The crypto venture capital industry has become more selective thanks to the general market downturn and wavering trust caused by a slew 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 focus in both the crypto VC world and across the community as new use cases, protocols and projects arise.
Anywhere from 20% to 50% of crypto-related pitches today are DeFi-focused, several investors we surveyed said. That shows there’s a vast number of DeFi projects looking for funding.
“To stand out in this crowded space, founders should focus on highlighting unique technology and a clear advantage for a specific use case, as well as a defensible moat,” Alex Marinier, founder and general partner at New Form Capital said.
Ultimately, DeFi is a mirror reflection of traditional finance (TradFi), and founders who have deep sector expertise in TradFi, coupled with a fundamental understanding of blockchains will stand out from the other teams, Paul Veradittakit, general partner at Pantera Capital, shared.
Last year, the crypto world faced a handful of massive industry-changing events like the Terra/LUNA ecosystem collapse in May and the cryptocurrency exchange FTX collapsing in early November. Both events brought down a lot of smaller startups and big players who intermingled with those now defunct market players.
As the market looks toward the future, some venture capitalists are revamping their investing strategies, while others are holding to their current plans, with perhaps a small tweak or two. Read on to find out how active investors are thinking about DeFi, how they’re advising their portfolio companies amid the lack of funding, the best way to approach them and more.
We surveyed:
- Michael Anderson, co-founder, Framework Ventures
- Alex Marinier, founder and general partner, New Form Capital
- Samantha Lewis, principal, Mercury
- Paul Veradittakit, general partner, Pantera Capital
- David Gan, founder and general partner, OP Crypto
- Mike Giampapa, general partner, Galaxy Ventures
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 thinking about the DeFi market, we look at the total market cap of DeFi assets, total value locked (TVL) and 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 increases, we also think it’s possible that total market cap could follow.
We’re keeping a close eye on the sector’s relative activity, like trades, volumes and users, compared to centralized alternatives like exchanges. Despite the negative sentiment surrounding crypto today, we still believe activity will eventually return to the industry. However, in the aftermath of all of these dramatic centralized finance (CeFi) explosions, we think that the next time users decide to enter the space, they’re going to think twice about trusting a CeFi exchange or company and instead opt to use decentralized protocols.
What were the biggest challenges your firm 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 blowups and failures that have rocked our industry. We were able to avoid the vast majority of these blowups, as we passed on several FTX ecosystem projects.
As a result, Framework wasn’t hit nearly as hard as many of the big VC firms in the space, and we’re in a pretty strong position to continue deploying capital in this new market.
These CeFi incidents have caused plenty of collateral damage across the industry, so a major priority over the last 12 months has been making sure all of our portfolio companies are sound, liquid, well capitalized and can survive the next 1-3 years. This means helping the founders in our portfolio cut costs, prioritize high growth activity and providing advice on product, growth and future fundraising strategy in a less friendly funding environment.
In general, our position is a validation of our core theses over the last three years, and we’re going to continue doubling down on DeFi, web3 gaming and more. Given that a lot of the other firms aren’t actively investing at this time, we see this market as a great opportunity for Framework to selectively deploy capital.
How are you advising your portfolio companies going into 2023?
We’re working with them to cut costs and focus on surviving the next 1-3 years. We believe in crypto long term, but we don’t know how quickly the market could bounce back, and so survival should be the top priority.
We’re also encouraging founders to think more strategically about project development. If a team was focusing on three different areas, we’re encouraging them to instead prioritize the highest-growth activity only.
Of all the pitches you get, what percentage are DeFi protocols or projects? What can they do to stand out in the broader crypto landscape?
These days, around 30%-35% of the pitches we receive are firmly DeFi-focused.
If a DeFi project wants to really stand out, we want to see that they’re thinking about where the puck is going. We’re looking for projects that have the potential to be regulation-friendly. It’s a non-starter if the team is not thinking about regulation or thinks they can just figure it out down the line.
Additionally, we’re interested in projects that have direct connections to institutions or at least a compelling growth strategy that involves institutions. We don’t think that retail will offer projects a large enough market in DeFi over the next two years, so creating something attractive to institutions should be more of a core focus than previously.
We also want to see that the project is differentiated from a product perspective. We’re not interested in another Uniswap clone, or an Open Sea copycat of the flavor of the week alt-L1.
What is your current strategy for investing in DeFi protocols and projects? How has that changed from past quarters?
In 2020, during the height of DeFi summer, the market was big enough that projects courted retail and DeFi degens [a nickname for people interested in risky, niche, speculative crypto projects]. The market is totally different now.
Unfortunately, retail was blown up more than a dozen different ways last year, and they’re unlikely to come back for a few years. As a result, we’re focusing more on projects that are thinking about addressing new, more institutional users and markets.
We understand that regulation is likely coming down the line, so we’re very interested in projects that are pro-regulation, or at the very least, regulation-friendly.
What types of DeFi use cases do you think will gain more mainstream adoption going forward? Which areas of DeFi are now perceived as more significant than they used to be?
With the Merge officially behind us, liquid staking has become a big area of excitement for us. We think liquid staking projects will receive much more attention after Shanghai goes live and users have the opportunity to withdraw their assets without worrying about illiquidity.
How can the gap between traditional finance (TradFi) and DeFi be bridged?
We need to see more DeFi products and services that more realistically accommodate institutions. This means projects that have pro-regulatory elements baked into the products themselves, including KYC, the ability to limit certain assets and more. Projects that institutions will be able to transact with won’t look and feel like the traditional DeFi we’re accustomed to and will coexist as a relatively different ecosystem.
How do you think regulatory frameworks can affect the DeFi space? Which country or region seems to be going in the best direction?
At some point in 2023, we’ll have the landmark crypto regulation that everyone has been waiting on for years. More clarity could be very positive.
We don’t have a firm position, but on the surface, it looks like the U.K. is rapidly becoming one of the most open, from a thought-leader perspective.
How do you like to receive pitches? What’s the most important thing a founder should know before they talk with you?
We really like a good storyline. 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 everyone else. Competitive advantage is key for 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 around $50 billion in TVL. In the next five years, we expect the market to bifurcate into two categories: permissioned and permissionless.
Permissioned DeFi will gain traction among institutions, because it marries the benefits of blockchain technology with the compliance standards of traditional finance. If just a small percentage of traditional finance activity moves on-chain, it could create a market opportunity worth more than $1 trillion.
When you add in permissionless DeFi, which is more geared toward individual users and makes up most of DeFi today, the combined market has the potential to become worth anywhere from $500 billion to $2 trillion by 2028.
That said, DeFi’s growth 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 firm faced in 2022? What steps are you taking to better prepare for 2023?
Navigating the high-profile collapses (Terra, Celsius, FTX) was certainly the focus of 2022. We had to take more time to support our founders and ensure they have sufficient runway to endure an extended bear market.
This year, our focus is on helping founders find creative ways to grow through this market and position themselves for the next bull market. We’re also focused on sourcing opportunistic investments at attractive valuations and incubating more projects in-house.