How to make it in crypto. Part 3

We already discussed overall what crypto is, why it matters, and how to time the market better. Now we will discuss how to find exact projects to invest in.

Are you early?

You should always ask this question before hitting the buy button. Even now in the middle of a hardcore bear market, we have more than 15000 projects. To make it big you should be selective and just buying the project which has already made 10–100x to private investors will not make you much money compared to the risks you take. Because there are a hundred investors who are just waiting for their assets to become liquid to sell them. Again, there are too many projects to select from and if you are just starting you don’t have the knowledge yet to find great opportunities.

Personally, I would always suggest looking for buying only when you see potentially significant structural change in the market when something that never before was imaginable now becoming a reality. For example, the recent event known as defi summer was a striking example of such change.

In the early spring of 2020 crypto community finally understood that the best way for tokens to capture value is to not reinvent the wheel and make them behave as equity — generate cash flow from protocol and give it to token holders (I talked about it here). To get this token though you need to use the protocol, and provide some value to it (the idea is great, give a token to actual users and not speculators). The first clear example of such a mechanic where it clicked for everyone was Compound, there you gave liquidity to the protocol, for example, by providing a loan to someone on the platform. In the case of UMA protocol — taking one side of the trade on their platform (eg. shorting the price of some asset). In exchange for your service platforms were giving you their tokens. You might think it wasn’t a big deal, but it was because at the same time, there was a way to incentivize defi markets to move money around and a semi-legal way to offer equity to non-accredited investors because they were not buying it, but merely granted it for providing liquidity.

As people understood that defi has not only real products but also a clear way for value generation for tokens every defi token went literally parabolic, we all were in awe of how much money we were making just by being here early and understanding what is going on.

However, structural change can happen not only with newly launched tokens and platforms. Here we need to talk again about Ethereum, the asset that reinvented itself several times and gave incredibly profitable opportunities for investors who could recognize fundamental changes in the protocol and how they will change the market.

In 2016 Ethereum gave rise to ICOs, before launching a crypto coin you would need to create the whole thing from the ground up, consensus mechanism, code base, and get miners to mine your coin in exchange for keeping transactions going in your blockchain, get exchanges to list your weird asset… let me put this way, it’s a huge burden and very few people knew how to do that. But with Ethereum, you can literally launch a new asset within minutes, because a token is just a registry of who owns and how much of the “ASSET”. Now it’s an ERC20 standard, where everyone knows how to handle and integrate it. And to buy such tokens at ICO you need ETH, of course, Ethereum’s valuation went ballistic.

Another Ethereum reborn was at $100 in 2018, was it early? For someone who bought it in 2014 on ICO at $0.31, hell no. But when you see it in the context of a year-long excruciating bear market and simultaneously at the crisp of a new strong cohort of protocols building real products on top of it, hell yes, you are early.

So to sum it all up, be early to fundamental changes in the market or particular asset, otherwise you have a much lower chance to make it.

Product

Even if you were able to spot a structural change in the market you should find good protocols with good products that people want to use, there is no way around it. Sure, you can buy meme coins or hype, but it’s really hard to spot if you don’t have a network and quite deep expertise, plus there are a lot of pseudo-hype coins and very few projects with good products, it’s much easier to select from the later. So, at first, you should be looking for products with real users, preferably something you are using yourself.

Valuation

Things are looking great, there is a technological breakthrough in the tech or market at the structural change and you see projects which can profit from it. How to decide which projects to select? Again, the easiest way to quantify whether you are early or not is the valuation of the project. I would even specify it as a comparative valuation to a cohort of similar projects in terms of product, key metrics of adoption, level of the team etc. It’s kind of insane how little new investors are considering the valuation of the project they invest in when it literally means whether you are buying a cheap or overpriced asset. For public tokens, you should always consider valuation after you find out an interesting product.

Let’s consider an example from CoinGecko as Uniswap’s token — UNI.

Uniswap is DEX Decentralised exchange with a great product and a strong team. Look at the first line called Market cap, it is 3.828 Billion dollars, not a cheap valuation in comparison to any technology company or a defi protocol, for instance, Coinbase valuation is $16B. Also, Uniswap was founded in 2018, so you are definitely not early here. But Uni is the best defi product out here, so it’s definitely something to consider.

Now I want you to look at Fully Diluted Valuation or FDV which is 5.079 Billion dollars.

Fully diluted valuation is the total value of a project or platform, assuming all potential outstanding tokens have been issued and are in circulation, including those reserved for future issuance or allocated for team members, investors, or other stakeholders. It provides a more accurate representation of the true value of the project, taking into account potential future token dilution.

It’s actually really close to Market cap which is a good sign. Because when tokens are launched more often than not, they have a small market cap and comparatively high FDV, which literally means that protocol will print a lot of new tokens to liquidity providers who will sell these tokens in huge amounts and lower the price if there is not enough new buyers.

Unfortunately, for most of the projects, there is rarely a huge demand in 2–6 months to cover the printing of new tokens especially if FDV at launch already more than 200 million dollars. But quite often teams with good new products and high-profile VC investors launch at insane FDVs over $1 Billion and a low market cap of $10–40 million. Because of low numbers of outstanding tokens for a month price can make some gains, but over time these tokens are just going down due to high token inflation and no real demand.

A great example of an interesting product and a good team but a high FDV problem is Ribbon Finance.

The price chart is a never-ending story of liquidity providers and investors selling this token, price is 97% down, FDV is still $164 million, which isn’t that cheap btw in comparison to how little the product generating in fees. The greedy mistake was to launch a token at 5.5 Billion dollars with no real traction, investors who bought it on the day trading started never had a chance.

Interestingly, the market cap hasn’t even gone down much since the start, but a huge disparity between market cap and FDV, hence massive token inflation created this situation. Below is the market cap chart performance, where we can see that there were just enough buyers to somewhat sustain the market cap, but not the price with such massive token inflation.

Price aggregators are currently looking like a never-ending grave of such charts, RBN is not even a criminal case, just a colorful one. Ribbon has already gone through a bear market and the worst part for it is over. Not saying it’s a good buy, but just that it was incredibly stupid to buy such a token at launch, now it just doesn’t look great, yet not catastrophic.

However, there were a lot of ethereum copycats such as Solana, defi projects there went over the line, and you could easily find tokens with a 1 million market cap at launch and several billion FDV. Even after a devastating bear market, they are still overpriced. Their sole purpose of them was to enrich a small number of private investors and the infamous Sam Bankman-Fried fast, but the ecosystem as a whole now has an easily recognizable aftertaste of financial fraud.

Price to Sales P/F and Price to Revenue P/S ratios

I should mention that they are applicable basically to every crypto asset with one exception — Bitcoin (maybe a bit Ethereum).

P/F and P/S are new metrics for crypto and people are debating how valuable they are. Though of course they were not created by crypto, they are used in a bit different forms for companies for eternity, they literally help you to understand how fast you can get enough cash flow from the company you are buying. For companies P/E, P — company valuation, E — earnings annualized (cash that business generates after all expenses), P/E = 10 means you need 10 years to get back the amount of money you spent on a company, after that you have the company and generating fresh cash.

I would honestly say that crypto is very narrative driven and metrics not always mean a lot in short term. However, if protocol can’t generate any cash flow, people are not ready to pay for service provided and protocol valuation is several billions, you would be a sucker to invest in such project. P/F and P/S are the simplest, the most basic metrics that you can’t just overlook.

Here is SushiSwap financial metrics.

Let’s look at P/F and P/S numbers. P here means FDV, F means Fees traders paid (annually), S means revenue (annually) and calculated as Fees traders paid minus what Sushi platform pays to Liquidity Providers for their service, so S=F-(what Sushi paid to LPs from fees).

There is one caveat though regarding P/F and P/S metrics, how much money protocol is spending to attract these liquidity providers besides cut of the fees. I saw numerous people and even analysts make that mistake because they do not look deeply into protocol financial statements and actual numbers. No surprise, but most of the protocols are not making money.

In the next post here, you will learn how to understand every other metric in detail and how protocols are trying to game them. I will show more about powerful metric aggregation platforms, where to find new projects early, and how to select the best of them.