“Crypto doesn’t care about fundamentals”. Is it sustainable?

  • Cash flows and revenues can be bearish for digital assets, as they place limits on their potential valuations in line with traditional companies with much slower growth trajectories
  • “The nature of cryptocurrencies is that it cares about growth potential,” said a portfolio manager

Most cryptocurrencies die.

It is well known among those who have witnessed more than one cycle. Hundreds, if not thousands, of tokens go up, along with bitcoin and ether, but rarely – or often never – recover all-time highs.

Only 26 of the top 200 digital assets by market cap have continued to set new highs since the peak of the last bull market in January 2018.

Half were tier 1 tokens, such as litecoin, ether, and cardan. Five were governance tokens that grant voting rights that power decentralized financial protocols, such as Gnosis and district0x.

It is not a rosy image. But the outlook worsens further when defining how much a cryptocurrency is worth in terms of bitcoin, instead of the usual dollar.

Switch to the price of bitcoin and only six of these cryptocurrencies have surpassed their previous peak in the same time period: dogecoin, binance coin, chainlink, decentraland, vechain and enjin coin.

A small selection of winners, representing only 3% of the top 200 digital assets. There isn’t even a clear trend linking them.

Dogecoin is literally a “to the moon” self-parody, while the tier 1 token vechain is powered by the “blockchain for supply chain” meme.

Binance Coin boasts some resistance backed by tempting burning mechanisms. Chainlink is arguably more useful than most, supporting an extensive ecosystem of data feeds and pricing oracles, linking various blockchains and smart contracts to execute transactions without third-party validators.

The success of Decentraland and enjin coin, industry participants say, can be explained in part by the metaverse brouhaha and blockchain-based gaming dapps (decentralized applications) that are expected to grow in popularity soon.

Such spurious connections suggest that most digital assets inevitably grow in a bull market, but quickly become kaput once the hype wears off, destined never to revisit their glittering glories to make the most purchased bag holders whole.

So how do you fairly evaluate digital assets? How much is cryptocurrency worth, really?

Considering that the top 200 coins of the previous bull market fell more than 90%, in dollar terms, from all-time highs, how and why do markets decide how much to go down?

Cash flows are bearish for digital assets

Token Terminal is a platform that offers ways to understand everything. It offers a range of metrics that aim to compare various protocols, echoing traditional business valuation methods in price-to-earnings and total revenue ratios.

“Looking back, especially comparing the 2018 bull market with what we saw in 2021, it is very difficult to really build any kind of thesis as to why certain tokens are successful,” Oskari Tempakka, head of Token Growth, told Blockworks. Terminal.

The platform measures the protocols that generate cash flows together with blockchain startups that operate entirely on the chain. Protocols could not be evaluated based on these factors during the latest bull market, Tempakka said, as it was only in mid-2020, during the DeFi summer, when the first Ethereum-based applications actually started generating streams. positive cash flow for the protocol.

The bottom line: Analyzing the top-rated cryptocurrencies from the last bull, whether in dollars or bitcoin, on a fundamental basis is essentially impossible.

However, half of the top 200 digital assets that hit new all-time highs during the most recent cycle were Tier 1 assets.

Layer-1s, the backbone of digital assets, outperformed this time thanks to healthy name recognition and the efforts of legions of developers, as well as deep market makers and traders who favor assets with higher liquidity.

There has to be sizable market capitalization for a hedge fund worth over $ 1 billion to bother trading an asset, or it shifts the price needle so much in building a long or short leg that profits become obsolete.

“I’d say the thesis behind tiers 1 is that you’re essentially building an infinitely scalable regulation tier for any other application built on top,” Tempakka said. “It’s easier to build a more bullish thesis without a valuation cap than a pure application – that’s how we’re looking at levels 1 right now, at least the ones that are actually capable of generating cash flow and capturing that value. ”

Cash flows are actually bearish as they refer to trying to price cryptocurrencies. They are not a bearish metric per se, but industry participants argue that the fast-growing trajectory of cryptocurrencies requires a different picture.

Applying the core stock picking techniques of conventions would never work with venture capital-backed startups, they say, so why should it work when it comes to digital assets?

If it is possible to value a cryptoasset based on conventional fundamentals, a relatively apple-to-apple comparison with a real-world company should also be possible.

“Crypto doesn’t care about fundamentals, about traditional cash flow sense,” Hassan Bassiri, vice president of portfolio management at digital asset manager Arca, told Blockworks. “The nature of cryptocurrencies is that it cares about growth potential.”

Bassiri added: “Let’s say something like Aave or Yearn is trading at a price-to-sell ratio of 1,000, but its fintech competitor neobank is trading at 200 – is the cryptocurrency worth a multiple of 5 times higher?”

Leveraging cash flows to value digital assets, just like an Amazon or Tesla stock, implies they can’t rise forever, a kryptonite-like idea for cryptocurrency diehards.

In fact, cash flows provide a method for valuing digital assets, which automatically means they can’t rise forever, a kryptonite-like notion for cryptocurrency investors.

The result: a volatile and upside-down market that favors social sentiment and glamor over Econ 101.

Fundamental-driven markets are on the horizon

If looking back doesn’t illuminate how traders value digital assets, who can say which projects in a sea of ​​high hopes have a realistic chance of surviving the bear market?

A reason for optimism, according to Bassiri: more and more protocols are working to link real-world use cases to on-chain performance. Case in point: MakerDAO’s recent move to launch a $ 100 million loan denominated in the DAI token to the 151-year Huntingdon Valley Bank, with the potential to boost revolver credit to a staggering $ 1 billion in 12 months.

Token Terminal’s Tempakka is vying for prospects of a future where most of the best tokens are driven by measurable fundamentals and must generate sustainable cash flows to power that model.

“If you’re a traditional private equity investor, you’re coming to a stage where you can look at the cryptographic protocol’s revenue data and actually build a solid investment thesis around it,” Tempakka said.

In other words, it’s slowly – then, perhaps, all at once – becoming possible to rationalize crypto games to something more tangible than hype or belief.

Many institutional traders focused on digital assets would argue that the world is already here. Cryptocurrency hedge fund companies build complicated quantitative models around social sentiment and the ebb and flow of trading volumes.

But these players are often the first to admit that strategy-building beliefs change rapidly in cryptocurrency. Fundamental metrics are ultimately becoming powerful support for sophisticated investors – consider the rise of discretionary strategies – but, for now, they’re just one piece of the overall puzzle.

The rest is complemented by in-depth research that explores the details of the developer teams and their abilities, or lack thereof, to tackle the high and winding road that lies ahead.


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  • David Canelli
    Blockworks
    publisher

    David Canellis is an Amsterdam-based editor and journalist who has been in the cryptocurrency industry full-time since 2018. He is heavily focused on data-driven reporting to identify and map trends within the ecosystem, from bitcoin to DeFi, from crypto stocks to NFTs and beyond. Contact David by email at [email protected]

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