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The crypto venture capital industry has become more selective due to the general market collapse and wavering confidence caused by numerous scandals and market disruptions, but investors in major firms still write checks in the space.
Amid market volatility, decentralized finance, or DeFi, is an area that continues to receive attention in the crypto VC world and the community as a whole as new use cases, protocols and projects arise.
Today, between 20% and 50% of crypto-related plans are focused on DeFi, according to several investors we surveyed. That shows that there are a huge number of DeFi projects in need of funding.
“To stand out in this crowded space, founders need to focus on highlighting unique technology and clear value for a specific use case, as well as in a defensible way,” said Alex Mariner, founder and general partner of New Form Capital.
Finally, DeFi is a mirror reflection of traditional finance (TradFi), and in TradFi, the founders with deep sector knowledge, combined with a fundamental understanding of blockchains, stand out from the rest of the group, said Paul Veraditakit, General Partner of Pantera Capital.
Last year, the crypto world experienced a few massive industry-changing events, such as the collapse of the Terra/LUNA ecosystem in May and the collapse of cryptocurrency exchange FTX in early November. Both events brought down many small startups and large players who have now merged with their market players.
As the market looks ahead, some venture capitalists are refining their investment strategies, while others are sticking with their current plans, perhaps even a little or two. Read on to find out what active investors think about DeFi, how they advise their portfolio companies in the absence of funding, the best way to approach them, and more.
We surveyed:
- Michael Anderson, Co-Founder, Framework Ventures
- Alex Mariner, Founder and General Partner, New Form Capital
- Samantha Lewis, Principal, Mercury
- Paul Veradittakit, General Partner, Pantera Capital
- David Gann, Founder and General Partner, OP Crypto
- Mike Giampapa, General Partner, Galaxy Ventures
Michael Anderson, Co-Founder, Framework Ventures
How big is the Defy market today? How much do you expect it to grow in the next five years?
When we think about the DeFi market, we look at the total market capitalization of DeFi assets, Total Value Locked (TVL), and transaction volume. While total value locked (TVL) as a measure certainly has its flaws, we still think it’s a good measure of activity in the sector. We think that as TVL increases, the overall market value will likely follow.
We closely monitor the sector’s relative activity in terms of transactions, volumes and users compared to centralized alternatives such as exchanges. Despite the negative sentiment around crypto today, we believe that the movement will eventually return to the industry. However, after all these dramatic explosions of centralized finance (CeFi), we think that the next time users decide to enter the space, they will think twice about trusting a CeFi exchange or company and instead choose to use decentralized protocols.
What are the biggest challenges your organization faces in 2022? What steps are you taking to better prepare for 2023?
Like most investors in the space, our biggest challenge is navigating the seemingly endless booms and busts of CeFi. We’ve been able to avoid most of these explosions since we’ve deployed several FTX ecosystem projects.
As a result, Framework hasn’t been hit as hard as some of the larger VC firms in the space, and we’re in a very strong position to continue deploying capital in this new market.
These CeFi events have caused a lot of collateral damage in the industry, so the priority for the last 12 months has been to ensure that all our portfolio companies are healthy, liquid, well capitalized and viable for the next 1-3 years. This means helping founders in our portfolio, prioritizing high growth activity and advising on product, growth and future fundraising strategy in a less friendly funding environment.
Overall, where we are is a validation of our core theme over the past three years, and we will continue to double down on DeFi, web3 gaming and more. As many other firms are not actively investing at this time, we see this market as a good opportunity to selectively deploy capital for Framework.
How are you advising your portfolio companies going into 2023?
We are working with them to reduce costs and focus on survival in the next 1-3 years. We believe in crypto for the long term, but we do not know how quickly the market will recover, and therefore survival should be the priority.
We are also encouraging founders to think strategically about project development. If a team is focusing on three different areas, we are encouraging them to prioritize only the highest growth activities instead.
What percentage of all the places you find are DeFi protocols or projects? What can you do to stand out in the wider crypto landscape?
Currently, about 30%-35% of the pitches we receive are strictly DeFi focused.
If a DeFi project really wants to stand out, we want to see where they’re thinking about where the puck is going. We are looking for projects that have the potential to be compliant. A team is a non-starter if they don’t think about rules or think they can understand the basics.
Additionally, we look for projects that have a direct relationship with institutions or at least a compelling development strategy that includes institutions. We don’t think there will be enough market for retail projects in Diffie in the next two years, so creating something attractive to institutions should be given more attention than before.
We also want to see that the project is different from the production point of view. We’re not interested in another Uniswap clone, or an open sea copy of the alt-L1 flavor of the week.
What is your current strategy for investing in DeFi protocols and projects? How has it changed from previous episodes?
In the year In 2020, during the peak of the DiFi season, the projects were large enough to retail and emulate DiFi discs. [a nickname for people interested in risky, niche, speculative crypto projects]. The market is completely different now.
Unfortunately, the retail business was blown in more than a dozen different ways last year, and they aren’t likely to come back for a few years. As a result, we focus more on projects that address new, multi-institutional users and markets.
We understand that regulation may be coming down the line, so we are very interested in projects that are pro-regulation or at least regulatory-friendly.
What kinds of DeFi use cases do you think will see more mainstream adoption in the future? Do you understand which areas of DeFi are more important than ever?
With the merger officially behind us, liquidation has been a huge source of joy for us. We think liquid storage projects will gain more attention after Shanghai Live goes live and users have the opportunity to withdraw their assets without worrying about illegality.
How to bridge the gap between traditional finance (TradFi) and DeFi?
We should see more DeFi products and services that actually host institutions. This means projects that have pro-control elements baked into their own products, including KYC, the ability to restrict certain assets, and more. The projects that the institutions interact with don’t look and feel like the DeFi we’re used to, and they coexist in a relatively different ecosystem.
How do you think regulatory frameworks could affect the DeFi space? Which country or region seems to be moving in the best direction?
Sometime in 2023, we will have the landmark crypto regulation that everyone has been waiting for for years. More transparency can be very positive.
We don’t have a firm position, but on the surface, the UK seems to be rapidly becoming one of the most open, from a thought-leadership perspective.
How do you like to receive leads? What is the most important thing a creator should know before talking to you?
We love a great story. We want to know why you’re working on this problem, why you need a solution now, and why you think you can beat everyone. Competitive advantage is key for us.
Alex Mariner, Founder and General Partner, New Form Capital
How big is the Defy market today? How much do you expect it to grow in the next five years?
The DeFi market is currently around $50 billion in TVL. In the next five years, we expect the market to be divided into two categories: licensed and unlicensed.
Permissioned DeFi will be widely accepted among institutions as it marries the benefits of blockchain technology with traditional financial standards. If even just a few percent of traditional financial transactions move on-chain, it could create a market opportunity worth more than $1 trillion.
When you add in permissionless DeFi, which is more focused on individual users and comprises the majority of DeFi today, the combined market has the potential to be worth $500 billion to $2 trillion by 2028.
That said, Defy’s growth isn’t just about use cases. It will also influence the development of infrastructure, regulation and financial innovation.
What are the biggest challenges your organization faces in 2022? What steps are you taking to better prepare for 2023?
Exploring the high-profile failures (Terra, Celsius, FTX) was definitely the focus of 2022. We took a lot of time to support our founders and make sure they had enough runway to weather an extended bear market.
This year, our focus is on helping founders find creative ways to grow in this market and position themselves for the next bull market. We also focus on generating favorable investments with attractive valuations and generating additional projects at home.
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