A New Paradigm for Crypto: Fundamental Analysis

Who is going to be the Warren Buffet of crypto?

January 3, 2024Michael Nadeau
A New Paradigm for Crypto: Fundamental Analysis

Hello readers,

From day one, our thesis has been that “cryptocurrencies” will mature into onchain businesses — with clear business models, cash flows, and long-term economic value creation. Ultimately, we believe that crypto (public blockchains and the protocols and businesses built “on top” of them) will grow into a universally accepted, global asset class. The technology will then slowly seep its way into internet-native business models across a wide range of industries.  As this occurs, we believe speculative and narrative-based investing will shift toward value and fundamentals-based investing.

And we’re now seeing the green shoots of this in real-time. In this week’s report, we’re sharing some recent developments as it pertains to onchain data, crypto fundamentals, and new financial products coming to crypto.

Disclaimer: Views expressed are the author's personal views and should not be taken as investment or legal advice.

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Value Investing: A Brief History

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.” 

- Benjamin Graham (the pioneer of value investing)

It’s easy to take the maturity of the traditional markets for granted today. After all, the global equities markets hold nearly $110 trillion of value — with about $45 trillion based in the United States alone. 61% of Americans own stocks, and 53% of US households participate in the stock market.  This didn’t come about by accident. Rather, it took centuries of technological and social progress to produce the market structure we see today. 

It all started in 1602 with The Dutch East India Company — the world’s first publicly traded company — which spawned the Amsterdam Stock Exchange and the birth of the stock market.

Stock markets later emerged in European cities like London and Paris in the 1800s. In the US, the Industrial Revolution brought with it a boom in speculation around railroad stocks after the birth of the New York Stock Exchange.

By the early 1900’s stock markets had become central to the world economy. However, lack of regulation and access to information led to the stock market crash of 1929 and The Great Depression. 

Speaking of access to information. Public blockchains uniquely solve this challenge — with firms like Token Terminal presenting the data in ways that can inform crypto firms, investors, and regulators. As one example, below we can see the build-up of leverage within the crypto ecosystem in real-time —  which we view as a tool for regulators. 

Back to history.

In response to the market crash and subsequent depression, governments introduced new rules and regulations — including the Securities Act of 1933 and the Securities Exchange Act of 1934 in the US, while establishing the Securities and Exchange Commission to oversee financial markets. 

It was around this time that Benjamin Graham wrote his first book, “Security Analysis,”  laying the groundwork for fundamental analysis and intrinsic value. 

Graham’s ideas were further popularized by Warren Buffet in the 1950s and 60s due to his success with Berkshire Hathaway. As value investing gained popularity in the 70s, 80s, and 90s, the market achieved consensus around financial data and core metrics such as price to earnings. Price to book. Dividend yield. Debt to equity. Free cash flow. Return on equity. Net margins. 

Along with this came investing concepts such as “economic moats,” and “durable competitive advantages.”

Of course, none of this was possible without quality data. Without the data, stocks would trade on speculation, narratives, and brand. 

Speaking of quality data. It’s well known that crypto markets have largely traded on speculation and narratives to date. But we think this is changing right before our eyes.

Because crypto has fundamentals. 

Below we have Uniswap’s fees and P/F ratio (price to annualized fees) over the last year:

Is P/F the best way to do relative comparisons of decentralized exchanges? That’s for the market to determine. But we now have quality data through which the market can draw those conclusions. 

Shifting to lend/borrow protocols — below we have Aave’s active loans vs daily P/S ratio (Price to Sales) since launch. 

The Aave protocol makes money by taking a % of interest and liquidation fees paid to its supply-side lenders. Therefore, an investor would want to understand the correlations between active loans, interest rates, and protocol revenue. 

Of course, the KPIs and metrics are different in crypto. But the core concepts remain — investors will study data to identify gaps in the market — which can inform portfolio construction. 

Financial Statements

Thanks to platforms like Token Terminal, crypto now has financial statements. But unlike traditional finance, the data is updated in nearly real-time and served to us via immutable public blockchains. 

Below we have Lido’s (the largest liquid staking solution on Ethereum) financial statements over the last few years:

Relative Analysis

We can even do relative comparisons across projects, sectors, blockchains, etc. Below we are looking at the top Ethereum L2s by fees, revenue, expenses, cost of revenue, token incentives, and earnings.

The Takeaway?

Just as Warren Buffet was filtering through financial statements in the 1950s looking for “cigar butts” (undervalued stocks with some “smoke” left), investors can now take a similar approach to crypto.  

Of course, it’s important to consider that the concept of “value” is subjective. At the core of “value” are human opinions and social constructs — which are formed via consensus amongst the market at large.

But it all starts with data. Revolutionary thinkers use the data to put forth their best ideas. And then the market will decide which ideas persist over time.

Crypto: From Speculation → Utility → Fundamentals

“Crypto is pure speculation.” 

“It’s just computer code. There is no intrinsic value.” 

“Crypto isn’t backed by anything.” 

Sound familiar? Anyone who has been around crypto long enough has heard traditional counterparts talk down on the industry as an investable asset class. 

In many instances, these folks are specifically correct in the short run. 

But we have strong evidence to suggest they are directionally incorrect in the long run.  

Why? 

As we mentioned: Crypto. Has. Fundamentals. As a reader of The DeFi Report, you already knew that. But it’s still somewhat shocking to us that this is not yet the market consensus. 

Case & point: below we have 365-day fees amongst the top 25 crypto projects. Note the power laws.

Next, we have monthly active users.

And here we have monthly active developers across the top 25 Layer 1 networks:

Up next is the Total Value Locked across the top 25 projects:

And here we have token incentives — which can be viewed as distributions of equity to early users and the supply side of each network:

Speculation & Innovation

It’s important to recognize that speculation is at the core of every innovation throughout history. Simply put, it takes speculative capital to birth new industries. We saw this with the Age of Steel and Electricity. The Age of Oil. Automobiles & Mass Production. We saw it with Railways. More recently, we’ve seen it with the introduction of the Age of Information and Telecommunications.  

With history as our guide, speculation ultimately leads to productive capital finding its way to its highest and best use. Sustainable business models eventually emerge. Infrastructure is put in place. Utility is cemented. Rules and regulations are implemented.

Ultimately the market achieves consensus concerning the best ways to use, and value the new technology (and the businesses utilizing it). 

We see this playing out today with the Age of Blockchain Technology or Web3 — which is installing a new data layer into the internet. One that introduces the concept of shared, global accounting ledgers and digital property rights.  

The foundational infrastructure is now largely in place. The tech is starting to scale. Sustainable business models are emerging. Utility is being cemented. Cash flows are being generated. And economic value is being created. 

With this comes a new set of fundamentals. New ways for investors to ascertain value. New ways to analyze onchain data. 

And the introduction of indices and new financial products.

New Financial Products & Indices

Amongst the many parallels between crypto, past innovations, and investor psychology comes the move away from speculation and narrative-based investing — toward value and fundamentals-based investing as the industry matures. 

Naturally, new financial products are coming to market — designed to give investors broad access to crypto assets with clear product/market fit — as defined by cash flows, users, value locked, etc. 

Of course, the Bitcoin ETF is top of mind for the market today. But it’s what comes after the first ETF that truly excites us. 

We think ETH will be second. And if (when?) we see the introduction of new rules and regulations for the industry, we expect to see a Cambrian explosion of new financial products coming to market. 

Instructive in this regard is the introduction of the MarketVector Token Terminal Fundamental Index — a groundbreaking approach to creating broad, fundamentals-based exposure to the best-performing crypto protocols and networks. 

How it works:

  • The index leverages onchain data from Token Terminal measuring projects with the highest fees and daily active users.

  • Includes the top 10 projects.

  • Comes with two weighting options: 1) based on fundamentals, 2) based on market cap.

Who is MarketVector?

MarketVector is one of the world's top thematic index providers, with over 177 indices created and leveraged by asset managers globally. 

Looking Forward

We said it once and we’ll say it again: crypto has fundamentals & top-notch data providers. This has set the stage for large TradFi players to leverage onchain data informing new indices. And once we get new regulations, we believe onchain data will catalyze a new era in financial innovation.

As these indices and financial products begin to proliferate within asset management firms around the globe, we should expect the next wave of “smart money” to find the highest-quality projects. 

Gaining an investment edge will require access to quality data before the rest of the market has it. 

As such, tools such as Token Terminal become crypto’s version of the Bloomberg Terminal. 

Access to quality data = access to quality information. We think this could kick off a domino effect across the industry — from regulators —> investors —> crypto projects. 

After all, the granularity of data we can observe on crypto networks is unprecedented in finance. To further our point, below are Uniswap’s retention rates for monthly active users:

We think regulators should view applications like Token Terminal as a new tool at their disposal. As a friend.

After all, Token Terminal brings transparency to the crypto markets. In fact, we believe there is far more transparency in crypto than in the traditional markets thanks to the open data structure and and real-time data services they provide. 

An analogy may be helpful to explain why. Imagine you’re trying to understand the financial health of a mall with hundreds of stores within it. Would you want to simply review a financial statement for the mall? Or would it be more helpful if you could see the financials of every store within the mall in real-time? Just imagine what it would be like to see sales happening across hundreds of stores at once. To be able to track the footprints throughout the mall and within each store. And to know exactly how the performance of each store impacts the financial health of the mall. 

Would this provide more or less protection for investors? Here’s a peek behind the curtain so that you can decide for yourself:

For a more consolidated view, below we have Ethereum’s top 10 projects based on 365-day gas fees over the last year:

And here we have Ethereum’s top 10 projects based on 365-day transactions:

Ultimately, we believe onchain data is creating a path toward compliant token launches and listings.

Below is a high-level view of how we see that playing out. 

  1. Congress and the regulators create new rule sets for projects to launch tokens.

  1. Upon meeting certain timelines and criteria (“sufficient decentralization”) per new rules and regulations, projects will issue tokens to market makers via centralized and decentralized exchanges. This is their “going public” moment. Tokens compliantly issued will meet the rules for “digital commodities” and could be regulated by the CFTC in the US — whom we expect to regulate crypto exchanges.

  1. Exchanges will need to comply with a series of investor disclosures upon listing the token.

  1. When the token lists on exchanges, the project will simultaneously list with an onchain data platform such as Token Terminal. Token Terminal becomes the Yahoo Finance or Edgar Database for crypto markets. 

  1. Third parties will audit Token Terminals data visualizations, and the listing projects smart contracts. 

  1. Buy and sell-side research will cover projects with clear fundamentals. These projects make their way into indices and new financial products. 

Crypto Projects

The takeaway if you’re a crypto project? Find product/market fit and then get listed with a platform like Token Terminal. 

It’s hard to imagine large pools of capital being able to invest in unlisted projects. These projects will be seen as “second tier” since the market will not be able to assess their fundamentals.

With large TradFi firms entering the space, listing with a data provider will allow the market to observe your project, and potentially get you added to new indices leveraged by asset managers globally. 

This means large pools of capital are more likely to find listed projects moving forward.

Investors

Get yourself a Token Terminal. Study onchain data. Read The DeFi Report. And  watch The Rundown — where we use onchain data powered by Token Terminal to identify and analyze projects with clear fundamentals and product market fit. 

Thanks for reading.

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Disclaimer: Individuals have unique circumstances, goals, and risk tolerances, so you should consult a certified investment professional and/or do your own diligence before making investment decisions. The author is not an investment professional and may hold positions in the assets covered. Certified professionals can provide individualized investment advice tailored to your unique situation. This research report is for general educational purposes only, is not individualized, and as such should not be construed as investment advice. The content contained in the report is derived from both publicly available information as well as proprietary data sources. All information presented and sources are believed to be reliable as of the date first published. Any opinions expressed in the report are based on the information cited herein as of the date of the publication. Although The DeFi Report and the author believe the information presented is substantially accurate in all material respects and does not omit to state material facts necessary to make the statements herein not misleading, all information and materials in the report are provided on an “as is” and “as available” basis, without warranty or condition of any kind either expressed or implied.

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