Valuing Crypto Assets Pt 1. — Niche Exploitation

Backstory (can be skipped if not into reading)

Recently, I was at CESC (The Cryptoeconomic Security Conference hosted by Berkeley Blockchain) and it was probably the most impressive gathering of blockchain nerds I’ve seen so far. This went way beyond the starry eyed “blockchain is going to change the world” hype; that part was already accepted. These people, all of whom were incredibly smart, were now in the “let’s get down and dirty to make it happen” phase. This meant tackling the hard problems in security, scaling, mechanism design, token economics, and all the other complicated stuff most people would rather not think about when throwing money at the next coin headed to the moon. As I spoke to others there, one common question kept coming up when I told them we watch the markets: “how are you valuing these assets?”. Now letme reiterate, these people were fucking smart. So when they asked that question what many really meant was this: “How are you valuing these assets in a way that I’m already not?”. Most were already really good at assessing the technical and economic fundamentals of an asset; so how can this process be improved?

That question has been one we, along with a lot of brilliant minds in the space, have been constantly working on. In fact, I came into CESC with a certain framework of valuation, but after I left that framework has become much more evolved, and I don’t believe the evolution is done yet.

Since I’ve been asked to experiment with different formats for the newsletter and because this seems to be a very pertinent question in the space right now, I figured I’d share our approach: in digestable chunks of course. We’ll tackle a section in our assessment framework one by one, and then give a more comprehensive view of them together.

Why not give it all at once?

Two reasons:

  1. Most people will glance at the whole thing, get a general idea about everything and forget it. I’d rather each aspect receive proper understanding.
  2. It’s actually still a work in progress, as I said the evolution still isn’t complete. But that doesn’t mean there aren’t certain aspects that can’t be discussed and considered right away, especially the ones I feel have been less valued.

Keep in mind this isn’t financial or investment advice, simply analysis from an entrepreneurs lens. So with that said, let’s get into it. I found it fitting to begin the journey with something that has been seen and mentioned everywhere else quite a bit but often gets forgotten in the high aiming crypto space: Niche Exploitation.

Niche Exploitation

Fun fact: 48% of companies founded since 1996 were still around in 2004, 4 years after the dot com bubble had burst. What was a common trait of the guys still chugging along? They had found a niche (specific market) demographic that was really into using them. Amazon started this with books, Ebay started with Pez dispensers, and some like wrestlinggear.com are still alive without ever leaving their niche (I’ll let you guess what they sell).

This going narrow in order to go broad approach isn’t new philosophy. It’s something mentioned in countless startup books in the past 20 years, and is something Y Combinator has been preaching consistently with the phrases “monopolize a small market quickly” and “it’s better to make a few people really happy than a lot of people semi-happy”. With crypto projects being more like startups (yet to be proven product/market fit and business model) than publicly traded companies, we believe there should be extra scrutiny as to what niche market(s) these projects seem to be capturing.

The Civic Case

Let’s take Civic (CVC) for example, their goal is to be the decentralized identity verification app between individuals and verifiers (entities that need your personal information). A pretty big task to say the least, but this approach can be segmented, and a segment Civic has seen promise in going after has been ICO registration. For those unaware, registering for token sales can be a cumbersome process for all parties involved, and Civic’s app can make the process a lot smoother. In fact, they probably should get a fair deal of credit for the 0x token sale being lauded as one of the best handled so far. It’s also not a shock that Civic’s token price took a nice pump right when the 0x token sale happened (mainly from speculator hype). Now, a judgement of Civic can become how well they can corner the token sale registration niche, or how well they can can exploit that niche for greater markets.

For example, Civic has also partnered with Shapeshift and it’s Prism Exchange. This works well because the likelihood of overlap between Prism Exchange users and token sale investors is pretty high. So if they capture users through the token sale sign up process, they can retain them by being the simplest method of accessing the Prism Exchange when it launches. They can then potentially use this as a springboard to partner with more crypto asset exchanges, and possibly then non crypto ones.

It’s important to acknowledge that not every market bounce will mean success, some can lead to dead ends and others (like partnering with regulatory bodies) may dissuade previous markets from continued usage. But overall growth is pretty much good, especially in crypto since network growth and asset price are often correlated.

Competitive Niches

The Civic example works well because they’re targeting a niche market that isn’t being heavily competed for, but also has room to grow their product into more serious markets. The YC rule of “monopolize a small market quickly” is quite an important one. Many crypto assets, although pursuing a niche, are facing a lot of competition which makes monopolizing the niche market difficult. When this happens first mover generally gets a big advantage, granted their product satisfies the market well, especially in an highly demanded scenario. For example, we’re currently seeing a lot of crypto projects go after the crypto-asset trading space in the form of decentralized exchanges (DEXs). It’s a seemingly niche market with a lot of competition, but there’s a highly demanded scenario in which there is a lack of market satisfaction. This is in the process of purchasing tokens that have been distributed, but not made it onto the major centralized exchanges.

Currently the most popular options for this are: Etherdelta, a decentralized exchange that is far too slow, or Liqui, a centralized exchange that allows IOU exchanges but has high fees and poor support. We know the demand is high based on the volume both register, but we know the market is unfulfilled based on how much both are also avoided until a major exchange release along with the rampant complaints among the community. Whichever upcoming DEX successfully captures this traffic first will put themselves in a promising position.

Streamlined Growth

One reason niche exploitation is so crucial is because it allows projects to focus on streamlining and optimizing resource allocation. For example, if a project knows its going after the ICO registration niche, it’ll figure out the resource costs and the hurdles in the process of partnering with an ICO and becoming part of their signup flow. The process is also likely to get easier and more efficient every time they do it, as they learn from previous mishaps. Basically, you can get a rinse and repeat network growth model. This works better for application assets (used directly by end users) than protocol assets (built on top of), but can be used for both. For example, Quantum (Qtum) is a protocol asset that requires developers to build smart contracts on top of it. However, Qtum can also carve out a niche market targeting mobile developers and narrowing further if necessary.

Quantifying for Assessment

Evaluating the niche exploitation alone is obviously not enough to judge an asset as a good investment, but we feel it’s vital to track as it’s a strong indicator of the health of the project as a whole. If there isn’t any niche market retainment, chances are your token economics will mean little and the asset is mainly speculative. Also, a lot of this can be quantified. It just requires case by case contriving and some ball parking. In the Civic situation you can generate figures based on ICO registration count, and in the DEX case you can look at the volume the incumbents register post major ICO to see what a new entrant would leech. These figures can come in handy when looking at relationships with other framework points that we’ll be covering in the future.

Past History

I’d like to add that this isn’t something that has yet to happen in the crypto space, it’s happened already. Bitcoin had great niche exploitation in numerous markets, such as countries with volatile currencies as well as in the dark web (yes, the black markets definitely had a major influence in Bitcoin’s growth). Ethereum also had it in the form of ICO’s. In the latter case, the niche actually grew out to a large market, which is the ideal. This probably wasn’t Ethereum’s goal, but finding a successful narrow market doesn’t always happen intentionally, which is part of the reason it’s pretty easy to identify in hindsight and a lot tougher looking forward. But hey, that’s what makes it fun!