Security tokens have rapidly developed as one of the most important trends in the crypto asset ecosystem. As a result, we have seen an explosion on the number of startups trying to enable different components of crypto-security solutions. The implementation of those startups requires levels of capital that are not available in venture or private equity markets. Consequently, the security token space might be headed for a familiar phenomenon in funding cycles: the series A crunch.
Before venturing too deep in the series A crunch arguments with respect to security tokens, I would like to clarify that my intentions here are not to project any cataclysmic short-term future for the security market space but rather analyze an important market dynamic that should not be ignored. I also understand that this post might be hard to read by many passionate founders invested in security token products but, hopefully, the arguments are pragmatic enough that help provide a better perspective about the immediate future of the security token market.
The series A crunch is a phenomenon that occurs in fast-growing, and often overhyped, markets when there is a misalignment between the capital available for seed rounds, the value captured by startups in the market and the capital pools available for series A financing. From a market dynamics perspective, a series A crunch results on a large number of startups raising angel or seed rounds but not delivering enough value to make it to a series A. Graphically, the series A crunch looks similar to the following:
Conceptually, a series A crunch is the consequence of relatively easy access to early stage capital in a market that is developing faster than its venture investing pools. Any series A crunch typically results in a large percentage of startups going out of business and a small number of well capitalized companies leading the charge into the next phase of the market that will then produce more startups.
Series A Crunch and Security Tokens
In the context of security tokens, a series A crunch seems inevitable. With the exception of a few well capitalized companies, most security token startups raised small funding rounds 10–12 months ago which means they are entering the next phase of their funding cycle. Unfortunately, the access to series A capital in the security token space is still very limited and the technological foundation of the space still very immature. That seems like the perfect storm for a series A crunch. In case you are still skeptical, let’s go a bit deeper and explore some of the key market dynamics that are conspiring towards a series A crunch in the security token space. Below, I listed 10 arguments that justify the thesis of a security token series A crunch:
1. Most Venture Funds Haven’t Developed a Thesis About Security Tokens: Excepting tier1 funds like Andreessen-Horowitz or Union Square Ventures, most VC funds haven’t incorporated security tokens as part of their investment thesis and are waiting for the market to develop a bit more before placing bets.
2. Security Token Startups Capitalized in a Healthy 2017 Crypto Climate: The crypto-boom of 2017 made it relatively easy for security token startups to raise angel or seed rounds but not enough for a series A.
3. Crypto Venture and Hedge Funds are Underperforming: The segment of the investment community that is super bullish on crypto such as the crypto hedge funds have vastly underperformed in the current market and are experiencing a capital crunch themselves.
4. The Security Tokens Market is Likely to Take Years to go Mainstream: I think the optimism within the security token startup community doesn’t correlate with the realities of the market. Every data point in the space indicates that the security token market might take a few long years to achieve any level of mainstream adoption.
5. There Haven’t Been Many Great Security Token Projects: Without any interest of criticism any specific project, I think we can all agree that most security tokens issued until now haven’t been great. There is a lot of expectations around the trading of tokens like Science and Blockchain Capital so hopefully that will contribute towards the momentum in the market.
6. Public Technology Market Corrections: Technology stocks are experiencing a fairly decent correction with about 80% of the tech sector trading at an average 10% down from their 52-week highs. Bearish sentiment in public tech market typically translates into a conservative tech venture investing climate.
7. Crypto Market Bloodbath: The massive drop in the value of cryptocurrencies is contributing to the skepticism of the venture community.
8. Security Token Exchanges are Taking a Long Time to Launch: An integral component of the security token market such as exchanges is taking some time to materialize causing most investors to adopt a wait-and-see strategy.
9. Lack of Crypto-Economics: Most security token platforms in the market haven’t injected clear crypto economics into their products or don’t even have a token. Token economics has been one of the most attractive factors for venture investors deploying capital into crypto and blockchain startups. The absence of that factor contributes towards the financial skepticism of most venture groups.
10.Limited Monetization and Scalable Revenue Models: From a venture investor perspective, there is only a handful of security token startups that have delivered enough value to justify a series A investment. Excepting vehicles like stable coins, most monetization in the space has been on a project-by-project basics which is relatively hard to scale. Until recurrent and scalable revenue models start becoming more viable for security tokens, most venture investors might remain on the sidelines.
The Side Effects of a Series A Crunch in the Security Token Market
If we accept that a series A crunch in security tokens is mostly an inevitable part of the evolution of the space, then the next logical step is to try to assess what will happen during this market phenomenon. Here, we can draw some lessons from recent technology movements such as big data or virtual reality that went through their own series A crunch. Here are a few ideas:
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Many Security Token Startups Will Shut down in the Next Few Months: It is likely that many of the security token vendors that are not able to raise significant funding in the next few months will be forced to shutdown
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Funding will Be Mostly Allocated to Exchanges and End-To-End Platforms Tokenization Platforms: In this early stage of the market, end-to-end platform offerings result more attractive to VCs and are likely to capture some important part of the capital deployed in the space.
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Vertical-Strategic Investors will be Relevant in the Next Phase of the Security Token Market: In the absence of mainstream venture investing, sources of capital from vertical groups in industries such as real estate or finance might take a prominent role.
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More Stablecoins and Utility Tokens: Look out for more players launching stablecoins a la TrustToken or SmartValor or incorporating utility tokens into their offering to improve monetization.
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Only a Handful of Startups Survive to the Next Phase of the Market: Based on the current funding raised by security token startups, I think is pretty likely that the next phase of the market will be led by a very small number of companies that are well capitalized to wait for the development of the space and build the correct infrastructure building blocks. After that, we should see a reemergence of new security token startups that tackle new areas of the market.
Making predictions about markets has never been my forte and not something I particularly enjoy doing. The confluence of events in the security token market is making a series A crunch looks like a very likely phenomenon. While painful in the short term, the correction might remove a lot of the noise in the security token space and catalyst the best projects into the next phase of the market. One thing is for certain, we are going to find out soon who is for real in this space.