Why so risky? How Web3 venture capitalists are funding Ponzi schemes

Venture capitalists are used to measuring companies by their revenue growth. Exponential growth signifies that a startup has discovered a profitable new business model. One of the brightest examples of such Web3 projects is the play-to-earn game Axie Infinity. The game had an impressive $3.5 billion transactions in 2021, and its in-game token, $AXS, grew by 18,000%. 

After months of incredible growth, the daily earnings of the typical player of Axie Infinity (a “scholar” in the Philippines) have fallen below the Philippines’ minimum wage line for all but the high ranking players, and even they have seen earnings decline since August pic.twitter.com/ejidWkWc1G

— Lars “Totally Texas” Doucet (@larsiusprime) November 12, 2021

As with any game of this kind, you have to pay for specific bonuses that give boosters. You earn in-game items as NFTs and tokens during the game and particular tasks. You can reinvest these tokens into the game or take them out and get real money.

Recently, Axie Infinity has been suspected by some investors of operating a Ponzi scheme (pyramid scheme). Strangely, it’s only now getting so much publicity. After all, most such projects, as well as the venture capital funds that fund them, make a lot of money by methods that are very much like a Ponzi scheme. 

Prior to Packy’s post, others had already caught on to the fact that Axie is structurally a Ponzi scheme.

If any VC had searched “Axie Infinity” on YouTube, they’d have been able to watch this helpful animated explainer that was posted Jul 4, 2021: https://t.co/tcmv2XfPG9 pic.twitter.com/t6f1dUJ8Y3

— Liron Shapira (@liron) August 3, 2022

What is play-to-earn (P2E)

Play-to-earn allows players to earn in-game items as NFTs and tokens, which they can convert into cash for real profit. Millions of dollars have been invested in the games like these, and leading publishers like Ubisoft and Square Enix are joining in.

How venture capitalists make money

Despite the extreme risks, venture capitalists invest millions of dollars in ventures in their infancy in the hope that they will grow and make a lot of money. But it’s a myth that VCs are the primary funding source for startups.

Venture capital (VC) firms (BTW, they are made up of a pool of investors who want to make a quick buck) are in the business of making money for their clients, and they don’t care about your startup idea or the profound idea behind it. They only care about whether the venture can get off to a fast start to become attractive for the next round of funding and increase the value of the initial investment.

Why take risks all the time

Venture capital funds constantly work with high risk and high return: they receive funds from investors (limited partners or LPs). Therefore, it is not enough for a venture capital fund to be on the plus side. For them, a steady 10% return may not be enough given the risks of the startup market. For most LPs, even 10% does not justify the risk. Therefore, the initial investment needs to be tripled to get a 12% return over ten years. So all the venture capital funds are interested in is how fast the startup can make a big break.

“Understand, your VCs are a business. If you can’t draw how they make money, you’re screwed,” startup pioneer and Silicon Valley legend Steve Blank said once.

Venture capitalists indeed take a lot of risk with their investors’ capital, not their own. In most venture capital funds, the partners’ capital is only 1% of the total. So observe who you give your money to for investment (remember the story of 3 Arrows Capital?).

True or false: venture capital = a Ponzi scheme?

In essence, venture capital firms’ work is similar to a Ponzi scheme (in some ways): the profits of previous investors are paid by new participants, who are lured by sweet promises and shares. Thus, only those who were first to jump in earn money on the projects. But subsequent players and investors risk being fooled.

They have different business models, after all. Venture capital is financing a startup company that has difficulty getting credit from banks, etc. A Ponzi scheme is basically considered fraudulent if the money is paid to old investors at the expense of new investors.

On the other hand, like a Ponzi scheme, a venture capital fund may sooner or later collapse because of outright poor returns.

Venture capitalists care that the startup exists until the next round. But they care little about what happens to it afterward.