Dialogue with Qianfeng Capital Steven: How the Big Winners in DeFi Are Made

Author: Wang Dashu.

Qianfeng Capital is a rapidly developing crypto VC fund this year, creating an investment matrix for early-stage and growth-stage equity investments as well as Alpha Strategy and Beta Strategy for crypto digital assets. Recently, it has attracted significant attention with several high-quality research reports.

Steven, co-founder of Qianfeng Capital responsible for Alpha Strategy, stated that he is an early believer and long-term supporter of Ethereum. His long-term focus and investment in Ethereum have allowed him to perceive the potential value of some DeFi projects in advance and make early arrangements, achieving multiple returns on various tokens such as LINK and AAVE. This time, Chain Catcher had an in-depth conversation with Steven, during which he reviewed the entire investment process in DeFi and shared his views on industry cycles, hotspots, and trends for next year.

1. Reviewing the DeFi Investment Journey

Chain Catcher: A16z summarized 12 key questions in the cryptocurrency investment field, one of which states that investment needs to fund innovation at every layer of the tech stack and every stage of development. How does Qianfeng define the tech stack of its investment areas?

Steven: We primarily consider issues from a fundamental perspective. I personally categorize the tech development stack of ETH. For example, the earliest ETH was a token supported by miners through simple consensus, which meant it had value for a period, marking the first stage of tech development; next, ETH opened the ICO platform, leading to simple smart contract interactions, but not real commercial applications, marking the second stage of tech development; after that, the development of DeFi represents the third stage of tech development, where smart contracts have more complex operational processes and commercial landing logic.

I believe that after these three stages, what everyone really needs to consider is improving user experience and technological innovation, so the next technological advancement should be ETH2.0 achieving 10,000 TPS efficiency, which can truly realize project landing. At that time, it will be even more necessary to view the development of this market with traditional internet thinking.

Chain Catcher: DeFi can be said to be the hot spot before the institutional bull market. I heard that your layout in DeFi has brought significant profits to the team. Could you review the logic and process behind your layout in the DeFi track?

Steven: Qianfeng truly began to engage in DeFi layout in the second half of 2019. At that time, we observed that the number of transactions, wallet addresses, and developers on Ethereum were continuously expanding. These developers had previously started their ventures on EOS but later realized that EOS was not very friendly and had a poor experience, choosing to return to Ethereum.

At that time, Ethereum's price was very low, fluctuating between $100 and $200. We believed that Ethereum's valuation should not be at such a level, so we began to layout Ethereum. The layout was quite broad, covering not only DeFi but also traceability and cloud storage.

In March of this year, we observed that the trading volume of DeFi products we invested in 2019, such as Kyber and Loopring, began to grow weekly, maintaining a growth rate of about 50%. This data made us feel that the entire decentralized exchange might undergo a transformation, so in the first half of 2020, we decided to increase our investment. Initially, we focused on exchanges like Kyber that were starting to see increased trading volume, and later on AAVE, as it transitioned from the original order book model to a liquidity pool model, successfully reforming its approach.

Overall, the logic is quite simple, the micro perspective is whether the project is doing things, while the macro perspective still returns to value investment. Value investment requires us to continuously observe the data of a certain public chain and remain sensitive to the moving projects above, so we can make early layouts.

Starting from this logic, I gradually looked into stablecoins, oracles, and so on. Oracles are actually quite interesting; one point that people may not be aware of is that before 2020, the largest oracle provider was MakerDao, which was the biggest player at that time with only 5 or 6 nodes globally. Although we knew it was a particularly centralized solution, we understood that it would not do harm.

However, when I went to Hangzhou for a meeting in January this year and encountered the CEO of Chainlink giving a speech, I discovered that they had already hired over 70 nodes and some exchange projects were using their products. We began to realize the importance of the oracle track, and when looking at the entire track, only Chainlink could be compared with MakerDao. MakerDao is a particularly centralized solution, and its business focus is not on this. In contrast, Chainlink has particularly good imagination. At that time, LINK was priced at $2-3, and we began to layout. When it rose to $18, just before peaking, we exited.

The reason for choosing this exit point is that it should not have such a high value. The market was very strange; although it had a lot of imagination, it was just a service provider, and its value had already surpassed the overall value of all the B-end users being served, which is an impossible phenomenon. Like China's Wind Information, its value adds up to more than 70% of the value of financial institutions, which is an unhealthy state, but that's a topic for another time.

Through this process, we invested in projects like AAVE, Kyber, and Chainlink.

In fact, another project, 0X, started in 2017, but when we researched their annual report this year, we found that their team was particularly low-key, having never raised funds, purely working on Ethereum layer two scaling and applying this solution to their own exchange, creating a decentralized exchange. As you can see, ZRX's trading volume can now rank in the top three, and its value should be underestimated up to now, so we basically choose these projects based on this logic.

My investment logic is very simple; it’s not as complicated as everyone thinks. I have been a firm supporter of Ethereum since 2017. Because of my strong support for Ethereum, I missed out on the 2018 EOS entrepreneurial boom, leading to many projects I didn't invest in. Looking back now, it's hard to say that this choice wasn't worth it, because for me, there was no way to have faith in EOS.

Chain Catcher: The foundation lies in underlying cognition. I'm curious about how you value these DeFi projects and what standards you refer to for specific decisions?

Steven: Valuing DeFi is relatively easy. First, these products have definite cash flow, which can be calculated using traditional PE and PS economic models. For example, we can clearly see that the annualized yield of DeFi is about 300 million, which allows us to calculate its annual inflation rate and correspondingly derive its valuation.

If we focus on a single token, we mainly look at the fundamentals, which cover four main points.

First, can the team’s integrity be sustained? For example, a once-famous project like AE has a concerning issue where their founding team has repeatedly changed, which is a particularly bad signal. If the integrity of the founder cannot be sustained, then internal problems are likely to arise.

Second, can the development capability be sustained? We look at whether community developers are continuously working and whether they are following the previous roadmap.

Third, can community enthusiasm be sustained? We observe the level of community discussion, whether the fan growth curve is healthy, and whether the content being discussed is focused on the token price. If the price drops and the team is blamed, it indicates an unhealthy situation.

Fourth, can financing be sustained? The most intuitive example is that established projects like Maker, AAVE, and Compound still receive funding from large institutions this year. Just the resources from these institutions can prevent the project from being limited in the future. These are considerations based on sustainability. Of course, we also use our more objective FCCS quantitative standards and Alpha rating methods.

Chain Catcher: AAVE, as an annual DeFi project, is actually one of the earliest lending protocols. Now, due to the rising token price, it has re-entered the investor's perspective. I noticed that you have included it in your investment portfolio. Can you share how you discover valuable old projects?

Steven: It's quite complex. We conducted research reports on Salt and ETH-lend, two contemporaneous projects, back in 2017. Although the latter had its clever aspects, Salt had a better user experience, so we positioned ourselves in Salt. It wasn't until the second half of 2019 that DeFi began to show signs of life, and ETH-lend quietly reformed, transitioning from the original order book model to a liquidity pool lending model, greatly liberating the original liquidity and allowing for some capital accumulation on the platform.

At the same time, when we experienced the product, we noticed that its overall interface and user experience had changed significantly, including the name changing from the low-key ETH-lend to the more vibrant AAVE (Ghost), and the introduction of innovative mechanisms like flash loans, doing a series of imaginative things.

After refocusing on it, we saw that the lending balance began to slowly exceed similar products, likely leading to a Matthew effect, so we began to gradually reduce our positions, ultimately achieving relatively high returns. Overall, it was a process of moving from denial to attention, and then gradually liking it.

But in retrospect, I feel that investment must embrace change. For example, when seeing innovation, we must also see if the innovation meets user needs. If all conditions are met, we then look at whether users are willing to pay for it and whether there is a possibility of forming a Matthew effect. If the prediction is yes, then we gradually place our bets.

Chain Catcher: Compared to your DeFi investment portfolio, you only have KSM in your Polkadot ecosystem investment portfolio. I'm curious why you chose only this among so many projects in the Polkadot ecosystem?

Steven: Although Gavin also came from Ethereum, Polkadot itself is cross-chain, so we first need to look at the necessity of cross-chain. Currently, the largest project in cross-chain is WBTC. Secondly, we compare the number and quality of developers in the Polkadot ecosystem against Ethereum, and it is clear that Ethereum holds a monopoly position. For other platforms to develop in the face of such a platform, they must possess higher characteristics, which Polkadot has not yet proven.

Moreover, Polkadot has been online for so long; are there any truly strategic projects? Many A-grade projects encountering the hype of Polkadot will even give valuations of 100 million or higher, which I find particularly hard to understand. Therefore, we remain cautious towards its ecosystem projects.

My intuition always feels that Polkadot's state is very similar to that of EOS at that time. Many investors who participated in EOS ended up in a dismal situation, so everyone is still cautious to avoid entering the second EOS.

Chain Catcher: You have invested in many projects in the past. What commonalities do you see among the failed projects?

Steven: To put it simply, the commonality is that some teams have good fundamental data but are too obsessed with building fundamentals and rarely engage in marketing, which ultimately leads to the market not pricing them highly. This naturally puts investors in a passive position. I believe that investing in the blockchain industry cannot be too idealistic, and we cannot blindly adhere to value investment, especially from 2018 to 2019, when many people were harmed by this mindset.

2. Transitioning to an Institution-Dominated Market

Chain Catcher: Investment is inseparable from personal knowledge systems and cycles. What cycle do you think the current blockchain industry is in?

Steven: It is transitioning from the primitive era to a stage similar to the traditional A-share market. On one hand, we see this year's data showing that the people who can make money are mostly institutions, while retail investors are mostly losing money, which is a common phenomenon in the stock market. For example, unicorns like Uniswap are difficult for ordinary investors to reach without relying on professional institutions. On the other hand, the bull-bear conversion in the entire crypto circle is faster than in other industries, and the opportunities for speculation are becoming fewer compared to earlier times; it is almost impossible to invest in thousand-fold or ten-thousand-fold coins again.

Chain Catcher: In the past, the industry generally believed that primary market investments were more certain than secondary market investments and that it was easier to obtain low-priced chips. How does Qianfeng view this perspective as a mixed crypto investment fund linking primary and secondary markets?

Steven: Good question, but the reality is quite the opposite. The secondary market is more certain than the primary market. The reason is that most primary market projects in the blockchain industry do not have clear business models; they cannot generate cash flow for a long time. Once you invest and encounter uncertainties like a lack of enthusiasm in the track or issues with the founder, you cannot value it, let alone transfer equity. However, secondary market investments are different; even if risk control is poor, as long as you are slightly sensitive to information, you can cut losses in time and withdraw the remaining value.

Chain Catcher: Ethereum 2.0 is currently the most discussed topic in the industry. Many opinions suggest that the transition from POW to POS will generate various variables, especially given Ethereum's large scale, which could cause significant shocks to the industry if not handled carefully. You have been following Ethereum since 2017; could you analyze the potential risks involved?

Steven: To be honest, I didn't expect the deposit contract lock-up amount for ETH2.0 to be so high. But no matter how high it is, assets staked in will take at least 1-2 years to release. With such a long cycle, if we cannot ensure what the returns will be, the risk is still very high, as time is crucial for investors. As Zhang Lei from Hillhouse Capital said, what deepens the moat over time is "assets," while what becomes more detrimental to business over time is "costs." Many secrets are hidden in time, and time will nurture everything.

Of course, for ordinary investors, there is no real risk. If I had to say, I think the only risk might be missing out. Recently, many people believe that ETH has risen many times this year, and the future growth potential may be lower than BTC. However, I think this is a low-probability event. From both a technical perspective and the development trend of Layer 2, ETH is looking positive. But for developers, the risks might be higher because they must make choices about the technical framework. If they are somewhat confused, they can wait to see the upcoming phased results before making a choice.

Chain Catcher: After being in the industry for so long, are there still things or phenomena you cannot understand?

Steven: Perhaps it was around August and September when YFI/YFII/YFII drove annualized returns of over ten thousand. At that time, many friends around us went all-in on this farming, some even with technical backgrounds, which was really magical.

In fact, whether it's called a liquidity pool or a yield pool, they are all built on top of the underlying projects like MakerDao, AAVE, and Compound, whose yields only range from 3-15%. So no matter how much leverage is used, it cannot achieve thousand-fold or ten-thousand-fold returns. The reason it reached such levels is entirely because the top-level building blocks are sucking the blood from the foundational level, and it can even be said to be a purely illusory phenomenon, similar to the ICO boom back then, which I cannot comprehend.

Chain Catcher: One last question, as the year-end approaches, everyone is making predictions. What do you think the trends will be next year?

Steven: I believe the first trend will be Ethereum's Layer 2, which includes two directions: Optimistic rollups and ZkRollups. If interested, one can make some medium to long-term bets; the second is the potential and development of DEX in the derivatives market. There are now a large number of futures DEXs on roadshows and fundraising; the third is anonymous coins. Regardless of the market cycle, anonymous coins are a necessity and are likely to have independent market trends, so everyone can look into the anonymous coin track and research the coins they like.