As an early-stage investment fund, we aim to back founders building innovative solutions for imminent problems. In order to deliver outsized “venture scale” returns, we need to pursue contrarian bets on non-obvious platforms and technologies. Ventures Capitalists (VCs) strive to be agreed with in the future, not the present.
However, this fundamental concept has been largely ignored in recent cycles as many VCs have been chasing popular trends (vs non-obvious ideas). There is an ever present element of FOMO (fear of missing out) where lacking exposure to certain themes could result in being left behind. Yet this feeling of FOMO is a crippling mentality for any investor to have, as you become a victim of the markets very quickly.
Recently, these hype-driven investment cycles have been around two key technologies: Web3 and Artificial Intelligence (AI). Although the recent spike in AI interest (~4 months old) is much more recent than Web3 (~24 months old), both categories have previously faced their own respective boom and bust cycles over this past decade. Given our firm’s industry focus, both of these themes have been prevalent in gaming as this industry is an ideal target for the implementation and adoption of new technologies.
Widespread interest in Web3 and AI does not necessarily mean that individual investments are automatically rooted in consensus market opinions. After all, “Web3” and “AI” are effectively collections of technologies with virtually unlimited applications. There are countless different investable sub-verticals within each of these trends.
That being said, we do believe that the recent investment hype cycles in each of these categories has focused heavily on the productization of back-end technologies. Most of what we are seeing in Web3 and AI are not necessarily core infrastructure (L1 Blockchains such as Ethereum or Large Language Models such as OpenAI’s GPT-3), but rather front-end wrappers or aggregators leveraging this technology. There is an important distinction between Web3 / AI core solutions (often investable) and the front-end products (usually uninvestable) that are leveraging the technology.
Gaming: by labeling products as “Web3 games” or “AI-enabled game development tools”, teams are trying to position these back-end enablement technologies as core drivers of their product. This is being done in the hopes that they can achieve an edge in the market by using these underlying core drivers, as they are still relatively novel and underutilized. However, most companies right now are failing to cement a sustainable moat or differentiated advantage given everyone else also has access to the same third-party tooling. Unless a company is building its own internal blockchain or truly proprietary AI models, these capabilities inevitably become ubiquitous and the playing field levels.
This may seem like a simple matter of semantics, but the focus on back-end tooling as a value proposition has practical implications for startups. Most notably, the vast availability of capital for Web3 and AI-enabled platforms has resulted in a corresponding inflow of talent and new companies. This was a particularly prominent theme in Web3 throughout 2021 and 2022, where teams were either applying blockchain to their existing products or attempting to build new products around the technology. The same trend is currently picking up within AI.
The downside to this is that we have often seen founders trying to build a product around an attractive narrative that is driven by the underlying technology rather than building a product or solution that truly solves a need-to-have for their customer or user base. After all, in Q3 2022, $1.3b in venture capital funding was allocated to a blockchain gaming market with just over 900k monthly active wallets. That is a lot of funding for a plethora of blockchain companies that have been unsuccessful in attracting new users or achieving true value creation.
At the end of the day, the value of a product will be determined by its usefulness to the end user. The fundamental belief that Web3 and AI have the ability to create outsized value is a key reason there is so much attention on these categories. However, to truly build a superior and defensible product there must be some element of differentiation. Everyone having access to the same set of back-end enablement tools fails to yield a competitive advantage. Success is ultimately determined by what value you create with those tools and resources (talent, tech, capital, etc).
For example, in the gaming industry, studios do not try to publicly differentiate based on the external game engine, netcode, and file management system they leverage. This is only a noteworthy differentiator when these technologies are built in-house or are not widely accessible.
There are many gaming projects being funded that we believe would struggle to raise without posturing the advantages of externally over-leveraged Web3 / AI tools. In most cases, we do not believe this makes sense when the “competitive edge” is rooted in someone else’s data and technology.
Takeaway: While we are excited about the benefits that emerging technologies like Web3 and AI can bring to the future of gaming and beyond, we do believe that many founders and investors are misrepresenting exciting technology trends as unique and sustainable moats for the businesses they are building and funding. Broader infrastructure improvements are being conflated with the success of individual assets that stand to benefit in the near term (but not the long-term) from third-party technological progress.