Original text compiled and translated by: TechFlow
Moderator: Jason Yanowitz, Founder of Blockworks; Santiago R Santos, Investor
Guests: Regan Bozman, co-founder of Lattice Fund; Mike Zajko, co-founder of Lattice Fund;
Podcast source: Empire
Why Retail Can’t Win | Regan Mike, Lattice Fund
Air Date: June 25, 2024
preface
In this episode, Mike and Regan from Lattice Fund dive into the structural issues shaping this cycle. They discuss why it’s been difficult for retail investors to achieve significant gains, the evolution of token distribution methods, and the impact of venture capital on market dynamics. The topic then shifts to emerging opportunities in DePin and the changing landscape of L1 and L2. Finally, they explore the growing importance of token distribution and audience for new blockchain projects.
The main points are as follows:
The current market cycle is driven more by macroeconomic factors than by new crypto-native innovations. This makes the market feel different from the past and lacks new applications that can attract retail and institutional investors.
Since projects are valued higher before public sales and many projects distribute tokens through airdrops, the potential gains of retail investors are greatly reduced. This change in market structure makes it difficult for retail investors to get huge returns through early investment.
FDV limits the market’s upside potential, causing the nominal value of tokens obtained by retail investors to be pegged to a higher FDV, further compressing the market’s growth space.
Lattice Fund focuses on early-stage investment strategies and emphasizes the advantages of small teams and funds. They also discussed how to survive and thrive in the current market environment.
There is a huge liquidity mismatch between the primary and secondary markets, and the impact of ETFs on the market and the effectiveness of airdrops as a marketing strategy are discussed.
Why has this cycle ended?
In this segment, several guests discuss the structural issues of the current crypto market cycle and explain why this cycle feels different than previous ones.
Jason first introduced today’s guests, Regan and Mike, who are the co-founders of Lattice Fund.
Jason pointed out that the current market cycle feels a bit strange and wanted to discuss some structural issues such as low circulation, high fully diluted valuation (FDV) and token distribution.
Regan believes that the biggest difference between this cycle and the previous ones is that it is driven more by macroeconomic factors rather than new crypto-native innovations. For example, the launch of Bitcoin ETFs and macro capital inflows into the market lack new major innovations. Although there are hot spots like meme coins, they are not the main market drivers.
Mike added that the current market lacks new applications that can attract retail and institutional investors. In past cycles, such as DeFi Summer and the NFT craze, retail investors could have fun and gain benefits by participating in various new applications. Now, new infrastructure-level innovations (such as Eigenlayer) are difficult for ordinary investors to understand and accept.
Jason concluded that market structure problems in the current cycle have left investors confused and dissatisfied, especially those who are accustomed to gaining returns through new applications and innovations.
Why can’t retail investors make money?
Regan said that while some people have made a lot of money through memes, he is mainly discussing the traditional venture capital token market. He pointed out that in the past, retail investors could get very high returns by participating in token sales, such as turning $20,000 into $500,000 in Solana's ICO. However, such opportunities are now scarce.
Regan explained that a major change in the current market is that projects are valued higher before public sales, and many projects do not sell tokens to the public at all, but distribute them through airdrops. This method greatly reduces the potential returns of retail investors. For example, participating in Eigenlayer's airdrop may only allow investors to double their initial investment instead of getting hundreds of times the return as before.
Mike added that this structural change in the current market makes it difficult for retail investors to get huge returns through early investment as in the past. In the past cycles, retail investors could have fun and gain benefits by participating in various new applications and innovative projects, but now such opportunities have become less.
Jason also mentioned that the model of the traditional capital market is to conduct an IPO after multiple rounds of financing, which is similar to the current changes in the crypto market. Retail investors in the crypto market are very different from retail investors in the stock market.
Market upside cap
Regan believes that the current project pre-public sale valuation (FDV) is higher. This means that the nominal value of the tokens obtained by retail investors is linked to a higher FDV, limiting the market's upside potential. For example, if a project is publicly listed at a $10 billion FDV, the market's room for continued upside is greatly compressed.
Jason mentioned that as the industry grows and success stories increase, more and more funds are flowing into the market, resulting in higher and higher valuations of projects before they go public.
Mike also added that the current system is more like the traditional capital market, with a large number of venture capital funds involved, resulting in fewer opportunities for retail investors to participate.
Mike pointed out that many projects choose to work with a single investor rather than conduct public token sales, partly to avoid regulatory risks. Although this protects the project party to a certain extent, it also limits the participation opportunities of retail investors.
The guests also discussed how to solve this problem. Mike suggested that projects can allow more retail investors to participate through public token sales during the growth stage, rather than relying solely on large venture capital funds.
Regan believes that projects should be sold publicly at lower valuations in the early stages and raise less pre-sale funds, which can give the community more room for growth.
Lattice Fund’s Strategy
Mike pointed out that when a project is listed with a high valuation (such as 5 billion or more), who the future buyers are is a key issue. Traditionally, retail investors are the main buyers of these new tokens, but there is currently a lack of large institutional buyers in the market to take over these highly valued tokens. Therefore, even if there seems to be a high return in the short term, the value of these tokens may be difficult to maintain in the long run.
Regan explained that Lattice’s investment strategy is to focus on early-stage projects. In the current market, many large funds have high minimum investment amounts, making it difficult for early entrepreneurs to obtain funds. Lattice chooses to operate in this relatively uncrowded market, focusing on helping startups grow in the early stages rather than participating in large projects that have gone through multiple rounds of financing.
Regan said Lattice prefers to keep its team and fund small and stick to its investment strategy, which not only brings impressive returns but also allows the team to focus on what they are good at.
Finally, Mike mentioned that the biggest concern for entrepreneurs when launching tokens is still legal and compliance issues. Many entrepreneurs hope to find a different approach from airdrops and high-valuation, low-circulation tokens, but there is no clear solution yet. Therefore, despite entrepreneurs' willingness to change the status quo, airdrops are still the main token distribution strategy in the absence of regulatory clarity.
Survive this cycle
Mike pointed out that there is a huge liquidity mismatch between the primary and secondary markets in the current market. Many projects have received multi-billion dollar valuations before they are publicly listed, which leads to huge selling pressure when the tokens are listed. Even if the project itself is well executed, such as Arbitrum, there is still a large influx of tokens in the market, causing prices to fall.
Mike mentioned that investors need to choose tokens more intelligently, and the industry as a whole needs to grow to attract more participants and capital inflows. He believes that the current problem is mainly the structural imbalance of capital flow, and more new participants and funds need to enter the market to balance this.
The guests discussed the impact of ETFs on the market. Although the launch of ETFs is considered a sign of institutional funds entering, in fact, most ETF buyers are still spontaneous retail investors. This means that although ETFs increase the accessibility of head assets (such as Bitcoin and Ethereum), they do not necessarily bring a large amount of funds into mid- and long-tail assets (such as tokens with lower market capitalization rankings).
Regan pointed out that investment strategies in the current market may change. In the past, investors would buy mainstream assets such as Ethereum and then invest in other altcoins. But now, with the emergence of L2 and other multiple token options, funds may be more dispersed. This dispersion may affect the performance of mainstream assets, but it may also bring more opportunities for mid- and long-tail assets.
The panelists believe that the flow of funds in the future may be different from the past. ETFs and other new products may change the flow pattern of the market, making it easier for funds to enter the top assets, while also indirectly flowing into other assets through the wealth effect.
Low flow, high FDV
Mike pointed out that in a high FDV, low float environment, almost no one can profit in this environment except venture capitalists (VCs). After investing in a project in the early stage, VCs usually move on to the next project or sell their tokens on the market. Even if the project team continues to develop and deliver products, the long-term survival of the project will be challenging without a group of loyal supporters.
Regan added that after a token is listed, the natural buyers are usually retail investors. However, airdrops can siphon off a lot of buying demand from the market. People who want to get a project's tokens have often already received them through airdrops, so they are unlikely to buy more tokens at high FDVs. This situation leads to poor market structure, further exacerbating liquidity issues.
He believes that the phenomenon of low float and high FDV is actually a "red herring", that is, a misleading appearance. He pointed out that the current float ratio has not changed significantly from the previous cycle. Many successful L1 projects (such as Solana, AVAX, Near) did not exceed 1% when they were listed. The real problem lies in the mismatch between capital inflows and outflows, not the float ratio or FDV itself.
Jsaon mentioned that an important lesson they learned while working at CoinList is that "the token is the product". In Web2 companies, finding product-market fit is the key to success. Similarly, in Web3, it is also crucial to find a group of loyal users who love your token. Successful projects are often those that allow early contributors to make money, and these early contributors will become loyal supporters of the project and help spread the story of the project.
Solana is a classic success story. Although Solana was not a market darling and did not attract a lot of investment in 2019 and 2020, they built a group of loyal supporters by making early contributors earn money. These supporters not only helped promote the project, but also attracted more developers and users, thus driving the long-term success of the project.
airdrop
Jason raised the question of whether the airdrop should be abandoned because it might anger the community in another way, as those who have been receiving airdrops did not get them.
Mike believes that airdrops are effective as a marketing strategy and user acquisition method to guide people to use the product. However, the current airdrops are mainly used as the main strategy for token distribution, which may not be ideal.
He suggested that airdrops should be part of a broader toolkit, rather than the only strategy. For example, a points system could be used, where users could qualify for future token sales by earning a certain number of points.
Regan believes that token sales are the most logical way to give early users and the community unlimited upside. He noted that the regulatory environment in the United States is indeed challenging, but there are actually many ways to conduct token sales in more friendly jurisdictions. For example, Europe's MiCA regulations provide new avenues for compliant token sales. He believes that simply following the airdrop trend in the market without trying to innovate is a big mistake.
Reagan emphasized that in the past five to six years, the turning point of the entire industry usually occurred when new token distribution mechanisms emerged. For example, the emergence of initial coin offerings (ICOs), DeFi's yield farming, and DePin projects such as Helium have aroused great interest in the market. He believes that airdrops have been widely used as a marketing strategy for several years, and new strategies are now needed to attract the attention of the market.
Mike mentioned that when they saw the point activity mentioned in the market entry strategy, they thought it was just basic operations (table stakes) and needed to find a way to differentiate. They discussed Node Sales as a new fundraising method, in which users can pre-purchase the right to run a node to help decentralize the network.
Unique GTM and Financing
Jason mentioned Gala and how it seemed like a huge scam in the last cycle.
Regan said it was hard to tell, but he mentioned that the idea of reselling validator services in the network and helping decentralize it was interesting. There could be some regulatory breakthroughs with this approach that would allow people to actually contribute to the network.
Mike discussed the idea of using a points campaign as a sales access point. He thought this would not only get people involved in the sale, but also incentivize them to take actions during the points campaign to gain sales access. He hoped someone would try this approach.
Jason brought up the comparison between traditional venture capital funds (e.g., seed funds, Series A, Series B, etc.) and the cryptocurrency market. He pointed out that there is a lack of funds similar to later stages (e.g., Series D, Series E) in the crypto market.
Regan believes that over the past four or five years, the best growth-stage strategy has probably been to just buy a bunch of tokens. He believes that while these funds should exist, if we think of a token generation event (TGE) as a company going public at a Series A or B, then growth-stage investors should buy tokens directly or do over-the-counter (OTC) rounds. He doesn’t think there’s a huge gap in the market where protocol teams need a $75 million Series D.
Mike mentioned that in a traditional IPO environment, investment banks would form a syndicate and market to high net worth clients. However, in the crypto market, growth-stage funds may eventually distribute tokens through airdrops. This raises the question of who will be the next buyer.
Jason mentioned a tweet from Arthur from Defiance, arguing that fundraising by large VC funds could have a value-extracting effect on the market unless they use a large portion of the funds raised to liquidate tokens.
Regan believes that this view also applies to venture capital firms in traditional markets. The problem is that there is a lack of pre-IPO or allocators of liquid tokens in the market, which leads to a structural mismatch between capital inflows and outflows. He believes that smart allocators should put more funds into liquid markets.
He also believes that it is very difficult for hedge funds to operate liquid assets in this environment due to high market volatility. But as the industry matures, more LPs (limited partners) will include crypto assets such as Bitcoin in their portfolios, which will help solve the structural mismatch problem.
DePin
Jason observed that founders in the DePin space tend not to be crypto-native, which makes this space very interesting. He mentioned projects such as Geodnet and noted that these founders are more focused on tokens as flywheel incentives rather than community building and token price appreciation.
Mike believes that the DePin field has changed in the past six months, and more crypto natives have begun to enter this field, trying to make money quickly. He gave an example that the team members of the Demo project have backgrounds in the automotive industry, consensus systems (Consensys) and chain analysis (Chainalysis). This diverse team combination enables them to succeed in the industry.
He stressed that teams with industry expertise are more likely to succeed because they can find experts in the crypto space to supplement their teams.
Regan said they are very excited about the DePin space and hope that this excitement can be conveyed to the audience. They have been working on network startups for seven years and believe that the current problems are well known, but it is more important to find solutions rather than complain about the market situation.
Regan mentioned that their investment thesis has always been around products that can scale the market or the infrastructure that supports these products. They believe that DePin is one of the first categories to really reach scale. They also mentioned some applications such as Layer 3 and Galaxy that are starting to have more of their own technology stacks and thus capture more value.
Regan mentioned some projects, such as Blur, that are capturing more value by vertically integrating and owning more infrastructure. They believe that this trend will allow applications to re-price in this cycle and capture more market value.
L1s L2 Panorama
Jason mentioned some blockchain projects with built-in distribution channels, such as Telegram’s TON and Coinbase’s Base. They discussed how these projects can leverage their existing user base to drive blockchain adoption.
Mike believes that distribution channels will become increasingly important as an advantage. He mentioned that they have invested in projects such as Layer 3 and Galaxy, which are the first point of contact for many people to enter the world of cryptocurrency. He believes that projects with a large user base may not be as technologically advanced as other projects, but they can still succeed due to the advantages of their distribution channels.
Regan believes that as technological tools advance, it is becoming easier to create your own blockchain. Now, more innovation is shifting from the pure technical level to how to build a unique user base. He also mentioned that more and more venture capital funds are flowing into applications rather than infrastructure.
Regan explained that their core strategy is to invest in early-stage projects, with about 20% of the fund going to buy liquid tokens in the secondary market. They are primarily looking at products that may have tokens because they believe this is where the biggest opportunities for crypto-native value capture lie.
Mike said that although the first half of this year was a bit frustrating because he didn't see a lot of new innovation, he has been very surprised by the new founders entering the field in the past three months. He believes that the market is improving, more interesting projects are emerging, and the quality of entrepreneurs is also improving.
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