ETHCC thinking: It's all the fault of the rules of the game, don't blame the participants

Compiled by Deep Wave TechFlow

During the @EthCC conference, I spent a lot of time one-on-one with serious builders, venture capital firms (VCs), and market makers. Here are some of my reflections on the current state of the industry:

1. Blame the rules of the game, not the players

"We love consumer applications, but 90% of the projects we closed this year were infrastructure projects." A lot of construction Investors and venture capital firms agree that we have too many people building infrastructure and a lack of real consumer applications with users. Most of the venture capital firms I talk to express interest in consumer decentralized applications (dApps). However, looking at recent financing announcements, it is easy to see that the market is still dominated by infrastructure projects.

This is a vicious cycle that is hard to blame on any single stakeholder:

• Projects and VCs want to list on large centralized exchanges (CEX) with good liquidity
• Centralized exchanges want to market Project listings with activity (high fully diluted valuation, FDV) and top backers offering good incentives
• Infrastructure projects have valuation premiums due to the resources required to build, so more capital is invested in these projects, forming A cycle.

2. VC interest in early-stage investments at high fully diluted valuations (FDV) has declined

Project valuations have increased significantly since the fourth quarter of last year. Many private financings or Series A rounds have project valuations in excess of $1 billion FDV, especially those related to AI.

On the other hand, most recent large-scale startups have underwhelmed (e.g. $BLAST is under $2 billion; $ZK and $W are at $3 billion; $ZRO is at $4 billion). The overall altcoin market is weak, with many VC-backed projects trading at lower FDV than their last private funding rounds.

In the current market environment, the chance of a VC getting a 50-100x return is almost impossible. Not to mention, VC is also subject to a lock-in period (~1 year lock-in + 2-3 years vesting period). These projects may need to survive the next bear market and compete with more new projects that are able to attract users quickly due to the short attention span of the industry.

Therefore, more VCs are looking for liquidity strategies (if their investment strategy allows), or over-the-counter (OTC) transactions at significant discounts relative to the last round valuation (or current FDV if the project is in the process of trading) ). For VCs with more resources, they are incubating projects founded by former employees to ensure they are the earliest investors with higher return potential.

Many VC analysts and research partners are turning to join the emerging Level 1 or Level 2 blockchain (L1/L2) ecosystem, or start their own projects. Direct involvement in project development appears to be a higher expected value (EV) option than investing. One advantage is that they can use their experience and connections to raise capital for the projects they are involved in because they understand the concerns and needs of VCs.

Additionally, overall underperformance of altcoins has resulted in lower returns on allocated capital (dpi) for limited partner (LP) funds. It's difficult to raise money for a new fund if it can't deliver a strong track record. Some of these funds have spent most of their capital in the last year, and even if attractive investment opportunities now arise, they have no funds left to use.

3. Old wine in new bottles

Those concepts that did not become as popular as expected were repackaged into new forms. For example, Intents were once a hot topic, but were quickly replaced by concepts such as Decentralized Autonomous Organizations (DAs) and restaking.

Many projects are now rebranding themselves as "chain abstractions" or even "AI", especially those intent-driven projects that embed some large language model (LLM) or algorithmic elements.

In addition, most decentralized Internet of Things (DePin) projects have added "AI" elements to their brand strategies to attract the attention of venture capital companies.

This phenomenon is similar to last cycle’s security tokenization projects turning into real world assets (RWA) in this cycle.

I think there is nothing wrong with rebranding, finding a narrative that the market recognizes is not easy. However, the market is still waiting for the next brand new narrative rather than a repackaging of old concepts.

4. Not all narratives are “investable”

There is a difference between popular narratives and popular verticals.

Account Abstraction is a popular narrative that provides a better user experience. But this is not a vertical field, but a function that will be embedded in different application scenarios, such as from wallets to games, from decentralized finance (DeFi) to social finance (SocialFi). You still need a concrete product to sell, that is, there won't be a project that just says "we do account abstraction" but "we created a wallet that supports account abstraction" or "a game with account abstraction functionality" "etc.

Just chasing the hottest narrative without analyzing the vertical (product) it’s in is dangerous for VCs because you might be investing in the hottest narrative in the wrong vertical.

5. Market making is not a peace of mind

Market making can indeed be a profitable business, but as some US players exit the market due to regulatory issues and new players continue to pour in, the field has become more competitive.

Some market makers are willing to engage in price wars in order to win transactions. In the option mode (the mode preferred by most market makers), the market maker borrows Token from the project team for selling orders, and needs to invest stable currency for buying orders. This either requires a lot of capital (if using own funds) or is costly (if borrowing from elsewhere and paying interest). Therefore, the option model is not "costless" for market makers.

To win a deal, a market maker needs to have the following: i) good relationships and reputation, ii) an attractive proposal, iii) providing value-added services to clients.

The project team is also becoming more and more familiar with different market makers, so the information asymmetry advantage of market makers in negotiations is disappearing, and market competition is becoming increasingly fierce.

6. Market Catalysts (ETFs, Elections, Interest Rates)

Most people are waiting for the ETH ETF to be listed, hoping that its price action will rise like the BTC ETF did after the listing.

Unlike the BTC ETF, the hope is that the ETH ETF will be a powerful catalyst for Ethereum-related tokens.

There are also expectations that after ETH, more altcoin ETFs will be approved (could be the SOL ETF next?).

If more altcoin ETFs are approved, the ultimate goal of the project will be to get ETF approval rather than listing on a top centralized exchange (CEX). This will completely change the market’s perception of older coins.

Another market catalyst is the US election, with hopes of electing a crypto-friendly regime and favorable policymakers.

An interest rate cut is expected this year, with more likely to come in 2025. This will bring more liquidity to the cryptocurrency market.

Although current market conditions are somewhat lackluster, most people are optimistic about the outlook for the next 2-3 quarters. The mood is to stay calm, not to be too impatient, but to be confident and expectant.

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