Dec 11, 2021
Defying Crypto Markets, Gamestop Style: Understanding Deep Value Investing
Remember that Reddit user who made $50 million dollars on a Gamestop trade? Check out some of his content (here’s his Youtube channel) and you’ll begin to see that there’s a legitimate and replicable framework for the consistent value extraction behind his market-defying performance.
Even better news? The style of investing that brought him ludicrous success in the stock market is largely applicable to crypto markets for just about anyone with a bit of knowledge and experience who is willing to put in the elbow grease.
So keep your Twitter directional traders, your signal groups, and your beta-alpha-gamma-Fibonacci technical analysts. We’re on a mission today — no, a quest. A quest for what Keith Gill (AKA Roaring Kitty) calls deep value.
The basic idea, when applied to crypto: the biggest blue-chip cryptos are rewarded with the most analyst coverage and investment simply because they are the biggest blue-chip cryptos. Success and attention begets success and attention even when the value available is obscured and overcrowded. And by looking elsewhere, by specifically seeking out the overlooked or written-off, we can find asymmetries that will help us outperform over long periods of time.
Asymmetry: the Fundamental Concept of Deep Value Investing
Deep value investing turns the prevailing narrative on its head. What if, instead of looking for consensus, we looked for an absence of information — crypto protocols that have little to no analysis available, that are ignored for some reason, or that are trading at massive discounts to similar protocols or prior all-time-highs.
In this dark underbelly of crypto, we’re looking to discover asymmetry: there is no reason to be afraid of potential losers as long as we have an above-average chance of finding winners.
Take the above graphic: while deep value might underperform over certain time periods, we’re looking to extract value in big wins, in black swan events, in huge pumps that verify that our thesis was correct all along.
To find these asymmetries, we seek out ideas and catalysts that can drive explosive sentiment change: cryptocurrencies in the dumps, that, with just a bit of help or an innovative change, could flip around at a moment’s notice and pump in price. The possibilities of these radical turnarounds are often undervalued by markets and can represent a buy opportunity with an asymmetrical average expected return.
Seeking Fundamental Discounts
Cryptocurrencies are incredibly hard to value: truly decentralized protocols don’t pay taxes, take on debt, or even exist in physical jurisdictions. So many of the common ratios that are used in traditional finance are simply irrelevant or nonsensical.
What can you do? Compare the protocol to other cryptocurrencies based on the metrics that do exist: plenty of cryptos have cash flows, buybacks, or staking yields. Token emissions are important to look at to understand inflation, and user growth/total value locked are both universally looked at for a reason. Make sure you’re weighing protocols against each other in a sensible way: lending platforms should be compared to other lending platforms, DEXes against DEXes.
For an example, take this table we made for a Crypto Pragmatist Pro report comparing some decentralized exchanges. We looked at daily volume and compared it to market cap to see if some protocols stood out as over- or undervalued.
Sure enough, Trader Joe ($JOE) looks like an absolute steal, turning over twice as much daily exchange volume as its market cap. As other protocols do less trading volume on 3x the valuation, $JOE might be worth a deep dive. Sometimes, you’ll find a red flag that explains away some or all of the undervaluation. But when you can’t find one, you might be looking at a deep value deal.
Wallet Analysis
Since most cryptocurrencies exist on a public ledger, small-scale investors have a tremendous advantage: they can look at so-called whale wallets to copy wealthier and more successful market participants. Take a look below at this $350 million Ethereum wallet that’s considered one of the holy grail wallets of DeFi:
These high-value wallets can often give us insight into what expert participants are doing with their capital, how smart money is allocating and if they’re in the process of moving into higher risk, smaller-cap positions or if they’re in the process of derisking.
You don’t necessarily have to just look at whale wallets worth hundreds of millions, though. Just looking at wallets that have large ownership stakes in a single protocol (insiders) can be tremendously helpful to signal good buy opportunities. Lots of selling? That’s a bad sign. A lot of large buying in wallets that already own the assets is often a buy signal.
The quote from investor Peter Lynch applies here:“Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.”
Thesis-Based Investing
When looking a cryptocurrency from a deep value investing approach, we’re not looking for something with strong sentiment, a good social media presence, and all-around rising growth numbers. We’re most often buying an asset for a single theory or concept (thesis), waiting for that thesis to be confirmed or denied, seeing price respond, and then pulling our investment out.
Take for example Trader Joe ($JOE), which we previously discussed as undervalued. If the discussed ratios suddenly flip, Trader Joe pumps 5x, and now the protocol becomes overvalued relative to its volume when compared to other exchanges, it’s probably a good time to sell.
Or say we buy based on insider movement, but then the token price dumps and those same insiders pull their investment out. That might invalidate our thesis on insiders knowing something the market doesn’t and could be a signal to cut losses.
Deep Alpha
There are many asymmetries to be found in crypto, especially with this deep-value, smart-money investing style. With a lack of analyst coverage, low liquidity, and anonymous development teams, a minefield of dying protocols and rug pulls gives way to tremendous opportunity as you realize the power of seeking out fundamental value in overlooked, smaller-cap altcoins.
One thing that can be important is creating a network. Establish yourself on social media. Anonymous accounts are ubiquitous in cryptocurrency Twitter. Once there, add value to the conversation. Ask questions, write threads on what you learn. Before you know it, you’ll be participating in private Discord and Telegram groups with plenty of alpha available.
The final step is getting onboarded to on-chain analytics platforms like etherscan.io and other blockchain explorers. Zapper.fi helps you track whale wallets, there are abundant paid and free options for all the crypto analysis you could dream of.
Managing a Deep Value Portfolio
Managing a deep-value portfolio requires the recognition that inefficiencies exist in the market. Any investor who thinks all inefficiencies have been arbitraged away is better off allocating to blue chips or indexes.
Thus, a deep value investor must change their thinking to truly outperform; instead of looking at an asset and asking ‘what does the market know that I don’t,’ they must begin to think: “what do I know that the markets do not.”
Portfolio Organization
At Crypto Pragmatist, we frequently talk about managing portfolios like a venture capitalist. This is the style of investing typically used when investing in smaller-cap cryptos, and in our experience these buy-and-hold strategies are both simpler and more profitable. We’re not really looking for 50% swings over a month, but for 10-baggers (or even better) over a year or more. And in crypto, they’re not necessarily that scarce.
Because deep value investing ultimately produces lot of losers, to protect ourselves, we have to diversify. So how do we organize positions? Dividing them up into small sections of our portfolio and riding them out. Ten or more positions is common, even 25 or 50 2% investments might be right if you have a larger amount of capital (and time). Since we’re investing longer-term, we don’t have to be watching them every minute, just waiting for a denial or confirmation of our thesis.
A quick note: people who invest in this way typically have a minority of their net worth in these high-risk positions. Although deep value portfolios might outperform in meaningful ways, it’s important to be hedged for the downside. Also, because this style of investing relies on the market discovering value and bringing it up to fair valuations, profits must eventually be rotated out of high-risk positions into safer assets or newer, undervalued ones.
How to Size Positions
While scaling up is important and doubling down on winners when momentum shifts is a good skill to have, it’s vital to avoid overallocation. This strategy automatically allocates higher percentages of your portfolio to the winners as they grow, so starting things off with an even, small-ish percentage of your portfolio is probably the way to go.
How to Take Advantage
The type of investing we write on at Crypto Pragmatist is probably best classified as ‘Deep Value’ investing: we look for large asymmetries, big discounts on cash flows, quantifiable (but sometimes obscured) value, and seek out positions that often go against market consensus. And ultimately, this has brought us a track record of success.
While this research can be taken on by individual, and all of these skills can be learned and developed, we consolidate our research in our Crypto Pragmatist Pro reports, where we preform deep analysis on specific altcoins. That’s where we make the money that supports this free newsletter.
If you’re interested, please check it out! You can subscribe with a month-long, risk-free guarantee here. If you’re not interested, please ignore and excuse our self-promotion.
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