DeFiance Founder Arthur0x: The bear market should have ended, currently bullish on LSD and decentralized exchange race
Original Title: Conversation with DeFiance Founder Arthur0x: Bullish on LSD in the Long Term, Crypto Market Unlikely to See New Lows
Original Source: ChainCatcher
Recently, there have been reports in the market that crypto investment fund DeFiance Capital has completed a "eight-figure" fundraise and started investing in March. Previously, ChainCatcher reported in October last year that DeFiance Capital founder Arthur0x was planning to raise $100 million for a new fund.
As Asia's largest DeFi-focused fund, DeFiance started early in the DeFi space and invested in almost all major DeFi projects, including Lido, dYdX, Aave, Synthetix, Balancer, and more. DeFiance's managed assets grew from a six-figure number to a nine-figure number in just three years.
DeFiance's investment style, "fundamentally driven rather than narrative or emotion-driven," has truly solidified its position in the crypto market's intense fluctuations, capturing value closest to the essence.
DeFiance's achievements today are also inseparable from its founder and fund manager, Arthur0x.
In 2017, Arthur0x got involved in cryptocurrency and blockchain, and due to his early investment during his university years, he keenly observed that the value of digital assets would continue to rise in the medium to long term. Subsequently, Arthur0x resigned from an international oil trading company where he was employed at the time and entered the blockchain industry. This work experience also helped him establish a relatively strict risk management standard in crypto investments, allowing DeFiance to minimize losses in events like Terra and FTX's rug pulls.
Aside from being an investor, Arthur0x consistently shares his views on the industry on Twitter, actively seeking feedback and filtering information from the market. However, he deliberately maintains a certain distance from the market, refusing to constantly expose himself to the information flow, giving himself time to contemplate the deeper and long-term effects of short-term market fluctuations.
ChainCatcher recently interviewed Arthur0x, delving deep into topics such as DeFiance's investment strategy, the new fund's investment direction, recent market trends, and more.
1. ChainCatcher: What is Defiance Capital's investment philosophy?
Arthur0x: Defiance is a research-oriented investment firm, meaning that we consider many factors to evaluate a project's value. We have internally established a set of criteria, which includes assessing the team quality, protocol valuation, technical architecture, community engagement, and more than ten other dimensions to evaluate a project.
First, we look at the team's capabilities, followed by TAM, meaning Total Addressable Market, to understand the market opportunity.
We then consider whether the project aims to solve a problem that will exist in the market long term and if it is a genuine solution. This is often easily overlooked during a bull market. For example, a new public chain or DEX may attract capital and users, but the more critical question is whether the project is genuinely addressing a fundamental issue; otherwise, it is just a short-term trend.
In addition, we also assess the project team's ability to lead the community, as community culture is crucial in this industry. We also look at the project's value capture capability, with each project having different criteria in this regard, and our team has put in a lot of effort in this area.
Earlier, our investment philosophy also mentioned an "active investment approach." However, currently, being "active" seems somewhat too idealistic. The ideal state is for investors to deeply engage with the project to help improve certain underperforming aspects. However, in reality, investors in the crypto industry do not yet have the legal rights that traditional stock market investors have to influence project decisions. Therefore, until investor rights are well defined and investment standards similar to those in traditional industries are established, whether a project is willing to allow investors to participate deeply in collaboration is crucial.
Currently, the investment industry lacks such a set of standards, so our initial "active" investment philosophy is not easy to implement.
2. ChainCatcher: Recently, a16z's proposal to deploy Uniswap V3 on the BNB Chain, using all its 15 million UNI tokens to vote against, has sparked criticism of "oligarchic governance." How do you view this?
Arthur0x: I think since this was the initially agreed-upon governance standard, it cannot be said that a16z has too much power. The key point is that in the crypto industry, many things have not yet established good industry standards, or better standards have not emerged. When issues arise, people start blaming VCs for having too much power. However, it must be recognized that all of this is based on the consensus that was previously formed.
I believe we are still in the early stages of project governance, and mature industry standards have not yet emerged. Even with some good proposals, people have not been very active in implementation. For example, in 2018, Vitalik proposed a new fundraising method called DAICO, aiming to integrate the idea of a Decentralized Autonomous Organization (DAO) into the ICO fundraising process to address issues with traditional ICOs. In this model, the project team does not receive all the fundraising amount upfront but instead goes through five stages, only receiving the funds for the next stage after meeting certain requirements. This model to some extent protects the interests of investors.
Unfortunately, very few project teams have actually implemented this model; they prefer to quickly receive all the funds raised. As for investors, many are more concerned about short-term gains and are not interested in the project's long-term development. Therefore, in this market, governance is often seen as something that sounds good in theory, but as soon as it becomes slightly inconvenient, it is not implemented.
3. ChainCatcher: What is the relationship between Defiance and project teams?
Arthur0x: It depends on the project. If the project team prefers to have more frequent communication with investors, we will try to provide assistance as much as possible. Of course, there are also some very independent projects with which we basically maintain a relatively low level of communication.
4. ChainCatcher: Why was DeFi initially chosen as the focus of investment? Recently, Defiance has also been paying attention to blockchain games and some infrastructure. What are the considerations behind this?
Arthur0x: Initially, choosing DeFi as the focus of investment was because decentralized finance is the infrastructure of the blockchain industry. This industry will inevitably need a financial system to support it; otherwise, digital currencies will have a hard time growing.
We later started to invest in blockchain games because after looking at many Web3 applications, we believe that games are the most likely entry point for Web3 to achieve large-scale adoption. In 2021, Axie's parabolic growth in the gaming industry demonstrated that the potential of Web3 games has not yet been fully realized, sparking a massive influx of gaming talent into the industry.
Compared to that, our investments in infrastructure are more selective, focusing only on projects where we can provide significant added value. After all, we are not a fund specializing in infrastructure.
5. ChainCatcher: What are some of the more successful cases in current investments?
Arthur0x: The project with the highest peak ROI is Axie, with a peak ROI of close to 2000x, starting at around 8 cents and reaching a peak price of over $160. Of course, it's not possible to sell all at the peak as some tokens are still locked, and even though the ROI is high, the initial investment amount was small. During Axie's first funding round, there were very few investors in this space, especially considering it was during a bear market. The total funding in that round was less than $1 million, so we didn't invest a lot. But purely in terms of ROI, this project has been the highest.
If we look at the space, the most successful investment we made was in DeFi. We entered this space very early on, so as of now, we have invested in most successful blue-chip DeFi projects such as dYdX, Sushiswap, AAVE, YFI, Synthetix, etc.
Our investments in the secondary market have also performed well. Because many DeFi projects in the early days did not have a so-called seed round, to invest, you could only buy tokens or participate in liquidity mining. In fact, many of the projects I mentioned earlier like YFI, Synthetix, Sushi were investments made in the secondary market.
6. ChainCatcher: You previously mentioned that the team turned a six-figure investment portfolio into a nine-figure one within 3 years. What is the current status of the fund?
Arthur0x: It is indeed true that the team turned a six-figure investment portfolio into a nine-figure one within 3 years. Currently, our first-phase fund still has nine figures in assets, but the first-phase fund has essentially completed its investments. We have started investing the second-phase fund.
7. ChainCatcher: Earlier, it was mentioned that a new fund would start investing in March. Which areas and directions will this fund focus on?
Arthur0x: We are most bullish on two key areas right now. One is LSD (Liquid Staking Derivatives). Although this space is already very hot, we actually started following it from the first half of last year. We also have investments in this area among our existing investments, such as Lido, which we invested in very early, around the first half of '21.
Essentially, Liquid Staking is a much-needed solution in this market. Many POS projects require staking, but users don't want their assets locked for too long in a project. Liquid Staking solves this problem by providing liquidity while allowing staking. Moreover, Proof of Stake is set to become a major trend in blockchain and will continue to grow, so despite the current hype, we remain bullish on the LSD space for the long term.
Another track is decentralized perpetual swap trading. After the rug pull of the centralized exchange FTX, the market needs better alternatives, but currently, centralized exchanges dominated by Binance still hold the majority market share, with decentralized perpetual swap trading accounting for only 5% or even less of the market. However, the demand for decentralized perpetual swaps will gradually increase. I believe that its market share is likely to grow rapidly to 15-20% in the next one to two years, as it has great potential. After all, perpetual swap trading is a fundamental need in the crypto space. This is a proven track where money can definitely be made. It all comes down to which team can execute the best and ultimately capture the market.
So, currently, we consider LSD and decentralized perpetual swap trading as the two most obvious tracks. No matter what happens in this industry, they can achieve sustained growth. Once the tracks are identified, the next step is to look for the most promising and best-performing projects within that track.
Specifically, in the LSD track, we are bullish on Lido for the long term as both its architecture and team execution have been validated over time. We believe it will maintain its leading position in this track in the long run, barring major mistakes. We are still observing other relatively new projects, and currently find SSV's model quite interesting as its technical architecture allows it to maintain a cooperative relationship with other LSD projects rather than a competitive one. Hence, we find this to be a project worth researching.
As for the decentralized perpetual swap track, we have a long-term optimistic view on dYdX because the team has a very strong technical background, comprising engineers from the top echelons of Silicon Valley, and the team demonstrates strong execution capabilities. Furthermore, after dYdX decided to launch its own chain, the dYdX Chain, the value-capture potential of its token has become more evident. Apart from dYdX, we are also keeping an eye on GMX, but there is some doubt: whether GMX's current model can support its expansion to a larger scale. The larger GMX grows, the higher the benefit attackers can gain from price manipulation attacks through the price feed oracle. Hence, it is susceptible to price manipulation attacks (ChainCatcher's note: In September 2022, GMX suffered a $1 million loss due to an attack on its oracle fixed price mechanism).
8. ChainCatcher: What experiences did Defiance gain after the Terra and FTX events?
Arthur0x: After these events, we may hold a higher standard for team integrity. If an individual's character is questionable, regardless of how successful their project is, it may collapse in a short time.
The industry has recently experienced many similar events, where individuals and institutions such as Luna and FTX, who once dominated the industry, crossed moral boundaries due to issues in their character and behavior, leading to their downfall despite their significant impact. For investors, this type of investment doesn't hold much meaning unless you are pursuing very short-term gains. Therefore, investors must have a bottom line requirement for team ethics.
The renowned American angel investor Naval Ravikant once said: Pick business partners with high intelligence, high energy, and, above all, high integrity… And then high integrity is the most important because otherwise if you've got the other two, what you have is you have a smart and hardworking crook who's eventually going to cheat you.
In other words, if you only choose intelligent and energetic business partners, then you have only obtained a smart and hardworking swindler. Actions taken by those lacking integrity can be even more dangerous and may even harm you.
Another lesson is risk control, and in this aspect, we have done quite well. We did invest in Luna, but we did not incur significant losses due to Luna.
9. ChainCatcher: Actually, from last April's Terra Incident to almost a year later, there have been many "black swan" events, which may appear independent on the surface. Still, if you extend the timeline, you will find that these events are fundamentally related to each other. After this series of events, what key insight have you discovered?
Arthur0x: After an event occurs, we cannot just look at the surface of the news event; we must carefully analyze its chain reaction. We generally analyze an event with the mindset of its surface impact, second-level impact, and third-level impact, taking time to derive a conclusion.
For example, after the Three Arrows event, we deeply realized the profound impact of Counterparty Risk. Currently, this risk is prevalent in the blockchain industry since many institutions are interconnected. Having risk awareness in this regard will lead you to pay more profound attention to it.
For example, in the Three Arrows event, when assessing a VC's risk, we often look at how their investment portfolio has performed, but we may very well overlook their asset management risk. As a result, Three Arrows put money in places like FTX, Genesis, and also lent to market makers, and so on. These potential risks are points we need to analyze in the second-layer impact, which need to be taken into account. The subsequent ripple effects of Genesis lending money to Three Arrows are third-layer impacts.
10. ChainCatcher: Recently, the Fed has released liquidity through various tools, and some believe that the crypto market is gradually emerging from a bear market, but it does not yet have the conditions for the eve of a bull market. How do you judge this?
Arthur0x: For the most part, I agree. I think the bear market should be considered over, and the market probably won't see a new low. But whether the bear market will turn into a bull market still depends on the macroeconomy because after the bank crisis, the Fed is likely to stop raising interest rates and make efforts to increase market liquidity. Will this wave of liquidity enter the digital currency market and promote the repositioning of digital assets? There is a high possibility. So, we still need to rely on actual macroeconomic indicators and data to support this.
11. ChainCatcher: Relative to achieving multiple returns, investors need the discipline of timely stop-loss more. What is the team's stop-loss strategy usually like?
Arthur0x: Our stop-loss strategy is basically fundamental-oriented because the price fluctuations in this industry are actually quite significant. If we simply set stop-loss based on price fluctuations, we may make decisions in the worst-case scenario. So, we usually analyze the specific reasons behind the volatility through the price and then judge whether this event will cause a fundamental and structural change to the project before making a stop-loss decision.
12. ChainCatcher: Recently, the dYdX community voted through the DIP-20 proposal, deciding to reduce transaction rewards by 45%. What are the profound considerations behind this proposal? How does community governance achieve a balance between short-term and long-term incentives?
Arthur0x: I think this is a very natural process. The early transaction rewards were to attract users, and subsequently decreasing transaction incentives were to verify the true competitiveness of this product in the market. If there is still good trading volume after reducing the transaction reward, it proves that the product itself has created an application that meets the market's essential needs.
Reducing transaction rewards may lead to a decrease in trading volume in the short term, but in the long run, this proposal is necessary. I myself also support this proposal, and at the same time, you will find that the proposer of this proposal is a market maker who would profit from transaction rewards, but they are more willing to sacrifice short-term benefits to achieve the project's long-term sustainability.
13. ChainCatcher: What Will Be the Next Engine of DeFi?
Arthur0x: I don't have a very good answer. I think decentralized perpetual contract trading will be a track of continuous growth, but it is hard to say it will become the engine of DeFi, after all, the combination of perpetual contracts and other tracks is relatively rare and does not require a design like a Ponzi scheme through lending, etc. At this level, the convergence of LSD and other tracks will be relatively higher, and LSD's token will provide sustainable liquidity as a derivative.
Furthermore, the development of DeFi from 0 to 1 has actually taken place, a demand that has already been fully validated by the market. But how to grow to the next stage is still being explored, and I think all that is needed is time.
After all, what is happening in centralized finance now is a good validation. DeFi does not need to completely replace CeFi but provides an alternative solution. If institutions want to diversify their asset allocation, they can easily achieve this through DeFi's completely different architecture. So, I think this banking crisis is very likely to lead to a rediscovery of the design value of DeFi architecture by the traditional market and a greater willingness to try to use it.
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