The Case for Crypto Venture

Executive Summary

BTC and ETH represent ~2/3rd of crypto’s total market cap (excl. stable coins). This ratio has been relatively stable over time even though BTC and ETH tend to under-perform in bull markets and over-perform in bear markets relative to alts.

Almost all of Altcoin value is driven by:

• Smart Contract Platforms (e.g. Solana, Avalanche) which are generally venture-backed. These represent ~70% of Altcoin value and their share has been growing.
• Medium of Exchange tokens (e.g. XRP, Dogecoin) which are not venture-backed.

While owning BTC and ETH is a good first step to get exposure to crypto beta, investors can generate significant alpha by investing in early stage Smart Contract Platforms (SCPs) via specialized venture managers.

Historically, most of the returns generated by SCPs occurred before the launch of their liquid tokens. This was the case at any point during the last cycle.

We believe this will continue to persist due to the value capture mechanism of SCPs and the potential for monetary premium. We also see significant opportunities for future SCPs to be built and differentiate relative to existing ones.‍

Market Overview:

The total crypto market capitalization is $1.07 trillion as of March 6, 2023. If we exclude stablecoins, most of this is made up by Bitcoin and Ethereum.

There is a significant power law in crypto; over 75% of crypto’s market cap comes from the top 10 tokens.

BTC/ETH dominance has been remarkably stable over time, making up between 60%-80% of the overall market cap of crypto excluding stablecoins. BTC/ETH tend to overperform in bear markets while altcoins tend to overperform in bull markets.

Altcoin Composition

Looking beyond Bitcoin and Ethereum, we looked to understand the composition of the remainder of crypto’s market cap. The chart below shows that the majority is made up by Smart Contract Platforms (SCPs) and Medium of Exchange (MoE) tokens.

Legend: Altcoins (excludes BTC+ETH and Stablecoins)

• MoE = Medium of Exchange (eg. XRP, SHIBA, DOGE)
• SCP = Smart Contract Platform (eg. BNB, ADA, SOL, AVAX)
• DeFi = Decentralized Finance (eg. UNI, MKR, AAVE)
• Infra = Infrastructure (eg. LINK, GRT, AR)
• Exchange Token = Exchange Based Tokens (eg. CRO, OKB, KCS)

Of the altcoin market cap, SCPs have accounted for a greater share over time mostly at the expense of MoEs. 

Furthermore, we know that a majority of these SCPs have been venture backed. Nearly 60% of the total altcoin market cap is venture backed SCPs. This has grown steadily over the past 5 years.

Venture vs. Liquid Performance

The logical next step is to determine the best strategy for exposure to SCPs. Do most of the returns occur before or after a token launches? We analyzed two separate portfolio strategies - one venture and one liquid - to answer this question.

• Venture Strategy: Venture Strategy: We collected seed round size data for 41 venture backed SCPs. You can find the full dataset here. Using the published round size from Cryptorank and assuming a dilution of 15%, we estimated the entry valuation for each of these companies in the month that the round was announced. From there, we estimated return multiples by collecting the fully diluted market cap at two points in time, the date the tokens launched and today (3/6/2023). From this return data, we created two hypothetical portfolios: one where the portfolio weight is equal for each investment (i.e. equal weighted at entry), and the other where portfolio weight is valuation weighted (i.e. market cap weighted: smaller rounds imply lower valuations at entry and thus smaller portfolio weighting; larger rounds have larger portfolio weightings at entry).

• Liquid Strategy: Using the same cohort of SCPs, we ran a similar analysis but compared the valuation at the time of the token launch to 3/6/2023. And again we used the two different check size scenarios explained above.

As the table below shows, the majority of returns accrue to early stage venture investors. Most of the gains in these SCPs happened prior to token launch. Furthermore, an equally weighted strategy outperformed a market cap weighted strategy. This implies that investing with conviction in low valuation seed rounds is better than investing in an early stage index.

The table above outlines 3 additional takeaways:

1. On average, venture investors would have been better off exiting their positions at launch rather than holding them through today. That being said, most of these positions would have been locked at the time of token launch.
2. The time between seed to launch for SCPs is incredibly short, generally less than 2 years. This means that even with a lockup period of ~ 3 years, early stage venture investors in SCPs can realize and distribute returns in under 5 years. This is in stark contrast to most areas of venture where it can take over 10 years for investments to become liquid.
3. Despite generally poor performance after launch, there are still returns to be had with a liquid strategy if one focuses on lower valuation SCPs with a high conviction portfolio.

Investment Strategy Implications

If an investor is looking for crypto beta, owning BTC and ETH is a pretty good first order approximation of the crypto market. However, if an investor wants to generate significant alpha, exposure to altcoins is required. 

Our analysis has shown that SCPs are the best performing category of altcoins over the past few years. A majority of these SCPs have been venture backed and most of the returns accrued to their venture investors pre token launch.

We believe SCPs will continue to outperform other altcoins due to the value capture mechanism of SCPs and their ability to capture monetary premium vs. other forms of on-chain projects. For further reading on how SCPs capture value, see our prior research here: Modular Blockchain Economics‍

As a result, we believe that investors looking for crypto exposure should own a combination of BTC, ETH, and a portfolio of early stage venture managers with the following characteristics:

• Focus on investing in SCPs and other opportunities for “Monetary Premium” and value capture
• Valuation Discipline (ie small fund size, focused on early stage)
• Token Sell Discipline (willingness to trim positions after launch)
• Extremely high-bar for non-SCP investments

About Us

Stratos is an early-stage venture firm that backs transformative blockchain companies. We apply our deep research expertise to make convicted bets on top founders at the earliest stages.

We have backed numerous top companies in the space — most often as a lead investor. Our investments include Goldfinch Finance, Fuel Labs, Space and Time, Burrata, Subspace, and many more. Our team brings together a wide range of experience in venture capital, entrepreneurship and technology.

Disclaimer

The information presented in this blog post, including any references to fictional or hypothetical portfolio returns, is for educational purposes only. It should not be construed as investment advice, nor should it be relied upon for making any investment decisions. Past performance, including hypothetical returns, is not indicative of future results, and investors should be aware that investing in crypto carries risks, including the potential loss of principal. Consult with a qualified financial professional before making any investment decisions, and always conduct thorough research and due diligence.