What is value investing in crypto? To answer this question we turn to the new crypto investing bible – that is of course Crypto Investing Guide by Ian Balina and The Token Metrics Team. Chapter 4 goes in-depth on the fundamentals of value investing and how to apply them to crypto, we recommend you check it out after reading this. After all, why wait to change your life through crypto investing.
To invest with the intention of finding value, we must first set a benchmark. Benchmarks can be used to measure returns, risk, and allocation in a portfolio or asset. In the equities market, the most common benchmark for returns is the S&P 500. A commonly used benchmark to assess risk in both crypto and equities is the Sharpe ratio. The Sharpe ratio is the average return earned over a risk-free investment, the most common risk-free investment being U.S. Treasuries.
We must use data and analytics to determine the intrinsic value of an asset. In equities, this can be price-earnings (PE) ratio, free cash flow held by a firm, and price-to-book (P/B) value. These metrics can tell us whether or not an asset is undervalued relative to its competitors. In crypto, we still do not have a foundational way to determine the intrinsic value of a cryptocurrency. This makes value investing very difficult, but not impossible. The Token Metrics quant and data science teams are working on a machine learning algorithm that will generate a grade telling us if a token is undervalued or overvalued. Many metrics will be taken into account for this valuation grade, the most important being a project’s market cap compared to its competition. For example, Chainlink (LINK) the dominant oracle provider in the crypto space has a market cap of over $12 billion and Band Protocol (BAND) a competitor has a market cap of a little over $300 million. This would lead us to believe that should BAND have superior tech or fundamentals it could be undervalued.
The final important concept to know is what’s called a “Margin of Safety.” Your margin of safety is the room for error you allow below your calculated intrinsic value. If you value an asset at $30 and you purchase it for $25, then your margin of safety is $5. Famous value investors like Warren Buffett and Howard Marks preach the importance of margin of safety. Buffett was once quoted as saying “The three most important words in investing are margin of safety.” For crypto investors, we can find a margin of safety in a few ways. For bitcoin (BTC), we can look at the stock-to-flow model (S2F) and determine that BTC is undervalued when the price is below what the model calls for. We can calculate an asset’s distance from its all-time high, this tells us the discount we receive compared to the trader who paid the most for the same token (important note here is that there are no guarantees a token will return to its ATH, especially in bear markets). Perhaps our favorite way to determine the margin of safety, however, is using Forrest’s trend line analysis. When a cryptocurrency falls below the lower boundary of its trend lines then the distance below the lowest trend line is the margin of safety.
For now, value investing in crypto is not an easy task. One day, there will be an agreed-upon way to determine the intrinsic value of a crypto asset. When that day comes our jobs as value investors will be made much easier. However, just because there is not yet a formula to find value does not mean there is no value to be found. In fact, this could be the time in our lives where there is the most value available. Our team at Token Metrics works tirelessly to invent new tools and strategies for value creation. And we will continue to do so as we strive towards our goal of economic empowerment for all humanity.