Why is investment into non-financial blockchain applications lower than into financial applications?

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Master’ Thesis

Why is investment into non-financial blockchain applications lower than into financial applications?

MSc. Business Administration – Digital Business Student: Pascal Reder

Student Number: 11376007 University of Amsterdam (UvA)

Supervisor: Merve Güvendik 23rd_{of July, 2017}

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Statement of originality

This document is written by Pascal Reder who declares to take full responsibility for the contents of this document.

I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.

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Abstract

Blockchain based cryptocurrencies, like bitcoins or ethereum, have lately gained much attention in the media and in academia. Besides disrupting the financial world, the technology will extend its applications into various fields, such as smart contracts or any kind of decentralized storage, so academics see a bright future of the technology. However, venture capital investment into the technology is mainly concentrated on its financial applications and not yet on non-financial areas.

This study aims to analyze this discrepancy and to answer the research question: Why is venture capital investment in non-financial blockchain applications lower than in financial applications? To answer this question, semi-structured qualitative interviews were held with five venture capitalists to investigate the criteria they use when considering their investment into a potential venture and, more importantly, how they evaluate the performance of financial blockchain companies compared to non-financial. Therefore, in a theoretical framework eight categories, namely economic measures, non-economic measures, the product, the market, the team, the pitch, technological advancement and personal knowledge were set up, and the following was discovered: Investors agree that economic measures, the product, the market and team are decisive criteria on which financial blockchain companies perform better, and consequently make investment more likely. On the other hand, evidence was found that non-economic measures, the pitch, technological advancement and personal knowledge, did not favor investment in financial or non-financial blockchain companies.

Based on these findings, a lack of investment into non-financial applications can be explained, a gap in the existing literature can be closed, and practical implementations can be derived.

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4.3 TEAM CATEGORY 24 4.3.1 GENERAL IMPORTANCE 24 4.3.2 DIFFERENCES IN THE TEAM CATEGORY 25 4.4 PRODUCT CATEGORY 26 4.4.1 GENERAL IMPORTANCE OF THE PRODUCT 26 4.4.2 DIFFERENCES IN THE PRODUCT BETWEEN FINANCIALS AND NON-FINANCIALS 27 4.5 MARKET CATEGORY 28 4.5.1 GENERAL IMPORTANCE 28 4.5.2 DIFFERENCES IN MARKETS FOR FINANCIALS AND NON-FINANCIALS 29 4.6 PITCH CATEGORY 30 4.6.1 GENERAL IMPORTANCE 30 4.6.2 DIFFERENCES IN THE PITCH BETWEEN FINANCIALS AND NON-FINANCIALS 31

4.7 TECHNOLOGICAL ADVANCEMENT CATEGORY 32

4.7.2 DIFFERENCES IN TECHNOLOGICAL ADVANCEMENT BETWEEN FINANCIALS AND NON-FINANCIALS 33

4.8 PERSONAL KNOWLEDGE CATEGORY 34

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4.8.2 DIFFERENCES IN PERSONAL KNOWLEDGE BETWEEN FINANCIALS AND NON-FINANCIALS 35 5. DISCUSSION 37 6. CONCLUSION 41 REFERENCES 43 APPENDIX 47 INTERVIEW 1 47 INTERVIEW 2 60 INTERVIEW 3 68 INTERVIEW 4 77 INTERVIEW 5 83

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List of Figures

Figure 1: Venture capital funding into sectors: Extracted from Friedlmaier (2016) ... 5

Figure 2: Criteria that influence investment decisions ... 11

Figure 3: Determinants of economic criteria ... 19

Figure 4: Economic criteria in financial vs. non-financial applications ... 20

Figure 5: Determinants of non-economic criteria ... 22

Figure 6: Non-economic criteria in financial vs. non-financial applications ... 23

Figure 7: Determinants of team category ... 24

Figure 8: Team criteria in financial vs. non-financial applications ... 25

Figure 9: Determinants of product category ... 26

Figure 10: Product criteria in financial vs. non-financial applications ... 27

Figure 11: Determinants in market category ... 28

Figure 12: Market criteria in financial vs. non-financial applications ... 29

Figure 13: Determinants of pitch category ... 30

Figure 14: Pitch criteria in financial vs. non-financial applications ... 31

Figure 15: Determinants of technological advancement category ... 32

Figure 16: Technological advancement criteria in financial vs. non-financial applications .. 33

Figure 17: Determinants of personal knowledge category ... 34

Figure 18: Differences in personal knowledge category ... 35

Figure 19: Decisive categories that explain the lack of investment in non-financial applications ... 39

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List of Tables

Table 1. Overview of Investment Behavior ... 12 Table 2: Overview Research Sample ... 13 Table 3: Results of the Economic, Non-Economic, Team and Product Category ... 17 Table 4: Results of the Market, Pitch, Technological Advancement and Personal Knowledge

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1. Introduction

Cryptocurrencies like bitcoins are no longer known only by experts in the field of technology. Their prices have risen steadily over time, and their range of applications is constantly growing. However, too little attention has been given to the technology behind the cryptocurrency, blockchain technology. Since the introduction of bitcoins in 2008, interest in this form of currency has increased steadily among academic researchers, venture capitalists and the general public. Venture capital in blockchain-related industries grew from $2.13 million to $95.05 million, $361.53 million, and $893.07 (American dollars, from 2012 to 2013, 2014, and 2015, respectively).1 These numbers demonstrate the increase of demand and supply for venture capital in this area. Researchers agree that this technology has the potential to change the way we do business, as the internet did years ago (Matilla, 2016; Wörner et al., 2016). Possible applications outside of the world of finance include smart contracts, the internet of things (IoT) environment, and the efficient allocation of resources in supply chains (Atzori, 2017; Korpela et al., 2017), to name just a few. Although the technology is not yet very advanced, researchers estimate a big breakthrough in the next couple of years outside of the world of finance, which has already been disrupted by bitcoins.

However, although researchers expect a breakthrough in all areas, venture capital investment is mainly concentrated in financial applications and not non-financial applications. In order to understand this phenomenon and analyze the reasons behind the lack of investment in non-financial areas, this thesis poses the research question, Why is venture capital investment lower in non-financial blockchain applications than in financial blockchain applications?

Therefore, a conceptual framework including eight different categories that parse the investment decisions of venture capitalists into blockchain companies were introduced to be tested. These ones include economic measures, non-economic measures, the team, the product, the market, the pitch, technological advancement and personal knowledge. A variety of studies explain the world of cryptocurrencies, blockchain and the fact that venture capital is concentrated on the world of financial applications. However, no study explains why this direction of investment is so prevalent. This study helps to close this gap in the literature.

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As such, this study analyzes the performance of financial and non-financial blockchain companies on different categories, explaining this lack of investment. For this purpose, semi−structured interviews with five venture capitalists were conducted. Beyond the theoretical relevance of the research, the practical implications of this thesis apply to start-ups, who can gain better understanding of what investors are looking for, and to investors, that who can gain insight into the decision-making process of other investors.

Chapter 2 of this thesis offers a review of the literature, including of blockchain technology, the academic discussion of cryptocurrency and the capitalists. Furthermore, the theoretical framework is introduced, with its eight categories.

The research method and the sample are explained in Chapter 3. Five venture capitalists were interviewed in semi-structured interviews and all asked the same questions to obtain reliable results. The presentation of the results follows in Chapter 4. The results appear per category, as described in the theoretical framework. It is shown that economic criteria, the product, the market and the team are reason that explain the higher investment into the financial blockchain area. The discussion of the results, the limitations of the study and its theoretical and practical implications are detailed Chapter 5. The limitations of the sample, such as a geographical limitation of the sample and the need for a cross category analysis, are discussed. Furthermore, the existing gap in the literature that will be closed is analyzed, as well as its contribution to the common understanding of venture capitalists’ evaluation of ventures. The thesis’s conclusions are offered in Chapter 6.

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2. Literature Review

Blockchain technology was born in 2008, when a white paper authored under the pseudonym of Satoshi Nakamoto was released, marking the starting point for the cryptocurrency bitcoin. Although Nakatomo never explained the origin of the name of the technology, researchers propose that the name derives from its ability to cryptographically chain blocks of data (Matilla, 2016). Walport (2016) defines the blockchain as a distributed ledger recording technology, which can record any transaction, of tangible or intangible form. The key advantage of blockchain that it circumvents intermediaries, such as a bank, thereby decreasing transaction costs and realizing advantages in efficiency (Zhu & Zhou, 2016). Besides being more efficient and reducing costs, certain features of this system foster safety and privacy, such as decentralization, distributed consensus and encryption (Seppälä, 2016). The public ledger is shared by a wide user base on the Internet, guaranteeing security and transparency. Every transaction needs to be verified by the public (mining) and is then stored on a new block, which is attached to the blockchain (Zyskind et al., 2015).

This literature review consists of four parts: First, bitcoins and the blockchain are introduced, briefly explaining the technology and its first application, the financial world. In the second part, it is shown that venture capitalist investment is directed mainly towards “the old-fashioned” financial applications of the technology and that non-financial applications lack investment. The third part of the literature review introduces venture capitalists, whose role as an investor is discussed and whose tasks are examined, as they extend well beyond financial contribution. The fourth and last part of the literature review introduces the theoretical framework of the study, developing categories defining the investment decisions of venture capitalists and determining this study’s methods.

2.1 Bitcoin and Blockchain

Although this thesis analyzes the lack of investment in the non-financial use of the blockchain technology, recording transactions in the world of payments was its first use. The cryptocurrency bitcoin evolved in this scenario. This currency has become very famous over the years, due to its fluctuations and a rising interest among people using bitcoins as investments, especially during times of crisis. From January 2014 to December 2014, the bitcoin to USD exchange rate fell from $950 to $250, but recovered again and is worth around

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S2,563, as of today.2 Looking at these numbers, one might suggest that bitcoins are a pure investment (arbitrage) tool. However, the advantages of this technology are such that experts consider its impact to be as significant as the impact of the Internet was (Friedlmaier, 2016). Nevertheless, this review does not concentrate on the technology itself, but on the status quo of academic research about blockchain and bitcoins, blockchain’s possible applications, venture capital investment in blockchain related businesses and the role of venture capitalists in the funding and post-funding processes.

Regarding the current state of academic research on blockchain and bitcoin, two important papers were published in 2016. Zhao et al. (2016) compared Google search volumes of the terms “blockchain” and “bitcoin” from 2011 to the end of 2016. While none of the keywords were of great interest to the public in the first two years, the search volume for bitcoins reached its peak in 2013. From that moment on, search volumes of bitcoin decreased and have now stagnated at 10%–20% of the peak level. On the other hand, and even more interesting, the search volume of the term “blockchain” began to rise rapidly at the end of 2014 and has since peaked. These numbers are supported by the number of academic papers on blockchain in the WebOfScience and SSRN. Before 2014, there were no publications on blockchain at all. However, as of 2016, 90 papers have been published in those two databases (Zhao et al., 2016). Yli-Huumo et al. (2016) extracted 41 papers from scientific databases and analyzed them, finding that more than 80% of these scientific papers were about bitcoins and a just under 20% dealt with other applications of blockchain, except bitcoins. This evaluation of the research shows that the area of blockchain is not yet well researched, although interest has increased. Not only has interest in academic research risen, venture capitalists have also started to consider blockchain technology as an interesting field of investment. More than $1.5 billion has been invested so far in blockchain-related businesses (Donegan, 2016).

2.2 Investment into Blockchain Applications

Friedlmaier (2016) conducted research on four databases to see in which industries most venture-capital-backed start-ups operate and how much funding they received. Two industries, “financial and insurance”, along with “information and communication”, together count for around 80% of all venture capital flows into blockchain related-start-ups, which proves that not only is the academic research directed towards the field of bitcoins, but venture capitalists are also more interested in funding opportunities in financial services, and many sectors that

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the academic research has identified as for future application did not receive much funding. These findings are demonstrated in Figure 1.

Figure 1: Venture capital funding into sectors: Extracted from Friedlmaier (2016)

Friedlmaier (2016) furthermore demonstrated that investment into non-financial fields is not high, although the academic research states that possible applications of blockchain technology, like to smart contracts, nanopayments or voting systems, will be disruptive in the financial industry (Matilla, 2016). This finding reveals a discrepancy between academics, saying that blockchain has a huge potential in almost any industry, and venture capitalists, who have yet to show substantial trust in the non-financial applications of blockchain.

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2.3 The Role of Venture Capitalists

Venture capital is (investment) money that investors provide, usually to start-ups that, according to the investor’s evaluation, show a promising growth potential.3 Zider (1998) explains the venture capital environment as follows: On one side are entrepreneurs who need funding, and on the other are investors, namely private investors and investment banks; venture capitalists are in between. Venture capitalists create a market by acting as an intermediary between firms looking for money and investors looking for investment opportunities. The decision criteria for venture capitalists differ clearly from those of investment bankers. Bankers usually stress the purely financial aspects of the proposal, and the company bases its decision purely on (financial) numbers, ignore factors like the market or the entrepreneurs themselves. However, venture capitalists emphasize both market issues and financial issues; moreover, the investor should be compatible with the company to reach certain goals together (Mason & Stark, 2004).

The role of venture capitalist is often misinterpreted by the public. Their job is not only to provide the necessary funding for a company, but also to be highly involved in the management of the venture (Gifford, 1997). According to Gorman and Sahlman (1989), venture capitalists spend around 80 hours a year on-site and 30 hours on the telephone with each company in which they invest. As such, they actively follow and help a venture to attract new sponsors, and they use their expertise to offer managerial advice or help with strategic decisions. Providing support on various levels, they act as a non-economic measures provider to bridge the gap between entrepreneurs, partners, funding and advisors. This connection is particularly apparent in the area of high innovation, which applies to blockchain-technology-based start-ups. Sapienza (1992) affirms the observation that venture capitalists’ contributions go far beyond providing money. He found out that their role changes from that of a financial contributor to that of a post-investment strategic partner involved in every management decision, from the funding through the possible exit or bankruptcy of the company. Traditionally, venture capitalists have a multi-stage decision process: Search (origination), proposal screening, proposal assessment (evaluation), due diligence, negotiation and closing, and post-investment involvement. The search process is more commonly described as a waiting process, since most inquiries go cold (Fried & Hisrich, 1994). The owners of the proposals that pass the screening process find themselves in a number of meetings with the venture capitalists to evaluate their business. Owing to the anonymity of cryptocurrency transactions and the

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potential ethical transgressions associated with them, emphasis on due diligence is of the utmost importance in this area, given the nature of either financial or non-financial blockchain companies. In the negotiation phase, negotiations about the structure of the investment and the firm’s financial structure take place. When the deal is closed, venture capitalists engage with the company whenever it is necessary. The level of involvement, however, differs from venture to venture (Feeney et al., 1999).

Considering the state of the research on and the nature of blockchain technology and business, the following research question was formulated to guide this research: “Why is venture capitalist investment into non-financial applications not yet as high as it is in financial applications?” In answering this question, this research investigates the underlying reasons behind the lack of investment into non-financial blockchain applications and the discrepancy between the optimistic forecasts of academic researchers and the low investment of venture capitalists in non-financial applications. This area of research has not yet been addressed in the academic literature, and is consequently of major interest. Besides contributing to the academic research on this topic, this research also has managerial implications. Understanding the reasons behind venture capitalists’ investment behavior will help blockchain start-ups better predict the amount of money they might raise and which applications of the technology see breakthroughs in the future. Furthermore, venture capitalists will gain an understanding of the factors determine their investment decision-making and how other venture capitalists evaluate potential ventures.

2.4 Theoretical Framework

As analyzed by Friedlmaier (2016), most venture capital investment was directed towards financial applications of the blockchain technology. However, the lack of investment into non-financial applications and the underlying reasons behind investors’ decisions is not explained by solely stating these numbers. The decision making process of venture capitalists is highly complex, and any miscalculation of a potential venture’s potential might lead to a loss of capital for the investor. Therefore, this theoretical framework introduces important criteria in the investment decision-making and the motives that drive venture capitalist funding. The review of the existing literature about venture capitalists’ decision-making criteria revealed various criteria, categorized into six categories, that determine whether a venture capitalist invests in a potential venture. Besides these categories, two categories were added that might also explain the lack of investment into non-financial applications, and these also need to be tested.

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Category 1: Economic category

One of the most obvious drivers of any investment is the high potential return on investment. According to Fried and Hisrich (1994), return on investment has three components. The investor needs to have an exit opportunity (sale of the company, public offering or buyback), a rate of return ranging from 30–70% of the initial funding, and an above-average absolute return. Myzuka et al. (1996) stated that two elements are important when considering an investment from the financial perspective: time to break even and time to payback.

Financial and non-financial blockchain investment opportunities might offer different and diverse rates of return; whether profit is the most decisive element in investment decisions remains to be discovered.

Category 2: Non-economic category

Non-economic measures may prove a valuable asset for a venture capitalist company in assessing and further developing future investment opportunities (Gorman & Sahlman, 1989). By investing in a start-up or company, venture capitalists create a network composed of entrepreneurs, advisors, partners and other providers. Given the nature of these start-ups—lack of capital, no assets and complete reliability on their technological advances (platforms)—other factors, such as being integrated in a network, information and knowledge exchange or a consulting role are considered when evaluating the investment opportunity (Bygrave, 1987). This study analyses the question of whether financial or non-financial blockchain start-ups are already integrated into an ecosystem and whether the venture capital firm can actively help them to enter an ecosystem.

Category 3: Team (founders) category

Empirical research has found that venture capitalists are interested in leaders with the following qualities: personal integrity, strong performance in earlier jobs, realistic expectations, an ability to define risks and develop plans to overcome these risks, and management experience (Fried & Hisrich, 1994). These findings align with the propositions of a good management team, according to Myzuka (1996): the leadership potential of the management team, the leadership potential of lead entrepreneur, the recognized industry experience of the team and a solid track record. Cusumano (2013) has gone even further, stating that some venture capitalists do not invest in ideas, but in people. He has furthermore claimed that especially in the tech sector, it

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marketing and sales skills to grow a product or service. In this regard, this study considers whether differences exist among the leaders of management teams among blockchain start-ups.

Category 4: Product category

Cusumano (2013) has stated that a compelling product or service is crucial, when considering funding a venture. The product or service needs to show a variety of attributes: for instance, whether it is proprietary or can be protected, and whether it has already gained market acceptance (Macmillan et al., 1985). A further quality that makes a product or service compelling is its product-market fit. It is highly probable that a product will have success if the product, or its underlying technology, is unique. Sometimes, buyers value a product or service even more if the business is located in the country or area in which they live (Myzuka, 1996). This research inquires about whether the quality of the product differs between financials and non-financials, along with whether a certain category has a better product-market fit, looking to decide whether the product determines the investment behavior of the venture capitalist.

Category 5: Market category

Cusumano (2013) has stated that the market in which the product operates is an important factor for the venture capitalist. If the product has already gained traction in the market, barriers for new entrants should be high, no price war is likely to be waged in the market, and neither suppliers nor buyers should be strong enough to negotiate prices to the disadvantage of the company. Macmillan et al. (1985) have proposed that a market needs to show significant growth potential, or the venture needs to stimulate an existing market or be able to create a new market. If the product itself, as described in category four, and the market of the product or service are the main determinants of any funding needs to be analyzed.

Category 6: Pitch category

The concept of a product or service is constituted by the potential for business growth, a good business idea, the competitive advantage the product provides and a reasonable capital requirement (Fried & Hisrich, 1994). Pitching its idea to the venture capitalist, the venture seeking company has a limited amount of time to present its main ideas. This study determines whether the pitch itself, or whole package behind it, is critical in investors’ decisions, and whether financial and non-financial blockchain startups differ.

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Aside from these six categories, which are based in the literature, two more categories that may represent major decision-making criteria for the venture capitalist are also tested.

Category 7: Technological advancement category

Blockchain technology is not yet advanced. According to Gartner’s (2016) technology-hype cycle, which positions new technologies in various phases—namely innovation trigger, peak of inflated expectations, trough of disillusionment, slope of enlightenment and plateau of productivity— blockchain technology recently entered the stage of peak inflated expectations. This area is defined by early publicity, along with the success stories and the failures of early start-ups operating in this field of technology. Gartner estimates that the breakthrough of this technology will require 5–10 years to become mainstream. Until then, blockchain-related start-ups, and even more non-financial start-start-ups, might find problems raising money from venture capitalists. This study investigates whether experts consider this technology, or its applications for financials and non-financials, to be too early to invest in.

Category 8: Personal knowledge category

The role of a venture capitalist goes far beyond the investment, as earlier noted. The venture capitalist is integrated in the investment, from the investment stage through the setup of a knowledge non-economic measures to strategic decision making within the firm (Gorman & Sahlman, 1989). Since blockchain technology is relatively new, investors might have the feeling that they cannot support the venture to the level they usually do and consequently hesitate in their investment decisions. Whether this assumption holds will be analyzed through this research.

In conclusion, when assessing a new potential investment, venture capitalists complete evaluations that go beyond financial analysis. While the return on investment and the potential cash-out are extremely important, they may not be the main drivers in the decision-making process. The personal experience of the management team, as well as the uniqueness of the concept, the product and the market in which it operates, seem to be equally important in getting funding. This research tests which of these criteria are important to investors into blockchain related technologies, which remains unknown.

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3. Data and Method

The literature review has offered an in-depth look into the blockchain technology in general, venture capital investment into financial and non-financial applications and the role of venture capitalists. Furthermore, eight categories of criteria have been developed in the theoretical framework that determine investment decisions.

The eight categories of criteria supposed to determine investment decisions are illustrated in Figure 2.

Figure 2: Criteria that influence investment decisions

3.1 A Qualitative Research Approach

This study gathered qualitative data, and due to the scarcity of literature and data on this topic, a descriptive study was conducted (de Vaus, 2001). Semi structured interviews were used as a primary data gathering method to collect information from the venture capitalists about their own practices, beliefs and opinions in investment decisions (Harrel & Bradley, 2009). Ragin

Economics

Fried und Hirsch (1994) Myzuka et at.(1996)

Concept Pitch

Fried und Hirsch (1994)

Personal Knowledge

Non-Economics

Gorman and Sahlman (1989) Bygrave (1987)

Team

Fried und Hirsch (1994) Cusumano (2013) Myzuka et at.(1996) Market Macmillan et al. (1985) Cusumano (2013) Technology Advancement

Investment

Decision

Product Macmillan et al. (1985) Cusumano (2013)

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(1992) explained that case studies, such as this one, concentrate on the complex interaction of many factors in a few cases, instead of looking at few variables in a large sample. This focus of “intensiveness” instead of “extensiveness” offers the most suitable way to gain new insight into venture capital investors, their investment decision criteria and the decision-making process. This approach is in line with the results of Pratt (2009), who states that these “how” questions, rather than “how many” questions perfectly fit for understanding the world from the perspective of those studied—in this case, the venture capitalist.

Six categories were thus extracted from the existing literature, plus two original categories, to be tested during the interviews with investors and venture capitalists. Using the results of these interviews, this study derives its observations and conclusions. All interviews were recorded and transcribed to ensure none of the interview information was lost. In sum, with this deductive research approach, this study collected data to analyze why investment behavior differs between the financial and non-financial applications of the blockchain technology.

3.2 The Subject of Analysis and the Sample of the Case

Venture capitalists are the subject of this study’s analysis, or in the words of Thomas (2011), the case itself. To answer the research question, investors (venture capitalists) were the suitable subject of analysis, as only investors know the underlying reasons for their lack of investment into non-financial blockchain technology. The sample was defined as a structured sample, in which no group is either oversampled or extracted. The strength of this sampling method is the generalizability of the results, compared to convenience sampling (Harrel & Bradley, 2009). However, having five interviews and four categories, one category needs to be slightly overrepresented, which is the category of investors investing in both blockchain applications. The investment behavior of the sample is demonstrated in Table 1.

Table 1. Overview of Investment Behavior

Only Financials Only Non-Financials Both Applications None # of Investors 1 1 2 1

Sample size is important when it comes to the validity of a study. However, there is no common theme among academics when it comes to sample size. A small sample might lack validity,

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Trotter, 2012). For this reason, this study aimed to find three to six respondents. From all the categories defined and shown in Table 1, this sample can be classified as structurally representative for this study. To better understand the background of the investing venture capital firm, Table 2 is added to give more detail about the venture capital firms in the sample.

Table 2: Overview Research Sample

Country Investment Focus Size of Investment (in US-$) VC 1 Germany Everything digital 0.5 to 3.5 million

VC 2 Russia Everything digital Up to 10 million

VC 3 Sweden Everything digital Series A upwards

VC 4 Germany Energy Not known

VC 5 Germany Software and

Marketplaces

100.000 to 1 million

3.3 The Structure of the Interview

The interviews were semi-structured, meaning that they included open questions, which gave interviewees the opportunity to freely explain their thoughts on the topic. However, a guide was also used, with questions and areas to be covered, and the questions were asked in the same order in each interview, to guarantee that all areas of interest would be tested, while additions could also be added by the interviewee (Leech, 2002; Harrel & Bradley, 2009). The interviews took the following structure: After a short introduction to the interviewer and an explanation of the study and its aim, interviewees had the opportunity to say something about themselves, their positions in their companies and their daily tasks. Conversation in this introduction did not contribute to the collected data, but had the aim of making the interviewee feel comfortable and clarifying the topic of the research (Leech, 2002). The data collection itself began with questions related to the eight categories under investigation, each of which were addressed in separate questions. Each question followed was modelled as follows (category 1 as an example): “How does your company value the potential return on investment when assessing whether to fund a venture?”

The idea of these open questions is not to get yes–or-no answers, but to fully explore the “why” or “how” behind investors’ decisions and to investigate the difference between financial and non-financial companies and the investment possibilities that they offer to investors.

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Continuing with category 1 as an example, follow-up questions subsequently arose to elaborate on the respondents’ answers concerning the difference between financial and non-financial blockchain applications: for instance, “(Why) do you think that non-financial blockchain start-ups offer less return on investment potential than financial ones?” To obtain sufficient data and a proper reading of the venture capitalists’ reactions, the interviews were conducted in person. These face-to-face conversations eliminated any potential intermittence or interruption in the interview, providing more valuable insight into their investment decision-making process. The nature of this interview format allows a more spontaneous and valuable feedback from the interviewee, providing more nuanced results for this research (Brinkmann, 2009).

Brinkmann (2009) furthermore stated that although the costs of face-to-face interactions can be high, the benefits of in-person conversations outweigh the costs, since control of the conversation and the accuracy of the responses is greater in face-to-face conversations. The complexity of the interviews and the ability of the interviewees to expand their arguments can only be facilitated through in-person conversations.

Following this approach, the interview structure remained constant, and all eight categories were tested in the same way, with a clear focus on the “why” and the “how” behind the decision-making process. It was important to ask in-depth questions so that the consequences and inferences drawn from the interview would provide enough evidence to improve the quality of the study. At the end of the interviews, interviewees were asked the question of whether, in their firms, they value start-ups according to other criteria than the ones proposed, what application of blockchain they expect to break through, and in what time frame. These final questions allowed interviewees to elaborate on their opinions about the future of the technology and its applications in the financial and non-financial blockchain world. All interview questions and the transcribed interviews can be found in the appendix.

3.4 Validity and Reliability

This research ensures validity by using the above mentioned methods. Multiple sources, such as a literature review and structured interviews, allowed for reliable comparison of findings which leads to a valid research outcome. Internal validity and causal relationships, whereby certain conditions lead to other conditions, was guaranteed by the clear research framework, including the eight categories to be tested. These categories were, with the exception of the two formulated within this thesis, each based on previous research. Furthermore, the interviews were semi-structured to allow the subject of the study, the venture capitalist, to freely offer

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their insights. The theory on which this research relied could thus be tested and developed. External validity was obtained through the sample of respondents: Representatives of venture capital firms that had already invested in non-financial blockchain applications, firms that had invested in financial applications, firms that had invested in both, and firms that had not invested in either were part of the sample to guarantee a non-biased sample.

Reliability was ensured through semi-structured interview questions based on an extensive literature review and asked in the same order to all respondents. All inferences and consequences reached by this thesis were supported by sufficient evidence and adequate data from the interviews. The unbiased nature of the results obtained and the method used should lead to similar findings if tested again by other researchers in the future (Yin, 2009; Gibbert & Ruigrok, 2010).

3.5 Limitations of the Sample

In terms of geography, the study was limited to three German investors, one Swedish investor and one Russian investor. This is a limitation of the study as, according to Friedlmaier (2016), 35.62% of all start-ups that operate in the blockchain environment are based in North America, and there are no North American investors in this sample. In return, a significant part of blockchain investment is not covered properly. Friedlmaier has furthermore found that investors are more likely invest in companies that are geographically close. From the interviews conducted, all investors who did invest operated world-wide, or at least across Europe. As such, a great part of the European and a small part of the American financial ecosystems were covered.

3.6 Data Collection and Coding

To obtain valuable results, the qualitative interviews were categorized into 16 different cases. Each of the eight investment categories was divided into two cases: the first examined whether a given category is of interest when evaluating a potential venture; the second examined whether the venture capitalists sees a difference between financial applications and non-financial applications when interpreting this category. Having the interviews structured by these cases, interviews were coded to identify emerging patterns and common themes (Strauss & Corbin, 1990). Codes were interpreted within one category, as well as across categories. To categorize and analyze the provided content, the software NVivo 10 was used. The researcher alone was responsible for the outcome of the analysis. Extensive knowledge of the software

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was gained through a course in the master’s program. The combination of the in-depth literature review and the analysis of the interviews obtained helped to determine the right codes for the data. Codes were applied until no further insight could be generated, to fully saturate the data (Strauss & Corbin, 1990).

Due to its framework, the study is classified as a deductive study. For the analysis of the interviews, a directed content analysis approach was undertaken. The goal of this approach was to validate or conceptually extend the theory. Relevant research findings were used as a guidance for the initial codes (Hsieh & Shannon, 2005). Predictions of the categories of interest or about the relationship among them were determined using this technique (Mayring, 2000). A main feature of this approach is that key concepts and variables are identified prior to the study and classified as codes (Potter & Levine-Donnerstein, 1999). Consequently, initial data that fit into a category were coded. Codes that did not fit into a category were saved, and new codes were developed over time to put them into new categories. These newly identified categories offered a new view on the subject and refine, extending and enriching the theoretical framework with its eight categories (Hsieh & Shannon, 2005). All five interviews were recorded with permission and were 25–45 minutes long, depending on the availability of the interviewee. However, all interviewees requested full anonymity, which has been provided by the researcher. As such, neither the names of the interviewees nor their company names are stated.

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4. Research Results

All results obtained in the five interviews with five different venture capitalists are presented in this chapter. Each category is presented in its own section and structured in the same way. The first part of each section analyzes whether the category plays a major role in the venture capitalists’ evaluation of a potential venture. The second part analyzes how venture capitalists evaluate the performance of financial and non-financial blockchain start-ups in this category. Comparing the performance of financial with non-financial applications by category allows the researcher to derive a clear picture of the reasons for the lack of investment into non-financial applications. This study’s results are represented in Tables 3 and 4, showing the general importance of each criterion when venture capitalists evaluate a venture and how they think financial blockchain companies perform on this criterion, compared to non-financial companies. Using economic measures—such as return on investment, time to break-even, exit opportunities or the level of risk of an investment—venture capitalists consider these measures as important, but not as important as was expected prior to the study. However, they see a big difference between financial blockchain companies and non-financial blockchain companies. While financial companies show a clear business model, key performance indicators, more revenue streams and exit channels, non-financial companies are often not return-driven and are riskier and more experimental. A clear explanation of all the results obtained in the study is presented in the following sections, addressing each category individually.

Table 3: Results of the Economic, Non-Economic, Team and Product Category

Economic Non-Economic

(Ecosystem)

Team Product

General Importance

- Important, but not as important as expected - Important - However, venture capitalists see themselves as an ecosystem provider. - Most important category - Very important category

Financials - Clear business model - Key performance indicators - Revenue streams - Better integrated - More institutions are interested in the outcome (e.g. banks) - Experience in banking or corporate world - Knowledge or experience of the - Clear problem is being solved (e.g. transaction costs) - Advantageous for the end user

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- More exit channels

problem they want to solve

- “Bad” products on the market

Non-Financials - Often not return-driven - Experimental - Riskier - Not integrated - Very techy à less interested in connection to the corporate world - Techy - Create the problem they want to solve - Difficult to understand - Monetization of the product sometimes difficult

Table 4: Results of the Market, Pitch, Technological Advancement and Personal Knowledge Category

Market Pitch Technological

Advancement Personal Knowledge General Importance - Important category

- Either big market that is un-digitized or small market with growth potential - Least important category - Venture capitalists value everything behind the pitch. - However, good tool for a first impression

- Important category

- Investors want to invest into “high-tech” and future technologies. - Not very important category - If personal technological knowledge does not exist, third-party consultancy is requested.

Financials - Over evaluated - Bigger than non−financial market

- Better developed

- Often better pitches due to the background of the team (banking/corporate) - More advanced or more applications than non-financials - Knowledge is more advanced - Applications are “easier to understand” - Easier to invest in

Non-Financials - Less competitive - Experimental - New markets will come up

- Better in answering follow-up questions due to the background of the team (techies)

- Breakthrough in 3–5 years - No clear picture of the extent to which it will breakthrough - Difficult to understand - Often not clear whether the blockchain really solves this problem

4.1 Economic Category

From all categories of this study, a person not involved in the venture capitalist environment might think that this category is of major interest when evaluating potential investments in

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blockchain start-ups. However, this study revealed that this category is not the most relevant, and there are big differences in how financial and non-financial start-ups perform in economic evaluations.

4.1.1 General Importance

The study has shown that venture capitalists take a variety of criteria into consideration when assessing a potential venture, in respect to economic means. To be more precise, four criteria in the category of the economic decision criteria were found in the interviews, when respondents were asked about the general importance of economic measures, namely return on investment, exit opportunities, the consideration of different risk levels and potential losses. These findings are demonstrated in Figure 3.

Figure 3: Determinants of economic criteria

Exit opportunities were commonly mentioned, but not classified as a main decision criterion. According to the venture capitalists, these are difficult to evaluate, especially when the fund acts as a seed fund or Series A fund and when the fund invests in disruptive technologies.4 The threat of potential losses, however, was closely connected to differences in risk, as the following statement suggests:

“So we build our view on the risk or reward and then we, also given what the probability of losing our money on the investment is, we decide actually how much of the fund we are going

to put into this investment. Anything from half a percent of the fund up to ten percent of the fund.”

Return on investment was not considered a driving criterion by all venture capitalists. However, the ones who mentioned it stated that a fund is a performance-driven institution that

4_{For more information of funding rounds follow: http://www.investopedia}

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needs to deliver results if it wants to succeed in a new round of funding. That assumption shows that return on investment is, if not necessary in all ventures, an important criterion. A desired return on investment was around three to ten times the initial investment.

4.1.2 Economic criteria in financial vs. non-financial applications

When it comes to the venture capitalists’ evaluation of the performance of financials as opposed to non-financials on the category of financial performance indicators, six different themes were identified: a clear business model, exit channels, key performance indicators, revenues, risks and “too early to say.” These themes are pictured in Figure 4.

Figure 4: Economic criteria in financial vs. non-financial applications

First, a big difference was seen between the business models of financials and non-financials, meaning that financial applications often have a clear business model. These applications provide a clear benefit for the end-user, for instance the transaction of money. In contrast, non-financial applications are often technologically advanced and try to solve a problem that is not beneficial for the end user.

Second, experts share the opinion that financial applications have a wider range of possible exit channels, compared to non-financial applications. These may include banks, corporations or other funds.

Third, the success of financials was assessed to be easier to determine than the success of non-financials, with clear and measurable key performance indicators and instant creation of revenue streams. These assumptions were affirmed in the following statement:

“But with [financial] applications, you see instant success. User growth, revenue growth, you have a lot of KPIs you can analyze. With the infrastructure applications [non-financial

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become big, it needs to become a standard. That is hard to estimate. That’s why I would say that it is more difficult to do infrastructure [non-financial] topics.”

Fourth, financial blockchain companies are able to generate instant revenues, especially compared to infrastructure problems that only try to solve a problem on the blockchain, Fifth, assessing the risk of a potential venture, there was a clear opinion that non-financial applications show a higher risk.

However, sixth, two out of five investors also said that it is too early to evaluate and that decisions need to be made on a case-by-case basis.

In summary, out of these six themes detected when assessing the difference between financial and non-financial applications, five clearly favored financial blockchain applications.

The evaluation of economic drivers did not seem to play an important role in general and was widely considered to not be a main decision factor. However, when considering the difference between financial and non-financial blockchain companies, investors were clearly in favor of financial blockchain applications, as they consider them to be less risky, to offer them more exit channels, to be easier to measure, to show clear business models and to carry less risk than non-financial blockchain applications.

4.2 Non-Economic Category

Besides acting as a donor, a venture fund acts as a strategic partner in the post-investment phase and tries to connect its ventures either to each other or to other sources of knowledge exchange, all with the aim to integrate the venture into an ecosystem in which it can develop and grow. This study revealed that venture funds put a major focus on the integration of these start-ups and see themselves as a network provider.

4.2.1 General importance

With respect to the non-economic category, all venture funds stated that they see a need to create a community in which people can learn from each other. However, as shown in Figure 5, the dimension of knowledge exchange differs among investors. During the study, it was revealed that four different levels are of major interest for investors: the venture capitalist’s connection to other funds, their role as a strategic partner, their connection with corporations, and their ability to connect start-ups with other start-ups. All investors had in common that it

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is not necessary for the start-ups to be integrated into an ecosystem already, but that the venture fund is able to integrate them into an ecosystem.

Figure 5: Determinants of non-economic criteria

First, the venture capital fund’s connection to other funds was considered to be very important when it comes to follow-up investments. In this context, especially connections to the United States, where Series B investments onwards are more likely, it seemed to be very valuable to offer the venture more investment in later stages.

Second, the role of the venture capitalist in the post-investment phase was unclear. Given the high complexity of the technology, investors do not see themselves as advisors when it comes to technology, but rather as an ecosystem provider who delivers the network, as can be seen by this statement from an investor in the area of energy projects:

“We see ourselves as an ecosystem provider in the area of energy and not in the area of blockchain. That means that if we talk about the topic blockchain, the expertise in blockchain

needs to be on the start-up side. The energy expertise does not need to be there because that’s what we provide.”

Third, the provided network included the world of corporations which venture capital funds are able to set up. In this context, knowledge exchange or even acquisitions can take place. Fourth, a focus is put on the connection to other start-ups. This happens through events with all ventures. Through these events, funds hope to generate valuable knowledge exchange. However, this approach is more suitable when the portfolio of a fund is not very diversified, for example when all (most) ventures operate in the software industry. There, communication is tailored to the start-ups’ specifically shared problems.

In summary, providing a network was of utmost importance for the venture capitalists. Their help goes far beyond providing money, extending to aid wherever and whenever possible.

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When it comes to the analysis of the ecosystem, clear differences were seen between the world of financials and the world of non-financials. Three sub-categories of the category “ecosystem” were set up, namely ecosystem of financials, ecosystem of non-financials and no ecosystem. These are shown in Figure 6.

Figure 6: Non-economic criteria in financial vs. non-financial applications

With the exception of one venture capitalist, there was a clear tendency to state that financial blockchain start-ups are already better integrated into an ecosystem, since (mostly) at least one founder of the start-ups comes from the corporate (banking) world and knows the pain of a certain problem. This background facilitates the setting-up of a network:

“I think that financial blockchain companies are more integrated into an ecosystem than non-financials. That is often due to the fact that their applications are by their nature closer to the real life in a way. In financials, banks or other corporations often have a big interest.

That’s why they often support these companies from the very beginning.”

On the other hand, non-financial blockchain companies are often very “techy.” This means that there is often a clear focus on solving a problem by making it run on the blockchain. The lack of connection to the corporate world, however, is not a problem for the venture capitalists. One venture capitalist, who stated that neither financial nor non-financial applications are integrated into a certain network already, said that this lack of integration is no barrier for being hesitant to an investment:

“I would say that non-financials are not really in a network at the moment. Having said this, I mean that these companies are often very techy. For example, an infrastructure start-up is

just trying to write the code and make it run on the blockchain.”

In sum, there is a clear tendency towards the perception that non-financials lack a network and the understanding of a sector due to their “techyness” and their relative distance to applications

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of the technology. On the other side, financials are already very well integrated and are often backed by banks from the very beginning.

4.3 Team Category

The interviews suggest that the founders and the teams behind the founders are the main criteria for many investors to invest into a venture. As the area of blockchain is a very difficult one, the team members need to have certain skills, attributes and other conditions, as described in Sections 4.3.1 and 4.3.2.

Especially in the early phase of a start-up, like the seed or Series A stage, products or markets are often not well developed, so return on investment can sometimes not yet be generated at the moment of funding. As a consequence, investors invest in people who are, according to their view, capable of making the company grow. Figure 7 summarizes the different attributes, skills and other necessities valued when venture capitalists analyze a team. These values include a great culture within the company, expertise, a complementary team set-up, experience as an entrepreneur and variety of skills and attributes, such as being ambitious, analytical, and proactive, and having great hiring skills for the levels below the management team.

Figure 7: Determinants of team category

First, it is very important that a complementary team setup exists. This means that, in the best case, people with different backgrounds come together so that everybody can contribute knowledge and experience in various areas:

“We don’t want three business people to form a team and neither do we want three techies. We want a mix of functions.”

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Second, besides a complementary team setup, experience and expertise in the business are important. Experience in the sector they operate in, as well as earlier entrepreneurial experience, were highly valued. The venture capitalists reported being more likely to invest if founders had much experience in the sector and if at least one of these founders already had entrepreneurial experience—success or lack thereof did not matter.

Third, the management team needs to able to create a culture in which every employee is willing to give his or her best to contribute to the success of the firm.

Fourth, next to experience and expertise, various attributes and skills were requested by venture capitalists. The team needs to be ambitious, analytical and show great execution and analytical skills. A lack of expertise can be compensated by a great drive among the team and a willingness to engage deeply with the problem they want to solve. Being able to do this, the founders need to show great analytical skills so that they are able to identify main problems and find solutions to solve these problem. In addition to great execution skills, good hiring skills were also considered very important:

“Furthermore, they need to be able to hire good people. But that often goes hand in hand. If you cannot get an investor you are very unlikely doing well in attracting top talent.”

4.3.2 Differences in the team category

When it comes to differences between the team setup of financial applications and non-financial applications, the study revealed that venture capitalists see three categories between their respective markets: no difference in the team setup, teams from financial applications often coming from the banking (corporate) world and non-financial teams being more “techy.” These findings are demonstrated in Figure 8.

Figure 8: Team criteria in financial vs. non-financial applications

First, the theme emerged that founders from financial blockchain companies are from the world of banking or at least know the pain points that exist there.

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Second, the theme emerged that there are no differences in the founder’s team. However, this theme was only mentioned by one venture capitalist. The other four investors confirmed the other two themes.

Third, in the world of non-financial applications, a clear tendency towards more “techy” people was revealed. Solving the problem by writing code, in the first place, is more important for people than the attraction of more users and the monetization of the solution. In contrast, the blockchain community has a far better understanding of financial applications, as these are closer to the market and are more “concrete” than non-financial applications.

In sum, respondents demonstrated a clear tendency towards people being techier in the non-financial area and people coming from the banking world in the non-financial area. However, no clear insight could be derived concerning whether either one of these backgrounds is good or bad or whether one of these makes investors hesitant in investing.

4.4 Product Category

The product of a company is always at the center of its business. When assessing the question of what products a venture capitalist looks for, interesting insights were revealed.

4.4.1 General importance of the product

When it comes to the general importance of certain characteristics a venture capitalist looks for when evaluating the product, three categories were established: the product’s level of novelty, whether it has already seen success and its uniqueness. These are demonstrated in Figure 9.

Figure 9: Determinants of product category

The level of novelty has to be high, according to the interviewed venture capitalists. Nothing low-tech or not innovative would be further considered. On the other hand, besides its novelty,

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investors. For late-stage investors, it is impossible to invest millions of euros if the product has not shown success. For early-stage investors, no proven success was necessary. In the best case, the product is, furthermore, unique. Nevertheless, venture capitalists had problems evaluating the product on its own; the market for the product also had to be considered. If, for instance, a product operates in a big and already settled market, it needs to be 10 times better than the competition if it wants to get traction. These responses suggest that a clear product-market fit must be guaranteed.

4.4.2 Differences in the product between financials and non-financials

When evaluating the differences in performance between financials and non-financials in terms of the product itself, this study found out that venture capitalists see two differentiators between their respective markets, as illustrated in Figure 10. In general, many teams lack the answer to the “why question” behind their business models. Venture capitalists claimed that they often want to solve problems using the blockchain, but they have no idea why this solution is advantageous.

Figure 10: Product criteria in financial vs. non-financial applications

First, when it comes to the level of ability of product solving, investors think that financial applications are better at solving problems for consumers, so in the world of finance, the client benefits from the solution, for example saving money in a transaction. Non-financial products also solve problems, but these are often not understandable by an average user:

Second, investors cannot evaluate products based on the two dimensions financials or non-financials; rather, products need to be evaluated on a case-by-case basis. Products that are unlikely to succeed exist in the financial world and non-financial world alike.

“A blockchain solution that gets traction in the broad middle is something where the consumer does not understand that this is based on the blockchain. This could be in the world

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currency exchange rate. And if you do it on bitcoin or on any other cryptocurrency you just need to pay five cents for a huge transaction. So if the client doesn’t know how it works, but

he doesn’t care because it is cheap, then it is alright.”

Analyzing the differences in the products, no clear solution can be drawn to decide whether the products of one category are better than others and whether investors hesitate to invest because of a certain criterion that is not fulfilled by non-financials.

4.5 Market Category

The market in which a product operates was considered to be very important among the sample of venture capitalists. The findings concerning how they evaluate the general importance of the market are explained in Section 4.51 and the differences between financials and non-financials are explained in Section 4.5.2.

There was no common theme among venture capitalists that a market needs to show a certain set of characteristics to be important for them. However, venture capitalists value certain attributes, including the size of a market, its growth potential, its level of establishment and its level of digitization. These are shown in Figure 11.

Figure 11: Determinants in market category

In the area of blockchain or technology in general, investors do not necessarily look for big markets. In contrast, sometimes markets do not yet exist for early-stage investors. In the end, the market the company operates in needs to have a certain volume, but venture capitalists appreciate if their products (companies) create these markets, starting from a niche market. This strategy guarantees that the company can instantly act as a market leader.

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Respondents rated the level of digitization of the market as very important. Many big markets exist that are not yet fully digital and offer, consequently, great opportunities for disrupting technologies. However, they also stated that it might take much time and money to digitize a big market: “What might also be possible, when we have a look at logistics, which are already huge markets but fully un-digitalized. What we would never do. An ok big market which is about to shrink. That would be difficult.”

4.5.2 Differences in markets for financials and non-financials

When it comes to differences between the markets of financials and non-financials, this study revealed that venture capitalists see four big differentiators between their respective markets, as demonstrated in Figure 12.

Figure 12: Market criteria in financial vs. non-financial applications

First, when it comes to size, financial markets are clearly bigger than non-financials at the moment. In contrast, non-financial markets were considered to be quite experimental.

Second, they consider the market of financials to be more advanced, primarily because of investments that have already been made, but also given the media hype around cryptocurrencies, especially bitcoins. However, venture capitalists critiqued that financial markets are slightly over evaluated at the moment, which makes investment difficult.

Third, the market for the financials is more competitive, as these are already more advanced. In contrast, in the non-financial world, very few people can actually build these applications, which makes this area less competitive.

Fourth, blockchain technology will create markets not presently known or anticipated, which become even bigger in the world of non-financials, where applications are not limited to the area of payment, exchange or transactions.

“And the second point is that there will be huge markets created. That is a one-in-a-century technology which is about to be tested at the moment. Just like the Internet. It is not clear at

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all which dimensions this might have. There will be a lot of market makers, blue ocean, which means that there will things come up which nobody is aware of at the moment. But as of

today, financial is definitely bigger at the moment.”

In sum, respondents demonstrated a clear tendency towards financial applications, when it comes to market characteristics, valuing the security of an already established and bigger market.

4.6 Pitch Category

The pitch describes the approach of the start-up to get funding. This pitch usually includes a quick presentation of the team, the product, the market, the solution, the business model, the customer(s), the competition, a financial overview, funding and the legal plan.5

Regarding the pitch, the study revealed that investors value two different criteria when evaluating a venture, namely the ability to answer follow-up questions and general sales skills. A third theme emerged, namely the relative importance of the pitch itself, as can be seen in Figure 13. Investors commonly stated that they use the pitch only to get a first impression and idea of the company and what problem they are trying to solve. More important is everything "behind" the pitch.

Figure 13: Determinants of pitch category

First, and most important, the team needs to be able to answer follow-up questions. Venture capitalists need to see that the start-ups have a clear strategy and vision and that they have thought carefully about what they will do and what might harm them.

5