DeFAI slashed by 70%, are there still investment opportunities?

Author: SQUID

Compiled by Luffy, Foresight News

After experiencing a big drop in the market, let's take a look at where the real opportunities are.

In the past two weeks, the market value of DeFAI has fallen by more than 50% compared to mid-January, and it has fallen by 70% compared to the peak at the end of January. Data source: @cookiedotfun.

Decentralized finance (DeFi) is now a $1.25 trillion market, assuming that DeFAI accounts for 10%, that means there is still 15 times growth opportunity. In fact, I believe that there is even greater opportunity in the DeFAI market because the pricing in various subfields is currently not rational.

Recently, we witnessed an epic cryptocurrency liquidation. During this period, assets were indiscriminately sold off. Artificial Intelligence (AI) and DeFAI are among the hardest-hit areas.

Now it's time to search for treasures, let's delve into it.

Why is DeFAI so popular? First, let's take a broader look at the combination of cryptocurrency and artificial intelligence. The combination of cryptocurrency and artificial intelligence is a market worth $10 billion, which urgently needs to find 'practicality', and DeFAI seems to be the most likely to find practicality.

For most such crypto proxies, the product is their token. As a result, we see that the areas with the highest Product Market Fit (PMF) are those that make it easy for teams to launch tokenized social proxies and Launchpads. As the token supply grows exponentially, this market is tending towards saturation, and the demand for social proxy tokens and Launchpads will also decrease. Communities have to strive to look for new directions for development.

In the direction of ice hockey gliding (going with the flow)

From a macro perspective, DeFAI is meaningful, as it is the intersection of DeFi, the strongest application scenario of cryptocurrency, and one of the unsatisfied demands of artificial intelligence - finance.

That being said, just because the macro level of this field makes sense, doesn't mean that every project will work. Let's delve deeper and see where the opportunities might lie.

Observing the recent DeFAI market landscape, most of the projects launched have limited practicality in the DeFi field. I think this is due to the novelty of the field and the time required to build projects.

People want to get tokens, and most of the projects that have been launched are currently targeting the easiest to achieve but least practical goals.

Valuation chart, the project snapshot obtained earlier this month from @cookiedotfun, is now much lower in valuation.

Most of the market value of DeFAI is concentrated in the 'abstraction' category. Abstraction is mostly based on text-based alternative user experience (UX). This category is 'low-hanging fruit' because it leverages existing DeFi projects and Large Language Models (LLM) application programming interfaces (APIs), and it is logically limited, mainly based on intent. Given the current number of projects and valuations in this field, it is likely that the winners have already emerged, and compared to other categories, I think the opportunities here are limited.

I also encourage investors to try out these products. Personally, I find that most projects in the abstraction field do not provide a good user experience.

Interestingly, this market structure creates some opportunities for traders...

Recently, the valuation of DeFAI has dropped significantly, proving the skeptics right... Product development takes time, and considering the stage of the project, I believe this valuation decline is mostly reasonable. That being said, as prices fall, people may get bored, but I believe there may be opportunities in the future for those who keep an eye on the market.

So, where exactly is the opportunity?

First of all, I believe that most opportunities lie in tokens that have not yet been launched. That being said, these niche areas already exist, and some projects have already gone live. To seize the opportunity, you must keep an eye on the market and be prepared. To help identify the focus, let's review a framework for thinking about the DeFAI market.

Information Agent

This is the era of AI agents mining information and completing simple intentions.

Large language models are very good at processing text and communicating with text. As most AI agents currently utilize APIs of existing models, their most powerful application scenario is natural language processing (NLP). I won't delve into it here because there are many other materials that cover this area, but here are two advanced fields:

buy SOL through Jup'. Ultimately, these tools will use existing DeFi primitives / aggregators and cross-chain bridges to execute operations. I guess the 'winners' may have already emerged, and we may see market consolidation into a few platforms. Growth will be reflected in improving AI and aggregation capabilities, as well as expanding the user base, which is still an unproven market. Personally, I'm not sure if text-based interfaces can really improve the user experience of DeFi.

Analysis Tools: These are auxiliary tools that can help traders dig and process information. This is a diverse category, with some examples including code reviews, token analysis, and social sentiment analysis. Analysis tools will continue to evolve and play an important role in the evolving cryptocurrency/artificial intelligence ecosystem. AI-driven analysis tools compete in the same market as traditional analysis tools. Overall, there is still a lot of room for development in cryptocurrency analysis. I believe that specialized analysis tools will be able to extract more value than general analysis tools.

Projects worth paying attention to:

Abstraction: griffain, neur, The Hive, Venice, etc...

Analysis: Cookie DAO, Kaito AI, Hiero Terminal, and so on...

Smart DeFi

From information to action, being able to extract information and take action based on it.

Currently, this is a $200 million market, and I believe it will eventually capture a large portion of the DeFAI market. Assuming the market size is $12 billion, 'Smart DeFi' accounts for 50%, so this subsector still has 30 times the opportunity. Similarly, I believe the winners have not yet emerged...

Where is the practicality (value)? Initially, practicality will come from continuous monitoring and automation, allowing users to take advantage of small inefficiencies in the market, otherwise they may not notice these opportunities, or feel that these opportunities are too small to be worth their time. This market already exists. With the development of this field, large language models will not only enable the DeFAI protocol to achieve automation, but also adapt and expand the market scope to further increase returns. Over time, the degree of return enhancement will be synchronized with the development of intelligence, reasoning ability, and infrastructure.

Teams that succeed in this field will have to build or use custom models, DeFi infrastructure, and data pipelines. This deeper integration requirement is why this field is underdeveloped compared to abstract domains. Building these things takes time.

Smart DeFi is not a new market, but artificial intelligence can enhance and expand it. Examples of existing products include yield optimization projects Lulo, Carrott, and aggregators Ranger and Jupiter.

The existing area is a field where deterministic models perform well. For example, "The cheapest interest rate between X protocols is Y, so use Z". Ultimately, operations based on large language models may help improve these protocols by providing alternative user experiences or enhancing information, but existing projects are unlikely to be disrupted.

How will Smart DeFi expand in this market?

Large language models are probabilistic. In a fixed market, this can lead to poor performance, for example, if you always choose the cheapest when comparing trading prices.

The probabilistic nature and the ability to handle various types of information do provide advantages, which can allow DeFi to expand into new and more dynamic markets.

Over 50,000 new tokens are born every day. I know this data is a bit outdated, but this trend is still ongoing...

In the long tail of the market, the trading volume and value are constantly changing between new assets. Due to volatility, existing DeFi primitives are difficult to serve this category. As we continue to 'tokenize the world', this market will continue to expand.

In addition, tokens are not equity, and tokens can be constructed / represent value in various ways. The high diversity of assets in the market is another advantageous factor for intelligent systems.

Smart DeFi can help DeFi expand to this market for the following reasons:

Ability to mine / evaluate new assets

Monitor, understand, and take action on new market narratives

They can integrate social, on-chain, and off-chain data and take various actions using inference.

There is a synergistic effect at the macro level, but where are the opportunities?

Let's take a look at a promising niche, Smart LPing (Smart Liquidity Providing).

Liquidity provision is difficult because each fund pool has different risk conditions, and the returns fluctuate greatly between different assets. Currently, based on the user's investment philosophy, there are some tools to help with asset allocation, but the combinability/automation level is limited.

The vision of liquidity provision agents is to be able to optimize the yield of liquidity provision by adjusting risk parameters and selecting assets/funds pools based on a combination of on-chain and social data. Ultimately, it may create a new asset that can dynamically generate returns from the long-tail market, thereby improving overall market efficiency.

Raydium's fees, can be used as an indicator of on-chain transaction volume, why choose the native AI team?

Yes, it takes time to realize this vision. That being said, I believe native AI teams are more competitive in markets with lower market efficiency/absolute returns, because more returns can be attributed to intelligence. Native AI teams are smaller, so they can act faster and focus more on the 'intelligence' factor.

Some teams I would like to mention: Cleopetra, Alris agent, and Voltr.

Other areas I will not delve into include smart regular fixed investment, transaction execution, and products based on social signals. As intelligence increases, the proportion of returns attributed to humans will begin to be eroded by artificial intelligence tools.

Project Plutus has shown interesting early results in intelligent limit order, and I am looking forward to testing it myself.

Next, Alpha Hunter

Let's see if a proxy can generate Alpha returns.

Here are some common responses from more professional people in the industry. Although I agree that we are still far from this goal, I think it is ignorant to completely negate Alpha agents. You have to believe in something...

Generating Alpha returns is difficult.

In the traditional market, hedge funds spend billions of dollars each year partnering with the smartest people in the world to create an edge. However, systemic frictions mean that the cryptocurrency market is far less efficient than traditional markets, making it more feasible for proxies to generate alpha returns. New asset classes/narratives emerge every week, which means that cryptocurrencies cannot directly apply the same strategies as traditional finance.

Why give up Alpha?

I firmly believe that 'Alpha Hunter' will not be an innovation from 0 to 1, but will gradually emerge. In the foreseeable future, Alpha returns will still be driven by humans and assisted by AI. Over time, the returns will gradually be attributed to agents. Once a certain threshold is reached, we may see true 'Alpha Hunter agents' emerge, which will employ or collaborate with humans.

Tokens will help to initiate, coordinate, and integrate emerging ecosystems.

Currently, two protocols are being adopted using interesting methods:

Almanak: Almanak integrates premium data pipelines, advanced risk engines, and AI-driven agents to generate and execute various financial strategies under human supervision. It is an agent/strategy platform that can continuously identify Alpha returns and provide services to users in a secure non-custodial environment.

Allora: The Allora reasoning system aggregates and weights artificial intelligence predictions in real time based on accuracy and intelligence. Human participants act as workers, providing predictions and evaluating the quality of reasoning to improve the market predictions of the system. The goal is to apply these predictions to the market.

Cryptonative teams dedicated to model development will also play a key role. Ultimately, intelligence is key.

The protocols I like include: Pond (focuses on developing encrypted native models using on-chain data) and Nous Research (they have done a lot of work to help develop the optimal model for decentralized training, and they also mentioned exploring the 'demand' for agents).

This field is still in its early stages, so focus on teams with the potential to grow and develop.

With the continuous decrease in the marginal cost of intelligence and the increasing number of markets created every day, agents are ready to embrace a new emerging market segment, which is fleeting for humans and too dynamic for robots. Believe in something.