The crypto venture capital industry has become more selective thanks to the general market downturn and shaky confidence resulting from a slew of scandals and market disruptions, but investors at major companies are still writing checks in the space.

Amidst market volatility, decentralized finance, or DeFi, is an area that continues to gain traction both in the crypto VC world and throughout the community as new use cases, protocols, and projects emerge.

Anywhere from 20% to 50% of today’s crypto-related pitches are DeFi-focused, said several investors we surveyed. That shows that there are a large number of DeFi projects looking for funding.

“To stand out in this crowded space, founders need to focus on highlighting unique technology and a clear advantage for a specific use case, as well as a defensible moat,” said Alex Marinier, founder and general partner at New Form Capital.

Ultimately, DeFi is a reflection of traditional finance (TradFi), and founders who have deep industry expertise in TradFi, coupled with a fundamental understanding of blockchains, will stand out from the other teams, said Paul Veradittakit, general partner at Pantera Capital.

Last year, the crypto world experienced a handful of huge industry-changing events, such as the collapse of the Terra/LUNA ecosystem in May and the collapse of cryptocurrency exchange FTX in early November. Both events brought down many smaller startups and major players that mixed with the now-defunct market players.

As the market looks to the future, some venture capitalists are revamping their investment strategies, while others are sticking to their current plans, with perhaps a few tweaks. Read on to find out how active investors feel about DeFi, how they advise their portfolio companies when funding is lacking, how best to approach them, and more.

We examined:

• Michael Andersonco-founder, Framework companies
• Alex Marinerfounder and managing partner, New form Capital
• Samantha LewisFirst Name, Mercury
• Paul Veradittakitgeneral partner, Panther capital
• David Ganfounder and managing partner, ON crypto
• Mike Giampapageneral partner, Galaxy Ventures

Michael Anderson, Co-Founder, Framework Ventures

How big is the DeFi market today? How much do you expect it to grow over the next five years?

When we think about the DeFi market, we look at the total market cap of DeFi assets, total value locked (TVL), and trading volume. While Total Value Locked (TVL) as a measure certainly has its shortcomings, we think it is still a decent measure of industry activity. As TVL increases, we also think it’s possible that total market cap will follow.

We closely monitor the relative activity of the sector, such as transactions, volumes and users, compared to centralized alternatives such as exchanges. Despite the negative sentiment surrounding crypto today, we still believe activity will eventually return to the industry. However, in the wake of all these dramatic explosions of centralized finance (CeFi), we think the next time users decide to enter the space, they will think twice about trusting a CeFi exchange or company and in opt for decentralized protocols instead.

What were the biggest challenges your company faced in 2022? What steps are you taking to better prepare for 2023?

As with most investors in the space, our biggest challenge has been navigating the seemingly endless CeFi outbursts and failures that have rocked our industry. We’ve been able to avoid the vast majority of these outbursts because we’ve passed through several FTX ecosystem projects.

As a result, Framework hasn’t been hit nearly as hard as many of the big VC firms in the space, and we’re in a pretty strong position to continue to deploy capital in this new market.

These CeFi incidents have caused a lot of collateral damage across the industry, so a key priority over the past 12 months has been ensuring that all of our portfolio companies are sound, liquid, well capitalized and able to survive the next 1-3 years. This means helping the founders in our portfolio cut costs, prioritize high-growth businesses, and advise on product, growth, and future fundraising strategies in a less friendly funding environment.

Overall, our stance is a confirmation of our core beliefs over the past three years, as we continue to double down on DeFi, web3 gaming and more. Since many of the other companies are not actively investing at this point, we see this market as a great opportunity for Framework to deploy capital selectively.

How do you advise your portfolio companies to enter 2023?

We work with them to cut costs and focus on surviving the next 1-3 years. We believe in crypto in the long run, but we don’t know how fast the market could recover, so survival should be the top priority.

We also encourage founders to think more strategically about project development. If a team focused on three different areas, we encourage them to prioritize only the activity with the highest growth instead.

Of all the pitches you get, what percentage are DeFi protocols or projects? What can they do to stand out in the wider crypto landscape?

Today, about 30%-35% of the pitches we receive are heavily DeFi oriented.

If a DeFi project really wants to stand out, we want to see them think about where the puck is going. We are looking for projects that have the potential to be regulatory friendly. It’s a non-starter if the team doesn’t think about regulation or think they’ll figure it out later.

In addition, we are interested in projects that have direct links with institutions or at least an attractive growth strategy involving institutions. We don’t think retail projects will provide a large enough market in DeFi for the next two years, so creating something appealing to institutions should be a core focus more than before.

We also want to see the project differentiated from a product perspective. We’re not interested in another Uniswap clone or an Open Sea copycat of the alt-L1 flavor of the week.

What is your current strategy for investing in DeFi protocols and projects? How has that changed compared to recent quarters?

In 2020, during the height of the DeFi summer, the market was big enough that projects courted retail and DeFi swordsmen [a nickname for people interested in risky, niche, speculative crypto projects]. The market is completely different now.

Unfortunately, retail sales blew up in more than a dozen different ways last year, and they’re unlikely to come back in a few years. As a result, we are focusing more on projects that think about appealing to new, more institutional users and markets.

We understand that regulation is probably on the way, so we are very interested in projects that are pro-regulation, or at least regulation-friendly.

What types of DeFi use cases do you think will gain more mainstream adoption in the future? What areas of DeFi are now considered more important than they used to be?

With the Merge officially behind us, liquid staking has become a big area of ​​excitement for us. We think liquid staking projects will get a lot more attention after Shanghai goes live and users have the option to withdraw their assets without worrying about illiquidity.

How to bridge the gap between traditional finance (TradFi) and DeFi?

We need to see more DeFi products and services more realistically suited for institutions. This means projects with pro-regulatory elements baked into the products themselves, including KYC, the ability to restrict certain assets, and more. Projects that allow institutions to transact will not look and feel like the traditional DeFi we are used to and will coexist as a relatively different ecosystem.

How do you think regulatory frameworks could affect the DeFi space? Which country or region seems to be heading in the best direction?

Sometime in 2023, we will have the historic crypto regulation that everyone has been waiting for for years. More clarity could be very positive.

We don’t have a firm position, but at first glance it seems that the UK is rapidly becoming one of the most open countries from an opinion leader’s perspective.

How do you like receiving pitches? What is the most important thing a founder should know before talking to you?

We really like a good storyline. We want to know why you’re working on this problem, why it needs to be solved now, and why you think you can beat everyone else. Competitive advantage is key for us.

Alex Marinier, Founder and General Partner, New Form Capital

How big is the DeFi market today? How much do you expect it to grow over the next five years?

The DeFi market is currently about $50 billion in TVL. We expect the market to split into two categories over the next five years: permitted and unauthorized.

Allowed DeFi will gain popularity among institutions as it combines the benefits of blockchain technology with the compliance standards of traditional finance. Moving just a small percentage of traditional finance activities on-chain could create a market opportunity worth more than $1 trillion.

When you add in permissionless DeFi, which is more focused on individual users and makes up the bulk of DeFi today, the combined market has the potential to be worth anywhere from $500 billion to $2 trillion by 2028.

That said, DeFi’s growth will depend on more than just an increase in use cases. It will also be affected by developments in infrastructure, regulation and financial innovation.

What were the biggest challenges your company faced in 2022? What steps are you taking to better prepare for 2023?

Navigating the high-profile collapses (Terra, Celsius, FTX) was definitely the focus of 2022. We needed to take more time to support our founders and make sure they had enough runway to weather an extended bear market.

This year, our focus is on helping founders find creative ways to grow through this market and position themselves for the next bull market. We are also focused on finding opportunistic investments at attractive valuations and incubating more projects internally.