Post-Mortem on Venture Capital Failures In Web 3

Table of Contents

1. The Web3 Investment Paradox
2. In-Depth Case Studies of VC-Funded Failures
3. Common Pitfalls in Web3 Protocol Investments
4. The Post-Crash Culling: Case Studies from 2023-2025
5. The Investor's Blind Spot
6. A Framework for Safer Web3 Venture Investing
7. About Us
8. FAQ

The Web3 Investment Paradox

The venture capital landscape for Web3 presents a profound paradox. On one hand, it offers the potential for generational returns, driven by a technological paradigm shift promising to redefine the internet, finance, and digital ownership. On the other, it is a graveyard of failed projects, where staggering sums of capital have been incinerated with unprecedented speed and scale. For venture capitalists (VCs), navigating this high-stakes environment requires moving beyond traditional investment heuristics and confronting the stark reality of the sector's unique and often catastrophic failure modes.

The scale of this challenge is quantitatively severe. The failure rate for Web3 ventures is an alarming 90-95%, a figure substantially higher than that of traditional technology startups. This is not merely a matter of early-stage attrition; it points to structural issues within the ecosystem. Analysis of VC-backed projects reveals that nearly half (45%) have ceased operations, a statistic that directly challenges the long-held assumption that venture backing is a reliable indicator of a project's viability and long-term potential.

This trend holds true even at the highest echelons of the investment world, dispelling the myth of safety in following "smart money." Projects backed by top-tier VCs have demonstrated shockingly high failure rates. For instance, analysis of portfolios shows that 44% of projects backed by Polychain Capital are considered dead, alongside 72% for Yzi Labs (formerly Binance Labs) and 24% for Andreessen Horowitz (a16z). This undercuts the common strategy of "copycat investing," where smaller funds follow the lead of major players, and proves that in Web3, even the most reputable firms are not immune to fundamental flaws in their portfolio companies.

This environment of high failure is mirrored by extreme volatility in the funding landscape itself. After a period of frenetic investment that peaked with $33.3 billion deployed in 2022, crypto VC funding plummeted by 68% to just $10.7 billion in 2023, creating a significant capital bottleneck for innovation. While 2024 saw a modest recovery to $13.7 billion, this figure remains a fraction of the bull market highs, signaling a market shift from indiscriminate, hype-driven capital allocation toward a more cautious and discerning investment posture. The market has been scarred by multiple "crypto winters" and epic liquidation events, most notably the $1.8 trillion in value wiped out between late 2021 and the end of 2022, a period that included the seismic collapses of Terra/Luna and FTX.

The catastrophic losses suffered by VCs in Web3 were not merely the result of market volatility or the inherent risks of venture investing. They were precipitated by systemic failures in due diligence, a fundamental misunderstanding of Web3-native risks related to economic design and governance, and powerful psychological biases that flourished during a period of market euphoria. This report will dissect these failures through forensic case studies of the most significant collapses to provide a new, more resilient framework for future investment.

Project Name (Token)	Prominent VCs	Total Capital Raised (Approx.)	Peak Valuation / Market Cap (Approx.)	Outcome & % Price Collapse	Primary Reasons for Failure
FTX (FTT)	Sequoia Capital, Temasek, Tiger Global, SoftBank	>$2.2 Billion	$32 Billion	Bankruptcy, >99% collapse	Fraud, Commingled Funds, No Governance, Lack of Controls
Terra (LUNA)	Hashed, Pantera Capital, Polychain Capital	N/A (ICO/Token Sales)	>$45 Billion	Collapse, >99.9% collapse	Flawed Algorithmic Design, Unsustainable Yields, Death Spiral
Celsius Network (CEL)	WestCap, Caisse de dépôt et placement du Québec (CDPQ)	~$750 Million	>$3 Billion	Bankruptcy, >99% collapse	Mismanagement, Risky Investments, Misrepresentation, Ponzi-like characteristics
Internet Computer (ICP)	Andreessen Horowitz (a16z), Polychain Capital	$187 Million	~$70 Billion (FDV)	>99% collapse	Valuation Bubble, Hasty Launch, Slow Ecosystem Growth
Flow (FLOW)	Andreessen Horowitz (a16z), Dapper Labs	N/A	>$20 Billion	>96% collapse	Over-reliance on NFT Hype, Single Application Dependency
Yield Protocol	Paradigm	Undisclosed	N/A	Shutdown, 100% loss	Insufficient Market Demand, Unsustainable Model

In-Depth Case Studies of VC-Funded Failures

The theoretical risks of Web3 investing became a devastating reality during the 2022 market collapse. The failures of FTX, Terra/Luna, and Celsius were not isolated incidents but interconnected systemic shocks that exposed deep-seated vulnerabilities across the industry. A forensic examination of these events reveals that they were not simply "black swans" but predictable outcomes of flawed designs, failed governance, and a catastrophic breakdown in investor due diligence.

Case Study: The FTX Deception

The collapse of FTX, a crypto exchange once valued at $32 billion, represents one of the most profound failures of due diligence in modern venture capital history. Its demise was not the result of a clever hack or poor market timing but of what prosecutors have described as "one of the biggest financial frauds in American history".

Mechanism of Collapse

At its core, FTX's failure was caused by the fraudulent commingling of funds between the exchange and its sister quantitative trading firm, Alameda Research, both founded by Sam Bankman-Fried (SBF). Billions of dollars in FTX customer deposits were secretly funneled to Alameda to cover its massive, high-risk trading losses. This created an $8 billion hole in FTX's balance sheet, which was precariously papered over by the exchange's own centrally-controlled and illiquid token, FTT. Alameda held a significant portion of its assets in FTT, creating a dangerous feedback loop: as long as the market believed in FTX, FTT had value, which made Alameda's balance sheet appear solvent.

The trigger for the collapse came on November 2, 2022, when a CoinDesk report revealed Alameda's heavy reliance on the FTT token. This revelation prompted a crisis of confidence, which was fatally amplified when rival exchange Binance announced its intention to liquidate its entire FTT holdings. The announcement sparked a bank run, with customers rushing to withdraw $6 billion in a matter of days. With its customer funds already spent by Alameda and its FTT collateral rapidly becoming worthless, FTX was unable to honor the withdrawals, halted operations, and filed for Chapter 11 bankruptcy on November 11, 2022. <img width="895" height="663" alt="image" src="https://github.com/user-attachments/assets/e9224c70-8759-4c54-895e-20f672814638" />

Due Diligence Catastrophe

The list of VCs who invested over $2.2 billion into FTX reads like a who's who of global finance: Sequoia Capital, Temasek, Tiger Global Management, SoftBank, and the Ontario Teachers' Pension Plan, among others. Their collective failure to identify the fraud points to a systemic breakdown in vetting, driven by a potent combination of hype and fear of missing out (FOMO). SBF was widely portrayed as a visionary genius, the "next Warren Buffet," a narrative that seemingly allowed investors to overlook glaring operational deficiencies. Marcelo Claure, the former CEO of SoftBank, later admitted publicly, "we should NEVER invest because of FOMO and we should always 100% understand what we are investing in. I totally failed here on both".

The red flags were numerous and fundamental:

• Absence of Corporate Governance: FTX operated without a legitimate board of directors. Key decisions were concentrated in the hands of SBF and a small inner circle, with no independent oversight,a shocking omission for a multi-billion-dollar enterprise.
• Lack of Financial Controls: The company had no in-house accounting department. In his testimony, the new CEO John Ray, who oversaw the Enron liquidation, stated, "Never in my career have I seen such a complete failure of corporate controls". Payment requests were reportedly submitted via online chat platforms and approved with emojis. Furthermore, the company's financial statements were audited not by a reputable Big Four firm, but by a small, lesser-known entity operating in the metaverse, a fact that should have immediately raised questions.
• Opaque and Complex Structure: FTX was a convoluted web of approximately 130 affiliated companies, likely designed to obscure the movement of funds and navigate regulatory loopholes. This complexity made a clear understanding of the company's financial health nearly impossible.

The chasm between the investors' stated goals and the reality of FTX's operations was immense. Singapore's sovereign wealth fund, Temasek, which lost its entire $275 million investment, articulated its thesis as investing in a "leading digital asset exchange... with a fee income model and no trading or balance sheet risk". The reality was the polar opposite: FTX was taking on colossal, undisclosed balance sheet risk by effectively using its exchange as a piggy bank for its high-risk hedge fund.

Case Study: The Terra/Luna Death Spiral

The collapse of the Terra ecosystem in May 2022, which vaporized approximately $45 billion in market capitalization within a week, was not a case of fraud in the mold of FTX, but rather a catastrophic failure of economic engineering. It served as a brutal lesson in the inherent fragility of uncollateralized algorithmic stablecoins and the seductive danger of unsustainable yields.

Mechanism of Collapse

Terra's ecosystem was built on a dual-token model. It featured an algorithmic stablecoin, TerraUSD (UST), which aimed to maintain a 1:1 peg with the US dollar. Unlike collateralized stablecoins like USDC, which are backed by reserves of actual dollars or equivalents, UST was "backed" by a mint-and-burn mechanism with Terra's volatile governance token, LUNA. In theory, arbitrageurs could always swap 1 UST for $1 worth of LUNA, and vice versa. If UST's price fell below $1, traders could buy it cheap, swap it for $1 of LUNA, and pocket the difference, burning UST and reducing its supply to restore the peg.

The Anchor Protocol Catalyst

This delicate mechanism was supercharged by the Anchor Protocol, a lending and borrowing platform built on Terra that offered a staggering, fixed yield of nearly 20% APY on UST deposits. This yield was not organic; it was a subsidy paid for by the Terra project, funded by the continuous issuance of new LUNA tokens. Anchor became the primary driver of demand for UST, with over 75% of all UST in circulation deposited into the protocol at its peak. This created a "vicious dependence": the entire stability of the multi-billion-dollar ecosystem relied on an artificial, money-printing marketing scheme.

The "Death Spiral"

The system's collapse began on May 7, 2022, when several large withdrawals from Anchor Protocol, coupled with broader market weakness, caused UST to lose its dollar peg. As panic set in, a bank run ensued. Users rushed to redeem their UST for LUNA, but the arbitrage mechanism that was supposed to stabilize the system went into a fatal reverse. To process the flood of UST redemptions, the protocol was forced to mint LUNA at an exponential rate. The supply of LUNA hyperinflated from around 1 billion to over 6 trillion in a matter of days, crashing its price from over $80 to virtually zero. This "death spiral" obliterated the value of the asset that was supposed to be backing UST, leading to the total and irreversible collapse of both tokens.

VC Losses and Complicity

The Terra ecosystem had attracted significant backing from prominent crypto-native VCs. The most notable casualty was Hashed, a South Korean venture firm and one of Terra's earliest and most vocal supporters. Having acquired 30 million LUNA tokens in the project's early days, Hashed saw its position swell to a value of $3.6 billion at LUNA's peak. The firm lost over $3 billion in the collapse.

The failure of these sophisticated investors was a failure to question the impossible. The 20% "risk-free" yield offered by Anchor was a monumental red flag for an unsustainable economic model. Critics who pointed out its Ponzi-like characteristics were largely drowned out by the bull market euphoria and the project's charismatic founder, Do Kwon. VCs, caught in the narrative of a revolutionary new stablecoin, either failed to conduct a basic stress test of the economic model or chose to ignore the clear signs of its inherent instability. The lesson was stark: in crypto, if a yield seems too good to be true, it is not only false but is likely a systemic risk.

Case Study: The Celsius Implosion

The bankruptcy of Celsius Network exposed the dangers of centralized, opaque entities operating under the guise of decentralized finance. Celsius, which at its peak held over $25 billion in assets, collapsed due to a combination of gross mismanagement, reckless investment strategies, and a fundamental misrepresentation of its business model to its 1.7 million customers.

Mechanism of Collapse

Celsius built its brand on the slogan "Unbank Yourself," positioning itself as a safe, high-yield alternative to traditional banking. It promised users yields as high as 17% on their crypto deposits. However, Celsius was not a bank; it was an unregulated, high-risk investment fund. It took customer deposits,which, according to its terms of service, it legally owned,and engaged in a series of risky and often illiquid activities to generate returns. These included making under-collateralized loans to hedge funds like Three Arrows Capital (3AC) and deploying assets into high-risk DeFi protocols, including Terra's Anchor Protocol.

The firm's business model was described by an insider as "very ponzi like," as it often used new customer deposits to pay the yields owed to existing customers. The contagion from the Terra/Luna collapse in May 2022 was a critical blow, causing massive losses for Celsius and triggering the insolvency of its key borrower, 3AC. This sparked a bank run from Celsius customers. Unable to liquidate its illiquid positions to meet the surge in withdrawals, Celsius froze all customer accounts on June 12, 2022, trapping $4.7 billion in user funds. A month later, it filed for bankruptcy, revealing a $1.2 billion deficit on its balance sheet.

Due Diligence Failures

Celsius raised approximately $750 million in a Series B funding round in late 2021, led by prominent investors WestCap and Canada's second-largest pension fund, CDPQ. The due diligence failures in this case were particularly egregious, as they involved ignoring clear regulatory and operational red flags.

• Ignoring Blatant Regulatory Risk: Celsius was operating in multiple jurisdictions, including several US states, without the required money transmitter licenses. Furthermore, state regulators in New Jersey and elsewhere had already determined that its interest-bearing accounts constituted an unregistered securities offering and had issued cease-and-desist orders prior to the investment round. These were not subtle risks but direct, public regulatory actions that were either missed or dismissed by investors.
• Overlooking a Pattern of Poor Risk Management: The company had a documented history of operational failures and poor risk management that predated its final collapse. This included losing tens of millions of dollars in incidents such as the StakeHound private key loss and making ill-advised bets through the DeFi manager KeyFi. A thorough diligence process should have uncovered this pattern of recklessness.
• Failing to See Market Manipulation: Celsius actively used customer funds to purchase its own CEL token on the open market. This was done not just to pay customer rewards but to artificially inflate the token's price, thereby propping up the company's balance sheet and creating a false image of financial health. This clear market manipulation was a fundamental sign of a deeply unhealthy and deceptive business.

The interconnected nature of the 2022 collapses reveals a critical lesson for Web3 investors. The failure of one major entity can trigger a cascade of insolvencies across the ecosystem. Terra's collapse inflicted direct losses on Celsius and was a major factor in the bankruptcy of the hedge fund Three Arrows Capital. The ensuing market-wide liquidity crisis and loss of confidence created the conditions that exposed the fraud at FTX. This demonstrates that traditional, single-company due diligence is insufficient.

Common Pitfalls in Web3 Protocol Investments

Beyond the headline-grabbing catastrophes of FTX, Terra, and Celsius, a vast graveyard of smaller, VC-backed projects litters the Web3 landscape. Their failures, while less spectacular, are often more instructive, revealing a consistent set of patterns and pitfalls that investors can learn to identify. These common failure modes fall into three broad categories: flawed economic design, poor product-market fit, and an over-reliance on hype in a competitive market.

Unsustainable Tokenomics and Economic Models

A primary cause of failure is the prioritization of speculative tokenomics over the creation of a sustainable business model. Many projects are designed not to generate external revenue but to drive up the value of their own native token, creating a system that is inherently fragile and prone to collapse. As one analyst noted, "If your Web3 startup can't generate revenue outside of token speculation, you're not building a company,you're playing financial roulette".

• Unsustainable Yields: The promise of unnaturally high, fixed-rate returns proved to be a recurring vulnerability. Yield Protocol, backed by the influential firm Paradigm, and Notional Finance, backed by Coinbase Ventures, were both fixed-rate lending protocols that ultimately failed. They shut down or saw their tokens lose over 99% of their value due to a combination of insufficient market demand for their products and economic models that could not be sustained without continuous capital inflows.
• Structurally Flawed Models: The algorithmic stablecoin model, exemplified by Terra/Luna, has proven to be a particularly dangerous design. The failure of a similar project, Iron Finance, in 2021 had already demonstrated the "death spiral" risk inherent in such systems. The core lesson for investors is that collateralization is not an optional feature but a fundamental requirement for stability. Any model that relies on a volatile, algorithmically-linked asset to maintain a peg is carrying a hidden systemic risk.

Failures of Product-Market Fit (PMF) and Go-to-Market (GTM)

A significant portion of Web3 failures stem from a cultural bias within founding teams, who are often deeply technical but lack expertise in marketing, sales, and community building. This leads to an excessive focus on technological novelty at the expense of user experience and a viable go-to-market strategy. Reports suggest that over 40% of capital invested in Web3 has been wasted on ineffective marketing efforts that failed to build lasting user bases.

• Slow Ecosystem Growth: Internet Computer (ICP), which raised $187 million from top-tier VCs like a16z, suffered a more than 99% collapse from its peak valuation. The project was technically ambitious but failed to foster a vibrant developer and user ecosystem quickly enough to justify its massive initial hype and valuation.
• Over-reliance on a Single Narrative: Flow (FLOW), another a16z-backed blockchain from Dapper Labs, was purpose-built for NFTs and games. It experienced massive success with its flagship application, NBA Top Shot, during the peak of the NFT bull run. However, this success masked an underlying weakness: the entire value of the chain was heavily dependent on a single application and a transient market trend. When the NFT market cooled, Flow's token value plummeted by over 96%, revealing the danger of not diversifying its ecosystem.
• The Web3 Gaming Graveyard: The Web3 gaming sector is littered with the corpses of well-funded projects that failed to bridge the gap between financial speculation and genuine fun. Nyan Heroes, despite raising $13 million and attracting over a million players during promotional playtests, could not retain its user base once the airdrop campaigns ended. Similarly, Rumble Kong League, which boasted an endorsement from NBA star Steph Curry, fizzled out due to a poorly executed token launch and a failure to build a sustainable community. These examples underscore a critical lesson from a Web3 gaming content creator: "Don't waste money on big marketing pushes too early... It means nothing if players can't stick around".

Over-reliance on Narrative and Competition

In the most competitive sectors of Web3, such as Layer-2 scaling solutions, even projects with strong technology and significant VC backing can fail if they are unable to carve out a unique position and attract a critical mass of users and developers. Launching into a crowded market without a clear differentiator is a recipe for obscurity.

• The L2 Bloodbath: Projects like Fuel Network (FUEL), Dymension (DYM), and Eclipse (ES) were all well-funded players in the modular blockchain and Layer-2 space. Despite their technical promise and investor backing, their tokens collapsed by over 94%, 97%, and 64% respectively. They entered a hyper-competitive arena dominated by established players and a constant stream of new entrants, ultimately failing to achieve the network effects necessary for survival.

A crucial realization emerging from these patterns is that in Web3, token price is often a dangerously misleading vanity metric, not a reliable proxy for product-market fit. During the bull market, many investors and founders mistook a rising token price,often fueled by speculative hype, airdrop farming, and aggressive marketing,as a sign of genuine traction. However, true product-market fit is demonstrated by sustained, organic user engagement that persists after initial financial incentives are removed. The collapse of countless projects, particularly in DeFi and gaming, proves that a high token price can create a powerful illusion of success, masking a complete absence of a real user base or a viable business model. Diligence must therefore shift its focus to on-chain metrics that reflect non-incentivized usage, such as protocol revenue, developer activity, and user retention. The guiding question for any investment should be: "Would people use this even if there was no token attached?".

The Post-Crash Culling: Case Studies from 2023–2025

The market downturn of 2022 did not mark the end of VC-funded failures; rather, it initiated a prolonged culling of projects that could not adapt to a more constrained funding environment and a market less tolerant of hype. The period from 2023 to 2025 saw a continuation of these trends, with even well-backed projects succumbing to familiar pitfalls. A 2024 study of 1,181 VC-backed crypto projects revealed that nearly 45% had ceased operations, and 77% generated less than $1,000 in monthly revenue.

Case Study: The Fixed-Rate Fallacy - Yield Protocol and Notional Finance

The DeFi bear market claimed two of the most prominent projects in the fixed-rate lending sector, demonstrating that even with elite VC backing, a niche product with insufficient demand cannot survive.

• Yield Protocol, backed by the influential firm Paradigm, announced it would wind down operations in late 2023. The team cited a lack of sustainable demand for fixed-rate borrowing and increasing regulatory pressures as the primary reasons for the shutdown.
• Notional Finance, which counted Coinbase Ventures among its investors, suffered a similar fate. While the protocol remains operational, its native token (NOTE) collapsed by over 99% from its all-time high, with its market capitalization shrinking to just $1.7 million and daily trading volumes often falling below a few thousand dollars.
  The simultaneous failure of these projects underscored a fundamental miscalculation by investors: the addressable market for fixed-rate DeFi products was far smaller than anticipated, and the models were not sustainable without continuous growth.

Case Study: Qredo - Failure of an Institutional Hopeful

Qredo was positioned as a key piece of institutional-grade infrastructure, offering decentralized crypto custody solutions. The project raised a landmark $80 million Series A round in 2022, led by 10T Holdings and including Coinbase Ventures. Despite this significant war chest and institutional focus, Qredo struggled. After multiple rounds of layoffs in 2023, the London-based company entered administration in February 2024. Its failure was a stark reminder that even ventures targeting the supposedly "safer" institutional and infrastructure side of Web3 are not immune to market headwinds and operational challenges.

Case Study: Kadena Foundation - The Limits of Centralized Support

The shutdown of the Kadena Foundation in October 2025 illustrates the fragility of projects that, despite being decentralized networks, rely heavily on a single corporate entity for development, funding, and ecosystem growth. Kadena, a layer-1 proof-of-work blockchain, announced it was ceasing all business operations and active maintenance, blaming "market conditions" and an inability to sustain its activities. <img width="895" height="663" alt="Screenshot from 2025-11-01 23-19-22" src="https://github.com/user-attachments/assets/9370a8bb-19af-4aaa-98ab-519854be168c" />

The news triggered an immediate crash of over 60% in its native KDA token. While the blockchain itself remains operational through independent miners, the dissolution of its core supporting entity raises significant doubts about its long-term viability, future upgrades, and ability to compete. This case highlights a critical due diligence question: how truly decentralized is a project, and can it survive if its primary corporate backer disappears?

Case Study: Blade of God (BOGX) - A Web3 Gaming Betrayal

The Web3 gaming space continued to be a graveyard for well-funded projects that failed to deliver on their promises. Blade of God X (BOGX), an action RPG, raised $6 million from prominent investors like Delphi Digital, OKX Ventures, and Yield Guild Games (YGG). However, in April 2025, the game's former Chief Marketing Officer publicly accused the project of abandoning its Web3 roadmap after securing the funds. The allegations included that the development team had shifted focus to a purely Web2 version of the game, failed to pay the Web3 team, and even used internal accounts to win cash prizes intended for players. This case exemplifies a recurring failure mode in Web3 gaming: projects that use the "Web3" and "NFT" narrative to raise capital but lack the commitment or ability to integrate these elements in a meaningful way, ultimately alienating the community that funded them.

The Investor's Blind Spot

The widespread losses in Web3 were not solely the fault of misguided founders or flawed protocols; they were enabled by a systemic breakdown in the due diligence processes of the venture capitalists who funded them. This breakdown was not random but was driven by a combination of powerful psychological biases, procedural shortcomings, and a fundamental misalignment between the traditional VC model and the unique demands of the decentralized technology landscape.

How FOMO, Herd Mentality, and the Power Law Distorted Risk Assessment

The market frenzy of 2021 created a perfect storm of cognitive biases that led to a suspension of critical judgment. The primary drivers were Fear of Missing Out (FOMO) and a resulting herd mentality.

• FOMO and Herd Mentality: The 2021 bull market was described as a "veritable gold rush" where the fear of missing out on exponential returns overrode the discipline of rigorous diligence. VCs, seeing their peers close deals at a frantic pace and at eye-watering valuations (sometimes exceeding 100x projected revenues), felt immense pressure to participate or be left behind. This created a powerful herd effect, where the presence of other reputable investors in a deal was taken as a substitute for independent verification. This dynamic was particularly evident in the FTX case, where a long list of sophisticated investors piled in, each seemingly reassured by the presence of the others. This behavior leads to "copycat investing," where smaller funds simply follow the lead of Tier-1 firms, further concentrating capital in hyped projects and amplifying systemic risk.
• The Power Law Trap: The venture capital model is predicated on the Power Law, which posits that the returns from a single, wildly successful investment can compensate for the losses of an entire portfolio. While this is a cornerstone of VC strategy, during a hype cycle, it can be perversely used to justify a lack of diligence. The perceived risk of missing a potential 100x return (a "power law" outcome) becomes greater than the risk of losing 1x the capital on a failed investment. This mindset encourages VCs to take flyers on hyped projects with charismatic founders, prioritizing speed and access over deep, critical analysis.

Identifying the Gaps in Traditional Vetting

The aftermath of the major collapses revealed that in many cases, what passed for due diligence was mere "diligence theater",a performance of vetting that lacked genuine substance and failed to uncover fundamental flaws.

• Superficial Diligence: The FTX case is the most glaring example. Temasek, a globally respected sovereign wealth fund, claimed to have conducted an eight-month due diligence process on FTX. Yet this extensive process somehow failed to identify the complete absence of an independent board, the lack of basic financial controls, or the use of a small, unknown accounting firm. Similarly, Tiger Global Management reportedly engaged a team of expert consultants for its diligence but still missed the critical red flag concerning SBF's absolute control over the tangled web of FTX-linked entities. This suggests that investors were asking the wrong questions or were too easily satisfied with superficial answers, likely blinded by the project's meteoric growth and SBF's compelling narrative.
• The Need for a Web3-Native Approach: These failures highlight the inadequacy of applying a traditional private equity diligence framework to Web3 projects. Vetting a Web3 protocol requires a specialized skill set that goes far beyond analyzing financial statements and management team résumés. A robust, Web3-native diligence process must include:
  • Deep Technical and Security Analysis: The ability to scrutinize smart contract code for vulnerabilities, assess the security of the underlying blockchain, and understand the risks of cross-chain bridges and other complex infrastructure.
  • Sophisticated Tokenomic Modeling: The capacity to dissect a project's economic model, stress-test its incentive structures, and identify unsustainable mechanisms like artificial yields or death spirals.
  • On-Chain Data Verification: The use of blockchain analytics tools to independently verify a project's claims about user activity, transaction volume, and treasury holdings, rather than relying on company-provided dashboards.
  • Nuanced Governance Assessment: A clear understanding of the risks associated with both extreme centralization (as in FTX) and poorly designed, inefficient decentralized autonomous organizations (DAOs).

A deeper, structural issue contributing to these failures is the fundamental mismatch between the timeline and growth expectations of the traditional VC model and the reality of building secure, sustainable decentralized networks. The VC model is optimized for rapid, aggressive expansion to generate returns within a finite fund lifecycle, often 7-10 years. This "growth at all costs" mentality is profoundly dangerous in Web3. When founders are pressured to scale prematurely, they are incentivized to cut corners on critical but time-consuming processes like security audits, to launch tokens before achieving product-market fit, and to use unsustainable incentives like Anchor's 20% APY to manufacture the appearance of traction. This inherent conflict between the VC mandate for speed and the Web3 requirement for methodical, security-first development is a root cause of many of the ecosystem's most devastating failures. It suggests that for Web3 to mature, either the VC model must adapt to become more patient, or new forms of "patient capital" must emerge that are better aligned with the long-term, iterative process of building resilient decentralized infrastructure.

A Framework for Safer Web3 Venture Investing

The 2022 crypto winter and the subsequent failures of numerous VC-backed projects served as a painful but necessary market correction. The era of indiscriminately funding projects based on a whitepaper and a charismatic founder has ended. The future of successful venture investing in Web3 will be defined by discipline, deep technical expertise, and a return to the first principles of value creation. The lessons learned from the graveyard of failed protocols provide a clear blueprint for a more resilient and rigorous investment framework. VCs must move beyond hype and adopt a modernized due diligence process that is native to the unique opportunities and risks of a decentralized world.

The Four Pillars of a Resilient Web3 Investment

A comprehensive diligence process for Web3 can be structured around four key pillars. Each pillar is a direct response to the specific failure modes observed in the collapses of FTX, Terra, Celsius, and others.

1. Team & Governance: The FTX saga was, above all, a failure of governance. Beyond assessing a team's technical and business acumen, VCs must rigorously evaluate its commitment to transparency, ethics, and robust oversight. The presence of a truly independent board of directors with real authority is no longer a "nice-to-have" for later stages but a critical requirement from the outset.
2. Technology & Security: A protocol's code is its foundation. Investment should be contingent on multiple, independent smart contract audits from reputable firms. Furthermore, diligence must scrutinize the protocol's architecture for hidden points of centralization, such as a heavy reliance on a single cloud provider like AWS for essential functions like RPC nodes, which can undermine the entire premise of decentralization. A project must demonstrate a clear technical moat and a proactive security posture, including active bug bounty programs and a well-defined incident response plan.
3. Tokenomics & Economic Viability: The Terra/Luna and Celsius collapses were fundamentally failures of economic design. VCs must have the in-house expertise to model and stress-test a protocol's tokenomics. The central question must be: Is the yield organic or a subsidy? If a protocol's revenue is primarily generated from its own token emissions rather than from fees paid by genuine users, its economic model is unsustainable. The token must have a clear utility that provides value to the ecosystem beyond pure speculation, and its distribution must be scrutinized for unfair insider concentration and vesting schedules.
4. Traction & Community: The bull market created a fog of vanity metrics. True traction is not measured by a temporarily inflated token price or a swarm of airdrop hunters. VCs must leverage on-chain analytics to differentiate real, sticky user behavior from speculative activity. A healthy project has a community of genuine users and developers who are actively engaged in building and using the protocol, not just speculating on its token. Product-market fit must be demonstrated before aggressive, VC-funded scaling, not the other way around.

A Call for Disciplined, Value-Oriented Investing

The Web3 venture landscape is maturing. The capital that flows into the ecosystem in the coming years will be smarter, more cautious, and more demanding. Success will require a paradigm shift for VCs, moving from momentum-chasing to fundamentals-based analysis. This involves embracing new tools and methodologies as core components of the investment process. Deep on-chain analysis, smart contract security auditing, and economic model simulations can no longer be outsourced or treated as a final box-checking exercise. They must be integral to the initial screening and deep diligence of any potential investment.

The goal is not to eliminate risk,an impossibility in an innovative sector like Web3,but to intelligently manage it by avoiding the unforced errors of the past. By learning the lessons from the Web3 graveyard and applying the rigorous, multifaceted diligence framework outlined below, VCs can better position themselves to identify and back the truly transformative projects that will survive the hype cycles and build the enduring infrastructure of the next-generation internet.

Category	Key Due Diligence Questions & Red Flags
Technical & Security Diligence	- Have the smart contracts undergone multiple, independent audits by reputable firms? (Red Flag: No audits or audits by unknown firms.)<br><br>- What is the protocol's dependency on centralized infrastructure (e.g., RPC providers, sequencers, cloud hosting)? Is there a clear path to decentralization? (Red Flag: Critical functions run on a single AWS server.)<br><br>- Is there a public, well-funded bug bounty program? What is the team's documented incident response plan for a major exploit? (Red Flag: No clear security plan.)
Economic & Tokenomic Viability	- What is the primary source of protocol revenue or user yield? Is it generated from organic economic activity (e.g., trading fees, lending interest) or from protocol token emissions/subsidies? (Red Flag: Yields primarily funded by inflation.)<br><br>- What is the core utility of the native token? Would the protocol still provide value to users if the token did not exist or had no speculative value? (Red Flag: Token exists only for governance or to be farmed and sold.)<br><br>- Analyze the token distribution and vesting schedules. What percentage is allocated to the team, insiders, and VCs versus the public/community? (Red Flag: Highly concentrated insider ownership with short vesting periods.)<br><br>- Has the economic model been stress-tested? What happens during a 50%+ market downturn or a mass withdrawal event? Does it contain a reflexive "death spiral" mechanic? (Red Flag: Stability relies on continuous growth.)
Governance & Team Oversight	- Is there an independent board of directors with meaningful oversight and the power to challenge the CEO? (Red Flag: Board is non-existent or composed of founders and employees, as with FTX.)<br><br>- Who has multi-signature control over the treasury and critical smart contract functions? Are the signatories independent of one another and of the founding team? (Red Flag: CEO has unilateral control over funds.)<br><br>- Are there regular, audited financial statements prepared by a reputable (e.g., Big Four) accounting firm? (Red Flag: Audits are done by small, unknown firms or are unavailable.)<br><br>- What is the regulatory posture? Has the project sought legal opinions on its status as a potential security in key jurisdictions like the U.S.? (Red Flag: Ignoring or being dismissive of regulatory compliance.)
Community & Market Traction	- Analyze on-chain data: What is the ratio of daily active users to speculative traders? What is the user retention rate over 30/60/90 days? (Red Flag: High user count with near-zero retention after an incentive program ends.)<br><br>- Evaluate the quality of the community. Is the Discord/Telegram/Forum filled with substantive discussion from developers and users, or is it dominated by price speculation and "wen token" messages? (Red Flag: Community is a crowd, not a user base.)<br><br>- Map the protocol's counterparty risk. Which other major protocols or entities is it heavily reliant on for liquidity, collateral, or services? (Red Flag: Heavy exposure to a single, potentially unstable entity.)

About US

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Reach out to us for queries and security assessments!

Works Cited

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