Views on DeFi for 2023 and Beyond

The risk-reward of investing in DeFi is not too appealing at the moment given the higher interest rate environment, protocol-specific idiosyncrasies, and the likelihood of changing one’s framework several times for the next bull run. The macro backdrop and relative quiet in crypto space lead me to believe a significant bull run is a few years away and the interim will be marked by smaller rallies and selloffs.

Higher interest rates drive up the cost of capital, which makes investment more challenging. Although we have established a recession by the definition of the word, it does not quite feel that way yet, but people are tightening their wallets in anticipation of a bad market and simultaneously getting 4%+ risk free on their USD deposits. As a result, it is not the best time to invest.

Another risk in my opinion is the fact that we have not had a significant selloff in equity markets and have not hit severe pain for the average citizen. The S&P 500 bottomed out in the high 3500s several times last year, which marks a drop of only 25% from the highs. Given all the froth in the global economy, including insane premiums for real estate and new and used automobiles, there may need to be more unwinding before we can say with a higher probability that a bottom is possibly in place.

One counterpoint to those issues is investing now in seed and series A round investments at valuations discounted from the 2021–22 froth. Betting on a strong team, especially if they are solving a key problem or shipping a new innovation, can be rewarding here as the team may have a fresh start and fresh capital, have learned from their own or others’ experiences in 2020–2022, and not suffer from some protocol-specific issues like reduced runway or boredom. Investing in rounds that have not released tokens yet also enable some longer-term holding without worrying about token unlocks increasing the supply during the holding period while waiting for the next bull run.

Buying the dip and holding here is tricky, because we do not know how projects will fare in the medium and long term, including the strong ones! I have heard stories of protocols lying about the length of their fiscal runway. Given events like the FTX collapse, the cash runway might be carelessly stored on a CEX and lost. Perhaps the runway was quietly invested in a token that is down 50–90%. I have also heard stories of some founders and engineers looking to move on to new projects. Boredom in a bearish market is very real. These are all vulnerabilities that might not frankly be known to investors without high levels of transparency. We will likely see many more projects succumb to these vulnerabilities in the next year or two, especially as the bear market reveals which projects are excess to requirements (we do not need 500 DEXes in crypto!).

I notice when I talk to people in the ecosystem, sometimes their frame of reference is suggestive of a lack of updating their framework. For instance, an Ethereum DeFi maximalist might reference protocols from the 2020 DeFi summer at a high rate relative to other ecosystems and newer developments. There are always new entrants, and

The app-chain architecture of ecosystems like Cosmos is a great way to have the capacity to scale, but in practice having a small, low-revenue dApp as its own chain is not optimal as it requires bootstrapping new validator sets and getting enough to have it decentralized. It is ideal to have the scalability without having to build the infrastructure outlay from scratch.

Of course, there will be exceptions, if large companies want to run their own permissioned blockchain where they validate themselves.

I admittedly know little about gaming, but think this area will be a driver of crypto growth in the next wave. Some gamers have been reluctant to enter the space but as the world continues to go more online it feels inevitable that this area will grow. Knowing from my childhood how we would always move on to the new games that were released, I would refrain from having a view on specific games. However, I believe the infrastructure that provides a foundation for a world of changing games and gaming trends can be a solid investment.

Next on line in moving financial functions on-chain is building options. Options pricing feels like it has enough of a moat relative to perpetual futures protocols due to the complexity of options, so poorer designs and less competent teams will get filtered out more easily. I am still researching which protocols I like best as there is a variety in mechanism designs among them.

Saga enables developers to take a single tenant virtual machine and automatically launch it onto a dedicated blockchain, complete with fully provisioned validators and an optimally incentivized security structure. Saga is mainly targeting web3 games to use its “chainlets” and already has ~50 innovators in the first batch of its innovator program. Saga is based in the Cosmos ecosystem.

(Disclaimer: I invested the Series A round of Saga)

Celestia is a modular consensus and data network, built to enable anyone to easily deploy their own blockchain with minimal overhead. This aligns with my bullishness on the idea of being able to build more chains but abstracting the infrastructure difficulties away and making things plug and play, rather than having each new project needing to bootstrap a large validator set to be decentralized. Celestia will initially be focused on the Ethereum Virtual Machine and the Cosmos SDK.

Celestia’s combined Series A and B round came in at a $1 billion valuation.

I believe this is a strong project as the tokenomics are well thought out and the architecture is solid with the Move language. However, I am not sure about the projects building in the ecosystem, and I am even more uncertain about Sui’s ability to build an intrinsically motivated community. It could end up being a higher-quality sequel to the Solana pump. Mysten Labs’s latest raise was for $2 billion, and only part of that can be attributed to the Sui blockchain, so it is tough to say which valuation to benchmark Sui against for when its token starts trading.

For these projects I like, I believe there should be opportunities to buy dips, especially for Celestia and Sui relative to their higher bull market valuations.

Overall, I think it is good to have some core long-term exposure here but I still believe we can see better levels due to global economic factors. On a crypto-specific basis, it feels like we have gotten most (definitely not all) of the vulnerabilities out of the way. It will be interesting to see if in 2023 there is forced selling from investors who are underwater or experiencing financial difficulties.

My gut instinct is Ethereum will be the money of crypto, and not Bitcoin, which will either serve as digital gold or see its relative dominance erode even further. If you want to add to core long-term positioning at current levels in any token and can withstanding further losses, this offers the best risk-reward in my view.

Solana obviously has some problems, which include the network being down, VC-heavy ownership, ecosystem tokens with low market cap to FDV ratios (despite their heavy selloffs!), and developers moving to other ecosystems. In spite of these negatives, I think buying Solana on deeper dips (in the $4–7 range if we get it) could offer strong risk reward, especially for trading around a position. It seems like Solana has a very loyal community and we cannot ignore the enthusiasm of the Solana community at the November conference just days before the FTX and Alameda-driven selloff.

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