Disclaimer: Your capital is at risk. This is not investment advice.
With Bitcoin dropping from the $50k range to below $40k, ByteTree has been warning readers of the growing disconnect between on-chain fundamentals and the market price. Meanwhile, Token Takeaway has been recommending well-funded and more long-term investments, which is where the alpha will be.
When the digital asset market is faltering, the smart investor looks for the leaders. This is a tried and tested strategy, one which has proven lucrative over previous market cycles. On the other hand, reckless mania/hype trading can lead to being left with a worthless bag.
The History of Digital Asset Cycles
|2013||83% + 50%|
|2021||54% (so far)|
Many new market participants haven’t experienced the fascinating crypto market cycles. These cycles can prove detrimental to investors who blindly follow the hype and ignore the fundamental network activity that underpins market price.
2013, 2017 and more recently, 2021 are the key cycles that every digital asset investor should study. Furthermore, these crashes tend to have key events which cause the penny to drop. In 2013, the Mt. Gox exchange could not keep up with the amount of trading and went offline, which caused a ripple effect and consequent Bitcoin crash from $260 to $50. After recovering, in December that year, China started a campaign to ban Bitcoin - causing a 50% drop.
Initial Coin Offering Scared The Market
In 2017, a more significant event occurred. Initial coin offerings, or ICOs, were essentially token sales that were supposed to provide crypto projects with funding to launch the ideas they had pitched to the market. ICOs became the new craze and publicly made both companies and token holders rich, or did they? Around 90% of all ICOs have failed from 2017 to the present date.
More than 800 token sales were conducted in the ICO boom, raising around $22bn. To give an idea of the size of these offerings, EOS, Telegram, Bitfinex and Huobi token alone had a combined value of $7.1bn raised through ICOs, according to CryptoVantage. Tezos, which we covered last week, raised a staggering $230m.
While ICOs were not the sole cause of Bitcoin’s crash from $20,000 to $3,000, they were a signal of market mania. Furthermore, many left their tokenholders holding the bag, and some projects simply just stole users’ funds. Both of these points were escalated when investors realised they were in a bear market.
However, astronomic alpha was made by smart investors who picked their token sales well.
|Project||Amount Raised||%Return (vs USD)|
|EOS||$4.2b||$0.990 - $4.34 (ATH-$22.71) ~450%|
|Filecoin||$257m||$5 - 74.11 (ATH - $190) ~1,500%|
|Tezos||$232m||$4.70 - $5.79 ($7.55) ~25%|
Where Is the Alpha Currently?
In 2021, we experienced a multi-faceted crash. Leverage for the first time proved to be a systemic issue, NFTs (non-fungible tokens) resembled the ICO boom and, finally, the exploitation of open-source code drove copy-cat protocols to be exploited. Aside from the mania, early investors who managed to identify alpha experienced the best returns.
Other alpha-generating opportunities arose in early summer 2020 when new ideas were being launched. For example, Dapper Labs and their FLOW blockchain. Originality carries value in this space. This can be seen from Compound.Finance, which has been copied time and time again, with many copy-cats being exploited (over $150m were lost in smart contract exploits in 2020 alone).
DeFi Presents The Best Investment Case
A sector-based approach is key to identifying the substrate of tokens that investors should gain exposure to, with correct market timing. In our opinion, as far as applications go decentralised finance (“DeFi”) holds the most promising prospects. In future, it is the most likely sector to disrupt its traditional counterpart.
So, if DeFi is the most significant investment opportunity, how should one gain exposure to the right tokens? Just like the survivors from ICOs or 2020 protocols, survivors share similar characteristics: original idea, well-funded, expert team and constant development.
Considering the potential of DeFi, seeing the largest lending and borrowing protocol, AAVE, at rank 45 puts its market value below many tokens which provide vastly less utility.
|DeFi Token||Market Cap Rank|
The rankings of the top DeFi tokens simply does not reflect the scale of the sector they lead. This is partly due to the popularity of “ETH killers” and NFTs. This presents investors with chances to generate good long-term returns. After all, that is what Token Takeaway is all about.
Let’s look at these protocols’ total value locked (TvL) relative to the market cap of the top valued coins. AAVE’s TvL is larger than the market cap of 13th place LUNA, Maker would be 14th place ahead of smart contract blockchain Cosmos, Compound would be 19th and CRV ahead of DEX Uniswap at 14th.
Maker (ticker-MKR) stands out in terms of potential alpha. This is due to their partnership with Centrifuge Protocol and Tinlake, and their vision to bring real-world assets to DeFi. They were successful in funding NewSilver, which lends money to fix and flip mortgage users. Not just a vision but a reality.
As their venture expands and more real-world assets come to Maker, which is the most experienced DeFi protocol, more alpha will be generated. A market cap ranking of 63 is severely undervalued on a relative basis. If we experience a market drop, this token should be one to keep on the radar.
An investment thesis should be no different from traditional strategies; pick the leaders, the well-funded and the constantly improving. This is the winning strategy, and those that apply it to crypto will generate significant alpha.
Investors should rest assured that alpha will continue to be found in abundance in the digital asset space. The years 2013, 2017 and, we believe, this year will/have separated the wheat from the chaff, in the sense that copy-cats, less experienced and mania driven investment will generate negative alpha or simply fail.
DeFi presents an investor with the most promising investment opportunities. The sector has the most respectable tokens and the most relevant blockchains, meaning it is unlikely to disappear. If we consider that we are at the tail end of the hype surrounding the “DeFi summer”, and if there is an incoming bear market, it is worth highlighting undervalued tokens like Maker. Overall, investors should look to DeFi for long-term alpha.