It’s been a while since my last post, mainly due to a combination of laziness and lack of motivation. Btw, have you seen the image of the article? It was created with Stable Diffusion 1.4, the model with which I created my profile pic, IMO it was the first model to generate artistic/creative images, they do not have the typical appearance of images generated with AI. Sorry, let’s get to what we came for.
What is value investing?
As the name suggests, it is an investment strategy focuses on acquiring undervalued assets, where the intrinsic value is greater than the current price.
Value investing goes hand in hand with fundamental analysis, some of the characteristics that are usually looked for are:
- Low price in relation to book value: stocks whose market price is low compared to the book value of their assets.
- Significant safety margin: the margin of safety is the difference between the intrinsic value and the price, it provides protection against errors in valuation.
- Low P/E ratio: a low price-earnings (P/E) ratio compared to the industry or the broader market.
- Solid Finances: companies with strong balance sheets, low debt and consistent cash flows.
- Competitive advantage: companies with sustainable competitive advantages that allow them to maintain a dominant position in their industry and generate high returns on capital.
As a fact, Benjamin Graham is considered the father of value investing and Warren Buffett, who is the most famous and successful investor in the world, was his student.
Can value investing apply to crypto?
This is a great question, in fact, why don’t you take a few minutes to reflect on this and draw your conclusions?
Although in crypto we can see memecoins making 100x, cryptos without value or with high FDV going up and things worthy of the most bizarre circus, my opinion is that yes, we can apply value investing in cryptos but with some differences, differences that we do not take into account, decent value investing strategies for the stock market would make us lose a lot of money in crypto.
One of the biggest differences is in the fundamentals and their weight, since in such a changing/new industry, growth metrics such as revenue, active users, etc. have less weight than in stocks, since they can change very quickly, they can be manipulated or influenced by farm rewards that will eventually end, making a protocol that a few months ago seemed like a fundamentally sound bet, now a bad investment.
What cryptos could be value investments?
Well, now that we know what value investing is and we know that it is possible to apply it when investing in cryptos, the next question is: What cryptos could be value investments?
To find an answer, let’s review the characteristics of value investing and try to apply them to crypto:
Risk Free Value
The first was “low price in relation to book value” and this in crypto is known as Risk Free Value (RFV).
RFV investments consist of purchasing tokens where the value of their treasury is greater than their marketcap (MC), waiting for this valuation error to be corrected. This correction can occur in different ways, it could occur organically, where more people notice this error and buy the token until it reaches a fairer valuation, it could also occur through buybacks, where through governance, it is proposed to use part of the treasury or income to buy back the token below its fair value and finally it could be through a “rage quit” or a complete closure of the protocol, where investors are allowed to exchange their tokens for a proportional part of the treasury.
It sounds like free money, but it has its risks, many times this discount has its reasons, the first and most common is distrust in the team, since they could do a rug pull or ignore their community while doing a slow rug, draining the treasury little by little through salaries, budgets or other bad practices. There is also opportunity risk since the waiting time could be prolonged, causing us to miss other opportunities during that period.
Many of these situations have already happened in crypto, some that I remember are ROOK, Tribe DAO, NonusDAO, Nexus Mutual, Aragon, FLOOR and NFTX. Additionally, the Patagon v. Spartacus case has laid good legal groundwork, demonstrating that while this industry is young, DAOs are not immune to the law.
Another interesting case study is Concave, it probably deserves its own article, it traded below its book value for a long time, they used the treasury to participate in different seeds, they acquired Fjord for $1.5m and managed to launch it at $250M FDV and all this value is being returned to the holders. For example, you could have bought CNV for less than $4 during the entire bear market, and for each token you would have received $9 in USDC for Fjord fees, $15 in locked FJO tokens and the distribution of other seeds such as Tapioca and Berachain is still missing ( probably +$15 more per token).
Arbitrages would also fall into this category, they usually occur when assets lose their peg, such as stablecoins or liquid staking/restaking tokens trading below 1:1. Some that I remember are crETH2, USDC, stETH and ezETH. Each case must be analyzed individually, since we all know what happened with UST.
As I write this, there are some RFV opportunities, such as GNO buybacks made through this wallet, we also find the case of JPGD and HEGIC, where both tokens are trading at a large discount in relation to their treasuries, which are practically 100% ETH, so I see them as ways to be long ETH. The latest is USDR, a stablecoin that trades at $0.61 and is backed by real estate in the process of liquidation.
It is interesting to know that Warren Buffet began his career with this type of play, Berkshire Hathaway, was a textile company, which Warren acquired to reorganize it and sell it profitably, but the management was opposed to this, so he took over and the rest is history.
Safety margin
The RFV mentioned above could also be considered as a safety margin, but it is not necessary for the treasury to be greater than the MC for the safety margin, for example if a protocol has a treasury that represents 70% of the MC, this would that in the worst case, we only lose 30% of our investment. There are several protocols with decent treasuries, you can check it out on DefiLlama, many even put their treasuries to work in DeFi, such as TempleDAO and ParagonsDAO.
Low P/E ratio
Although they are few, there are profitable protocols (they earn more than they spend) and although most will have a high P/E, there will be some exceptions. However, as I mentioned previously, this metric can be manipulated or can vary greatly given the changing environment that cryptos represent.
Token Terminal is a great tool to start seeing this data, we could start with the Fee Panel, and see which protocols generate the most fees, but those fees may not go to the protocol, as in the case of Uniswap, which although it is one of the main ones in fees, 100% goes to liquidity providers (for now), that is why we have the Revenue Panel, which shows the part of the fees that goes to the protocol, but this is not enough, since the protocol could be spending a lot on incentives (expenses) to generate those fees, which is why we have the Earnings Panel that shows the revenue minus the incentives.
Another great tool to see all this data is the Defillama Fee Panel, and if you want to take another step, you will also have to consider the protocol expenses in salaries, marketing, development, etc. A good tool for this is the Defillama Expense Panel (thanks again llamas).
Taking this data into account, currently we can see that most L1/L2 have a negative P/E, the largest dapps like AAVE, MKR and LDO are starting to become profitable, with a P/S (Price-to-Sales ratio) of around 20–30.
But if we talk about low P/E, the business that comes to mind currently is Rollbit, a crypto-casino that has an FDV of $232M and if we annualize the revenue of the last 30 days, we get $342M per year, which would give us a P/S of only 0.68! If we wanted to know the P/E we would have to discount the expenses, but Rollbit is not very transparent with this, perhaps this lack of transparency added to some controversies and lack of focus from the team is the reason for the discount, imo these situations are what usually generate good buying opportunities, but DYOR since revenue seems to be declining little by little:
Another one that comes to mind is Banana Gun, the dominant trading bot on Telegram, although it has risen a lot with the announcement of the listing on Binance, it is trading at a P/S of 12, with real income, products in development and organic growth, as always DYOR.
Solid finances and competitive advantage
Let’s go with the last two characteristics of Value Investing, when talking about solid finances, we talk about no debt (it is not common in crypto but there have been cases, generally after exploits), increasing and moderately stable profitability, organic growth and productive treasury . On the other hand, when talking about competitive advantage, we are talking about a strong brand, intellectual property (for example Uniswap V3 protecting its code), network effect and liquidity, these characteristics allow the protocol to maintain a dominant position.
Lido is a great example of this, it is by far the protocol with the highest TVL ($33B vs $15B for second place), stETH has a marketshare of 29% (followed by Coinbase with 12.7%, EtherFi with 4.8% and Binance with 3.5%), in addition stETH is considered the safest LST, it is the one with the most liquidity and the most integrations throughout DeFi, we can see the users’ preference for stETH over other LSTs in the launch of Eigenlayer or Simbiotic, where the first caps to fill is stETH, by far. This is undoubtedly the best example of competitive advantage in DeFi, an organically created monopoly!
Aave and Uniswap also fall into this category, Aave has a marketshare of 37% and Uniswap with 28%, also Uniswap represents 52% of the total volume among DEXs. These two are well-established protocols, strong brands, degens feel safe lending or providing liquidity, and as that competitive advantage increases, these protocols will improve their profit margins, such as Uniswap charging a 0.25% fee on its interface , that although this fee goes to Uniswap Labs, this could change in the future.
Maker is another great protocol, it probably has the strongest financials, but I doubt its long-term competitive advantage, other stablecoins like USDC and USDe seem to be gaining more ground.
Although this is a stock, Coinbase ($COIN) is another good investment in value, with a clear competitive advantage, we can see it for example in its LST $cbTH, which charges a 20% fee, the highest in the market , since Lido and Binance charges a 10%. Coinbase has a wide range of products, such as its CEX, futures, staking services, its own L2, wallet, circle, etc.
Solana could also fall into this category, although their finances are bad, since inflation far exceeds what they generate in fees, this could be a strategy to gain marketshare (is working). In addition, it has its own ecosystem with organic growth, real users, a very low entry barrier and a great user experience.
A dominant protocol in Solana is Jito, it is the dapp with the highest TVL, with $2B, although JitoSOL only has 3% of marketshare, since the majority of SOL is staked natively, it has 48% of marketshare among the LSTs (Lido has a 71% marketshare if we apply this method), Jito’s revenue seems firm and growing, although the current valuation is quite high ($2.7B versus Lido’s $1.9B), everything will depend on the future of Solana.
Another business that I really like in Solana is Phantom, it is the default wallet and the interface is 10/10, I also consider that in the future the majority will have a wallet on their phone, not on a PC, so Phantom and its mobile app have a great advantage in this sense, it is possible that their competitive advantage allows them to charge fees for swaps (as Metamask, Rabby and Uniswap Wallet do). Although it does not have a token, I have it on my list with a high priority.
That’s all, it should be clarified that although I did not talk about tokenomics, it is another important point to investigate, I suppose that the tokenomics that go hand in hand with value investing are simple tokenomics, where most of the tokens are already in circulation and value is delivered to tokenholders in any way. Good ponzinomics can be favorable to start the project and obtain liquidity, but they will not be profitable in the long term, the only way to be profitable in the long term is to have a real product that generates profits.
I hope the article has been useful and entertaining to you, if so, share it with more people, I have no financial interests in writing, I do it out of passion, if I see enough support, that will motivate me to write more!
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