Unraveling the Value-Based Approach for Profitable Crypto Investments
Summary:
This article discusses the need for a robust value-based framework for profitable crypto investments. It critiques the efficient-market hypothesis and states that market prices don't always represent true value due to irrational behaviors, using the crash in Apple's and GAP's stock prices during Covid-19 as instances. Highlighting the role of fundamental analysis in identifying undervalued securities, the article emphasizes the importance of valuation over price. It also discusses the challenges in crypto asset valuation due to market diversity and offers a few strategies to approach it. The article, an extract from the "Digital Asset Valuation Framework" by HashKey Capital, encourages investors to make decisions rooted in value, not speculation.
Profitable investments in cryptocurrency demand a robust framework for decision-making rooted in value. The efficient-market theory posits that asset prices integrate all known data, representing the ideal value. Nonetheless, the crypto and stock markets provide countless instances that debunk this claim. It's clear that markets aren't efficient. Consider Apple's stock price, which dropped 30% during the Covid-19 downturn in February 2020. Did Apple experience a 30% drop in product sales or earnings? Or why did GAP's stock plummet 70% over 49 days? Was there a sudden 70% drop in clothing sales for America's biggest apparel retailer? The unequivocal answer is "No". Markets often behave irrationally, and prices don't always mirror value, as evidenced by Warren Buffett's colorful description of Mr. Market as a "drunken psycho".
This brings us to the idea of value investing, which seeks to pinpoint securities that are undervalued due to market irrationality. Investors purchase these securities on the basis that the price will eventually reflect the actual value. The same occurs with crypto assets. During the Covid-19 downturn in March 2020, Bitcoin's (BTC) price took a 50% hit, only to bounce back to prior levels 55 days later, ultimately doubling in price five months later. Did this volatility closely mirror the network's actual value, its activity, number of active wallets, transaction volume, and network utility? No. The key is to utilize the proper tools like fundamental analysis for uncovering these opportunities.
Crypto assets, though a relatively new class, follow similar fundamental principles. They mostly represent an underlying network, utility, or community, built on a degree of decentralization. The market perpetually oscillates between bull and bear sentiments, between greed and fear, and between unattainable optimism and unjustifiable pessimism. Rational investing strategies rely on valuation methods and risk can be minimized by avoiding overpayment for overhyped projects by looking at their valuation metrics instead of just their prices.
Price, which is dictated by variables such as sentiment, market hype, speculation, and overinflated news, often deviates from real value. Crypto tends to be even more susceptible to irrationality, especially of late in the memecoins sphere. Traditional financial valuation methods can help dilute the hype and identify projects with sustainable growth potential as the industry matures.
Crypto asset valuations don't follow a uniform approach due to the diversity of assets in the market. Investors should explore different options to find an approach that best suits each case. Identifying the asset type—be it a nonfungible token (NFT), a payment token, a utility token, or something else—is essential. Metcalfe's Law could be employed to value native cryptocurrencies like Bitcoin, or layer-1s like Ethereum (ETH), or other methods such as the stock-to-flow model.
Long-term successful crypto investing doesn't necessitate an exceptional IQ, unique business insights, or privileged information. A strong framework for making investment decisions based on value and not speculation is all that’s needed.
This article is an extract from the "Digital Asset Valuation Framework," published by HashKey Capital in April 2024. HashKey Capital's partner of liquid funds and research, Jupiter Zheng, who served previously as the deputy head of Zhongtai Financial's FinTech Department and as a senior associate in research at BOCOM International, compiled it. The information contained herein is for general information purposes and should not be considered as legal or investment advice. The views expressed are solely those of the author and do not necessarily reflect the views or opinions of Cointelegraph.
Published At
6/23/2024 4:26:52 PM
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