Welcome to the Inquisitive VC, today I am speaking to Richard Chen a General Partner at 1confirmation, a seed-focused crypto venture fund.
We talk about Richards's prediction of underrated product trends for 2024, the function of airdrop and points, difficult questions asked by LPs and much more. I hope you enjoy the episode!
Welcome to the Inquisitive VC podcast. In this episode, we had the opportunity to discuss 1confirmation with Richard Chen, a Partner at a crypto venture capital firm. He discusses his background in crypto starting in 2015, founding 1confirmation in 2017, and some of their successful investments like OpenSea. He also discusses NFT funds, points systems, airdrops, recent investments, and challenges in fundraising.
[00:24] Can you share your journey, your background, and what led to the startup confirmation?
I got started in crypto in 2015, I conducted research in distributed systems and photography at Stanford, where I initially discovered the fascinating aspects of Bitcoin and blockchain technology. My entry into crypto was more driven by the technical side rather than the ideological aspects tied to concepts like Bitcoin as hard money or gold, which had been a common entry point for many. Around 2017, I co-founded 1confirmation, one of the first venture funds in the crypto space. Differentiating ourselves from the hedge funds of that era focused on short-term price predictions, we opted for a long-term VC approach, backing founders at the seed stage and supporting them through bear markets. Our first fund in 2017 yielded notable successes, with OpenSea standing out from our seed round investment in early 2018. Other triumphs include Dydx, MakerDAO, SuperRare, and various prominent DeFi and NFT projects. We maintain a focused strategy on our third fund, concentrating on seed rounds, leading investments, and maintaining a small, concentrated portfolio to dedicate ample time to our portfolio founders.
[2:00] What do you see as the predictions for underrated product trends in crypto 2024?
I wrote a Substack article two weeks ago, sharing my three predictions for 2024. I've been doing this series annually since 2019, and it's always fascinating to look back and see how accurate my predictions have been. This year's predictions focus on prediction markets, on-chain messaging, and account abstraction. In particular, the 2024 election year has significantly boosted the volume of prediction markets. Our investment in the Polymarket, a leading prediction markets platform, has seen eight out of their top 15 volume days in just the first 16 days of January. Events like the Bitcoin ETF approval and the Iowa caucus have driven this surge. Predictive markets are becoming increasingly vital as people lose trust in mainstream media. These markets provide a unique insight into the truth, especially on topics like the room temperature superconductor or geopolitical conflicts like the Israel-Gaza complex.
https://twitter.com/richardchen39/status/1743274395118780652
[4:45] How do you see the current prediction markets differing from their earlier counterparts?
The primary change I've noticed is the evolution in product timing, especially in prediction markets. Investing in Augur in 2018 attracted early users like libertarian cypherpunks, who viewed it as a novel use of crypto and libertarian ideology. Today, with mainstream figures like Trump engaging in prediction markets on platforms like Truth Social, and even mainstream media floating political prediction markets, there's broader attention and awareness. The product usage timing is now more favorable. Moving on to on-chain messaging, a significant pain point for our portfolio founders is the inability to connect with their top users. Projects like XMTP are working on protocols, but leveraging on-chain addresses as identities could revolutionize this space. I'm enthusiastic about seeing more startups tackle this category. Lastly, on account extraction, the idea has been around since Ethereum's beginnings, with Vitalik discussing it from 2013-2016. However, it previously required a hard fork to implement. The game has changed with Ethereum's recent upgrade, especially EIP-4747 going live. We invested in the Bundler and Paymaster project Pimlico, which operates in the account extraction space. As more wallets and apps adopt this framework, I anticipate seeing Pimlico and similar projects powering the user experience in 2024 and the future.
[8:30] Where do you perceive the most value within the crypto space in the current market? Is it primarily in NFTs, the underlying infrastructure, or a combination? What do you think about it in the recent transition?
Both NFTs and infrastructure play a pivotal role in value creation, drawing parallels to the early days of Bitcoin and Coinbase in 2014. Back then, VCs grappled with whether to invest in Bitcoin or related equity companies. Interestingly, Bitcoin outperformed nearly everything except Coinbase, showcasing the potential of investing directly in the asset or in companies closely associated with it. Similarly, in the NFT space, the question arises: Should one invest in blue-chip NFTs like punks and high-end art or focus on infrastructure marketplaces such as OpenSea and others? While the verdict is still pending, I see significant value and potential upside in investing directly in the assets rather than solely in the supporting infrastructure within the NFT class.
[9:57] Lately, some projects have implemented a point system, rewarding users for different actions. I'm interested in hearing your perspective on these point systems. I'd like to know your views on airdrops and how effective you believe they are for projects.
Points are intriguing for a couple of reasons. Firstly, they let you offer incentives without launching a token, sidestepping regulatory questions. Many projects use points as it's cost-free, allowing them to defer the token decision. However, users might be surprised that points sometimes convert to tokens. Secondly, points enable continuous rewarding of behavior, unlike one-time airdrops. This fosters ongoing engagement and loyalty, similar to airline point systems. Additionally, the off-chain nature of points allows teams to assess engagement metrics retrospectively, facilitating a more brilliant conversion to real dollar value through tokens without being locked into specific values. This off-chain approach is more efficient for rewarding usage.
[12:50] Why do some projects opt for older technology, like points reminiscent of airline points, instead of straightforward tokens?
Indeed, it's a double-edged sword. When you keep everything on-chain, it becomes transparent, making it extremely easy to be manipulated. Knowing precisely how much you'll be rewarded for a specific transaction or behavior within a protocol creates a scenario where professional civil farmers can exploit this predictability. They might spin up numerous addresses and engage in these behaviors because they clearly understand the rewards they'll earn.
[13:40] Moving on to airdrops, do you view them as a valuable mechanism for token projects?
I engage in token projects, which revolve around conducting a token launch. When initiating a token launch, the initial distribution must be directed toward communities or entities that are adequately decentralised. This is the underlying rationale for implementing airdrops. The critical question is: What is the optimal distribution method? How can one mitigate the influence of Sybil attackers within the distribution sets? These remain open questions actively addressed by various teams. Notably, there have been intriguing mechanisms for airdrops over the years. For instance, one of our portfolio companies, Hop Protocol, pioneered a bounty program that rewards individuals for identifying simple addresses to counter Sybil attackers in the airdrop. Bounty hunters received a percentage of the reward for their services. This innovative approach set a precedent, with projects like Gnosis Safe and others adopting similar strategies inspired by Hop's initiative. In the broader context of points and airdrops, it parallels the evolution of internet marketing in the late '90s. During that era, substantial venture capital funding was poured into banner ads. However, the industry matured over time, developing the ability to measure and quantify customer acquisition costs, customer lifetime value, cohort analysis, and retention analysis. Likewise, the crypto industry is becoming more sophisticated in measuring various growth metrics.
[13:40] Given the increasing hype around intents, do you believe they are a valuable approach?
I'm not suggesting that intents are inherently evil. Computer scientists, technologists, and researchers tend to coin new terms for breakthroughs, often resulting in reinterpretations of existing concepts from traditional finance. As the industry matures, there's a shift from relying on passive liquidity and memes, prevalent in 2019 when market makers were scarce, to the current landscape in 2024, with substantial monthly trading volume. This transition is leading towards a structure more akin to traditional order books. Consequently, mechanisms like an RFQ system or other intense orders have emerged for users to execute transactions efficiently.
[18:00] Can you share insights into some of the most challenging questions you had to address while securing investments from LPs for crypto and NFT funds?
I tweeted this about a month ago on Twitter—a compilation of frequently asked questions from Limited Partners (LPs) in the space. The primary concern is "Where's my DPI?" for distributions to paid-in capital. Many funds are sitting on significant paper gains but haven't distributed much to LPs, causing apprehension. The second common query involves broader macro issues like rising interest rates affecting crypto and tech VC due to the denominator effect. LPs are now hesitant to allocate more to private investments. FTX, CZ drama, and reactions to big headlines are also hot topics, given the history of notable figures in previous cycles. Lastly, there's a recurring question about the use cases of crypto beyond speculation, revealing a growing divide in the industry—some see it purely as a new form of speculation. In contrast, others continue to believe in Satoshi's broader potential and ideals, exploring various use cases like prediction markets and zk-tech for the long term.
[22:15] What advice would you offer to an emerging crypto fund manager during fundraising?
Frequently, I observe individuals simply parroting the prevailing narrative on Crypto Twitter. However, consistently aligning investments with consensus often results in market underperformance. Examining historical data on successful VC funds reveals that extraordinary outliers emerge by adopting bold, contrarian theses and committing wholeheartedly to them. In the VC realm, where extreme power laws govern, a significant portion of investments tends to fall short, and the top 10% account for the lion's share of returns. One must recognize that hitting outliers necessitates making many contrarian bets to stand out. Despite the likelihood of many failures, the success of even one can overshadow all the others, exemplifying the nature of success in a power-law-dominated industry like venture capital.
[24:20] With your experience in crypto VC, especially on your third fund, are there any companies you'd include in your anti-portfolio that you've learned valuable lessons?
I have quite a few examples in my anti-portfolio. One notable instance is a project I passed on when it was valued at $60 million; now, it stands at $14 billion. Reflecting on infrastructure investing, I've learned that, despite my technical background and inclination to delve into architectural nuances, the critical factors often boil down to the quality of the team and whether they're pioneering a unique space. For instance, last year's project, initially known as Lazy Ledger and later rebranded as Celestia, changed its design multiple times since the pitch meeting. Ultimately, what mattered most was that it introduced a novel concept—a separate chain for data availability, a first-of-its-kind project at the time. This experience underscores that, in infrastructure investments, being at the forefront of a new space and having exceptional founders matter more than delving too deep into the technical intricacies of architectural design, which can evolve significantly.
[26:35] What's your secret obsession that many people know about?
I'm obsessed with tennis, a sport I picked up around three and a half years ago during the pandemic. I play almost daily and consider myself a tennis Maxi, often enjoying Pickleball. Attending the USA Open and various live matches annually, I've built connections in the crypto community through tennis. When I travel to a new city, I bring my racket and tweet about finding hitting partners, and that's how I make new friends in the crypto space.
[27:43] Finally, what's the latest publicly announced investment, and why did you make it?
We recently invested in Titles at the end of last year, Titles.xyz. It represents a fascinating crossover between AI and crypto, offering a compelling use case. Titles enable generative artists to train on their artwork using stable diffusion AI models. Collectors can then mint NFTs of the AI-generated outputs. Particularly noteworthy is how Titles addresses the legal complexities surrounding AI-generated content in traditional media. The platform allows original creators to receive royalties and attribution for their work while leveraging AI tools for monetization. Titles provide the necessary tooling for artists and users, making it legally permissible to use AI tools without concerns about intellectual property issues.
Disclaimer: The Inquisitive VC is provided for informational and educational purposes only and is not intended to provide commercial, financial or legal advice. Nothing in this article and podcast constitutes an offer of securities or regulated financial products or financial services to any persons or a solicitation to buy or sell any tokens or securities or to make any financial decisions. Do not trade or invest in any project, tokens, or securities based upon this podcast episode. The host and guests may personally own tokens or be an investor in projects that are mentioned on the podcast.
Richard Chen - 1confirmation