Dialogue with the founder of DeFiance: Low interest rates stimulate crypto investment, and excess private equity drives up the valuations of good projects.

A deep dive into the differences between liquidity investment and venture capital in cryptocurrency investment.

Compiled & Edited by: Deep Tide TechFlow

Guest: Arthur Cheong, Founder of Defiance Capital

Background Information

In this episode of the DCO podcast, we invited Arthur Cheong, the founder of Defiance Capital. We explored the differences between liquidity investment and venture capital in cryptocurrency investment. In a context where venture capitalists fiercely compete for private placement deals and inflate valuations before projects go public, the relatively less competitive liquidity market often offers smarter and more flexible investment options. Arthur shared how he seizes opportunities in these markets and discussed the unique advantages of investing in Asia.

Getting to Know Arthur from Defiance Capital

Arthur began investing in traditional financial markets over a decade ago and started applying his experience from traditional finance to the crypto market in 2017. The host mentioned that Arthur wrote a paper on synthetic assets during the bear market of 2018, which caught the host's attention, and since then, the host has been following and learning from Arthur's insights.

Arthur's Investment Journey

Arthur shared his investment journey. He mentioned that he was interviewed by a local media outlet at the age of 21, becoming a representative of young investors due to his active participation in his university's investment club.

Arthur started investing in the stock market at 19 and has always firmly believed in the importance of financial education. Coming from a relatively ordinary family, he often witnessed his parents arguing over financial issues, leading him to believe that learning how to manage finances is key to improving one's life.

He studied economics and used his small savings to learn about the market and investing. After graduation, he continued to invest and began exploring cryptocurrency in 2017, diving deep into the field and focusing on investing in crypto assets.

Transitioning to the Crypto Space

Arthur recounted his transition from traditional markets to the crypto space. He noted that the rise of Ethereum in 2017 piqued his interest, as he was attracted to the potential of building various decentralized applications on the blockchain. He believes that the global nature of the crypto market is its unique feature, as it is not limited by geographical boundaries, providing vast opportunities for investors.

Arthur pointed out that the crypto industry is still relatively young, allowing new participants to make a more significant impact in this field. In traditional markets, it often takes a long time to accumulate experience to compete on equal footing with existing players, whereas the crypto market offers more opportunities for risk-takers. Additionally, the potential for high returns in a short period was also a significant factor in his shift to the crypto space.

Impact of Low Interest Rates

Arthur noted that many investors first experienced the phenomenon of zero interest rates after the financial crisis. Following the 2008 financial crisis, zero interest rates persisted for a long time, making illiquid investments more popular, as low rates encouraged people to take on more risk for higher returns. With the low returns on safe investments (e.g., only 2% or 3%), investors were more inclined to pursue higher-risk investments to achieve 70% returns, thus meeting their portfolio needs.

Arthur believes this is one of the reasons why alternative investments (especially illiquid ones) have rapidly grown over the past 15 years. Low interest rates incentivize investors to chase higher-risk investment opportunities.

The host mentioned a correlation between the phenomenon of low interest rates and interest in cryptocurrencies. He recalled a few years ago in Singapore when crypto.com offered a rate of 4%, while Singapore's rate was zero, attracting many people to the crypto market. Arthur agreed, stating that receiving 0% interest in banks heightened people's interest in any investment return above that, prompting them to explore emerging investment opportunities like cryptocurrencies.

"Cynicism" in Cryptocurrency

Arthur mentioned that over time, the maturity of market participants may lead to more cynicism. He believes this phenomenon is not solely due to the collapse of FTX or Three Arrows Capital, but rather the experiences and growth of investors in the crypto market. While the competitive environment in traditional markets often leads investors to experience this maturity earlier, participants in the crypto market typically join due to ideals like decentralization and anti-censorship.

Over time, Arthur stated that investors would realize that many theoretically beautiful concepts face challenges in practical application, leading them to become more skeptical. He pointed out that the low entry barrier of the crypto market attracts a diverse crowd, including highly intelligent innovators and some opportunists, creating significant uncertainty in the market.

Arthur further emphasized that despite the presence of cynical sentiments, maintaining "cynical optimism" is crucial. He believes investors should not easily trust everything but also should not completely dismiss the potential of new technologies. Striking this balance is not easy, and many tend to lean towards one extreme.

When discussing how to better manage risks through cynicism, Arthur believes this mindset helps investors focus more on potential downside risks. He pointed out that identifying potential bad investments is key to successful investing, especially in illiquid markets.

Finally, Arthur shared some experiences to avoid investment pitfalls, including paying attention to whether project teams are willing to accept feedback and improve. He believes that if a team is deaf to external feedback, it is often a red flag indicating potential issues with the project.

Connecting East and West in the Crypto Space

Arthur pointed out that while cryptocurrency is a global industry, there are significant differences in thinking and mindset between the East and West. He believes that assets that can form consensus between the East and West tend to perform better. For example, Ethereum gained widespread recognition in the Eastern community, especially during its initial years in China, laying the foundation for its subsequent development.

Arthur further explained how geography influences the formation of investment theories. He noted that Western communities often focus more on the technology itself, while Eastern investors pay more attention to the project's background, supporters, and market distribution. Eastern investors recognize that, in addition to technology, many other factors can significantly impact a project's success.

The host added that the West has technology, while the East has users. The Eastern market tends to be more receptive to new technologies due to a relatively ambiguous regulatory environment that allows for innovation. Additionally, Eastern entrepreneurs often focus more on product distribution, while Western entrepreneurs are more obsessed with the technology itself.

When asked how to specifically bridge the gap between the East and West, Arthur stated that as investors, they can understand the different perspectives of both sides. Living in Singapore, a global city, allows them to communicate with founders and investors from China, gaining balanced market insights.

Finally, Arthur mentioned that the early internet also experienced similar asymmetries, especially in countries like China and India catching up to the infrastructure and user behavior of the United States. He believes that similar phenomena currently exist in the cryptocurrency space, particularly regarding investment opportunities and market reactions.

Liquidity Investment vs. Venture Capital

Arthur pointed out that there is currently an excess of private capital and a lack of specialized capital in the public market. He believes this capital imbalance creates more opportunities for investors. Although venture capital still receives substantial funding, the number of quality projects is relatively low, allowing excellent projects to achieve higher valuations.

Arthur further explained that the capital structure in traditional markets is primarily composed of ordinary investors, while the situation is reversed in the crypto market. In the crypto market, the scale of venture capital far exceeds that of hedge funds, leading to an unusual situation: without ordinary investors, venture capitalists find it challenging to find exit opportunities. Therefore, Arthur believes that the return potential of liquidity investments is higher due to relatively less competition in the public market.

He also emphasized that liquidity investors can better manage risks, especially in rapidly changing industries where investors need the ability to flexibly adjust their portfolios. The NFT space has experienced significant volatility over the past two years, and many investors failed to adjust their investment strategies in time, leading to losses.

Arthur mentioned that while venture capital typically relies on the "power law"—where a few successful investments can cover the losses of the overall portfolio—in the crypto market, exit opportunities have become more challenging, and valuations are continuously compressed. Therefore, he prefers liquidity investments, as they allow him to manage risks more effectively.

When discussing project valuations, Arthur suggested that teams should consider appropriate valuations when going public. He believes that an undervalued project may signal low quality, while an overvalued project could lead to difficulties in the price discovery process. Therefore, he recommends that teams determine reasonable valuations through benchmarking to provide investors with some upside potential in the public market.

Arthur also noted that although many projects have valuations far exceeding his suggested levels at the time of listing, this does not mean the market will correct this phenomenon. He believes that the issue of high valuations currently present in the market still needs to be addressed, and both investors and project teams need to be more cautious in this process.

Market Slump and Exchange Influence

The host mentioned that in the current market slump, the issue for many liquidity investors is not just waiting for valuations to drop before seeking opportunities, but recognizing that the market needs participants who can provide liquidity at appropriate valuations. Exchanges should not be the only institutions determining listing valuations; as the market matures, a liquidity fund ecosystem may gradually develop, which will help prevent tokens from experiencing a 90% drop after listing.

Arthur added that while venture capital (VC) may, to some extent, inflate valuations, he believes the role of exchanges is equally significant. Over the past decade, many significant industry events have been related to exchanges, and the current market still cannot completely escape the influence of exchanges. He pointed out that exchanges often have incentives to list projects at high valuations, as this is usually accompanied by incentives for launch pools. Project teams may pay 5% to 10% of their supply as listing fees to exchanges, and high valuations make these incentives more valuable.

Arthur also mentioned that when the market begins to decline, these incentives have already been paid to users, who may quickly sell these tokens, leading to further price drops. Therefore, exchanges play an important role in the pricing process, and their influence should not be underestimated.

The Role of Narrative in Market Dynamics

The host mentioned that this is a great time to discuss the article he wrote last year titled "The Narrative Advantage." The core idea of the narrative advantage is that all markets operate based on narratives. Products or projects need to have some fundamental core ideas to support them, allowing people to categorize them into broader categories, which drives the formation of inequality. He observed that attention and capital flow like a river, where investors can choose to go with the flow or against it, or view it as the relationship between a sail and the wind. If one can think smartly about positioning and narrative, they can find the right place in the flow of capital and attention.

He further pointed out that attention and capital are highly correlated. Without attention, even a large influx of capital is not very meaningful; conversely, without capital, it is impossible to effectively utilize the attention gained. Therefore, understanding and utilizing narratives is particularly important in market dynamics.

The power of this narrative not only influences investors' decisions but can also shape the overall trends and sentiments in the market. Through effective narratives, projects can attract more attention and funding, allowing them to stand out in competition.

The Impact of AI and Other Trends

Currently, AI is a great example, as many consumers' attention is focused in this area, so companies that concentrate on AI often manage to raise significant capital and convert that funding into more users. Clearly, this trend should ultimately translate into a meaningful user base and returns. However, if everything collapses, the market will face issues. The host mentioned that similar situations have occurred in areas like gaming and NFTs, and may now also appear in HDI. Overall, he emphasized the importance of narrative, stating that businesses cannot completely detach from narrative, nor can they build a company solely based on narrative.

Arthur agreed with this view, stating that the article perfectly summarizes certain beliefs that drive the market. He noted that many people subconsciously understand these concepts, but few can articulate them clearly in writing. This phenomenon is particularly evident in the cryptocurrency space due to the lack of valuation frameworks. People invest in this industry to seek out potentially groundbreaking projects; as long as a project shows the potential to change the world or shift paradigms, it typically garners more attention, capital, and resources, even if these projects may not yet be validated.

He cited the example of Data Availability (DA) and mentioned the launch of Celestia. Celestia's price in the public market once approached a tenfold increase, although it later retraced. Doubts are increasing about how much value the DA layer can accumulate in the long term and whether it will fall into zero-sum competition in terms of fees. Consequently, Celestia's valuation has also undergone adjustments. However, if one can deeply understand DA technology and believe it will play a central role in modular architecture, then early heavy investments in Celestia or other DA solutions make sense.

The host continued to discuss Celestia's price trends, mentioning that Celestia traded at $2 at one point, and when DA became the narrative, the price soared to $17 or $18, even exceeding $20. He believes this is a great example of how an asset may be undervalued for a period, but as the narrative drives it, the price can rise rapidly.

The Parasitic Nature of L2 on Ethereum

The host pointed out that before version 1.5, L2 paid certain fees to Ethereum, part of which came from users' MEV (Miner Extractable Value) and transaction fees. However, since the introduction of blobs, the fees L2 pays to Ethereum have decreased by 90% or even 98% or 99%. He illustrated this with the example of cloud service providers (like Amazon) lowering storage costs, arguing that although fees have decreased, the increase in demand can offset this decline.

He then posed a question: if L2's fees decrease by 98%, will this be compensated by increased demand for L2? He expressed uncertainty about whether this demand would be met. At the same time, he pointed out that L2 has the flexibility to choose when to submit data to Ethereum, thus "gaming" gas fees to some extent. Therefore, unless L2 can bring MEV into L1, he believes L2 has indeed exhibited parasitic behavior so far.

Arthur agreed with this view, stating that L2 is indeed parasitic to L1 at this moment, as all fees are declining. He noted that L2 is effectively capturing existing users and has not genuinely attracted new users to use L1 as an asset. Despite improvements in technology and increased scalability, this has not translated into greater demand for Ethereum as an asset. He believes that L2 can only avoid being seen as parasitic if it expands the market size.

Arthur further explained that many of the current fees for L2 come from priority fees and a small amount of MEV, so L2 has no reason to pass this feedback to L1. He emphasized that L2 needs to attract new users to maintain demand for Ethereum as collateral, thereby preserving Ethereum's position within the entire L2 ecosystem.

The host then inquired whether, with the development of wallet account abstraction and chain abstraction, the fuel assets for L2 would change, and whether other assets would be used as fuel.

Arthur believes this will not have a significant impact on Ethereum's position, as the current demand for Ethereum primarily stems from its attributes as a programmable currency, rather than fuel demand.

Arthur thinks that in the long run, this may not be a good phenomenon, as it is generally hoped to be closer to users to capture value. He pointed out that while Ethereum's brand remains strong in the short term, this distance may begin to have an impact over a five to ten-year timeframe.

The host added that many DNS and router companies experienced significant declines after going public in the early days. He compared the discussion of fuel fees to bandwidth, suggesting that while L2 can scale infinitely, it remains unclear whether this will increase Ethereum's value over time.

Arthur further pointed out that the success of Ethereum as a technology platform may not align with its value as an asset, which is a dangerous relationship. He emphasized that while Ethereum's brand remains strong in the short term, how to capture value will become increasingly important in future markets.

Revisiting Game Theory

Arthur's team wrote a comprehensive paper on games a few years ago, identifying three parameters or frameworks for evaluating excellent games: team background, product and distribution, and economic sustainability. Arthur stated that they revisited this framework and believe these traits remain key to the success of Web3 games. Recently, he has been playing "Black Desert" and mentioned that it is the first AAA game from China, which has provided him with many insights.

He pointed out that the over-financialization of many consumer products makes it difficult to distinguish whether a true product-market fit has been found. If a true market fit is not found but significant resources are invested, this can be very dangerous for entrepreneurs and teams. He believes that the initial success of many games often relies on incentive mechanisms, without any game being self-sustaining and demonstrating sustainability.

Arthur continued, stating that while they have seen some limited successes, these successes are not enough to excite crypto investors. For example, the daily active users of the Pixelmon game stabilize at 2 million, but compared to other Layer 1s, its valuation is not high. He believes that crypto investors generally hold a discounted attitude towards the gaming industry, and the current crypto gaming sector has not launched sufficiently large projects to change market perceptions.

He mentioned that over the past two years, the Web3 gaming industry has attracted significant capital, with at least $15 billion to $20 billion injected. Therefore, funding is no longer an excuse, and the next one to two years will be a critical period to test the results of these investments. If results cannot be demonstrated during this time, venture capital and investors may not inject further funds into the Web3 gaming industry.

The host also shared his perspective, mentioning that he recently played "Red Dead Redemption" and considers it a beautiful game. He emphasized that unless similar games can be developed, he will not participate in Web3 gaming. He pointed out that many Web3 gaming studios may not focus on the games themselves but rather on the data availability layer or packaging the same content in different ways.

He mentioned that in the future, time may be used as an excuse, suggesting that many excellent teams need years to build. Speaker 1 then joked that when applications are unsuccessful, they turn to infrastructure.

Arthur agreed with this view, mentioning that in the crypto space, more and more people seem to be building "applications that serve other developers," a trend that is also becoming increasingly common in game development.

The Future of DeFi and the Potential of Aave

The host mentioned a recent paper by Arthur's team about Aave. He began to think that DeFi primitives (like lending) should ultimately approach valuations in traditional finance. He asked Arthur for his thoughts on this and whether he could elaborate on their views regarding Aave.

Arthur responded that regarding the first part of valuation, since the DeFi industry is still small, valuation multiples do not need to converge, as DeFi still has much room for growth. For example, JPMorgan is already the largest bank in the world, and one cannot expect its scale to double without economic growth. However, DeFi still has many exponential growth potentials as long as other parts of the world remain unchanged. Therefore, he believes that DeFi's valuation multiples should not be the same as traditional finance, as it still has much growth potential.

He further pointed out that DeFi's scalability is far superior to other financial services. Compared to traditional finance and fintech, DeFi has very low marginal costs. For instance, as long as the market size expands and the number of users increases, Aave does not need to do much to achieve growth. In contrast, fintech often only provides a better front-end interface for traditional finance without fundamentally changing anything. Therefore, as the scale expands, fintech will still inherit the cost structure of traditional finance.

Arthur believes that DeFi will not face this issue because its marginal costs are low, and as long as the product is correct, it can scale quickly. He mentioned that the rapid growth of DeFi in 2021 was precisely due to this.

Regarding Aave's potential, Arthur expressed confidence in the future of DeFi. He believes that decentralized currencies (like Bitcoin and stablecoins) and finance-related use cases (like speculation and fundraising) have already found product-market fit in the market. For DeFi, he is very confident that it will continue to exist in the next five years, but he is concerned about whether it can grow tenfold in that time. He emphasized that what he focuses on when investing in DeFi is not whether it will exist, but whether it can surpass its current level.

Arthur also mentioned that DeFi is experiencing a classic Gartner hype cycle, with 2025 being the peak of excitement, followed by hacker events and various issues. He believes that DeFi is currently emerging from a valley of despair and may gradually enter an enlightenment phase in the coming years, where everyone will return to basics and acknowledge that blockchain remains the best choice for financial use cases.

He concluded that finance is currently the largest use case in the crypto space, and while other use cases are interesting, they are far smaller in scale than finance. He anticipates that when people realize this, certain leaders in the DeFi space will be repriced.

Finally, Arthur pointed out that many infrastructure projects are valued at $10 billion or $20 billion, while Aave's valuation is only $1.5 billion. As one of the most important primitives in this field, he believes Aave has significant room for valuation improvement.

Challenges and Opportunities in DeFi

The host mentioned that Arthur has been observing DeFi for six or seven years. He asked what changes have occurred during this time that keep Arthur optimistic about the industry and confident that it will continue to exist and grow.

Arthur responded that, first, more and more wealth is being stored on-chain in the form of digital assets, such as Bitcoin, Ethereum, and stablecoins, creating a need for financial services to manage these assets. He stated that if DeFi's product-market fit were not high and did not accelerate, he might hold a pessimistic view. However, as long as the total amount of on-chain assets continues to increase, he remains optimistic about DeFi's growth, as the two are correlated.

The host further inquired whether there have been any internal changes within DeFi, such as changes in fundamental primitives or improvements in user experience, aside from the external factors mentioned.

Arthur believes that over the past two years, security practices and methods to prevent vulnerabilities have improved, as everyone has become aware of the seriousness of the issue. He mentioned a recent cybersecurity company called Hyper Native that raised significant funds aimed at conducting technical assessments before vulnerabilities occur. He believes that security will improve in the coming years, and the user interface and user experience of on-chain interactions will become more user-friendly, similar to Web2's secure login methods (like email and password). He thinks the technology has matured and will gain widespread adoption in the future.

Arthur also noted that those who have experienced the past two years know which practices are unsustainable, so he believes there will not be a repeat of those mistakes in the short term. He does not think that similar unsustainable policies will re-emerge in the market.

The host, however, presented a contrary view, arguing that unsustainable phenomena still exist. He mentioned the case of the Pump Fund, pointing out that out of the 2 million tokens launched, only about 92 tokens have a market cap exceeding $1 million. He believes that some older individuals in the crypto space may not be aware of this.

Arthur agreed that the Pump Fund is indeed a bubble, rather than a simple Ponzi scheme. He believes that participants in Ponzi projects are usually aware that they might lose 99% of the time. He pointed out that the problem with DeFi is that many projects make false promises, such as Luna being marketed as sustainable when it was not.

Arthur emphasized that while participants in the Pump Fund know what they are doing, many projects in DeFi make unrealistic promises. He believes that although the Pump Fund may be a value extraction project, its operation is transparent.

Regarding Friend.tech, Arthur stated that the project could grow larger, but its structure is still not decentralized enough at the moment. Speaker 3 added that the success of Friend.tech relies on the participation of certain large funds, but since key control has not been returned to the community, its level of decentralization is questioned.

In conclusion, Arthur believes that the future of DeFi is still full of opportunities. Despite facing challenges, DeFi will continue to develop with technological advancements and market maturation.

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