Dialogue with Electric Capital partner Ken: We are a product-oriented VC with a focus on tech talent
Original author: Edgy, DeFi researcher
Original compilation: Leo, BlockBeats
Electric Capital is one of the more active venture capital firms in the industry. In March 2022, they raised $1 billion for two funds. Some of Electric Capital's more well-known investments include Frax, dYdX, Near Protocol, Eigenlayer, etc. Recently, DeFi researcher Edgy interviewed Electric Capital partner Ken Deeter. Ken Deeter is a partner on the investment team at Electric Capital, focusing on DeFi, crypto gaming, crypto collectibles, and other areas. With 15 years of experience leading teams and developing products as a software engineer and product manager at VMware and Facebook, Ken and Edgy had an engaging conversation about "how VCs consider making investments, Electric's investment perspective, 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 organized and compiled the following:
Note: This interview does not constitute any investment advice. It is entirely Ken's personal thoughts.
VC's Broad Net
Edgy: Venture capital firms have large portfolios and numerous investments. Some joke that this is a method of casting a wide net and then praying that the investment projects succeed. Why is that?
Ken: Many VCs have their own theories and professional standards. It's important to know that 90% of early-stage investments will go to zero; this is an inherent risk of investing in early projects. Indeed, many projects have excellent founders, ideas, or other great attributes, but the outcomes can still be poor due to various negative factors, perhaps Covid-19 or Powell's wrong decisions. In terms of casting a wide net, I believe all investments carry risks. You might invest in 40 projects, but as long as one project succeeds, your losses on the other projects are far outweighed by the benefits of discovering a successful project. So, investing broadly is just a way to diversify risk; it's a mathematical mindset. As for how to choose investment projects, each VC has its own ideological framework and makes selections based on certain aspects.
Electric Capital's Distinction
Edgy: There are many venture capital firms in the crypto space. How does Electric Capital stand out?
Ken: There are two points: First, we have a product-centric mindset. Our core team has spent a lot of time researching products and startups, and many of our colleagues have experience in engineering and design, so we tend to share similar ideas with founders who can create great projects. Especially in the crypto space, many teams primarily copy other projects; they take shortcuts and aim to create tokens and engage in token economic games to make quick money. If we don't feel that "this person is genuinely trying to solve some problems in the crypto space," we will avoid such people and projects.
Second, we have a very strong technical inclination. For example, I was previously an engineer, and one of Electric Capital's co-founders is also an engineer. We previously worked together on some engineering projects at Facebook. Half of our team consists of engineers, and we have the capability to conduct technical due diligence. We genuinely enjoy participating in the technical aspects of every project we invest in. For instance, we think about issues like what to do if gas costs are too high or if there are problems with proxy contracts. At that point, we assist in addressing some of the detailed issues. The crypto industry is still in its early stages, and we need to know that the team is indeed developing in the right direction and considering some tricky case issues. On the other hand, once we participate in certain projects, we also handle some on-chain issues, participate in governance, and provide liquidity to the protocol. We need some project teams to understand what we are doing and also let the project parties know how to leverage VC resources to help the protocol succeed, such as in designing the protocol and token economics.
In summary, we are a team focused on product orientation and are predominantly technical experts.
Deal Flow
Edgy: Many people want to enter the venture capital industry. How does one become a venture capitalist? How do you attract quality deal flow and attention from promising protocols?
Ken: Regarding how to become a VC, I believe there is a conventional path. To be honest, I joined Electric Capital quite late; other co-founders have been in VC longer than I have, so they have some impressive investment records. After I joined Electric Capital, I needed to achieve some results, especially in the DeFi space. But basically, this crypto game is the same; when you invest in some projects, you are also building your own reputation. This means you bring significant value to the founders you work with. They need help in areas where you excel, and you have to roll up your sleeves and get to work. You might have only written a $25,000 check or something else, but you genuinely helped them succeed in certain matters.
In reality, most founders chat with each other to gain deeper insights. Some companies will do very well. For example, when some startup founders are considering starting a company or raising funds, they usually reach out to other founders and say, "Hey, who is the most valuable person in your company?" They often respond, "You should go talk to Ken or someone else because those people are truly valuable and capable."
This is also what I understand as the best "deal flow." Once you get on the right track and bring a brand into a normal development phase, people start to pay attention to you. They will say, "I know Electric Capital; they are impressive." Investing in a project is actually quite easy, but I want to say that we still adhere to some interesting matters, gaining early access to projects from their founders so that we can know if we are ready to participate.
Many founders I have worked with continuously pass information to me, saying, "Hey, I just spoke with him, and he wants to chat with Electric Capital. Can you set up a time to meet?" This kind of conversation happens frequently around me. All of this provides value and guides you to become a very effective investor.
L1 and L2
Edgy: How do you view the various Layer 1 and Layer 2 solutions in 2023? Did Ethereum win against Layer 2?
Ken: I remember in 2021 and 2022, especially in 2022, gas fees on Ethereum were extremely high, which also provided opportunities for other L1s because their transaction speeds would be faster under high gas conditions. Of course, during this bear market, they have suffered significant blows, so we began to focus on the technology of all L2s. I don't think we can smoothly write the story of "the correct architecture of L2" at this point; it seems Ethereum is still mainstream, and L2s merely exist. To surpass Ethereum, at least in terms of transaction data, you need to add a zero. If Ethereum is a complete entity, ZK technology might take us a bit further.
However, at present, these L2s do not have performance similar to Solana (in terms of latency and throughput), nor do they have sharding performance like Near, or parallel execution performance like Sui and Aptos. I think it's difficult to say who the ultimate winner is at this point; we don't know the answer yet, but Ethereum is indeed still in a leading position. For instance, there may be some regional or critical reasons; perhaps Democrats use one chain ecosystem while Republicans use another. No one knows how to resolve these preferences, just as people favor certain things for various reasons.
Evaluating Founders
Edgy: A fundamental element of a protocol is the quality of its founders. VCs have more opportunities to interact with founders than retail investors. What do you think makes a successful founder? Additionally, is there a difference between Web 2 and Web 3 founders?
Ken: Evaluating founders requires looking at many angles. The first is that you must understand the reasons behind what they are doing. If you easily sense that founders are just trying to take shortcuts, like "the crypto bull market is here; I need to exploit it to make quick money," then they really have no faith, right? Most successful projects in crypto have quietly built and prepared for funding for a long time when no one was paying attention, and they only succeed when they adapt to market conditions. So, you want to find founders who genuinely have strong beliefs; they need to have a strong crypto conviction, be able to observe what is happening in the crypto world, and endure many dark moments to achieve success. You may see many second-time and third-time founders; they know what they are doing and will continue, which is why they find it easier to secure investments because they are experienced.
Besides that, different fields require a lot of considerations. Founders need to solve many different problems. Some are interested in token economics and protocol design, while others care about who you hire and where the company is going to be based. They face too many different issues. The best founders, like Mico—one of Electric's partners—have explained many interesting comparative cases to me. To create a company, you need to have 50 threads with reasonable plans. If a founder pushes forward a thread without careful consideration, that thread will mostly fail during implementation. If you have 10 different threads, you will have multiple "well-considered" solutions when facing various problems in the company, and you will gain greater influence.
Profitability
Edgy: Whenever token unlocks approach, investors feel fear. They worry that VCs will dump on us. How do you balance supporting the long-term vision of a protocol with realizing some profits? Do you have any standards for this?
Ken: Generally, we know that most significant successes do not happen in just two or three years; they occur about once every ten years. If you look at traditional company IPOs, all the recent occurrences in SPAC (Special Purpose Acquisition Company) models still require 6-9 years to reach an IPO. We believe that such events rarely happen within these time frames unless the team leaves the project or for other reasons, such as us no longer being interested in that project. Generally speaking, we tend to hold these tokens, and tokens have many use cases. In most cases, if there is some sort of voting escrow model in the project, we will actually re-stake some of our unlocked tokens again, locking them up for different periods. We want to earn governance rewards or governance income.
In general, we take a long-term view. When you work at a venture capital firm, you are ultimately hired by investors to create returns for them. From a risk management perspective, in some cases, we will have conversations with investors, and they will say, "Hey, we think this is a long-term thing." But just like the current market, you have some views on taking profits or holding long-term risk exposure. For example, some investments may have multiplied by 100 times or more in the short term, which is rare. Most of the time, it's a multiple of profits. For any investment, going back to what I said earlier about how venture capital works, if your investment results in a 2, 3, or 4 times return in the short term, it is not the outcome you want from a venture capital strategy. You need to wait for 50 times or 100 times.
But at least in the long term, if we profit early from certain investments, we will also be optimistic about them. However, this does not actually bring a sense of achievement to the investment; math does not work that way, and we do not consider too much in such situations. As projects enter their sixth or eighth year, we start to think, "Okay, there is a lot of liquidity in the market, things are developing well, or there are some amazing successes." Ultimately, the valuation may be judged by us as the initial investors, and this is when we should start to think about whether an exit still makes sense.
Venture Capital Portfolio Construction
Edgy: Portfolio construction is crucial for retail investors. How do venture capital firms determine stake sizes and portfolio construction? Do you have any rules you consistently follow?
Ken: I think this question has two aspects. First, generally speaking, venture capital firms have their own target check sizes and deployment sizes. Many times, it boils down to "doing as much as you have money for." If there is no organization or fund to do this or capable people to help the founders they work with, they will struggle 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 stage of investment, and the diversity of the portfolio. But generally, in a given fund, there may be about 20 main funds, depending on how many employees you have and the size of your investment team. There may be special cases where you have one or two super-large funds in your portfolio, but generally, the sizes of these 20 funds tend to be similar. Of course, some of them succeed while others do not. You will double down on the successful investments and abandon the unsuccessful ones. Then, venture capital is an asset class within a broader investment portfolio; at least most of our investors think this way.
The service we provide to investors is a portfolio of early-stage products we believe in, which, if successful, will yield high returns. But this is just our expectation; not all methods are effective. In fact, most methods fail, which is the reality of early-stage product investment. Therefore, I think it is difficult to compare this with how retail investors build portfolios because venture capital itself is an inherently mathematical investment structure.
Real-World Adoption
Edgy: What kind of products do we need to drive more real-world crypto adoption at scale?
Ken: I often think about this. Regardless of when technological changes occur, the purpose of the products we build is to solve existing human problems. The users of these products will not change over time, nor will their needs; only the ways technology addresses these needs will change. So, if you think about what DeFi is, it is the demand for financial services. As a financial need, it has existed for a long time. Looking at NFTs, PFPs, or similar things, they symbolize 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 it is always difficult to know exactly what future products will be or in what form they will appear. To some extent, I have given up trying to predict future products. Even for products I have personally worked on in previous companies, you don't know how they will evolve, even if you think you are the best expert in that area. Speaking of which, humans are always too complex, especially with these network products. It is difficult to predict the online dynamics of hundreds of millions of people, as their behaviors are based on their desires to satisfy their needs. So now I have slightly deviated from that line of thought, focusing more on what problems these products can solve and what will ultimately happen. When I think this way, I suspect it might be the next stage for products like NFTs. NFT-like products have already established many social use cases, not just purely for introducing on-chain financial products.
I believe our most urgent need now is to help people get accustomed to operating wallets and using these on-chain products with lower risks because I think these products will ultimately become the pinnacle of finance like DeFi. There are certainly many people in the world pursuing DeFi because they are interested in this type of finance. However, users of Venmo or PayPal, for instance, are mostly not very interested in DeFi, but they know how to operate their phones because they have been using them for many things. So, when this new financial application appears in a form they are familiar with, it will be much easier to increase adoption.
However, at present, I think if you are not someone interested in crypto finance, you have to overcome multiple barriers to become a crypto adopter. So I suspect we need more categories of applications where people enter not to participate in DeFi but to install their wallets. For example, they might buy PFPs or other things, engage in social activities, gaming, or other lower-risk use cases. If we can bring hundreds of millions of people into online wallets, that is the first step to getting people into the "crypto space." At that point, they will realize that there is actually much more they can do in this space, which I believe will ultimately lead to large-scale adoption.
Crypto Belief
Edgy: We are currently deep in a bear market. After Terra, FTX, and the SEC lawsuits, some people are starting to lose faith. What makes you confident that there will be more adoption, usage, and innovation? Please give us some hope!
Ken: I believe that the belief in crypto comes from your belief in the world. Personally, I have experienced many cycles of crypto adoption. When I was younger, no one had PCs. We have come from that era to now, where everyone has a computer, to everyone being online, from AOL in the U.S. to having the internet, to now everyone having a smartphone, to everyone being able to send their photos to social media and put them online. I have witnessed all these transformations.
One more thing is that, in hindsight, I think you should also notice that there were many problems during the early adoption phase of these applications. You might have had an experience that seemed ordinary at the time, but during the process, you would think—"This is the future, right?" I still clearly remember in high school when my friend and I used dial-up modems to order something, like music CDs. At that time, you would receive a paper music catalog, tear off a page from the back, write down all the CD numbers you wanted, and then send it along with that paper. You might receive a box with your favorite music CDs weeks later. Compared to filling out forms in web browsers like Netscape 1.0, this was a very popular method at the time.
Just like filling out forms in web browsers back then, there was no security or confidentiality, but they just appeared. Although it wasn't the prosperous time yet, now, as long as you experienced it, you would feel, "This is the best way we can use so far." To some extent, everyone would do this. So I think crypto is the same; you only have hope if you have experienced it. Interestingly, many people say that crypto will be adopted, perhaps currently smaller than emerging economies. But now, traditional financial infrastructure is indeed not that great; much of the U.S. financial infrastructure is actually very inconvenient. But now, you find that "as long as I know someone's address, I can send him $5,000 to buy 5,000 stablecoins." I can trade crypto around the clock and easily confirm transactions. It is divided into instant settlement and relatively instant settlement. If you have experienced all these things, it feels like the first time you bought something on the internet. It took time to achieve this, but current crypto is clearly a better way to handle it, and then you experience DeFi and other crypto services.
I believe my confidence in crypto comes from having experienced many cycles like this, and I have also experienced the early skepticism of the world towards crypto. But at the same time, there are some conflicts in my mind, but there is always a saying: "Oh, this is obviously a better way to do things." Ultimately, I still see the victory of technology, even though many people do not know what crypto is. Crypto is undergoing this cyclical path, and these large-scale adoption curves may take decades, but they will eventually reach a peak.
SEC
Edgy: The SEC is suing everywhere. A few weeks ago, they sued Binance and Coinbase. Should we in the crypto space show more concern about such matters?
Ken: In fact, strategically, I think the SEC's crackdown on Coinbase may be a mistake. The SEC is very good at targeting the "bad guys" in most people's minds. When the SEC does this, most people will say, "Perhaps they are expanding their regulatory scope or something else." But should we really defend the SEC? There are many projects in the industry that people consider to be trash, but most people are unwilling to take the risk of ruining their reputation. But as you said, "I think Coinbase is a well-liked and respected company in the crypto industry that has been trying to do things the right way, attempting to communicate with the SEC and do what they should do, trying to advance their conversations." So I think if there is a company (including Binance) that can support those interested in crypto in the U.S., it should be Coinbase. But it sounds like Coinbase is also going to join this regulatory battle in the U.S. and will not back down. If you want the entire community to unite against you, then keep targeting Coinbase. I think, to some extent, the SEC's way of regulating Coinbase to attack crypto does not make strategic sense.
I think this is likely to end up in a very high appellate court-type case, rather than the Supreme Court, or it may stimulate legislative action because, in the political realm, there is something to be gained by doing something about crypto. Even if Coinbase is shut down or severely attacked, it will still exist in other areas of crypto.
Becoming a Full-Time Analyst
Edgy: Many people are particularly interested in becoming full-time researchers or analysts. If someone wants to become an analyst at a venture capital firm like Electric Capital, what should they do?
Ken: The criteria for determining full-time analyst qualifications may vary by company. At least from my perspective, we tend to prefer people with technical backgrounds. Crypto is a field that involves multiple disciplines. Fundamentally, we need to analyze various stages of the process. If we were in a more mature industry, there would be sources like Bloomberg data or every protocol being fully compliant. You need to have skills in digital computation and modeling exercises to understand some projects and industry changes. Perhaps some people have traditional analytical skills, like quantitative analysis; they can work, but that is not what we need in crypto.
You need to have the ability to analyze using Dune, solve problems, or you can run a node independently, extract and analyze data to find issues. 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 in the absence of docs, you have to read the code. So, if you do not have the ability to technically detail some things in this industry, you are not a qualified analyst. It depends on what you can understand and how much you can contribute. A technical background—this is also our hiring standard.
Book Recommendations
Edgy: For those who want to have critical thinking, do you have any recommended books? What should one read to become a better investor?
Ken: Books about the history of financial development and evolution have been particularly helpful for me, especially those that can inspire me in the DeFi space. I remember 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 is slightly exaggerated, but the content tells stories about large hedge funds, which helps in understanding how they succeeded or completely failed. Hedge funds have a long history, and understanding these contents can also help me better understand the evolution of financial structures, such as the current financial system, which should be well-regulated but has some potential loopholes and methods that could lead to its failure.
Another book I want to recommend is "One Nation Under Gold," which is about the history of gold in the U.S. I think all the books I like are historical. You can see some "incredible" overlaps between past financial developments and the current trajectory of crypto in these books. That is really great. Going back to what I said earlier, humans have not changed; only technology has changed. 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 historical books. These books can connect the past with the present. I also like authoritative books about the innovator's dilemma and business cycle patterns, just to better understand what changes are happening in the world due to technological changes.