Series B rounds are all about scalability. The companies that reach this round are in the development phase.

They are looking for ways to expand their operations and further improve their market reach. At this point, it goes without saying that they already have a huge user base.

To accelerate its expansion, the company plans to use the resources to build a capable team and solidify its product. Specifically, the company needs to invest in marketing and sales, human resources, business development, and customer service.

Series C: Expansion stage

The last official round of VC financing is the expansion stage. In this phase, a company aims to expand into additional markets and diversify its product lines.

Companies that achieve Series C funding are already established in their industry. Fundraising helps them to develop new products or services and introduce their business to international markets.

In this phase, scaling also takes place through the acquisition of other companies. For example, a company offering cryptocurrency brokerage services is doing well in the United States and wants to expand into the Canadian market.

The company may also seek to introduce other financial services outside of its traditional scope.

In this phase, the investment risk is lower, but so are the potential returns. A startup at this level needs to generate enough sales – if not profit – with a commercially available product. Many recipients of growth financing have been in the market for two or three years.

Because of this, more external parties are entering the investment management process. In addition to VCs, hedge fund managers, private equity firms, and investment banks are also joining the push, all with an eye on the company’s equity.

It’s worth noting that many companies arrange a Series C round of funding to increase their valuation before an initial public offering (IPO).

Additional series (optional): Pre-IPO stage

In the pre-IPO phase, with a proven product or service, some companies intend to go public for different reasons. Reasons for going public include improved access to investors of all types and additional capital, greater public confidence, and significant publicity.

This funding round is dedicated to activities such as mergers and acquisitions, approaches to eliminate competitors, and financing in preparation for the IPO.

How do venture capital firms work in the cryptocurrency industry?

The cryptocurrency industry is still in its infancy and there is endless room for growth. Many venture capital firms are aware that cryptocurrencies are the future and do not want to miss out on what is perhaps the greatest investment opportunity of our time.

Despite this, the cryptocurrency market is still volatile, but VC companies that trust blockchain and cryptocurrency companies are willing to take additional risks.

Venture capital funding in the crypto space is no different than typical venture capital funding, with one exception. The startups benefiting from the promotion operate in the cryptocurrency market.

While VC funds are considered a traditional funding approach, they are increasingly turning to cryptocurrencies due to widespread adoption.

It is due to major advertising platforms like Facebook and Google deciding to lift the ban on cryptocurrency ads.

Additionally, VCs view the cryptocurrency industry as a less risky investment due to its widespread adoption by institutional investors.

However, this can be seen as a double-edged sword. After all, more investment has resulted in thousands of new projects being launched. So while only a handful can be intentional scams, most are high-risk investments.

But that hasn’t deterred many VC funds, who are well acquainted with the fact that with high risk comes big rewards. And indeed, crypto startups can generate some of the highest returns in any industry. After all, taking calculated risks and managing risks are skills that VC fund managers possess.

Pros and cons of Venture Capital funding in crypto

As with VC funding in general, the pros and cons for the cryptocurrency space are similar. VC firms seek high returns reflected in equity with a potentially quick exit. This means there can be pressure to deliver quickly and a risk of giving up some control.

A major benefit of being a venture capital recipient is that it brings an air of legitimacy to the crypto startup. This legitimacy has the potential to attract more funds from retail investors as well.

This is because ICOs and other types of crypto fundraising introduce much lower barriers to entry. (In many cases, a website and a decent white paper are all that are required to launch an ICO.)

In contrast, VC funds will have done much more due diligence, like verifying the soundness of the project and the team’s ability to deliver on the project’s promises, as well as examining the community and the market at large to forecast profitability. In addition, VC funds include experienced fund managers who have specialized in company valuations.

Despite the downsides, Venture Capital investing helps build fantastic relationships and excels at forging connections across different industries. Therefore, a VC firm’s contacts can prove helpful when challenges arise in an unfamiliar area.

VCs understand that not all projects are successful. Sure, their main goal is to make money, but should a company go bust, the company is under no obligation to repay any funds. Sophisticated investors like VC funds are trying to take emotion out of the equation, which should ease some of the pressure.

Additionally, VC funds have long taken calculated investment risks so they understand how the game is being played. The experience they may be able to share can prove invaluable investment advice for many crypto companies.

Alternatives to Venture Capital funding for crypto project enthusiasts

Legitimate cryptocurrency companies may be reluctant to go down the ICO route as ICO has had a bad reputation in the past mostly due to scams. But ICOs have come a long way since the ICO craze of 2017 that flooded the market with bad projects. Should such a company determine that venture capital is not the funding approach they wish to take, they may consider STOs, IEOs, and IDOs.

It is important to note that these approaches attract retail investors with small amounts of funding. This is in contrast to VCs and angel investors who can bring in a significant amount at once.

Security token offerings come closest to a regulated environment. This approach is attractive for several reasons. The most important reason is that it offers security to potential retail investors.

With the crypto space growing rapidly, it’s understandable that many new retail investors are hesitant to jump in. The mainstream media is full of negative stories about scammers and carpet pullers.

A rug pull is when project owners dump their tokens on the market and disappear with investor funds. For this reason, offering an STO to new retail investors can be a solid funding approach.

Initial exchange offerings are similar to ICOs, but with one major difference: they are backed by an exchange. This works when a project team approaches an exchange and comes to an agreement behind closed doors.

The exchange supports and publicly lists the project for a listing fee and a percentage of the tokens. The exact agreements vary from case to case. If a VC’s legitimacy is attractive to a crypto startup without having to resort to VC funds, the team may consider an IEO. Reputable cryptocurrency exchanges can also lend significant legitimacy to a project.

DEX Initial Offerings are the newest fundraising tool available to cryptocurrency startups. DEXs (decentralized exchanges) are the foundation of decentralized finance (DeFi). By eliminating the need for an intermediary, DEXs offer users a private and low-cost approach to trading. DEXs can do this through an aggregation of smart contracts designed to run from code once certain conditions are met.