A fool and their Web3 investment will soon be parted

These are turbulent times for Web3, the name under which a range of economic activities related to blockchain, the metaverse, cryptocurrency, NFTs and distributed ledger technology (DLT) are taking place. But if you raise your hand to shield your eyes from the apocalyptic eclipse and tweak your fingers just a little bit, you should be able to glimpse the venture community’s continued enthusiasm for all things crypto, despite the current massacre.

However, compared to a few months ago, just before the current bear market, there has been a noticeable change in both the elapsed time to funding and the extent to which investors expect their founders to demonstrate a better mastery of crypto business. models.

Bullish on web3

Before the bear market, the web3 startup frenzy was so vicious that investors didn’t have the luxury of time to dig deep into some of the underlying fundamentals. According to Haya Al Husry, a program manager at Outlier Ventures, “we saw other investors close their rounds in just two to three days, which meant there was literally no due diligence.” Outlier is a global metaverse accelerator with several investment programs, some targeting specific blockchains, and others like a decentralized financing program (aka “DeFi”) that are chain agnostic.

However, with rounds taking weeks or months to close rather than just days, investor exuberance has given way to a more comprehensive review of startup Pro Formas. Not only do investors want to know that founders clearly understand the impact of cryptocurrency volatility on the bottom line, they also want to see exactly how startups plan to mitigate that impact.

While many retail investors feel the sting of cryptocurrency volatility in their attempts to buy low and sell high (or even if they’re “HODLing” – hold on for life), many Web3 startups end up getting stung by the transaction- and gas costs related to the chain(s) on which their project is active. Those fees are almost always paid with the chain’s native cryptocurrency. In many cases, if the value of the cryptocurrency falls, the transaction and gas fees drop accordingly (in terms of US dollars). Likewise, as is the value of the cryptocurrency balloons (as is known from cryptocurrencies), so is the US dollar adjusted value of the transaction fees.

Some founders enter the investment conversation with an awareness of this nuance. Others don’t. “Of those that do,” Al Husry says, “a common mitigation strategy is to pass on volatility-induced cost increases to the end customer.”

Depending on the underlying chain, this can have serious unexpected consequences for end users. In May of this year, the buyer of a $25 NFT ended up paying $3,325 when: $3,300 in fees were levied on the transaction, thanks to both Ethereum’s congestion prices and the then-rising value of ETH (Ethereum’s native cryptocurrency). If clients of a project are asked to eat up the cost of cryptocurrency volatility in a way that unexpectedly drains their wallets, it won’t be long before those clients leave the project (and investors lose their dollars).

For business applications that rely on public DLT as a means to decentralize trust and improve transparency in multi-stakeholder ecosystems, such as supply chains, a mitigation strategy of the kind Al Husry describes is imperative. CFOs with a penchant for predictable total cost of ownership will be annoyed by any application whose cost of ongoing use is unknown, let alone subject to cryptocurrency volatility. In other words, simply passing cryptocurrency volatility to the end customer will be a non-starter in many situations.

In situations where the end customer’s reluctance to absorb the risk of volatility threatens the viability of the Web3 project, other mitigation options exist. For example, some projects rely on a smart approach that splits a single fee across a series of transactions, while others build on chains whose total costs are unrelated to cryptocurrency volatility.

Shifting flows

The long-term impact of cryptocurrency volatility on a project’s total cost of ownership is a fundamental financial detail of running a web3 project, but one that is easily overlooked for founders and investors alike. Founders should come to any investment conversation prepared with more than just an understanding of the impact of cryptocurrency volatility on their bottom line. They need to prove how that volatility will be managed or mitigated so that it doesn’t affect their investors’ ROI.

Meanwhile, savvy investors looking to avoid a surprise in a few months or years should pin their founders to this part of their model to understand exactly what measures will be taken to mitigate the impact of cryptocurrency volatility and to what extent, if applicable, customers will be affected by that strategy. If the founders left out this footnote or don’t have the answer, your spider senses should be tingling.

As Al Husry told me, “We advise our founders that when the tide goes out and you’re standing there naked, it will show.” In other words, whether you’re a founder or an investor, make sure you’re covered for the changing currents.

Mance Harmon is co-founder and co-CEO of Swirlds Lab and co-founder of Hedera.