Crypto Venture Investing Complete Guide: How to Become a Web3 VC?

If you’ve been investing in cryptocurrencies for more than a year, you’ve likely explored various ways, from simply purchasing coins on exchanges to engaging in complex DeFi strategies. However, VC-style investing in crypto startups remains a largely inaccessible and often unclear avenue, typically open only to those with personal connections. Even a simple Google search fails to provide a straightforward answer to the question, “How can I invest in a crypto startup, and is it even worth it?” This article aims to fill that gap and provide the clarity you’re seeking.

Key Findings:

• Venture investing in crypto offers better entry points: By investing in crypto startups, you position yourself at the top of the financial hierarchy, moving beyond the role of exit liquidity that most retail investors are confined to.
• The current crypto VC landscape is still far from its prime: In the first seven months of 2024, crypto startups raised over $6.45 billion, marking a decline from the 2021-2022 peak when similar amounts were being raised each month.
• Investment Exits are Unique in Web3: Unlike traditional venture capital, in the crypto space, exits typically occur after the token launch, which can happen at any time. This accelerates the investment lifecycle but often adds complexity to the investor’s journey.
• Equity share in crypto Is more important than tokens: Crypto tokens offer startup teams a fast and cheap way to generate profit. Many teams are eager to trade tokens for investment capital, paying little attention to their prices because they hold little value to them. Therefore, successful crypto investing involves securing both equity shares and tokens.

Why You May Need Crypto Venture Investing?

In crypto, putting your money into early-stage companies is a chance to gain massive profits and potentially back the next generation of industry leaders. Here are several more specific reasons why you might consider diving into this space:

• You want to avoid exit liquidity traps. If you’re frustrated with serving as the source of exit liquidity for larger players who often dominate public markets, venture investing offers a more level playing field. With venture investing, you have the opportunity to be part of the growth story from the beginning, rather than being at the mercy of market giants.
• You are already a venture investor and want to shift to the more crypto-oriented portfolio. As an experienced venture investor, you might be looking to increase your exposure to the crypto sector. Crypto startups operate in a rapidly evolving and innovative environment where the potential for exponential growth is much higher compared to traditional startups.
• You seek startup-funder synergy. If you’re a startup founder yourself, investing in other crypto ventures can provide valuable insights and expertise. So, you can not only leverage your investment portfolio, but also gain strategic partners and collaborators for your own ventures.
• You want a more relaxed investment strategy. After succeeding in the high-paced world of crypto trading, you might be looking for a more hands-off approach. Venture investing allows you to take a longer-term view, focusing on a project’s growth potential rather than the daily volatility of the market.
• You just want higher risk for greater reward. Whether you are a real estate or stock market investor accustomed to more stable returns, you may be tired of steady, but slow gains. Well, then, VC-level investing in crypto is your call.

State of Crypto Venture Capital in 2024

Before delving into the mechanics of crypto venture capital and entry strategies, it’s crucial to start with a brief overview of the current landscape in crypto VC.

Crypto Fundraising Statistics

In the past seven months of 2024 (January through July), crypto startups have raised more than $6.45 billion. According to the data, there seems to be a delayed correlation of funding rounds count with the Bitcoin price action, which is the main indicator in the crypto world. On March 14, 2024, the Bitcoin price reached new all-time highs at $73,738, and amidst this, raising rounds obviously became easier for funders.

In terms of funds raised, the market is far from peaking in the 2021–2022 period, when $4–7 billion was being raised per month. So far, the record-breaking month of 2024 is July, with only $1.11 billion raised. Notably, that was a pretty boring and lackluster month for crypto, with altcoin prices constantly declining and Bitcoin single-handedly sucking out all the liquidity from the rest of the market.

Of the 692 venture rounds with disclosed amounts from Jan. 1 through July 31, mid-sized rounds led the way in both the number and cumulative percentage of funds raised. The most common funding rounds ranged between $3 million and $10 million, closely followed by those between $1 million and $3 million. Meanwhile, the total number of venture rounds for the seven months of 2024 has already exceeded 1000, of which more than 300 have been undisclosed.

Seed-stage venture rounds remain the most popular among crypto investors, accounting for more than a quarter of the total amount. Strategic rounds, characterized by a leading strategic investor increasing their stake at various stages of a startup’s development, comprised 16.56% of the total. The size of these rounds is less often disclosed.

OKX Ventures and Animoca Brands emerged as the most active Web3 VC funds by number of rounds, each participating in 65 rounds from January through July. Nearly all active VC funds typically lead the rounds they participate in, except for Polychain Capital.

Top 10 Crypto VC Rounds in H1 2024

1. Monad – $225 million in Series A. Monad is an EVM-compatible blockchain that enhances the Ethereum ecosystem by enabling parallel execution of transactions, thereby increasing processing efficiency without altering the functionality of Ethereum-based applications.
2. Farcaster – $150 million in Series A. Farcaster is a sufficiently decentralized protocol for building social apps, ensuring that users can always communicate and developers have permissionless access to public data. The protocol is built on five core components: accounts, usernames, signers, messages, and storage.
3. Berachain – $100 million in Series B. Originated as a meme, Berachain is an EVM-compatible blockchain secured by the innovative Proof-of-Liquidity Consensus Protocol. It features a tri-token system, including the native gas token “BERA,” a stablecoin “HONEY,” and the non-transferrable governance token “BGT,”.
4. EigenLayer – $100 million in Series B. EigenLayer is a restaking protocol on Ethereum that allows ETH stakers to re-utilize their stakes. This approach aggregates ETH security across various decentralized applications, enabling stakers to earn additional fees while supporting innovation in consensus protocols, data availability layers, and more.
5. Sentient – $85 million in Seed. Sentient is an AI research organization building an open AGI economy for AI developers and creators, enabling them to monetize and collaborate on open-source AI models through blockchain-enforced economic alignment.
6. Auradine – $80 million in Series B. Auradine is a web infrastructure company specializing in scalable, sustainable, and secure solutions for blockchain, privacy, and AI. Auradine develops advanced software, hardware, and cloud solutions.
7. Zama – $73 million in Series A. Zama provides homomorphic encryption tools that enable developers to process data securely without decryption, allowing for the creation of private smart contracts on public blockchains. This technology ensures that transaction data and contract states remain accessible only to authorized users, maintaining privacy and security.
8. Babylon – $70 million in Series B and C. Babylon is a Bitcoin staking chain that aims to scale Bitcoin by leveraging Bitcoin’s asset value, reliable timestamping, and censorship-resistant blockspace.
9. Partior – $60 million in Series B. Partior is a blockchain-based technology provider focused on streamlining cross-border payments and value exchange for financial institutions.
10. Figure Markets – $60 million in Series A. Figure Markets integrates traditional finance liquidity with decentralized asset control, enabling investors to access a wide range of blockchain-native assets, including cryptocurrencies, stocks, and alternative investments, all within a unified platform.

Profitability of Web3 VC Funds

Accurately calculating a venture fund or investor’s true profitability in the crypto space is challenging without comprehensive reporting from their side. In the absence of complete data, we will estimate profitability using retail ROI.

At the moment, the three most profitable Web3 funds are Union Square Ventures with a portfolio of 40 deals and an ROI of 1266x, Paradigm with 93 deals and an ROI of 1079x, and 1confirmation with 39 deals and an ROI of 1074x. Interestingly, despite their high activity, Animoca Brands and OKX Ventures do not make it into the top ten most profitable venture funds.

A closer look at recent performance reveals that 213 new projects were launched in the second quarter of 2024. Of these, only 23 startups delivered returns of 900% or more, indicating an 11% chance of selecting a highly profitable project. The average ROI for newly launched tokens during this period was 420%. The best performers in terms of ROI included Donato Creator Token, PrivateAI, Lifeform, Carlo, FreeBnk, Nuklai, and Lista.

This is a relatively low profitability level for the cryptocurrency sector, and there are several factors contributing to this, which warrant a deeper exploration in a separate article. Briefly, the key reasons include tough macroeconomic conditions caused by the Fed’s combating inflation, along with a significant delution of liquidity in the crypto market. The liquidity delution is driven by the increasing ease of launching new tokens, resulting in a rapid inflation of their numbers.

Future Crypto Trends

The rapid inflation of token supplies and the growing dissatisfaction among retail investors with venture-backed tokens have paved the way for Bitcoin’s dominance and the rise of memecoins. Although the memecoin craze had largely faded by August 2024, the underlying issues that fueled it persist. Whether these challenges can be resolved—and if the market can return to the levels of profitability seen during the post-COVID era of cheap money—remains to be seen. Only time will tell.

However, you shouldn’t hesitate to invest in this sector; it represents the future, much like the Internet once did. Web2 giants like Google, Microsoft, and Meta have also experienced non-linear growth; it took them years to find their paths to success, shape the Internet as we know it today, and generate substantial returns for their investors. The recent decline in venture capital profitability in the cryptocurrency sector is simply a natural part of the market’s maturation and increasing complexity, not a reason to abandon it. Take a look at the adoption curves of Web2 and Web3 for perspective.

As for the cryptocurrency trends that will shape the industry in the coming years, perhaps here are the main ones:

• Bitcoin scaling solutions. The quest to unlock the multi-trillion dollar liquidity trapped in Bitcoin has been a long-standing ambition for funders and investors. For years, creating an ecosystem on Bitcoin akin to Ethereum seemed out of reach, but recent developments have shifted the landscape dramatically. The next few years are poised to be the golden age of Layer 2 solutions on Bitcoin, with the potential for new leaders to emerge and make most of altcoin chains useless.
• Tokenization of everything on Ethereum. After the approval of the Ethereum ETF, the tokenization of traditional financial instruments is just a matter of time. Larry Fink, CEO of BlackRock and a leading advocate of tokenization, is set to usher in a new era where stocks and real estate will be transformed into tokenized assets, making them more accessible liquid.
• Crypto gaming. The first generation of crypto games with Play-to-Earn mechanics fell short of expectations, but this doesn’t spell the end for crypto gaming. A new wave of games featuring fully on-chain game logic, known as autonomous worlds, is now emerging. These innovative games are poised to find their market fit and redefine the future of the gaming industry.
• AI-driven blockchains and protocols. The AI hype has fully infiltrated the crypto world. The big questions now are: how many years until we see fully decentralized artificial intelligence, and how much could an early-stage investor stand to gain?

Stages of Venture Capital Funding in Crypto

In traditional venture capital, there are typically seven stages, ranging from the initial concept to the final exit, whether through an initial public offering (IPO) or acquisition. However, in Web3 VC, things are slightly different due to the advent of tokenization. That means most investor exits now happen following a token generation event (TGE), typically in the form of an ICO, IDO, airdrop or other initial token offering.

Sometimes, the product, if it’s a Layer 1 blockchain, simply can’t function without token. But more often, the token itself is the only product, and launching it can be as simple as pressing a couple of buttons. Thus, traditional stages of startup development are less relevant for many cryptocurrency projects, as teams can speedrun the process, and exits can occur right after the seed stage or sometimes even before it.

However, from time to time we are dealing with a startup that has a product that goes beyond just a token. In that case, it’s essential to be aware of the stages of a startup’s life span because venture capital funding and its efficiency are closely aligned with the life cycle of a startup. We define four main stages of the crypto startup life span, with an additional exit stage that can occur earlier or later.

1. Pre-Seed Stage

The pre-seed stage occurs before a startup can access venture capital. At this stage, the primary focus is to validate the startup’s idea by building a prototype or minimum viable product (MVP). Funding at this stage is typically absent since the founder can write the initial code.

2. Seed Stage

During the seed stage, the startup has moved beyond the initial concept and is beginning to demonstrate its potential as a viable business. The startup must show early signs of product-market fit and the capacity to grow and scale. At this stage, it is important to secure funds for specific activities, such as market research, product development, and assembling a team. The seed stage continues to be the most sought-after entry point for many venture capitalists, as it has historically produced numerous success stories, often yielding a hundredfold increase in investments.

3. Series A Stage

The Series A stage often marks the first round of significant venture capital financing. At this point, the startup, if it has survived, has typically completed its business plan and developed a product or service that has achieved initial market traction. Now, the primary objective is to refine the product, expand the customer base, and demonstrate a consistent revenue stream. At this stage, startups tend to show investors that they are solid and have a clear plan for long-term profitability. So, fundraising goes easier as the startup has demonstrated its viability, and the potential for investment profitability diminishes.

4. Series B and Beyond

Reaching the Series B stage essentially means that a crypto startup has survived and captured some market share. In the fast-paced and highly competitive crypto space, new competitors can emerge and disrupt entire niches in just a few weeks. At this stage, the focus shifts from rapid expansion, typical for traditional venture, to just maintaining relevance and improving user experience. Typically, by this point, most projects have either launched a token or are on the verge of doing so. With valuations likely to be overpriced at this stage, here comes a critical strategic decision point: it may be wiser to explore exit opportunities rather than pursuing further investments.

Exit Stage

Generally, there are two types of exits, depending on what exactly you’ve invested in—either in a cryptocurrency protocol or in the company developing that protocol, which is registered in the real world. In the first case, you receive tokens in exchange for your investment, while in the second, you gain equity in the company. Each approach has its own advantages and pitfalls.

Most commonly, you invest in a protocol in exchange for tokens. In this scenario, you need to wait for a token generation event (TGE) and the start of the vesting period, which typically begins no sooner than a year after the TGE. However, over the past year, multiple OTC (over-the-counter) markets have emerged that allow you to sell tokens before they are unlocked. As mentioned earlier, a TGE can happen at any time, depending on when the team decides to tokenize their protocol. However, it’s important to be cautious about TGEs that occur too early, as this may indicate that the team is more interested in quick financial gains than in the long-term success of the product.

Suppose you’ve invested in the company itself. In that case, the exit strategy theoretically mirrors that of traditional venture capital, where you would wait for an IPO or acquisition, or you could also sell your stake on the OTC market. However, no cryptocurrency company has yet gone public, except for miners and companies like MicroStrategy, which pivoted into the crypto industry. Some companies also offer investors token allocations on top of equity shares. For example, ConsenSys, the developer of MetaMask and the Linea chain (a Layer-2 for Ethereum), follows this practice.

How Does Venture Capital Work in Crypto?

Venture investment funds are essential in driving business growth, and the Web3 industry is no exception. However, crypto still remains akin to the “Wild West,” where the inherently free and hardly regulated nature of cryptocurrencies broadens opportunities for unethical behavior. Some funds deliberately invest in and promote baseless dummies and arrange numerous pump-and-dump schemes. In these schemes, funds owning a significant portion of a token’s issuance artificially inflate its value and pay out influencers to entice retail buyers. At the peak of the hype, these funds sell off their holdings at inflated prices and abandon the project, leaving it to slow rug pull. At the end, retail investors and even many venture capitalists find themselves trapped indefinitely in these investments, helplessly watching the token’s value refresh its lows.

In this challenging environment, your role as a VC investor is crucial because you are the main source of capital for every other party in the space. Without your money, the industry will die, and you should recognize that and act accordingly. Here are the steps to guide you.

1. Find the right VC fund Not all VC funds are created equal—some are unworthy and tied up in shady market manipulations, while others tend to genuinely make the crypto space a better place. Research the track record, investment strategies, and ethical standards of potential funds, and ensure that everything aligns with your investment philosophy and risk tolerance.
2. Research the cryptocurrency market for trends and needs A thorough understanding of the current and future trends within the cryptocurrency market will highlight its direction and point to the missing pieces needed to make significant progress. This understanding involves not only tracking market dynamics, such as price movements and trading volumes, but also staying aware of technological developments, regulatory changes, and emerging sectors.
3. Choose startups based on market problem and solution fit Follow the principle of market problem-startup solution. Evaluate whether the startup’s product or service directly addresses an actual market need or it’s just a hype-driven copycat. A strong product-market fit is a key indicator of a startup’s potential for success and a critical factor in your selection process.
4. Get to know startup teams If possible, try to establish a relationship with the startup teams, even if it’s just through chats, emails, and streams. A team’s ability to navigate challenges, pivot when necessary, and drive the project forward is often more important than the initial idea itself. If you recognize this ability in the team, you’ll strengthen your investment thesis and may even be able to impact the direction of future development.
5. Negotiate for equity in addition to tokens While tokens are often the primary form of exchange-for-investment, negotiating for equity can provide more lucrative return. Equity gives you a stake in the company itself, which aligns your interests with those of the company’s founders and other investors.
6. Develop a clear exit strategy Finally, it’s critical to have a clear exit strategy for each investment. The strategy is simple: get rid of tokens as fast as possible but keep equity. The data shows that in crypto, the earlier you sell tokens after TGE, the more successful your investment is. This means that while the future of cryptocurrencies is bright, it’s better to be rich in money, not tokens.

Crypto Venture Investing with Banana Capital

It’s time to tell you about who we are and what makes our offering unique. Banana Capital is a full-cycle investment company: hedge fund, venture capital arm, and incubator, specializing in Web3 projects. Banana Capital offers a comprehensive approach to venture investing in the Web3 space:

We support startups beyond investment

At Banana Capital, we believe that successful venture investing goes beyond merely providing financial resources. We are deeply involved in the incubation process, offering guidance and support from the earliest stages of a startup’s development through to its market entry and beyond. This hands-on approach ensures that our portfolio companies are not only well-funded but also well-prepared to thrive in the rapidly evolving Web3 landscape, securing our clients investments.

We focus on infrastructure projects

We are primarily focused on infrastructure projects. We understand that blockchain infrastructure plays a key role in the development and scalability of the entire industry. By investing in infrastructure projects, we are laying the foundation for future innovations. This focus not only aligns with our long-term investment philosophy but also often yields better returns.

We leverage extensive experience

Banana Capital’s origins as part of a family office where we invested our own capital. Over the years, we have refined our strategies to achieve consistent and high returns, regardless of market conditions. Our extensive experience in the Web3 space, combined with our disciplined approach to risk management and asset allocation, has allowed us to outperform key benchmarks, including the U.S. Venture Capital Index and CCI30. Our history of using our own capital underscores our confidence in our strategies and our commitment to delivering value to our investors. Please review our Web3 Market Report for Q2 2024.

We offer multiple investment options

Banana Capital’s strategy focuses on participating in pre-seed, seed, private, and KOL rounds, targeting both long-term and short-term investments. We seek to combine equity and token investments and capture value from multiple aspects of a project’s success. We anticipate returns ranging from 60% to 400% APY.

If you’re eager to replicate this success, we’re excited to share the exact steps to make it happen – Banana Capital Support.

Tips on Becoming a Successful Venture Investor in Crypto

A successful venture investor is a mix of knowledge, talent, and experience. All of this won’t come at once, and you will make a lot of mistakes along the way. But don’t be afraid to make mistakes, because mistakes are our best teachers. For now, here are some basic tips that guide our team.

• Understand how the venture capital industry works in general and Web3 VC in particular. This includes understanding of VC investment stages and their specifics; the structure of startups and VC funds; and the risks and rewards associated with venture investing. This knowledge will help you make informed decisions about which companies to invest in and when to exit investments.
• Build up your network of industry contacts. Building a network of industry contacts is crucial for any venture investor, as it allows you to stay on top of new investment opportunities, market trends, and industry news. Build private relationships with founders, VCs, and other investors, or at least follow up with them on X (former Twitter), and, eventually, that will give you valuable insights for more informed investment decisions.
• Develop a strong investment thesis. An investment thesis is a set of criteria you can use to evaluate potential investment opportunities; it is your list of dos and don’ts. An investment thesis can be universal and applicable to all investment opportunities or specific.
• Constantly reevaluate your investment theses. Things change very quickly, especially in crypto. Yesterday you invested in a bullish startup on the crest of a hype wave, and today it’s already dead because key team members have left or the protocol was hacked and drained.
• Always seek mentorship and guidance. You should always learn from more experienced venture capitalists; it’s the only way to gain concentrated experience of another person’s trial and error, rather than going through everything yourself and spending more time.

Conclusion

Crypto venture investing presents both substantial opportunities and unique challenges. As this guide has shown, the crypto space is rapidly evolving, with a growing number of startups seeking to address critical market needs through innovative solutions. However, success in this dynamic environment requires more than just capital—an individual retail investor won’t be allowed to invest in a project at an early stage, no matter how much they offer. This is where a venture fund comes in, with its reputation, connections, and ability to negotiate a venture deal, opening the door to this market for retail investors.

By partnering with the right venture capital fund, like Banana Capital, and following a disciplined investment process, you can position yourself to capitalize on the transformative potential of Web3. Banana Capital’s comprehensive approach, extensive experience, focus on infrastructure projects, and strong profitability metrics make it a strong choice for those looking to succeed in this space. Whether you’re a seasoned venture investor shifting to crypto or a newcomer eager to explore, this guide offers insights and strategies to help you make informed decisions and increase your chances of success in crypto venture investing.