Crypto Venture Capital's Rejection of Venture Capital and ‘The Box’

The mechanics behind crypto yield farming are eerily simple, but that simplicity should act as a warning label rather than an advertisement.

AccessTimeIconMay 1, 2022 at 2:50 p.m. UTCUpdated Jul 12, 2022 at 5:23 p.m. UTCLayer 2
AccessTimeIconMay 1, 2022 at 2:50 p.m. UTCUpdated Jul 12, 2022 at 5:23 p.m. UTCLayer 2

George Kaloudis is a research analyst for CoinDesk Research.

I really like Bloomberg’s "Odd Lots” podcast. The hosts are quite good (Tracy and Joe) and they consistently bring on impressive guests (readers might remember the Reserve Asset 3.0 piece inspired by Zoltan Pozsar on an “Odd Lots” podcast).

Well, on this Monday's episode, “Odd Lots” had Sam Bankman-Fried (SBF). He is probably best known for his exceptional hair, but he also founded crypto exchange FTX. He ranks among crypto’s richest and, given he studied physics at MIT, probably one of its classically brightest (whatever that means). On the podcast, he compared crypto “yield farming” to a “box” that lets you take out more money than you put into it.

Magically.

That quote hit me like a ton of bricks, but then he tacked on a swipe at venture capital’s investment approach that irked me. His view on venture capital is shared by many, but that view has been muddied by the introduction of crypto. I’m not suggesting SBF is wrong necessarily. What I am suggesting is that crypto venture capital … is … just … not really … venture capital.

That (and maybe more …) below.

George Kaloudis

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I’m a bitcoiner. According to the internet purist’s set of rules, that means that I need to shun altcoins and “crypto” altogether. But honestly, that’s boring.

I’m not boring, so I pay attention to the hellspawn landscape of “crypto this, NFT that and blockchain everything” that Bitcoin inspired. Part of that means that I listen whenever SBF speaks. I want to zoom in on two specific things he talked about in the podcast mentioned in the introduction: 1) The Box and 2) venture capital.

'The Box'

On the podcast, Matt Levine (every newsletter writer’s hero) asked SBF to give “an intuitive understanding of yield farming.”

Sam responded with:

You start with a company that builds a box… they probably dress it up to look like a life-changing, you know, world-altering protocol that's gonna replace all the big banks in 38 days. Maybe for now ignore what it does and pretend it does literally nothing. It's just a box. You can then put a token in The Box and you take it out of The Box. Alright so, you put it into The Box and you get an IOU token for having put it in The Box and then you can redeem that IOU back out for the token.
Sam Bankman-Fried

Ok … a weirdly simple example using a somewhat cynical tone: The Box seems kind of meaningless, a technologically enabled piggy bank.

He went on:

In like five minutes with an internet connection, you could create such a box and such a token, and [decide] that it should be worth $180 based on the effort that you put in. In the world that we're in, if you do this, everyone's gonna be like, ‘Ooh, Box token. Maybe it's cool.’ Then it appears on Twitter, and it’ll have a $20 million market cap …
Sam Bankman-Fried

Then the yield farming kicks in, and The Box starts giving out tokens as interest payments to people who have put tokens in The Box.

Say the total amount of money in The Box is $100 million, and it pays out $16 million a year in X tokens – that's a 16% return. That's pretty good. So people put a little bit more in. And maybe that happens until there are $200 million dollars in The Box… And now all of a sudden everyone's like, wow, people put $200 million in The Box! This is a pretty cool box, right? Like, this is a valuable box as demonstrated by all the money that people have apparently decided should be in The Box. And who are we to say that they're wrong about that?
Sam Bankman-Fried

Uh … who turned the heat up in here? This is a scathing take on yield farming that you’d only expect from its harshest critics. That it came out of the mouth of one of crypto’s richest was surprising. SBF basically said that yield farming consisted of:

Step 1: Put money in The Box.

Step 2: Wait.

Step 3: ???

Step 4: Profit.

I have nothing more to add, because I think these quotes largely stand on their own. I wanted to write about these quotes to highlight that individuals should exercise caution when it comes to deciding on partaking in yield farming or not. Your yield might just be grounded in nothing except The Box. Which can be fine, as long as you understand that and are OK with it.

Crypto venture capital vs. venture capital

After talking about yield farming on the episode, SBF answered a question about how he thought the “institutional or quasi-sort of venture capital money” found the next big thing in crypto. SBF offered to pull it back further and answer how he thought venture capitalists found the next “anything they’re going to invest in.”

He said:

You get a bizarre process. Venture capitalists see what all their friends are chattering about. And their friends keep talking about this company or this token, and they start FOMOing [fear of missing out-ing] and then their LPs [investors in the venture capital fund] are like, yo, have you made us a lot of money off of this company or token yet? And, the answer is no, we haven't invested in it. But that's not a good answer given what question your LPs just asked. So instead you're like, oh boy, you're gonna be excited about what we have done and/or will do. And then you find a way to get into that token and/or company.
It's bizarre processes like that, ultimately, that are like shaping venture capitalists’ investments in both traditional equities and in cryptocurrencies.
Sam Bankman-Fried

Again. Cynical. But for all my personal cynicism, I don’t completely agree with SBF here. I think that even though he tried to opine on venture capital in general, he still offered up his crypto venture capital take. Because crypto venture capital and traditional venture capital are different.

Venture capital is a form of equity investing that targets startups and early-stage companies in emerging industries. Once a venture capital equity investment is made, so begins the five to 10 year process of business growth, development and execution. Only then do venture capitalists and their LPs make a return. Rinse and repeat. Venture capital funds have a long-term time horizon just as the private equity and private credit funds do.

Crypto venture capitalists, when they’re not investing in the equity of companies operating in the space (companies like Coinbase), are investing in tokens. And when they’re not getting in early on presales, they’re getting in later when their LPs ask if they’ve invested in certain projects (as SBF suggested).

This model is not really venture capital at all. If a token a venture capitalist buys after an LP asks then spikes in price, the venture capitalist can harvest returns by selling on the open market, maybe after years but sometimes after months.

This is one of the places where crypto token venture capital deviates from traditional venture capital. The lack of liquidity of traditional venture capital investment commitments is part of the reason investors expect “good” returns; they are taking a risk by tying their money up for at least five years, and investors feel they should be paid for that risk.

With token investments, crypto venture capitalists can get in and out of trades as easily as hedge funds do. That’s what I think SBF was describing, but that’s not venture capital.

And that’s just one of the differences. There is much more that can be written that deserves attention. For example, there probably is a level of 'FOMO' in traditional venture capital that is spurred on by the immense amount of capital that has been raised in recent years looking for investments. There’s also something to be said about the headline fundraising numbers advertised by token investing venture capitalists, but that’s for another time (and perhaps another author).

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George Kaloudis is a research analyst for CoinDesk Research.