Interview with HashKey Capital’s Deng Chao

Throughout 2022, venture funds seeking to capitalize on the growing embrace of Web3 products and services helped the space shatter all previous fundraising records, even in the face of bearish market conditions.

However, investing in early-stage blockchain startups is not the same as traditional investing. The Web3 space is relatively new and still evolving, requiring a different approach. Also, because the crypto industry is not heavily regulated, it becomes important for venture capital firms and investors to understand the legal and regulatory implications of investing in crypto projects.

Between evaluating the team behind a project, technology usage, market demand and sustainability, investors must go through many checkpoints before making investment decisions. To better understand how the crypto investment industry works, we sat down with Deng Chao, CEO of Hong Kong-based HashKey Capital, which invests exclusively in blockchain technology and digital assets.

With new investors entering the market and the Web3 ecosystem thriving, we invited Deng to share his thoughts and perspectives on the current investment landscape. Chao has over a decade of experience in the asset management and fintech sectors and holds a master’s degree from the University of Hong Kong. He is also an early founding member of Wanxiang Blockchain Labs.

Investments across crypto projects are at an all-time high. What do you think is driving the appetite for the industry at this stage?

Deng: In every new industry there is an early bubble, not just in crypto. Crypto is still in its infancy and when it comes to development it has a lot in common with the early internet industry. People are interested in finding more opportunities in crypto because there are more opportunities than traditional industries, even more than the internet industry now.

In addition, crypto and blockchain can be seen as disruptive innovations that solve real-world problems. These technologies have the potential to bring great leaps in efficiency across various industries, such as the financial industry, the internet and games, and create massive network effects. These network effects are achieved through decentralized networks and, most times, without relying on centralized parties. This is incredibly unique if we look at how technologies have historically developed since the first industrial revolution in the last 250 years. This is what creates asymmetric opportunities and drives so much investment desire in the crypto space.

Is investing in crypto initiatives the same as traditional investing? Are there any additional parameters or areas of due diligence that crypto venture capital funds should consider before investing?

Deng: In general, the investment framework remains the same. The difference is that there are two types of investment structures in the crypto field, one of which is the traditional equity structure, which follows the traditional investment method. Companies using this structure typically offer centralized services for crypto users. Another aspect is token structure, which requires consideration of token economics, token utility in products, management of token issuance and liquidity, and stakeholder interests.

On top of that, the blockchain space is an extremely fast-paced industry. Product development cycles are accelerated by the fact that almost everything in the crypto space is open source and transparent. This often translates into something called composability. Composability refers to the ability to build on top of existing components to create new functions and new products.

While this is a great thing for accelerating the development of new products on the blockchain, it often makes them technically very complex. This is why crypto VCs like HashKey Capital have a team specializing in technology research and due diligence, which is a big part of our decision analysis and differentiates us from traditional venture capital.

Can you provide a brief overview of how crypto funds evaluate crypto projects they evaluate? What are the steps or processes they carry out?

Deng: There are several things to consider, and there is no strict rule for evaluation. However, it is best to consider four key aspects: the sector, the team behind the project, the feasibility of the product, as well as its token economy and valuation.

To start, we need to understand if it is promising enough or if the upside is big enough. More importantly, investors need to update their sector focus quarterly or occasionally based on market trends. Next, we want to see a good track record. It is important to assess the mindset and insight into what the team behind the project is doing. Strong technology? Strong operation? Strong resources and networks? Is the team well dedicated to what they are building?

Then there is testing the product market’s adaptation and long-term sustainability. For example, if it is a technology-oriented project, it is a good idea to consider whether the technical design is feasible. Other considerations include analyzing whether the project is sustainable and whether it is really necessary for the project to issue a token. If a token is required, investors should also check and ensure that the token is reasonably priced.

When we talk about return on investment (ROI), many believe that crypto investments can provide outsized returns. How true is this assumption? How do you think returns differ from traditional investments, and what are the potential advantages and disadvantages that crypto VCs must navigate?

Deng: As an early investment, it gives higher returns. Public data shows that BTC, ETH and the early top 30 token returns are thousands of times. But it’s also riskier, with 95% of projects struggling to survive the winter. Successful crypto projects have greater returns and shorter payback periods because tokens give these projects early access to liquidity. Therefore, while seizing opportunities, it is more important for VCs to manage risks well. These risks differ from traditional risks not only in asset prices, but also in products, strategies and crypto-specific risks, such as the impact of FTX events.

Play-to-Earn games and Web3 projects have collected the largest share of venture funding this year. With all the new segments emerging in the blockchain universe, which crypto-based niches do you think have the greatest potential to attract capital in the near future?

Deng: Both P2E and Web3 projects belong to the application layer, and relatively few projects do exceptionally well in the application layer. Now we are more concerned about the underlying infrastructure and some middleware, which is the premise that the future application layer can explode, such as ZK, AA, Rollup, data, communication, storage layer, etc.

According to our research, the NFT/gaming category received around $7 billion in venture funding last year. The infrastructure sector mentioned above also collected around $7 billion. Infrastructure and middleware are the core of the ecosystem’s development and represent a fundamental layer. Investing in this infrastructure layer is like being able to invest in the internet layer 30 years ago instead of investing in individual applications.

Your fund, HashKey Capital, is a leading investment company in the crypto space. Can you tell us more about how your firm overcomes crypto market volatility? More importantly, how do you as a venture capital fund deal with the current crypto winter?

Deng: We need to zoom out and look at the macroeconomic cycles that include all asset classes, including crypto. Understanding the big picture and these market cycles can really help investors adjust their investment strategy and better time their investments.

We’ve tried to align our latest fundraising with these market cycles, and the timing of our current VC fund couldn’t be better. We’ve raised $500 million in 2022, which means we’re now deploying the fund in a market where startup valuations are much more realistic. We see this as a great time to build and invest, away from the hype and FOMO.

Can you weigh in on new crypto projects seeking capital? Is there a specific way they need to approach venture funds? From your point of view, what is the most optimal approach an early stage crypto startup can take?

Deng: Well, there is no clear answer to this question. HashKey Capital invests in projects at any time. But from the start it is important that the founders can communicate their vision, determination and why they are building “XYZ”. A clear and concise deck can be the entry point.

Studying the VC space is important. The first step is to create a spreadsheet with all the VCs investing in the crypto space. Then try to understand the relationships between these VCs. Many of them can co-invest in projects and share the deal flow between them. Step two is to create a private Twitter list with all VCs and respective partners. Try engaging with them on Twitter to start building basic social currency.

The next step is to start emailing the most important VCs. When meeting with VCs, the goal is to convey your passion to the VC and share what value your project brings to the world. Finally, it is extremely important to leave your ego at the door when talking to a VC. Remember that a “no” in your seed round can turn into a “yes” in the Series A round. Maintaining good relationships with each VC, even after being rejected, can later pay off tenfold in the next round.

Mediation