Part 2: Broken Unit Economics — Investor Incentives

A deep dive into the macro incentive structure at play

Introduction

As we trend deeper into the depths of the bear market, we start to see more ugliness unravel itself. What’s interesting is that this isn’t anything new but rather is exposing what was always there. As a follow-up from the first part of this that talked about broken incentives, this one is going to be framed around the typical crypto investor psychology and how it pertains to value. The core truth of this whole phenomena comes down to:

The time to value creation versus the time expected to extract value is very misaligned.

What do I mean by it? Well the expectation of a lot of crypto investors (retail, whales, institutional) is that value can be extracted in less than 12 months.

Realities of Building

The reality of building anything unique/hard/game-changing is that it takes quite literally years. You need the market, product and team to be in perfect alignment. Often this is what that process looks like on a multi-year timeline:

• The first year is just scrambling to get a functional team together doing something vaguely around the idea you set out to do

• The second year is where things make a bit more sense but there are still a lot of unknown unknowns you’re working through

• The third year you’re in a groove where most of the unknowns can/have been answered and execution becomes critical

• The fourth year is where you actually start to see real, scalable success

Now of course this is highly generic and varies from business to business but I will happily call bullshit on anyone who thinks you can achieve all of the above in 12 months. Why? Well if it was possible within 12 months everyone would do it and it probably wouldn’t be that hard.

Incentives of Investing

Let’s now switch to the other side of investors. Of course this doesn’t describe all investors (size, source of funds, etc) but the incentives will create similar patterns of behaviour. So what are the incentives at play:

1. Everyone is trying to snipe the lowest possible valuation before a coin launches

2. By investing into said coin, the coin can leverage all the brands that have invested to drive a ton of FOMO

3. The clauses for investors typically involve 6-24 months of investing (that’s being generous on the upper end). Weak projects will allow a portion of coins to be fully unlocked on launch

4. The coin launches at a very high valuation because the excitement of the coin prices it as if it has already succeeded

5. As soon as the coin goes down investors have two key options:

   a. Hold until the team delivers on the value they set out to create

   b. Sell while you can because you’re still in the green

The last point is where you have the fundamental incentive problem crop up.

To balance things out, some investors are happy to have no liquidity for 4+ years but they are very few. Why? Because they fundamentally understand this dynamic and the incentive tension.

On the other hand, you also have projects that will do $100m seed rounds and try to ask for 4+ year vesting which doesn’t make sense because the ask price is way too high for the duration of illiquidity.

Closing

As I’ve articulated numerous times in various blog posts, the incentives to play short-term games usually trump long-term value creation in crypto. As I think about this problem the key thing that solves these issues is profitability. Everyone is scared of being the last bag holder since the bag is actually worthless.

What happens when the bag is a cash flow generating asset that gives real cash back to the bag holders?