"Beating" VC, the crypto field has become the "wealth handbook" for KOLs

Original: bloomberg

Compiled by: Ning, Tuo Luo Finance

KOLs are undoubtedly a very special presence in the crypto field.

Due to often having a large following, they can serve as powerful tools for attracting attention, but they are also strong candidates for exploitation. To use a somewhat inappropriate metaphor, KOLs can act as both referees and athletes.

However, in an industry where sentiment and liquidity play crucial roles, KOLs, who are much closer to frontline investors than institutions, largely bring more benefits than drawbacks. After all, the marginal cost of issuing tokens is close to zero, but liquidity is priceless. Clearly, project teams have also sensed this favorable wind.

In recent months, discussions about KOLs and VCs have been incessant. KOLs often have shorter lock-up periods and lower valuation discounts, but compared to VCs, who must invest substantial amounts of real money and share resources in sales, operations, and technology, KOLs often seem to fulfill their obligations simply by posting a few tweets.

In response, some VCs have expressed grievances, and even retail investors believe that KOLs are entities that can more easily profit in a bull market. But is that really the case?

Amid various controversies, Bloomberg recently published an in-depth report on KOL rounds, analyzing the advantages and challenges of KOLs. Below is the full translation by Tuo Luo Finance:

Back to March, when the cryptocurrency market was booming, Bitcoin was continuously setting historical highs, and billions of dollars were flowing into spot ETFs. Among them, a special group of investors was more excited than most others.

At that time, the startup Monad Labs completed a new round of fundraising, with a valuation of up to $3 billion from venture capitalists, including Paradigm. By cryptocurrency standards, Mona was already a very large fundraising deal, but it had a notable feature—according to insiders, some individuals referred to as "KOLs" were allowed to invest at only one-fifth of Paradigm's valuation.

These so-called "KOL rounds" are quite similar to the celebrity marketing that U.S. regulators have cracked down on in recent years. As digital assets emerged from the bear market, "KOL rounds" sprang up like mushrooms after rain, becoming a remarkable phenomenon in the crypto world. Compared to celebrity transactions, the investors receiving favorable terms are more likely to be crypto authors or influencers rather than the usual marketing targets like athletes or other stars.

According to interviews with KOLs, entrepreneurs, and legal experts, KOLs typically receive various favorable conditions, such as valuation discounts and shorter lock-up periods, as a return for promoting cryptocurrency projects. In recent months, similar transactions have become a source of controversy, with opponents focusing on insufficient information disclosure and the potential risks faced by retail investors.

Several industry insiders familiar with such transactions indicated that at least some startups did not require KOLs to disclose project affiliations during fundraising, which clearly violates relevant U.S. regulations.

Of course, there are currently no signs that Monad Labs' fundraising violated any U.S. securities laws. One investor stated that the company did not impose any explicit requirements on KOLs, while CEO Keone Hon declined to comment on the lock-up terms and disclosure rules given to such investors.

Paradigm, based in San Francisco, also declined to comment, as it operates one of the largest crypto venture capital funds.

KOLs and Cryptocurrency

Michael Selig, a partner specializing in securities law at Willkie Farr & Gallagher LLP, responded in an email: "Incorporating KOLs and influential industry figures into a funding round and hoping they will promote the project tokens may be subject to scrutiny by the U.S. Securities and Exchange Commission."

The existence of KOL rounds is partly due to the uniqueness of the cryptocurrency market. In crypto fundraising, digital asset startups typically offer equity to raise venture capital, while other companies raise funds by selling issued tokens or affiliated tokens. The project's valuation depends on the quantity and price of the sold tokens, similar to stock sales, which also include hybrid financing rounds of tokens and equity, such as the Monad Labs mentioned earlier.

Purchasing tokens generally does not provide investors with the same protections as equity financing, but it does offer a clear advantage: investors can sell tokens within just a few months, while equity investors are often bound for years until liquidity events like an IPO occur.

Moreover, KOLs play a very unique role in the cryptocurrency market. Over the years, as celebrities, athletes, and self-proclaimed experts have continuously promoted projects online, cryptocurrency has thus spawned a meme coin industry. During the initial coin offering boom in 2017, having a large following on Twitter could be a ticket to wealth for authors, specifically by acquiring popular tokens at a discount in advance and then selling them for huge profits after the price rises.

The Temptation of "Making Big Money"

It is worth noting that becoming a KOL investor does not necessarily require a large following.

Simon Chadwick, co-founder of the cryptocurrency platform Eclipse Fi, stated: "Almost anyone with some influence or community can become a KOL. For example, this could be someone with 5,000 users on Twitter who writes research reports." He was referring to the social media platform now known as X.

Eclipse Fi's main business is assisting projects in issuing tokens on the Cosmos blockchain. Chadwick mentioned that to facilitate token issuance, the company has built a network of over 400 KOL investors that startups can leverage. "The potential for quick returns is so great that some KOLs attempt to set up multiple accounts using fake social media accounts, allowing them to invest multiple times in the same funding round."

Chadwick emphasized that KOLs participating in such transactions can receive discounts of 20% to 50% and shorter lock-up periods, in short, they can sell tokens earlier than other investors.

KOL rounds indeed benefit the crypto ecosystem. "Some KOLs have invested in hundreds of rounds and made a lot of money," he stated.

The U.S. Securities and Exchange Commission, as a regulatory body, has been cracking down on KOL marketing in cryptocurrency projects. In October 2022, Kim Kardashian agreed to pay $1.3 million to settle allegations from regulators that she failed to disclose she was paid to promote a digital token, thus violating U.S. regulations, although she did not comment on the allegations. Four years ago, the SEC fined Floyd Mayweather for similar reasons for not disclosing a cryptocurrency marketing plan.

Emily Meyers, general counsel and chief compliance officer at the crypto venture capital fund Electric Capital, stated that in light of the SEC's lawsuit against Kardashian and similar cases from last year, she would advise projects against conducting KOL rounds. In a case from last year, the SEC charged eight celebrities, including Lindsay Lohan, for failing to disclose compensation received for promoting tokens.

Six of the accused celebrities, including Lohan, reached settlements without admitting or denying the SEC's allegations.

Currently, the SEC has not responded to Bloomberg's request for comments on KOL rounds.

Pump and Dump?

Regardless of the regulatory impact, KOL rounds are undoubtedly controversial in the cryptocurrency field.

A crypto KOL posting under the pseudonym CL, who is a member of the early investment group eGirl Capital, admitted that she has recently been continuously approached by cryptocurrency projects hoping she would invest as a KOL. CL is not based in the U.S., and due to the sensitivity of the topic, she requested anonymity. Due to potential reputational risks, they have avoided such transactions.

With nearly 200,000 followers on X, CL stated that the surge in KOL transactions is "an extension of low-market-cap token accumulation and pump-and-dump schemes, but on a larger scale."

Chadwick from Eclipse Fi said that in large transactions supported by major venture capital, KOLs are usually willing to accept longer lock-up periods. However, they would demand higher discount rates in such transactions.

Orla Browne, strategy director at Dealroom, believes that due to the often opaque details surrounding KOL investments, venture capital data statistics do not separately report on KOL round financing.

In practice, they often take different forms, such as some transactions outlining in written contracts the promotional work KOLs should do, while others are completed via Telegram. Some are part of venture capital-supported financing, while others are earlier projects that are not mature enough to attract major venture capital investments.

Although the vast majority of KOL transactions consist entirely of tokens, some transactions combine equity with warrants for yet-to-be-launched digital currencies.

Bloomberg reviewed a written contract for KOL financing, which stipulated that KOLs investing at a discount must promote the project through podcasts and TikTok videos. The agreement also mentioned that KOLs must disclose their affiliations with the project when promoting it.

However, many projects do not choose to do so.

0xJeff stated, "This is not a requirement." He is the operator of the cryptocurrency consulting firm Steak Capital, which lists KOL management as one of its services. "It really depends on whether the KOL wants the community to know about their investment relationship and whether they have any affiliation with the project." Like CL, OxJeff requested anonymity for his tweets and did not use his real name.

Anxiety is Spreading

Jed Breed, founder of Breed VC, stated that large cryptocurrency projects typically do not impose explicit requirements on KOL investors. Instead, the issuers aim to establish what is referred to as a "secret network" within the cryptocurrency KOL community. Breed remarked, "I've never seen a venture capital deal conducted this way, where if you want to get this allocation, you need to do X, Y, Z, and so on."

Of course, there are also very popular startups that do not need to offer favorable conditions to KOLs.

Humanity Protocol is building a blockchain network that uses palm prints for identity verification. This month, the company raised funds at a valuation of $1 billion from venture capital firms like Animoca Brands. KOLs invested about $1.5 million in March, but their investment conditions "were the same as some venture capital firms," and the investment cap per person was only $25,000, revealed Humanity founder Terence Kwok.

Joshua Cheong, a product engineer at Parity Technologies, participated in Monad Labs' financing as a KOL and stated that the company did not require him to promote the project when investing. He declined to comment on the valuation and lock-up period.

According to OxJeff, KOLs in the U.S. are more cautious about SEC scrutiny, so they usually choose to disclose their relationships with project parties when promoting projects or tokens.

OxJeff believes that regardless of where KOLs are located, a sense of anxiety has already begun to spread throughout the community. This is largely because "on-chain detective" ZachXBT—a Twitter user with nearly 600,000 followers on X—has begun publicly criticizing and exposing KOL transactions.

"If I say KOLs don't need to worry, that would definitely be a lie; all KOLs are panicking right now," OxJeff stated. "Especially now, there are countless KOL rounds, many of which are not going smoothly."