Blockchain fundraising can (and will) revolutionize venture capital investment standards
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The interest of laymen in early stage risk finance has never been greater. In recent years, fintech innovations have enabled consumers to gain more power over their financial fortunes; such services have made managing personal finances easier, more secure and – given the trend towards gamification – fun. Consumers are certainly excited: between 2020 and 2021 alone, consumer adoption rose from 58% to 88%, according to a recent Plaid report†
The rise of fintech tools has also enabled consumers to have more direct power over their investments. Conventionally, high net worth individuals would rely on a broker or advisor to build their investment portfolio – an out of sight, out of mind approach that required a significant amount of capital and expensive fees. But now, fintech platforms like Robinhood and Coinbase are giving investors at every income level the ability to manage their investments on their own.
However, this financial power has been limited to certain spheres. While private investors (eg laypersons) have successfully penetrated the stock market, their participation in the venture capital (VC) sector has been minimal to the point of elusiveness.
Retail investors don’t currently have easy access to VC opportunities
In 2020 equity crowdfunding — ie retail participation in the private investment market — reached a total volume of only $1.5 billion† This amount accounts for less than 1% of the global VC market, which in total $300.5 billion the same year. As founder of the Wealth Club, Alex Daviestold the Financial Times, “Private markets are an exciting area that is normally impossible for normal investors to get a slice of the pie.”
So why are retail investors so underrepresented in the VC sector? For the most part, the problem stems from their non-expert status.
Venture capitalists are professional investors; they have extensive connections in the business world and are sought after for their consulting skills and their checkbooks. But for retail investors, investing isn’t a full-time job — it’s an interest they pursue with their spare time and money. As hobbyists, they often lack the connections necessary to learn about fledgling ventures before entering the stock market, let alone getting involved in the development process.
Retail investors also tend to have a lower risk tolerance than the average VC. Venture capitalists often make investments knowing they can lose everything. According to a CB Insights report, 67% of venture capital backed companies either flop or become self-sufficient and no longer offer any opportunity for returns.
For a professional investor, these losses may just be the cost of doing business. But for retail investors investing their extra income, a two-in-three chance isn’t very attractive.
The lack of connections and low risk tolerance of retail investors makes perfect sense given their non-expert status. However, these factors have also led retail investors to stay out of the VC sector, even during the digitally-enabled fintech revolution.
This exclusion is a problem. First, it drastically reduces the amount of funding available to startups. Second, founders are subject to the whims and preferences of conventional venture capital investors, who may demand changes that are inconsistent with the founders’ vision, prioritize scalability over sustainable growth, or be unwilling to nurture newer ideas.
“With retail investors, the market is blessed with flexibility as their volume transcends any form of collusion or dominance,” noted Rayol Hwang, a crypto attorney and the CEO of Hillstone Partners, in an article for Nasdaq earlier this year. “Even entrepreneurs are not pressured to scale their business and can focus on sustainable growth.”
Retail investors can give young projects wings, provided they can enter the VC market at all.
Blockchain-based venture capitalism: an inclusive fundraising solution for private investors?
When deployed correctly, blockchain-based solutions can enable retail investors to make the most of early-stage opportunities without incurring an overwhelming burden of risk. The technology can remove the two main barriers that amateur investors face today: awareness of risk and opportunity.
Let’s look at the risk first. In a conventional investment scheme, a private investor simply puts out a certain amount of capital and hopes for a return that he may never receive. However, if a startup raises money through the blockchain, it can offer investors the opportunity to provide liquidity through tokenized staking.
With tokenized staking, an investor buys tokens – such as project-specific cryptocurrency assets that can be traded, stored or sold. This stake provides funding for the project and provides some protection to the investor, as tokens gain value as currency on their own. Investors can discharge these assets if they lose confidence in the project or simply want to make up for a loss. Startups can further protect potential investors from loss by anchoring their token prices to real assets such as gold, silver or fiat currency.
Dynamic Coin Supply (DYCO) illustrates this idea. According to the DYCO model, startups return their tokens to fiat currency (USD) for 16 months. If investors want to exit the project within that grace period, they can recoup their investment. Fiat support could also allay investors’ fears of crypto volatility, as pegging a token’s asset price to USD sets a price “floor” while still allowing for value growth.
Tokenized staking allows retail investors to invest in early stage opportunities without having a two-thirds chance of total loss. That said, risk reduction isn’t the only benefit this arrangement offers. As token holders, private investors have the opportunity to contribute to and be heard within a project’s community by voting on proposed project changes. It’s not just checkbooks; their votes matter.
This capacity for investor participation speaks to the core of VC culture. Venture capitalism isn’t just about fundraising – it’s about giving founders advice, guidance and support as they get their businesses off the ground. To date, those advisory contributions have been provided by a limited pool of conventional venture capital investors. Hosting early investment and fundraising opportunities on the blockchain allowed founders to access a wealth of funding and new perspectives.
To capitalize on blockchain-based fundraising and opportunities, retail investors need formalized support
Blockchain offers private investors the opportunity to usher in a new era for venture capitalism, but it won’t automatically deliver it. To break down the proverbial walled garden around VC, retail investors need an easy-to-use, fiat-enabled platform that supports and guides them through the investment process.
Here are a few reasons for this. First, private investors are ordinary consumers; most will not have the skills or inclination to navigate the complex Defi ecosystem without guidance and fiat support. Second, amateur investors may be hesitant to invest with no assurance that a blockchain-based project is legit. After all, it’s not unheard of for unscrupulous profit-seekers to plunge into a project, pull out when the token price peaks, then let the project and the remaining backers crumble without funding. Then there are compliance considerations. Today, regulatory uncertainty is widespread enough to give any amateur investor a break.
However, if retail investors gain access to an organized, layperson-friendly platform that facilitates fiat onboarding, provides vetting services and provides compliance support amid an evolving regulatory landscape, retail VC investing could very well become a norm.
The investment industry needs this change. For years, the barrier to entry for VC investment was too high for the average layperson to climb. As a result, both startups and investors are limited in their ability to perform. But amid a massive consumer shift towards digital finance, we have the opportunity to use layperson-friendly blockchain solutions to break down walled gardens and provide a truly welcoming environment with reasonable risk for retail investors.
All we have to do is act on it.
Hatu Sheikh is co-founder of DAO Maker.
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