If Crypto’s Bull Market Made VCs Look Smart, What Happens Now?

Hindsight is 20/20, and its perspective is often brought into further clarity by regret. Just ask some of the venture capital industry’s most well-known firms, like Tiger Global Management, SoftBank and Sequoia Capital, who all wrote big checks supporting the since-imploded cryptocurrency exchange FTX and its charmingly unkempt wunderkind CEO, Samuel Bankman-Fried (SBF).

While “past performance may not be indicative of future results,” the now worthless investments made by blue-chip funds face inevitable writedowns — if not outright write-offs — creating a backdrop that could jeopardize future big-name investments in the cryptocurrency industry.

FTX was one of the most highly valued venture-backed crypto companies. At its height, the exchange was worth a staggering $32 billion before coming crashing down to zero in the span of a few days. Exactly how an unforeseen freefall of this magnitude impacts other late-stage valuations and corresponding investments made across the entire industry remains to be seen, but it certainly will not make things any easier for cash-hungry startups down the road.

Leading VC firm Sequoia, for example, wrote down the entire value of its $214 million stake in FTX last week, as reported by Bloomberg. Other FTX investors, including the Singaporean state holding company Temasek, which gave SBF’s exchange $300 million, are similarly writing off their own investments. SoftBank has also indicated that it expects a loss of $100 million on its FTX investment, as reported in the same Bloomberg article.

Investors face tough questions

Perhaps the biggest question the so-called “smart money” VCs and others will face following FTX’s combustion is why, with all their sophistication and investment prowess, didn’t they ask more questions themselves and foresee this before it was too late?

How FTX was able to extract $2 billion in funding from some of the sharpest financial minds in the business will forever be an asterisk on their accolades.

FTX’s own lack of internal controls are well reported on and documented, but where were the appropriate due diligence stopgaps and guardrails supporting its investors’ own processes?

Temasek, for example, made clear in an official statement that it had spent eight months reviewing FTX’s audited financials and documents before taking a 1% stake in the crypto exchange.

In a since-deleted article on Sequoia’s website that is still viewable as an archived webpage, SBF was effusively praised as a “genius.” That he was playing a video game throughout the entire call was even viewed by some partners as an affirmation of his boy-genius personality, rather than a potential red flag.

To be sure, the COVID-era has seen more than its share of newfangled high-fliers, such as cartoon monkey NFTs, or everyday Joe’s making millions from joke-tokens like Dogecoin. FTX was different and branded itself as a responsible actor and carried itself, at least outwardly, like a more traditional financial firm.

Just as all Wall Street firms do, FTX also lobbied D.C. power players, put its name on sporting arenas, and had a deep bench of celebrity spokespeople on hand to burnish its reputation.

Admiration, not adulation

Cryptocurrency startups, when the industry was hot, had little problems attracting investors, who poured billions of dollars into the market during the bull run of the past few years. Andreessen Horowitz, for example, successfully closed four crypto funds in recent years, alongside numerous others launched by its competitors.

What’s interesting is that even now, many VCs and investors still admire the underlying technology of blockchain and speak highly of its disruptive potential to reliably transfer assets, at scale, between parties with no need for an intermediary, as well as it ability to record transactions on an immutable ledger that simultaneously serves as a public database.

Tellingly, a big part of FTX’s problems lay in how the exchange strayed from the Web3 technology underpinning it. Rather than being displayed publicly “on-chain” and properly decentralized, the company’s financials were instead rarely looked at in a type of obfuscated “black box” that was off-limits to all but a handful of top executives.

While nothing has actually changed regarding the core technical architecture and fundamentals underpinning both crypto and Web3 applications, the context and trust in its supposed generational advancements has had the rug pulled out from under it, at least for the time being.

For now, as humbled investors busily downplay the scale of their financial involvement in FTX and point to other successful investments they’ve made, questions linger as to the long-term effect this ordeal will have on future risk appetite as spurned FTX customers, both individual and institutional, face the reality that they may never see their money again.