Encryption funds face the impact of "bad years": challenges and opportunities during the industry's adjustment period

The term "vintage" originates from the wine industry, used to describe the quality of wine from a particular year. In the investment world, this term is used to refer to the founding year of a fund, reflecting the economic environment at that time, which directly influences the fund's return rate. For encryption funds established during periods of loose monetary policy, they are currently undergoing severe tests from "bad years."

The Consequences of a Bubble Burst

Recently, a pessimistic sentiment has permeated the encryption investment circle. A Web3 fund with a scale of 400 million USD announced the suspension of investments in new projects and follow-up fundraising plans. Although the fund claims to have invested over 40 million USD in more than 30 projects over the past three years, the deterioration of the current market environment has forced it to hit the pause button.

This decision reflects the current predicament of encryption venture capital: both fundraising scale and investment enthusiasm have declined, the token lock-up model is under scrutiny, and some investors have even turned to the secondary market and hedging operations to protect their portfolios. Under the multiple pressures of high interest rates, unclear regulations, and internal industry issues, encryption venture capital is undergoing the most severe adjustment period in its history.

An industry insider revealed that although several venture capital funds they invested in have captured top projects, the overall investment has already recorded a 60% impairment, and it is expected that only 40% of the principal can be recovered in the end. He pointed out that sometimes, even if the decision is correct, it may still be defeated by time and years. However, he holds an optimistic attitude towards the next round of encryption venture capital, believing that the industry may迎来新的创新浪潮, similar to the rebound after the 2000 internet bubble.

The prosperity of the encryption industry from 2021 to 2022 is closely related not only to the promotion of innovative concepts such as DeFi, NFT, and blockchain games but also to the global central banks' loose monetary policies. Large-scale quantitative easing and zero interest rate policies have led to a flood of global liquidity, with a large amount of funds flowing into high-return assets, resulting in the so-called "everything is a bubble" phenomenon. The emerging encryption industry has become one of the main beneficiaries during this period.

In the face of an unprecedented investment boom, many cryptocurrency venture capitalists have adopted a "lift the sedan" investment strategy, making large bets on conceptual tracks while neglecting rational analysis of the intrinsic value of projects. This investment behavior, detached from fundamentals, is essentially "expected pricing" under ultra-low capital costs. A large influx of funds into overvalued projects has laid hidden dangers for future market adjustments.

The token lock-up mechanism is originally intended to prevent project parties and early investors from concentrated selling in the short term by releasing tokens in a long-term phased manner, thereby protecting the stability of the ecosystem and the interests of retail investors. Common lock-up designs include "1 year cliff + 3 years linear release" and even longer lock-up periods of 5-10 years. This mechanism is intended to constrain project parties and venture capitalists, enhancing investor confidence.

However, when the Federal Reserve began tightening monetary policy in 2022, the encryption industry bubble burst. Overinflated valuations quickly receded, and the market entered a "value regression" phase. Crypto venture capitalists not only suffered heavy losses in early investments but also faced skepticism from retail investors who mistakenly believed they had made huge profits.

Data shows that the valuations of most tracked projects have significantly declined, with some projects experiencing year-on-year declines of up to 85% to 88%. Many venture capitals that promised to lock in their positions may have missed better exit opportunities in the secondary market last year. To cope with this dilemma, reports indicate that some venture capitals are secretly collaborating with market makers to hedge the risks of locked positions through derivatives and short positions, attempting to profit from the market downturn.

In the current weak market environment, newly established encryption funds are also facing significant challenges in fundraising. Data shows that 2024 is the year with the lowest level of encryption venture capital financing since 2020. Although the number of new funds has increased, the fundraising scale is far from the levels seen during the bull market periods of 2021 to 2022.

The Impact of the Meme Craze and Bitcoin ETFs

In the context of the industry lacking clear product narratives and practical application scenarios, the community has begun to turn to meme hotspots to generate topics and traffic. Meme tokens, with the allure of the "get-rich-quick myth," have repeatedly sparked trading frenzies, attracting a large amount of short-term speculative capital.

These Meme projects often experience brief and intense hype, but lack long-term development momentum. As the narrative of "casino-ization" on-chain spreads, Meme tokens begin to dominate market liquidity, capturing users' attention and capital allocation focus. This results in some truly promising Web3 projects being marginalized, struggling to gain sufficient exposure and resources.

At the same time, some hedge funds have begun to enter the Memecoin market, attempting to capture the excess returns brought by high volatility. For example, a hedge fund supported by well-known venture capitalists launched a liquid fund investing in Meme tokens within the Solana ecosystem, providing investors with a substantial return of 137% in the first quarter of 2024.

In addition to the meme craze, the launch of Bitcoin spot ETFs may also be one of the potential factors exacerbating the downturn in the altcoin market and the venture capital predicament. Since the first Bitcoin spot ETFs were approved in January 2024, institutional and retail investors can directly invest in Bitcoin through regulated channels, with traditional Wall Street asset management giants entering the market. The initial launch of the ETF attracted nearly $2 billion in capital inflow, significantly enhancing Bitcoin's market position and liquidity.

However, the emergence of Bitcoin ETFs has changed the original capital flow logic of the industry. A large amount of capital that could have flowed into early venture capital funds or altcoins has chosen to remain in ETF products, converting into passive holdings. This has not only interrupted the past capital rotation rhythm where altcoins would rally after Bitcoin's rise, but it has also led to an increasing divergence in price trends and market narratives between Bitcoin and other tokens.

Under this trend, traditional capital is increasingly concentrated in Bitcoin, making it difficult for entrepreneurial projects in the Web3 space to gain sufficient financing attention. For early-stage venture capital, the exit channels for project tokens are limited, and the secondary market lacks liquidity, resulting in extended repayment cycles and difficulties in realizing returns, forcing them to slow down their investment pace or even suspend investments.

Moreover, the external environment is equally severe: high interest rates and increasingly tightening liquidity have made LPs hesitant about high-risk allocations, while regulatory policies, although constantly evolving, still need improvement.

Industry insiders point out that the challenges currently facing the market include: a user base that has already formed, most of whom are accustomed to speculative trading behavior; difficulty in finding new infrastructure-level investment opportunities; and most attempts at encryption reconstruction in areas such as social, gaming, and identity have failed to achieve breakthrough progress.

Under multiple pressures, the "darkest hour" of encryption venture capital may continue for a while. However, as history shows, each industry adjustment can give rise to new opportunities. Investors need to remain patient and focus on projects that truly have innovative value, preparing for the next round of industry growth.