The Delphi Podcast Host and GP of Delphi Ventures Tom Shaughnessy sits down with Arthur Cheong, founder & portfolio manager at DeFiance Capital, Asia’s largest DeFi focused crypto fund. The two discuss biggest wins and losses, effective due diligence, traits of successful crypto communities, and more.
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(1:50) First Question: Arthur’s Intro and What is DeFiance Capital.
(2:17) How long have been the fund around / how many deals have DeFiance done at a high level focus on tokens or equities.
(2:48) How DeFiance works.
(8:12) How Arthur draws the line on new areas to invest in.
(12:30) Differences between traditional venture investing and VC in crypto.
(19:36) Founders / how Arthur sizes up founders / red flags that avoid investing in a founder / anonymous founders.
(31:04) Arthur’s thoughts on founders giving up control to the community.
(33:26) Concentration versus diversification.
(40:53) How Arthur allocates his time to funds or projects.
(43:46) The best advice Arthur’s ever gotten from a crypto founder / the best advice that Arthur’s ever given to someone on crypto.
(46:45) How much cash Arthur has in the fund and what he thinks about it.
(48:41) Arthur’s thoughts on global markets and how it affects crypto.
(51:59) Arthur’s thoughts on a situation where governments take a very aggressive stance against crypto.
(55:00) What was Arthur biggest loss, why did he miss it, and what is he going to do for the future so it doesn’t happen again.
(58:36) Arthur’s thoughts on investing in the L1s.
Hey everyone. Welcome back to The Delphi podcast. I’m your host, Tom Shaughnessy and I help lead Delphi ventures. I’m really excited to have on the first guest for our Delphi VC, crypto series. Arthur of DeFiance Capital. Arthur how’s it going?
I’m great. Thanks for having me on Tom. It’s been a pleasure. And it’s one of my favorite podcast series as well.
Awesome. I appreciate the kind words. Arthur, let’s dive right in. Tell me a bit about yourself and your firm.
I’m Arthur, the founder of DeFiance Capital. DeFiance Capital is DeFi focus crypto fund that combines fundamental research and an active involvement approach. There’s a tagline we like to use, is heavily inspired by [inaudible 00:00:46], which is, we think that DeFi will be traditional finance for the next decade. So, yeah.
That’s awesome. And how long has the fund been around? And how many deals have you done at a high level focus on tokens or equities, or?
The fund has been around for close to a year. We generally focus on token deal, but we do make pure equity investment from time to time as well. Before the fund is formed, I’d been investing in the crypto space for around two years. Yeah, so my crypto investment experience has been slightly more than three years.
That’s awesome. Yeah, no, I’ve seen your ascent, and it’s been absolutely incredible. So let’s start at the beginning. I mean, how do you walk the line of filtering plays given the sheer number of opportunities in crypto? How do you decide what to pass on? How do you spend decide what to spend time on? I think everybody assumes VCs just sit there all day and spend the time on their top players. But it’s really not the case. There’s a lot of work that goes into it.
Yeah. So I think, first of all, is to really to determine our circle of competence. I think there’s a reason we focus on DeFi, because we know that in this area, we do have an edge and we know how to evaluate projects in this space. So actually, I think we acquired, I think one year ago. Is actually quite rare but we actually do not really make any layer-1 investment. I think Polkadot was one of the most popular investment by all the crypto funds. We actually have [inaudible 00:02:28] position. Even for like other layer-1 like AVAX, Solana. We actually also have zero position in all of them.
So, because we think that layer-1 is deFinitely one of the biggest sector in the space, but is quite hard to evaluate what is the fair value range because there’s no consensus. I mean, except for Bitcoin mining, where there’s a lot more data, you can draw some framework to analyze that. For all this layer-1s, it’s actually quite difficult. And some of them can be worth like 10 billion without any actual usage. Actually Cardano is like 30 billion, right? And then you have some that’s like 1 billion. And as you look at an active user number, they actually have the same as Cardano. So you actually couldn’t really understand why. It’s really about the hype. So I think that it’s a bit difficult. So that’s why we focus on DeFi, focus on the circle of competence.
And then within DeFi, we also look at what’s happening in the market. You can draw some reference. I think to the first phase, we think that the foundation need to be built, which is why we focus heavily on DEXes, and also lending and borrowing. Because I think that when you look at finance from a first principle overview, the foundation will always need to be built first. So I think that… And DEXes is not something new as well. People have been building them since 2017. And then you also gradually see the volume climbing throughout the bear market. So I think that as a result, we think that DEX is the product market [inaudible 00:03:55] is proven, but there’s still a lot of innovation. So this is an area we’ve been focusing on.
And lending and borrowing is just a key pillar. The reference also like from success of BlockFi, Celsius. There is clearly a lot of demand for crypto lending and borrowing services. So these two segment of DeFi has been what we focused on a lot over the larger part of the last 12 months. And then we look at what is the next space that is going to be built and get adopted. And our conclusion is [inaudible 00:04:27]. So this is where we’ll be making a fair amount investment as well.
So I think this kind of narrowed down the focus. So I think we do look at other verticals, because there are some great founder that always surprise you. But I think those, the team and the whole… You need to lot more stars to be aligned for us to be more confident in making investment outside of the core segment where we’re focusing on.
And I think that after spending some time in the space, you kind of develop some heuristics as well to help you spend a better time to filter out something that’s not even worth looking. So I think co-approach does work, but I think a lot of time a very resourceful team and founder will know how to lead a warm introduction. Although I don’t like it when I was entrepreneur, I think that it is much more helpful having a warm intro, because that gives some context on your background, all this thing. And I’m much more likely to spend time looking at it as well.
So, the resourcefulness of the team, and the way they’ve been pitching the product. I think the experience, the team really know how to position themselves, and they know what’s happening as well. You can see some team, right, they come and pitch, “Oh, this is like a $1 trillion market. We’re doing this, this, this, this.” But actually, all of the point they mentioned has already been done by [inaudible 00:05:55], but they are not even aware. So this is a very clear pass, because they are not even aware of what is happening in the market.
And sometime you look at, they say, “Oh, we already have other investors involved.” And I don’t want to name the funds out there, but there are some funds where you look at who’s involved, you know that they’re not the real long term crypto investment funds. So you tend to avoid these. So I think generally this is how do you screen the number of opportunities in crypto.
And also, last but not least, you’d build a very good network of other crypto investor you can exchange your opinion with. I think this one takes time. But I think, if you make yourself known in the space and you contribute to the discussion be it on Twitter, or some Telegram group, I think sooner or later you’ll build your own network, and you’ll share the info, and you also get to share some of the info by other crypto investor in the space as well.
It’s a phenomenal answer. I totally agree on the warm intros. It’s kind of a first filter. That’s a really good point. My follow-up question though is, where do you exactly draw the line? Because let’s take an example. Let’s say that you’re not focused on NFT’s, you’re going to automatically pass on these deals, maybe becomes a mega market, then you’re behind. Where do you draw the line? Where do you start to learn? Because there’s some things where, just totally excluding all layer-1s to your point, could be great because you have way more time to spend on DeFi. But you might miss Terra, you might miss Polkadot. How do you draw the line on new areas to invest in?
Yeah, I think you just have to accept that there’ll be some play that you miss. I think as an investor… I don’t think any investor can catch all the major plays in the market. There’s probably one or two traders that can do that. But I mean, that’s not the way we really approach the market. So I think we just have to accept that there are some layer-1 play that we will miss. I think this year actually have been pretty great year for layer-1. Most layer-one actually outperformed DeFi, if you use January 1, 2021 as a starting point. Filecoin, Polkadot, Solana did very well. Yeah, I think if you look at it, you can consider as a miss for us, but we think that it’s just not within our circle of competence. So we’re fine to accept that.
But I think that said, NFT we do have some pretty successful investment. I think both us and you guys are one of the earliest backer of XINFINITY. And it was one of the best performing investment for us this year as well. I think that what really attract us because all stars aligned, right? When you look at crypto, community it’s always one of the most important factor. I think, even during a bear market, the team has been very focused on building a community, a very organic, grassroots based community, and just steadily grow from that. The active user number wasn’t as great as currently. Right now there are 500,000 daily active users. But back then they have like 10,000. And then within a month, you see them go to 12,000, 13,000. So it’s always organic, steady growth.
And I think I was always very… Being a casual gamer myself, I was always very bullish on companies or the NFT element with games, and also making a collectible. So I think there’s always a lot of potential there. And I like the way that he was approaching it. Yeah, I think this is why I think the all stars aligned. The valuation back then was fair. And I can see the growth. Is just the market wasn’t… I think that this will not be a very big thing. But I mean, that’s where you get the best risk reward, right?
Another NFT investment where we did very well is Mintable. So it’s a pure equity play. They raised a recent run of 75 million valuation. It’s one of the NFT minting and marketplace platform. I think there’s some luck element because the founders there is based in Singapore, and I know them for a while. And then, yeah, I always know what he’s building on. So I think that that’s a good thing, build your connection with the founders and the entrepreneur, even when you’re not ready to invest that time. I think sometimes it pays a lot of good dividends. But how do you decide a time? I don’t have a perfect answer for that. I think everyone just need to decide how much time do you dedicate into building the entrepreneur network as well.
How aggressive are you with those founders? Like the ones that aren’t raising, you’re extremely interested in what they’re building. Do you go out of your way to convince them to raise? Or are you more of the opinion that you should follow, help out, and then when they eventually do raise, get involved as much again?
I would say on a scale of 1 to 10, I’m probably on a 6, not the most aggressive kind. Because I want the team to have a very clear idea how are they going to spend the money. Actually a lot when you force the team to raise, they’re not really sure how to utilize those capital effectively. So I think have a conversation with the team first, let’s say, if you can raise this, how are you going to expand your company or your protocol? Who are you going to hire? What’s your growth direction is going to be? Yeah, so I think we are not the most aggressive, but I think sometimes we will take the initiative to say that, “I think in this environment, you can raise and we can definitely help in that regards.”
Just switching gears a bit, what do you think are the biggest differences between traditional venture investing and VC in crypto? I mean, obviously, the community side takes a big part. Not exactly just a bunch of VCs taking down rounds, it’s the VCs, the community, angels, value add investors, strategics, and there has to be a good portion of the tokens for the community. How do you weigh the difference, I guess, between traditional VC and crypto VC? And then as a secondary question, what do you think is a good number for the community involvement here? I know it’s kind of hard to answer vaguely, but interesting to get your take there.
Yeah, I think the biggest difference is, the mindset is actually quite different. I do think that the traditional VC has been learning as well. I think, it used to be I think that traditional VC that there was a lot of famous story like Socratic took the entire round [inaudible 00:12:13], and then they went out extremely well for them.
But I think in… They always come from pointed out, if we see something have a lot potential we believe in, we want to take the entire round. And usually in a traditional VC, an entire round means that at least 15 to 20% of the company for each stage. So as they say both rounds are done by one VC, they probably own close to 40% of the firm. And they usually have at least one or two board seats, let’s say four or three. So they can actually kick out the founder after two rounds of investing, if they’re the sole investor.
This is a lot less common in crypto. I actually do not know any crypto protocol where the team are been removed by the crypto VC, except for Tezos. There’s probably some conflict there. But I didn’t follow up yet, but it was quite messy.
It’s an old [inaudible 00:13:10] story, yeah.
Yeah. So I think the power of the team, and the founder is DeFinitely a lot stronger. I think he’d probably take time to evolve to tilt the balance slightly back to the investor side. But I think it is always a marketing, because right now it’s a lot harder to demand all this thing. I think there are some new way to structure around where you have equity plus token warrant. And then I think mostly, a lot more of the value team use this kind of structure where you have equity and the investor have a board seat, then you have a token warrant. But I think for the other international team, usually you do a pure [inaudible 00:13:44] deal. So you do not have a board seat.
So I think that’s kind of the mentality. It’s a lot less likely you can be hostile. Although I do think this can be a valid strategy, because sometimes the team are just not the best fit to lead the protocol or the project forward, and you want to install a new team. But I think it’s just due to the context and the circumstances a lot harder to do in crypto, it’s just a reality we have to accept.
And I think second thing is, I think sometimes they are some crypto funds that have a lot of value, and they can cover most aspect of the other funds. But I think there’s actually more of the case that this is not true, where you actually benefit from having at least a few other investors on board as well to help in various aspects. So I think the key is there’s no formula around it. And you want to get to the sweet spot that you have a few backer that all of them have sufficient skin in the game to really help you out. But not too much of a party round where everyone put in 100,000 or 200,000, and the fund is a huge, and then you’re just way too insignificant for their fund to even bother spending any resources to help you down the road.
So I think, usually, let’s say you’re raising a seed round that’s below 3 million, I think not more than five good funds, crypto funds. And then you probably have another three or five angels. I think that is a good number to have. If you have too much, and you dilute the round too much, I think people are just not incentivized to help. So I think that’s generally how I do it. You want to find the right number, not too much of a party route, but you get a few funds that add value in a very different perspective.
I’m totally with you there. I think the two extremes don’t make sense, having a fund take a whole round or having party round with 100 or 200 people, it just doesn’t make sense. I agree with you having a select group of people who are incentivized, but also add value of different ways where the communication is real, makes a lot of sense.
My follow-up question for you is just on the community side. What do you think the best way is for a project that you’re investing in to both, one, incentivize the community with their token? I mean, the goal is to make people rich. AX is a good example you brought up. But also to keep them engaged in ways where, if they want to, say, remove the founders, the community has that power, has that structure. What is the best way to get the community involved from a token allocation perspective, but also from a game theory perspective for different projects?
Yeah, I think it depends on the lifecycle of the protocol. I actually think it’s fine at the earlier stage for the protocol ownership to be slightly concentrated. I think the investor can probably own between 5 to up to the max of 20%. I think that’s probably the highest it should go. And then a team should own around at least a 10 to up to 25%. And then the protocol treasury can own another 10 to 15%. And then you allocate 50% for the community. And the amount of 50% for the community, how do you get it to the [inaudible 00:17:01]? I mean, the very popular matters right now are liquidity mining.
Although, I do think unfortunate historical situation is, actually so called a public sale, I think sometimes it’s a good way to distribute a token to the community that value it the most. I think there’s a lot of benefit to liquidity mining. I was a big champion of it. But a poorly designed incentive or liquidity mining program actually end up leading the token being more concentrated because those people with the most amount of capital and resources will just go and farm it. And they’ll end up owning more of the token as well. So I think it’s really important, how do they design the incentivization process?
So yeah. And then, about 50%, I think that if it’s possible, I think around 5 to 10% of it can still be done through public sale. If you can get a coin list, I think the most popular way is to get on various of these auction and ideal platform. So Sushi have conducted I think three or four of their launch pad. I think it went fairly okay. You also have the very popular Balancer liquidity bootstrapping pool as well. I think that’s been a very big success, because it’s off the front running issue, like the board can’t get in and just take a token allocation and pump the price up immediately.
So I think these two are the most popular method right now. There’s obviously other auction platform. But yeah, I think Balancer is the most popular one followed by others. I think Sushi is gaining some traction as well.
That’s awesome. And Arthur, just switching gears a bit, I want to talk a bit about founders. I’m a huge believer in the founding teams. So a lot of the stuff that we personally invest in, we go to great lengths to diligence on the technical side, on the smart contract side, product market fit strategy, etc. But crypto moves so fast that you’re really taking bets on founders, right? Like, these are the guys that are going to be here full time, 18 hours a day, 24 hours a day navigating it. How do you size up founders? How do you get comfortable with investing in them? And it would be really helpful to know any red flags that turn you off from investing in a founder.
I’m probably going to get some heat for saying that. But I think first of all, I believe that the number of founders that can be multitasking is extremely limited. So I have a huge preference for founders who are really focused on one protocol or company or project they’re working at one point of time. Because I think that especially given the pace of crypto, managing one is tough enough. Managing more than one, two or three is just naturally going to lead to a split in resources and attention. And I think it’s also pretty bad for the mental well being of the founding team as well, anyone involved.
So I really prefer to be just focusing on one project because that’s where you dedicate 100% of your attention is. And I kind of want to see that the founder and the team to really believe in it and to find a way to just turn it around. I think when you have enough conversation, be it on verbal or on a audio approach, you can sense how much fire the team has in it. I mean, there might be some guy that are better at faking it. But I think when you have a few interactions, you can see like the passion they have, how much energy they’re devoting. And it’s something that they went above and beyond.
I think, right now when the project get bigger, it’s a bit harder. But I think generally, in the early stage, the very good founder, they are hyper focused on getting the product feedback from the community. They will spend a lot of time just to get a product feedback. And sometimes just doing something that they should not be doing, let’s say doing some small customer support. I’m not saying all of them should do that, they are usually much better task for them to focus on. But it’s just that they are so focused on the product and the user feedback, they’ll inevitably spend more time on the community and understand what the user really want. So they’ll spend a lot of time finding new product, talking to the community, and try a lot to read and understand the space. You just see that the passion they have for the project is very different.
And yeah, so I think as a result, I like a very highly focused founder, and they have a lot of passion, energy. And to a certain extent, I like where the founder is so called have their stake on the line. The success of this protocol will really affect how successful he or she will get as well. So I think it just is a very natural thing, where people get a lot more successful and wealthy, they might still have the passion, but it’s a lot less likely to affect his fortune, right? So he might just not give 100% energy. I think it’s just a very natural for humans. But as an investor, I just like to invest in a founder that has a lot more energy and focus. Yeah.
Arthur, you bring up a good point there that the success of the project would change their life. Would that negate you from investing in a project where the founder’s already wildly successful and, say, wealthy?
It will not, because I do think there are some people who just really enjoy starting new companies or project and just making it big. I think there’s quite a few serial entrepreneurs in the space. But I think that I would really to dig deeper on their motivation, and just do some follow-up observations on how much energy are they dedicating on this compare to the previous project. I think sometimes, you can see it. Yeah.
And what’s your take on, let’s say you invest in a founder you love, and one of your concerns is that they start multiple things, their time is fractured. I totally agree with you. But what happens when you invest in a founder and then they go and start multiple things? Do you size down your investment? Do you not follow on? Do you not spend too much time? Do you give them advice? What do you do then`?
I will really put a lot of time to observe the traction of the project or investment we did, and then see that, how is the founder allocating the time. I mean, I don’t rule out exceptions, but I think it’s just difficult. So that’s why we just pay a lot attention to see if the [inaudible 00:23:36] investor are being affected or not. I think if he’s being affected, I think we might make some changes to our allocation and our stake.
And do you have a concern or a preference on anonymous founders? Will you invest in anonymous or pseudonymous founders?
Yes, I didn’t really invest in anonymous or pseudonymous founder before. I think that it is really context dependent, and on a case by case basis. Because I think that you have I think a few fairly successful anonymous founder in the space as well. I think Alchemix is quite successful. And there’s a few others as well. But I think that there’s definitely a lot more due diligence needed, and you need to know that how can you protect yourself against the founder just, let’s say, going missing.
Yeah, so I think that we just need to be a lot more careful on how we can protect against the the founder just go MIA and just not doing anything. Yeah. I mean, there are some anonymous that despite being anonymous, they spend a lot of time in the community, they build out a profile for a few years. So the chance of them… You can know them a lot better, although they’re anonymous, by how they portray themselves in various platforms, and their contribution record, and probably just their help profile. So I think this inspire a lot of confidence. But if it’s just come out of nowhere, and just suddenly put a lot of ambitious claim, yeah, I think these are a lot less likely for us to invest in.
If you had two investments, let’s say both are million dollars, and one’s a known founder and one’s an anonymous founder, and you know them just as well in your mind. Would you size up the known founder more than the anonymous founder? Or would you keep those checks equal?
I think in that case, the founder factor will not affect us the most. It’s probably the other factors of the protocol that will affect our investment size the most.
That makes sense. And I mean, just on deal terms, how aggressive are you at negotiating the difference in valuations? I mean, are you one to say, “Hey, you know what, don’t do this at 60 million. I’ll invest it for you at 50.” Because obviously, on the exit, the initial multiple makes a big difference on how much your exit multiple is.
I hope I can be more aggressive. But the reality is, it’s really a founders market for the last three to six months. So we usually try to talk them to a more sensible level, if they were ridiculous. I think their view will go quite hard on negotiating it down, or to a more sensible level if we decided to leave. If we’re just participating, I think that we just don’t negotiate it hard, because I think that a lot of other funds have committed on the same valuation, and then your bargaining power is just not that strong as well. Yeah. So I think just to put out the bull market, the balance of power is really on the founders and the team side when it comes to negotiating valuation. Unless in some cases, yeah.
Yeah, I know. I’m with you. It’s hard when a lot of people get involved and they start to… The teams get credit. And then it’s hard to make a decision there. And just circling back a bit, can you give me an example of one of your favorite founders in crypto? What’s the passion that they showed you that just led you to want to write a check on the first call?
Do you want to talk more about like the early stage founder or like the growth stage kind of founders? Because I do think there are some differences as well.
That’s a good point. I’ll let you take it whichever way you want.
Okay, I think, some of my favorite founders are Stani and Kain. I think right now, it seems very obvious, right? Because you look at the success of this protocol. Yeah, but I think back then, when I make that investment, it wasn’t obvious. So somehow, we wind back the history a little bit. So I think, okay, let’s just start for Kain. So when we invested in 2018, it was the bear market. And so how do I make the [inaudible 00:28:01]. Because I spent actually two months in the community just start talking, poking around, asking a lot of questions. And he actually managed to response. And I think at an initial stage, my question wasn’t the most friendly, because I really want to dig deeper on the design, and poke hole, like is this design like bulletproof?
So the team just has a patient answer. And the fact is, that time the market wasn’t in the best condition of… The founder could have just don’t give a damn, because this guy has a lot of question, but doesn’t matter anyway. They probably won’t look for funds or investor and whatnot. This is just a retail. So the fact that the founders managed to look at this and just to answer the questions in regards to market conditions, shows a lot. And subsequently, throughout the tough condition, the team never gave up. So I think this is something you need more time to assess, where the team just have the grit and tenacity to persist through a tough market condition. Yeah, and then this is where I keep sizing on my investment as well.
And then for Stani, it’s the same story. I made investment in Aave a little bit later, I think actually around early 2020. But I know Aave has been around since 2017 as well. So is the same perfect example of two plus years of brutal bear market. The community have just given up, everyone have sold their token, but the team has not. Still iterating on their product and pivot until they found a way out.
And I met Stani and the team, I think at 2019. You can still see the fire in them. They still have the passion for the product they’re building, although the market has not fully recovered by that point. And I think that that’s a great example of the founder that you have the fire in them regardless of market condition, and then just keep building and find a way out. So I think that these two are my favorite founder.
And then you can see that throughout the group, both Synthetix and Aave has become a multi billion protocol. But I think you can see the team has a lot of fire and a focus on building the product. You can see them from the social media and from the innovation and from the idea they are putting out in community. So they still want to grow the protocol to the next level. But for some, you can see their founder is… I don’t want to put a name out there, but you can see them being a little bit more relaxed, and seems to be focusing a lot more on the other initiative as well. Yeah.
Again, it’s a great answer about building confidence during a bear market, seeing founders continue to build, seeing that passion. I totally agree with you. 2018 was not an easy time to invest.
And let’s talk about the end of your example there. Let’s say, now Aave, Synthetix are major protocols. Kain has obviously started to step back a bit, let the community takeover. That’s my understanding. How do you think about founders giving up control to the community? Because I don’t think we’ve actually really seen it happen yet. Other than, let’s say Bitcoin where Satoshi is gone, right. How do you envision founders going away while you maintain your conviction in the project in the community, and this actually working out?
Yeah, I think that before the founder decided to, let’s say, take a more hands off approach, he need to cultivate a various knowledgeable and a strong community that can partially take over his task. It doesn’t have to be one person, it can be a group of people. Or it can be part of the other team member that take like a leading role in a team where the founder take a hands-off approach. I think that’s fine. But I think that the team or the founder have to ensure that they have managed to cultivate that, so that when he stepped back that there isn’t a vacuum.
So I think that the fact is, I mean, the Synthetix poodle blog post, Kain decided to come back and take a more active role in the council, prove that it’s actually much harder than a lot of people imagined. I think Synthetix already have a very strong committee. But it’s still hard for a leading figure to come up. Because when you get very decentralized, people usually want to avoid a situation where there’s one guy that’s a boss and ordering people around. But then sometimes you need a guy that’s a key coordination where when it comes to some important decision, he can place a lot more influence and move it forward, instead of the thing get stuck in a deadlock.
So yeah, I think it’s a very tricky. You just need to build the foundation. So it’s very classic question of, let’s say it’s a family business, the patriarch is 80 years old, he’s going to retire. How does he handover? Let’s say his son is not interested in the business. What’s the best way to hand over, right? So I think it’s a classic management question as well. So I think crypto is just that there’s a potential involving the community, but you need to ensure the community is ready as well.
Yeah, I’m totally with you there. I think it’s way harder than people think. But I think eventually, it’ll get done. And I guess just switching back away from founders for a bit, just back to your fund and sizing up investments and stuff like that, because working with founders gets you the conviction to invest. What are your thoughts on concentration versus diversification? And it would be helpful if you could differentiate between you at the fund level, and I guess you at a personal account level?
Yeah, I think that I definitely advocate for a more concentrated approach. But there is a threshold to that. I think that the key to decide how concentrated you can be is, one of the investment, let’s say it goes down by 80%. Or let’s say it’s zero. I think it depends on how mature this protocol is. So for us, we are comfortable having like a slightly higher percentage, let’s say up to 30% in one DeFi protocol, only where this developer will have a very proven product market fit, is a very mature stage like Aave, and is already have a lot of liquidity that we know that we can actually increase or reduce our size where we need to. Not for very early stage protocol. So like we will not allow some early stage illiquid stuff to be 20% or 30% of our fund.
So, I think you have to make sure that if one of them go down like 80 to 90%, your fund will still go out fine. So I think this is the highest concentration you can go for, one investment that if this one goes down significantly, 80%, your fund will still be fine. I think that’s the highest concentration you can do. So in that case, I think it depends on the fund size as well. I think if you are, let’s say low figure fund, you can be fairly concentrated on let’s say only having 10 [inaudible 00:34:58]. I actually think that is an OK way to play the market.
Because what I realized the market right now, unless you’re trading, let’s say, from a more medium to long term investment approach, when the market goes up, you see a lot more divergence in performance that use, let’s say Q1, there’s a few that really outperform. Let’s say Binance [inaudible 00:35:20], the PancakeSwap did very well. It did 2,000%. DODO did very well as well. And I think Aave and… Sushi did well, and then it corrected down too a bit. But the difference is huge. I mean, I think PancakeSwap did I think 2,000%, and Aave did 3, 400%, Sushi did 5, 600%. And then there’s a few other that more than 1,000%.
But actually they are, I want to put a name out there, but there’s some DeFi protocol or some other project, they only do like 50 or 100%. So you see a lot of divergence for Q1 actually this year, even though it’s a crazy bull market out there. But when the market corrects, the correction go to one. So everyone just correct down 60% at the same time anyway. So when you look at the correction, it’s not much difference. There’s a difference between the 60% correction and the 80% correction. You obviously want to avoid 80% correction one.
But yeah. So we do have one that corrected 80% from the peak, which is Alpha. But also Alpha did very well during Q1 as well. So I think that’s why it makes sense to be fairly concentrated, because you get the dispersion of return when it’s going up. But when going down, it’s all the same anyway. So right now, there’s not enough crypto that is negatively correlated with the market. Let’s say, when the market is going down, only stable coins stay [inaudible 00:36:43]. Everyone else is dropping. I mean, Bitcoin dropped at least [inaudible 00:36:46]. So I think that’s why I think it makes sense to be fairly concentrated to the level that you will not damage your fund if one of them go to zero.
I really like your take. I mean, might as well stay concentrated because you get most of the way up and it’s all the same on the way down. It’s actually it’s a cool way to think about it.
And the other question for you there is, when you’re looking at deals and you’re investigating, early on, you said Synthetix, you were pretty you know upfront with your questions. When you approach a team, first call, second call third call, you’re reading stuff, you’re on the chats, Discord, how skeptical are you? How critical are you? Do you try and be their friend? How do you go about getting info, but also being critical, poking holes, but also showing interest? How do you do that?
Yeah, I think a lot of the way is just how you communicate. I think that a lot of time, the team will also understand, as a fund, we need to do our due diligence. I think it’s just key, when you ask the question, you don’t want to make it seems like the other project is superior to what they are building. You’re just really trying to understand an asset from an objective manner. Like, how are you going to solve this if this happens? So I think that most of the team, they understand this.
And I think that how deep we go is also, as much as I dislike saying this, it depends on the market condition as well. Because in a bull market, you just have very limited time. And I think there’s also some use cases where you have to take a leap of faith as well. So I think this is also where we start making a little bit more venture bet. Because in our view venture, but also a lot of time, the concept is a lot less proven, so you have to take some leap of faith and trust the founder capability of building it.
I actually think there are some use cases in DeFi right now that… But also there’s actually around more than five teams that are already working on it, they all have raised a decent amount. I think the use cases actually not proven yet. I may get a lot heat for saying the use cases, but because we are… Ourselves we also have made the investment, because we think that it’s okay to take a leap of faith, but I think the use case is actually not proven yet. So yeah. So in this case where we think the use case is not proven, we will be a lot more skeptical and ask a lot more question. Although in the end, we might still make the investment.
What do you think your time is from first finding a play, to writing a check in a bull market, in a bear market? And let’s be specific on it being a venture style, riskier play, let’s say 50 mil [inaudible 00:39:26] or under? How long would it take you to get comfortable to write a check?
I think in a bear market, usually it will take at least two weeks. And it can be up to a month for us to make a decision. I mean, that’s the general rule of thumb. Sometimes we do make it faster. I think in a bull market, we try to do it within two weeks, sometimes within a week. But if something is rushing us for two days, we usually do not do that. I think that is just too little time for us to do due diligence. Yeah. I think, for bull market, it’s usually one to two weeks. And-
Yeah, my next question was going to be, do you give into teams that say closing in 48 hours? I mean, I don’t know why I would want to work with that team and there’s not enough time to do due diligence, but I agree with you.
I don’t recall us having done that. Probably, we have done one or two. But there must be some circumstances like the social proof were so strong, the use case was extremely obvious, and the team was very strong, like another whole style and life situation and we are just taking a participation round where we know that the social proof is strong enough there, and you have all the other factors aligned that make it a investment cases that’s very unlikely to flop. So yeah, then we might do that. But I think it’s very unlikely.
Just switching gear here, let’s say, made a bunch of investments, which you have. You have as number of growing portfolio companies with varying amounts invested, some could be large investments, some could be small. How do you use your time on portfolio management after you write a check? I mean, there’s obviously so many ways that you can help a project, but your time is limited and I hate to say it, but your time is worth well more than other people’s time. How do you allocate your time to these funds or projects? But also I guess, how do you let them know what you’re good at so that you can effectively allocate time for them?
Yeah. I think, we usually let them know what we are good at, at the beginning, before we invest. And I think at this stage, our value add should be quite obvious. I think, if they are not aware, we are one of the most active [inaudible 00:41:48] for most of the top DeFi protocol out there, for those that we have a sizeable stake. I think a lot of times we just have to pass the improvement proposal, we have to hit the quorum. Yeah, I mean, at this stage, I think the DeFi protocol know that we are doing that to help them through. Because I think quite of time, the voting empathy is real. So if you do not vote, it’s actually quite hard to pass a quorum. Yeah.
Also, I think early stage liquidity provision, we are one of the very few firm that’s very comfortable interacting with DeFi protocol right from the start and deploy institutional size of capital to help them bootstrap it. This is the value that we bring in obviously to the governance and token design as well. I think right now it should be fairly known what we are good at.
And how do we determine the time? We do have a team. Actually, I think at this stage, given the number of investments we make, it’s not possible anymore for me to cover everything. We do have a team of seven, including myself to cover the stuff we invest in. And each of my team, they cover between 10 to 15 protocol we invest in. So how do we decide a time? I think it just really depends on the protocol, how much happening there. I think some teams are pretty good at doing their own thing and when they need the help, they will ask. But some team they appreciate the investor reaching out to say, “What can we do to help?” So I think it depends.
Some team that likely if we have like a bi-weekly call, Monday call with them, [inaudible 00:43:29], and then have a to do task, what can we help? That is part of our to-do list. Some team, we only have a call where we need to, and we need to check out what’s going on. Yeah. I think it’s pretty case by case basis. Usually, I think the more mature team need less help, so we have a little bit less this kind of of active discussion.
That’s awesome, Arthur. All right, cool. We went through all the operational stuff. Now, I want to get into the fun stuff. My first question for you on this side of things is, I guess what’s the best advice you’ve ever gotten from crypto founder, one of your mentors, etc.? And I guess, what do you think in your opinion is the best advice that you’ve ever given someone on crypto?
Wow, that’s tough. I think for crypto, I think my biggest advice is just to have the persistent to survive after you’ve done homework, you’ve made your research. Sometimes you just have to believe in something if you have done your research and you know that this is the right thing. And you do not get too carried away by what’s happening on the market. You need to have a very good balance between absorbing the info the market is giving you, but not being carried away by the current emotion of the market.
I like that. No, I totally agree. Switching gears a little bit again, my next questions are on just mental health, taking breaks, taking a vacation. Are you 20 hours a day until you’re tired? Do you turn your phone off at 1:00 AM? How do you handle disconnecting, recharging, what do you do to achieve that?
Yeah, I think that everyone approaches it differently. For me, it’s just to have a time off. You just have to make yourself… I think people who have spent more than one year in the space kind of know, find their own way how to approach this. For me, it’s just that during weekends, I just tend to be a lot less hands hands-on. I think I still look at the market, probably I check the price once or twice a day at most during the weekends, and just scroll the Twitter, but just not really on a working mode. And then just take a walk, just go and do something else.
And I think that you need to develop a way to not check the price too often. I think a lot of the guys that just got in, they tell me, “I think this is a bull market. I check the price every 10 minutes, every hour.” I think that’s definitely not healthy. I think you need to find a few times where you just don’t check the price that often, because it will not change, whatever you’re doing. Even, let’s say in the bull market, you can set your target price, your stop loss, whatever, and then just approach it in a more sensible manner.
Although I think that there will be sometime where you’re more intense. Let’s say, I think all of us remember the DeFi summer period where if you miss out for one or two days, you miss out a lot. I think that time, I was a lot more intense, but then I scaled down the intensity gradually over the time. Yeah. I think they just have to find some way not to be attached to whatever happening in crypto all the time.
That’s a really good point. Yeah. I also slow down a bit on the weekends as my team probably notices. But the other side of things, just on the cash basis, do you ever have a high percentage of cash in the fund? I mean, I feel like there’s always something to play, there’s always place to allocate to, you can always go short. There’s always a way to take a view on the market. How much cash do you ever have at a max and how do you think about that?
I think so far since the fund was formed, the max cash position we have is around 20%. Theoretically, the highest we will go is probably around 60%. Because I think that no matter how bearish you are, you still need to take into account that crypto, the upside usually significant outweighs the downside because the upside can be multiples 10 times, 20 times but the downside is you can go to zero. Even you’re super bearish, it still makes sense to maintain some exposure in case there are some positive element that surprise the market.
I think it’s probably 60% cash is highest we will go. And highest, if we ever go, is 20%. Because I think since we started investing, we invested from a bear market. And a bear market you want to be a 100% deployed, actually. It’s counter intuitive and you never know where the bottom is. But I think that when you have sufficient confidence, you just have to go a little bit more aggressive, and then stay quite fully deployed at the bottom, and then slowly take profit and have higher cash position as the bull market goes on.
I think this is how we play it. But I will say, myself, because I’m more of a optimist at heart, I always glass half full kind of person. So I always see a lot of positive things. So I think our cash percentage traditionally has not been that high. A lot of times we’re just quite invested.
Yeah. No, ours is not. There’s just too much out there too many opportunities. Following up with that question, I would love to get your view on markets, but also in a macro and a micro level. I’d love to hear your take on where you think we’re going with global markets and how that affects crypto? Also, if you want to take it the way of where we’re going with Web3 and DeFi, and stuff like that, at a micro level, that also be interesting. But I’d love to get your opinion on what the end state for crypto is? Do we actually put Wall Street out of business? Does crypto take over the world? What exactly is the end state in your mind?
Yeah, I think that, again, this is a very fluid situation. It depends on how the world evolves. It’s just like, it’s not really the crypto, but look at COVID. I mean, back then, I think the situation might be able to manage if all of the countries took COVID a lot more seriously at the beginning, not when it’s too late. I think that there’s a very critical time element back then that the countries that took it a lot more seriously at the beginning managed it a lot much better. And the country that took vaccination a lot more seriously, also did much better right now at the second or third wave as well. There’s obviously a lot of the timing in many of the fluid situation there.
I think for crypto, I think the end stage is really to become a alternative approach to the current way it’s being set up. Let’s say for the DeFi side, is the alternative way of managing of your finance, be it on a personal level or the corporate or institutional level. It’s just a different reality that is being presented. Whether it will succeed or not, I think there’s a very high chance it will, but I wouldn’t say it’s a 100%.
I think that this is the alternative approach that our space is trying to present. How much adoption it ends up getting, it depends on the effort we put in. Also, it depends on how hard the establishment pushback, and how much the neutral player, how much are they adopting it? I think there’s a lot of factors in play. I think right now, our site is doing quite well in pushing the innovation and product adoption part. I think you also see quite a lot of interests on the neutral player to adopt this technology, but I think that the pushback is actually getting quite strong.
I think for the DeFi side, the most obvious one is the of FATF guidance, they delayed it to October, but based on the current version, it was definitely not the most friendly towards DeFi because they basically want to put DeFi on the same bucket on a regulation as the centralized crypto company. That will make it extremely difficult. Then on the Web3 side is also alternate reality where instead of all the data are being controlled by a centralized web tool company like Facebook, Google, we have Web3 all the identity is individually owned. I think that one is even earlier than DeFi, because all of the basic pillar is not ready and adopted yet, but yeah. How will we get there depends on how successful the sector is in in pushing that, and how much pushback we get.
What do you think happens in a situation where governments take a very aggressive stance against crypto, beyond like the China ban news, the US government hits, that kind of stuff we’ve seen in the past? Do you think crypto survives? Do you think this is going to happen? Because it’s kind of all up in the air.
I think crypto will survive, but the scale of the crypto space will probably get smaller and they will grow a little bit slower as well. I think there will always be growth. It’s quite hard to have a total ban, just like the media industry have fought a pretty big war against the torrenting space. I think that in the end people are still using torrenting. I’m still using torrenting from time to time. But I think what is interesting is what has disrupted the torrenting industry is the fact is like some two companies like Netflix did so well in their streaming content and make it pay $10,000 a month, is actually less of a hassle, instead of going to search for some of the torrent content you want to look for. So people just don’t mind paying 10, $15 a month just to subscribe. It’s just about a user convenience point of view. It’s just easier to access the content on Netflix, rather than trying to find the seed of the content you want and download.
In that sense, I think it will survive, but also it will grow slower if you face a very hostile pushback from the government. And actually I think right now, it’s a very good life situation happening. You can observe of China. I mean, I’m a native Mandarin speaker, although I’m not Chinese by nationality, I think they are actually taking a pretty hostile approach to all the things that are not under their control right now. Actually crypto is only part of the extension. You can look at the country’s approach to the Web2 founders. All the big successful startup founder are all stepping down in the same six months. I think it’s not a coincidence that they’re all retiring as a CEO or sometimes even as a chairman, handing over their reign to some other people. You have Alibaba, you have Meituan, is at least that. You also have ByteDance. Yeah, they’re all retiring as a CEO as well. And they’re also getting a lot less public on the media side because they know that the government’s cracking down.
On the crypto side, it’s a lot more severe. The mining is a total ban. I think the fiat on-ramp is being significantly curtailed. I think that the growth of the Chinese market in crypto will actually slow down from here. And then, with the fiat on-ramp being significantly restricted, I think you can see, can the grow still sustained? I think we just have to observe for the next six month.
That’s totally fair, Arthur. Just to close out, because we’re running low on time and I wanted to keep these at the 60 minute mark, I’d love to talk about what was your biggest loss, biggest miss, and why did you miss it, and what did you do different or what are you going to do for the future so it doesn’t happen again? I know it’s a humbling question, but we’d love to get your take on it.
Yeah, I think, because the fund has been only formed for around a year, so I think that it was a glad that we did not suffer any major losses at a fund yet. But on a personal level, I think the most brutal experience I had was really on Ether. I remember holding it all the way down from $800 down to 500, and I think obviously the bottom was $80. Actually throughout that time, I think Ether’s fundamental was actually not that bad, because despite the bear market, you still see the transaction actually was staying at the same level. It’s just that the price kept going down. People are still using the network.
But I think it’s a question of the role of Ether in Ethereum. Ethereum can be used without Ether being worth a lot. I think that was a very popular talking point back then. There was a lot of attack on Ether as it’s not a good store of value. I mean, all the ICO’s are dumping it. I think that was pretty painful. I think that the experience is, besides the fundamental, you also have to take into account what the market is feedbacking to you, and then some of the dynamic. I think at that point in time, you just have a huge selling pressure, and the asset at that point in time and the market cap, is also quite big at the level that the fundamental wasn’t strong enough to support it at, let’s say $800 price level yet. I think at that point in time, the fundamental can probably support it at a 200 to $300 level, which is where it stabilized after bouncing from 80. It spent a lot of time below 300, is basically between 200, 300 level. It was bouncing there for most of 2019.
So I think there was a painful experience where the fundamental was actually better, but you also need to look at the other dynamic and where can your fundamental support the price level? I think the answer is at the point of time, the level it can support is 200 to 300 level.
And I think when it comes to the biggest miss, I would have to say is probably LUNA. I think that it’s actually interesting. LUNA is something that we actually invested in, but I think we lost a bit of patience with the progress. Because I think that although the CHAI payment has been doing well, I think that there wasn’t enough adoption in the crypto space. I think that given the market condition, you need some crypto adoption for the project to do well. But actually the founder did recognize that and managed to penetrate a crypto space whereby in the end with the anchor protocol and mirror protocol. But it’s just something that we were focusing too much on the Ethereum ecosystem, and just a little bit dismissive on the other ecosystem.
So I think that was a pretty big miss for us. And to some extension, the BSE ecosystem as well. I think that the number of good investment you can finance is not much, but I think for example, PancakeSwap, I think like it or not, there is a lot of user and the product market is proven. I think these two are probably the biggest miss for us.
Arthur, thank you for being candid. Those are great examples of on the liquid side, understanding the fundamentals. On the VC side, digging in and understanding the plays. My last question for you just to close out, to play devil’s advocate a bit, you opened with, you wouldn’t want to invest in the layer-1s, it’s not the circle of competence. But the misses you shared were on the L-1 side. But where do you draw the line going forward. If a new L-1 pops up, will you dive in? If DeFi happens on Terra, will you use your DeFi experience on ETH to dive in? How do you readjust your circle of competence to include the things that I guess you missed in the past?
I think it’s just a constant learning process. Because these plays move very quickly, so obviously by subscribing to you guys, Delphi digital, we are a user as well, all the other research services, and talking to people, and just observing the attraction. Because if a layer-1 is taking off, you usually can see it from a user metric. I think Polygon is a perfect example. I think before Polygon achieved this level of success, most people wasn’t talking about it. Actually you can see the user number were just growing at an exponential pace during the first two [inaudible 01:02:30], and it’s just not slowing down at all. Then you can see the project deploying.
I think you just have to adjust to the new reality that the market is telling you. And I think the really good thing and the advantage of crypto investor compared to a lot of other investor is, a lot of time, if you’re willing to pay the attention, the data is there for you to decipher and analyze it. The data is public and free, actually. You just need to find the right tool to analyze them. I think this actually gives crypto investors a lot of advantage.
Arthur, I really appreciate you being the first guest on our five-part VC series. Your success at DeFiance has been incredible to watch. For those that know how much damage you’ve done, I mean, it’s been incredible. And I appreciate our chats and learning so much from you. Really appreciate you coming on. For those who are looking to follow Arthur, I’ll share all of his links in the show notes. If you’re not following him, you should be. Arthur thanks again so much for coming on.
Thank you for having me, Tom, it’s a pleasure.