Author: Octoshi
Compiled by: TechFlow
What is value investing?
As the name implies, value investing is an investment strategy that focuses on acquiring undervalued assets whose intrinsic value is higher than their current market price.
Value investing is often combined with fundamental analysis and usually focuses on the following characteristics:
Price below book value: Stocks with lower market prices have higher book values of their assets.
Significant margin of safety: The difference between intrinsic value and market price that provides protection against valuation errors.
Low Price-to-Earnings Ratio: The Price-to-Earnings (P/E) ratio is lower than that of the industry or overall market.
Financially sound: Companies with strong balance sheets, low debt, and stable cash flows.
Competitive Advantage: Companies with sustainable competitive advantages are able to maintain a dominant position in their industry and achieve high returns on capital.
In fact, Benjamin Graham is considered the father of value investing, and the world’s most famous and successful investor, Warren Buffett, was his student.
Can value investing be applied to cryptocurrencies?
This is a great question, in fact, why not take a few minutes to think about it and come to your conclusion?
Although in the cryptocurrency space we can see memecoins that have gone up 100x, cryptocurrencies with no real value or high fully diluted valuations (FDVs), and all kinds of weird phenomena, I think we can apply value investing in cryptocurrencies, but we need to be aware of some differences. Traditional stock market value investing strategies may result in losses in cryptocurrencies.
One of the biggest differences is in the fundamentals and their weighting. In such a fast-moving emerging industry, growth metrics like revenue, active users, etc. are weighted less because these metrics can change quickly and can even be manipulated or influenced by temporary incentives. These incentives will eventually end, making an investment that seemed fundamentally sound a few months ago, a poor choice now.
Which cryptocurrencies might be good value investments?
Now that we understand the concept of value investing and know that we can apply it in cryptocurrency investing, the next question is: Which cryptocurrencies might be value investments?
To find the answer, let’s review the characteristics of value investing and try to apply them to cryptocurrencies:
Risk Free Value (RFV):
The first characteristic is “price below book value,” which in crypto is called risk-free value (RFV).
RFV investing involves buying tokens whose treasury value is greater than the market capitalization (MC) and waiting for this valuation error to be corrected. This correction can happen in different ways, such as organic growth, where more people notice the error and buy tokens to reach a fairer valuation; through governance proposals, using part of the treasury or revenue to buy back tokens below their fair value; or through a complete shutdown of the protocol, allowing investors to exchange tokens for a corresponding portion of the treasury.
This may sound like free money, but it has its risks. Many times, there is a reason for this discount, most commonly a lack of trust in the team, as they may do a "rug pull" or ignore the community while slowly "rugging" and gradually draining the treasury through salaries, budgets, or other bad practices. There is also opportunity cost, as wait times may be extended, causing us to miss other opportunities.
These situations have happened many times in crypto, some of the cases I remember are ROOK, Tribe DAO, NonusDAO, Nexus Mutual, Aragon, FLOOR and NFTX. In addition, the case of Patagon v. Spartacus laid a good foundation for the law, showing that despite the youth of the industry, DAOs are not exempt from the law.
Concave is a case worth exploring in depth. It has long traded below book value, they used the treasury to participate in multiple seed rounds, acquired Fjord for $1.5 million, and successfully launched it at a fully diluted valuation (FDV) of $250 million, all of which was returned to holders. For example, throughout the bear market, you could buy CNV for less than $4, and per token you would receive $9 in USDC as Fjord fees, $15 in locked FJO tokens, and distributions from other seed rounds like Tapioca and Berachain are still ongoing (potentially another $15 per token).
Arbitrage also falls into this category and usually happens when an asset loses its peg, such as a stablecoin or a liquid staking/re-staking token that trades at less than 1:1. Some examples I remember include crETH2, USDC, stETH, and ezETH. Each case must be analyzed separately, as we all know what happened to UST.
UST Chart
At the time of writing, there are some RFV opportunities such as GNO buybacks through specific wallets, and we also found cases of JPGD and HEGIC, two tokens that are trading at a significant discount to their treasuries, which are almost 100% ETH, so I think they are ways to hold ETH long-term. The latest opportunity is USDR, a stablecoin trading at $0.61, backed by real estate that is being liquidated.
Interestingly, Warren Buffet started his career with this strategy. Berkshire Hathaway was a textile company that Warren bought to restructure and sell at a profit, but management objected, so he took over the company, and the rest is history.
boundary of safety
The above RFV can also be considered a margin of safety, but it does not necessarily require the treasury to be larger than the market capitalization (MC) to be a margin of safety. For example, if a protocol's treasury is 70% of the market capitalization, it means that in the worst case scenario, we will only lose 30% of our investment. There are several protocols with decent treasuries that you can check out on DefiLlama, and many even put their treasuries to work in DeFi, such as TempleDAO and ParagonsDAO.
Low P/E ratio
Although not numerous, there are indeed some profitable protocols (revenues exceeding expenses), and although most will have high price-to-earnings (P/E) ratios, there will be some exceptions. However, as I mentioned before, this metric can be manipulated or fluctuate wildly due to the changing environment of the cryptocurrency market.
Token Terminal is a great tool to start looking at this data. We can start with the Fees panel to see which protocols generate the most fees, but these fees may not go into the protocol, for example Uniswap, despite being one of the main fee generators, 100% of the fees go to liquidity providers (for now), which is why we have the Revenue panel, which shows the portion of fees that go into the protocol, but this is not enough because the protocol may spend a lot on incentives (expenditure) to generate these fees, which is why we have the Revenue panel, which shows the portion of revenue minus incentives.
Revenue Dashboard
Another great tool to look at all this data is the Defillama expenses dashboard, and if you want to go a step further you also need to consider how much the protocol is spending on salaries, marketing, development, etc. A great tool to do this is the Defillama expenses dashboard (thanks again llamas).
Taking this data into account, we can currently see that most L1/L2 have negative P/E ratios, with the largest dapps such as AAVE, MKR and LDO starting to become profitable with a price-to-sales ratio (P/S) of around 20-30.
But if we talk about low P/E ratios, the business that comes to mind right now is Rollbit, a crypto casino with a fully diluted valuation (FDV) of $232 million, if we annualize the revenues from the last 30 days we get $342 million per year, which would give us a price-to-sales (P/S) ratio of just 0.68! If we want to know the P/E ratio we need to deduct expenses, but Rollbit is not very transparent in this regard, maybe this lack of transparency combined with some controversies and lack of focus from the team is the reason for the discount. Personally, I think these situations usually create good buying opportunities, but do your own research (DYOR) as revenues seem to be gradually declining:
Rollbit Revenue
Another one to watch is Banana Gun, a popular trading bot on Telegram. Although its price has risen sharply after the announcement of Binance listing, its price-to-sales ratio (P/S) is still 12, and it has real revenue, products in development, and organic growth. It is still recommended to do your own research (DYOR).
Dune Banana Bot Dashboard
Solid financials and competitive advantages
Let’s look at the last two characteristics of value investing. Financial soundness includes no debt (although not common in crypto, there have been cases after breaches), increasing and relatively stable profitability, organic growth, and a productive treasury. Competitive advantages include strong brands, intellectual property (e.g. Uniswap V3 protects its code), network effects, and liquidity, which are the characteristics that allow protocols to maintain their dominance.
Lido is a great example. It is the protocol with the highest TVL ($33 billion vs. $15 billion for the second place), and stETH has a market share of 29% (followed by Coinbase with 12.7%, EtherFi with 4.8%, and Binance with 3.5%). Moreover, stETH is considered the safest Liquid Staking Token (LST), which is the most liquid and most integrated in DeFi. We can see the preference for stETH in the launch of Eigenlayer or Simbiotic, where stETH is filled much faster than other LSTs. This is undoubtedly the best example of competitive advantage in DeFi, an organically created monopoly!
Lido Market Share
Aave and Uniswap also fall into this category. Aave has a market share of 37% and Uniswap has 28%. In addition, Uniswap accounts for 52% of the total trading volume in decentralized exchanges (DEXs). Both protocols are mature protocols with strong brands and users feel safe when borrowing or providing liquidity. As competitive advantages increase, these protocols will increase their profit margins, for example, Uniswap charges a 0.25% fee on its interface, although this fee is currently owned by Uniswap Labs, this may change in the future.
Uniswap Revenue
Maker is another great protocol that may have the strongest financials, but I question its long-term competitive advantage, and other stablecoins like USDC and USDe seem to be gaining more market share.
Even though it is a stock, Coinbase ($COIN) is also a good value investment with clear competitive advantages. For example, its LST $cbTH charges 20% fees, which is the highest in the market as Lido and Binance charge 10%. Coinbase has a wide range of products such as its CEX, futures, staking services, own L2, wallets, Circle, etc.
Solana could also fall into this category. Despite its poor financials, as inflation far outstrips the revenue it generates through fees, this could be a strategy to increase market share (and it’s working for now). Moreover, it has its own ecosystem, organic growth, real users, very low barriers to entry, and a good user experience.
One of the dominant protocols in Solana is Jito. It is the dapp with the highest TVL at $2 billion. Even though JitoSOL only has 3% of the market share, as most SOL is natively staked, it has 48% of the market share in LST (Lido has 71% if we apply this methodology). Jito’s revenues seem solid and growing, and even though the current valuation is quite high ($2.7 billion vs. $1.9 billion for Lido), everything will depend on Solana’s future.
Jito Market Share
Another Solana project that I really like is Phantom, which is the default wallet and has a very user-friendly interface (10/10). I think in the future most people will be using wallets on their phones rather than their PCs, so Phantom and its mobile app have a significant advantage in that regard. Its competitive advantage may allow it to charge fees on exchanges (like Metamask, Rabby, and Uniswap Wallet). Although Phantom does not have a token, I have listed it as a high priority project.
Phantom ranks#1among Finance Apps on Google Play
To be clear, although I did not discuss Tokenomics, this is another important point to study. I think the Tokenomics that match value investing should be simple, where most of the tokens are already in circulation and can bring value to token holders in various ways. Good Ponzinomics may help a project launch and gain liquidity, but it will not be profitable in the long run. The only way to be profitable in the long run is to have a real product that can generate profits.
I hope this article was useful and interesting to you, if so please share it with others. I write purely out of passion and without any financial gain, if I see enough support it will motivate me to write more articles!
