Great Crypto Projects Aren’t Always Good Investments

Ignore This Reality at Your Peril as a Cryptoasset Investor

Five components of Investability

Disciplined Well Structured Capital Allocation Process
Proven Natural Demand (adoption increasing over time)
Mechanism to Capture Value
Brand
Defensibility

When investing in something you want to make sure your money is well spent via a disciplined well-structured capital allocation process. Capital allocation encompasses the ways projects can deploy their funds to increase the value of the related token.

Does the project have processes in place to get contributions from external parties? Things like bug bounties or a dedicated pool of funds targeted for rewarding outside contributors.

What about funds for growing the ecosystem, dedicated developer funds to invest in applications using the project as its foundation?

Maybe the project forsakes these temptations, choosing instead to dedicate the majority of funds to building out an internal development team if they hire well this may be the way to go.

The key is to understand what the project is spending its funds on and whether this spending has the potential to deliver value to token holders. Tossing funds around to win the press release game is not sustainable. If a project you’ve previously invested in does this. I’d view any associated price spike as an opportunity to take some money off the table.

As an investor, it’s important to recognize. Technically shit projects can turn into great investments if they deploy their capital to build a brand.

Brand

While no cryptoasset to date has been able to compete on brand alone. It is an important factor to consider with the potential to become a dominant one given the number of funds raised in the space in 2017. The way a project manages its brand can be one of its most powerful differentiators.

Take Tron, with no technical achievements of note it was able to buy BitTorrent, an extraordinary technical achievement. Due to the amount of capital it was able to raise from the marketing savvy of Justin Sun.

It started out as a hype machine with a plagiarized white paper.

And

Now has the opportunity to become a significant project because of the war chest it acquired as a result of its positioning and associations with prominent Chinese business people like Jack Ma.

While technologists are understandably dismissive of these types of projects, investors don’t have the luxury of discounting this approach.

Even if you decide you don’t want to invest in these types of projects, you need to be aware of their potential to impact your investments as a risk factor. Examples abound in the history of technology of companies with superior products being bankrupted by competitors with inferior products and better branding.

There is no reason to think crypto will be different as it attracts more and more users. Scrappy underfunded teams with elegant technology may not realize returns on their projects. If there is an abundance of well-branded competitors doing a better job of generating network effects by drawing more users to their platforms’ even if their technology is inferior.

So assessing demand is critical as an investor to determine whether a project is gaining traction.

Proven Natural Demand

When trying to assess demand. Activity is more important than volume. A project with more active addresses and higher transaction volume has more proven demand to me than one with lots of addresses.

Verifying demand is tricky. Trying to separate actual users of a product versus speculators can be less than straightforward. Further compounded by the fact in some cases the drive to speculation is fueled by usage of the product.

Coinmetrics.io provides the cleanest data in this regard as they attempt to separate on-chain transactions from speculative activity, requiring an on-chain transaction for an address to be considered active.

Author’s note – If you don’t want to download and aggregate data directly from coinmetrics. Onchainfx sources their active address and network transaction data from there.

Mechanism to Capture Value

The value projects deliver makes them exciting. The value projects capture determines their investability. You are looking for moats. What does a project offer to incentivize users to keep using it versus defecting to other options?

Historically companies capture the most value from having direct relationships with end users. Google and Facebook are the prime examples of two companies who do this extraordinarily well. How they built business models to do so is outlined by Ben Thompson here.

TL/DR: Google and Facebook control demand for the abundance of information in the world with the user experiences they provide. Using their UX as a moat to capture value from users, disrupt the business models of incumbents, and cripple the efforts of potential competitors.

Their success has been a motivating factor behind many of the prominent crypto projects coming to market today. Giving users more control over their data and enhancing privacy via permissionless entities. In response to the lapses of judgment and potential for abuse from incumbent centralized providers.

UX is an overlooked mechanism to capture value in the cryptosphere. While Facebook and Google are outstanding technical achievements, the ease of interacting with their platforms is what has driven them to dominant market positions.

The most elegant technical solution will not turn into a good investment unless it is able to attract users. Since UX is underdeveloped projects able to deploy superior UXs will have the opportunity to capture more value than technically superior competitors.

Governance is another mechanism projects can employ to capture value. There are tons of Bitcoin forks out there. Some having done quite well for themselves while others have fallen to the wayside. The most interesting one to me is Decred.

Unlike some teams, the Decred team didn’t fork Bitcoin to make a quick buck. They recognized the technological elegance of Bitcoin while feeling additional value could be added by incorporating formal governance mechanisms into a blockchain project. Working to create a distributed governance process giving token holders a voice in the project's direction and hopefully rewarding holders with price appreciation as this process accrues value to the project over time.

Note - The strength and size of a cryptoassets community is a robust mechanism for value capture as well.

Defensible

Sustainable value capture in the cryptosphere is elusive. Because it’s elusive anytime a project figures it out you can be sure there will be fast followers looking for their piece of the pie. Mechanisms used to capture value have to be defensible to deter entry by potential competitors.

Projects with steeper learning curves are more defensible. Expertise in building distributed computing systems is limited. Presuming a project isn’t layering on complexity for complexities sake. The more challenging it was to build its initial components the more defensible it is.

In this regard native projects are preferable. Building a native project requires cumulative experience that is not easily replicated. If a native project gains traction being the incumbent provides a layer of defensibility against rival projects looking to get into the space.

Contrast this to forks, attempts to leapfrog the learning curve and layer on differentiated functionality without a full understanding of the original projects subcomponents. To date, there haven’t been many successful forks outside of a handful of well-funded projects. Usually with technical talent that has defected from the original project.

The ERC-20 space were limited experience is required for a competitor to launch an alternative. Minimal technical knowledge combined with a prowess for raising funds in a questionable fashion and you’re in business.

Obscurity is underrated as well. Solving difficult technical challenges behind the scenes with the goal of eventually becoming a vital part of the cryptosphere technology stack. Is a more defensible position than the latest well-marketed fork with Bitcoin in its name even if they are unknown and lowly valued.

Pre-commitment is another dimension of defensibility. If a project was launched with a specific purpose in mind directly sanctioned or funded by another more well-known project. It has an advantage deterring other potential competitors because if its solution is adequate the well-known project is likely to adopt it over other projects it has no attachment to.