Understanding the Current Crypto VC Landscape
The recent outperformance of meme coins compared to venture capital (VC)-backed projects has led many market participants to criticize VCs and their investments. While some criticisms are valid, others lack a deep understanding of the nuances of private markets.
Projects often raise multiple rounds of funding before a Token Generation Event (TGE) to scale their offerings. In exchange for providing riskier early-stage capital, venture investors receive tokens at lower valuations. Projects benefit from strategic capital, such as marketing support, tokenomics consulting, and access to VC networks—resources typically unavailable to smaller retail investors. As funding rounds progress and valuations change, the types of VCs involved also evolve, as each firm has different risk profiles and fund sizes.
Most crypto VCs manage assets below $50 million, allowing them to invest in pre-product stage projects at lower valuations. To align the long-term interests of VCs and other stakeholders, tokens acquired through private markets are subject to cliff and vesting schedules.
During the vesting period, VCs often see significant unrealized gains. They may hedge through derivatives or arrange over-the-counter (OTC) trades with private buyers. However, they face constraints due to investment mandates, capital requirements, and liquidity limitations. Some VCs may also lack the execution knowledge and risk management frameworks needed to handle liquid positions, creating additional barriers to effective hedging.
As a result, OTC trading desks have emerged as the most viable option for VCs to realize profits before TGE. While secondary market data on global trade volume and valuation is public, the OTC market operates differently. Trades are conducted privately, making it difficult for unified platforms to track global transaction data. Although estimating the size of the OTC market is challenging, reported activity from OTC desks can reveal trends.
OTC desks, such as STIX, have processed over $200 million in volume since late 2023. STIX primarily handles assets among the top 200 altcoins (both major and minor). Over the past year, significant OTC activity has occurred, including liquidations (e.g., FTX estate sales of locked $WLD and $SOL) and direct treasury trades by token foundations (e.g., $SUI, $AVAX). This market is expected to see long-term growth, driven by VCs seeking early profit realization and post-TGE projects in need of capital.
The Rationale for OTC Trading: Price Discovery in Private Rounds
Below is a list of VC-backed tokens and their performance since TGE. Most of these tokens struggled to maintain their high valuations three months later, making it difficult for VCs to realize their investments at peak fully diluted valuation (FDV) once unlocking began. This price action harms all market participants. Liquid market buyers who purchased at higher prices eventually become structural sellers alongside VCs receiving their vested tokens.
In fundraising cycles, the common practice of increasing valuations primarily privatizes upside potential and market optimism. This phenomenon exposes retail investors to significant negative price discovery after TGE. Without sufficient incentives for public market participants to support a project, a lose-lose situation arises. Both VCs and retail investors face challenges in the long term as markets trend toward fair value.
We strongly believe that leaving room for upward price discovery in secondary markets helps build a stronger support base, ultimately extending a project’s lifespan. One existing method to facilitate pre-TGE price discovery for retail participants is through spot and/or pre-market trading. In pre-market trading, spot tokens listed pre-TGE act as promissory notes (i.e., IOU tokens) redeemable for the underlying asset at TGE. Alternatively, perpetual pre-market contracts are synthetic markets designed to track the price movements of the underlying asset (often hedged via swap options issued by foundations).
Accessible derivatives platforms like Aevo, Whale Market, and major CEXs offer pre-market trading. However, these products carry liquidity and incremental risks. Exchanges may face significant losses if liquid market buyers purchase pre-TGE tokens that perform well post-TGE. Participants must also consider counterparty risks, such as lack of legal claim rights to the underlying asset or the exchange’s inability to absorb losses from profitable pre-market traders.
Another way to facilitate upward price discovery in secondary markets is to expose private markets to downward price discovery before TGE. This could reduce markups between funding rounds. The chart below illustrates a simplified comparison between two hypothetical projects, highlighting the potential benefits of OTC trading for post-TGE performance. If a down round occurs between Series A and TGE, where existing investors sell their allocations at a loss, it may signal to the team that their TGE valuation should be lower than initially expected. This adjustment helps align project valuations with market expectations.
If a project eventually succeeds and reaches the same post-TGE equilibrium price, having a larger proportion of profitable token holders from liquid markets can help sustain support for the project.
Inside Crypto OTC Desks
While allowing more downward price discovery in private markets sounds ideal, challenges arise due to legal restrictions and the complexity of trade types. There are two main types of OTC trades: outright purchases and funding rate arbitrage.
Outright purchases typically attract valuation-sensitive investors seeking directional exposure to the underlying asset. This process involves taking over SAFT/SAFE contracts from prior investors or obtaining tokens directly from project teams. When purchasing SAFT/SAFE contracts from early investors, trades are usually priced at face value or with a 25–30% pre-TGE premium.
In contrast, funding rate arbitrage buyers are less sensitive to valuation. Their profits depend on the discount rate, the funding rate of perpetual contracts, and the exchange rates for these tokens, achievable through delta-neutral strategies. STIX reports that such buyers often secure discounts of up to 60–65% to execute these strategies. However, this opportunity comes with three caveats: the availability of perpetual contracts for the underlying asset, sufficient liquidity to execute trades, and ensuring the opportunity cost of collateral does not exceed the profit from the discount rate and spot price difference. These buyers require significant collateral to avoid liquidation of their short perpetual hedges, as any liquidation from short squeezes could render the trade unprofitable.
Due to the different types of OTC buyers, large OTC trades announced by token foundations should be viewed critically. Such trades may reflect price arbitrage opportunities rather than genuine long-term demand.
Challenges in the OTC Market
One issue in OTC trading is the presence of anti-assignment clauses in contracts. These clauses prevent investors from transferring their shares to third parties (new OTC buyers) without founder approval. STIX reports that such clauses exist in 30–45% of SAFTs.
If a foundation blocks an OTC trade, buyers must bear additional counterparty risk. In the absence of a robust legal framework accompanying "formal trades," buyers have limited recourse in cases of seller misconduct. This risk is exacerbated for smaller funds, as they may face less reputational impact compared to larger, more established VC funds.
In 2021 and 2022, fundraising levels reached all-time highs, fueled by pandemic-era stimulus and promises of high returns from early fundraising in 2019 and 2020. During this frenzy, deals closed quickly as VCs were capital-rich and eager to deploy funds. However, the bear market of 2022/2023 brought drastic changes. Down rounds became more common, risk appetite diminished, and TGE delays became the norm. These shifts in market dynamics, coupled with several high-profile collapses (e.g., Terra, FTX, 3AC), led to stagnant fund performance and reduced capital inflows into crypto VCs.
Declining investor demand for venture capital is evident. PitchBook reports indicate that new funds are taking longer to raise capital (21 months in 2024 vs. 6 months in 2021). Additionally, VC funds raised in 2021 and 2022 will soon enter the divestment phase of their 4+2 structures, introducing structural sellers to secondary markets.
Underperforming crypto VC funds are exploring alternative strategies, such as liquid token investments or OTC trading. While the latter often comes with cliff and vesting terms, investment timelines are generally shorter than traditional VC structures, benefiting time-sensitive investors. If OTC trading becomes more common, platforms like STIX could benefit from surging market demand by offering a value proposition as a full-service desk addressing a fragmented market. 👉 Explore advanced trading strategies
The Future of Venture Capital in Crypto
The current trend of drying crypto VC funding raises existential questions for the industry. One possible path forward is adopting an activist approach. Instead of betting on the next "0 to 1" opportunity, funds could focus on acquiring liquid tokens and leveraging their expertise and networks to scale projects from "1 to 10."
This shift could align more closely with market realities and create sustainable growth models for both investors and projects.
Frequently Asked Questions
What is an OTC trade in crypto?
OTC trades are private transactions conducted directly between parties, outside of public exchanges. They are often used for large-volume trades to avoid market slippage and are common in crypto for vested tokens or pre-TGE allocations.
Why do VCs use OTC desks?
VCs use OTC desks to realize profits from their investments before tokens are fully vested or publicly tradable. This helps them manage liquidity, hedge risks, and navigate regulatory or contractual constraints.
How does pre-market trading work?
Pre-market trading allows investors to trade tokens before they are officially listed on exchanges. This can involve IOU tokens or synthetic contracts that track the expected value of the token post-TGE, though it carries unique risks like counterparty exposure.
What are the risks of OTC trading?
Key risks include counterparty risk, lack of transparency, legal constraints like anti-assignment clauses, and potential liquidity issues. Buyers must conduct thorough due diligence to mitigate these risks.
How is the crypto VC landscape changing?
The crypto VC landscape is shifting towards shorter investment horizons, increased use of OTC markets, and a focus on liquid tokens. This reflects broader market trends and the need for more flexible investment strategies.
Can retail investors participate in OTC markets?
Typically, OTC markets are accessible only to institutional investors or high-net-worth individuals due to high minimum trade sizes and complexity. Retail investors usually gain exposure through public exchanges or derivatives platforms.