Hello Defiers, happy Friday! This week’s interview is with Michael Anderson and Vance Spencer, co-founders of crypto venture fund Framework Ventures. Michael and Vance talk about their investment thesis, which starts out with mapping out the space, and picking out the winners in each category, with the advantage of having built a blockchain startup themselves. But it doesn’t stop there though, as they also strive to become their portfolio companies’ most active users. This means they have to be immersed in crypto 24/7 —“This is all we do, like, at all,” Vance says.

They talked about how the emergence of token-based business models in the past year has been a breakthrough for crypto, legitimizing the space as a new asset class, and the pros and cons of the dividend model and versus the buy and burn model. Michael and Vance also compare investing in AMMs like Uniswap, which have become a public good, versus investing in borrow-lend desks like Compound, which can have large AUMs, versus margin trading protocols, which can capture more fees.

Vance believes new developments in decentralized exchanges this year will drive 10% of centralized exchanges’ volume. Michael believes governance tokens are akin to early startup equity. They also talked about why they love the philosophy driving SNX and discussed why the underdog mentality of LINK Marines is bullish for Chainlink.

🎙Listen to the interview in this week’s podcast episode here:

Michael Anderson: I think the start of the crypto journey for us was being in San Francisco in the tech industry in 2012-2013. That was at the time when Ripple was really kind of taking off, but then there was this whole concept of smart contracts platforms. And we started to get to know Ethereum through reading the white paper really early in 2014 and that was where our journey took off with the ecosystem growing and the ability to create any program on top of Ethereum.

After that, Vance and I were living in Los Angeles, each working for different technology companies and we actually started living together. And I think, in one of our first conversations, we both ended up talking about Ethereum and that's when we knew we would probably have a fruitful relationship.

Vance Spencer: Mike was a PM at Dropbox and Snapchat, I did corporate strategy at Netflix first in the US and then in Tokyo for a couple years. So, you know, I think what's different about us and a few other different firms or people in this space is that we have a consumer internet background.

And we look at this stuff through the lens of, this is technology. The money side of Bitcoin is interesting to us, but our original thought on Ripple was, this could be a bank, maybe this could be a way to do remittances, what are the technology platform implications of this stuff. And so that's generally where we've approached it. It's been a while, it's been probably six years since we started thinking that way and it's been kind of nothing until now, until DeFi, until it started to have real product-market fit. And so, it seems like blockchain takes forever to develop and we can testify to that, but it's very rewarding to see you know, the kernels of a large industry starting to form.

Quitting Netflix

Camila Russo: It's interesting to meet people who are getting into this space from the technology side more than the currency, monetary side of things. So, what about the technology was it that really intrigued you?

MA: Well, fundamentally blockchain enables permissionless value transfer that can be applied to anything worth value, whether it's money, whether it's digital collectibles, and we can talk about our Hashletes experience, or whether or not it's a financial transaction involving synthetic assets. A permissionless, open and transparent financial system is really what you can build once you have the ability to have permissionless value transfer. And so, as Vance said, we just started to on a whiteboard, list all the different things that you can do once you start having that capability. And for us, it felt endless and it just felt like it was time for us to quit our jobs at Netflix and Snapchat respectively and go in and be full-time blockchain people.

VS: The other side of that is like, if you want to build a consumer internet app, you can list it on the app store, you can distribute it pretty easily, and as long as it kind of stays within the confines of the app store guidelines, you're pretty much good for experimentation. And there's a few different business models, you can do subscription, advertising, you can try different kinds of sub-verticals to target in terms of interest. But that's kind of the consumer internet side of the world.

Finance Ripe for Disruption

If you really want to experiment with financial technology and applications, there's not a whole lot of places developers can go. They can’t just roll up to Goldman Sachs, Morgan Stanley, and say, listen, I have this new idea for a new bond instrument or I have this new idea for a new asset class. They would be like, A, who are you, B, get out. And so, that new sandbox for experimentation and development is really something that was fundamentally new for us and then we could kind of see the far-reaching implications. And so, I think that the largest total addressable market in the world, which is finance and a total lack of experimentation development, that just felt to us like an opportunity that was ripe for disruption.

“The largest total addressable market in the world, which is finance, and a total lack of experimentation development, that just felt to us like an opportunity that was ripe for disruption.”

CR: It is huge. And just the ability to have permissionless financial system seems unbelievable and that it's actually working is even more incredible. So, how was it leaving these huge tech firms, very reputable firms, for the unknown territory of blockchain. How was that jump? Were you already moonlighting in your new crypto company? How was that transition?

MA: Yeah, so what I would say is it was probably one of the easiest decisions I think we both ever made. And a lot of that was because of the fact that we had been so deep within this industry, watching from the sidelines, investing on an angle basis and building tools and little features that we felt would be interesting, but never had enough time to be able to devote to do the things that we wanted to do.

Builders’ Scar Tissue

And leaving our respective companies, we were already one foot out the door. And so, it felt like the right time, the perfect place and it was just a great time to be able to go off and work on something that we believed in, but where it also felt like we could push the needle. That was our Hashletes experience. We were building digital collectibles, we were licensed by the NFL to build football-based digital collectibles. We were one of the first I think apps in the app store to have a full Ethereum connection. And we use a lot of that experience and a lot of the pains and the scar tissue of that experience to inform our investment decisions now. We can sit across the table from an entrepreneur and say, hey, here's what our experience was like building on top of blockchain. And we understand and I think that's another differentiator that we have.

VS: Our pitch deck for our fund, one of the best sides I think we had in there was a screen capture of the Hashletes iOS app. And we basically circled each of the pain points; pulling data off chain, getting index data on chain. And really, our investment theses are tied to the pain points that we've had before.

I think a lot of the thinking from an investor perspective in the space is very top down. It’s like what's the total addressable market? If Bitcoin can become 10% of gold, if Ethereum can become 1% of AWS. We're very much bottom up. We like to think through the problems in very specific detail as they relate to each entrepreneur’s challenges and what they're trying to do. That's something that we have that none of the firms have, an ability to build products and an ability to really empathize with the entrepreneurs we're supporting.

DeFi is Right Now

CR: Okay, definitely want to dig deeper on your investment thesis now. When and why did you decided to launch Framework Ventures, and go from creating a product to investing in different products? It's a big change.

VS: Yeah, so I think the first thing I'll say is that Michael and I've been investing in the space since 2013. So we have a lot of experience in terms of assessing, evaluating and executing on deals. And we actually had a pretty dominant angel run for two years just kind of on our own. So, that led into starting the fund and developing our investment theses. It wasn't just flipping a switch from operator in a big tech company or operator in a startup to an investor.

We kind of had the training wheels, a little bit on the angel side, but really putting it all together, the fund, the LP base, the firm’s style, the investment thesis, executing on deals, like that's a whole another ballgame that we kind of had to get used to.

But, you know, that being said, we started Framework about a year ago and we started with $20 million. We're considerably bigger at this stage, we can't really get into how big. But our investment thesis was effectively, you know, we had Uniswap at the time, we had Compound starting to gain steam and we looked at the blockchain ecosystem and said, Web 3.0 is probably 5 to 10 to maybe 15 years away in terms of decentralized Twitter and decentralized Facebook, but DeFi can provide value right now. And so, just from that kernel of product-market fit, we were able to extrapolate what are the major horizontal categories of products we want to invest in. Where do they sit in a vertical DeFi stack, whether it's base layers and oracles and liquidity pools and synthetic asset pools? Then, you know, so on and so forth.

Value Capture

We started just mapping out the ecosystem and trying to understand not only where a lot of value is created, but where a lot of value can be captured. You know, an example of this is Uniswap is an amazing public good, but it's almost like investing in a public park at this point. You're not going to really be able to extract a lot of value out of it. Whereas some of the other technology layers, they're more value extractive in terms of being able to invest in them as a venture thesis.

And so that's really where we started and kind of where we ended is that you know, the intersection of automatic market makers like Uniswap, leverage, and synthetic assets is really where the world is going to today. We think that in two or three years, the crypto ecosystem, specifically DeFi, will look a lot like the Forex exchange that exists today. But in 5 to 10, you'll be able to trade all types of esoteric assets, whether that be Facebook likes or Spotify plays or really kind of anything that you can get a price feed for and collateral pools, that will be the first kernel of Web3t hat makes that vision real.

But we haven't changed our thesis, we've iterated on it a few times, depending on when things launch and the world changes. A good example of that was Compound last Friday That's kind of what we do and how we do it.

Winner Takes Most

CR: So, from this mapping of the ecosystem and determining all the different verticals there are and the different protocols in these verticals, is your idea to pick the winner in each and invest in one of each?

VS: I think a lot of it depends on what the entrepreneur is working on, what they're building. And a lot of these can coexist. I think there are a number of these markets that are not winner take all, it could be winner take most. Some of them, like oracles, we believe, are a winner take all market just due to the two-sided marketplace dynamics of an oracle network of data feeds and payment outputs. But when it comes to things like trading venues, when it comes to things like AMMs or asset specific AMMs, I think those things can be winner take most. And so, in that case, it's about finding the one or two best players in these ecosystems and backing them in a way that there are many different exchanges that exist, centralized changes that exist right now. They have different flavors and different features, but really, it's the same experience. I think that the DeFi ecosystem will ultimately end up being the same thing and there will be different venues that have different flavors and different features as well.

CR: And you spoke about this idea of determining which protocol has the potential to produce more value for investors. How do you go about analyzing that? Like how can you actually forecast what that value accrual will be?

MA: So, I think in 2019, some in 2018 as well, we went through a renaissance of tokens. And what Vance was talking about earlier and sort of the thing that gets us excited every morning when we wake up is that tokens for us represent a blank canvas design space. We're still working on what governance means, we're still working on what valuation models mean for tokens. But what we saw in the last 18 months was the ability for tokens to change their business model, for them to change their token economics. And in 2017, you would have said that was sacrilege, that was an absolutely non-starter.

Valuation Models

But now It's possible for those things to change. And with that change, we're starting to see two predominant valuation methods come to the fore. And that is either in the form of synthetics where you have a dividend issuance based on the amount of value that's captured within the network and that's distributed to participants of the network, whether it be stakers or voters or what have you. But then you also have this buy and burn model that Maker has created and promoted, where the value that's created or generated by the network is used to burn a certain amount of tokens, therefore increasing the percentage ownership of token holders.

And for any outside investor, for any person looking at the space who comes from traditional financial markets, this is a major box that they can now check. This is how we in this industry go from where we previously were over the last few years to being something that's universally recognized as an asset class that's investable because now we have valuation models. We're not talking about utility tokens, PV equals MQ anymore, we're talking about cash flows. And because of that, it's going to bring our industry into something where COMP and Compound’s token can be a billion-dollar asset if they have a value accrual method because they're that big and they have that potential. And that's where we can really start to see DeFi put itself on the map.

“This is how we in this industry go from where we previously were over the last few years to being something that's universally recognized as an asset class that's investable because now we have valuation models (…) And that's where we can really start to see DeFi put itself on the map.”

[This story was written and edited by our friends at The Defiant, and also appeared in its daily email. The content platform focuses on decentralized finance and the open economy and is sharing stories we think will interest our readers. You can subscribe to it here.]