A Qualitative Framework for Investing in Digital Assets
In the future, look out for articles that evaluate coins based on this framework.
Evaluating a cryptocurrency is similar to a VC evaluating an early stage business. It involves a high degree of speculation, and willingness to take high risk in return for outsized reward. The failure rate of projects currently trading on open markets is likely to be the same, if not higher, than the failure rate for start-ups (which hovers around 90%).
With this in mind, it is important to develop a robust framework that allows you to make intelligent decisions. Digital assets are the only investment open to everyday investors that is not heavily regulated, leaving vetting to individuals. Due to this, we are seeing massive speculation (and in January of 2018, a massive correction). A lot of projects that do not fulfill basic investment criteria have reached 100M+ valuations!
In this article I will be walking through the main questions that we ask when deciding which assets to add to our portfolio, so that hopefully you can avoid the next bitconnect.
Not every question will be applicable to every asset. There are many different types of digital assets with wildly different goals. It is left to the reader to decide which parts of the framework are valuable.
Outline of our Investment Framework
1. Project Overview
3. Business Case
What is the purpose? Summarize the purpose of the project in a paragraph and get down the salient points. Once done, ask yourself: is this really needed?
When was the project founded? Get background on the formation of the project.
What is the current market cap? Projects with larger marketcaps usually indicate lower risk with lower reward. Also be sure to look at the implied market cap, which takes into account current circulating supply. If only a small amount of tokens are circulating (<50%), the token may be overpriced.
What is the current 24hr volume? Higher volume means your investment is more liquid. This is important when in investing in a low cap coin.
What type of coin is it? A strong portfolio consists different sectors of coins. The main types are: Product (Has it’s own Blockchain), Utility (Product on another blockchain), Pure Transactional (Public), Pure Transactional (Private), Blockchain Services (Off chain solutions, providing interoperability), Protocol, Stable (Probably not the best if you’re looking for gains :)
Do they have a strong development team? Schooling, previous projects, GitHub activity, advisory board, etc. Enough developers to complete roadmap goals? Often you’ll see a small team with lofty goals. Team is the most important part of any start-up. If you were going to pick one criterion to judge, this would be it.
Why does the asset need blockchain to succeed? Many “assets” could just be called start-ups. Most do not require blockchain and only use it as a funding mechanism or a buzzword to attract outside investment.
Is the asset innovative? Does this asset introduce new or improved technology that solves a problem, addresses market need or creates value for network participants? If so, is the new technology explained/proven out in depth?
Have they built their own blockchain? What type of blockchain is it? Being a token is not necessarily a bad thing, but building out your own technology indicates greater upside potential. If they have, is it public/private, permissioned/permissionless. If it is private and permission, do they really need a blockchain?
Are there developers outside the core team working on the project? Projects with a large amount external stakeholders are usually more technologically sound than projects worked on solely by a core team. This is one way to judge the strength of a project if you are less technically savvy.
Is their white paper well done & technically sound? Even if you are not technical, there are ways to tell if a white paper is good or not. For example, if it looks like a powerpoint it’s usually trying to hide lack of content with flashiness. Does it include fluff, or unnecessary sections? Does it feel like it’s for marketing? (It shouldn’t). Is their vision clearly explained? Do they detail the risks as well as the opportunities? Whitepaper reading is a skill in itself.
Have they achieved roadmap goals? What is already developed, and what needs to be developed? Has mainnet launched? Has testnet launched? Do they have a working wallet? Do the roadmap goals look achievable? Now this is different when evaluating an early stage project, but for established projects looking at their history of delivering is important. Also, understanding what they still have to do & when they plan to deliver it can help predict pumps…
If it is a token, is it blockchain agnostic? Success is based on the performance of a platform indicates a lack of foresight on the project. If they have no plans to address this, that is a red flag. For example, both Modum & Ambrosus are attempting to build out a chain for medicial & food shipment tracking but only one has structured itself to succeed even if Ethereum fails.
Is the technology sound, secure or proven? It’s OK to have unproven technology, but the team should have a history of responding thoughtfully and completely to potential issues. If issues raised by the greater community have gone unanswered by the development team, be wary of the project.
Is the team well positioned to succeed in this market? Do the founders have success in this area already? Are the relative newcomers? Any advisors on the team with deep experience? Do you trust the team to overcome obstacles? If you’re making substantial investment, I would encourage reaching out to the team and talking to them directly.
What is the addressable market? Is it large enough to warrant the current valuation? Often times you will see assets with large valuations even though their addressable market is quite small.
Who is the end user for this? What are their incentives for using the end product?
Is there a clear vision & roadmap outlined? Make sure the founders can present their vision with absolute clarity. Having too many different avenues of attack is a red flag. Usually projects trying to eat the world one piece at a time do better.
Is there anything in production or current uses? Is the product being used in any meaningful manner? What are the potential use cases, and how far off are they from being in production?
What does the competitive landscape look like? Is the project a leader? A follower? With frameworks built out for all competitors, how does it compare? This is a great question when valuing potential investments. Small caps often have large caps pursuing the same goal. By comparing the fundamentals of both, you can get a feel for a valuation of the small cap. At Ledger Capital, we do this constantly by placing “asymmetric” bets on small caps we believe are almost as proven out as their large cap counterparts but priced at 1/10–1/100 the price.
Is this competitive against current centralized solutions? An extension of “does this need a blockchain”. Perhaps this project will be more competitive then existing blockchain projects, but will lose out to a centralized solution.
How did they fundraise? Did they have an ICO? Airdrop? Pre-sale? Be wary of projects that sold out in a pre-sale as they have massive concentration of token supply. Just know how the initial token supply was generated and if there were any issues with the process.
Are their operations in order? Have they used funds in a intelligent manner? Is there transparency? Thoughtful cash management is important for the long term viability of any project.
Are there external stakeholders? A good sign of success is investment from outside stakeholders. Watch out for big names. Don Tapscott and Tim Draper are brilliant, but throw their money at a lot of projects. Their investment does not mean they are the best projects in the space. There are some prominent investors that sell their name to sub-par projects in exchange for cash. Don’t forget to vet the investors!
Crypto & Token Economics
Is the governance structure well designed? How are people incentivized to act in and improve upon the network? Identify the stakeholders, power brokers and influencers. Does the governance structure ensure an fair & streamlined decision making process?
Has the network experienced growth over time? Look to see if there has been significant adoption in terms of nodes/mining etc. You want to see a robust ecosystem growing.
Is a token necessary? Is the unique token required or can it be substituted for ethereum/bitcoin? Many projects will have tokens that are fundraising mechanisms and little else. The token should be indispensable to the functioning of the system. It should provide incentive for interacting with the system. This could be a whole article by itself…
Is the token well designed & distributed? Inflationary? Deflationary? What is the circulating supply?
Is the token distributed in a fair & equal manner? A token that is concentrated in the hands of the team with low circulating supply has inflated pricing. Fair distribution is key in having a successful project, as it is indicative of a stronger, more decentralized network.
Is there liquidity? The number of exchanges that support the asset, the 24hr volume. A good indication for an underpriced project is high volume relative to market cap in addition to listing on a small amount of exchanges.
Is the community large? Look at telegram, reddit, discord, twitter, bitcointalk. How many people are talking about the project? Small cap but large community is always a plus.
Is the community excited? What is the vibe of people interacting with the project? Are they excited, scared, etc. How are people talking about the project?
Is the community engaged? Are there people actively engaging with the project? Using it in daily life, building out supporting projects, etc. Any community that takes an active role in furthering the projects goals is a good sign.
Is the community mature? If there are an abundance of memes vs intelligent conversations that is something to take note of.
Does the team interact with the community? This is probably the most important. Projects with a responsive and interactive team generally come out on top and indicate a certain level of seriousness about a project.
Is it more or less likely to be regulated than its peers? Privacy coins, potential securities and ponzi schemes seem likely to be regulated in the near term.
Hopefully when you come across a new investment, you can now more accurately judge whether it is a good investment or not! Feedback, questions and angry comments are always welcome.