DEX Progress to be a "Landmark Event" Over the Summer: Framework Ventures

Hello Defiers, happy Friday! This week’s interview is with Michael Anderson and Vance Spencer, co-founders of crypto venture fund Framework Ventures. Michael and Vance talk about their investment thesis, which starts out with mapping out the space, and picking out the winners in each category, with the advantage of having built a blockchain startup themselves. But it doesn’t stop there though, as they also strive to become their portfolio companies’ most active users. This means they have to be immersed in crypto 24/7 — “This is all we do, like, at all,” Vance says.

They talked about how the emergence of token-based business models in the past year has been a breakthrough for crypto, legitimizing the space as a new asset class, and the pros and cons of the dividend model and versus the buy and burn model. Michael and Vance also compare investing in AMMs like Uniswap, which have become a public good, versus investing in borrow-lend desks like Compound, which can have large AUMs, versus margin trading protocols, which can capture more fees.

Vance believes new developments in decentralized exchanges this year will drive 10% of centralized exchanges’ volume. Michael believes governance tokens are akin to early startup equity. They also talked about why they love the philosophy driving SNX and discussed why the underdog mentality of LINK Marines is bullish for Chainlink.

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btw, I was excited to see The Defiant podcast was included in the Forbes best crypto podcasts list as an honorable mention :)

🙌 Together with Quantstamp, a leading blockchain security firm keeping your money legos safe, Kyber Network, the on-chain liquidity protocol for the tokenized world, and Keycard, the secure, contactless hardwallet & open source API.

Michael Anderson: I think the start of the crypto journey for us was being in San Francisco in the tech industry in 2012-2013. That was at the time when Ripple was really kind of taking off, but then there was this whole concept of smart contracts platforms. And we started to get to know Ethereum through reading the white paper really early in 2014 and that was where our journey took off with the ecosystem growing and the ability to create any program on top of Ethereum.

After that, Vance and I were living in Los Angeles, each working for different technology companies and we actually started living together. And I think, in one of our first conversations, we both ended up talking about Ethereum and that's when we knew we would probably have a fruitful relationship.

Vance Spencer: Mike was a PM at Dropbox and Snapchat, I did corporate strategy at Netflix first in the US and then in Tokyo for a couple years. So, you know, I think what's different about us and a few other different firms or people in this space is that we have a consumer internet background.

And we look at this stuff through the lens of, this is technology. The money side of Bitcoin is interesting to us, but our original thought on Ripple was, this could be a bank, maybe this could be a way to do remittances, what are the technology platform implications of this stuff. And so that's generally where we've approached it. It's been a while, it's been probably six years since we started thinking that way and it's been kind of nothing until now, until DeFi, until it started to have real product-market fit. And so, it seems like blockchain takes forever to develop and we can testify to that, but it's very rewarding to see you know, the kernels of a large industry starting to form.

Vance and Michael. Image source: Forbes

Quitting Netflix

Camila Russo: It's interesting to meet people who are getting into this space from the technology side more than the currency, monetary side of things. So, what about the technology was it that really intrigued you?

MA: Well, fundamentally blockchain enables permissionless value transfer that can be applied to anything worth value, whether it's money, whether it's digital collectibles, and we can talk about our Hashletes experience, or whether or not it's a financial transaction involving synthetic assets. A permissionless, open and transparent financial system is really what you can build once you have the ability to have permissionless value transfer. And so, as Vance said, we just started to on a whiteboard, list all the different things that you can do once you start having that capability. And for us, it felt endless and it just felt like it was time for us to quit our jobs at Netflix and Snapchat respectively and go in and be full time blockchain people.

VS: The other side of that is like, if you want to build a consumer internet app, you can list it on the app store, you can distribute it pretty easily, and as long as it kind of stays within the confines of the app store guidelines, you're pretty much good for experimentation. And there's a few different business models, you can do subscription, advertising, you can try different kinds of sub-verticals to target in terms of interest. But that's kind of the consumer internet side of the world.

Finance Ripe for Disruption

If you really want to experiment with financial technology and applications, there's not a whole lot of places developers can go. They can’t just roll up to Goldman Sachs, Morgan Stanley, and say, listen, I have this new idea for a new bond instrument or I have this new idea for a new asset class. They would be like, A, who are you, B, get out. And so, that new sandbox for experimentation and development is really something that was fundamentally new for us and then we could kind of see the far-reaching implications. And so, I think that the largest total addressable market in the world, which is finance and a total lack of experimentation development, that just felt to us like an opportunity that was ripe for disruption.

“The largest total addressable market in the world, which is finance, and a total lack of experimentation development, that just felt to us like an opportunity that was ripe for disruption.”

CR: It is huge. And just the ability to have permissionless financial system seems unbelievable and that it's actually working is even more incredible. So, how was it leaving these huge tech firms, very reputable firms, for the unknown territory of blockchain. How was that jump? Were you already moonlighting in your new crypto company? How was that transition?

MA: Yeah, so what I would say is it was probably one of the easiest decisions I think we both ever made. And a lot of that was because of the fact that we had been so deep within this industry, watching from the sidelines, investing on an angle basis and building tools and little features that we felt would be interesting, but never had enough time to be able to devote to do the things that we wanted to do.

Builders’ Scar Tissue

And leaving our respective companies, we were already one foot out the door. And so, it felt like the right time, the perfect place and it was just a great time to be able to go off and work on something that we believed in, but where it also felt like we could push the needle. That was our Hashletes experience. We were building digital collectibles, we were licensed by the NFL to build football-based digital collectibles. We were one of the first I think apps in the app store to have a full Ethereum connection. And we use a lot of that experience and a lot of the pains and the scar tissue of that experience to inform our investment decisions now. We can sit across the table from an entrepreneur and say, hey, here's what our experience was like building on top of blockchain. And we understand and I think that's another differentiator that we have.

VS: Our pitch deck for our fund, one of the best sides I think we had in there was a screen capture of the Hashletes iOS app. And we basically circled each of the pain points; pulling data off chain, getting index data on chain. And really, our investment theses are tied to the pain points that we've had before.

I think a lot of the thinking from an investor perspective in the space is very top down. It’s like what's the total addressable market? If Bitcoin can become 10% of gold, if Ethereum can become 1% of AWS. We're very much bottom up. We like to think through the problems in very specific detail as they relate to each entrepreneur’s challenges and what they're trying to do. That's something that we have that none of the firms have, an ability to build products and an ability to really empathize with the entrepreneurs we're supporting.

DeFi is Right Now

CR: Okay, definitely want to dig deeper on your investment thesis now. When and why did you decided to launch Framework Ventures, and go from creating a product to investing in different products? It's a big change.

VS: Yeah, so I think the first thing I'll say is that Michael and I've been investing in the space since 2013. So we have a lot of experience in terms of assessing, evaluating and executing on deals. And we actually had a pretty dominant angel run for two years just kind of on our own. So, that led into starting the fund and developing our investment theses. It wasn't just flipping a switch from operator in a big tech company or operator in a startup to an investor.

We kind of had the training wheels, a little bit on the angel side, but really putting it all together, the fund, the LP base, the firm’s style, the investment thesis, executing on deals, like that's a whole another ballgame that we kind of had to get used to.

But, you know, that being said, we started Framework about a year ago and we started with $20 million. We're considerably bigger at this stage, we can't really get into how big. But our investment thesis was effectively, you know, we had Uniswap at the time, we had Compound starting to gain steam and we looked at the blockchain ecosystem and said, Web 3.0 is probably 5 to 10 to maybe 15 years away in terms of decentralized Twitter and decentralized Facebook, but DeFi can provide value right now. And so, just from that kernel of product-market fit, we were able to extrapolate what are the major horizontal categories of products we want to invest in. Where do they sit in a vertical DeFi stack, whether it's base layers and oracles and liquidity pools and synthetic asset pools? Then, you know, so on and so forth.

Value Capture

We started just mapping out the ecosystem and trying to understand not only where a lot of value is created, but where a lot of value can be captured. You know, an example of this is Uniswap is an amazing public good, but it's almost like investing in a public park at this point. You're not going to really be able to extract a lot of value out of it. Whereas some of the other technology layers, they're more value extractive in terms of being able to invest in them as a venture thesis.

And so that's really where we started and kind of where we ended is that you know, the intersection of automatic market makers like Uniswap, leverage, and synthetic assets is really where the world is going to today. We think that in two or three years, the crypto ecosystem, specifically DeFi, will look a lot like the Forex exchange that exists today. But in 5 to 10, you'll be able to trade all types of esoteric assets, whether that be Facebook likes or Spotify plays or really kind of anything that you can get a price feed for and collateral pools, that will be the first kernel of Web3t hat makes that vision real.

But we haven't changed our thesis, we've iterated on it a few times, depending on when things launch and the world changes. A good example of that was Compound last Friday That's kind of what we do and how we do it.

Winner Takes Most

CR: So, from this mapping of the ecosystem and determining all the different verticals there are and the different protocols in these verticals, is your idea to pick the winner in each and invest in one of each?

VS: I think a lot of it depends on what the entrepreneur is working on, what they're building. And a lot of these can coexist. I think there are a number of these markets that are not winner take all, it could be winner take most. Some of them, like oracles, we believe, are a winner take all market just due to the two-sided marketplace dynamics of an oracle network of data feeds and payment outputs. But when it comes to things like trading venues, when it comes to things like AMMs or asset specific AMMs, I think those things can be winner take most. And so, in that case, it's about finding the one or two best players in these ecosystems and backing them in a way that there are many different exchanges that exist, centralized changes that exist right now. They have different flavors and different features, but really, it's the same experience. I think that the DeFi ecosystem will ultimately end up being the same thing and there will be different venues that have different flavors and different features as well.

CR: And you spoke about this idea of determining which protocol has the potential to produce more value for investors. How do you go about analyzing that? Like how can you actually forecast what that value accrual will be?

MA: So, I think in 2019, some in 2018 as well, we went through a renaissance of tokens. And what Vance was talking about earlier and sort of the thing that gets us excited every morning when we wake up is that tokens for us represent a blank canvas design space. We're still working on what governance means, we're still working on what valuation models mean for tokens. But what we saw in the last 18 months was the ability for tokens to change their business model, for them to change their token economics. And in 2017, you would have said that was sacrilege, that was an absolutely non-starter.

Valuation Models

But now It's possible for those things to change. And with that change, we're starting to see two predominant valuation methods come to the fore. And that is either in the form of synthetics where you have a dividend issuance based on the amount of value that's captured within the network and that's distributed to participants of the network, whether it be stakers or voters or what have you. But then you also have this buy and burn model that Maker has created and promoted, where the value that's created or generated by the network is used to burn a certain amount of tokens, therefore increasing the percentage ownership of token holders.

And for any outside investor, for any person looking at the space who comes from traditional financial markets, this is a major box that they can now check. This is how we in this industry go from where we previously were over the last few years to being something that's universally recognized as an asset class that's investable, because now we have valuation models. We're not talking about utility tokens, PV equals MQ anymore, we're talking about cash flows. And because of that, it's going to bring our industry into something where COMP and Compound’s token can be a billion dollar asset if they have a value accrual method, because they're that big and they have that potential. And that's where we can really start to see DeFi put itself on the map.

“This is how we in this industry go from where we previously were over the last few years to being something that's universally recognized as an asset class that's investable, because now we have valuation models (…) And that's where we can really start to see DeFi put itself on the map.”

Margin Vs. Borrow/Lend

VS: To take Michael’s pointeven further. So, now you have these value capture mechanisms, whether it's buy and burn or a dividend. So, let's take the example of Compound versus dYdX and which one will create more value. Compound is just borrow/lend, while dYdX is basically a derivatives platform with borrow/lend functionality enabled within it.

And if you look at dYdX, because people are trading derivatives instead of just borrowing and lending spot assets, the borrow and lend rates are consistently a lot higher than they are on Compound. And so, as an investor, you have a decision to make. If you want to invest in a borrow/lend desk where you can maybe get a lot more AUM but the margins are going to be thinner. Or do you want to invest in a derivatives exchange, where it's a bit riskier, you're creating higher borrow/lend markets, there's more fees flowing to either a protocol or a company.

But these things sit at different layers of the stack. And I think you could make the argument that, if you were to rebuild Compound all over again, maybe you would try to build margin trading on top of it or maybe you would try to build derivatives trading on top or anything, just to bootstrap the fee base. And we're kind of starting to see people pick up on, okay, maybe building a borrow/lend desk isn't enough, maybe I need to build margin trading, like Aave is trying to do.

You know, this is kind of where the space is going, where you're seeing platforms that usually operate at this level of the stack, trying to move up or move down to create more value and capture more value. And that's certainly something we think a lot about.

CR: Interesting. Okay, so I have two follow up questions on that. The first is, so it seems to you that you're more bullish on this margin trading model than on the more plain vanilla borrow/lend model. Do you have any investments in in any of these platforms?

VS: Oh, yeah. So, I mean, we've invested in both. So, you know, we're certainly not like this one bad, other one good. You know, Synthetix is coming out with futures in the next month and a half, two months, FutureSwap, of which we led the last round of and had a monster alpha, that's coming out in the next three or four months.

Generally, we think the derivative space, if you look at the open interest on platforms, like BitMEX or Huobi or OkEX, that’s in the tens of billions of dollars a day on any given platform. And at certain point, as an investor, you're kind of saying, alright, I'm going to aim for the largest total addressable market and, and maybe I hit somewhere, but it ends up being large when. So, I think you know, those are investments we've made there.

Web2 to Web3

On the borrow/lend side, we've also made investments in a couple protocols that are coming out later this summer, which have a new take on bootstrapping a credit score, because that’s one of few areas that Compound and Aave don't really tackle yet is, how do you actually use Web2 data, whether it's credit cards or bank statements or whatever, to help people build a credit score on chain where they don't have to consistently over collateralize these loans.

CR: Can you say what the name of the project is?

VS: Yeah, the project called Teller. That's the one that we're super excited about, because it's just doing something new, where it's bringing Web2 data in a way that’s secure, to kind of help people think about and build a credit score. But you know, we invest in all layers in the stack, so we're certainly not bearish on a specific layer.

CR: Okay. And then the other thing I wanted to ask you was on this dividend versus token burn models. Which do you see more potential going forward? I mean, or does it just depend on the protocol, which works best? How do we evaluate that?

MA: Every single protocol, just like every single business has a slightly different business model and they're kind of like a fingerprint for the company. We think that the token economic model is kind of like a fingerprint for the open distributed network. So, to your point, every single one of them needs to be specific to that specific network.

Dividend Vs. Buy & Burn

But some of the pros and cons of each are when we're investing, one of the major themes that we look for is what is the community, what is the group of people that are supporting this network? And one of the best things that we've seen with Synthetix is that there's this fervor around every Wednesday being payday because that's when the dividend is issued. So, as you're thinking about community development as a protocol entrepreneur, that's one aspect that we promote as a great potential mechanism.

On the flip side, if you're doing a buy and burn from an investor perspective, it's a tax-advantaged way of distributing cash flows because you don't have the dividend which once you receive it is technically taxable. With a buy and burn it means that you can have more ownership of the network without having to have that be a taxable event every single time.

With Synthetix’s dividend model “there's this fervor around every Wednesday being payday because that's when the dividend is issued (…) With a buy and burn it means that you can have more ownership of the network without having to have that be a taxable event every single time.”

So, here's just some of the different flavors that we like to think through and things that we like to promote with entrepreneurs that we're working with that are thinking about their token economics from the ground up. And yeah, I think each of them is different and there are probably more philosophical perspectives that you can get into arguing one way or another, but I think they both work in different ways.

VS: Yeah, I think the other aspect is like there's a time dimension to it. You give someone a dividend and that's money in their pocket and that's interesting, they can do something with it. But that's a moment in time. If you burn a Maker token, it's burned forever. So, all future participants in the network are also realizing that value. Time is a very interesting construct when it comes to these valuation models and certainly buy and burn has an advantage there. What it lacks is the consumer feedback loop that it creates. When you give someone money and you can be like, what are you going to do with it? Put it back into the ecosystem? Are you going to take it somewhere else? You know, are there incentives I can create for you to keep it in in this closed feedback loop?

“Time is a very interesting construct when it comes to these valuation models and certainly buy and burn has an advantage there. What it lacks is the consumer feedback loop that it creates. When you give someone money and you can be like, what are you going to do with it? Put it back into the ecosystem? Are you going to take it somewhere else?”

CR: Are earnings more uncertain with a buy and burn token mechanism? Because in the end it will depend on market appetite for the token. You can burn that token, but if people are selling it, you know investors will still lose out and in that sense maybe a dividend is like a safer bet.

MA: Yeah, I think both arguments are to be made. If you have stable cash flows, you're going to be fine either way. But to Vance's point, the amplification of a buy and burn over time, I think builds in an exponential way or a nonlinear way, as opposed to a dividend, which when you receive that dividend, it's distributed and it's gone. You have to think about things on a discounted cash flow perspective with the dividend. Whereas buy and burn, it's maybe more of a percentage ownership of the network over time.

And in the case of Maker, I think they're probably the biggest in the buy and burn camp. If the model is that you buy and burn whenever you have positive cash flows and then you inflate and dilute everyone when you have negative cash flows, it can go both ways. So, the entire value accrue that you assume when you have the buy and burn with Maker token could be eliminated if you know, like we saw on March 12, there's an under-collateralization of Dai and that needs to be remedied. So, yeah, it really depends on the model.

Link Marines

CR: And you mentioned the fervor of the Synthetix community with these like paydays. And that immediately made me think of the Chainlink community, which also is super, you know, enthusiastic, I guess is that way to say it. And so, I just wanted to get your thoughts as an investor. Why do you think this happens?

VS: I think the funniest part about the Chainlink community is that, you know, we talk to Sergey on a fairly regular basis, and he liked doesn’t know he’s a meme. And it's like, that's perfect. It just generates a lot of excitement. And I think that there's a few different things that went into the creation of the LINK Marines

And I think the first is a large total addressable market. If you think about where value might start to accrue in a world where smart contracts are relatively commonplace, the natural choke point is when you're feeding in data to the blockchain. There's a set of people who have access to the data, they have some pricing power over the demand side of the smart contract requesters. So you can very rationally reason through a world war Chainlink is accruing some fraction of the value that Ethereum is accruing. I think that's the first and most important thing.

On Chainlink, “if you think about where value might start to accrue in a world where smart contracts are relatively commonplace, the natural choke point is when you're feeding in data to the blockchain.”

Sergey and the team are just incredible entrepreneurs. You know, all they do is focus on this one problem, and they do it extremely well. You know, they're on point with marketing integrations, pushing the limits of really what you can do on an oracle service and redefining what an oracle service is. That's kind of obviously the second part.

And the third part is that, I think the best communities start very small, and Chainlink when it was in its infancy and in late 2017, we found it was predominantly found on Reddit and 4chan communities. Not a lot of people knew about it. And even when people tried to promote it, the people in Reddit and 4chan would literally kind of hold it down or report it so that other people couldn’t know about Chainlink and that could preserve the smallness of the community for quite some time.

And that smallness bred fervor and that fervor bred excitement. And once the team started putting the oracle solution on mainnet and delivering on some of their more lofty expectations, that excitement just exploded. But it really all starts with smallness in these communities and building identity and something that is able to be memed, like the oracle problem is three words and pretty much everybody understands what that is and you can extrapolate what type of value you might capture and what the token might do. So, it’s very simple. That's one of the things that we counsel. Almost out of all the projects we invest in is that you have to have something that is short, punchy, it's descriptive, it's prescriptive to people. And I think that's something that Chainlink did very unintentionally well.

“(Chainlink’s) smallness bred fervor and that fervor bred excitement. And once the team started putting the oracle solution on mainnet and delivering on some of their more lofty expectations, that excitement just exploded.”

First, I think it was for six or nine months, there was no communication from Chainlink to the outside world. It was just like we're building, we're not going to update you on anything that's not technical related, sorry. And so just as people read the Bitcoin white paper and didn't really have Satoshi to ask questions to, they made something of it on their own and they made it their own ideology. That very much happened with Chainlink as well.

Underdog Story

MA: The only thing to add is just thinking about the timelines here, I think is really interesting, because Chainlink launched in September of 2017, it had a run up from about $0.09 or $0.11 to $1.40 and then it dropped down to maybe $0.18 or $0.17. A major thing that we have noticed within the community because we've been a part of it the entire time, is this true sense of being an underdog. I think the market never fully recognized Chainlink, it still doesn’t, and I still think that it's confused about what the Oracle problem is and how Chainlink can really solve it. And I think that underdog story pervades this cohesive community at the base-base layer. Because everybody remembers what it was like, when we were all in the Slack together talking and thinking about what Chainlink could be potentially as the price was dropping 90%.

“I think the market never fully recognized Chainlink, it still doesn’t, and I still think that it's confused about what the Oracle problem is and how Chainlink can really solve it. And I think that underdog story pervades this cohesive community at the base-base layer.”

And one of the things that got us really excited about Synthetix is I think there's a lot of congruency between the Chainlink story and the Synthetix story as well. They started off as Haven, they pivoted, also saw a 90% decline in token price. And they’ve come through in amazing fashion against all odds and I mean, what there is and I can't think of anyone in the blockchain space where you have a successful pivot. So, the people that were on that journey from day one, and the team definitely being a couple of them, it just builds this cohesive nature that I think is really hard to disrupt. And that I think, is ultimately what helps these distributed networks win.

Realization of the Product

CR: Yeah. I love to have this background of the early LINK Marines community. I didn't know that, it's so interesting. Okay, so you mentioned how they both had or at least LINK had this kind of underdog mentality, but I mean, the token itself, it's more than doubled in price in the past year, Synthetix is up by even more. So, to you, is it still undervalued? And of course you'll say yes. But if you can kind of walk me through your reasoning why it's still a good investment after this huge rally these two tokens have had?

VS: Let me pre-face whatever Michael is about to say, with this is not financial advice.

MA: Well, we don't really think about it in terms of what the price is, that it's not something that we evaluate. We evaluate these projects on a non-price, non-financial specific basis, because what we're looking for is the full realization of the product or the capability that was promoted in the whitepaper or the original thesis or the end state of the development of these projects. And I would say there's basically only one asset in this space that has maybe realized its full vision, which is Bitcoin. Even Ethereum is still under construction. Chainlink is absolutely still there as well.

And yes, it may have been the most successful blockchain network in the past year, but it still feels like we're fighting an underdog story and it still feels like there's so much further to go. And obviously, Synthetix is there as well. And so, we think about it and we, as investors, we will eventually have to return capital to our LPs, but we haven't sold a single asset and we won't for a while, I believe. We want to see these things through, whether the price is up, down or sideways. And that's generally how we view investing in this space. And while others may be looking for a quick flip, we are long-term, venture-style investment holders of assets. And I think that could be a different differentiation when you're talking about certain investors who aren't going to have the same perspective. And so, we really want to partner with the core teams that are building these protocols and see it through.

VS: Chainlink right now is in like V.05. We're not even, at 1. So right now, what's happened to Chainlink is that they're trying to bootstrap the marketplace, they're getting a lot of node operators that can provide really high quality price data and they're valuing these providers and they're making sure that they have strong uptime and strong DevOps. And when price feeds go down at two in the morning, there's somebody on page duty to figure it out. And on the other side, they're building out all the integration. So, you know, they're powering probably more than 60 or 70 % of DeFi at this point and that's the other side of the equation.

Eventually, what Chainlink is going to do is they're going to open up the node router ecosystem to anybody that has these price reference feeds or any other data that's interesting, whether it be stocks or Forex or commodities or sports data or whatever. And they'll open that entirely up, they'll start their staking program where people are earning programmatically based on any of the requests that come through. That'll be phase 1 of this network. And I think getting to that phase is the first point at which we would say, okay, this is where things are starting to solidify in terms of vision.

Oracles More Than Prices Feeds

So, that's definitely one point. But also, generally, we see price feeds is the least interesting part of oracles. Even the definition of what oracle's do, to do off chain computation, to attest certain things without revealing them, to act as a de facto scaling solution. The boundaries between what smart contracts are and what oracles are, are really going to start to blur over the next 3-6 months.

“The boundaries between what smart contracts are and what oracles are, are really going to start to blur over the next 3-6 months.”

We have a vision of what Chainlink will become and we're tracking alongside of that. We're very happy with how fast the team is moving. And as long as Chainlink has that underdog mentality, we think that it's going to be extremely successful. It's, the most valuable ERC-20 I think and it's never taken on real VC funding. And I think that point escapes a lot of people. I think Ethereum has an obsession with blessing certain projects, whether it be Maker, whether it be Compound. And then if you don't get the blessing, you're kind of like out in the cold. But this is a point to the contrary, which says that the silent majority of people are really interested in stuff like this. And even if you don't have kind of the buy-in of a lot of the Ethereum thought leaders, you can really make a go of building a successful technology product.

Ethereum Blessing

“I think Ethereum has an obsession with blessing certain projects, whether it be Maker, whether it be Compound. And then if you don't get the blessing, you're kind of like out in the cold (…) I think that having that blessing is less important than it used to be.”

CR: Do you really think Chainlink doesn't have the blessing of Ethereum?

VS: There was a year and a half where Chainlink was really derided as an oracle solution. And this was when Maker's oracle solution was more prominent. But, you know, I think that having that blessing is less important than it used to be, which is good because it represents not only the maturing of the ecosystem into something less tribal, but also the increasing decentralization of the Ethereum community where there's not a kind of few arbiters of what is good and what is bad. And I think that's just great for the entire space.

CR: I agree. And about Synthetix, I wanted to ask you, Kin had this great op-ed on The Defiant saying why Synthetix will never include permissioned assets on its system and why that's so important to him and to the platform. And this is obviously a different position with Maker, which is already including permissioned assets as collateral. There's pros and cons to this take. And a con is it might limit the growth of the assets that can be in the platform, because it just by definition reduces the liquidity that can go on there. What's your view on this? Is this something that that concerns you or do you like this approach?

Philosophical Approach

MA: So, I will say one of the things that we really respect about Kain is his philosophical approach and his strong perspectives because he is the prototypical head of the protocol that we're looking for when we think about other new investments. And this is another example of him taking a philosophical perspective.

We use USDC for operations and we have a lot of it just as a company. And so, we're not ones to say that it's something that we are not going to dabble in and are going to use for our own purposes. But we completely agree with Kain’s philosophical approach. And if we really think about where the liquidity, where the collateral potential could come from, the two largest pools within the crypto ecosystem are completely permissionless and completely decentralized, those being Bitcoin and Ethereum.

“The ability to have the only permissionless stablecoin with real volume, with real asset value on Ethereum having that be sUSD, is a potential advantage in the face of Dai or USDC, which are backed by centralized assets.”

Only Permissionless Stablecoin

And so, while it's true that the ability to have centralized collateral may help in times of need as they did with Maker, we think that the ability to have the only permissionless stablecoin with real volume, with real asset value on Ethereum having that be sUSD, is a potential advantage in the face of Dai or USDC, which are backed by centralized assets. So, it's a huge advantage right now. I think as the industry matures, we'll see where the collateral pools start to gravitate, if it's WBTC, if it's USDC as the largest pools, then yes it could hamper growth, but we are going to back Kain’s perspective and then we're going to be behind him and the team all the way. And if this is the way that they want to go, then we're going to see that through as well.

VS: Yeah. So the way you interact with the Synthetix system as a trader is, you have USDC or USDT and you have to buy sUSD in order to trade on the Synthetix exchange contract. So, that peg is basically maintained on the curve at the moment where there's a lot of sUSD, and there's a lot of other USDT, Dai, USDC. You can get from centralized assets like USDC or USDT into sUSD pretty frictionlessly. So, I will say that, you know, Kain’s perspective of the collateral pool of Synthetix will not be centralized is a lot different than saying centralized assets will never have a bridge to interact with this.

The other thing I'll say is investing in protocols and doing math like total addressable markets and layers of the technology stack, that's all awesome, but 95% of this is who is sitting in the chair doing the work and yelling at people and cracking the whip and doing all that good stuff? It's hard to find. There's only so many Leshners, there's only so many Kains, there's only so many Runes.

Tier-1 Entrepreneurs

You know, we can think of probably one hand of protocol entrepreneurs that are of the tier-1 caliber that can really take a network from zero to a billion. And I think that's the real scarce resource in crypto is those incredible entrepreneurs. Because almost two and a half, whatever years into a bear market, the only people left are kind of the renegades and the true believers. And that just means the filtering has been so heavy that there's not that many entrepreneurs.

“There's only so many Leshners, there's only so many Kains, there's only so many Runes (…) The real scarce resource in crypto is those incredible entrepreneurs.”

And though I think one of the things that we're the most excited about is the interest from high quality consumer technology people around the world into crypto replenishing the entrepreneur well, so that we can start to draw some fresh perspectives into it. Because at this point, I think that you kind of expand a little bit larger and make the value prop a little bit clearer for developers or entrepreneurs to build on top of blockchains.

CR: Yeah, I think that's a really interesting perspective that the scare resource in DeFi and crypto is quality entrepreneurs, especially after a long bear market. And that leads me to, I wanted to ask about the difference that you've seen with your experience investing in crypto so far as VCs with what investing in traditional startups is like?One important difference we talked about is you're investing in tokens instead of equity or maybe you're investing in both. Investing in tokens means you get liquidity right away and maybe that allows you to do some trading, and the business models itself are so different, the type of talent is different. It just seems like two completely different worlds. So what do you think are the main things that makes VC investing in crypto unique and how is a VCs role in this space different from a VCs investing in traditional startups?

Traditional VCs Vs. Crypto VCs

MA: You're exactly correct. They're absolutely different in almost every way, shape and form, other than the fact that you're giving money to get an asset and hopefully, the asset goes up. But, you know, that's about it. Everything from what the cap table looks like and how it's structured, how we evaluate these different protocols versus what we'd be looking for with a company to what the exit opportunities look like and how we manage those, everything is different. So, a couple examples.

A token cap table, in most cases, is going to be inflationary by nature, where the ownership that you have over time, if there's tokens that are being distributed out over time, that percentage of ownership goes up, whereas at every single successive stage of fundraising for a company, you're diluted down as an entrepreneur. And so, having that difference is something that we spend a lot of time with potential companies, protocols, networks, just walking them through the dynamics of that. You know, if you have a small percentage now, it's going to grow over time. You normally have 60% at the end of the seed round, well, now, that could be 20% by the time you do an IPO. I mean, all of these things need to be talked about.

CR: Just interrupt for one second to make sure I got this right. So, it's inflationary because you start out kind of owning a piece of equity and then that might increase because you're also owning tokens, in the case say, they do an ICO or?

MA: No, no, sorry. What I'm saying is, if you have 10% of the tokens, but then tokens are distributed to stakers as many of these networks are or they're distributed to its participants. You know, if you are an owner of a token, you want to incentivize active participation in that network and usually that's in the form of more tokens. And so, it would be like Robert Leshner who owns some tokens based on his Compound Labs relationship, but then he’s also a lender or a borrower within Compound and earning more COMP tokens by participating as a user. So, that aspect is fundamentally different.

The staging of these investments, you know, we break the world down into pre-launch, post- launch and growth. Whereas a venture investor in the traditional equity markets would say seed, series A, series B. And so, we think about different staging and what needs to happen at each one of those different stages.

Another major difference, I would say and we've talked about this is our evaluation criteria involving community and what community is doing. And community for us is super important, because what that ends up happening is building the norms for governance. It starts to transition once you've fully decentralized into what the governance model is for the network.

“Another major difference (between DeFi protocols and traditional startups) is our evaluation criteria involving community and what community is doing because it end up building the norms for governance.”

And I think it's also really difficult to build governance models from the start and have them be the right ones at the end. And so, you have to have governance be a moving target as the community develops. And so, those are all the things that are different.

The things that are same are the long-term horizon of how investments need to be made in this space. And I think we've come to the conclusion that there's three things you need to do when you're investing in the space. The first is, you have to be non-consensus and right, you have to hold on to the assets for a very long time and you have to be active in the ways that you participate in the networks.

“You have to be non-consensus and right, you have to hold on to the assets for a very long time and you have to be active in the ways that you participate in the networks.”

And so for us, you know, those are the three things that we try to focus on, trying to get to the bottom of how we can participate and be as active and helpful as possible, having a multi- year time horizon and then also thinking about what are the things that nobody else is thinking about and how can we take advantage of our perspectives.

Active Involvement

VS: Yeah, I can’t think of anything more terrifying than writing a check to protocol and being like, alright, let me know how it works out, we'll be back in two years. That is just like so irresponsible. It's hard to even fathom for us. Active participation is born out of a desire to support the entrepreneurs we invest in, but also, you need more perspectives, you need more eyes. The protocol entrepreneur founded it, sure. But this is everybody's. I don't think you can catch Vitalik saying, this is my network. It's everyone's, it’s dependent on the efforts of a community.

And so, a lot of our participation is out of the desire to support people, but also out of fear that if it isn't shepherded the right way, it's going to be subject to one person's vision, or facilitator or whatever. And so, I think that that's a part of what we do.

MA: And to add one more point. I think, tactically the way that we do this is we actually have two separate companies within Framework. We have Framework Ventures, which is the investment side where we make investments from and that's an investment company. But then we also have a company called Framework Labs, which is best described as our development company. So, this is where we build products, we build tools and features to be keepers and networks or liquidators on platforms. And we also do things like provide liquidity. We're big market makers or traders on platforms that we’re trying to grow. We'll provide collateral to bootstrap the network. And what we really do is we put our money where our mouth is and support our investments, not just with initial dollars to build the networks, but once they launched, once they hit that growth phase, to be the most active participants in the network.

“We put our money where our mouth is and support our investments, not just with initial dollars to build the networks, but once they launched, once they hit that growth phase, to be the most active participants in the network.”

CR: I think that's such an interesting difference with traditional investment, just how much more active investors are kind of required to be in DeFi especially because it's so early that you can actually make a material difference in the community. And second, because of the very nature of these protocols, you actually, own a piece of it. And not just because you're an investor, but in the ways you can participate in it with staking and governance.

And so, with COMP, investors can make actual meaningful decisions in how the protocol is run. And I think they're expected to, being holders of a large percentage of tokens. So, it becomes a little bit of your responsibility to be really active in your own investment. I guess it takes like a special kind of investor to go into crypto.

VS: This is all we do, like, at all. We live together, we work together, we are on crypto Twitter 24/7, we're looking at products 24/7. Crypto is not a spectator sport. You have to be in the game. You can't really be on the sidelines. And so, I think that's something that along with a few other characteristics that make us a lot different, is that this is all we live and breathe and these are predominantly the markets that we grew up in.

“Crypto is not a spectator sport. You have to be in the game. You can't really be on the sidelines.”

I think a lot of VCs grew up in equity markets and taking company public. We grew up in the launch of Ethereum, the bull market of 2017, the bear market of the past three years and now the resurgence. It's really hard to understand this stuff if it's not from first principles. And I think that if you didn't start in 2015 and you're not reasonably young to kind of really participate in this as a full contact sport, it's hard to really get a sense of what's going on.

CR: And, I mean, speaking of governance, this is a little bit of a topic, but there was obviously the lunch of COMP recently and it was hugely successful, we got big rally on the first day. And I wanted to ask your thoughts on governance tokens, which to me, they're a little bit confusing in why they're attractive to traders? Because, in essence, what they do is they allow for the community to participate in governance and supposedly, that's all. I mean, you can maybe expect people to vote in some sort of dividend or some sort of way for these tokens to earn value over time. But right now, that's not the case, at least for COMP and for other governance token models. So, to you, is it just like a way of earning a piece of these protocols and hoping that later on, there will be some business model baked into the token?

Governance Tokens

MA: The way I think that we can look at governance specific tokens, it's kind of like wishing for more wishes. When you have the ability to create anything through the governance proposal process, whatever they are for this specific token, you can create anything as this open, blank canvas design space of tokens starts to mature. Just like we saw in 2019, there was a resurgence of token valuation models.

I think, as we start to form what those are and how they work and why one is better than another or more specifically for that asset, why one would work versus another, that could be something that's voted in as we think about what governance models work best for these tokens and what can be changed. You know, those things can all happen by the use of the governance aspect. And just by launching a token, that's governance specific, it means that you have the flexibility to go wherever you want to take it over the next couple of years or decades. So that's how I see governance tokens.

And I think, at some point, the other way to think about this is comparing it to startup equity. If it's just governance, that's really what you get with shares of a startup. There aren't really cash flows that you have control over or the ability to gain by investing in early stage startup. There aren't really any other aspects other than voting for things, like should the company be sold, should the company go public? And that I think is probably the best corollary to thinking about how early protocol governance tokens should be viewed. And maybe some of them will become Google where you have this always on money spigot, and maybe your Google shares are your ability to have a valuation for that. But I think that happens so much later in the lifetime of these early stage protocols and companies that right now it's really sort of akin to a startup.

“The other way to think about governance tokens is comparing them to startup equity. If it's just governance, that's really what you get with shares of a startup.”

CR: That's interesting. Yeah, that makes sense. To finish. I'm interested what are the next things that a you're excited about and maybe if we can get it to be more specific, what use cases do you think are the ones that will, bring the next wave of adoption in DeFi?

DEXs to Drive Adoption

VS: Next wave of adoption, so, there's a large and immediately addressable market in crypto today and those are the centralized exchanges. And decentralized exchanges of the world have a few different problems. I don't actually think that you don't hold your own funds, is that big of an issue and like, you're subject to the whims of Arthur Hays.

But the real problems are if I have a position on BitMEX and someone's just stop loss hunting, which is, for people who don't know, you're intentionally manipulating the order book to try to liquidate people, that's a big, big issue. And there's no transparency, there's no accountability. Those are the pain points that are real and which will drive people off those exchanges.

And then the question is, where are they going and why? They could go to other centralized exchanges, those largely have or will have the same set of problems just because of the way the incentives are set up. But on the other side of that, is DeFi and the value prop that exists when you have this intersection of AMMs leverage and synthetic tokens where you can effectively replicate the centralized exchange stack, without any of the bad stuff, without any KYC, with transparency as to how the order broken oracles operate. And I think that'll be big.

The things that are holding us back there right now are obviously, the construction of those protocols and we've been investing in the new derivatives platforms for about a year now. And we're kind of in the gestation period where we're going through code audits and code freezes and making sure everything is good and final for the release. And we expect those to be out this summer. So, it'll be a large landmark event. And that'll bring over, call it 10% of that volume on centralized exchanges.

DEX developments launching this summer “will be a large landmark event. And that'll bring over, call it 10% of that volume on centralized exchanges.”

CR: Sorry. Are you saying that this summer, you're expecting new Dexes and like margin trading platforms to launch? Or is it like the existing platform will have new capabilities that they're launching?

VS: So, Synthetix will be launching futures. FutureSwap will be launching futures. There's a couple others that will be launching futures. But those first futureswill be the first time we’ll be able to have leverage and funding rates and there's so many externalities to the creation of funding rates in the sense that people can arb DeFi to CeFi, they can arb DeFi to DeFi, like there's a lot of value and a lot of those futures products are time constructs where you're charged the funding rate every eight hours, so people will stay on crypto longer, and become more sticky, so that'll be quite important. And that will be big.

But the thing that I think everybody is really waiting for is scalability, whether it's the EIP-1559 helping out a little bit, or whether it's Layer 2 solutions fully coming into their own, like the Optimism demos we've seen. That is the main thing that will really make the trickle into a flood from the centralized exchanges, which effectively just take all the money for themselves, to this more decentralized world where things are more transparent, the community ownership is real and the products are at feature parity. So, that's what I'm excited about.

“But the thing that I think everybody is really waiting for is scalability (…) that is the main thing that will really make the trickle into a flood from the centralized exchanges, which effectively just take all the money for themselves, to this more decentralized world where things are more transparent, the community ownership is real and the products are feature parity. So, that's what I'm excited about.”

MA: Yeah, it's exactly what I'm excited about. The only other thing I would add is, what this means is the consumerization of DeFi is real. And we're starting to see that with things like Dharma, and their dollars to Dharma savings account. That is something that I can show my mom and say, hey, is this something that you want? It’s 15 times the national average and savings rate.

And then the other side of it would be with Teller being able to bridge the Web2 and Web3 ecosystem to get more effective rates and more effective use of capital. That is where we're going to start to see instead of 150% over-collateralization, we actually have 75% collateralization. So, as DeFi starts to bridge this fully decentralized, with centralized when it comes to product features that enable the consumerization, I think we're going to start to see a number of those products launch in the next six months. And that's when we start to see an influx of new users that previously wouldn't understand this crypto native, crypto specific ecosystem versus something where you can show them a product and say, hey, is this something that you want? So those things in addition to the scalability, I think will enable the consumerization.