Dialogue with DeFiance founder Arthur0x: Long-term optimism for LSD, the crypto market is unlikely to see new lows

Interview: Nianqing, ChainCatcher

Guest: Arthur0x, Founder of DeFiance Capital

Recently, there have been reports in the market that the crypto investment fund DeFiance Capital has completed "eight-figure" fundraising and began investing in March. Previously, ChainCatcher reported in October last year that DeFiance Capital founder Arthur0x was raising $100 million for a new fund.

As the largest DeFi-focused fund in Asia, DeFiance started laying out its strategy in the DeFi space early on and has invested in almost all leading DeFi projects, including Lido, dYdX, Aave, Synthetix, Balancer, and more. DeFiance has transformed its assets from six figures to nine figures in just three years.

DeFiance's investment style, which is "fundamentally driven rather than narrative or sentiment-driven," has allowed it to truly settle down amidst the severe volatility of the crypto market, capturing the essence of value.

The achievements of DeFiance today are also inseparable from its founder and fund manager, Arthur0x.

Arthur0x was introduced to digital currencies and blockchain in 2017. Having started investing during his university years, he keenly sensed that the value of digital assets would continue to rise in the medium to long term. Thus, Arthur0x resigned from the international oil trading company he was working for at the time to enter the blockchain industry. This work experience also helped him establish a relatively strict risk control standard in crypto investments, minimizing losses for DeFiance during events like Terra and FTX.

In addition to being an investor, Arthur0x continuously shares his views on the industry on Twitter, which is also his way of actively seeking feedback and filtering information from the market. However, he deliberately maintains a certain distance from the market, refusing to expose himself continuously to the information market, allowing himself time to think about the deeper and longer-term impacts of short-term market fluctuations.

ChainCatcher recently interviewed Arthur0x, who discussed DeFiance's investment strategy, the direction of the new fund, recent market hotspots, and more.

Related Reading: The Secrets Behind DeFiance Capital Founder Arthur's Bets on DeFi Projects - ChainCatcher

1. ChainCatcher: What is DeFiance Capital's investment philosophy?

Arthur0x: DeFiance is an investment institution guided by fundamental research, meaning we consider many factors to assess a project's value. We have established a set of internal evaluation criteria, looking at the project from over a dozen dimensions, including team quality, protocol valuation, technical architecture, community engagement, and more.

First, we look at the team's capabilities, followed by TAM, or Total Addressable Market, to see how big the market opportunity is.

Then we consider whether the problem the project aims to solve is a long-term issue in the market and whether it is a genuine solution. This aspect can often be overlooked in a bull market. For instance, when a new public chain or DEX appears in the market, it may attract capital and users, but it is more worth pondering whether this project addresses a fundamental issue; otherwise, it is merely a short-term behavior.

Additionally, we assess whether the project team has the ability to guide the community, as community culture is very important in this industry. We also look at the project's value capture ability, which varies among different projects, and our team has put considerable effort into this area.

In the early days, our investment philosophy included "active investment methods," but currently, "active" seems somewhat idealistic. The ideal scenario is that investors can deeply engage with the project to help improve aspects that are not well done. However, in the crypto industry, investors do not yet have the legal rights that traditional stock market investors possess to influence project decisions. Therefore, before investors' rights are well-defined and investment standards similar to traditional industries are formed, the willingness of project teams to allow deep participation from investors is crucial.

Currently, the investment industry lacks such a set of standards, making our initial "active" investment difficult to implement.

2. ChainCatcher: Recently, a16z cast a vote against the proposal to "deploy Uniswap V3 on BNB Chain" using all of its 15 million UNI tokens, which sparked criticism of "oligarchic governance." What is your take on this?

Arthur0x: I believe that since this is the consensus-based rights standard that everyone initially formed, it cannot be said that a16z has too much power. The key point is that many things in the crypto industry have not formed good industry standards, or better standards have emerged, and after problems arise, people start blaming VCs for having too much power. However, it must be recognized that everything is based on the consensus formed previously.

I think project governance is still in its early stages, and mature industry standards have not yet emerged. Even if there are some good proposals, people are not very active in executing them. For example, Vitalik proposed a new fundraising method called DAICO in 2018, hoping to integrate the concept of decentralized autonomous organizations (DAOs) into the ICO fundraising process to address the issues present in traditional ICOs. The project team would not receive the entire fundraising amount at the beginning but would go through five stages, receiving funds for the next stage only after meeting the requirements. This model protects investors' interests to some extent.

Unfortunately, almost no project teams have implemented this model; they prefer to quickly secure the entire fundraising amount. For investors, many are more concerned about short-term benefits and do not care about the project's long-term development. Therefore, in this market, discussions about governance are often "nice to say," but as soon as there is any inconvenience, they will not be executed.

3. ChainCatcher: What is the relationship between DeFiance and project teams?

Arthur0x: It depends on the project. If the project team prefers to communicate frequently with investors, we will do our best to provide assistance. Of course, there are also some very independent projects that maintain a relatively low frequency of communication with us.

4. ChainCatcher: Why did you initially choose to focus on DeFi for investment? Recently, DeFiance has also been paying attention to blockchain games and some infrastructure; what are the considerations behind this?

Arthur0x: The initial choice to focus on DeFi was because decentralized finance is the infrastructure of the blockchain industry, and this industry inevitably needs a financial system to support it; otherwise, digital currencies would struggle to grow.

We later began investing in blockchain games because after observing many Web3 applications, we felt that games are the most likely entry point for the mass adoption of Web3. In 2021, Axie's parabolic growth demonstrated the untapped potential of Web3 games, which also attracted a large influx of gaming talent into the industry.

Related Reading: DeFiance Capital: Play-to-Own Will Replace P2E as the Future of Web3 Games

In contrast, our investments in infrastructure are more selective; we only invest in projects where we can provide significant added value. After all, we are not a fund that specializes in infrastructure.

5. ChainCatcher: What are some of the more successful cases in your current investments?

Arthur0x: The project with the highest peak return rate is Axie, with a peak return rate of nearly 2000 times, with an investment cost of around 8 cents and a peak price exceeding $160. Of course, it is impossible to sell everything at the peak, as some tokens are still locked, and although the return rate is high, the investment was relatively small. At the time of Axie's first round of financing, there were very few investors who believed in this sector, and since it was during a bear market, the total financing for that round was less than $1 million, so we did not invest a lot. But in terms of return rate, this project is the highest.

From the sector perspective, the most successful area we invested in is DeFi. We entered this sector very early, so we have invested in almost all currently successful blue-chip DeFi projects, such as dYdX, Sushiswap, AAVE, YFI, Synthetix, etc.

We also performed well in the secondary market. In the early days, many DeFi projects did not have seed rounds, so if you wanted to invest, you could only do so by purchasing tokens or participating in liquidity mining. Many of the projects mentioned earlier, such as YFI, Synthetix, and Sushi, were investments made in the secondary market.

6. ChainCatcher: You mentioned that the team transformed a six-figure portfolio into a nine-figure one in three years. What is the current status of the fund?

Arthur0x: It is indeed true that we transformed a six-figure portfolio into a nine-figure one in three years. Currently, our first fund still has nine-figure assets, but it has basically completed its investments. We have already started investing in the second fund.

7. ChainCatcher: I saw that the new fund will begin investing in March. What areas and directions will this fund focus on?

Arthur0x: We currently see two sectors as the most promising. One is LSD (Liquid Staking Derivatives). Although this sector is already quite hot, we actually started paying attention to it in the first half of last year. We have investments in this area, such as Lido, which we invested in very early, around the first half of 2021.

Essentially, Liquid Staking is a solution that the market urgently needs. Many POS projects have staking demands, but users do not want their assets locked for too long; Liquid Staking solves this problem while maintaining liquidity. Moreover, Proof of Stake will become a major trend in blockchain and continue to grow, so even though it is already hot, we will still be optimistic about the LSD sector in the long term.

The other sector is decentralized contract trading. After the collapse of the centralized exchange FTX, the market needs better alternatives, but currently, centralized exchanges led by Binance still dominate the market, with decentralized contract trading accounting for only about 5% or even less. However, the demand for decentralized contracts will gradually increase, and I believe its market share could quickly grow to 15-20% in the next year or two, as contract trading is a necessity in the crypto space. This is a sector that has been proven to be profitable; it just depends on which team can execute the best and ultimately capture the market.

Thus, we currently believe that the LSD and decentralized contract trading sectors are the most obvious sectors. Regardless of what happens in this industry, they can achieve sustained growth. Once the sectors are determined, we can then look for the most promising and best-performing projects within those sectors.

Specifically, in the LSD sector, we are long-term bullish on Lido, as its architecture and team execution capabilities have been validated over time. We believe it will maintain its leading position in this sector for the long term, barring any major mistakes. We are also observing other newer projects, and currently, we find the SSV model quite interesting, as its technical architecture allows it to maintain a cooperative relationship with other LSD projects rather than a competitive one. Therefore, we think this is a project worth studying.

In the decentralized contract sector, we are long-term bullish on dYdX because this team has a very strong technical background, consisting of top engineers from Silicon Valley, and their execution capabilities are also strong. Additionally, after dYdX decided to launch its own public chain, dYdX Chain, the value capture ability of its tokens became clearer. Besides dYdX, we are also keeping an eye on GMX, but we have some doubts: whether GMX's current model can support its expansion to a larger scale. As GMX grows larger, the benefits attackers can gain from price attacks on oracles also increase, making it more susceptible to price manipulation attacks (Note: In September 2022, GMX suffered a $1 million loss due to an attack exploiting its oracle pricing mechanism).

8. ChainCatcher: What lessons did DeFiance learn from the Terra and FTX incidents?

Arthur0x: After these events, we may hold the team to a higher standard of integrity. If a person's character has issues, no matter how successful their project is, it can collapse in a short time.

Recently, the industry has experienced many similar events. Individuals and institutions like Luna and FTX, which once wielded significant influence in the industry, collapsed due to character issues and breaches of ethical standards. For investors, such investments are not very meaningful unless you are pursuing short-term benefits. Therefore, investors must have baseline requirements for the team's integrity.

The famous 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 hard-working crook who's eventually going to cheat you."

This means that if you choose business partners based only on intelligence and energy, you end up with a smart and hardworking fraudster. The actions of those lacking integrity can be even more dangerous and may harm you.

Another lesson is risk control; we have actually done quite well in this area. We did invest in Luna, but we did not incur significant losses there.

9. ChainCatcher: Since the collapse of Terra last April, there have been many "black swan" events over the past year. On the surface, they seem independent, but if you extend the timeline, these events are essentially interconnected. After this series of events, what insights have you gained?

Arthur0x: After an event occurs, we cannot just look at the surface of the news; we need to analyze the chain reactions carefully. We generally analyze an event according to surface impacts, second-level impacts, and third-level impacts, spending time to derive a conclusion.

For example, after the Three Arrows incident, we deeply realized the profound impact of Counterparty Risk. This risk is prevalent in the blockchain industry, as many institutions are interconnected. If you have awareness of this risk, you will pay more attention to it.

For instance, in assessing the risk of a VC, we often look at how its investment portfolio is performing, but we may overlook their asset management risks. As a result, Three Arrows placed money in FTX, Genesis, etc., and lent to market makers, among other things. These potential risks are points we need to analyze in the second-level impacts. The subsequent implications of Genesis lending money to Three Arrows are third-level impacts.

10. ChainCatcher: Recently, the Federal Reserve has released liquidity through various tools, and some believe that the crypto market is gradually emerging from the bear market, but it does not yet have the prerequisites for a bull market. How do you assess this?

Arthur0x: I mostly agree. I think the bear market should be considered over, and the market is unlikely to see new lows. However, whether the bear market will turn into a bull market still depends on the macroeconomy, as the Fed is likely to stop raising interest rates and work to increase market liquidity after the banking crisis. Whether this wave of liquidity will enter the digital currency market and promote the reallocation of digital assets is also highly probable. Therefore, we still need to look at the actual indicators and data in the macroeconomy for support.

11. ChainCatcher: Compared to achieving multiple returns, investors need to cut losses in a timely manner. What is the team's stop-loss strategy?

Arthur0x: Our stop-loss strategy is fundamentally driven because the price fluctuations in this industry are quite significant. If we purely base stop-loss decisions on price fluctuations, we might make decisions in the worst-case scenarios. Therefore, we generally analyze the reasons behind the price fluctuations and determine whether this will cause fundamental and structural changes to the project before making a stop-loss decision.

12. ChainCatcher: Recently, the dYdX community voted to pass the DIP-20 proposal, deciding to reduce trading 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. Early trading rewards were aimed at attracting users, and gradually reducing trading incentives is meant to validate the product's real competitiveness in the market. If there is still good trading volume after reducing trading rewards, it proves that the product itself meets the essential needs of the market.

Lowering trading rewards may lead to a decrease in trading volume in the short term, but in the long run, this proposal is necessary. I personally supported this proposal, and you will also find that the proposal was put forward by market makers, who profit from trading rewards but are more willing to sacrifice short-term benefits for the project's long-term sustainability.

13. ChainCatcher: What will be the next engine for DeFi?

Arthur0x: I don't have a very good answer. I think decentralized perpetual contract trading will be a continuously growing sector, but it is hard to say it will become the engine of DeFi, as the combination of perpetual contracts with other sectors is relatively rare and does not require nested designs through lending, etc. On this level, the intersection of LSD and other sectors will be higher, as LSD tokens will provide sustainable liquidity as a derivative.

Moreover, the development of DeFi from 0 to 1 has already occurred; it is a demand that has been fully validated by the market. However, how to grow to the next stage is still being explored, and I think what is most needed is time.

After all, what is happening in centralized finance right now is a good validation. DeFi does not need to completely replace CeFi but rather provides an alternative solution. If institutions want to diversify their asset allocations, they can fully achieve this through the completely different architecture of DeFi. Therefore, I believe this banking crisis is likely to lead to a rediscovery of the design value of DeFi architecture in the traditional market, making them more willing to try using it.