Augmentum enters the DeFi space with ParaFi

As we kick off 2021 we are delighted to announce our investment in and partnership with ParaFi Capital, who are backing pioneers in the decentralised finance (DeFi) and blockchain spaces.

We have outlined below our investment rationale on the emerging DeFi space and why we chose to back the ParaFi team in particular.

Emerging technology continues to disrupt finance services

Software continues to permeate every industry, driving efficiencies and facilitating innovation. Financial services continue to be a beneficiary; with technology improving the quality of services and access to them. The fintech companies we invest in often gain their central competitive advantage through their ability to leverage software-driven processes and efficiencies to a greater degree than incumbent firms.

Our central thesis is built around the conviction that the opportunity for continued tech-led disruption in financial services is monumental. With financial services incumbents still owning 91% of the $11 trillion global financial services revenue opportunity¹, there is no shortage of headroom for fintechs to continue to grow market share.

Financial services industry revenue breakdown in 2019. Source: IMF Fintech: The Experience So Far 2019, Graphic: Augmentum

DeFi is gaining momentum

Activity in the DeFi space has gained significant momentum in recent years, attracting capital inflows of $21bn in the last year alone². Our partnership with ParaFi highlights our conviction that software-led disruption will move even deeper into the financial services stack, with the potential for software to fulfil the crucial role of trusted intermediaries in financial transactions.

Within the DeFi ecosystem, teams of developers are rebuilding fundamental layers of the financial system with open source software. Whereas traditional finance relies on centralised intermediaries to arbitrate transactions between counterparties, decentralised finance uses programmable ‘smart contracts’: software programs run on blockchains which execute automatically when a set of required conditions are met. They are decentralised because, once written and launched, no centralised party is required to instruct them to execute — they execute only if the specific conditions are met. Transactions facilitated by smart contracts are validated (i.e. recorded) by the nodes of the blockchain that the contract runs on.

Smart contracts specify the rules of a transaction just as a centralised intermediary would in the world of traditional finance. Among their advantages are their transparency; once launched, the code governing a contract becomes open source, fully available for any market participant to audit. With the ‘rules’ of a transaction made available for all to see and understand, a new type of trust exists separate to the trust signalling from regulation and reputation relied on in traditional finance.

Smart contracts also have inherent composability; like Lego blocks, lines of code can be combined to build protocols (decentralised applications built from suites of smart contracts) which emulate, and even improve on, the centralised financial services lend, borrow, trade, insure we know and use today.

By removing third party intermediaries, decentralised transactions also typically cost less; users pay small amounts to have their transaction validated by the network in place of fees to third parties. The following diagram contrasts how an individual would interact with a traditional exchange vs a decentralised exchange protocol (DEX), demonstrating a simplified chain of interaction and lower fees:

CeFi vs DeFi exchanges value chain. Source: BCG

Protocols form the infrastructure layer of the DeFi ecosystem, with participation and value accrued by those delivering the most valuable services to users.

Top 5 DeFi protocols by Total Value Locked. Source: BCG

As pure software, protocols are hyper-scalable with complete repeatability of use at minimal incremental cost. It is simply not possible for centralised institutions — reliant on high-touch, human-led processes — to scale with anything close to the levels of efficiency seen in the decentralised space. Plus DeFi offers broad accessibility; anyone connected to the ecosystem can interact with a protocol, should they find the transaction it facilitates to be of value to them.

The open source nature of smart contract code and inherent composability accelerates innovation cycles meaning the pace of development is rapid. Community participation and true network effects create a hugely exciting and uniquely collaborative ecosystem which is attracting world class developer talent.

Today the DeFi opportunity is nascent and the potential is significant. Ultimately, we believe efficiency wins out and will continue to drive adoption and value creation in the DeFi space. In time we expect to see a blending of the centralised and decentralised finance universes with centralised institutions adopting decentralised infrastructure in order to stay competitive.

ParaFi: A world-class team of specialists

Led by Ben Forman, the ParaFi team has impressed us from the outset with their deep sector expertise and network — built through time in both traditional finance institutions (including TPG, Blackstone and KKR) as well as in the crypto and wider emerging technology spaces and alignment on a data-driven approach to opportunity evaluation and powerful ongoing portfolio support.

We are looking forward to continuing our exchange of ideas moving forwards as ParaFi’s European partner, joining their wider investor network which includes esteemed US funds such as Bain Capital Ventures, Galaxy Digital Ventures and individuals such as Henry Kravis (KKR Co-Founder & CEO). Together we will invest in emerging DeFi protocols; the smart contract infrastructure layers which support key applications in the growing DeFi ecosystem, building on ParaFi’s investments to date which include Uniswap, MakerDAO and Compound.

We believe we have found a world-class team to partner with as we enter the space. ParaFi’s DeFi specialisation compliments Augmentum’s wider fintech expertise and our teams are uniquely placed to identify and back decentralised finance applications with global potential. Working together we will back development teams on the ground in Europe and the United States and co-invest in projects prior to public launch, providing our respective investor groups with access to a unique portfolio of high potential DeFi assets and maximising potential returns.

Learn more about the Augmentum portfolio at www.augmentum.vc/our-portfolio

Learn about investing in fintech with Augmentum (LSE:AUGM) at www.augmentum.vc/investors

¹ IMF Fintech: The Experience So Far 2019
²
DeFi Pulse (accessed 6/1/21)
³
DeFi Pulse (accessed 4/1/21)

Important Information
This financial promotion is issued by Augmentum Fintech Management Limited which is authorised and regulated by the Financial Conduct Authority under Firm Reference Number: 811734. Augmentum Fintech Management Limited is appointed as manager to Augmentum Fintech plc. This financial promotion is for information purposes only and nothing contained in this financial promotion constitutes investment advice. This financial promotion is intended for professional investors and for retail investors who have sufficient knowledge and experience of UK listed investment trust companies. If you as a retail investor are uncertain whether an investment is suitable for you, you should seek advice from a regulated financial adviser. The value of investments, and any income from them, can fall as well as rise and you may not get back the amount invested. Reference to “Augmentum” or “Augmentum Fintech” refers to “Augmentum Fintech Management Limited” unless otherwise stated. Reference to the “Company” refers to Augmentum Fintech plc. Reference to “we”, “our” and “The Augmentum Team” refers to employees, consultants or advisors of/to “Augmentum Fintech Management Limited”.

Augmentum Fintech is the UK’s only publicly listed investment company focusing on the European fintech sector.