Are they investing in Web 2.0 sites because they're cool? Nope - because they can do contextual advertising. Which will be the next big thing; Microsoft's adCenter will allegedly detect your gender from your surfing habits and allow advertisers to deliver 'relevant' ads on the next page you visit.
But that's not quite all the answer. The VCs are investing because they all want whatever turns out to be the next Google: Google's VC had another 199 projects you've probably never heard of, and that was just in that 12 months. There's the me-too element and the 'new and shiny' bubble element. There's the fact that if you're under 21, 60+% of the content you look at online is generated by someone you know (news as entertainment rather than information again). Tim O'Reilly has been saying for a long time that the future of Web applications is metadata (Amazon ratings, flickr tags, digg 'dugs' and the rest), and that the smart companies get us to make the metadata for them.
And the other side of the coin is Identity 2.0, as it seems to be called. Add together the US laws on ID theft that mean companies have to disclose how many personal details they lose in laptop thefts, stolen backup tapes and good old-fashioned hacker break-ins, the post-SarbOx emphasis on compliance and regulation and the fact that the head of compliance is more likely to be on the board than the head of IT. Not many companies want the responsibility of keeping a lot of customer data unless it's sanitised and anonymised. Technology and privacy advocates are finally going in the same direction: put the user back in control of what data they disclose to a site and tell them where what they say is going (at least in the first instance). Over the next year or so we'll start seeing more ways to log in with tools like InfoCards that give you at the very least more of an idea about who is tracking what about you.