The exit game between venture capital and hot money, starting from Friend.Tech

Original title: VC vs Liquid Fund Inside FriendTechs Exit The Chopping Block

Guests: Haseeb, Tarun, Jason, Tom

Original translation: zhouzhou, joyce, BlockBeats

Editors Note: This podcast explores in depth the impact of the sharp drop in the price of Friend.Tech tokens on project planning and user retention. It also discusses the ethical issues of crypto project exits, especially project termination after token issuance, and the different roles of venture capital and liquidity funds in the crypto market. In addition, the program analyzes the negative effects of airdrop mining and the impact of hedge funds on market liquidity and efficiency. The podcast also mentions the conflict between market speculation and long-term value creation, as well as the room for improvement in market efficiency.

The following core questions are raised and explored in this podcast:

Friend.Tech tokens plummeted.

Project Exit and Ethical Issues

The different roles of venture capital and liquidity funds.

The negative impact of airdrop mining.

Lack of market strategy and arbitrage behavior.

TL;DR:

Friend.Tech Token Plunge: The 96% drop in the price of the Friend.Tech token reveals the risks of issuing tokens without a sustainable product plan and user retention strategy.

Project exit and ethical issues: The issuance of tokens by early-stage projects has sparked discussions about whether project teams should have ethical obligations when they exit, especially when the project is accused of “running away” after it is terminated.

The role of venture capital in the crypto market: Low barriers to entry allow a large number of venture capital to enter the crypto market, pushing up project valuations, leading to over-promotion and under-delivery.

Challenges of early token issuance: Early token issuance often confuses market signals and harms the long-term potential and user retention of the project.

Venture Capital vs. Liquidity Funds: Explores whether venture capital is extracting value from the crypto market, or whether liquidity funds can improve market efficiency.

Hedge Funds and Market Efficiency: Whether hedge funds can improve market efficiency by increasing market liquidity and price discovery remains a hot topic.

Airdrop mining and wash trading: Airdrop mining affects project indicators by creating false user growth data, resulting in value extraction.

Haseeb: Our special guest today is Jason Choy, the entrepreneur from Tangent. Jason, you live in Singapore, right? Is American politics a hot topic in Singaporean circles?

Jason: Everyone is paying attention to whats going on in the US lately. I generally operate on US time. In the past few weeks, we have been watching the Feds movements and political debates all day long. To be honest, this is my least favorite part of the crypto cycle.

Haseeb: Are you following World Liberty Financial and the Trump family’s DeFi projects?

Jason Choy: I heard that this project is related to Aave, and it seems to coincide with the sharp rise in the price of Aaves token. But other than that, I havent paid much attention to this project. Is there anything we should pay attention to?

Tarun: I think I said this project is a “rug scam” or a “poor man’s exit scam.”

Friend.Tech Token Plummets

Haseeb: The story that dominated the news this week was Friend.Tech, a SocialFi project that basically lets you bet on creators and buy their tokens to join the creators chatrooms. It was very popular in the summer of 2023, but then it cooled off. This year they launched their own token, but it hasnt performed well, and the price of the token has almost fallen all the way, and is now down 96% from its all-time high. The initial market cap was about $230 million, and it has now shrunk to about $10 million. Friend.Tech has been criticized in recent times.

About 4 days ago, the Friend.Tech project transferred control of the contract to an invalid address, essentially burning their own admin key. As soon as this news came out, the price of Friend Tokens immediately plummeted, and many people claimed that Friend.Tech was running away, which means they issued the tokens and then left, abandoning the project, and the project was a shell because it could not function at all.

An interesting detail here is that Friend.Tech did not sell their tokens. According to our understanding, the tokens were not sold to investors, and even the team themselves did not hold these tokens. So this is a so-called fair launch of tokens. The team also said that they have no plans to shut down or abandon the project, and the application is still running, but everyone seems to interpret it as Friend.Tech running away.

This incident has sparked a broader discussion about what kind of responsibilities crypto project teams should bear after launching products and tokens. The reason why this story is a bit strange is that Friend.Tech did not sell tokens to retail investors, and the team itself did not hold these tokens. So I would like to hear your views on the Friend.Tech incident, especially on the responsibilities that crypto entrepreneurs should bear when launching products?

Jason: I did buy those tokens and lost a lot of money on Friend.Tech. I had a lot of airdrops and keys, joined clubs, and was active on the platform. I was probably one of the largest holders of tokens in the world at the time, at least in the public wallet. So now my tokens are worth 96% less, but I still feel that he launched an app that we like, and at least for a period of time, people did use the app. He also issued the token fairly, without doing a large internal sale, and I think his real problem is user retention and the timing of the token issuance.

An anonymous developer creates an app and everyone starts talking about it, which is typical in crypto, and we saw a lot of this in the last cycle of DeFi, but not so much in this cycle. A topic will catch everyones attention and people will talk about it for weeks, and this is the Friend.Tech moment. And there are a lot of clones from this project, such as Stars Arena on AVAX, and a bunch of other imitators. This reminds me of the last DeFi, so Im excited and think that maybe we will see a new wave of social applications from here, but it hasnt happened yet.

Haseeb: Tom, what do you think of this situation?

Tom: I think that kind of thing involves accountability or what you might call “runaway” behavior. The worst runaways are probably the worst ICOs that raise a ton of money and make a lot of promises and visions, but then deliver nothing. I think those are the teams that are often accused of that wave of projects in 2017, and then you look at some of the tokens or NFT projects, projects like Stoner Cats, which may not have promised to develop a TV show, but if you’re just selling a JPEG, that’s OK. And then there are some meme coins that don’t have any expectations or promises or any clear vision, they’re just themselves.

The Friend.Tech team didn’t distribute tokens, they just built a product, but I feel like there seems to be more anger towards the Racer and Friend.Tech teams than towards other teams. It’s a little strange that Racer has received more criticism than the teams that didn’t do anything. Because the team didn’t keep the tokens, they made money from transaction fees – they made about $50 million from transaction fees on the platform. Usually this revenue goes into the DAO treasury and the team may be able to get a grant from it, but in the case of Friend.Tech, all of the revenue was completely private and the team directly profited from these transaction fees.

Isnt this what everyone wants? Everything is decentralized, there is no administrator, you can operate it yourself, and no one can run away from you. But it may depend on everyones mood or the development of public opinion, and things will become negative. I dont know why the Friend.Tech team was targeted this time, after all, there are worse examples in the crypto field.

Haseeb: Yeah, people are angry because everyone knows that Friend.Tech has made over $50 million in transaction fees in a year and a half, but none of that money has flowed into the Friend.Tech token. I saw Hasu provocatively raise this point that when you issue a token, people naturally understand that it means that the token will accrue value in the ecosystem of the product, but this token is like joining a club or something, it is not the thing that accrues value from the business. The business accrued $52 million in value, thats it. So at least one logical complaint is that they knew people had this expectation, but they still chose to do it this way and violated expectations.

Tom: I think if it was a more traditional project where the team allocated tokens, then the team made money by selling tokens, the funds flowed into multi-signature wallets, and then the team ran away, people would have more reason to be dissatisfied. But in the case of Friend.Tech, from the beginning to now, everything about the flow of transaction fees, payment methods, and system operation has been very transparent and nothing has changed.

So, on a surface level I can understand why people would have negative feelings, but on a deeper level I don’t think it’s that big of a problem. I think the Friend.Tech setup is unique in that it’s essentially a meme token, and that was pretty clear from the start.

Jason: I think a lot of the problems could have been solved by launching the token later, before there was any value accumulation mechanism, and they hadnt found the product market fit cycle. I think the application had strong virality initially, but they didnt solve two big problems. The first problem is that platforms naturally become small circles, such as the price of buying keys is built into the price curve. So the Friend.Tech group quickly excluded a lot of people because the price rose to 5 ETH, and as a result, these groups had a hard time expanding beyond 30 people, so they never solved this scaling problem.

The second problem is that the value creators get on the platform is one-time. If you earn fees from people buying your keys, then once someone buys your key, you have no incentive to continue providing value because you dont make money from people participating in your group. You can say that if creators are not active, people can sell their keys. But in reality, creators dont have much incentive to stay active because the creators themselves dont hold the keys in the first place, because the creators have to buy their own keys themselves.

If they had fixed these issues before launching the token, maybe they could have kept some heat. If I remember correctly, they launched the token right when the user curve started to drop off sharply, almost like a desperate attempt to attract people back with the promise of an airdrop, so they rushed the launch of the token.

Haseeb: This did trigger a surge in users, and everyone came back to the platform and saw that there were new features, new club systems. But the features didnt work, and the experience was terrible. It was more like they wasted the platform opportunity to attract users back through airdrops, which was really difficult to deal with as a startup. Friend.Tech finally debuted on the biggest stage in the crypto space, but it screwed up, and it became very difficult to seize a similar opportunity again.

Tarun: I was active for a while, but then it became that people bought my keys just to ask me questions. I was like, I don’t have time to be a QA robot all the time, doesn’t ChatGPT already exist? But I want to say that Friend.Tech actually got the “hype + entertainment” metaverse gameplay wrong. They were indeed the first to create this model. The idea of burning keys and charging fees is actually exactly the same as the entire meme coin gameplay – someone injects liquidity, they burn the keys, and the fees are divided between the creator and the platform. This is exactly what Friend.Tech did, but they may have done it too early. Because Friend.Tech’s gameplay suddenly became mainstream on the Solana chain, but Friend.Tech itself failed to seize this opportunity.

Haseeb: I think what Friend.Tech didnt understand, or what Pump.fun understood, is that you can start with a bonding curve, but you cant stay on the bonding curve forever because it will eventually break down. You have to transition at some inflection point, rather than continue to stay on the bonding curve.

Tarun: I think part of the reason people are upset with Friend.Tech is that theyve seen some of the more successful mechanics now, and the early Friend.Tech doesnt fare as well in comparison, but I think theyre on the right track. You could say Friend.Tech figured out the memecoin game before it became popular. But I kind of felt like the social part of it was very fake, and I remember at one point I went back on the platform and all my key holders were bots, and they were asking me the same question like 500 times.

Haseeb: Why do they ask these questions?

Tarun: I think they were hoping to get a bigger airdrop reward by interacting a lot. Because everyone was trying to get the airdrop at that time, some places became very strange. I think at the beginning, these rooms were quite interesting and unique, but then they became sour. When I think Friend.Tech really entered the mainstream, it was when those OnlyFans creators started to move in, and it stopped being just a niche crypto project and became something that really attracted the masses.

Tom: Thats true. OnlyFans revenue eventually reached $8 billion, and 80% of that revenue went to the creators, not the founders of the platform.

Jason: There are also some local stars on Friend.Tech who have done very well on the platform. These are some good signs that creators can build their own careers through the platform.

Jason: Friend.Tech did have some early signs of success, but it felt like the team didn’t iterate enough on their core product ideas. They seemed to see that people liked the platform and thought things would naturally fall into place, but their infrastructure was so poor.

Haseeb: The rate of adding new features is too slow, and the chat experience has not improved. I feel like they fell into their own product trap, because the product started to take off, so they felt that they should stick to the original direction. Friend.Tech has not really developed beyond the initial framework. It is an application where you chat with people who have your keys, and thats it. I dont think they have enough desire to try new things, maybe they should do something closer to the spirit of memecoin.

Tarun: Yeah, at a certain point, you feel like joining someone’s group chat doesn’t have any particular appeal. You start out with interesting questions, and then it becomes, which coin do you think will go up? Or which project do you think is going to go up? And I also felt that Racer’s Twitter presence during that time was a bit off-putting, which was one of the reasons why I stopped using Friend.Tech.

I used to like his research-based Twitter content, which was very profound and niche. But since he started Friend.Tech, his content has become less good. I feel that this product not only did not allow me to get good content, but also reduced the quality of his own content as a creator. It is a lose-lose situation. Now if you want to get good content, you have to buy his key and enter the exclusive room of Racer, and you will not get the good public content.

Project Exit and Ethical Issues

Haseeb: I want to focus on the issue of how founders in the crypto space exit. In traditional startups, it is normal to close a startup. In the crypto space, closing a project is a bit strange. The main problem is that there is no regulation, no ready-made exit process or guide. People don’t know how to end it and what responsibilities the founders should bear. I am curious about what cases you have seen in this regard?

Jason: In the early stages of a project, the difference between success and failure is often very large. If you want to give founders some advice on how to make the right decision when they realize that the project is not working, I think it is relatively simple to shut down the project in the very early stage, because that is suitable for the tokens that have not yet been issued. Your stakeholders may only be four or five people, such as angel investors and a leading venture capital. You just need to communicate with them, work with lawyers to handle the dissolution of the company, and return the investment in proportion. It is basically a very simple process. But once you issue tokens, you are no longer facing only a few investors, but may face thousands of token holders.

Haseeb: So you think the solution to this problem is to control the timing of token issuance? You shouldnt issue tokens before the project is ready, unless you are sure that you have found the product market fit point and are ready to accelerate growth through token injection. Do you know of any examples of tokens that have successfully exited? For example, FTT, although its project has stopped operating, the token is still traded. And Luna, although there is no substantial development anymore, the token still exists.

Tom: Yes, there is a version of Luna called Luna Classic, which we like to call the classic version in the crypto space. In fact, something similar happened just this week. Vega, a decentralized derivatives platform, they have their own chain, and they put forward a proposal, basically to gradually withdraw and shut down the chain. This kind of thing is quite simple. Although it is decided by a community vote, the team has essentially decided to withdraw and gradually leave.

This reminds me of the discussion about IoT smart home devices. When the companies that make these devices go out of business or want to stop providing services, people often complain, Why did you destroy the device I spent $1,000 on? They would like the company to open source the code so that users can run the server themselves. If the company can do this, it is undoubtedly the best course of action. But there are costs and legal issues involved, and few teams actually open source the code.

Jason: Indeed, if you can do that, thats the best path. In the crypto space, if you want the community to take over, then open source the front end and let the users run and govern themselves. If you unilaterally shut down the project, it will be more difficult. To do this requires complete decentralization, or at least close to complete decentralization. Projects like Friend.Tech, they have servers hosting chat messages and are responsible for a lot of actual operations. Without these functions, Friend.Tech is almost nothing.

Tom: Yes, there are very few projects that are completely decentralized and gradually shut down. The examples I can think of are Fei and Rari Capital, but they are really rare. In most cases, as long as someone is willing to run the infrastructure, they can exist and be traded forever, such as Ethereum Classic (ETC). The standard of death of tokens is quite unique in the crypto field. Although these tokens are still on the chain and even have people providing liquidity on some exchanges, they are basically dead by most standards.

Haseeb: Tangent Fund invests in both early-stage startups and liquidity markets and token issuance, right?

Jason: Yes, that’s right.

Venture Capital vs. Liquidity Funds

Haseeb: Recently, many people on Twitter have been discussing the dynamic relationship between VC funds and liquidity funds, believing that VC funds are net extractive to the crypto industry, that is, they take more money from the crypto ecosystem than they put in. VC funds invest in new projects, usually at low valuations, and when these projects mature and are listed on major exchanges, VC funds will sell their tokens, which takes money out of the crypto ecosystem instead of injecting money into the ecosystem. So this argument is that more VC funds are bad for the industry, and they should allocate capital to the liquidity market and directly buy already listed tokens on the market instead of continuing to invest in new projects.

There is a growing consensus that VC funds are “extractive” or a net negative for the industry. Considering your previous experience at Spartan, which did both liquid markets and venture capital, what do you think of this debate and where you stand at Tangent?

Jason: Not all VCs are the same. I think the threshold for starting a crypto fund in 2020 is relatively low compared to the Web2 space because this is the first time many people are entering this space. Therefore, there are a large number of funds in the market, and they have lower quality requirements for projects, resulting in many random projects being funded. After these projects were listed, people blindly hyped them up, and in the end, many tokens went one-way down. This gives people the impression that VCs just bought at low prices and then tried to sell at unreasonably high valuations when they were listed on exchanges.

We have seen this a lot, but I would not deny the entire crypto venture capital field. What we do at Tangent is that we believe that part of the funds in this field are over-allocated, with too much capital chasing too few high-quality projects. Just like the venture capital field of Web2, in the end, those VCs who are good at picking good projects will dominate the market. So when we founded Tangent, our original intention was not to compete with these big funds, so we hoped to support these companies by writing smaller checks.

I think the current liquidity market lacks a mature price discovery mechanism. For the valuation of start-ups, it is usually a competition among multiple mature venture capital funds to find a reasonable price. In the public market, there does not seem to be much consensus, and there is generally no strict standard for the valuation of tokens, so we need a more rigorous price discovery mechanism.

Tarun: One of the interesting things about crypto is that it almost always blurs the lines between private and public investing. Like you said, in crypto, it seems like everyone can participate. This is in stark contrast to traditional markets, such as private equity. Traditionally, you might only have one liquidity opportunity when a company goes public, and there is nothing in the documents I read about frequent buying and selling. In contrast, in the crypto market, investors not only participate in the project launch, but also help find liquidity, connect market makers, and do a lot of related work themselves, which leads to different market structures, which is why the price discovery mechanism in the crypto market is relatively poor.

And I think that pricing in the private market is even more inefficient than pricing in the public market. Many times, the final price of a transaction is not what investors think is reasonable or willing to pay. Due to competitive pressure, investors may have to pay a higher price to win the transaction. This auction mechanism often leads to a lack of pricing efficiency.

Haseeb: Yes, there is a winners curse. The winners curse refers to the fact that in competitive auctions, the winner often pays a price that exceeds the actual value of the subject matter. Investors in the crypto space seem to be more willing to take this risk. When the US government auctioned oil field blocks in Alaska, the government allowed oil companies to collect a sample from the land and then decide on the bid amount. At that time, due diligence was just someone going to the land to take samples and measure, and there might not be the current sonar technology. The problem is that such auctions often lead to bidders paying too high a price because they made overly optimistic assessments based on limited samples.

Tarun: Exactly. If one bidder samples a patch of land with lots of oil, they will assume that the entire patch is an oil field, while another person samples a patch with no oil. The true value of the land is actually the average of all the bidders’ information. But because this information is private and bidders don’t share it, the winner is often the person who overbid. They may have sampled a lucky patch of oil and misjudged the overall value of the land. This is known as the “winner’s curse”—even though you won the auction, you actually won an overpriced resource, in this case, an asset you were planning to resell in the future, but you found out that you actually overpaid for it.

Haseeb: Do you think that this “winner’s curse” phenomenon only exists in crypto venture capital, or does it exist in all venture capital?

Tarun: I think this phenomenon exists in all venture capitals, but it is more obvious in crypto venture capital. Because private investors in the crypto market are also investors in the public market. They will participate in the liquidity construction of token issuance, such as reaching an agreement with market makers to provide supply. In the traditional public market, these processes are usually completed by bank intermediaries. Banks are responsible for pricing and bookkeeping, but banks are not the owners of the assets, usually third parties.

In the crypto market, private equity funds are able to intervene more when assets are publicly traded. In the public market, private equity funds have very limited intervention capabilities. So in the crypto market, although it looks like a winners curse on the surface, it is actually different because private equity funds can influence liquidity events.

Dont you remember how every other week, the partners at Benchmark would complain about how the bank was pricing the company wrong? They complained about how the IPO was priced wrong and they had lost control of the price. It affected how they priced the Series C, it affected how they priced the Series A.

Lack of market strategy and arbitrage behavior

Tom: It may indeed bring some additional impact, but I dont think it is significant. As you said, at most it is an introduction to the market maker, but it does not mean direct participation in pricing or negotiation. Sometimes you may lend assets to the market maker, or do other operations. In traditional markets, these are usually done by third-party intermediaries, while in the crypto market, the role of intermediaries is not prominent.

Crypto investment is not a simple commodity auction. Usually, it is not the team with the highest bid that wins. In fact, the team with lower costs can often obtain cheaper capital. This is also the reason why European family offices invest in Series A is often mentioned, because there are indeed low-cost funding options there. The venture capital funds that everyone is familiar with are often not the investors with the highest bids, which also explains why they can achieve better returns.

Tarun: I think one of the main differences between crypto VC and tech VC is that tech VC places more emphasis on brand because their liquidity cycle is longer. Therefore, startup teams are usually willing to accept larger discounts in exchange for high-profile brand support. In the crypto space, teams are much less tolerant of this, especially after 2019.

Haseeb: A lot of the big-name brand funds will actually help you find clients, especially in the early stages.

Tarun: I agree that branding is very important in the early stages. But in the later stages, the market becomes more homogenous and branding is less influential. The problem is that there is no traditional late stage in crypto, it is almost all early stage until the liquidity event occurs, and Series B can be considered late stage in a sense. Traditional venture capital may have Series D or Series F, but the stage division in crypto is not clear.

Haseeb: The premium for brand in the crypto space is higher than that of traditional venture capital. Brand is particularly important in the seed or pre-seed rounds because when there is no product, everyone relies on signal transmission. If a top fund participates and the other is an unknown fund, the transaction price difference between the two will be very large. Therefore, crypto investment is not only a bid for capital, but also a bid for reputation. In the crypto space, the balance between capital and reputation is more prominent than in traditional venture capital.

Tarun: I agree with your point about later stages, like Series F etc, but in early stage tech investing, especially AI investing, I do think the influence of brand is even.

Tom: In 2020 and 2021, many people believed that cross-border investment funds like Tiger Global dominated the market and drove up prices. However, in the end, this argument did not come true, and instead the phenomenon of winners curse emerged. But this is not the norm in the venture capital market, and it is not the case in todays market. Therefore, it is difficult to be convincing to predict the future based on data points from a few years ago.

Jason: I think the public market in the crypto space gives projects valuations that are much higher than their actual value, which allows VCs to make huge gains on paper. For example, we invested in a new Layer 1 project at a fully diluted valuation (FDV) of $30 million, and three months later, when the token went live, the market pushed its valuation up to $1 billion. This almost forces VCs to sell tokens when the tokens are unlocked, so the public market provides VCs with an opportunity to cash out.

Behind this phenomenon is the different liquidity window of the crypto market from the traditional market. Traditional venture capital projects usually take 7 to 11 years to achieve liquidity, while crypto projects may be able to issue tokens a few months after the company is established, and liquidity comes faster, which is much shorter than traditional venture capital. In particular, new meme tokens are launched almost every 15 minutes.

The existence of the liquidity window does exacerbate this phenomenon, and projects often dont have enough time to deliver on their vision. This is not just because VCs drive project progress or token issuance too quickly, but also because the market assigns a huge speculative premium to almost any crypto project with potential, and this early overvaluation is difficult to sustain. So, I think this problem will eventually correct itself, and retail investors have realized that buying new project tokens at billions of dollars in FDV often results in losses. We analyzed the token issuance in the past six months, and the prices of almost all tokens have fallen, except for meme coins.

Haseeb: The market has fallen sharply in the past six months, with almost all assets down about 50%, which makes me have reservations about this view. Ironically, we also manage a liquidity fund ourselves, and we prefer to hold for the long term. I disagree with his view that liquidity funds are good for the industry and VC funds are harmful. His argument seems to assume that what we are building in the crypto field has no real value, as if we are just playing a shell game.

If you think there is no real value, why participate? In fact, VC-backed projects – whether it is Polymarket, Solana, Avalanche, or Circle, Tether, Coinbase – have expanded the crypto industry landscape and attracted more people to the market. Without these VC-funded projects, the value of Bitcoin and Ethereum may be much lower than it is now.

The view that there is nothing worth building anymore and that new projects are worthless is too narrow-minded. Historically, this skepticism of new technologies is untenable. Even though most VC-funded projects eventually go to zero, this is common in venture capital across all industries. Buying into liquidity tokens is still necessary.

Tarun: I think VC funds have also driven the development of the entire industry. We do need more liquidity funds, but it is unreasonable to completely deny the contribution of VC funds. You mentioned that the entry of liquidity funds into the market will improve market efficiency and benefit the crypto industry. My rebuttal is that the operating mode of liquidity funds is to buy early, sell at high points, and then look for the next opportunity. Their purpose is arbitrage, not long-term capital injection. If operated properly, liquidity funds will eventually extract more funds rather than inject more.

Tom: I have worked in both traditional finance and crypto private equity, and this debate also exists in traditional finance. Some people criticize venture capital for only raising book value without really creating value, and believe that capital should be invested in liquid hedge funds. This is actually a classic contradiction in capitalism: the conflict between long-term but uncertain returns and the need to know all information now drives the existence of trading activities. I think the public market in the crypto field has performed poorly in raising funds for project teams. Unlike the traditional stock market, teams rarely sell tokens directly on the public market, and almost all of them are sold to venture capital.

Haseeb: In the stock market, if a company needs funds, it can raise them by issuing new shares or debt, and the market is generally optimistic. But in the crypto space, it is difficult for teams to obtain new funds through the public market, and token trading is more of a buying and selling between retail investors, lacking an effective financing channel. Most people on Crypto Twitter seem to support hedge funds, which is contrary to the attitude of the traditional market. Hedge funds usually trade with retail investors, but Crypto Twitter supports them.

Tarun: Didnt you follow the GameStop incident? That was the opposite situation. In the GameStop incident, people hated hedge funds, while in the crypto field, everyone seemed to prefer hedge funds. Haseeb mentioned that retail investors participate in the crypto market through liquid tokens rather than private transactions, so they are more likely to resonate with liquid funds.

Jason: Arthur mentioned that most VCs in the crypto space underperformed because the barrier to entry was low in 2019 and 2020, which led to many low-quality projects being funded and entering the market at overvalued valuations. This caused VCs to cash out quickly, leading to a negative view of VCs. But we are very careful in choosing partners, such as co-investing with Dragonfly, because we have similar standards and tend to fund projects with real potential.

In addition, the statement that liquidity funds extract value is also an oversimplification. There are many different strategies in liquidity funds, and even high-frequency trading funds can add deep liquidity to the market. Many crypto funds are similar to VC funds. They are usually theme-driven, publicly share investment logic, help the market become more efficient, and transfer capital from low-quality projects to high-quality projects.

Haseeb: You mentioned that some hedge funds underperform, but there are also funds like Berkshire Hathaway that help the market and improve market efficiency. So, what types of hedge funds are bad for the industry? Because your statement just now is a bit vague, do you mean arbitrage funds are bad, or long-short funds are bad? Which funds do not meet your criteria?

Jason: It is difficult to say which type of fund is bad. For VC, if VC keeps funding those runaway projects, it is obviously not good. But for liquid funds, this is an open market and anyone can participate. I don’t think there is any legitimate fund strategy that specifically supports scams.

I think there is a very clear line between legal and good and bad. As long as it is not illegal, I dont think I am qualified to judge which type of funds are bad and which are good. But I think the funds that are most valuable to the market are those theme-driven funds that share investment ideas publicly. If I had to choose, I would prefer these funds rather than high-frequency trading companies. Theme-driven funds help the market discover prices better and transfer retail capital from bad projects to good projects. Of course, the two functions are different, so it is difficult to say which strategy is a net negative for the industry.

Haseeb: Tarun, what do you think?

Tarun: You mentioned that the word illegal is a bit subtle. The crypto market is indeed vague in some definitions, and many things may involve violations if you dig deeper. For example, many companies engage in wash trading. I think the market should develop to a certain extent that the cost of wash trading is high enough to prevent this behavior. The goal of the crypto market is to prevent wash trading, rather than relying on SEC investigations like traditional markets, which usually lag behind the incident. If you look at the penalty cases, it usually takes five years for the results to come out. The crypto market has not yet fully reached this norm. There are indeed many people who make profits in this way, and they do not contribute to price discovery.

Hedge Fund Types and Their Impact on the Market

Haseeb: Can you talk a little more about other hedge fund strategies?

Tarun: I think there are some strategies missing in the crypto market that are more significant than some of the bad existing strategies. For example, in traditional markets, you can find self-financing portfolios, where the expected growth of assets covers the cost of funding, such as option premiums. But in the crypto market, 90% of derivatives exposure is mainly perpetual contracts (perps), which are not self-financing because you have to pay the funding rate all the time. Although staking exists, there is also a maturity mismatch problem.

This is why there are not many long-term traditional hedging funds in the crypto market. There are more short-term operations or long-term holding strategies, and the operations in the middle ground are almost missing. If the transaction frequency of these funds is plotted, the traditional market will show a normal distribution, while the crypto market has a bimodal distribution. Every time a new DeFi mechanism or staking mechanism emerges, this distribution pattern may change, but it has not yet been fully integrated. Therefore, the lack of medium-frequency operations is an obvious shortcoming.

Jason: If I were to point to a hedge fund strategy that is detrimental to the industry, I would say it is the systematic airdrop farmer strategy. This type of operation brings confusing indicator data to project founders, making it difficult to judge whether the product is really matching the market. And these airdrop farmers only extract project value and will not stay to use the product. Many studies have shown that the user churn rate after the airdrop is over is as high as 80%, which is not good for founders and projects.

This strategy has limited scalability and is usually operated by a small team of two or three people. Although there have been larger airdrop mining operations, such as Pendle’s TVL performed well at its peak, the scale of such operations has decreased today.

Tarun: I would like to see a more efficient, transparent and mature market. Although progress may seem slow, the field is indeed maturing compared to 10 years ago.

Haseeb: Yes, after this discussion, I generally agree with Jasons point of view. Short-term hedge funds can improve liquidity, and long-term funds can make the market more efficient and reallocate capital to some extent. Although Tom mentioned that capital reallocation in the crypto market is not meaningful because it is difficult for project teams to raise funds through the public market, they can still obtain capital through other channels, such as DWS or venture capital funds, and their discounts will be reflected in the public market, and price signals will also be transmitted back from the public market. Therefore, these strategies are generally reasonable.

Tarun: Another problem is that some risk-free operations can make a profit, and these operations have no impact on the long-term liquidity or price of the asset. For example, wash trading is to obtain agricultural incentives, but this incentive does not make traders take risks, so it has no positive impact on the project. The market should let participants take certain risks so that they will promote the long-term development of the project. Although airdrop farmers now take some risks, this does not change their unproductive nature.

Haseeb: Yes, but taking risks can prevent such behavior from undermining project indicators. If I believe that the project will have a positive outcome, the risk will motivate me to make positive contributions to the project. Operations with no risk of return only inflate the projects indicators without any actual help.

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Original author: STANFORD BLOCKCHAIN CLUB Original translation: TechFlow * Note: This article comes from Stanford Blockchain Review. TechFlow is a partner of Stanford Blockchain Review and is exclusively authorized to compile and reprint it. An interview was conducted with Heath Tarbert, Circle’s Chief Legal Officer and Head of Corporate Affairs, former Chairman of the Commodity Futures Trading Commission (CFTC), and former Assistant Secretary of the U.S. Treasury Department. This article is a long-form exploration of discussions and ideas from an interview with Jay Yu of the Stanford Blockchain Club in June 2024. Click here to watch the full video . introduction Today, stablecoins are an important part of the crypto industry, combining the reliability of the U.S. dollar as a store of value with the tradability and ease of use…