Point The Finger At The Bogey

Not Yourself

The fallout in the crypto venture capital world is predictable. I was reading the daily email from Fortune’s Term Sheet. Here is the link. Predictable in that the VCs aren’t blaming themselves.

I will tell you this. When I have had investments fail the first thing I do is examine everything I did leading up to the investment. Why did I make it? What was going on that caused me to run down the decision tree path that I did? Then I examine my actions post-investment. Did I do anything or give advice that harmed my investment? Basically, it’s '“How did I fuck up?”

Funny thing, when I was trading on the trading floor I’d do similar analyses with trades that went well and went bad. A lot of trading sage’s tell people to keep a journal and the reason you do that is not because you like to write and want to have a record for your family but so that you can be accountable to yourself.

Brian Lund

has written about that a lot on his site over the years.

Writing a deal memo really helps with startup investing, especially on failures. Ironically, it helps with exits too. If you do it well, you can get some objectivity.

Here is what the article quoted VCs as saying.

 for startup valuations, “everything [will come] down even further in our mind than what they were yesterday.” Valuations across the board, including in crypto, have been falling in recent months, but bigger cuts post-FTX are already happening. 

the founder profile for prospective investments may be under greater scrutiny now, too. “We need founders who are committed to the core mission and not adding layers of additional risk onto the business. It’s a hard thing to assess, but it’s part of having the conversation with entrepreneurs at the early stage,”

Lastly, governance, and particularly board-level governance, is something that’s looking ever more critical in light of the FTX mess: “It raises the importance of board seats, which, in traditional tech, investors of our size were always used to getting.…As you saw in crypto [and with FTX], there was less of that

None of that is introspective. None of those things points the finger the other way.

Notice what they didn’t say as well. They didn’t say that their fund might not have had the bench to evaluate an investment that they made. A lot of these crypto funds are made up of people with good backgrounds on paper that allow them to raise money from LPs but they don’t have the experience yet to really hone in on what will make certain types of businesses successful or failures.

I remember early in the crypto days I would get a lot of deal flow about setting up trading platforms to trade crypto. My first question was always about clearing and settlement. However, entrepreneurs that wanted to set up trading systems would always want to show me their matching engine. Clearing and settlement are the backbones of a trading system, though the most boring part of it.

One of the most valuable things I did in my career was participating actively in the Strategic Planning Committee at CME. Jimmy Oliff ran it and it wasn’t a process that was passive. It allowed me to really examine the guts and glue of an exchange before being turned inside out. I was 38 then.

Looking back, when I invested in Bitnomial, Luke and I chatted at length about clearing, settlement, and his experience in that area. He had tremendous experience there and when you spoke with people that worked with him everyone said he was incredibly capable. One of the first hires I found for him was James Walsh. He had done legal work at CBOE, and he came from a trading background so he was a perfect early hire for Luke. A guy I knew personally took a job there. That guy was a great angel investor and was really respected in HFT circles as a great engineer. What a great sign of confidence to see that happen at an early stage. Another company I was invested in had an employee leave to take a job there. They took care of all the hard unsexy stuff early in the process because they had to in order to do what they wanted to do which was trade, clear, and deliver physical cryptocurrency.

Can you imagine the ruckus if the exchange failed to be able to deliver?

Bitnomial hasn’t been a high flyer like other exchanges. They don’t have multi-billion dollar valuations. But, it’s in business and it’s doing what it set out to do. If you want a job there, they are hiring. They are the only designated contract market in the world that delivers cryptocurrency on settlement, and they are growing. Turtles beat rabbits in the real world, not just in fairy tales.

I won’t get into the differences between cash-settled and physical delivery but physical generally has a more specific price that sends better market signals to commodity markets. This is key for someone who wants to hedge. Is Bitcoin a commodity or not?

Venture capital is a competitive marketplace. It’s also gossipy. Fear of missing out and fear of people talking behind your back is a real concern. That drove a lot of the investment decisions in crypto.

I agree, valuations are going to come down. The Fed raised interest rates a bunch. Even without a crypto crash, valuations were going to come down because the cost of capital went up. That’s Finance 101.

But, when valuations were going up my guess is the bulk of VCs didn’t come out and say they were way too high. Believe me when I tell you it’s great for your ego to see an investment you made go to a sky-high valuation. That’s no different than making a great trade and getting a nice return off of it. You can get smug and ignore all the underlying wave action that is moving your investment that you have nothing to do with or no control over.

Instead, the VCs probably just said, “that’s the market” without looking at the corresponding risk. Cheap money doesn’t just change risk preferences, it impacts the discipline you have when you invest. Today, “that’s the market” is saying they are losing lots of money and a lot of investments won’t recover.

Having a board seat is fine. But, having a board seat isn’t a be-all, end-all. It does bring a sense of organization and procedure to the company that isn’t there when everything is loosey-goosey. By the way, that’s an argument for priced rounds of financing versus notes and SAFEs. Boards can only do so much.

I think that VCs will have to vet founders better. Do you invest in horses or jockeys? In early stages, you invest in jockeys. You better be able to figure out if that jockey is a good one or not. Everyone misses, even the best investors. I have missed myself. But, one skill some of us picked up from the trading floor is how to size up people pretty quickly. It really helped me in startup investing.

VCs lost discipline. They need to retool their teams and retool the stuff they do leading up to investment. That’s easy to do if they have the objectivity and guts to do it.

Entrepreneurs need to build stuff that is useful and that customers are willing to pay for. This has always been incredibly hard and it will continue to be incredibly hard. That’s why entrepreneurs deserve our utmost respect and gratitude. When you make something that is useful to end users and change their life, nothing is more rewarding.

Added:

This is even worse than I initially thought. It is looking like Bankman-Fried moved money from FTX to the wholly-owned market-making firm Alameda Research to cover losses. That’s MF Global and that is illegal. See this on MF.

By the way, CME Group has a subsidiary that makes markets in Forex. So, it’s not the fact FTX had Alameda. It’s how it was structured and the actions FTX took to bail out Alameda. CME is public, and you can read all about it in their SEC filings. FTX, not so much.

As my friend Craig Pirrong who I am sure will blog about this said, interesting that trust is a feature of the blockchain and crypto.

There is a lot of fraud in crypto for all the trust……..