Dialogue with Pantera Partner Paul Veradittakit: Investment Opportunities in a Bear Market

Source: Wu Says Real

Pantera is one of the largest and oldest VCs in the blockchain industry, with a current fund size of $5 billion, and it is also an important investor in Terra. In this conversation, we discussed the macroeconomic situation, investment opportunities in a bear market, Meta's new public chain, and the reasons behind the collapses of 3AC, Babel, and Terra with Pantera partner Paul Veradittakit and SynFutures founder Rachel, where some insightful discussions took place.

Colin: What do you think about the recent market trends?

Paul: The bull market in 2017 was primarily driven by retail funds under the ICO model. In contrast, the bull market in 2021 was mainly led by institutional investors, with more and more institutional capital entering the space, including pension funds. The decline in the market is fundamentally due to profit-taking outflows, and we are experiencing a downturn cycle that we have never encountered in the context of an economic recession. The current market is closely linked to the Federal Reserve's policies and the global macroeconomic situation, but I believe that most of the bearish expectations have been fully priced in. The market's turning point may not necessarily have to wait for the Bitcoin halving, as that is still a bit far off.

The Ethereum merge might become this turning point, decoupling the crypto market from the global macro situation. After the panic selling drove Ethereum down to a bottom of $800, many of us genuinely felt that we might have hit the bottom. The merge and some other factors could drive the market up, although volatility in the process is inevitable.

Rachel: My career began with macro research. I agree with Paul that many price actions are closely related to the Federal Reserve's decisions. Currently, the nominal neutral interest rate in the U.S. is close to the target set by the Fed in June, and falling oil prices are alleviating inflationary pressures, while there are also concerns about recession. I believe the U.S. balance sheet is very different from what it was ten years ago and cannot withstand such prolonged high interest rates. On the positive side, it seems that the worst is behind us, and Web2 institutions and those looking to enter the space are increasing, so the crypto industry may have the opportunity to recover earlier than the general market.

Colin: Do you think the Ethereum merge will successfully occur, and what impact will it have?

Paul: I believe it can proceed on time, and even if there are delays, it will happen shortly after September. Most of the time, developers only provide a vague timeframe; they don't like to commit to a specific date. However, I think this time we might see a relatively certain date on the horizon. The Ethereum merge is very important as it will allow more people to participate while also reducing supply, as people will want to stake to earn rewards. The Ethereum post-merge will attract more developers and consumer users, further driving ecological prosperity.

Colin: Do you think miner-supported ETC or ETHW will succeed?

Rachel: As long as there are miners, exchanges, users, etc., supporting it, a successful fork can happen, which is the beauty of open blockchains. However, I do have some doubts about whether it will grow into a very successful public chain. The fork of BTC, BCH, was not an easy task even with so much support at that time. Today, the support for Ethereum forks is much less than that for Bitcoin forks. Additionally, unlike Bitcoin, Ethereum has a large ecosystem that includes DeFi, NFTs, and gaming. How do you convince all the builders in the ecosystem to shift in that direction? I have many questions about this.

Colin: Currently, VCs seem to be cautious about investments, even though many funds have completed large fundraising rounds. What do you think?

Paul: There are more funds raised now than ever before. Most of these funds will still target seed rounds and Series A. Even in this bear market, we see many serial entrepreneurs and many Web2 entrepreneurs joining. Many are trying to enter early seed rounds, which I would say are between $1 million and $5 million, and there is room for growth for companies financing around this scale and valuation.

As the market stabilizes, we will begin to see more Series A and B deals. What is Pantera doing? We are currently very focused on seed rounds, usually around areas like DeFi and infrastructure. In the last bear market, we were the second-largest investor in Polkadot.

We are very interested in DeFi. As the industry matures with the growth of market size, we may start to conduct more research at the application layer. As this field becomes increasingly globalized, we will start to see many types of companies that have already succeeded and established infrastructure in the U.S. appearing abroad.

Therefore, I believe there is still room for innovation in custody and trading in both CeFi and DeFi, perhaps in KYC and REGTECH (regulatory technology). There will likely be increasing demand for more information, perhaps more customer data. So I think we need to prepare for a regulated world, or we are starting to see more institutional investors entering this space. They will need more data to make decisions. There is a lot of data on-chain and off-chain, so they can be combined and possibly linked to credit and similar things.

I believe fragmented data blocks will become increasingly important, and of course, I think many different markets will be disrupted by blockchain. Many things seen in the U.S. also exist in Asia/Southeast Asia. We are also interested in consumer-facing products; we recently invested in a company called Optic, which is similar to Chainalysis in the NFT space. If NFTs are to grow, they will definitely have trading markets and derivatives markets, and at that point, users need to be able to distinguish the authenticity of the NFTs they hold. This type of infrastructure tool can truly help projects move forward. By the way, there is also the insurance sector. Insurance will become another huge market.

Colin: What do you think about the currently popular Meta public chains (like Aptos and Sui)?

Paul: They may be incorporating some technologies, especially around sensitive data and financial data. The developers I have interacted with seem a bit excited about using Move compared to Rust or Solidity. Therefore, there may be some progress there. We have not started to engage yet; it will be a tough battle, and we want to wait and see how the ecosystem develops.

At this stage, it is actually difficult for new public chains to gain market attention, but the Meta public chains do have two characteristics: they have stronger privacy, especially for projects involving sensitive data/financial data, which is a significant plus; secondly, their development language Move. I have asked some developers about their experience with this language, and most expressed that it is relatively more surprising than Rust/Solidity. Although I believe the market has entered the tail end of the new public chain phase, I still think they have some potential, even though competition is tough. Pantera currently has no risk exposure to them because, given this tail end phase of new public chains, we tend to wait and see how the ecosystem develops. If the data shows that the ecosystem is attractive and the timing is right, we will definitely seize the opportunity.

Rachel: We are also very focused on this. From a builder's perspective, entering a new ecosystem requires a lot of resources and time costs, and we need to observe whether the network ecosystem can attract users. Therefore, to attract builders, there must be significant appeal, either in terms of the user base of the ecosystem or substantial incentives. Currently, L1 is very hot, with the Ethereum ecosystem thriving and far ahead of other L1s. Moreover, the design of public chains essentially involves trade-offs regarding the impossible triangle, requiring significant breakthroughs in technology; otherwise, a lot of effort must be put in to achieve new adoption.

Colin: Pantera is an investor in Terra and sold 80% of its holdings before the LUNA collapse. Can you elaborate on that?

Paul: Initially, we bet on the team and what they had done around payments in the past. Later, they shifted their focus more towards DeFi, including Anchor, etc. Luck can also affect any investment here. For us, we did not foresee the subsequent developments of Terra. This is one of those things that none of us could predict. It is clearly a lesson for all of us. There are also Celsius and 3AC; from deeper due diligence to risk control to transparency, this is why DeFi is really cool compared to some things that happened in the past. However, in the end, we will all progress together as an ecosystem.

We know 3AC, but there was no business intersection; not because we thought they weren't smart, but because there was never anything that really fit for us to collaborate on. Their risk exposure exceeded their capacity to bear. From what I have seen publicly, it is very unfortunate, especially for some clients.

Colin: Are the reasons for 3AC's failure similar to those of Babel Finance? During the 2020 March 12 incident, the lending industry also faced a huge crisis. Why is Babel Finance collapsing again now?

Rachel: From our understanding, 3AC invested in GBTC and UST, and then also took on a lot of leverage, leading to liquidations when the market dropped significantly. This is similar to Babel Finance and other companies.

If you ask me my opinion on this and why Babel collapsed again, you can always attribute it to their overly optimistic view of the bull market, as well as the recklessness and lack of risk management that has been talked about in the industry. But the fact is, this is part of human nature, the greedy side of human nature, amplified by asymmetric incentive structures.

This exists not only in the crypto industry. During the financial crisis of 2008 with the collapse of Lehman Brothers, people had already begun discussing the incentive structures of these practitioners. If you take on a lot of risks, you might have the chance to win huge bonuses. But if you fail, the punishment in most cases is just losing the rewards or your current job, and you might quickly start another career. This is the asymmetric incentive structure. Babel Finance failed once but was able to restart quickly. After the lessons from Basis Cash, there was Terra, and people got used to the idea that especially in the emerging crypto industry, failure is okay, especially for those who have nothing to lose; you can immediately start over.

However, once you take on more risks, you can easily gain a lot of fame, wealth, or even everything. Therefore, the intrinsic incentive structure ultimately leads everyone to take on more risks. I believe in DeFi and the DeFi space. But if you ask what to do about this issue, I would say that pure DeFi itself is not the ultimate solution. The transparency and credibility of DeFi can bring many good things to the industry, but it is just a means to an end, not the end itself.

To address these types of incentive structures, you really need to rely on some kind of anti-human norms. This is not just about government regulations, but also includes self-regulation within the industry itself. For example, similar to the requirements in traditional finance to set aside a certain amount of funds as risk reserves, there are some limitations on what you can do and how to protect users. So I would say that as the industry develops, certain types of regulation, whether authoritative regulation or self-regulation within the industry, will emerge, and the transparency of DeFi and other similar blockchain technologies will help ensure that regulation is in place, moving towards a broader direction and showcasing a healthier financial system.

Rachel: I have a question for Paul. I am also curious about how you made the decision to exit your Terra position.

Paul: First, it was just about risk management of funds. I think when you see a position rise to such a high level, and the price has exceeded the fundamental value, you will assess whether the corresponding position size makes sense, and then understand its concentration in the overall portfolio, ultimately deciding to reduce some risk exposure. However, this process is not like an exact science; it is more akin to an art.

Rachel: In the ups and downs of the market over the years, what advice do you have for projects and builders under these market conditions?

Paul: I believe that now, during the bear market, is indeed the best time for building. Your employees will no longer be excited about making big money from trading or speculation; everyone is focused on building, working hard to adapt products to the market, or striving to achieve profitability fundamentally. This means that the focus on B2B may be greater than on B2C, and then genuinely trying to find other ways to build exposure. Build the team and project foundation, especially around products that will support the next bull market. If you are an exchange, make sure you can support the next wave of use cases that are likely to emerge during the next bull market, and ensure that customer support and all these things meet the standards.