Understanding Cryptocurrency-based Projects Part I — Analysing Project Value
(Disclaimer: This post is for general information purposes only. It does not constitute investment advice or a recommendation or solicitation to buy or sell any investment and should not be used in the evaluation of the merits of making any investment decision. This post reflects the current opinions of the author and is not made on behalf of bitgrit or its affiliates nor does it necessarily reflect the opinions of bitgrit.)
Context
Cryptocurrency projects saw explosive growth in 2021, ending the year with a combined Total Value Locked (TVL) of $100 billion USD¹. NFTs also saw shining results, with a whole range of so-called “bluechip” NFT projects such as BAYC and CryptoPunks being sold for hundreds of thousands each.
Naturally, many of us have been drawn in by these massive returns but what are the drivers of value exactly and how do we know whether they’ll keep going up?
Due to the nature of both crypto and the applications that are built on it, the risk compared to traditional stock investment is multitudes higher, and is something that you should keep in mind when deciding how much to put into projects.
Many new projects only have a website, a Twitter page, and a bold slogan as the basis for their entire public identity. And yet, they go on to become amazing success stories. The key here is knowing what to look for.
Here is a list of a few factors that I immediately look for when I come across a project, though this is by no means an exhaustive list. In this article, we will be focussing on analysing project value. Our next article will be going over project price.
Analysing Project Value
1. Usefulness of Project
2. Usefulness of Token
3. Project Potential
4. Gut Feeling
1. Usefulness of Project
Projects can come in all shapes and sizes, each project attempting to provide a new service for cryptocurrency enthusiasts. NFT renting, fractionalised tokens, lending platforms, gaming — the list goes on. Let’s use an example to see how we would judge projects that we find.
“Xelsius Finance” plans to take DeFi by storm, it’s creating a new Decentralised Exchange (DEX) that allows you to trade ETH with other popular cryptocurrencies.
Will they see growth? DEXs are nothing new after all. Do they offer something extra that doesn’t already exist? Do they do the same thing but better?
Questions like these are the right ones to ask and, for most serious projects, tend to be answered in detail in their white paper or Medium page. Being able to understand the utility of what a project offers is vital — a project offering something novel helps offset the enormous risk that is inherent with investing in early-stage projects.
2. Usefulness of Token
What does the token do on the platform? Most importantly, does the growth of the project contribute to the growth of the token? Many tokens offered by projects serve strictly as a governance tool, meaning the demand for the token is based on how many users want a say on how the platform functions. Unlike stocks, tokens do not represent a percent share of the profit a service makes.
This isn’t to say governance tokens won’t appreciate, take UNI for example. It’s exactly this type of token, yet it has seen considerable growth. However, there’s an argument to be made that a lot of the growth of UNI is somewhat speculative in nature. To have the required 1% of UNI tokens to submit proposals, you would need 10,000,000 UNI, or $150 million dollars. Of course, having less would still entitle you to vote on proposals, but it’s obvious to see the mismatch between the token’s price and inherent value here. Price changes in UNI since the ICO reflect this too. While the TVL of the protocol has more than doubled in 2021, the UNI token itself is down 65% since its $45 dollar high in April 2021².
3. Project Potential
Continuing with our fictitious project example in the previous paragraph, Xelsius Finance, now affectionally known by its loyal Twitter users as XelFi, is planning to release its token, $XLF. Once released, they’ve decided to buy back and burn $XLF tokens every month through their platform’s trading fees, which in theory, will drive up prices.
This addresses the utility of their token, as its price is loosely pegged to the platform’s performance, but how will it be able to accumulate these fees in the first place? This is where the optimistic forward thinkers among us shine the most and take advantage of the opportunity. They firmly believe that XelFi will be adopted by the masses this year, just as Opensea was the year before. They already see a vision of the trending #XelFi hashtags before the tweets are even made, or the profiles posting them are created. This may sound absurd but that’s exactly how many of the big companies that we know today started, through investment by these kinds of investors. However, there are a whole lot more like-minded investors who have come out on the other end of this, where the months pass and their projects see little adoption and their tokens decline in price as the hype dies down.
How can we know which path XelFi is going to go down? I couldn’t tell you and despite what Twitter influencers may have you believe, neither can they (without inside knowledge). It’s worth keeping an eye on the general sentiment of other potential investors but everyone has different reasons and motivations for investing in a project, some not so innocent. (Advertising or “Shilling” is commonplace in the Crypto.)
There is something that you should trust though, which is your gut feeling.
4. Gut Feeling
The basic procedure for acquiring penny stocks for most private investors goes as follows: look up the financials of the company, figure out if it's undervalued, decide where it sits in the current climate, and buy the stock through the broker.
DeFi however offers a very different experience. There’s a lack of financial information available and much of the traditional process is inapplicable. Many DeFi investors are instead driven by unique concepts/ideas, speculation, and social interaction.
Many protocols have active community channels on Twitter and Discord, allowing users to both interact with one another and the development team, getting to know who and what is involved in the project on a more human level. Website design, the choice of language used, topics of discussion, and even the type of humour used in their marketing all tend to cater to a certain demographic, which if you’re included in, leads to an extremely tailored experience. (“Cozy” as it’s also been put). Couple this with the thrilling high of rapid price appreciation, it’s easy to see the draw for many; not only are these projects a perfect fit for you but they’re also fun as well.
It becomes for many, less about the value of the project and more about the value of their experience. This is of course is perfectly fine — if kept in check. A very similar experience can be found in something far less attractive, speculative bubbles (and cults for that matter). It can very easily lead to holding onto tokens that rationally should have been sold at the first sign of trouble but instead were held due to a sense of mistaken trust in the project.
Trust your gut, appreciate the level of effort that’s being put in by the team, get to know the project in and out, and interact with like-minded users. Just make sure to keep your wits about you and always question whether you’re onto a winner or being dragged into a loss.
Thank you for reading this article!
For part II, we will be looking into how we can analyse a project’s price. This is where we can apply more technical analysis into our decision and explore what exactly drives token prices.
References:
TVL Definition: https://www.nasdaq.com/articles/what-is-total-value-locked-2021-09-29
DEX Definition: https://en.wikipedia.org/wiki/Decentralized_exchange
[1] https://www.defipulse.com/
[2] https://www.defipulse.com/projects/uniswap
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