Exit Strategies, Fundamentals and Cleaning House

Level 3 - Virgin DeFi Analyst

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If you speak with crypto critics, you commonly hear something along the lines of “crypto is relearning why regulations existed in the first place.”

This comment stands out to us because not only do we agree, we find it to be one of the reasons why crypto is fascinating. Crypto is not just relearning why regulations exist - crypto is an entirely new market and asset class that is rebuilding markets themselves from the ground up.

The stock market was created in 1792. Investment principles and strategies, financial markets, what works and what doesn’t.. people have had hundreds of years to figure these out in the context of stocks. The invention of cryptoassets will go down in history as being equally important as the invention of stocks. And. We’ve only had a few years to try and figure out what works.

Exit Strategies

As an investor, there are really three main actions that matter:

• Buy

• Hold

• Sell

• *Within crypto: Earning new issuance (i.e. staking)

While there is the perception that some investors like Warren Buffet simply “hold forever,” most investors do sell at some point. You sell for many reasons but ideally you sell because you’ve realized your expected returns and believe you can redeploy your capital into something with higher return (or reduced risk) in the future. Generally speaking, institutional investors enter investments with an exit strategy in mind.

Cryptoassets are liquid on day one. Low market cap illiquid tokens need to bootstrap liquidity because that is eventually how investors will exit with larger gains. Unlike TradFi, where a private equity fund might plan to exit to other businesses or other private equity fund, the “exit strategy” for token buyers is to create liquidity. Some places liquidity can come from include:

• Protocols put up their own liquidity using treasury assets

• Protocols rent liquidity by allocating reward tokens to liquidity providers on decentralized exchanges (DEX)

• Tokens are listed on centralized exchanges where market makers put orders in their books to create liquidity

Tokens high in demand have 1) more valuable token rewards (by having a more highly valued token) and 2) more liquidity (due to highly valued rewards and likely higher trading fees). We put together a Yield Farming Model here for people interested in understanding the components of returns for DEX LPs.

Having liquidity, then, is the primary goal for larger investors looking for an exit at a high multiple. For the many of us that aren’t privy to private market deals and 9-10 figures in dry powder, our best bet in many cases is to coattail big players.

So as a crypto public market participant, the life cycle of a trade would look something like:

• Find token that has a good team, project and is likely to create value

• Buy it early enough in its life while it’s *relatively* undiscovered (easier in slow markets)

• Hold until market discovers the token (generates demand) and/or more liquidity enters the market

• Sell when market has absorbed the thesis

We think the way people will interact and succeed in crypto markets is going to evolve and change over the years. We posit that successful strategies from last year and the years prior will either be competed away or become irrelevant as market dynamics change and use cases for more cryptoassets are developed.

In the year ahead in DeFi, we think a buy and hold strategy will struggle due to the massive FDVs and unlocks occurring with limited demand for tokens coming from the public market. As we mentioned here, you should focus on event driven trades that exhibit the characteristics of a trade outlined above and take profits more liberally than usual.

Select projects will weather the storm and gather more attention and market share. These projects will set the stage for the next bull run as people once again discover new ways that cryptoassets accrue value and change the game. When risk appetite re-enters the market (and it will), these projects will be seen as “obvious in hindsight.”

Fundamentals: Do They Matter Yet?

This topic deserves its own dedicated post in the future but we will address it here briefly.

First off, we think there is a lot of misunderstanding as to what constitutes “fundamentals.” People seem to think fundamentals just means P/E ratios and revenues. That couldn’t be farther from the truth. Cryptoassets have their ownfundamentals that can’t be captured with traditional metrics (e.g. TVL, FDV, token supply dynamics, treasury assets, etc.) And. These quantitative components are only one part of fundamentals.

People seem to ignore the qualitative side when referring to fundamentals. This includes:

• What the protocol does

• Who the team is behind the protocol and their abilities

• Competitive positioning

Taking that into account, we would argue fundamentals do matter already in certain instances but the degrees to which they matter varies significantly. There are tons of meme assets that have no underlying business that creates value and no reason to otherwise exist. Of course fundamentals don’t matter in the case of Shiba Inu coins.

Having a black and white view of they matter vs. they don’t matter is simply setting yourself up for disappointment. Everything is about context. Different tools matter for different industries - this aspect of investing is not native to crypto.

Would you value an airline company based on the brand of cookies they serve on board? Probably not. You might look at things like available seat miles and revenue passenger miles. Those same metrics wouldn’t be applicable to oil & gas companies or casinos.

So when thinking about fundamentals, you need to understand what you really mean by fundamentals, what type of asset you’re looking at and what matters in that specific situation.

Sidenote: Cleaning House

If you have not done so already, we would revisit everything in your portfolio and conduct the following analysis:

• Team: Get an idea of what the team is up to, how active they are, and if they’re still building. If they seem to be standoffish / unplugged and haven’t shipped anything in months, cut your losses.

• Token supply dynamics: Figure out how much supply is coming online in the next 3 - 12 months. Projects with a low market cap and high FDV with near term negative catalysts (token unlocks!) should be shed. Check out our free post on Etherscan to learn how you can verify token vesting schedules if they are not clearly stated in the protocol documents.

• Reason to hold: Anything you are holding at this point should have a clear reasoning behind it. Even if major coins like BTC and ETH bounce upward, that does not mean your coin will recover. If your entire thesis relies on BTC and ETH recovering so you can sell, you’re likely better off rotating into another position that you have a better thesis on because, in theory, that coin should recover with the majors as well.

Until next time, anon..

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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.