Blockchain plays by its own rules.
A decentralized environment where we’re dealing with services not guaranteed by a single provider, but a peer-2-peer network, blockchain is governed more by the laws of supply and demand than any of the top-down decision-making we’ve come to expect in centralized solutions. Whether it’s the transaction fees, token prices, or the trustworthiness of a network, the market decides on all of those factors, introducing previously unseen uncertainties or unexpected surprises.
As a result, similarly to how developing applications on the blockchain requires new design patterns, fundraising in a blockchain startup and the underlying incentive layer require new thought processes.
For example, if at any point a project receives funding in the form of cryptocurrency, or receives needed liquidity to bootstrap their multi-sided applications, it’s going to need a risk management plan. In case the value of the cryptocurrency fluctuates, a startup needs a contingency on how it will manage oftentimes rapid movements. Additionally, storing crypto is fundamentally different from fiat funds. Keeping it on exchanges or in a hot wallet (a wallet connected to the internet) means facing the risk of being hacked. Managing a startup’s cold wallet like Ledger or even paper forms (disconnected from the internet), on the other hand, brings a whole range of infrastructural challenges a team needs to deal with or turn to custody services like Coinbase Custody.
What are the ways of funding an idea to grow it into a product in this new environment?
When it comes to funding, all of the standard concepts are present: crowdfunding, angel investments, venture capital funding, incubators and accelerators, etc., are all valid methods startup founders make use of. Some of them have developed in specific ways to adapt to the space, while others remain mostly unchanged. The range of approaches to be taken into consideration is broadened by blockchain-specific funding methods like DAO’s (Decentralized Autonomous Organizations). The following guide seeks to provide you with useful tips on how to interact with each of those methods.
The blockchain industry growth correlates strongly with venture capital and hedge fund investments. According to Crypto Fund Research, 804 blockchain investment funds operate today, and the amount of assets under their management has grown from $190 million in 2016 to over $21 billion in 2020. The opportunities of having a startup funded by an investment fund are consequently vastly broader than 4 years ago.
What to look out for?
- Identify potential investors. An investment fund’s existing portfolio will tell you a lot about whether it might be interested in your startup. Depending on the development stage your project finds itself in, you may need to find a fund with a record in the seed stage or round A through C funding. “Does the investment fund have any interest in blockchain technology?” is another question worth answering. And to go even deeper, does your project’s background fit a relevant theme? For example, an investment fund with a heavy focus on exchanges might not be interested in your developer tooling startup.
- Reach out. After identifying the investment fund, it’s time to reach out. Best case scenario: you know someone who can introduce you to a point of contact at the fund. To sift through offers, investment funds rely heavily on references in identifying serious opportunities.
- Climb the ladder. The corporate structure of investment funds oftentimes means startup founders need to patiently scale the ladder of contacts, starting with an analyst and leading up to a conversation with a partner. Keeping your pitch on-point in each of those interactions, regardless of the level, will give you the confidence you need to successfully present when it really matters.
- Educate yourself on term sheets. It’s the single most important document of any investment discussion as it details the foundations of a deal: from investment amount, through company valuation, to how the ownership of your startup will be structured.
Angel investors have become increasingly prominent in the startup world in the past decade. Usually investing during the seed stage (the earliest official funding round), these individuals operate using their private funds and are typically interested in high-risk, high-reward opportunities. Similar to investment funds, blockchain angel investors’ activity has grown rapidly in the past years, more than doubling the deal count in years 2015–2019, according to a report by CB Insights.
What to look out for?
- Find angel investors and reach out. Either through the use of online resources, e.g., AngelList or networking, try identifying and reaching out (preferably through an introduction) to angels whose portfolio would benefit from a blockchain startup.
- Identify their needs and articulate yours. The 1-on-1 relationship you’ll have with an angel investor allows you to make sure your expectations align early on. Be prepared to honestly answer questions on what returns the investor may anticipate and in what timeline. Don’t be afraid to ask what kind of amount they’d be willing to invest or how they’d view their involvement post-investment.
- Be flexible. Remember that dealing with individuals will always be different than with a venture fund. The whole process from introduction to investment will vary in each of your interactions, and you need to adapt accordingly.
Blockchain incubators and accelerators
Whether your startup is just an idea or a minimum viable product, incubators and accelerators are worth considering as they’re never confined to exclusively raising capital. In fact, direct funding coming from an accelerator/incubator often pales in comparison to other benefits. For their participants, such programs often offer fundamental mentoring which is especially useful when dealing with as new and unusual an industry as blockchain technology. In addition, the networking possibilities open new ways of growing a startup even after leaving the incubator, not to mention the typical introductions to investors that such programs offer.
What to look out for?
- Find and research programs. The world of blockchain incubators and accelerators is constantly changing with new opportunities coming up regularly. Websites such as incubator list’ can help identify active programs, but it’s a startup’s responsibility to see if their project would be a good fit. For example, incubators may be better-suited for startups with a great idea in need of structuring, while accelerators may require the project to be more structured timeline-wise, able to push a product to market at the end.
- Apply prepared. All respected programs require going through an application process. In addition to mastering your pitch and being ready to answer difficult questions, make sure to research the particular program and the driving philosophy behind it. Similarly, as with previous methods, the list of past graduates will tell you a lot about what kind of startups they’re looking for.
- Once in, get down to business. Accelerators and incubators are great tools for driven founders: networking, creating relations with advisors, learning valuable skills, and gathering input on your post-program strategy are all to be taken advantage of.
As was previously mentioned, blockchain projects can use funding tools widely available elsewhere but can often add unique twists to the equation: take the recent ChainMonsters Kickstarter campaign. This particular Flow-supported project created an incentivization mechanism using a distinct aspect of blockchain technology: non-fungible tokens. By giving out unique digital assets to its backers, ChainMonsters managed to generate scarcity and greatly encourage funding.
What to look out for?
- Find the right model. While reward-based crowdfunding is by far the most prominent, with platforms like Kickstarter dominating the market, several different models exist, e.g., equity-based and debt-based crowdfunding. This guide from the European Commission goes in-depth over each type, its characteristics, and suitability.
- Establish a community. On a fundamental level, crowdfunding is all about the crowd and your ability to convince it of your vision. In the world of decentralized blockchains, communities are what drives engagement and excitement throughout all stages of your project, but nowhere is it as tangible as when crowdfunding. Here, traditional PR approaches should be replaced with organic marketing and direct communication with your community, e.g., via Discord or Telegram.
- Specify the product you will deliver. Because your investors aren’t a single entity, a whole range of expectations will be set on your project unless you start out by strictly specifying the product you promise to deliver. By being open with your community, you not only avoid (potentially catastrophic) misunderstandings but also build trust with your backers.
Decentralized Autonomous Organization (DAO)
Similar to STOs, DAO-based startup funding is still an opportunity waiting to be popularised. The idea here is as follows: imagine a decentralized investment fund in which investors are smart contract participants whose voting rights, e.g., deciding which project to fund, directly correspond to the amount they have invested. The idea gained traction in 2016 with the creation of The DAO, but its subsequent hacking and dissolvement have damaged the prospects of a functioning, investment-focused DAO. However, the concept didn’t die, and with the recent launch of The LAO the world of for-profit DAO’s may still have much to offer.
What to look out for?
- Do your due diligence. Before applying for DAO funding, make sure you understand the decentralized nature of any decision-making processes within the organization and the legal implications a DAO investment would mean for your startup. It’s worth noting that DAO’s vary significantly on the decentralization spectrum. In the past years, a number of supposed investment DAO’s emerged, mainly resembling centralized funds with a limited community aspect.
- Get involved with the community. Because all participants of the DAO are your potential investors, becoming an active part of the community before applying will help your prospects of getting funded. Organic excitement around a startup is your best friend when dealing with decentralized funding.
All of the methods mentioned above serve different needs, pose various challenges, and can be considered when looking for funding. In the end, finding opportunities has always been a creative endeavor in the technology sector, but it’s even more so with blockchain where unique funding approaches add to the uniqueness of the field itself.
Guest Blog Post by Mateusz Rzeszowski