‘I’m worried about the overall lack of LP appetite going forward.’ • TechCrunch

During an unprecedented bull run, crypto-focused investors raised, and deployed, billions of dollars in capital. But now, not only are VCs operating in a bearish crypto market, they are navigating the fallout of the FTX collapse and the potential impact it will have on their investment strategies moving forward.

Double Down founder and general partner Magdalena “Mags” Kala and Dragonfly general partner Tom Schmidt shared their views at TechCrunch’s crypto conference in Miami on Thursday on what’s next in crypto in the wake of the FTX drama.

Luckily, the pair each closed their respective funds this year — Schmidt’s firm closing on an “oversubscribed” $650 million vehicle — and Kala’s Double Down just one week before all the FTX goings-on went down.

Both say they had already planned to proceed cautiously in deploying their capital, but now even more so.

“I am worried about contagion risk and for the other shoes to drop,” said Schmidt, who counts a number of exchanges in his firm’s portfolio. “We’re still holding our breaths and taking a pause to reevaluate what we will do in the coming year.”

“I’m more worried about builders not entering the space, builders leaving the space and the overall lack of LP appetite going forward,” he admitted.

Kala said she feels fortunate to be sitting on dry powder in light of the current macro environment.

“A lot of those who raised last year don’t want to have to raise again in 2023,” she said. “And so I think we will see a slowdown and higher bar for projects.”

Schmidt said he has been “very slowly” deploying out of his firm’s third fund.

“I have a reputation for being critical, and going deep to understand what’s happening,” he said. “Our long-term thesis is to use technology to create a new set of financial services, a financial substrate. And what we’re looking for are companies that fit that idea…at the same level of diligence.”

A lack of diligence has been cited with regards to the FTX debacle, with many wondering how the crypto exchange managed to raise so much money despite what Schmidt called “red flags.”

“The thing about FTX and Alameda is that it was so unbelievable when you heard it,” he said. “We were never fans. This was supposed to be blue chip and have blue chip investors backing them but the numbers never made sense. If you looked at how much they were making and how much they were spending on stadium sponsorships and donations, nothing really made sense.”

In Kala’s view, the whole debacle highlights that “decentralization is actually needed.” But she is not surprised that many investors may have overlooked so-called red flags.

“From a diligence standpoint, it can be that you see what you want to see,” Kala said. “In the moment you can be so taken by the narrative.”

Schmidt believes that the past few years represented an “anomaly” in diligence and the traditional venture process. He recalls meetings with crossover funds backing a company, in some cases deploying 20x more capital than him, where the investor clearly did not have a fundamental understanding of what the company was doing.

Overall, he does believe that regulation played a role in the FTX saga.

“Certainly regulation could have helped. It was this certain environment that pushed them offshore,” Schmidt said. “I expect we’ll see more of an attitude adjustment…I’d like to see the U.S. be a leader on this front.”

For Mala, “nothing has changed” with regard to the core fundamentals of crypto. She described FTX CEO Sam Bankman-Fried’s efforts when it came to regulation being “more like a dog and pony show.”

“The real change is happening with real players,” she said. “But also the other thing that we see with VCs is that slowly we are having this change of guard who are actually knowledgeable [about crypto.]”