The crypto venture capital industry has become more selective thanks to the general market downturn and faltering confidence caused by a series of scandals and market disruptions, but investors at major firms are still writing checks in the space.
Amid market volatility, decentralized finance, or DeFi, is an area that continues to be in the spotlight both in the crypto VC world and throughout the community as new use cases, protocols, and projects emerge. .
Between 20% and 50% of cryptocurrency-related launches today are focused on DeFi, several investors we surveyed said. That shows that there are a large number of DeFi projects seeking funding.
“To stand out in this crowded space, founders need to focus on highlighting a unique technology and clear advantage for a specific use case, as well as a defensible moat,” said Alex Marinier, founder and general partner at New Form Capital.
Ultimately, DeFi is a reflection of traditional finance (TradFi), and founders who have deep experience in the TradFi sector, along with a fundamental understanding of blockchain, will stand out from the other teams, Paul Veradittakit , a general partner at Pantera Capital, shared.
Last year, the crypto world faced a handful of 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 led to the downfall of many smaller startups and large players who mixed in with the now defunct market players.
As the market looks to the future, some venture capitalists are revamping their investment strategies, while others are sticking with their current plans, perhaps with a minor tweak or two. Read on to find out how active investors think about DeFi, how they advise their portfolio companies amidst lack of funding, the best way to approach them, and more.
We surveyed:
- michael andersonco-founder, framework companies
- Alex Marinerfounder and general partner, new form of capital
- samantha lewisprincipal, Mercury
- Paul Veradi Jacketsgeneral partner, Capital Panther
- david ganfounder and general partner, Crypto OP
- mike giampapageneral partner, galactic enterprises
Michael Anderson, Co-Founder, Framework Ventures
How big is the DeFi 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, the total value locked (TVL), and the trading volume. While Total Value Locked (TVL) as a metric certainly has its flaws, we think it’s still a decent measure of activity in the sector. As TVL rises, we also think total market capitalization is likely to follow.
We closely monitor relative industry activity such as transactions, volumes, and users, compared to centralized alternatives like exchanges. Despite the negative sentiment surrounding cryptocurrencies today, we still believe that activity will eventually return to the industry. However, after all these dramatic centralized finance (CeFi) explosions, we believe that the next time users decide to enter the space, they will think twice before trusting an exchange or CeFi company, and will instead opt for use decentralized protocols.
What were the biggest challenges your company faced in 2022? What steps are you taking to better prepare for 2023?
As with most investors in the space, our biggest challenge has been navigating the seemingly endless CeFi blowouts and failures that have rocked our industry. We were able to avoid the vast majority of these blowouts, as we passed several projects from the FTX ecosystem.
As a result, Framework wasn’t hit as hard as many of the big VC firms in the space, and we’re in a pretty strong position to continue to deploy capital into this new market.
These CeFi incidents have caused a lot of collateral damage across the industry, so one of the top priorities over the past 12 months has been making sure that all of our portfolio companies are strong, liquid, well-capitalized and able to survive the next few years. 1 to 3 years. This means helping our portfolio founders reduce costs, prioritize high-growth activity, and provide advice on product, growth, and future fundraising strategy in a less favorable funding environment.
Overall, our position is a validation of our core theses over the past 3 years, and we will continue to double down on DeFi, web3 gaming, and more. With many of the other companies not actively investing right now, we see this market as a great opportunity for Framework to selectively deploy capital.
How are you advising the companies in your portfolio for 2023?
We are working with them to reduce costs and focus on surviving the next 1-3 years. We believe in cryptocurrencies for the long term, but we don’t know how fast the market could recover, so survival should be the top priority.
We also encourage founders to think more strategically about project development. If a team was focusing on three different areas, we encouraged them to prioritize only the fastest growing activity.
Of all the pitches you receive, what percentage are DeFi protocols or projects? What can they do to stand out in the larger crypto landscape?
These days about 30-35% of the pitches we get are firmly focused on DeFi.
If a DeFi project really wants to stand out, we want to see that they are thinking about where the puck goes. We are looking for projects that have the potential to be regulatory friendly. It’s not a start if the team isn’t thinking about regulation, or thinks it can figure it out in the future.
Furthermore, we are interested in projects that have direct connections to the institutions or at least a compelling growth strategy involving the institutions. We don’t think retail will offer projects a big enough market in DeFi over the next two years, so creating something attractive to institutions should be a more central focus than before.
We also want to see the project differentiate itself from a product perspective. 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 that changed since the last few quarters?
In 2020, during the height of the DeFi summer, the market was large enough for projects to court retail and DeFi degens. [a nickname for people interested in risky, niche, speculative crypto projects]. The market is totally different now.
Unfortunately, retail exploded in more than a dozen different ways last year, and it’s unlikely they’ll return for a few years. As a result, we are focusing more on projects that are looking to address new users and more institutional markets.
We understand that regulation is likely to come later, so we are very interested in projects that are pro-regulation, or at least pro-regulation.
What types of DeFi use cases do you think will gain more mainstream adoption in the future? What areas of DeFi are now perceived as more important than they used to be?
With the merger officially behind us, liquid betting has become a huge source of excitement for us. We believe that liquid equity projects will receive much more attention after Shanghai goes live and users have the opportunity to withdraw their assets without worrying about lack of liquidity.
How can you bridge the gap between traditional finance (TradFi) and DeFi?
We need to see more DeFi products and services that are more realistically suited to institutions. This means projects that have pro-regulatory elements built into the products themselves, including KYC, the ability to limit certain assets, and more. The projects that institutions will be able to transact with will not look or feel like the traditional DeFi we are used to and will co-exist as a relatively different ecosystem.
How do you think regulatory frameworks may affect the DeFi space? Which country or region seems to be going in the best direction?
Sometime in 2023, we will have the landmark crypto regulation that everyone has been waiting for years. More clarity could be very positive.
We don’t have a firm position, but on the surface it seems the UK is fast becoming one of the most open, from a thought leader’s perspective.
How do you like to receive pitches? What is the most important thing a founder should know before talking to you?
We really like a good story. We want to know why you’re working on this problem, why it needs to be solved now, and why you think you can beat all the others. Competitive advantage is key to us.
Alex Marinier, Founder and General Partner, New Form Capital
How big is the DeFi market today? How much do you expect it to grow in the next five years?
The DeFi market is currently hovering around $50 billion in TVL. In the next five years, we expect the market to split into two categories: permissioned and permissionless.
Permissioned DeFi will gain ground among institutions, because it combines the benefits of blockchain technology with the compliance standards of traditional finance. If just a small percentage of traditional financial activity moves on-chain, it could create a market opportunity worth more than $1 trillion.
When you add permissionless DeFi, which is more geared towards individual users and makes up the majority of DeFi today, the combined market has the potential to be worth between $500 billion and $2 trillion by 2028.
That being said, the growth of DeFi will depend on more than just an increase in use cases. It will also be influenced by developments in infrastructure, regulation and financial innovation.
What were the biggest challenges your company faced in 2022? What steps are you taking to better prepare for 2023?
Navigating high profile crashes (Terra, Celsius, FTX) was certainly the focus of 2022. We had to take more time to support our founders and ensure they have enough runway to withstand a prolonged bear market.
This year our goal is to help founders find creative ways to grow in this market and position themselves for the next bull market. We are also focused on obtaining opportunistic investments at attractive valuations and incubating more projects internally.