Since the 2018 ICO bust, venture capital funding has become the primary avenue for blockchain startups to raise money. This comes with pros & cons which we will explore in this article alongside how raising capital works in the blockchain sector.
- How Private Funding Rounds Work
- Pros and Cons of Private Funding
- How Public Funding Rounds Work
- Pros and Cons of Public Funding
- Which is Right for Your Project?
- The Future of Crypto Funding
How Private Funding Rounds Work
During a private funding round the founders of a project will offer shares or tokens to a select group of investors in exchange for capital. These rounds are typically conducted in the early stages of a company’s growth, when it is still developing its product or service.
There are several types of private funding rounds in the blockchain sector, including:
- Seed Rounds These are the earliest rounds of funding, typically used to develop the initial concept and build the team. Seed funding is often provided by small independent angel investors or incubators working in the space.
- Series A, B, C These rounds are used to fund the company as it grows and develops its product or service. Larger crypto native funds will participate in these rounds.
- Pre-Sale Rounds These rounds allow private investors to purchase tokens at a discount before the public sale.
- Strategic Rounds These rounds often involve investment from a single investor with expertise in the sector. The aim is to provide capital and experience to help the project succeed.
Participation in private funding rounds is typically limited to corporate entities and high-net-worth individuals. These investors are often working full time in crypto and have a good understanding of the technology and landscape.
When raising capital you will generally be pitching to analysts who will then put a recommendation to a board who will then deploy capital raised from limited partners.
The exception to this is when raising small amounts of seed capital in which case you may find you’re pitching to individuals who are investing their own funds more frequently.
Private funding rounds are typically structured as a sale of equity or tokens. The terms of the sale, such as the amount of capital being raised and the price of the securities or tokens, are negotiated between the founders and the lead investor. The lead investor will then usually assist with introductions to additional VC’s who will fill the cap table.
If a token is already deployed then smart contracts can be used to set up vesting schedules. If not then equity or SAFT templates can be used. Funds are normally deployed by either bank wire or stablecoins.
Pros and Cons of Private Funding
| Pros | Cons |
|---|---|
| If you have an investable idea, industry connections and experience then private funding can be an efficient way to raise capital | VC’s are a clicky bunch and if you don’t get a warm introduction you will be playing a numbers game where response rates are maybe 3/100 for cold email of good pitch deck |
| Investors are experienced professionals who can provide valuable advice, guidance and networking opportunities | By limiting who can participate in a funding round the project is excluding the users and smaller stakeholders from having skin in the game |
| By limiting the number of investors in the round, startups can maintain greater control over their project and avoid outside “Wen lambo?” interference | If the project doesn’t work then VC’s may encourage/expect you to pivot until you find an idea that works and they can get a return on their investment. Writing off your time is less painful than writing off their investment |
| Most crypto funds will be used to standard industry documents and terms such as SAFT agreements and vesting periods | Your idea & team needs to stand out. If you are launching AI on the blockchain then active investors have probably seen 3 similar pitches already this week |
| Feedback from VC’s is very valuable in itself. If you know a VC personally who spends their time looking at decks all day then they will be in a perfect position to tell you why your idea is dumb |
How Public Funding Rounds Work
Public funding rounds were originally called ICO’s (Initial Coin Offering). During the 2017 bull market just a few years after Ethereum launched these became a widely popular and effective way to raise funding in the blockchain sector. At the start of 2018 crypto markets crashed and public funding dried up completely, many project failed which lead to the term having negative associations. Now we call them TGE’s, token generation events but the same mechanics apply.
Founders offer tokens to the public in exchange for capital, usually via a smart contract or 3rd party launchpad. Public funding rounds are open to anyone who wants to invest and has a digital wallet.
A project will usually provide a whitepaper which lays out the plan and technical merit of the what they are trying to do. Investors can then contribute either stablecoins or ETH to the token sale and when it’s finalised the projects token will be sent out to everyone that invested.
TGE’s generally last from a few days to a couple of weeks to give everyone opportunity to contribute. Some projects will whitelist community members to give them priority in a pre-sale before offering the product to the entire public. This ensures early stakeholders get a guaranteed allocation and can be a way to incentivise community members.
From a technical aspect a smart contract allows deposits and sends out ERC20 tokens. Most major projects will create a dedicated frontend section for the TGE with a simple UI.
Regulatory Concerns For Founders
Public funding rounds in the crypto sector have been subject to increased regulatory scrutiny in recent years. One of the key concerns is the potential for these offerings to be considered securities under securities laws.
In the United States the Securities & Exchange Commission (SEC) has taken the position that many tokens are securities and therefore must comply with securities laws, such as registration requirements under the Securities Act.
In some jurisdictions public funding rounds may also be subject to other types of regulation, such as anti-money laundering (AML) and know-your-customer (KYC) requirements. These regulations are intended to prevent illicit activities such as money laundering and terrorism financing, and require projects to verify the identities of their investors and comply with certain reporting requirements. To achieve this all participants need to provide photo ID before their address is whitelisted.
It seems probable that regulators will continue to target the blockchain sector over the foreseeable future so getting good legal advise and setting up the business in a crypto-friendly region is advisable.
Pros and Cons of Public Funding
| Pros | Cons |
|---|---|
| Public funding rounds align with the decentralized open nature of the blockchain sector providing financial inclusion for everyone and treating all parties the same | High levels of fraud and scams. Investors tend to do less due diligence which enables more rug pulls and fraudulent activities. |
| Tokens are held in smaller amounts by a greater number of investors. This can reduce volatility through greater distribution | Lower quality tend to do public rounds if they can’t raise privately. This has created a scenario where VC’s get the best deals in private rounds and everyone else gets the leftovers |
| Public funding enables users to become investors and stakeholders in the project aligning incentives and giving them upside potential for the projects success | Pricing is usually higher during a public round than a private round. The idea is that because VC’s are providing larger investment they should get better terms. |
| Public funding rounds are almost always held on chain with full transparency over terms, unlock schedules, volumes and distributions. |
Which is Right for Your Project?
This comes down to a variety of factors based on the projects needs and market conditions at the time.
If a project already has a large audience then a public funding round can potentially attract a large pool of community members and turn them into investors & stakeholders. For new projects that don’t have a product or community, a private funding round can provide the seed capital to get things off the ground.
If the project needs to raise capital urgently, a public funding round may be the best option as it can be completed in days if you can generate demand. Private funding rounds may take longer to negotiate and close.
Public funding rounds are subject to more regulations and compliance requirements than private funding rounds. If the project is in a jurisdiction which is not crypto-friendly and they are not prepared or able to meet requirements, a private funding round may be the better option.
The Future of Crypto Funding
LayerZero recently raised $120m at a $3B valuation, this included 33 VC firms. It’s a project I’ve had my eye on for a while and honestly it hurts a bit that as a developer that’s used the protocol I can’t allocate my own capital to take a stake in the success of the technology I am using.
Public funding rounds promote financial inclusion and help make ownership of a protocol more transparent. By issuing tokens on a blockchain, projects can ensure that ownership is publicly visible, allowing anyone to verify who owns what percentage of the protocol. This transparency can help to build trust and confidence in a project, and can also help to prevent fraud and other malicious activities.
While there are many benefits to private funding rounds which we have discussed in this article I hope that in the future more of the top protocols opt for public rounds and token generation events. As users and developers we get to choose which technology we adopt and we should strive to use projects that align with the ethos of financial inclusion.
Do we want to build an industry full of Coinbase’s and Opensea’s or do we want to create an ecosystem of DAO’s which are open, transparent models funded and owned by the community that use them?
