Singapore crypto backer shakes off bubble fears in hunt for next big thing

The crypto-focussed arm of Golden Gate Ventures believes crypto has the potential to outgrow even the internet.

Amidst Bitcoin’s boom-and-bust cycle in the past two years, Golden Gate Ventures’ crypto-focussed arm LuneX is looking to reinvigorate startups in the sector which has now gone past the 2017 hype.

Founded in October 2018, LuneX has been banking on continued innovation in crypto-friendly Singapore for a year amidst industry-wide consolidation. It invests in both base level tokens and equities of startups at the infrastructural level.

“Crypto will basically enable a whole new use case of the web. We think this will be a revolution, just like the internet was for content,” said Kenrick Drijkoningen, founding partner at LuneX. “We think that has the potential to even outpace the size of the internet over the next 10 to 20 years.”

LuneX was also one of the firms that SGInnovate tapped to co-invest in promising startups in the ecosystem. The first deal these two firms have made is with Merkle Science, a platform providing risk-monitoring solutions to detect and prevent the illegal use of digital currencies. Drijkoningen said it has benefitted them as they have been able to lead and even set the terms of certain deals.

In an interview with Singapore Business Review, Drijkoningen outlines developments in the crypto space and his belief in the potential of digital assets despite declining sentiment and interest.

Can you give us a background on what's happening in the cryptocurrency space right now? What trends have emerged and what opportunities are up for grabs?

There's a lot of consolidation happening. So we had a major hype cycle and in 2017, and since then, at least the public markets have cooled off. But underneath, there's a lot of progress being made in the industry. A lot of the infrastructure that needs to be built out that was not there two years ago, is now in place. And because we have that infrastructure in place, we were able to onboard a lot more people coming into this industry.

Custody, for example, is one of those. Two or three years ago, there was very little kind of institutional grade custody services for tokens, and now a lot of different players are offering that like Coinbase or BitGo. We invested in a company here in Singapore called Propine. So now it becomes a lot easier for larger kind of institution to access this space.

But the general, overall market sentiment has dropped. Interest in the space has gone away a little bit, but there's a lot of progress being made and a lot of companies are still being built.

What challenges are you seeing in the space and how are blockchain firms overcoming these?

There's the understanding of your end-user consumer where they wonder why do people need this and how can they use it. It's still very complicated to use this technology so there's a lot of education happening and that needs to continue for people to be on board into this whole ecosystem.

On the company side, I think funding has become more difficult for crypto-related startups because of public markets going down, resulting in the fact that there's less funding available for startups.

And third, is the global regulatory environment. It's not always clear where these things stand. For example, regulation in the US has been kind of slow to come about in terms of clarification from the different agencies. It's not always clear what the regulators are going to do and that's another challenge that firms have to face.

But slowly but surely, there's more clarity in this regard in terms of in the US where the Securities and Exchange Commission (SEC) has clarified, for example, that Bitcoin and Ethereum are not securities, whilst some other ones are, and that makes it a little bit easier.

In Singapore, Inland Revenue Authority Of Singapore (IRAS ) has clarified that these payment tokens will not be double-taxed. There's also this Payment Services Act, which takes care of some anti-money laundering (AML) concerns. So slowly, but surely this is happening, it will just take time for these things to develop.

Crypto companies and funds have gone through a challenging year. How has the strategies of affected firms changed?

2018 was just a down year, in which the prices of public tokens declined significantly. That spills over  into the private markets as well in terms of interest and investment going into the industry. That makes it a lot harder for funds to raise and it just dampens overall sentiment and makes it harder for companies to attract talent.

These companies have become more careful in how they allocate capital and in how many people they hire. They're trying to extend their runways and focus on actually gaining kind of adoption. In 2017, people forgot about adoption and we were just chasing the public prices. Now, the focus is very much more of "are these services actually needed?", "who's going to use the services?", and "can we actually charge for that?". So you see some kind of consolidation in the market like that.

But since the beginning of this year when Bitcoin kind of turned around and had quite a significant significant run, you see that interest is it's not quite there at kind of 2017 levels but you start seeing it coming back.

We see it as the internet bubble in 2001, when the NASDAQ crashed at some point, people thought that the internet was just a fad and wouldn't go away. And then, it actually became very clear that it was just the market getting ahead of itself and overpricing things. But then, good companies stuck around and actually became kind of some of the leading companies in the world today.

How would you assess the regulatory situation in Singapore with regards to cryptocurrencies? Do you think that there is still room for improvement in terms of regulations?

I think there's great progress being made. MAS recognises the enormous potential of this industry and what it can bring to Singapore in terms of talent and innovation. The primary concern is usually the AML, so they're putting some rules and regulations for that in place.

The regulators in Singapore are very forward-thinking in terms of pushing innovation and new ways of doing things, but the private sector in Singapore is a bit conservative if you talk about traditional financial institutions. It's a little bit the opposite in the US where the private sector is pushing this industry forward, but the regulator there is a little bit slower to come up with sensible regulation. It's the opposite with Singapore in that sense, but it's actually very good for companies who are looking to relocate or find a new home or to set up their business.

[With regards to regulation], there's a lot of things still need to be clarified. For example, the only custody license that you can get in Singapore is for security tokens, not for utility tokens such as BitCoin and Ethereum.

There's two schools of thought there. One is where you need to have regulation for develop first, and then come up with sensible regulations.

The second approach is that you cannot regulate for something that's very unclear and very nascent. I think that this should emerge from where the market is moving and what these companies are doing, and then put sensible regulations in place.

The Payment Services Act was passed last January. What changes will this bring to crypto firms?

It brings a bit more kind of oversight and the very much needed legitimacy to the space.The main thing on payment services is that crypto companies that deal with custody of tokens. We'll have to implement Know Your Customer (KYC) and AML rules and regulations, similar to the traditional finance industry.

That's a very good development that brings more legitimacy to the industry, and makes traditional financial institutions more comfortable. It makes it easier to onboard people.

This is also the reason why we invested into Merkle Science, which is a Singapore-based startup doing specifically that. They track blockchain transactions for AML issues and then reports it to the companies that use their service. 

What are your thoughts on initial coin offering (ICOs) and their viability as a funding method?

As a pure funding method, these things will slowly go away.

It comes down to the basic question: “what do you need a token for?”. A token is needed for layer one protocol, such as BitCoin and Ethereum and some of the other smart contract platforms.

During the ICOs, people started using these token sales as a fundraising mechanism. Instead of raising equity, they sold a token but then these tokens were used for different applications, and are just a layer one protocol.

So those things will go away, because the investor doesn't have any rights to anything in that business, as opposed to an equity and often these tokens were not really needed. A couple of years down the line, there should be a couple of winners in terms of layer one protocols and then the need for these base layer token sales will also be greatly diminished.

Secondly, it's also the regulators who have caught up with this and it's very clear now that some of these sales wore securities and then the companies now know that these are not allowed anymore as it would take too much of a risk to invest in them. The actual investors who invested in ICOs have also realised that these investments don't come with any rights and guarantees.

Also read: ICO boom threatens Singapore's VC scene

Can you provide a background on what LuneX does (e.g. investment outlook, mandate and thesis)?

We believe very much in an “infrastructure inversion” that's coming up. An infrastructure inversion is, for example, something that happened in the 90s, whereby you needed the phone companies to dial into the internet and at some point is this infrastructure inverted and now all phone calls is happening over the internet itself.

The new technology becomes the base layer. Right now, we need the traditional banks and financial institutions to enter the crypto ecosystem. Eventually, all these services will run on top of some public, open, permissionless blockchain. Our thesis is very much around the open, permissionless blockchains, because that's where the innovation will happen, that's why developers will come up with new ideas, business models and products.

Within that, we look at two layers. The first layer is those basic layer protocols are the ones like Bitcoin where people can just innovate on top off without asking permission from anybody. And the second level, basically, just above that is the infrastructural level that includes companies that are needed, basically to bring in more people and to make access to these base layers easier.

Custody is a good example of that, which includes AML/KYC services, identity services, staking services, wallets. All these infrastructural things that then make it easier for the eventual end-user applications to be built on top of that.

In a couple of years time, you'll see more end-user applications develop, but we very much invest at the base layer now and at the infrastructural level.

We do that in two ways: one is actually investing in those base level tokens, which we think will have value capture over time as these networks grow. And the other is investing in an equity of startups at this infrastructural level.

Can you walk us through the process of investing in these firms? What factors are you considering when making a decision to invest?

Companies have to fit within our thesis. Once they fit that narrative, our next primary focus is the team. So what has the team done in the past, do we think they have the necessary skills and expertise to actually build what they're what they're set out to build. We have invested pretty early on it like a seed level towards series A level and at that stage of company development is very much about the team, the founder, how open are they to feedback and how open are they to pivoting, if necessary.

You've been operating for a year - what milestones have you achieved so far? 

Right now, we're up 20% on the overall portfolio. We've done two deals in the US, one in Korea, and four or five now are in Singapore. Another very positive thing is that we have a very good partnership with SGInnovate that co-invests with us. Overall, it's been building out the portfolio and the companies, and it's very good to see that some of these companies are now in the process of raising up basically doing the follow on financing and we are actually seeing traction in the market.

Can you cite some notable startups that you have invested in?

One recent deal we did is Merkle Science, which is a KYC/AML crypto company. So they're doing very well with a lot of traction and they're talking to MAS on how to work with the regulations and how they can help shape those regulations.

Another great company is Propine, which has a female entrepreneur and she's been great in building her company. StakeWith.US is another deal we did together with SGInnovate. They basically provide staking-as-a-service for crypto networks and they're already kind of profitable, which is quite rare in the in the crypto industry.

[Beyond funding, we provide guidance and mentorship to startups] although it depends on what the needs are of these companies. To a number of them, we've introduced them to investors who are now looking to lead their series A. And other ones, we get more involved in the product development, or in terms of hiring, we can provide those types of services.

You have an upcoming final close of $10m crypto fund, what do you plan to do with this amount? About how many startups do you plan to back this time?

We're looking to continue in building out the portfolio as we have done so far, maybe ten or 15 more companies. Ideally, we would like companies that are very complementary to some of the companies that we've already invested in so they can help accelerate each other's growth.