Guide to Evaluating Crypto assets
When funny money enters the crypto void...
Crypto is a nascent and quickly evolving field with no standard valuation models nor financial reporting to the standards of equities.
To make matters more confusing, given the fact that interest rates have been converging to zero over the last decade+, there is more liquidity in financial assets than ever before in modern history, Fed’s continued QE, valuations have become a very ‘relative’ thing.
Plus, consider the idea that most cryptos around today won’t even exist in 5 years as the technology, competitive marketplace, and use cases continue to evolve.
Many dead coins from 2017 cycle are NGMI.
According to Steidelmeyer’s Auction Market Theory, consider also that price is an advertising mechanism.
Price only denotes ‘fair value’ at a certain point in time.
For the purpose of evaluating crypto assets, we do not care so much about price as we do about quantitative and qualitative factors such as usage metrics, product-market fit, and the competitive landscape especially across comparable assets, and more.
Narratives and market needs will shift, use case will evolve (and market participants will revalue the asset), and price will do its thing.
My aim as a crypto asset researcher is in:
Increasing understanding of specific protocols / networks / assets to market participants
Deriving insights from data/observations to further understanding of subsectors, themes (tokenomics, governance, etc.)
Helping the crypto space set standards for key sector metrics, over time develop frameworks for valuation, financial analysis
Traditional Methods of Analysis
Discounted Cash Flow Modeling & Analysis
Comparable Analyses across protocols
These valuation methods can be applied to cryptocurrency protocols.
I will expand upon these later in an update to this post or a later post.
CRYPTO-SPECIFIC ANALYSES
Non-Exhaustive (but covers many things) list of factors…
General Coin Information
Read the whitepaper — especially the abstract, use case, conclusion, and more specifically any section pertaining to token economics and governance
Problem solved & product-market fit, product and mechanism design
How scalable?
TPS and transaction time
Team history, team dynamics and experience, & competitor environment comparison.
Note that teams in crypto often can be pseudonymous and depending on the scope of the project (especially in DeFi due to regulatory uncertainty), this may not be a bad thing entirely but is something to keep in mind; it could be a DAO as well.
Ecosystem development & roadmap
Token use case — what is the token needed for? If the use case is not well defined then why will it have value to market participants?
TVL (total value locked) for DeFi — how much disparity exists between the current day leaders in DeFi? Resource to check this. Another resource here.
Total Value Locked signifies that investors have deposited their collateral and assets into the protocol.
NVT - network value to txn ratio over D1 assuming volume has a direct relationship to value- has limitations. Should more txn volume always mean more network value? Is txn volume a good indicator of the ‘worth’ of a protocol alone?
Revenue — protocols can earn revenue (fees) from various actions including fees paid to liquidity providers, interest paid by borrowers (e.g. MakerDao), fees paid from collateral liquidations (many DeFi lending markets), trading fees (many automated market makers), and more. Revenues can also be adjusted for inflation.
Does the protocol revenue accrue to holders of the token at all and if so, how much?
Risks, potential failure of product market fit, technical risks and exploits, always consider a bearish thesis
MCAP/TVL for DeFi, MCAP/Revenue
Do any notable VC’s already back the project such as Paradigm, Polychain, a16z, etc.?
This is not foolproof, they can be wrong and their ‘hurdle rate’ can be high to compensate for their expected failed investments, but they tend to have more experience navigating this field and one can get a better sense from their analysis. If possible, find the VC firm’s publication on the project. Example of report on Rune from Multicoin Capital
Token Economics
Token inflation rate, allocation, vesting, supply, lockup, staked, circulating supply, absolute FDV — Fully Diluted Value.
Dynamics of current supply and maximum supply should be noted.
FDV is the total market capitalization if all of the tokens were to enter circulation.
Large differences between the current market capitalization vs. the FDV can mean that over time, much more tokens will enter circulation which may lead to increasing sell pressure on the open market.
Therefore it pays to understand factors like token unlock scheduled (when do vested tokens get unlocked at which point they may be sold on the market?)
Tokens are often allocated for the founding team, advisors, etc.
There is usually a vesting period to ensure they have skin in the game and do not sell the tokens on the open market too quickly.
One can often see information about this from the website, ask the team directly, or check the code in the project’s GitHub.
It is important to note when any locked tokens can be sold. Find information regarding funding rounds, the price those tokens were bought for, and what else the initial token distribution looked like.
Fees generated and paid — e.g. bids by users (ETH gas):
Concentration of holders, wallet demographics — this can help see how distributed the token supply is vs. how concentrated it is amongst fewer holders which has implications for price stability
Sharpe ratio (compared to BTC)
Asset halving periods and date of maximum supply cap if relevant
Network effect
User behavior, sentiment, e.g. dogecoin vs ADA users will have different risk tolerances, time horizon, staking activity, etc.
Daily unique addresses/wallets, Daily transaction volume and trading volumes vs. market cap
If any bridges exist e.g. bridge from ETH to AVAX for example, one can use blockchain explorer or dune.xyz to see bridge volume and more txn volume.
Number of exchange listings esp. major US exchanges or other top exchanges such as FTX, Binance, Coinbase, Kraken, Gemini.
Audit their social media followers- twitter, telegram, and discord. Pay attention to any notable crypto community figures that follow the account or are involved in the community.
Search trends on Google for the project, notable media mentions and any partnerships, sponsorships, or adoption announcements.
Governance
Is there a foundation that leads governance or any company that holds a large amount of power?
Check the GitHub for commits and get a sense of the developer team doing said commits.
Understand decentralization at different levels such as at the miner level, nodes, voters, exchanges, etc.
How active is the community? Check their Telegram and Discord if relevant, look for signs of interaction and how easy it is to be able to talk to someone on the project’s team.
The team is incentivized to talk to you since they have a vested interest, and financial interest, in seeing the project succeed, word getting out, and larger investors deploying capital.
If an on chain governance system or voting system exists, see how active participation has been in the past.
How are protocol changes executed and how is development funded?
Always consider the scope of governance risk that may exist, i.e. economic parameters may be changed that can affect any end user and investor that may or may not have any say in these changes, or how frequently said changes can happen.
Other
Vulnerabilities and security — hashrate and its distribution, chance of 51% attack
Has a hack happened before and what was the vector? Has it been fixed?
Regulation esp. regarding US agencies. Refer to the US SEC Howey test to determine whether or not an asset may be considered a security and therefore pose regulatory risk for US persons.
More sector-specific analyses that may be covered in future pieces, i.e. metrics that may differ across lending protocols vs. DEX’s vs. derivatives.
BTC pair, ETH pair, compare said ratios to other Layer 1 protocols.
This last point is more a technically driven analysis than fundamental but since many market participants are looking at the same ratios and pairs, it can help understand price targets and inflection points price action wise in relation to price history in the BTC pair as the total market cap of the entire crypto space as well as that of BTC grows
Other quantifiable factors — see raw quantitative data from aggregation sources such as Dune Analytics, Nansen.ai. For example, one can use queries on Dune to explore volume across DEX’s on Ethereum, here they are ranked by volume with market share also shown.
%D market cap total (e.g. ADA.D, SOL.D, etc.) — this shows the % of Total Crypto Market Cap the coin in question has achieved.
Remember that markets are forward looking.
What will cause the asset to re-price and the market to create an imbalance of either demand/supply?
An upcoming catalyst?
A news driven event that causes the market to see the asset in a new light?
How is this asset priced relative to peers and to its own previous price history?
Does this asset belong to a vertical in growth or decline? E.g. Metaverse projects are currently in the forefront due to Facebook’s rebrand as Meta and focus on the metaverse.
In a future post over the next 2 weeks, I will do this sort of analysis for a Top 50 coin.
Then later I will done one for a <1B USD Market cap. and <200M USD Market cap.
Whenever possible for the metrics above, use primary sources such as the original whitepaper, transparent blockchain explorer data, and institutional aggregation sources such as Messari.io & The Block.