Conversation with Ken, Partner at Electric Capital: "We are a product-oriented VC with a focus on technology experts."
Original translation: Leo, BlockBeats.
Electric Capital is a relatively active venture capital firm in the industry. In March 2022, they raised $1 billion for two funds. Some of Electric Capital's well-known investments include Frax, dYdX, Near Protocol, and Eigenlayer. Edgy, a DeFi researcher, recently interviewed Ken Deeter, a partner of Electric Capital's investment team who focuses on DeFi, crypto games, and crypto collectibles. Ken has 15 years of experience leading teams and developing products as a software engineer and product manager at VMware and Facebook. The two had a fascinating conversation about "how VCs consider investment bets, Electric's investment views, how VCs profit, recent trends in the crypto world, L1 and L2, crypto beliefs and adoption, and how to become a crypto institutional researcher." BlockBeats has compiled and translated the conversation as follows:
Note: This interview does not constitute any investment advice. It is purely Ken's personal opinion.
VC's wide net
Edgy: Venture capital firms have a large portfolio and a significant amount of investments. Some people joke that this is a method of casting a wide net and praying for investment projects to succeed. Why is this the case?
Ken: Many venture capitalists have their own set of theories and professional standards. It's important to know that 90% of early investments will end up with zero returns, which is an inherent risk in investing in early-stage projects. Indeed, many projects have excellent founders, ideas, or other outstanding factors, but the final outcome is not good. There are always some negative factors, perhaps Covid-19, or perhaps Powell's wrong decision. For broad-based investment, I think there are risks in all investments. Maybe you invest in 40 projects, but as long as one project succeeds, your losses in other projects are far less than the benefits you get from discovering a successful project. Therefore, diversifying risks through multiple investments is a mathematical way of thinking. As for how to choose investment projects, each VC has its own ideological system and makes choices based on certain aspects.
Electric Capital 的不同点
Electric Capital's Differences
Edgy: There are many venture capital companies in the encryption industry. How did Electric Capital stand out?
Ken: There are two points: first, our product-centric approach. Our core team has spent a lot of time researching products and startups, and many of our colleagues have experience in engineering management and design, so we have some overlapping ideas with founders who can create good projects. Especially in the encryption field, many teams mainly copy other projects and take shortcuts, trying to create some tokens and play economic games to make quick money. If we don't feel that "this person is really trying to solve some problems in the encryption field," we will avoid such people and projects.
Secondly, we have a very strong technical bias. For example, I myself used to be an engineer, and one of the co-founders of Electric Capital is also an engineer. We have worked together on some engineering projects on Facebook before. Half of our team members are engineers, and we have enough ability to conduct technical due diligence. We also enjoy participating in the technical aspects of each investment project. For example, we will think about some issues such as what to do if the gas cost is too high, or what to do if the proxy contract has problems. At this time, we will assist in dealing with some details. We are still in the early stage of the encryption industry, and we need to know that the team is indeed developing in the right direction and will consider some tricky case issues. On the other hand, once we participate in certain projects, we will also deal with some on-chain issues. We participate in governance, provide liquidity to the protocol, and we need some project teams to understand what we are doing and let the project know how to use VC's resources to help the protocol succeed, such as designing protocols, token economics, and other aspects.
In general, we are a product-oriented team with a majority of tech experts.
Transaction Flow
Edgy: Many people want to enter the venture capital industry. How to become a venture capitalist? How to attract a flow of high-quality deal flow and attention?
Ken: On the question of how to become a VC, I believe there is actually a common path. To be honest, I joined Electric Capital quite late, and other co-founders have been in the VC industry longer than me, so they have some brilliant investment records. After I joined Electric Capital, I needed to achieve some results, especially in the DeFi field. But basically, the game of crypto is the same. You invest in some projects and establish your own reputation, which means you bring huge value to the founders you work with. They need help in the areas you are good at, and you have to roll up your sleeves and work hard. Maybe you only wrote a check for 25,000 or something else, but you really helped them succeed in some things.
Actually, most founders will chat with each other to get to know each other better, and some companies do it well. For example, some startup founders who are considering starting a company or raising funds will usually contact other founders and say, "Hey, who is the most valuable person in your company?" They usually say, "You'd better go talk to Ken or someone else, because these people are truly valuable and capable."
This is also the best "transaction flow" I understand. Once you get on track and bring a brand into the normal development stage, people will start paying attention to you and say, "I know Electric Capital, they are very powerful." Investing in a project is actually very easy, but I want to say that we still insist on some more interesting things, and get early access to projects from project founders, so that we can know whether we are ready to participate.
Many founders I have worked with constantly pass on information to me, "Hey, I just talked to him and he wants to talk to Electric Capital. Can you schedule a meeting?" These are common conversations that happen around me. All of these can provide value and guide you to become an impactful investor.
L1 and L2
Edgy: How do you view the various Layer 1 and Layer 2 solutions in 2023? Has Ethereum won Layer 2?
Ken: Remember that in 2021 and 2022, especially in 2022, Gas on Ethereum is very high, which also brings opportunities to other L1s, because their transaction speed will be faster when Gas is high. Of course, they have suffered a lot during this bear market, so we are focusing on the technology of all L2s. I don't think we can smoothly write the story of "L2 correct architecture" at the moment. It seems that Ethereum is still mainstream, and L2 only exists. If we want to surpass Ethereum, we need to add at least one more zero to the transaction data. If Ethereum is a complete entity, ZK technology may be able to take us further.
However, at present, none of these L2 solutions have the performance similar to Solana (in terms of latency and throughput), nor the sharding performance like Near, nor the parallel execution performance like Sui and Aptos. It is difficult to say who the ultimate winner will be at this point in time, and we do not yet know the answer, but Ethereum is indeed still in a leading position. For example, there may be some regional or critical reasons, or perhaps the Democratic Party uses one chain ecosystem while the Republican Party uses another. No one knows how to end these preferences, just as people favor something for various reasons.
Founder Evaluation
Edgy: One basic element of a protocol is the excellence of its founder. VCs have more opportunities to meet founders than retail investors. What do you think makes a successful founder? Also, is there any difference between Web 2 and Web 3 founders?
Ken: Evaluating founders requires looking at many angles. The first is that you must know the reasons behind what they are doing. If you easily feel that founders are just trying to take advantage of the crypto bull market, such as "the crypto bull market is here, I have to use it to make quick money" type of projects, then they really don't have much faith, right? Most successful projects in crypto were quietly built and prepared for financing when no one was paying attention, and finally achieved success when they adapted to market conditions. So if you want to find founders with real faith, they must have a strong crypto faith, be able to observe what is happening in the crypto world, and experience many dark moments to succeed. You may see many second-time or third-time founders who know what they are doing and will continue to do so. This is also why they will be more likely to get investment because they are experienced.
Other than that, there are really a lot of considerations that need to be taken into account in different fields. Founders need to solve many different problems. Some people are interested in token economics and protocol design, while others are interested in who you hire and where the company is going to be built. There are too many different issues to face. The best founders, like Mico, a partner at Electric, have explained to me many interesting comparative cases. If you want to create a company, you need 50 threads that include reasonable plans. If a founder pushes his thread without careful consideration, the thread will mostly fail in the implementation process. If you have 10 different threads, you will have multiple "well-considered" solutions to various problems the company faces, and you will have a greater impact.
Profit
Edgy: Whenever the token unlocking approaches, investors feel fear. They are afraid that venture capitalists will dump on us. How do you balance the long-term vision of supporting the protocol with gaining some profits? Do you have any standards for this?
Ken: Usually, we know that most significant successes are not achieved in just two or three years. For example, they happen once every ten years. If you look at the IPOs of traditional companies, all the recent ones have happened in models such as SPAC (Special Purpose Acquisition Company), and it still takes 6-9 years for the IPO to happen. We believe that such things rarely happen within these time frames unless the team leaves the project or there are other reasons, such as us losing interest in the project. Generally, we hold these tokens, and tokens have many use cases. In most cases, if there is a certain voting custody model in the project, we actually re-stake some of our unlocked tokens and lock them up again for different time periods. We want to get governance rewards or governance returns.
Generally speaking, we tend to take a long-term view. When you work at a venture capital firm, you are ultimately hired by investors to generate returns for them. From a risk management perspective, there are situations where we will have conversations with investors who say, "Hey, we think this is a long-term thing," but as with the current market, you have views on taking profits or holding long-term risk exposure, such as some investments that have multiplied by 100 times or more in the short term, which is rare, and most cases involve multiple returns. For any investment, going back to how venture capital works as I mentioned earlier, if your investment results in 2, 3, or 4 times in the short term, it's not actually the result you want from a venture capital strategy. You have to wait for 50 or 100 times.
But at least in the long term, if we profit from some investments early on, we will still be optimistic about them. However, this does not actually bring a sense of achievement to the investment. Math doesn't work that way, and we won't consider too much in such situations. As the project enters its sixth or eighth year, we begin to think, well, there is a lot of liquidity in the market, and the development is good or there are some amazing successes. The final valuation may be judged by us as the initial investors. This is the question we should start thinking about. Does it still make sense to exit?
Risk Investment Portfolio Construction
Edgy: Portfolio construction is crucial for retail investors. How do venture capital firms determine the size of their bets and portfolio construction? Do you have any rules that you always follow?
Ken: I think there are two aspects to this question. Firstly, generally speaking, venture capital firms have their own targeted check size and deployment scale. Often, this boils down to "how much money to do how much work". If there is no organization or fund to do this, or capable people to help founders work with them, it will be difficult for them to succeed. However, what is not clear to the outside world is that this needs to be determined based on the size of the fund, the investment stage, and the investment portfolio that looks diverse. But generally, in a given fund, there may be about 20 main funds, depending on how many employees you have and how large your investment team is. There may be special cases where one or two of your funds are super large, but generally the size of these 20 funds is often similar. Of course, some of them succeed and some do not. You will double down on the successful investments and choose to give up on the unsuccessful ones. Then, venture capital is a category of assets in a broader investment portfolio, at least that's how most of our investors think.
The service we provide to investors is a portfolio of investments in what we consider to be early-stage products, which we expect to yield high returns if successful. However, this is only our expectation and not all methods are effective. In fact, most methods fail. This is the reality of early-stage product investment, so I think it is difficult to compare it with how retail investors build their investment portfolios. Venture capital itself is an investment portfolio structure that requires mathematical calculations.
Real-world adoption
Edgy: What kind of products do we need to drive mass adoption of encryption in the real world?
Ken: I often ponder on some things. No matter when technological changes occur, the original intention of the products we build is always towards solving existing human problems. The people who use these products do not change over time, and their needs do not change over time either. It is only the way technology solves these needs that changes. Therefore, if you think about what DeFi is, it is a demand for financial services. As a financial demand, it has actually existed for a long time. Looking at NFTs, PFPs, or similar things, they are symbols of status, digital identity, or community membership. People want to stand out among their peers or want to be part of a community. These ideas have existed since the beginning of human history.
I often think that it's always difficult to know exactly what future products will be and in what form they will appear. To some extent, I have given up trying to predict future products, even those that I have personally worked on in my previous company. You never know how they will develop, even if you think you are the best expert in this field. Speaking of which, humans are always too complex, especially these network products. It's hard to predict the network dynamics of millions of people, whose behavior is based on their desire to satisfy any of their needs. So now I have deviated slightly from that kind of thinking and am trying to think more about what problems these products can solve and what will ultimately happen. When I think about it this way, I suspect it may be the next stage of things like NFTs. NFT-type products have already identified many social use cases, not just pure on-chain financial products.
I believe that our most urgent need right now is to get people accustomed to using wallets and these on-chain products at lower risk, because I believe that these products will eventually become the pinnacle of financial products like DeFi. There must be many people in the world pursuing DeFi because they are interested in this type of finance, but most of the Venmo and PayPal users, for example, are not interested in DeFi. However, they know how to operate their phones because they use them for many things. So, when these new financial applications appear in a familiar form, it will be easy to increase adoption.
However, currently I believe that if you are not someone interested in crypto finance, you have to overcome multiple barriers to become a crypto adopter. Therefore, I speculate that we need more application categories where people enter not to participate in DeFi, but to install their own wallets. For example, they may purchase PFP or other things, socialize, play games, and other lower-risk use cases. If we bring billions of people to online wallets, that will be the first step in bringing people into the "crypto space," and then they will realize that there is actually more to do in this space. This is what I believe will ultimately bring about a product with mass adoption.
Encryption Belief
Edgy: We are currently in a bear market. After lawsuits were filed by Terra, FTX, and SEC, some people have started to lose confidence. What makes you believe that there will be more adoption, usage, and innovation? Please give us some hope!
Ken: I believe that the belief in encryption comes from your belief in the world. For me personally, I have experienced many encryption adoption cycles. When I was young, no one had a PC computer. We have come a long way from that era to now where every household has a computer, and everyone is online. From America Online (AOL) to owning the internet, to now where everyone has a mobile phone, and everyone can send their photos to social media and put them online. I have seen all of these changes.
There is one more thing. In retrospect, I think you may have noticed that there were many problems during the early adoption phase of these applications. You may have had an experience that seemed ordinary at the time, but during your experience, you thought, "This is the future." I still remember clearly in high school when my friend and I used a dial-up modem to order something, like a music CD. At that time, you would receive a music catalog on paper, and then tear off a page from the back, write down the numbers of all the CDs you wanted, and send it along with the paper. Then, you might receive a box with your favorite music CDs a few weeks later. Compared to filling out forms in web browsers like Netscape 1.0, this was a popular method at the time.
Just like filling out forms in web browsers back then, there was no security or confidentiality, but they appeared anyway. Although it was not yet a prosperous period, if you experience it, you will feel that "this is the best way we can use so far", and to some extent, everyone will do it. So I think encryption is the same. You can only have hope if you have experienced it. What's more interesting is that many people are saying that encryption will be adopted, perhaps currently smaller than emerging economies. But now the traditional financial infrastructure is not that good, and many US financial infrastructures are actually very inconvenient. But now, you will find that "as long as I know someone's address, I can buy 5,000 stable coins for him with $5,000". I can trade crypto 24/7, and it is easy to confirm the transaction. It is divided into immediate termination (settlement) and relatively immediate termination. If you have experienced all of these, it feels like the first time you bought something on the Internet. It takes time to achieve these, but the current encryption is obviously a better way to deal with it, and then you experience DeFi and other encryption services.
I believe my confidence in encryption comes from experiencing many cycles like this, and also experiencing the world's skepticism of encryption in the early days. However, there are conflicts in my mind, but there is always a sentence: "Oh, this is obviously a better way to do things." In the end, I saw the victory of technology, even though many people don't know what encryption is. Encryption is going through this cyclical path, and the widespread adoption of curves may take decades, but it will eventually reach its peak.
SEC
Edgy: SEC is suing everywhere. A few weeks ago, they sued Binance and Coinbase. Should we in the crypto industry be more concerned about these types of things?
Ken: In fact, strategically speaking, I think the SEC's crackdown on Coinbase may be a mistake. The SEC is good at cracking down on the "bad guys" that most people have in mind. When the SEC does this, most people will say, "Maybe they are expanding their regulatory scope or something else," but do we really want to defend the SEC? There are many projects in the industry that are considered garbage, but most people are not willing to take the risk of ruining their reputation. But as you said, "I think Coinbase may be a very popular and respected company in the cryptocurrency industry, always insisting on doing things the right way, trying to communicate with the SEC, and trying to push the conversation between them." So I think if there is a company (including Binance) that can provide support for people in the United States who are interested in cryptocurrency, it should be Coinbase. But currently, it seems that Coinbase is also joining this war of US regulation and will not give up. If you want the entire community to unite against you, then continue to crack down on Coinbase. I think in a sense, the SEC's way of regulating Coinbase to crack down on Crypto is strategically unreasonable.
I believe that this is likely to end in a type of appellate court case that is very high, rather than the Supreme Court, or it will stimulate legislative action because in the political arena, something can be done to benefit from encryption, even if Coinbase is closed or severely hit, it will still exist in other areas of encryption.
Become a full-time analyst
Ken: The criteria for determining the qualifications of a full-time analyst may vary from company to company. In my opinion, we tend to prefer individuals with a technical background. Crypto is a field that involves multiple disciplines, and fundamentally, we need to analyze various stages of the process. If we were in a more mature industry, we would have sources like Bloomberg data or every protocol fully compliant. It requires a skill set of digital computation and modeling practice to understand some projects and industry changes. Perhaps some people have traditional analytical skills, such as quantitative analysis, and they can also work, but this is not what we need in crypto.
You need to have the ability to analyze Dune, solve problems, or run a node alone to extract and analyze data to find the problem. You also need to understand things like the differences between ve contracts on Curve and Balancer and why they are different. You need to read project Docs, but if there are no Docs, you need to read its code. Therefore, if you don't have the ability to explain things technically in this industry, you are not a qualified analyst. We also look at how much contribution you can make in addition to your understanding. Technical background - this is also our recruitment standard.
Book Recommendations
Edgy: Do you have any book recommendations for those who want to have critical thinking? What books should one read to become a better investor?
Ken: For me, books about the history of financial development are particularly helpful, especially those that can give me some inspiration in the DeFi field. I remember there is a book called "The Ascent of Money: A Financial History of the World", and another one about hedge funds, which seems to be called "More Money Than God: Hedge Funds and the Making of a New Elite". The title may be a bit exaggerated, but the content tells stories about large hedge funds, which can help me understand how they succeeded or failed completely. Hedge funds have a long history, and understanding these contents can also help me better understand the development of such financial structures, such as the fact that there are some loopholes and ways that may cause the failure of the financial system that should be well-regulated.
There is another book I would like to recommend called "One Nation Under Gold", which is about the history of gold in the United States. I believe that all the books I like are history books, and you can see some "incredible" similarities between the past financial development history and the current Crypto development trajectory in these books. This is really great. As I mentioned before, humans have not changed, only technology is changing. Many historical stories can give you some hints about how people should act in specific environments when the world changes. What you need is insight to help you understand or at least have a mental model to face the changing world.
Yes, I prefer history books because they can connect the past with the present. I also enjoy authoritative books on the dilemma of innovators and the business cycle, just to better understand what changes are happening in the world under technological change.
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