Dialogue with DeFi Trendsetter ParaFi Capital: The "Barbarians" Who Entered the Crypto World from KKR

Source: ChainNews
Author: Xiao Mao Ge

On March 12, The Wall Street Journal published a report revealing that Benjamin Forman, an investor who transitioned from the renowned traditional private equity giant KKR to the cryptocurrency world, made his first investment in the blockchain field: his cryptocurrency investment fund ParaFi Capital, along with Bain Capital and another crypto venture capital firm Uncorrelated Ventures, invested in the decentralized lending protocol MakerDAO last year.
The report stated that these three investment firms spent $7 million to acquire Maker tokens from the MakerDAO Foundation in the second half of last year, with an average purchase price of around $400 to $450 per Maker token.

This investment news was only made public months after the token acquisition was completed, but the timing of the announcement was somewhat awkward.

March 12, 2020, is a "Black Swan Day" in the cryptocurrency world. On this day, various global assets suffered severe shrinkage, and the cryptocurrency market was no exception, with Bitcoin experiencing a maximum drop of 50% and Ethereum also facing turmoil. Various DeFi platforms on Ethereum were forced to liquidate a large amount of pledged assets due to price plummets, and due to network congestion and oracle failures, the leading DeFi protocol MakerDAO incurred over $4 million in bad debt on that day ------ for a protocol that relies on collateralized assets for lending, this was a significant loss, necessitating the first-ever auction of MKR tokens to restructure capital to repay these under-collateralized bad debts. The price of Maker tokens once dropped to around $210.

Despite the fact that the price of Maker tokens was only half of its investment price at that time, Benjamin Forman was not worried about this investment. ChainNews contacted Benjamin Forman at that time to ask how he faced such a "paper loss." He told ChainNews: "We should look at this event this way: the resilience of the decentralized finance (DeFi) sector and the MakerDAO community during this market crash actually encouraged me a lot. They quickly improved the collateral auction mechanism and introduced USDC as a collateral asset. I think MakerDAO has done a good job in enhancing its ability to withstand further market deterioration."

At that moment of market panic, the founder of ParaFi Capital revealed to ChainNews that, in addition to investing in Maker, he had also invested in DeFi projects such as Kyber Network, Aave, Nexus Mutual, and Keep Network.

Five months later, the panic of "312 Black Swan Day" had long become a thing of the past, and decentralized finance had become a thriving new mainstream in the cryptocurrency field, with more and more DeFi projects being recognized by the market. If using capital return as a measure for investment projects, the portfolio disclosed by ParaFi Capital to ChainNews at that time showed that the DeFi lending protocol Aave and the DeFi liquidity protocol Kyber Network achieved astonishing returns of 3000% and 700%, respectively, since the beginning of the year.

Clearly, ParaFi Capital is a smart institutional investor that strategically positioned itself in the DeFi sector and gained an early advantage. Aave's founder and CEO Stani Kulechov once revealed, "ParaFi Capital is one of the earliest and largest institutional investors in Aave's native token LEND." AAVE has been one of the fastest-growing DeFi projects this year.

Founded in 2018 and headquartered in San Francisco, ParaFi Capital is a venture capital firm focused on the blockchain and decentralized finance markets. Notably, the founder of the firm, Benjamin Forman, comes from private equity giant KKR and is a former employee of KKR.

Public information shows that ParaFi Capital managed about $25 million in assets by the end of 2019 ------ in the cryptocurrency investment field, this asset size is considered medium. However, we can boldly speculate that the success of investment projects in the DeFi sector from the end of 2019 to the present has brought ParaFi an enviable growth rate.

I. Unveiling ParaFi's Investment Landscape

From the available information, ParaFi is quite mysterious, as it has neither published its investment data on its website nor has its Twitter account much activity. Based on public information and multiple confirmations, ChainNews has outlined ParaFi's investment landscape over the past two years:

From the current investment portfolio, it can be seen that ParaFi Capital has mostly invested in leading projects or infrastructure in the DeFi sector, with DeFi being the primary investment theme for the fund. In addition, ParaFi has also invested in the blockchain data indexing project The Graph and the cryptocurrency exchange Coinbase.

In the DeFi sector, the specific projects the firm has participated in include:

• DeFi lending protocol Aave
• DeFi liquidity protocol Kyber Network
• Synthetic asset protocol Synthetix
• Stablecoin project MakerDAO
• Decentralized lending protocol Compound
• Decentralized lending project Teller
• Ethereum mutual insurance protocol Nexus Mutual
• Privacy cross-chain protocol Keep Network

It can be observed that the projects already invested by ParaFi, such as MakerDAO, Compound, Kyber Network, and Aave, are all top projects in various sub-sectors of DeFi, covering foundational infrastructures such as lending, stablecoins, and finance.

Notably, ParaFi Capital recently announced its participation in the $1 million seed round financing of the decentralized lending project Teller, which was incubated by a16z's crypto startup school, and this project has not yet issued tokens. The Teller Protocol is a protocol that allows developers to create unsecured lending markets on the Ethereum blockchain, which can interoperate with centralized data providers and credit institutions to assess consumer credit risk, integrating data from traditional credit scoring systems (such as Equifax) into the decentralized lending market, thus connecting traditional finance with the DeFi world.

ParaFi Capital stated that its investment in the decentralized liquidity aggregation protocol Kyber Network was made through a non-public direct purchase of the project's native token KNC.

II. Backed by Traditional Capital Giants

What makes ParaFi Capital noteworthy is its background in traditional finance.

The core team of the firm consists of three members: founder Benjamin Forman, partner Santiago Roel Santos, and director Kevin Yedid-Botton. Benjamin Forman previously worked in credit at the private equity giant KKR and served as the head of the cryptocurrency and blockchain research department; Santiago Roel Santos previously worked at J.P. Morgan and served as the director of research and business growth at the biotech company Elysium Health; Kevin Yedid-Botton previously founded the Silicon Valley startup Tenzar Technologies.

While working at KKR, Benjamin Forman primarily focused on credit business, and after leaving in 2018, he founded ParaFi and secured investment from KKR co-founder and American billionaire Henry Kravis. This was Henry Kravis's first investment in a crypto venture capital firm, and he is one of the co-founders of KKR, a traditional private equity giant ------ the "K" in the name "KKR" comes from the initial of his surname.

"KKR" stands for Kohlberg Kravis Roberts & Co. L.P., which is regarded as a "veteran leveraged buyout king" in traditional finance and is one of the most successful industrial investment institutions in modern financial history, as well as one of the oldest and most experienced private equity investment firms globally, currently managing assets of approximately $98 billion.

American billionaire Henry Kravis

In addition to KKR, Bain Capital and the blockchain investment fund Dragonfly Capital Partners, founded by Bo Feng, are also among ParaFi Capital's investors.

This is an institution with deep ties to the traditional finance sector. Benjamin Forman previously conducted cryptocurrency research at KKR, but he expressed skepticism about the private equity firm's ability to invest in blockchain due to the lack of an optimal environment for such investments. He also stated his ambition in an interview, "I don't want to seek crypto investments within KKR; I want to build the KKR of crypto investments."

As Benjamin Forman mentioned, traditional capital giants may be unable to engage in cryptocurrency investments due to internal environment, policy risk avoidance, and other factors. However, by supporting new crypto investment firms independent of traditional capital, firms like KKR can also reap the benefits of crypto investments, potentially providing a good example for traditional capital investment institutions to enter the crypto investment field.

Another thought that ParaFi brings us is that, as ParaFi focuses on the DeFi sector, it not only brings value investments from successful DeFi projects to the traditional capital represented by KKR but also the high yields associated with DeFi funds may attract more traditional off-market capital in the future.

III. Shift in Investment Model: Deep Involvement in DeFi Project Governance

Unlike traditional investments, in addition to direct investments, ParaFi Capital has stated that it will actively participate in the governance of DeFi projects. Since most DeFi project tokens are governance tokens, this is, in a sense, an adaptation of capital to the inherently "decentralized" nature of DeFi projects.

Taking Kyber Network as an example, ParaFi Capital stated that it is collaborating with the Kyber team to develop the much-anticipated Katalyst version and will negotiate and actively participate in the governance of KyberDAO, including voting on network parameters. With the development of on-chain governance and DAOs in the DeFi sector, this has become a new paradigm for continuous investment and co-development between capital and DeFi projects.

Benjamin Forman stated in an interview: "We believe that investing in cryptocurrencies, especially in DeFi, requires taking proactive actions, which means being able to help portfolio projects as early as possible."

IV. Reaping Long-Term Dividends from DeFi Projects

With the development and improvement of DeFi and staking models, compared to traditional investment projects' equity or tokens, most DeFi projects are beginning to offer investors governance rights on the platform and more long-term development dividends, such as transaction fee dividends, staking rewards, and other passive income. ParaFi Capital stated, "We choose to invest in blockchain projects that have product-market fit and attractive token economic models."

The economic model of DeFi tokens is very important for ParaFi's investment considerations; they believe that good token value capture will provide different "moats" behind the protocols.

At the same time, due to the transparency and openness of DeFi projects, both institutional and retail investors will participate in liquidity mining or staking models under the same public mechanism. Taking Kyber Network as an example, ParaFi Capital can not only participate in project governance through KNC tokens but also earn ETH in the form of transaction platform fee dividends by staking KNC tokens. Under this model, better token value capture can further incentivize investment institutions to make long-term investments.

V. Hear What ParaFi Has to Say

ChainNews previously wrote in a report titled "What Areas Do Asia's Top Blockchain VCs Focus On? Definitely Not DeFi" in February of this year: "We found that these top blockchain institutions in Asia are also relatively cautious about investing in the DeFi concept, as they still lock most of their capital in entry-level products and exchanges with very clear profit models, as well as the underlying blockchain technology itself."

Compared to ParaFi, which focuses on DeFi investments, we might learn some lessons from ParaFi's experiences and perspectives. Why has ParaFi already positioned itself and continued to invest in the DeFi sector? What are their plans for the future?

We spoke with Benjamin Forman, founder and CEO of ParaFi Capital, about the firm's investment philosophy:

ChainNews: We noticed that ParaFi Capital announced earlier that it invested in Kyber Network and will participate in the staking and governance of KyberDAO. What were the main reasons for investing in and purchasing Kyber Network?

Benjamin Forman: We are excited about Kyber Network's potential to become the liquidity protocol for all decentralized finance. The significant growth in key metrics such as trading volume has impressed us; in the past year, Kyber Network's monthly trading volume has tripled, exceeding $15 million just in March of this year. Kyber Network has also been integrated by numerous related projects, including 1inch, Trust Wallet, and Argent. Additionally, the project has designed and implemented a well-thought-out token economic model, and the Kyber team has done an excellent job executing the project's roadmap.

Recently, ParaFi has been closely collaborating with the Kyber team to develop the highly anticipated Katalyst version. We look forward to actively participating in KyberDAO governance, voting on network parameters, and collaborating with professional market makers to bring more trading volume to Kyber Network.

ChainNews: Some have suggested that DEXs (decentralized exchanges) are replacing CEXs (centralized exchanges). What kind of DEX do you see potential in?

Benjamin Forman: We see promise in both automated market makers (AMMs) and traditional order book models. Uniswap, Balancer, Curve, and other AMMs facilitate permissionless trading of almost all tokens and provide token holders with opportunities to earn passive income. AMMs also allow projects to guide the initial liquidity of their tokens without relying on decentralized exchanges for listing.

We are excited about the next generation of automated market makers because this model focuses on specific use cases and more efficient trading. For example, Curve has developed a more efficient stablecoin trading model through its optimized AMM curve model targeting low-volatility assets. Balancer and Uniswap v2 allow for more modular trading pairs and lower slippage, effectively improving trading efficiency.

In terms of order book models, we are also beginning to see the emergence of decentralized exchanges that combine new scaling solutions, including DeversiFi integrated with STARK and IDEX 2.0. As these protocols develop, these projects add more tools for larger market makers, and we hope to see greater trading volume entering the DEX space. ParaFi Capital is also pleased to be a part of the Chicago DeFi Alliance and to see some traditional large trading firms exploring the DEX space.

ChainNews: We understand that the ParaFi team has experience in traditional investment. What are your main focuses in the cryptocurrency investment space?

Benjamin Forman: Our focus is on the decentralized finance sector (DeFi), which represents the next wave of financial innovation and is rapidly moving toward the world. The benefits of an open and decentralized financial system will be hard to ignore. ParaFi invests in the infrastructure of financial markets on the blockchain, which offers tangible benefits compared to the existing financial system, such as decentralized money markets, stablecoins, insurance, and derivatives markets.

ChainNews: When do you think DeFi will truly impact traditional finance? If it has a real impact on financial institutions, what would that be?

Benjamin Forman: We have clearly seen explosive growth in DeFi in terms of total locked asset value, user numbers, and project counts. This growth has begun to validate some of DeFi's core advantages over traditional finance, including unrestricted global access, minimal counterparty risk, guaranteed privacy, lower transaction costs, and faster processing speeds.

At the same time, DeFi brings new financial raw data, such as flash loans and automated market-making mechanisms. Although still in its infancy, we believe DeFi has already begun to have a real impact on traditional finance.

Taking stablecoins as an example, to date, the supply of USDT and USDC has nearly doubled, and this huge demand can be attributed to the ease of use of stablecoins in transfers, reducing fees, custody, and accessing open markets. We have seen cryptocurrency traders continuously using stablecoin trading pairs amid market volatility, while the demand for easy-to-use digital dollars is growing.

Beyond trading, Circle has also reported an increase in the use of USDC as a payment medium across various businesses, and payment giant Visa has been exploring stablecoin applications. We have also seen Nexo using MakerDAO to achieve cheaper credit lines, while Figure Technologies is adopting blockchain technology in the lending space to save costs.

ChainNews: What important factors influence your investment decisions? For example, team background, marketing ability, or business model? What are the main factors for traditional VCs to invest in cryptocurrencies?

Benjamin Forman: We broadly focus on the product, team, market, and token (if applicable), hoping to invest in blockchain projects that have product-market fit and attractive token economic models.

We also pay close attention to the competitive landscape to understand the "moat" behind any protocol. We believe that investing in cryptocurrencies, especially in DeFi, requires taking proactive actions, which means being able to participate early and help ParaFi Capital's portfolio projects.