Ecosystem Funds Don’t Build Moats. They Buy Time.

ICOs simplified and democratized risk capital. More people being able to participate in a simpler process has led to the leading blockchain projects being incredibly well capitalized.

Once that money is in the bank (or the digital wallet, as it were), the question of course becomes what the hell to do with it?

We’re entering the “protocol wars” phase of market evolution, in which players like Ethereum, EOS, Steller, Dfinity and more compete for developers to build applications on top of their protocol. In that context, each of those companies is forced to ask how to best use their war chests to compete.

One of the more interesting quirks of an open source industry is that there are significant limits to how much they can differentiate on the basis of technology. While they might decide to prioritize different tradeoffs (for example, having a different philosophy on the tradeoff between censorship resistance and performance), the default condition of the market is ultimately that everyone steals from everyone.

Some companies have chosen to reinvest part of their capital in the form of “ecosystem funds” – venture-style investment arms through which they can put resources into projects that chose to build on their protocol.

By far the most prominent aggressive of these strategies comes from EOS parent Block.one. The company has raised over $2B in a still-going token sale and has announced four separate ecosystem funds:

• $50m with Tomorrow Blockchain Opportunities
• $325m with Galaxy Digital
• $100m with FinLab AG
• $200m Asia-focused fund called EOS Global

Competitors including DFINITY, RChain and Stellar have all announced their own funds. Ethereum Capital is investing $50m in the Etherium ecosystem. L4, a fund collaborative co-founded by Ethereum leader Vitalik Buterin, announced a $45m fund for the MakerDAO ecosystem in February.

The ecosystem fund approach has not been without controversy. While some, like Multicoin Capital’s Kyle Samani, see it as simply a requirement of competing in the Protocol Wars, others are less convinced.

Table stakes for launching smart contract platform are going up.

Tezos doing ecosystem fund
EOS will too
Seems likely Dfinity will given how much they're raising

If you're building a competitive platform, you are going to need a 9-figure ecosystem fund to compete

— Integrated Kyle e/acc (@KyleSamani) December 29, 2017

A few thoughts on a recent trend I've been watching closely, which I'll uncreatively call The Rise of The Ecosystem Fund. I find this trend to be problematic for a number of reasons:

— AriannaSimpson.eth (@AriannaSimpson) April 6, 2018

San Francisco blockchain VC Arianna System has identified two separate problems. The first is fiduciary responsibility. In other words, is this what this capitalization was designed for? Of course, in an industry where tokens are share-like but don’t ultimate convey ownership, fiduciary responsibility remains a blurry concept.

The second is efficacy, in terms of both 1) the capacity of teams to effectively allocate capital and 2) the quality of the buy-in that capital represents. The first point is that venture investment is a specialized skillset separate and distinct from the expertise required to build blockchains, and it is reasonable to ask whether an ecosystem fund run by a blockchain leadership team is likely to identify good projects.

Given that most of these funds are collaborations with professional fund managers, and that, frankly, their entire existence is based on a land grab for developer attention, this question of allocation quality doesn’t feel all that relevant.

A better critique and consideration for the ecosystem funds has to do with their expectation around what sort of devotion to their protocol investment comes with.

When you invest with a mercenary attitude, you tend to attract people who only care about your cash. When the cash dries up, those teams move on.

This doesn’t mean that ecosystem funds can’t be an important strategic asset, but that the protocols behind them should understand what they’re dealing with.

Put simply, ecosystem funds don’t build moats. They buy time. They are a lease on developer attention that gives the protocols a window to build other, more durable types of network effects.