Issue #3 - How To Research a Project (High Level)

Researching a project to build your own conviction is a key next step in the journey of an on chain investor. Once you are able to (1) identify projects, (2) be able to research them (3) understand hype levels / implied expectations and (4) understand macro backdrop, you will be in a much better place than finding ideas just on twitter.

I’m not going to cover how to research the majors like BTC or ETH here. Your first step is to understand what your project does. You can go to the project website, twitter, its discord to get a sense of (1) does this seem like a scam, (2) are there people I know on twitter following this project and (3) is it VC-backed or is it anon based. You can use tools like coinmarketcap, Messari Research and Nansen to get an overview of the project, along with key KPIs for it. After reading into it, you will then be able to write in your own words a couple sentence overview of what the project does and how does it make money (ex. GMX is a decentralized levered perp exchange).

By this point, you understand if the project is at the protocol level (AAVE, MKR, DPX, GMX, SPELL, etc), or the layer/chain level (ETH, NEAR, AVAX, FTM, etc). The research process is different for both, so we can start with chains - important to note here that chains tend to be “lower risk” with a lot more VC involvement (still high risk), but their market valuations are usually much higher, so the amount of upside can be limited vs. early protocol level investments (unless you are very early).

Researching a Chain
Each chain can be thought of its own “crypto country”. They have different properties/trade offs, with some sacrificing certain security measures for lower transaction costs. I am by no means an expert, and you don’t need to be either! Because while people debate the merits of each chain, you as an investor can just see where the usage is. Usage can be looked at in terms of # of transactions, total value locked (basically an indicator of how much capital is being put to work on the chain) and number of users on any given chain to see if people like using it. Rather than debating who the future “Ethereum killers” are, I tend to just follow what people like. As it stands today, institutional/whale level DeFi lives on ETH/Arbitrum primarily, while retail usage for things like games lives on AVAX.

To me, non-major chains should typically be viewed as short to medium term trades vs. longer term holds. Why? Because there are over 100 different Layer 1 chains competing for TVL and users, and most chains go through some “hype” cycle driven by “fund” investments or initiatives that incentivize usage on the chain (really high APY farming for example), so a flood of mercenary capital comes in, but then leaves as the incentives dry up. A recent example is FTM. Its TVL exploded on the Andre / ve(3,3) incentive hype, and so did the FTM chain price. But these hype cycles die, and the TVL floods away. You can see the hype cycles in the TVL from Defi Llama below along with the trading of FTM token. Token up → TVL up → Token up, and then in reverse.

If you are going to make money on “chains” you are effectively trying to front run the hype cycle here. How do I research these and find out where the next one is coming? So a recent example is NEAR. For any of the folks using my Intro to Whale Watching you would have seen smart money moves earlier this year in NEAR. To research NEAR, you would go through their website, learn more about it on Messari, and try and find some factual / less shilly posts on twitter. And importantly, you would bridge and use the L1 yourself to feel out the user experience. High level, its just another Layer 1 that uses Proof-of-Stake, and is going to change the world (I realize this is an over simplification, but it usually doesn’t matter if its revolutionary or not). The network itself launched in April of 2020 (you can find this information on Messari).

Looking through Dune Analytics stats, you can see that total assets bridged through NEAR’s Rainbow Bridge never really had traction until late in 2021 (when smart money started buying), with total assets bridged recently hitting nearly $1.5bn.

You can see transaction counts are still growing pretty well right now (per Dune again).

What sparked it all and when should you have got interested? As I mentioned in the Chain overview, usually some incentive/grants program starts the hype cycle for a L1. In this instance, NEAR offered $800mm in grants to take DeFI market share back in October 2021. You saw some smart money front run this announcement, but activity on the chain slowed shortly after, before recently picking back up early in 2022. Then it raised $150mm from a group of Crypto investment firms, including 3AC, Mechanism, Dragonfly, a16z, Jump, Alameda, etc.

I don’t focus on chains, and they are inherently hard to value. But these L1 “hype cycles” are all the same. Take a chain with limited usage, launch incentives to bring mercenary capital in, major funds invest, price pumps, and then 6-12 months from now, the hype probably subsides, and moves on to another chain (this could be different for NEAR, but just stating this is how it typically flows). How do you know the hype is dying or if the token will underperform? I would watch 4 things:

1. Smart money / whale movements (they will start moving out when the show is over)

2. TVL increases / declines (TVL will start rolling over when the incentives are running out

3. Transaction/user counts (same thing here. Right now there is an imbalance of capital being bridged into the chain vs. out, so if you see this going the other way, its probably time to take profit)

4. Watch the supply distribution

So TVL is still exploding right now. In this phase of the cycle, its probably still good to be long the token (and if you are a full time degen, you should be looking into the underlying protocols that will move a lot more on NEAR than NEAR itself - but look out for scams/rugpulls).

Supply distribution / dilution is another very important thing to watch. Remember that these are just liquid markets of tokens, and the supply and demand of the token is why the price goes up or down. When you have a very crappy supply side structure, the token will go down longer term. This goes for both chains, and protocols. What is a “crappy” supply side structure Wizard? Look for 2 main things. Is the circulating market cap vs. filly diluted market cap way off? And what does the unlock schedule look like on vested tokens.

Example: the one and only SRM.
SRM (decentralized exchange on Solana) has just a $350mm circulating market cap per coinmarketcap vs. a FDV of $27bn. Or a ratio of FDV vs circulating of 77x. In laymans terms, this means that there is a LOT of money that is currently vested, and waiting to dump on you! When will they dump? Take a spin over to Messari, and look for “Supply Schedule”.

Looking at the unlock schedule of SRM, its circulating token supply will increase 2.4x over the next 12 months, increasing ~9% basically every month.

Given the mismatch in circulating market cap (which can be seen as $ demand for the token today) vs. the FDV, a supply side structure like this means that the token will face a mountain of sell pressure. Since September 2021’s start of the unlock phase for SRM, its token supply has increased 6x! Since the unlocks started, SRM has been the definition of down only.

Bringing it back to NEAR. To be a more sophisticated investor in chains, and onchain protocols, you need to be watching these unlock schedules, as they can have a meaningful impact on the tokens price. NEAR’s structure is much better, with a circulating market cap of $11bn vs. a FDV of $16bn, and only a ~36% increase in circulating supply over the next 12 months.

Hopefully this gives you some high level mental models to utilize when doing chain level research. I personally don’t focus on chains, so this is not my specialty. I tend to focus on protocols to find investment ideas (more upside, more risk).

Researching a Protocol:
This is more of my bread and butter. Again, my intro to whale watching, along with being on twitter will fill up the top of your “idea funnel” or things to look into. There are thousands, if not tens of thousands of projects to look into, so how do you know if your token is any good or not?

A key place to start, is again, going through the website, the discord, using the product if its out, reading fact based twitter posts, going through Messari, etc. Your #1 goal is to be able to explain (1) what does the project aim to do, (2) is there a need or addressable market for this project/product (3) what are the implied expectations and (4) what is the competition like in terms of usage, valuation, hype, etc.

I want to reiterate again, the goal is to build YOUR OWN conviction, not somebody else’s. If you don’t have conviction in an investment, when it falls 50% (as it almost certainly will), you need to have the conviction to stay in the investment or buy more at cheaper prices. I also tend to focus on projects that I have interest in and use/will use, to keep me engaged, which usually brings me into DeFi tokens.

Starting with what does the project do - you need to understand the functionality, roadmap, why will people use it, and how big of a market is it targeting. I am a big fan of Dopex, for example, because options are an inherently better way to both hedge and gamble then perps, and I think over time whales and retail will use it more (and perp volumes are massive = massive TAM). Instead of getting liquidated on a 30x levered ETH long, I can buy ETH calls (or use Atlantics when they come out) to get levered upside exposure without liquidation risks.

When looking at a project, you can’t look at it in a vacuum. As part of your diligence, you need to lay out a competitive landscape (my token vs. others), not only in terms of TVL/usage today, but product differences, investors/advisors involved, roadmap differences and community differences. Tokens with high TVL, but are not growing and with limited innovation will not do as well as projects with a cult community, low but growing TVL, and continued development of new, innovative products.

Most people fall victim to just comparing market caps of their token vs. next market leader, but all protocols are very hard to value, and you need to realize that token prices are driven by hype and narrative, much more than fundamentals. But also that growing fundamentals, can lead to hype and a narrative.

To hit homeruns I typically look for a low starting valuation, usually $50-150mm market caps that I think are building something special that can go to $1-2bn. I don’t research copy cat projects, as if the project can be easily forked, then the competitive advantages are very, very low. “Building something special” can be broken down into (1) a new concept completely (Dopex’s IROs + Atlantics, JPEG NFT lending, SPELL’s yield bearing token lending in the beginning, BTRFLY’s hidden hand) or (2) a better user experience / cuts out the middle man (GMX for example).

Ok so I found a small cap project, building something that I think is differentiated vs. peers, whats next?
Pop into the discord and ask some questions! Even if the questions are stupid, the way the community and team deals with your questions will tell you a lot. If they are defensive or block you, that is not a good community, and likely signals something is wrong with the product (or it won’t launch). If the token has a product, use it! If there are issues, give feedback to the team.

For protocol level projects, I tend to write up just a little one pager, on what does it do, what whales are invested / advising, will whales, retail or both use this, what is the current valuation vs. what I think it could be, how is usage/TVL doing over time, and what upcoming catalysts are there.

You can find whales involved in the project using nansen, or just clicking through Debank. Additionally, the website will usually say who else is advising on the project, and you will even see overlap of some people on various projects in the discord.

Valuation is very, very hard. Meme tokens with no functionality can hit $1bn - $40bn market caps, whereas key building blocks of DeFi like Curve/Convex, are $3-8bn FDVs. My best investments have come from buying at ~$100m and selling at $800m - $2bn, so that is the framework I would recommend. There are obviously other ways to look at it (some people would rather own cemented winners like CVX, rather than scrappy low cap alts), but if you want to hit 10-20x in 4-6 month timeframes, lower market caps can be your friend (but obviously can go to zero).

If the project’s product is out, map out usage over time - you can typically find this information from a Dune analytics page, or the project will have built out analytics for you. Using GMX as an example, their stats page gives you everything you need to know about growth over time.

For DeFi projects, its also good to do in-depth work on how the project makes money (how are the fees extracted, are they recurring) and are they given back to token holders (in GMX’s case 70% goes to GLP, while the remainder goes to GMX).

If the product is not out, then you want to front run the catalyst of them launching the project, as the token usually has an “alpha burst” around the release date. You can get this information by lurking in project discords, and finding which team members tend to leak alpha. You can also sometimes see a projects github to watch if they are working on something that the market is missing Then it comes down to (1) position sizing and (2) dollar cost averaging / buying dips, which will need separate write ups, but high level, you want to buy when the hype is low, and a few weeks or even a month before the major product launch, or if the product is already out, DCA at prices you like / when the project bombs out.

For protocols, you also need to do the same supply distribution analysis/exercise that I walked through on SRM, and specifically look into team token vesting, to see how long the vesting is. Longer vesting signals that the team will hopefully keep building for the long term, while aggressive, short term vesting means its probably a cash grab, where their incentives are to pump the price near term (can still make money on this), but long term will abandon the project.

This post is getting too long for email subscribers, so I will post a part 2 on a deeper dive into protocol research, but hopefully this gives you a great starting point. The key points I want to hammer home, and that you should leave with are:

1. Find projects that are different, and hard to replicate

2. That are backed by great teams and advisors

3. With a low starting market cap, with minimal CT shills

4. With good supply side token structures

5. With key upcoming catalysts / partnerships that you find in a project discord

6. Build your own conviction, don’t outsource it from a CT shill

7. And potentially most importantly, bring down the number of projects you actually invest in. There are not that many innovative or special things being built, and you only have so much time + capital to put to work. If you pull the trigger on something, it needs to have the potential to open up a lot of TVL/usage or bring new users into the space.

Hopefully you enjoyed this stack, and I will give more concrete protocol level research examples into a future issue in a few weeks. Please like, retweet, share, send around, whatever, if you found value from this!

Disclaimer: This content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.