Original title: Are VCs Limiting Cryptos Future?
Original author: Anthony DeMartino
Original translation: TechFlow
Overinvestment in public chains
Over the past two years, crypto VCs have overwhelmingly prioritized investing in public chains over other protocols. This shift has led to a proliferation of new Layer 1 (L1) and Layer 2 (L2) networks, but has left the ecosystem lacking high-quality protocols.
From a financial perspective, this strategy has paid off significantly, as many chains have market caps far exceeding their total value locked (TVL). In contrast, leading protocol valuations struggle to even reach 20% of their TVL.
Bottlenecks in basic services
This overinvestment creates bottlenecks for other basic service providers.
Specifically, cross-chain bridges, wallets, oracles, exchange integrations, and the ability to attract top stablecoins and protocols have lagged behind. As a result, new chains often rely on secondary alternatives, increasing friction for developers and users.
Currently, FireBlocks is the only institutional wallet at scale, so the lack of integration makes it difficult to attract institutional capital.
This problem will be more serious when the new public chain is not compatible with EVM, because the delivery time of FireBlocks will be longer.
This problem is particularly acute for chains using the MOVE language, where the lack of institutional support is evident.
Top-level cross-chain bridges like Layer Zero face the same challenge. A top-level bridge that both institutions and users can feel comfortable using is crucial to attracting capital and assets from other chains.
As the top cross-chain bridges have a large and growing transaction backlog, new chains must use weaker alternatives or pay high fees to increase priority. Some chains are happy to pay more fees to speed up transactions, while chains with less funds have to use secondary cross-chain bridges, which will limit their upside.
Protocol issues
The problem is particularly acute when it comes to protocols.
Some of the top new protocols, like ETHENA and Kamino, have TVLs 5 to 20 times that of many new chains, but their valuations pale in comparison.
This has led to underinvestment in available protocols, resulting in a huge shortage.
To combat this, public blockchain foundations have been forced to incubate amateur teams that often simply copy existing codebases rather than build robust, battle-tested solutions. This introduces significant risks in two main areas:
Attracting capital: Protocols developed by underfunded teams struggle to gain credibility, investor support, and TVL.
Security and Stability: It’s easy to copy an existing protocol like AAVE, but running it effectively and ensuring the safety of user funds requires experience and expertise.
Currency market crisis
Money markets are the lifeblood of any top public blockchain. However, handing these critical protocols over to inexperienced teams undermines the usability and trust of these chains.
While anyone can copy AAVE’s code using ChatGPT, successfully running a lending protocol requires deep knowledge of risk management.
A significant oversight in many of these clones is the lack of external risk managers (like Chaos Labs), which are critical to AAVE’s unparalleled safety record.
Simply copying the code without implementing the same risk controls will doom these protocols to failure.
As it turns out, we’ve seen several new money market protocols attacked during this cycle.
Additionally, when public chain foundations have to fund protocol development themselves, it means that outside investors are less interested. Lacking financial backers to support new protocols, they have a hard time attracting important LPs in the early stages, which is critical to success.
The DEX Dilemma
Although decentralized exchanges (DEX) are less important than currency markets, their absence or poor quality will hinder the success of public chains. Both spot and perpetual contract DEXs have difficulty attracting capital due to the following reasons:
Lack of Skilled Team: Many of these trading platforms are clones run by inexperienced teams.
Slippage and poor UI/UX: Lack of well-designed interface and deep liquidity prevents liquidity providers (LPs) from participating.
The result is a poor trading experience, large slippage, slow TVL growth, and a weakened ecosystem overall.
Changing incentive structures
Despite these challenges, economic incentives still favor investing in new L1 and L2 rather than protocols.
This imbalance can be addressed in three ways:
Protocol valuations must rise: The market needs to reflect the actual value and utility of the top protocols.
L1/L2 investments must decrease: If the chain’s valuation drops, capital allocation will naturally shift toward the protocol.
Protocols become their own chains: This trend started with the recent actions of HyperLiquid and Uniswap.
While it is clear that valuations between protocols and chains need to converge, it is less clear whether protocols should become chains.
This trend began to emerge in part in response to valuation imbalances. Not only are the top protocols attracting more TVL than most new chains, they are also receiving exponentially more fees, yet are still not favored by VCs.
While creating a great protocol is complex and rare, building a new chain is becoming increasingly simple and depends more on the quality of the marketing team than the skills of the developers.
Additionally, these teams may be distracted by building low-value technologies to boost valuations, thereby neglecting to build the protocol layer.
If this trend gains external momentum, it will only exacerbate the lack of protocol quality and perpetuate the cycle.
The key question is whether VCs will recognize and correct this imbalance before it is too late.
The future of the industry is at stake
If these issues are not addressed, the entire crypto industry risks stagnation.
Without a strong, well-funded protocol, new chains will struggle to provide the seamless user experience required for mainstream adoption.
Institutional players that quickly enter the space will be forced to retreat or fund their own protocols, forcing the industry to become more centralized.
Ultimately, VCs need to recalibrate investment priorities to break the stagnation, or the future of cryptocurrencies will be at risk.
—Anthony DeMartino, CEO and founder of Trident Digital and GP of Istari Ventures.
