Written by: Rob Hadick, Partner at Dragonfly

Translated by: Luffy, Foresight News

There has been a lot of discussion over the weekend regarding venture capital, especially VC in the crypto space, but I believe most of it has missed the core. Venture capital itself is a market, and venture capitalists are at the center of this market. The vast majority of discussions overlook the real decision-making logic of both parties involved in the transaction.

We have our own clients, who are the limited partners (LPs), and it is they who enable us to continue operating and pursue this business. The best venture capitalists often invest a substantial amount of their own money, making us clients as well. On the other side are the startups. I have a real responsibility to the founders of the projects I invest in; they are also aware of how much I value this, but all the startups I invest in are ultimately based on one core premise: Can I serve my clients well and satisfy them?

This doesn't just mean providing eye-catching absolute returns, as LPs do not evaluate this way. They care about many factors, with varying degrees of importance: risk-adjusted returns, reputation risk, regulatory risk, exit liquidity cycles, co-investors, access to core information networks, the ability to invest in assets and sectors suitable for discussion in social settings, and whether they can work with compatible people. We all know some large funds that consistently underperform their peers but are still pursued by capital. In a market with diverse choices, this is the reality.

So when you see the relevant data, it does not simply indicate that "institutions are no longer investing." It only indicates that LPs either want to reduce their allocation or are only willing to invest in fewer funds. The total amount of capital they are investing in this field is shrinking or they are only willing to allocate to higher-quality managers. In traditional venture capital, it is mainly the latter; while in the crypto space, there is both a decrease in capital and a reduction in the number of funds being targeted. This industry concentration is not a market failure; rather, it is the market functioning normally. There are many reasons behind this, but in the crypto space, the primary reason is the risk-adjusted returns and liquidity issues; additionally, part of the reason is that institutions are reluctant to associate with certain figures and events in the field.

Therefore, if venture capitalists want to continue to stand firm, they must ensure that their investment strategies align with the needs of the LPs, or be able to persuade them to accept a certain direction. You will constantly ask yourself: Am I investing in the right founders, in the right asset classes, in the right sectors? Is the risk exposure reasonable? Is the investment stage appropriate? The value of venture capital lies in adjusting these factors to satisfy the LPs. Of course, what may make LPs happy now might not be the same long-term, but this is also a decision that venture capital needs to weigh.

This means that in this cycle, you must focus on stablecoins, perpetual contracts, and prediction markets, even if you did not manage to pick winners early like some others. This does not mean that you cannot take large positions in high-risk, counter-consensus projects, but you must first prove that you are qualified to do so. A venture capital firm that makes a heavy reverse investment but fails will not be able to raise the next fund; while a venture capital firm that operates smoothly and returns funds continuously can. Reverse investment itself is a gradual scale; when we invested in the Polymarket expansion project with Founders Fund at the end of 2023 and early 2024, it was not the market consensus, and many even expressed confusion, thinking I was burning money on a project that achieves product-market fit only once every four years. But for venture capital, this doesn't count as extremely aggressive risk-taking.

The venture capital industry rewards stability and continuity, not the heroism of gambling everything on one bet. Only those who have proven themselves to act prudently are qualified to place heavy bets and make counter-consensus decisions.

Some believe that the hallmark of great investments is: you write the first check, and other funds follow suit, while this founder does not fit the model of most companies. This sounds very romantic, and if the story succeeds, it indeed is so. However, the reality is that if a founder does not fit any fund's investment paradigm, it is more likely that I am not smarter than others, but that I have overlooked certain key issues. This is not absolute; my team and I have indeed invested in founders overlooked by the market because we believe we have unique judgment, but the data shows that the success rate of betting on such projects is far lower than choosing more obvious founders.

On the other hand, there is also the viewpoint that attributes the current market conditions to a lack of original ideas from founders. This also misses the point. Founders' actions are driven by incentive mechanisms, and these incentives are complex and multifaceted: Do I like this direction? Can it attract venture capital support? Can it be turned into a big business? Am I proud of it? Ambitious founders often wish to work on projects with a broad scope and high potential returns, but this doesn’t mean the ideas must be entirely original. To summarize it as "plagiarism" is too simplistic; most great companies are not first in their fields but rather achieve optimization. Google was not the first search engine, Facebook was not the first social network, RedotPay will not be the last unicorn neobank, and Morpho will not be the last on-chain lending unicorn. I believe there will still be meaningful innovations in the prediction market field; even so, novelty is not the only important variable.

Ultimately, it all comes down to market laws. Venture capitalists will not receive returns for being counter-consensus; their returns come from making correct judgments, providing the products that LPs want, and considering every branch on the decision tree. This may sometimes be achieved through reverse thinking, but most of the time it is not so. Founders will not be rewarded for bold risks; their returns come from creating products that people want to use, can profit from, and generate value, and obtaining financing by convincing investors of their capability to do so.

Ideological grandstanding is mere empty talk. Ultimately, everything is determined by market forces.

Lastly, as always, I would like to add: Our doors are always open to all founders at the early stage, late stage, conventional paths, and counter-consensus directions.