Evegny Gokhberg: Market neutral DeFi strategies are essential for volatility, why diversification isn’t enough to manage risks, and the future of capital in DeFi | Raoul Pal

Key Takeaways

• Market neutral DeFi yield strategies aim to earn yield without being affected by price direction.
• Building a business on a market neutral foundation is crucial due to crypto’s inherent volatility.
• In the early days of DeFi, stablecoins could yield significantly high returns.
• The unique risk-return profile in crypto is based on software platform hacks, uncorrelated with traditional assets.
• Diversification in DeFi is insufficient alone to effectively manage risks.
• DeFi risk is likened to selling a put option, earning returns until a catastrophic event.
• A framework can categorize blockchain attack vectors to assess risk and diversify investments.
• DeFi’s annual default rate has decreased from double digits to 2-5%.
• Engaging with DeFi platforms requires understanding the primary risk of loss from hacks.
• The DeFi market remains structurally starved of capital despite new platforms.
• Supply and demand dynamics in DeFi will continue to favor allocators.
• On-chain trading strategies’ returns vary significantly with market conditions.
• Diversification is key in managing risk in on-chain trading strategies.
• Holding assets is preferable if they remain structurally sound and communication with the team is strong.
• The philosophy of diversification is crucial in the uncertain DeFi landscape.

Guest intro

Evgeny Gokhberg is the founder and managing partner of Re7 Capital, a DeFi hedge fund specializing in market-neutral yield strategies and on-chain risk management. He previously worked in investment management at UBS and Deutsche Bank, managing equity long/short portfolios, before transitioning to crypto in 2018 at Everledger. Re7 Capital has deployed approximately $1.2 billion in DeFi liquidity provision since its founding in 2021.

Market neutral DeFi strategies

• Market neutral strategies focus on earning yield without price direction impact.

• Think of it as a hedge fund that collects dollars, converts them into stablecoins, and earns yield

  — Evegny Gokhberg

• Building a business on market neutral foundations is essential due to crypto volatility.

• It was scary to base a business on something extremely volatile

  — Evegny Gokhberg

• Early DeFi days allowed for high stablecoin yields.

• You could earn 40% a year on stablecoins in simple ways

  — Evegny Gokhberg

• The unique risk-return profile in crypto is based on uncorrelated software platform hacks.

• Our risk is a random software platform getting hacked, uncorrelated with stocks or bonds

  — Evegny Gokhberg

• Diversification in DeFi is not enough to manage risks effectively.

• Diversification always sells but it’s not enough

  — Evegny Gokhberg

Risk management in DeFi

• DeFi risk resembles selling a put option, earning returns until a catastrophic event.

• It’s like selling a put option; you get paid until your counterparty goes bust

  — Evegny Gokhberg

• A framework can categorize blockchain attack vectors for risk assessment.

• Can we categorize all blockchain attack vectors and create a checklist?

  — Evegny Gokhberg

• DeFi’s annual default rate has decreased significantly.

• Default rates were double digits, now maybe 2-5%

  — Evegny Gokhberg

• Understanding the risk of loss from hacks is key to engaging with DeFi platforms.

• We accept losing money if a DeFi platform is hacked

  — Evegny Gokhberg

• The DeFi market is structurally starved of capital.

• DeFi TVL hasn’t grown since 2021; people are starved of capital

  — Evegny Gokhberg

Supply and demand in DeFi

• Supply and demand dynamics in DeFi favor allocators.

• Supply demand will favor allocators for the foreseeable future

  — Evegny Gokhberg

• The cyclicality of yields in DeFi impacts performance more than capital demand.

• Cyclicality affects P&L more than demand variance

  — Evegny Gokhberg

• Multiple layers of risk exist when holding crypto assets.

• We take three layers of risk: asset, platform, and chain

  — Evegny Gokhberg

• Convergence of CeFi, DeFi, and TradFi is expected over time.

• We’re seeing a convergence of CeFi, DeFi, and TradFi

  — Evegny Gokhberg

On-chain trading strategies

• On-chain trading strategies’ returns vary with market conditions.

• In bull markets, returns can be 25-30%; in bear markets, 5-10%

  — Evegny Gokhberg

• Diversification is crucial to managing risk in on-chain trading strategies.

• Enough diversification prevents single event impacts

  — Evegny Gokhberg

• The philosophy of diversification is crucial in the DeFi landscape.

• DeFi is six years old; we must diversify

  — Evegny Gokhberg

• The firm aims to remain flat on the year despite volatility.

• We want to be at least flat on the year, no matter what

  — Evegny Gokhberg

Bitcoin and altcoins

• Bitcoin is viewed as digital gold; other crypto are software businesses.

• Bitcoin stands alone as digital gold; others are software businesses

  — Evegny Gokhberg

• Altcoins are undergoing a cleansing process, with most expected to lose value.

• 99.9% of altcoins should be worth zero

  — Evegny Gokhberg

• The crypto market resembles early Silicon Valley startups.

• Imagine if every Silicon Valley startup was publicly listed on day one

  — Evegny Gokhberg

• A dual approach of top-down and bottom-up analysis is needed in crypto.

• We start top-down and merge it bottom-up

  — Evegny Gokhberg

Investment strategies in crypto

• Investing in crypto requires balancing established businesses and speculative bets.

• Run a barbell of concentrated risk with measurable, understandable assets

  — Evegny Gokhberg

• In an unforgiving market, patience is better than frequent trading.

• In this market, it’s better to be patient and not trade frequently

  — Evegny Gokhberg

• Holding assets is preferable if they remain structurally sound.

• We’ll keep holding if assets are structurally sound and communication is strong

  — Evegny Gokhberg

• The last part of the market cycle is crucial for altcoin gains.

• You need the last part of the cycle to kick in

  — Evegny Gokhberg

Market dynamics and liquidity

• Investors should approach trading with a clear understanding of risk.

• Be clear about your expected risk and avoid overtrading

  — Evegny Gokhberg

• Compounding gains in crypto is more effective by holding assets.

• The way to compound gains is to do nothing

  — Evegny Gokhberg

• FOMO is a major destroyer of returns in the market.

• FOMO is one of the biggest destroyers of returns

  — Evegny Gokhberg

• Current market volatility may be related to liquidity issues.

• I think it’s liquidity-related, but who knows?

  — Evegny Gokhberg

Market forecasts and opportunities

• There is hope for positive market movement if critical levels are held.

• As long as we hold these levels, there’s hope for positive movement

  — Evegny Gokhberg

• The market shows stability and altcoin outperformance compared to Bitcoin.

• Alts are not breaking down versus BTC; there’s stability

  — Evegny Gokhberg

• The current market resembles small caps versus major stocks.

• It’s like small caps versus majors in traditional markets

  — Evegny Gokhberg

• Investors should not panic sell during market distress.

• Don’t panic sell; it’s probably the opposite

  — Evegny Gokhberg

Disconnect between fundamentals and price

• There is a significant disconnect between DeFi fundamentals and price performance.

• There’s a disconnect between fundamentals and price in DeFi

  — Evegny Gokhberg

• Liquidity is a dominant factor affecting market narratives.

• Liquidity impacts market narratives and price movements

  — Evegny Gokhberg

• Lack of liquidity causes underperformance in software and crypto assets.

• Not enough money in the space to maintain performance

  — Evegny Gokhberg

• Gold’s rise attracts attention away from marginal assets like SaaS stocks and Bitcoin.

• Gold’s rise attracts capital, impacting marginal assets

  — Evegny Gokhberg

Banking system and leverage

• The banking system can create significant leverage through regulatory changes.

• Regulatory changes could lead to significant bank leverage

  — Evegny Gokhberg

• Re-leveraging in the banking system will increase liquidity and impact the business cycle.

• Banking re-leveraging will recycle capital through the system

  — Evegny Gokhberg

• Current market conditions indicate a lack of sufficient liquidity.

• The market shows insufficient liquidity, affecting performance

  — Evegny Gokhberg

• Gold peaks often precede Bitcoin’s performance, indicating potential market shifts.

• Gold peaks, then Bitcoin performs; signals are close

  — Evegny Gokhberg

Risk tolerance and investment decisions

• Risk tolerance is crucial for investment decisions, especially in volatile markets.

• Risk tolerance starts with understanding drawdowns

  — Evegny Gokhberg

• Investors should consider a benchmark like $ETH to manage risk.

• Use a benchmark like $ETH to manage risk effectively

  — Evegny Gokhberg

• Higher beta assets experience larger drawdowns compared to major crypto.

• Higher beta assets have larger drawdowns than major crypto

  — Evegny Gokhberg

• Investors need to be realistic about their risk tolerance and potential losses.

• Ask yourself if you’re willing to bear potential losses

  — Evegny Gokhberg

Market corrections and opportunities

• The current market correction does not indicate the entire crypto market is broken.

• The market looks like a sharp correction within a bull market

  — Evegny Gokhberg

• The market could change rapidly, but a prolonged downturn is not imminent.

• A prolonged downturn doesn’t feel imminent right now

  — Evegny Gokhberg

• Current market conditions should be viewed as an opportunity, not a signal to abandon.

• This is an opportunity, not a sign to abandon the industry

  — Evegny Gokhberg

• Market noise will ultimately be just that—noise.

• Noise in markets will be just that—noise

  — Evegny Gokhberg