At Blockforce, we pride ourselves on being data and process driven. In previous posts we have outlined our investment philosophy and decision making framework. This post, we would like to focus on what we look for when we conduct fundamental research into various cryptoassets to add to our Long Beta portion of our portfolio.
Conducting investment research in traditional financial markets such as stocks is a well understood process. While two analysts may arrive at different results based on their assumptions and beliefs, they likely both start with evaluating a company’s most recent quarterly financial reports. However, when it comes to the cryptoasset ecosystem, those processes may not be applicable depending on the token an analyst is evaluating. In this article, we will lay out a number of factors we dive deep on when evaluating various tokens to invest in.
Token Use Case
The first thing any investor should start with is understanding what the purpose of the token is. Bitcoin is a non-sovereign form of currency whose monetary policy is transparent, predictable and cannot be altered by any single entity. In this sense, bitcoin is a valuable store of value compared to fiat currencies. Bitcoin is also the vehicle by which one can transfer value over the fastest, cheapest and most secure international settlement network ever created meaning it could potentially eat into the market share of SWIFT or ACH.
However, most cryptoassets are not currencies, nor do they intend to be. Smart contract platforms such as Ethereum, Solana, Binance Smart Chain, Avalanche and others provide the architecture by which decentralized applications can be built on top of. In this sense, these networks function as decentralized versions of Amazon Web Services. Decentralized exchanges such as Uniswap, Sushiswap and Serum allow users to buy and sell assets without third party intermediaries. Protocols such as Aave and Compound enable pure peer-to-peer borrowing and lending. Helium is a distributed wireless network owned by its users, not a corporation. Other tokens, often referred to as governance tokens, enable users to vote on key decisions of the network thus giving them influence on the direction of the network or how funds are allocated.
While there are many viable tokens creating value for their users, not all tokens have such utility or purpose. Meme coins such as Dogecoin or Shiba Inu trade purely on market sentiment. Other crypto networks may not actually require a token to operate meaning the token exists for purely marketing purposes (we are looking at you XRP). We believe that if a cryptoasset is not actually ingrained and necessary to the functioning of a network, it is unlikely to hold its value over a long period of time.
When researching a token the first place to start is to understand what does the product do, what challenge is it solving, and what role does the token play in allowing the network to function properly.
Tokenomics is a term used to describe the economics of a token which helps to ascertain the future worth of an asset. Investigating the tokenomics of a coin involves studying the factors that impact the supply and demand of the token.
- Supply – understanding how many tokens currently exist and how many will exist in the future is crucial to understanding the future value of the token. There are three types of supply when it comes to cryptoassets. There’s the circulating supply, the total supply, and the max supply. The circulating supply of a token is the number of tokens that have been issued so far and are currently in circulation. The total token supply is the number of tokens that currently exist regardless if they are in circulation or not. And finally, the max supply of a token is the maximum number of tokens that can ever be generated. For some tokens, there’s no determined max supply. For example, bitcoin has a max supply of 21 million coins while Ether has no cap. This isn’t to say one is right and one is wrong, it’s merely to point out that every token tends to have its own unique supply dynamics which is an important factor when evaluating a token.
- Supply Issuance – the rate at which supply is issued is important to know because if there are too many tokens being released at once or too frequently, it could negatively impact the value of a token. Thus it’s important to determine if the supply issuance is inflationary, dis-inflationary or deflationary. Similar to fiat currencies, an inflationary token doesn’t have a max supply and will continue to be produced as time goes on. Some inflationary supply schedules are constant while others, such as Ethereum, are dynamic and vary depending on their use. A dis-inflationary supply issuance schedule releases new tokens over time but the amount of newly issued supply decreases. For example bitcoin has a fixed supply issuance schedule that reduces the amount of coins mined per block roughly every four years. Thus there will continue to be new bitcoin released onto the network until the year 2140, but at a decreasing rate. A deflationary supply schedule starts with a set number of tokens and reduces the number of total tokens by burning (aka destroying them) over time.
- Distribution method of the token – Understanding how new supply gets distributed among network participants is just as crucial. In proof of work based models, tokens are mined by network participants contributing computing power to run and secure the network. In a proof of stake model, “stakers’ earn tokens by putting up collateral rather than contributing computing power. Other distribution models may include issuing tokens based on network participation or some other mechanism.
- Initial Distribution and Ownership – it helps to understand how the first tokens were released. Some cryptoassets, such as bitcoin, have a “fair launch” in which everyone in the community has equal access to mine or earn cryptoassets from the beginning. In a fair launch, there’s no early access to the token or private allocations before making them public. In contrast, many projects have what is known as a “pre-mine” in which a select few market participants were either granted exclusive access to tokens before it was made public or were able to mine the token before it was publicly available to do so. This usually includes project developers, team members and early investors. Investors should also be wary if there’s any wallet or small group of wallets that own a disproportionate percentage of the circulating token supply, since this means there’s a risk of a single individual dumping their holding and dropping the price of the token in an instant. The more distributed the ownership and the greater the percentage of the token that is owned by the community, usually the better.
Another component to evaluate is the team behind the project. Ideally, it should be relatively straightforward and simple to find out information on the team using LinkedIn, Google and looking through their website. It’s often possible to get in contact directly with the team members through messaging platforms such as Discord and Telegram. It is typically a red flag if the names and faces of the team aren’t forthcoming or if the team uses pseudonymous personas.
Next, it is often helpful to analyze the composition of the team. There should be a substantial amount of technical team members compared to marketing, PR, legal, etc… A large marketing team and small development team is typically a red flag.
Finally, it’s important that the team members have relevant experience. How long have they worked in the crypto industry? What relevant projects have they been involved with in the past or is this their first foray in the industry? Do they have experience in relevant areas such as distributed networks or cryptography? Are they active in the community through messaging platforms, blog posts, github contributions, or other channels?
Due to crypto’s open nature, it’s often possible to learn a lot more about the team than one might initially think.
Assuming you are evaluating a liquid token rather than considering an investment into a project pre-launch, it’s often possible to gather fundamental data on the usage of the product. Most cryptoassets are built on public blockchains which means the underlying transactional data is typically available for anyone to access. As a result, there are a number of data services, both paid and free, that offer insights and charts of various blockchain based assets. Some of these services, though not an exhaustive list, include Glassnode, CoinMetrics, Messari, DeFi Pulse, and Dune Analytics. In addition, many cryptoasset projects or community members will create a dedicated website to track the activity on the network. Thus it’s often possible to measure the growth of the network over time.
Network Effects and Community
An unique aspect of the crypto industry is the fact that all transactions on a public blockchain are viewable by anyone and most of the technology is open-sourced. Thus, most of the code can be forked (aka copy and pasted) to create a very similar competitor. We have seen this multiple times in crypto’s history. Bitcoin was forked which created bitcoin cash. Ethereum was forked to create Ethereum Classic. Uniswap was forked to create SushiSwap. OpenDAO created a token to reward users of the NFT marketplace Opensea even though OpenDAO had no official affiliation with Opensea. Because code can be replicated, the technology is often not what gives tokens defensibility in the marketplace. What creates defensibility in this space is network effects and community.
Let’s start with network effects which is a phenomenon whereby a product or service gains additional value as more people use it. For example, the more apps that are built on the Ethereum blockchain the more users transact on Ethereum. The more users there are the more attractive that platform becomes to other developers who in turn create more apps and functionality on the Ethereum network. Ethereum has one of the largest developer ecosystems and by far is the most used smart contract platform today because of the network effects it has built over time. Ethereum Classic, which was forked from Ethereum in 2016 and has the same underlying code, has languished in relative obscurity because it never was able to replicate Ethereum’s network effects and community of developers.
Which brings us to the community aspect of tokens. Much of the interaction between a project and its users happens in messaging platforms such as Discord, Telegram and even Twitter. Joining these channels and engaging with the community of a project is a great way to get a sense of the direction of the project, the momentum a token has, and get answers to many of the questions you might have. In addition to community members providing answers, it’s often possible to connect directly with some of the developers of a project through these messaging platforms as well. It’s also helpful to observe how engaged the users of a platform are or if developers respond to requests and bugs in a timely manner.
The crypto ecosystem is still early and rapidly evolving. Over time the ways tokens are valued and analyzed will become more standardized similar to how valuation methods developed in the traditional financial system. However, therein lies the opportunity as well because with a little work, it’s much easier to gain an edge in the crypto market today than it is in the traditional financial markets.
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Disclaimer: This is not investment advice. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. All Content is information of a general nature and does not address the circumstances of any particular individual or entity. Opinions expressed are solely my own and do not express the views or opinions of Blockforce Capital or Onramp Invest.
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