Crypto Market Wizards is RabbitX’s series of interviews with sophisticated DeFi traders and investors. We discuss their background, strategies, psychology, risk management, and other interesting topics that helped cultivate their process and success.
We do this because it’s interesting, and we want to help everyone learn to be better traders. Part of what makes DeFi great is we’re all learning in public together, every day. This is our way of contributing to the community.
Our fourth interview is with Arthur, a prominent DeFi investor and the founder and CEO of DeFiance Capital, one of the leading VC firms in crypto (disclosure: DeFiance is an investor in RabbitX). Enjoy.
RabbitX: Tell us about yourself, your background, and what you’re currently doing.
Arthur: I'm Arthur, the founder of Defiance Capital, a crypto and web3-focused investment management firm based in Asia. Currently we manage a fund centered on investing in liquid crypto assets.
RabbitX: How did you get started in crypto and begin investing?
Arthur: I got into crypto in 2017, right when Ethereum had a massive move up. As someone who's been investing since I was young, the rise of ETH and crypto caught my eye. After diving deeper, I decided this sector had huge promise and was full-time in the space by 2018. My journey in trading and investing started even earlier though; I began investing when I was 20, mainly in the stock market.
RabbitX: Why stocks first and at what age?
Arthur: I bought my first stock at 18. But it wasn't true "investing", it was more based on stock picks from investment firms. I got serious around 20 when I started studying investment strategies and philosophies in depth.
RabbitX: What got you into stocks at 18?
Arthur: It was my own initiative. I think financial experience and education is critical, and mastering your finances is one of the most important things you can do. I think I understood this from a young age.
RabbitX: Was there anything during your upbringing that influenced your decision to go into investing?
Arthur: Definitely. For one, my family historically hasn't been adept at managing their money, mostly due to older generations lacking financial knowledge. Also, when considering careers that lead to wealth, I saw two paths: rising to a senior position at a big company or working in finance. At that time, about 10 to 15 years ago, technology companies weren't as dominant and finance seemed more promising.
RabbitX: Do you remember your first big win? Not so much in absolute dollar amount but as a percentage of your net worth at the time.
Arthur: Does it have to be crypto?
RabbitX: No any asset.
Arthur: My first big win was Alibaba around 2014-2015. When Alibaba got listed, they were one of the few profitable e-commerce and tech companies. I felt the market didn't recognize their potential due to misconceptions about Chinese companies. After I invested it tripled in a year.
RabbitX: It sounds like a very fundamentally driven approach to investing. Do you still do so today?
Arthur: Absolutely. My investment philosophy is grounded in fundamentals. While the strategy and framework adjust with market conditions, the core remains.
RabbitX: Talk to us about your investment philosophy.
Arthur: The important thing is to decide your time frame first. Many debates about investment strategies lack this clarity. I generally aim for a six-month to two-year time frame. It's long enough for theories to play out but short enough to adapt.
My strategy involves a concentrated portfolio of 5 to 15 investments that I understand deeply. Diversification has its benefits, but if you really want alpha, you can't be overly diversified. Beyond 10 to 15 investments, the benefits of diversification diminish. From there, I focus on sectors I believe in, diving deep into them to identify undervalued assets. Deep fundamental research gives the conviction to withstand short-term price volatility.
RabbitX: When you talk about fundamental factors, can you discuss some metrics you consider, especially since crypto has different dynamics than traditional equities?
Arthur: That's the challenge in crypto, fundamental metrics aren't universally agreed upon. In TradFi, we use discounted cash flow models and some well-known valuation metrics. But in crypto, we don't even agree on what constitutes revenue for a protocol. That's the challenge. However, we use different metrics for different assets. For an L1 like Bitcoin, I view it more as an alternative store of value (SoV). It's not a great payment channel because of its high transaction fees and volatility but a decent SoV. I evaluate Bitcoin by how it compares to other global SoVs.
For non-revenue generating SoVs, I consider what market share Bitcoin might occupy in different time frames to judge its relative value. For productive assets with utility, like L1s, I mainly look at two things: user engagement and the network's potential to capture a monetary premium.
A concept called the Market Cap Law helps guide me here. For instance, when Ethereum started it had minimal monetary premium. But now Ethereum's "moneyness" is higher than five to seven years ago. So it's essential to factor in its position as a Bitcoin competitor into its valuation. Another factor is the value these blockchains secure; TVL is a good proxy for this. And all these metrics are still evolving.
RabbitX: Could you explain the "moneyness" concept?
Arthur: Every asset has a degree of "moneyness". Fiat currency is fully money, while Bitcoin might be 50% due to people using it for both transactions and as an investment. That's how I define "moneyness".
RabbitX: So "moneyness" in your view boils down to how much that asset can be used for financial transactions to buy something?
Arthur: Right. The three main definitions of money are medium of exchange, unit of account, and store of value. The more an asset checks these boxes, the stronger its "moneyness".
RabbitX: Interesting, so since many NFTs are priced in terms of ETH rather than USD, this contributes to ETH moneyness right?
RabbitX: Do you think ETH could be more valuable than Bitcoin within a couple years?
Arthur: It’s very possible. But while Ethereum is innovative, the market might still see it more as a tech platform than a pure store of value. So the perception could be that its "moneyness" is around 20 to 30%, with the rest being its potential as an innovative platform for decentralized applications.
RabbitX: When selecting an investment, how do you determine your entry point?
Arthur: On entries: we're fundamentally focused investors. We don't just look at price, but moreso valuation multiples. Some in crypto don't care about intrinsic value, but if possible, we try to estimate a crypto asset's value range. If you find an asset that ticks all your boxes, you can't always wait for the perfect entry point.
RabbitX: How do you determine whether an investment was a success or failure?
Arthur: It's crucial to constantly re-evaluate. We regularly review our investments at least every two weeks. When you invest, you have a thesis, and you need to review if any fundamentals have changed or if new information has emerged that affects your evaluation.
If the fundamentals change without any new information, that can be seen as a failure in your predictions. If there's an unpredictable external factor that causes a price drop, it's part of the process. The key is to focus on building the right process. With a proper framework, given enough time, good results should follow. If they don't, then the framework needs adjustment.
RabbitX: So be process oriented, not results oriented. If the process is good, results will follow.
Arthur: Exactly. Use the results to refine your process. No one gets the right process from the start. Investing is a lifelong journey.
RabbitX: In markets, especially crypto, people sometimes misconstrue results, mistaking luck for skill. Bull market geniuses. Is this where the worst bad habits are formed? Because of the false positive on the process?
Arthur: Yes, absolutely. Many were successful for the wrong reasons. They might not retain their wealth because they didn't have the right process.
RabbitX: Can you comment on your risk management processes?
Arthur: We have position limits to ensure we don't put all our funds into one investment. Other standards include leverage limits and, for more trading-focused funds, drawdown limits. Being more investment-based, we have less-strict drawdown limits, but significant drawdowns would prompt a thorough reevaluation.
RabbitX: Do you ever go more than 100% allocated for the fund?
Arthur: No, we don't use leverage. Given our strategy, there's significant volatility, so we don't see the need to increase that risk.
RabbitX: What would be your advice for individual investors in using leverage?
Arthur: It depends. Are you talking about position-level leverage or portfolio-level leverage? Given crypto's volatility, I don't recommend portfolio-level leverage unless you're constantly monitoring it. Position-level can be alright; it can reduce counterparty risk because you don't fully margin on exchanges, and we're aware of counterparty risks in crypto.
One challenge in crypto compared to traditional investing is managing more than just market risk. You have to be wary of counterparty risks. Even big crypto exchanges can commit fraud. Beyond market risk, there are operational and counterparty risks crypto investors need to consider. It increases the complexity of crypto investing.
RabbitX: Can you discuss the VC investment landscape right now?
Arthur: There's still plenty of funds available, but VCs are more cautious now. Proper due diligence on investments can take one to three months. However, the timeframe has returned to normal, compared to the rapid closures seen in 2021-22. The decision-making process is slower, and investments have skewed towards the projects perceived as top-tier.
RabbitX: That's an intriguing shift. Previously many small startups could raise funds, but now larger sums are going to fewer ones.
Arthur: Correct. Nowadays, merely decent teams struggle to raise funds. Only the very best teams can secure investment.
RabbitX: Do you see this changing?
Arthur: I don't think so. The rise in interest rates means the opportunity cost of capital has increased. Investors are more demanding. When risk-free rates are high, a 13-15% IRR isn't as enticing.
RabbitX: Do you have an internal expected IRR?
Arthur: We follow a liquid venture model, investing in liquid tokens for the medium to long term. We aim to outperform bitcoin and ETH over market cycles.
RabbitX: So no on the IRR then, and it’s benchmarked against BTC and ETH returns.
Arthur: Yes, exactly.
RabbitX: Why did you choose to focus on liquid ventures instead of traditional VC investing?
Arthur: Currently, this strategy provides the best risk-adjusted return. The venture market was saturated, but it's less so now.
Another advantage of the liquid venture approach is that it lets you reevaluate your investments. This means you can possibly recoup your investment even if it was unsuccessful. In traditional VC, once you invest, you have to wait for an exit event to get your money back. If a project fails, it's usually written down to zero.
People underestimate how many of their investments will fail. I believe the returns from 2021 to 2022 will be disappointing because a higher percentage of projects will fail. In contrast to the 2017 and 2018 periods, many VC investments bounced back due to the bull market. But I don't see this trend continuing. With liquid ventures, you can adjust your investment if it doesn't seem to be working out. It's nearly impossible to always be 100% right, so this flexibility is advantageous.
RabbitX: What's the downside of being a liquid token?
Arthur: The downside is the volatility. You must be willing to handle day-to-day volatility which can be significant. Not every investor is equipped for it. There's a notion that investors prefer to have their money locked up for years to avoid seeing this volatility. So in some ways, traditional VC offers a service where investors don't see this frequent volatility.
RabbitX: Do you still have access to lower-valuation private deals?
Arthur: Yes and no. When investing at the early stages, often you don't have enough data to guide your decision. So it's mainly about betting on the team. Many VCs are comfortable with just that, but for us, it's not enough to ensure a good hit rate. We need more than just a good team and sector. There's also the issue of being locked in and not being able to take profits even when a project reaches its target price. I'd say the biggest challenges are operational and dealing with volatility.
RabbitX: How do you manage the emotional toll, especially during market downturns?
Arthur: With time you become accustomed to the volatility. You have to be prepared for the market to drop 20% in a day without a particular reason. However, the real emotional strain comes from unexpected events that not only impact prices but the foundation of the industry itself.
RabbitX: How do you unwind after a stressful day?
Arthur: I don't have a specific routine. I exercise regularly, at least twice a week, which helps. I also play computer games. Things that require full concentration helps me switch off.
RabbitX: Are there any books or resources you recommend?
Arthur: The classics are always good. I also recommend "Common Stocks and Uncommon Profits". The growth stock investing strategies of Peter Lynch align well with liquid crypto investing.
RabbitX: What advice would you give to new traders or investors entering this space?
Arthur: Prepare as much as possible before taking action. Do your homework. I often see people blindly following others without understanding the investments they're making. It's crucial to think independently and not lean too heavily on others' opinions.
RabbitX: Thanks for your time, Arthur. Let’s get back to building.