Original title: " a16z's Chris Dixon on the state of the crypto market "
Source: The Block
Compilation: Dong Yiming, ChainCatcher
Silicon Valley-based venture capital firm a16z has raised more than $7.6 billion so far to invest in cryptocurrencies and Web3. This article is translated from the latest episode of The Block "The Scoop" with a16z partner Chris Dixon, a16z partner Chris Dixon shared some guiding principles of a16z investing in the encryption field, and explained why the decentralized network replaced The time is ripe for a centralized enterprise network, and ChainCatcher cuts the content appropriately.
In this episode, Frank Chaparro and Chris Dixon also discuss:
- How Venture Capital Firms Manage Risk in Their Portfolios
- The relationship between the Internet and the "network"
- Why a16z never invested in FTX
- The Revolution of Decentralized Social Networking
Frank Chaparro: Welcome to The Scoop, today we invite Chris Dixon, the founder and partner of a16z. We will discuss with Chris his views on the current crypto market, recent investments and his outlook for the crypto market in 2023. We first met before the credit crisis, when the entire market was affected. And half a year has passed, and the encryption market has almost experienced what will happen in ten years. In such a volatile environment, what is your view as a venture capitalist on the current market?
Chris Dixon : For VCs, the time horizon is indeed more different. Hedge funds may be more trying to predict what will happen in 3 months or 12 months, but we have to think longer term. In my professional life, my general experience is that there are two levels of things happening at any time , one level is the technology level and the entrepreneurial level , and the other is the capital market level. There is some relationship between the two, but certainly not a 1-to-1 relationship. For example, I started my entrepreneurial career in 2003, during the dot-com downturn, and Amazon was only $6 a share. But in retrospect, that may have been the best time to build an Internet company in the past few decades.
Just like in the global financial crisis of 2008, we started investing in mobile applications. Looking back now, it was a great moment. Why? Because the Apple phone came out. The iPhone came out in 2007, and the App Store came out in 2008. If you look at all the top apps, the vast majority of them were created between 2008 and 2011.
It's just a general pattern throughout the history of technology. After that, I have been paying attention to the three main trends of encryption and blockchain, AI, and virtual reality for ten years.
Historically, every 10 to 15 years or so, a major new technology trend emerges . And I think we're on the verge of all these big changes , and it's a very exciting time in the evolution of technology. That's in stark contrast to a pretty bad year in the past. This is what happens in almost all high-growth technology companies, not just in the crypto capital market.
The current Internet crisis has spread to companies such as Google and Facebook. They have already laid off employees, and some consumers have also experienced bankruptcy. These are obviously very bad things for those affected. But if you pull out the time frame and look at the broader technology trends, I think there are some very strong things going on and overall the trends are positive.
Frank Chaparro : With the downturn in the entire technology market, the volatility of the cryptocurrency market has become more violent, and the profits of many encryption companies have been greatly reduced. What is the reason for people to single out crypto companies and crypto projects when the market is turbulent?
Chris Dixon : That's a good question. I think new technology is a bit of a double-edged sword, so cryptocurrencies get positive attention for being reliable, interesting, and novel, and at the same time, very controversial. I think large-scale controversies will also occur in the currently hot AI field, and we can see what happens next year. So, it's just a natural tendency: people pay more attention to the big, new, important things. Everything in tech is under the microscope, and the newer something is, the more energy surrounds it, and the more attention it gets, both for and against. This will be a recurring pattern, not just cryptocurrencies, but all major new technology trends will have this controversy.
A good example is when the web came out, there was a lot of controversy around it saying it was going to kill graphic design and printing. But if you look at the statistics, it's true that there are fewer jobs in these traditional roles, but instead it's creating more web design jobs, social media managers, uber drivers, etc. I think something similar will happen in the field of AI, AI will not create drawings and illustrations and such by itself. It's going to need people's help, it's going to just enhance what people can already do, and help automate it. But I don't think it reduces the amount of creative work in any way. But it does put pressure on some people who need to transform, and this brings about "political" problems. So, the same goes for the crypto market.
Frank Chaparro : The occurrence of the FTX incident has raised an interesting question-the role and role of VC in society. In the past few weeks, I have seen a discussion saying that VCs in the encryption field are not doing well enough, they have not done their due diligence, and some people say that VCs have excessive hype and excessive interference in project construction. What do you think of these doubts and criticisms? Is it skill or luck that a16z "dodged FTX's bullet" this time?
Chris Dixon : I want to say, first, I think it is good to have VC. There is a board of directors and a dedicated financial department behind corporate governance. These supervisions are very important. We strongly encourage this. We did not participate in the investment of FTX, and I don't know what role its VC plays in it.
But why is FTX headquartered in the Bahamas? Mainly for regulatory reasons. Because a16z invested in Coinbase, my criteria for judging centralized exchanges is based on years of experience working with Coinbase. In Coinbase's board of directors, 70% are consultants on finance, security, and compliance. This is a very strictly regulated company. Moreover, centralized crypto exchanges should be regulated.
I think the real innovation is DeFi, which enables users' assets to be hosted on the chain, and you can trust this software instead of other people to keep assets. Most of our investments in the encryption field are around the chain, but some intermediate bridges, such as Coinbase, are also needed to help people enter the fully managed world by providing fiat currency rails. And these companies cannot simply rely on on-chain guarantees and must be regulated.
Our investment method in the past 10 years has been "must choose one of two", either all must be on the chain, such as Uniswap; or be regulated in a country , have audited financial data, have 1:1 customer assets, and have Highly secure hosting. If a project or company is offshore, somewhere in between, there are some hidden dangers.
But fundamentally speaking, these should be the work of regulatory agencies. Regulations should clarify the system and require companies to choose one of the two. If they are not on the chain, they must have proper financial security and compliance. Have proper code auditing for security, not both .
Therefore, some offshore exchanges seem to be more innovative and flexible than Coinbase, but in my opinion, these advantages are all because they cut off 70% of the business related to security, compliance and finance. The reason why I did not invest in FTX is not pure luck, but also inseparable from the hard work of the past ten years. It is not to say that in our investment portfolio, there will be no mistakes in projects, but we will work very hard in screening projects to identify whether they are truly technological innovations. If a project has neither on-chain trust nor off-chain regulated trust , I wouldn't consider putting money there.
Frank Chaparro : What investment directions are you currently focusing on? I know you used to focus on investment in payment and decentralized finance. Are there any new changes now?
Chris Dixon : Our investment areas are mainly divided into two major directions, one is investment in the infrastructure layer , and the other is investment in the application layer . The direction of investment in infrastructure includes layer 1 blockchain and layer 2 cross-chain bridges, wallets and all other things needed to build applications.
I think it 's exciting that this may be the first time in the history of encryption that there is enough infrastructure to support tens of millions or even hundreds of millions of users . As for the application layer, that is the DeFi, payment, etc. you just mentioned. Payments have been an often talked about area in crypto, dating back to Bitcoin. We invested in the Bitcoin Lightning Network company Lightspark this year. This company was founded by David Marcus. He is the former CEO of Paypal and the head of the previous Facebook Diem project. Interesting things.
In addition, the current web3 games are also very interesting. We currently have investment in about 15 game projects, but only one or two games are officially launched for the time being. So, there's a ton of games coming out over the next 12 months. The group of people who entered the Web3 encryption game 3 years ago are very typical encryption people, they are game lovers. The 15 companies just mentioned are all people from top game teams such as Blizzard, Riot, and Valve.
Speaking of NFT, I think NFT brings cryptocurrency out of the financial world and brings it into a larger world, the media world . Clearly, there are more people in the world interested in media than in finance. I think the path to get us to 1 billion people actively engaged in crypto is probably going through the media somehow. There are a bunch of interesting new social networks being built, such as our investment this year in Farcaster, a decentralized social protocol that builds a trusted neutral protocol that lets users build direct relationships with their audiences, giving developers the freedom to This is a new architecture that I think is very interesting.
Frank Chaparro : How would you describe the benefits of decentralized social?
Chris Dixon : Mainly the dimension of money and power. First look at the conversion rate (take rates). Conversion rate is a very important concept, which refers to the percentage of money flowing through the network that network operators keep for themselves. Ubiquitous in social networks like Facebook, Tiktok or Youtube, the conversion rate on Youtube is 45%, so creators get 55%; Twitter has a conversion rate of 100%, and Facebook also 100%.
So what does this mean? Take Zinger as an example, they built an active gaming platform on Facebook, and then Facebook took all the money. We live in an age where social networks are owned by platforms. They have extremely high conversion rates, which creates a low incentive for people to create content. Such networks are a bit like theme parks in that they are centralized and managed from the top down. Nobody wants to build on that. This is the money part.
Then there's the power part. Is it a good thing to buy Twitter and then decide to change all the rules? Just like you may or may not like Elon Musk, no one person should have that kind of power.
If you look back at the history of the Internet, initially emails were not owned by the platform, they were owned by the community. The community of software developers who build email clients and email access points decides on changes to the protocol.
Decentralized social networks are good for creators, developers, because they can get more money, and they can build real businesses. But at the same time, there are broader societal implications surrounding how we should manage these networks so that they become a core infrastructure and a critical part of our lives.
We do not interact directly with the Internet, but with the networks built on top of it. So email is a network, YouTube is a network, Twitter is a network, and Facebook is a network. Networking is what we do with the internet. In my opinion, there are basically three main ways to build a network: one is a traditional protocol network, such as an email system, managed by the community; the other is an enterprise network, and now the network we build on the blockchain belongs to the enterprise Networks such as Ethereum combine the best features of enterprise networks and protocol networks to distribute token power to the community in the form of email and the web. Because of the AirDrop, the community took ownership and built a contingent of true believers.
It's a much better architecture that is open and can use encryption as a method of security instead of hiding things behind firewalls. From a financial and control point of view, it is more inclusive, and people can own part of the network through tokens, while also having certain control rights and rights to community governance.
But we're still figuring it out, and I don't think we've found the best way to govern it. There should be a discussion about how to do decentralized governance, but unfortunately, this conversation only happens within the cryptocurrency community. I don't understand why it's not happening more widely, but it's certainly a more pressing problem.
Regarding the power of ownership, the examples of uber and Airbnb come to mind. If you were an early Uber driver, you helped build the Uber network; if you were an early Airbnb host, you helped build the Airbnb network. If you were an early Twitter user, what did you get? You get nothing. This may be the appeal of Dogecoin. It's a dumb product that doesn't do anything. But that sense of ownership has given it a very strong following, and it's a very powerful force.
While the crypto market is negative right now, I can share some good news. I spend most of my time meeting with entrepreneurs and what I see is this: crypto infrastructure has really improved , there's a bunch of really interesting applications being funded , the market is cooling but these interesting things are being built . In our portfolio, about half of the products have not yet launched, and many investments have been made recently, but product development does take a long time.
In other words, there will be a lot of product launches over the next 12-18 months. This is also somewhat representative of the broader market. So, I'm excited for next year.
Frank Chaparro : How much money is currently deployed by a16z, is it 50%?
Chris Dixon : Less than 50% of the $4.5 billion crypto fund Crypto fund 4 is deployed, and most of the funds remain undeployed. Most of the money raised recently has not yet been put in place, and I don't know the exact number.
a16z has a venture capital fund, but we never raised a hedge fund, the two are very different. Maybe I can give a simple explanation: Both of these funds are going to raise money from so-called LPs (Limited Partners), but the difference is that venture funds have a minimum lock-up period, which means that if you want to Invest in our funds and your money is locked for at least 10 years. And to be honest, it's usually 15 years, and we're going to extend that. You cannot redeem your money during this period.
But also because of this, we will invest this money in assets that need to be held for a long time. In addition, compared with hedge funds, our profits (Carry) as GPs (General Partners) will also be delayed a lot. Because of the different payment structure, hedge funds can make money in the second year, while venture funds usually take more than 5-7 years to get money. So if we raise a venture fund, we will have a longer time to deploy the capital.
By the way, I see a lot of people speculating "whether a 16 z will dump the tokens of the portfolio in a bear market", in fact a16z's crypto fund still holds 95% of the investment . Many people misunderstand our model. If you have read related science on venture capital, you must have seen something called the J curve, which describes the characteristics of venture capital returns: first decline, but then rise, it looks like the letter J. All of our data shows that most of the investment returns are in the later stages of the fund. And in venture capital, the worst thing you can do is sell a good asset prematurely. I empathize with those who have lost their jobs and I understand the pain, but it doesn't really affect our model.
Frank Chaparro : I don’t know if you can talk about this issue. For example, you invested in Uniswap and you are really optimistic about it. Do you have the right or ability to buy more tokens of this project?
Chris Dixon: We have this power, and we've done it a number of times, I can't say which projects specifically, but it's possible.
Frank Chaparro : So how do you do risk management in this regard? For example, if you invested in a company in the early stage, its tokens have doubled many times. If you don’t take some out, isn’t it a bit unrealistic, or you haven’t done the best risk management?
Chris Dixon: In my experience as an angel investor over the past 15 years, there have been too many stories in Silicon Valley of too many investors selling all kinds of hot companies for too low a price. Therefore, we must look at the problem from the perspective of venture capital. In the long run, we must design a more accurate evaluation model, such as inferring their valuation from the growth of the agreement and the cash flow generated by the agreement. We have a dedicated data science team doing professional valuation analysis.
We do n't care too much about the performance of a certain project in the past 3 months and those transaction data points with momentum effect , but look at the value-added space of investment from a long-term perspective . If the project does what we know it to do, we believe it. I really look at the world from the perspective of product and technology innovation. We like those open source developers or hackers. I think a key reason is that they have deep professional knowledge in related fields, so we don’t They are expected to have experience running a business or building a team, and that's where we can help them.
a16z strives to invest in founders of technology products and then help them do other things. Venture capital is a people business , and we bet on people . Although we spend a lot of time in the market, technology and other aspects, it's all just to help us be smarter to ultimately evaluate and help entrepreneurs. Just like looking for truffles, you're looking for someone very special who has a unique view of the world and the ability to build something special, and investors need to be smart enough to recognize them when they arise.
