DeFi: The Future of Finance that is Already Here
Over the next 10 years, we believe the following are inevitable:
DeFi will represent a significantly bigger share of global transactions, revenue, GDP and consequently market value
Digital Assets will be included in the asset class investment list of stocks, bond, commodities and real estate
Stablecoins will drive the evolution of payments and compete with the Visa, Mastercard, SWIFT and other traditional payment services
DeFi will overtake many of the traditional financial services (TradFi) and in some cases completely replace them
Decentralized finance is the next chapter in financial infrastructure. When someone describes FinTech, they often describe web or mobile interfaces for banks and financial institutions, accelerated borrowing times, robo advisory, or improved accessibility. FinTech has largely provided a digital interface to an analog industry. So while FinTech companies have improved the accessibility and efficiency of financial services, much of the underlying operations remained unchanged. The future of money and all financial services is digital. DeFi represents a step function improvement to finance, where the money and financial applications are digitally native, programmable, and accessible. This is all provided with fewer middlemen (meaning cheaper) and with more security and safeguards. Crypto currencies and the associated protocols have aptly been described as the “internet of money” and their usage and adoption will follow a similar trajectory to the internet. Blackrock now recommends a 2% allocation to Bitcoin and we’ve seen several pension funds and sovereign wealth funds add it to their investment allocation. Despite the increased awareness and accessibility of Bitcoin, DeFi and many other pockets of the digital currency space remain less understood and underowned.
If you look at recent success stories within FinTech (the last 10 years), your short list would include companies like Stripe. Stripe’s success can be attributed to several factors which include: Focus on Developer Experience, Ease of Integration, Global Reach, Continuous Innovation, Trust and Security, and Scalability as well as the vision and team behind the helm. You could use the exact same words to describe digital currencies and protocols. In 2023, Stripe processed $1T in total payment volume. PayPal processed $1.53T in payments during 2023. Visa and Master card processed $15.7T and $9T respectively in 2023. Stablecoins that use crypto rails and underpin decentralized finance processed $3.1T in the last 30 days and $24.7T in the last 12mo. (Also noteworthy that it’s Visa that is reporting these figures).
The combined market capitalization of Stripe, PayPal, Square, Visa and Mastercard is $1.257T. These are largely just payment processors. This doesn’t include banks, exchanges, remittance companies, brokerages, and all the other markets that DeFi will disrupt and eventually dominate. By our own estimation, the combined market capitalization of DeFi applications is ~$160B. This is a little apples to oranges, as the DeFi figure excludes protocols like Ethereum and Solana for which these stablecoins move and applications run, but it’s clear that the valuation of DeFi will be much larger in the coming years given the TAM (total addressable market) and growth trajectory.
The top financial apps in the app store consistently include Coinbase and other wallet apps. It’s also worth noting that the commonly used financial apps (Venmo, CashApp, PayPal, Robinhood) ALL support crypto or have a crypto offering. In addition to facilitating the trading of crypto, Paypal has its own stablecoin. While the example above focuses on payments and money transfer, stablecoins are the canary in the coal mine as they are the most basic building block of finance. Stablecoins, which are the digitization of fiat currency on blockchains, are the gateway between TradFi and DeFi. Following the growth in the stablecoin market, we’re seeing a lot of other traditional financial assets being tokenized such as treasuries and private credit. Now that there is widespread use of stablecoins with broad connectivity, DeFi and the various use cases it supports are in a position to accelerate.
The most common critique of people unfamiliar with crypto, and specifically DeFi protocols is that “there are no cash flows”. While this is true for Bitcoin, it cannot be further from the truth for DeFi protocols. Over the last 90days, DeFi protocols (as measured by our eligible universe of assets) generated $1.7B in fees, for which a large portion is distributed to underlying token holders. The average net fee growth over the last 30days for this same universe of assets was 81%. A majority of the top names within DeFi trade at a fee multiple <10 (many less than 5). The trailing 12mo P/E ratio of stocks in the Nasdaq 100 is ~35 with EPS growth in the last year of 9.17% on average. So DeFi protocols generate cash, are growing at a high double digit clip, benefit from stablecoin settlement that now eclipses all large payment processors combined, and trade valuations that are between ⅓ and ⅕ of the average stock in the Nasdaq.
Just like all banks have websites and offer mobile banking, in the not so distant future all financial transactions will run on crypto rails and decentralized finance protocols will underpin all financial transactions - from tap payments at the local grocery store, to savings, and investments. Furthermore, many of these services will be offered or provided to customers without them even knowing they’re using crypto rails (just like people don’t understand existing payment networks or think about how their credit card is processed when ordering online).
While we’ve been involved in crypto now for 7+ years, we decided to launch a DeFi focused fund this year as we felt we are finally at an inflection point and that there will be significant tailwinds behind decentralized finance over the next 3-5 years that include but are not limited to:
Regulatory clarity
Improved token models that result in better value capture/value accrual (read: tokens that look like equity and have cashflows)
More direct investment in liquid token markets vs. venture capital
Convergence of valuations between liquid tokens and public equities
Technological maturity that enables adoption by broader audiences
Institutional investment
We are already seeing signs of this materializing, specifically 1, 2 (as a result of 1), and 5. The incremental investment that will come in the next 12mo will be a driving factor to normalize valuations which we think is conservatively another 5x from here and likely much larger given the TAM for DeFi is much larger than just TradFi.
The most common question in crypto is "Is it too late?" Given the trajectory of the technology, infrastructure and regulation we believe the definitive answer is no, and for DeFi it is just the beginning.