"It's not just about money; it's touching a very primal desire to connect with others:" ParaFi's Santiago Roel

Hello Defiers! Sharing last week’s podcast and interview —apologies for the delay! I spoke with Santiago Roel, partner at ParaFi Capital, one of the most active investment funds in DeFi. Before going full crypto, Santiago worked at JPMorgan’s investment banking arm, and then invested in fintech and software at a venture fund.

He now uses his more traditional VC frameworks to analyze open financial protocols and finds that even by those metrics, DeFi comes out ahead. Amid growing sentiment that DeFi protocols should distribute their tokens to a broad community and not concentrate them among early investors, Santiago argues VCs can play a positive role in the growth of their investment, from providing connections to actual liquidity. Roel spoke about ParaFi’s investment thesis and opportunities he’s seeing in the firm’s venture and arbitrage funds.

We also talked about the seemingly crazy new DeFi meme tokens and Santiago says to not underestimate their value. Maybe part of the reason traders are pouring millions into these tokens comes from the human desire to connect with others. Bonding with people from all over the world over something that seems like an inside joke, and actually owning that protocol, is proving to be extremely powerful.

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🎙Listen to the interview in this week’s podcast episode here:

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Santiago Roel: My background is in traditional finance. I was at JPMorgan and that's where I first discovered Bitcoin in 2012. For me, what really drew me in was the remittance use case. I'm from Mexico and so really being able to move money cross border continues to be a big pain point. People are being charged 5-10, even more cents on the dollar to send money cross border. That to me was a killer use case of Bitcoin. I really got my hands dirty on it, started buying Bitcoin and sending it to Mexico to my family. For me, that's where it really clicked, that was an aha moment.

It really comes from the perspective of asking, there ought to be a better way to do things. That's a guiding principle for investing is, if you were to redesign a financial system from scratch, how would it look like? I think we certainly can agree that the financial system as it stands today has a lot of gaps and hasn't really caught up to the internet. That was always in the back of my mind, nagging at me.

“That's a guiding principle for investing is, if you were to redesign a financial system from scratch, how would it look like?”

When Ethereum launched, as you do a great job narrating in your book, it was fascinating to see the programmability of money. I was investing in open source software and fintech at the time at a fund called Sageview Capital. That's where I really started getting more involved in projects like Ethereum and other applications being built on top.

I joined ParaFi with my partner, Ben, to really double down on this thesis that blockchains are going to totally transform how we think about finance, how we think about money, how we think about value. It is very exciting to see, I think the early signs of that.

CR: Super interesting to hear how you were drawn into Bitcoin because of the remittance use case and how you were using it firsthand in Mexico with your own family. At the time you were at JPMorgan, were you able to influence any of your own work there and bring Bitcoin in or was it just something you were doing on the side?

Going Full-time

SR: I had to go to the local Bitcoin hubs in New York to buy my first Bitcoin. There was very rudimentary infrastructure at the time, small meetups. I would show up at suit and tie and people look at me in a very weird way. JPMorgan has been very active in crypto as you know and now recently with ConsenSys. But at the time, it was not even on the map.

Over time, I think a lot of investors in this space now are full-time. You struggle to really sell the vision of blockchain, of crypto, at your fund or at your company. That just really puts in perspective, we are so early here. Because I think, there are a lot of different narratives and stigmas associated with crypto and I think that at some point, you realize I have to do this full- time.

This space has so much innovation, so much talent, that it's hard to keep up even on a full- time basis. It's been sort of an uphill battle. I talked a lot of fund managers and they all come to that realization that you can't do it from a traditional organization. You have to part ways and I came to that conclusion and joined ParaFi.

CR: When was it that you left and went to go full-time crypto?

SR: I've been investing in a personal capacity kind of crypto by night, over the last seven years and then I fully decided to start running my own staking, operating nodes to validate. That was like over a year ago. My background is in investing, that's what I love to do. Over the last year and a half, I was contemplating raising a fund, joining a fund and that's where I landed with ParaFi. Sort of how I think about the world, how I think about investing in crypto is very much aligned with how ParaFi as organization looks at the world.

CR: Let's talk about that. What is ParaFi about? What is the investment thesis, how do you go about finding opportunities?

Finance as Killer Use-Case

SR: The core bet that we're making is that one of the most killer use cases of blockchain technology is to transform financial infrastructure. We are investing in, think of it as the next wave of innovation of fintech combined with open source and really powered by blockchain technology. That includes all the different money verbs, you can think of lending, borrowing derivatives, insurance.

For us, the bet that we're making broadly is that this is a secular trend, finance is going to be transformed probably from the outside in. Then we start saying, okay, what are the immediate, different pieces of infrastructure that need to be built to provide what we call DeFi. A lot of it is copying, I think parts of silos of the traditional finance world into DeFi, porting those over, but then also mashing up different combinations to create new primitives. We have a good pulse on what has worked in traditional finance and copying that over, plus also new primitives that are uniquely enabled in this ecosystem.

What Needs to be Built

As it relates to how do we form a thesis, how do we go about finding opportunities. It really comes from sort of first identifying ‘what are the applications that need to be built?’ What are the use cases that are missing in this ecosystem? For instance, we say, hey, look, we ought to be able to borrow at a fixed rate. That is not typically possible today. But we look at traditional markets where the notional amount of fixed-rate borrowing versus variable is 25 times larger. Someone's going to solve that, someone's going to crack that nut. We'll go out and find and then once we build that pieces, we say let's go on and find the best operators that are going to execute and place bets or a bet accordingly.

“As it relates to how do we form a thesis, how do we go about finding opportunities. It really comes from sort of first identifying ‘what are the applications that need to be built?’ What are the use cases that are missing in this ecosystem?”

Another opportunity is, hey, how do we do under-collateralized loans? Everything right now in the system is over-collateralized for a reason. There's no reputation layer in crypto. How do we think about insurance? That's from first principles, we go back and say, this is how the system should look like and then from there drill down and say, okay, let's find the best operators to execute.

CR: So you look at traditional finance and say, these are the main pieces that make things work and so, what needs to be built in this parallel financial system for it to work? That's how you come with this thesis like, okay, we need under-collateralized loans, we need a fixed-rate loans, we need insurance, and then go after the people building those things?

SR: Correct. Different from a lot of funds, what really informs our thesis as well as that we’re power users of these networks, so, we're actually interacting with a lot of these protocols. It's coming from a pain point. It's like ‘God, I wish that if the collateralization ratio wouldn't be 150%,’ maybe it could be lower. I wish I could borrow at a fixed rate. I wish I could buy more cover on Nexus or more insurance for my portfolio on how we think about risk management. We're actively interacting with these networks and from that vantage point, we'll say we identify the areas of opportunity that need to be built in this system.

“We're actively interacting with these networks and from that vantage point, we'll say we identify the areas of opportunity that need to be built in this system.”

CR: What about those things that are outside the box, which aren't even in traditional finance, how do you arrive at those pieces?

Novel Opportunities

SR: No, certainly, it's super exciting. Our investment on Aave was predicated on that to some respects. You look flash loans and just for the audience, flash loans allow you to borrow and repay on the same block. That is a trader’s dream. Imagine that you're really good at finding real estate. Say, you walk around, you see a house, and you say that's worth $2.5 million. You can buy for a million and you have another buyer that's willing to buy it at 2.5. You see this delta because you're good at real estate, you have an eye. But what's the problem? If you don't have the capital to buy the house and then resell it, none of this works in traditional finance. With flash loans, you can. You don't need the capital.

All of a sudden, it creates so much efficiency in the system, because it allows smart developers or anyone in the world really to take advantage of these arbitrage opportunities and in this case, would be able to borrow a million, to buy the house and then sell for 2.5 and get 1.5.

You might argue, well, what's the value of all that? It creates more resiliency in the system. It creates more efficiency in the spread. It incentivizes more market participants. It lowers the barriers to entry that you don't need to have capital to interact in that system.

When you think about traditional finance, you need to have a prime brokerage account and only the big boys can play, are invited to the big poker tables. Right now, the smartest guys in the room might be a very smart individual that has a really good pulse for finance. It's totally transforming the way that we think about giving access to more players in the system and democratizing access to capital.

CR: For sure. I think that's what's so exciting about decentralized finance, which is really I think better described as open finance, just this system that's open to anyone who can and wants to use it. Definitely, tools like flash loans make it even easier, because you don't need to have that much capital to start playing.

Granted it is super risky —or not that risky, because you can just return the loan within the first block if the trade doesn't work out. But, for it to be profitable, you need to find all the pieces to match in a very short period of time. I guess, it reduces the barriers of entry in terms of capital, but you still need to be very technically savvy and an experienced trader to use many of these protocols.

Hobbyists

SR: Absolutely. I think that really conceptualizes how early we're on this system. It's a lot of hobbyists if you will, that are interacting with these protocols and testing them out. But that's a good thing. That's a natural evolution of technology.

SR: The other primitive is collectibles. Broadly, a lot of people tell us well, how do you think about DeFi? It's very niche. It's very small. Why just specialize in DeFi? Why not touch everything in blockchain, all the different use cases that we were promised but still haven't shipped? In response to that, it's like, well, it has most the most product-market fit. Actual earnings, traction, users. The value proposition is too hard to ignore; it fulfills this characteristic of 10X better than the traditional finance and I think you alluded to it earlier.

But broadly speaking, how we define DeFi is transfer of value, full stop. When you think about what value means, when you have digital scarcity, which you've never had before, then you start seeing the possibilities. This system where the way we think about money has been really around for 80 years since Bretton Woods. If you look over time, there was a time that been whale bones fulfilled the moneyness property. I think we're seeing a really interesting confluence of trends from metaverse like Fortnite and video games and eSports combined with everyone is online, and the way we think about value, I think will radically change.

Is it crazy to think that you can use your crypto kitties as collateral for a house in five years? Because you have AMMs, you have system to provide good price discovery on digital scarcity and I think that's a new primitive that is going to unlock so many different applications, so many different use cases with composability.

“… broadly speaking, how we define DeFi is ‘transfer of value’, full stop.”

CR: It's so interesting. How do you think our idea of money is changing because of these technologies? Is it something like, anything can be money, you can tokenize anything and put it on an exchange or put it on a lending platform and use it to take out a loan or open a savings account and do things that before could only be done with actual currency?

Redefining Money

SR: It is fascinating, I think that you have to think about what defines good properties of money, what money is. It's recognizable; there are market participants that recognize the value in this. It's tangible, it's divisible, and there are certain properties of authenticity, if you will. I think blockchain checks a lot of those boxes: you have digital scarcity, you have provability by code, that there's only X amount of Bitcoin or X amount of crypto collectibles or X amount of whatever token.

You also have a very fluid market where anyone can provide a market on any token. I think, you've never had global untethered pools of liquidity that are interacting in a very explosive way. Historically, if you had a baseball card, well, the baseball card could break, how do you prove the authenticity of the baseball card well, you have experts that look at the card and then well, it's very localized. How do you sell, maybe eBay or maybe PayPal allowed you to put your collectible on there and sell your baseball cards. Massive markets, wine, art.

Now you have digital representations of these things with provable certainty that they're authentic with price discovery at a global scale and so that I think checks a lot of the boxes of money.

[ … ]

Paid subscribers have access to the full transcript, including sections on:

• Token vs. equity investments “At a different evolution of the company's lifecycle, you might have equity and then you migrate to tokens and everyone is incentivized to accrue value of the token layer.”
• Value of VCs“I would encourage, go talk to our founders. We live and die by our reputation. Anyone that's criticizing funds, at least our view is, we live and die by that and that's the most important thing that we have from a deal sourcing perspective.”
• Cross-blockchain explosion“There's a fascinating rotation of capital that's happening very rapidly and across networks to capture to optimize yield.”
• Under-collateralized lending “There is an opportunity to create trusted pools of liquidity that reduce collateralization ratio and build a reputation layer.”
• Better than fintech““Traditional fintechs, many of them don't even have earnings, but they're public and they trade out pretty nosebleed valuations. You've never really had this high growth and profitability.”
• Power of communities “Don’t forget this: Creating a community of enthusiasts is extremely powerful. (…) At the end of the day, it's touching a very primal desire to connect with people, to connect with others.”

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The Defiant is a daily newsletter focusing on decentralized finance, a new financial system that’s being built on top of open blockchains. The space is evolving at breakneck speed and revolutionizing tech and money. Sign up to learn more and keep up on the latest, most interesting developments. Subscribers get full access at $10/month or $100/year or 70 Dai/year, while free signups get only part of the content.

About the founder: I’m Camila Russo, author of The Infinite Machine, the first book on the history of Ethereum. I was previously at Bloomberg News in New York, Madrid and Buenos Aires covering markets. I’ve extensively covered crypto and finance, and now I’m diving into DeFi, the intersection of the two.