By: Social Graph Ventures

Compiled by: TechFlow

This post discusses the criteria we use at Social Graph Ventures when evaluating venture investments. I call this the token durability and profitability criterion, which is unique to cryptocurrency venture investing because token generation events enable early liquidity.

Today, 95% of the crypto deals we cover include token warrants, agreements for future tokens (SAFTs), or some legal clause that spells out how early investments will be converted into tradable tokens when the company decides to launch.

The way we evaluate these token risk trades is: either they are durable or they are profitable.

Durability

A durable investment thesis is when the value of a token remains stable over time. This means that the project has a clear path to create a continuous stream of revenue that can add value to the underlying token. The token has a flywheel effect that aligns stakeholders. The token governs the use of these revenues and derives value directly from them while controlling the future of the project. It's a very elegant model. Sometimes, a durable thesis doesn't even require issuing a token.

When evaluating a theory of durability, you should ask yourself:

  • Do I believe these founders are fulfilling their life’s mission? Is this going to be their life’s work? What happened in their lives that put them in this position?

  • Does the current product have clear traction that will justify a steady revenue stream now or in the future?

  • Is there a token model flywheel that accelerates the project’s path and is still sustainable 10 years from now? There are many more, but these are the basics. If the answer to these questions is yes, then you have a durable project.

Profitability

On the other hand, we have the profitability thesis, where as an investor you need to assess the potential exit value of the token once it goes live.

The poster child for this theory is memecoin. The token is not backed by any revenue. Its value relies on attention, community, and speculation. Its value fluctuates wildly, and except for a few memecoins (or NFTs) with strong brand value, there is little reason to think it has durability.

In a similar space, there are also a number of “utility token” projects where there is really no clear logic for how cash flows are tied to them. The company may generate cash flows, but those cash flows may flow in whole or in part to equity holders. This dichotomy makes these digital assets very ambiguous and difficult to price.

When evaluating your profitability theory, you should ask yourself:

  • Has the team been able to create a strong brand and community?

  • What is the token unlocking schedule for this deal for me and others?

  • What is the story behind this and how long will it last after the tokens are unlocked?

  • At what valuation did I invest, and at what valuation do I think it will trade at TGE and at different points in time?

Durability vs. Profitability

Obviously, evaluating durability is more challenging than evaluating profitability. Both can generate returns for your portfolio, and that’s where the dilemma lies. Further complicating matters is that profitable trades can sometimes generate returns faster and have higher internal rates of return (IRR) than durable trades.

This is similar to value investing and trend investing in traditional finance, but at an earlier stage, the market is less efficient and legal gray areas are everywhere.

We would like our portfolio to consist entirely of durable projects, but this is difficult to do, and missing out on a profitable trade may not be a wise choice at the time. The opportunity cost of a profitable trade in the cryptocurrency space is very high. This is why we see many "VC tokens" experience booms and busts. This is also why those who enter the market early have the most profit, while latecomers often gain nothing.

To sum up: we try to make your portfolio as durable as possible, but we will not give up those "left-brain" trades that may bring profits to the portfolio. ("Left-brain" trades generally refer to investment decisions based on logic, analysis and data-driven)

This article is for informational purposes only and does not constitute a recommendation to buy or sell a security or to pursue any particular investment strategy. This article should not be relied upon as an evaluation of any investment or any particular investment strategy. You should consult your own advisors regarding business, financial, tax, legal and all other relevant matters regarding any investment. The views expressed in this article reflect the current opinions of the author and do not necessarily represent the opinions of Social Graph Ventures LLC.