Anatomy of a Narrative

Level 3 - Virgin DeFi Analyst

Welcome Avatar! When you’ve got little in the form of users, revenue, or any other numerical way to illustrate value, all you’ve got left is conversation.

Or in other words, telling a story.

Storytelling can take assets to ludicrous valuations in the billions or even tens of billions in value.

Narratives are why Tesla, Dogecoin, Nikola, WeWork and many other companies take on a life of their own, with their valuations stretching far beyond what any reasonable numbers-based valuation can justify.

Sure, valuations were also elevated by overflowing liquidity in capital markets.

But some assets stood out among the pack and reached exorbitant, vertigo-inducing heights.

These assets were backed by powerful narratives.

In today’s post, we go over the anatomy of a narrative, and how building narratives for your own investments can make you a better investor.

Narratives Can Capture The Minds of Millions

We are well past the world of access to information. Today, everyone bombards us with information. Words pictures, sounds and videos leap out of our screens, grab us by our heads and make us pay attention.

Many times, we willingly give our attention up. After all, we have neither the time nor mental capacity to critically think about every piece of information that comes at us. Storytelling helps us make sense of the complex, fast paced world around us.

That also means people in today’s world make split second decisions based on bits of information.

We have no interest in getting into politics on DeFi Ed, but they serve as a perfect example of how powerful narratives truly are.

Narratives are what bring people to voting booths or onto the streets with picket signs.

A fair society must also be perceived as a fair society. If the narrative that society is highly unfair reaches a boiling point, you can have disastrous outcomes.

And while stats and numbers should matter, people respond more powerfully to emotion.

Hence, a rational actor must also consider the behavior of irrational actors.

Narratives in and of themselves are not irrational. After all, determining what the future may hold requires forming a story. It’s when narratives get carried away and are not grounded in reality that irrational behavior occurs.

Narratives in Investing

Believe it or not, much of investing even in the institutional investment world involves narratives.

When you put together an investment memo for your fund internally, to some extent you have to pitch a narrative behind the investment if you want the fund to invest.

No one is investing $100s of millions of dollars or billions into a company based on the numbers in a DCF model.

You have to formulate a story around a company and its future.

Think about Ethereum, for example.

Ethereum was founded in 2015 by boy genius Vitalik Buterin and was the world’s first smart contract platform. Anyone, anywhere, at any time can access and build on the Ethereum network without needing permission or even having to identify themselves. Ethereum maintains a permanent record of all the activity on its chain. As the largest, most decentralized and most used smart contract platform, Ethereum will be the base layer of the future of the internet and the financial system at large by eliminating rent seeking middlemen who invade our privacy and hold our assets.

That’s a powerful narrative.

Let’s unpack the anatomy of the Ethereum narrative. The important components are:

• The product

• Its history

• Inspirational leadership

• The markets it operates in

• Competitive positioning

• A bold vision for its future

Can you see all of these components in the paragraph on Ethereum above?

A narrative-first approach to investing would then assess these components and connect them to observable metrics.

Ethereum has the highest number of developers and validators. It is also home to almost all of the innovative applications in Crypto that have real adoption and has massive network effects that give it a competitive advantage over other smart contract platforms.

Now you can observe the narrative against things like the developer ecosystem and activity in DeFi or NFTs.

Narratives Outrun Reality

Crypto assets in particular have a tendency to become massively overvalued (sometimes to the point of creating risks to the broader ecosystem like Luna/Terra!)

When analyzing narratives for our own investments, we differentiate between what’s likely and what’s unlikely.

A great example would be OlympusDAO from last year.

The narrative of “decentralized reserve currency” was extremely unlikely but people were calling for $100 billion market cap. If you had ran numbers on what sustained buying pressure would’ve been needed at their rate of OHM issuance to maintain such a level, the numbers were astronomical. What they did have were treasury assets and community attention. A more realistic narrative would’ve been how they could use the assets they had to build a sustainable protocol within the crypto market.

You could even argue that Ethereum’s narrative outran reality for some time, with many of the projects that drove network activity being entirely speculative and deeply correlated to people’s lack of understanding and drunkenness on markets flush with liquidity.

Think critically about what narratives are likely vs unlikely, possible vs impossible, and you’re more likely to be able to sell when things get overheated and buy when things are oversold.

At DeFi Education, we look at everything holistically. We recognize that being too focused on narratives means you have blind spots. Being too focused on data means you miss opportunities. Being too analytical slows you down. Being too lax increases your risk.

It takes time to find the right balance.

We operate a paid substack for people who want to go beyond the basics and get direct access to how we think about markets, specific crypto assets, and the crypto ecosystem at large.

Disclaimer: None of this is to be deemed legal or financial advice of any kind. These are opinions from an anonymous group of cartoon animals with Wall Street and Software backgrounds.

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