Cryptocurrencies are booming, and a three-year-old investment firm has raised the largest new venture capital fund in history to keep the party going.
Coinbase co-founder Fred Ehrsam and former Sequoia Capital partner Matt Huang have finished raising $2.5bn this month for Paradigm One, their first venture capital fund. Investors jockeyed to commit money to the fund, allowing them to raise twice the amount they initially targeted.
“It is probably small relative to where we’re going in 10 years,” Ehrsam told the Financial Times at Paradigm’s sparse headquarters in downtown San Francisco, where plastic wrap covered new office equipment.
Paradigm’s eye-popping fundraise could stoke fears about a bubble in cryptocurrencies, especially in the niche corners of decentralised finance where the firm has made its name. Earlier this year, VC firm Andreessen Horowitz also raised twice as much as it had hoped for a new cryptocurrency fund, bringing in $2.2bn, which at the time it said was the “largest crypto fund ever raised”.
More than any other investors, both firms have staked their fortunes on an expanding ecosystem of applications based on ethereum, a digital ledger that allows programmers to write contracts automatically executing functions such as money transfers.
Crypto may look like a speculative casino from the outside.
But that distracts many from the deeper truth: the casino is a trojan horse with a new financial system hidden inside.
— Matt Huang (@matthuang) May 25, 2021
Matt Huang, the co-founder of Paradigm One, is bullish on the prospect of a new financial system unlocked by crypto
The programs run on what are known as tokens, digital assets that are granted to users over time, often giving them a say in governance. Paradigm has accumulated some of the largest token holdings in the sector by placing early bets on development teams, giving it rights to future distributions.
Paradigm’s first fund, which raised an initial $400m in 2018, made an annual internal rate of return of more than 200 per cent through the first half of this year, according to figures viewed by the Financial Times.
The fund’s assets have reached as high as $10bn, though they can fluctuate sharply with the price of cryptocurrencies, said people familiar with its holdings. Paradigm structured it like a hedge fund, meaning it does not need to return capital to investors by a certain date, a requirement of VC funds. Paradigm declined to comment on performance.
Paradigm’s founders said the world of token-based apps, sometimes referred to as web3, still had more room to grow. Several so-called decentralised finance protocols backed by Paradigm, such as the token exchange Uniswap, have soared in value in the past year as more people move money away from the legacy financial system. In areas such as gaming and music, developers are also experimenting with new ways to distribute value to consumers using tokens.
“The biggest companies in the world are large internet tech companies powered by network effects,” Ehrsam said. “We think decades into the future it’s very clear the largest entities in the world will be powered by tokens.”
Ethereum still faces doubters. The network has struggled with high transaction costs during busy periods, and some cryptocurrency entrepreneurs have challenged its dominant status as the infrastructure for decentralised apps.
“History has yet to be decided on it,” Ehrsam said. Paradigm isn’t solely betting on ethereum either, investing in a lending app called Jet Protocol that runs on rival network Solana, which claims faster transaction speeds.
Paradigm’s founders said they viewed their token investments as long-term holdings that could take at least 10 years to pay off. Like bitcoin, the assets can be highly volatile depending on the whims of cryptocurrency speculators.
“If liquidity were to dry up in the space, they’re going to be left holding a lot of assets,” said Graham Duncan, an early investor in Paradigm. But he’s still confident on their odds. “I think their time horizon will take them through it,” he said.
Start-up founders said Paradigm had rapidly grown into a desirable investor, partly by recruiting a five-person research team to work with portfolio companies. Financial services groups and the firm’s investors, which include the Harvard and Yale university endowments, have also turned to Paradigm for advice on the workings of digital assets.
At times, Paradigm has negotiated sweetheart deals with cryptocurrency groups seeking its endorsement. During a recent $73m token sale for Lido, an app for earning yield on ethereum and other blockchains, Paradigm led a group of investors that received a discount of about two-thirds compared with the token’s open-market price at the time of the initial proposal.
Optimism, a public benefit corporation developing a programme to make ethereum transactions more efficient, contacted Paradigm for investment after the firm brought on programmers it had previously hoped to hire.
“If we wanted to access their time, it made sense to go and try to get a check from Paradigm,” said Jinglang Wang, co-founder of Optimism.
Opyn, a cryptocurrency options program, chose an investment offer from Paradigm this year that valued the company lower than what Andreessen was willing to pay, said one person briefed on the deal who asked to remain anonymous. Andreessen declined to comment.
Paradigm purchased approximately 20 per cent of the company at a valuation of $28m, along with the rights to a proportional share of any tokens Opyn eventually creates.
After investing, Paradigm worked with Opyn chief executive Zubin Koticha and other employees to design a new kind of cryptocurrency derivative during a week-long retreat in rural North Carolina. Dave White and Dan Robinson, two Paradigm researchers, emerged as the lead authors of a paper introducing the concept.
Investors tend to be sceptical of large VC funds, which can be difficult to invest profitably. Huang said he had few doubts about Paradigm’s strategy. “If Fred and I ever found ourselves working in some kind of low growth, low return situation, I think we would prefer death,” Huang said.