Valuation Divergence in DeFi:Narrative or Data Matters?

After suffering a great loss at Cover protocol last month because of the black swan event, my mind has always been in a mess. Anyways, I pretty appreciate my friends who gave me comforts in the first place. Life is full of regrets.

To begin with, I must admit that I was not really into researching projects before this accident — it’s kind of path dependence and overconfidence, which may lead some inaccurate judgments in the following article. All personal opinions are biased, so please focus more on methodology than final outcomes.

Another disclaimer is that this methodology does not apply well to the current crazy bull market. A market-wide rise is mostly caused by the exciting sentiment. And I find I can hardly earn money by switching positions with the market hotspot, so I have time to write down this article.

I appreciate your patience of reading.

A Narrative-Data Axis

When we were in crypto 2016–2019, so-called public chain age, we did not judge public chain projects strictly on Internet style growth/data perspective because most chains were still in a very early stage and didn’t have an ecosystem worthy of analysis. This is also the greatness of Ethereum, in 2019 dapp emerges and in 2020 DeFi flourishes. DeFi acquires fast-growing users, which enables us to evaluate a project based on both narrative and data. (Maybe there are other ways but today I want to focus on these two aspects).

Narrative means a project’s idea and mechanism, while data shows directly how a project performs. As for me, I will classify projects in four quadrants using a Narrative-Data Axis .

a. Projects in the quadrant 1: well-known projects (market cap ranking above 100)

b. Projects in the quadrant 2&4: well-performed projects (market cap ranking in 150–300)

c. Projects in the quadrant 3: emerging projects, rubbish projects or dead projects (market cap ranking below 500)

A Narrative-Data Axis

You may feel confused why some rankings don’t exist in any quadrant, I want to name it as a ‘buffer zone’. A project may easily stand steadily at quadrant 2&4 but if it wants to enter the quadrant 1, it needs to go through the ‘buffer zone’.

The easiest money comes from the quadrant 3 to quadrant 2&4 or the “buffer zone”, the project just needs one strength in narrative or data. But if a project wants to enter the quadrant 1, it needs both developments in narrative and data. To be honest, it’s extremely hard and sometimes it needs some luck.

And the most difficult thing is accompanying a project from quadrant 3 to 1, if you do so, you are a lucky dog with the sharpest sense of smell. I tried but I failed, I bought Cover at $150-$300 ranking around 400 and its highest ranking is 130 and finally went to zero in Binance. This is the deepest sadness.

Examples to Elaborate

I must clarify the weight ratio of narrative-data is not 50/50, it depends on your personal appetite. My views are as follows.

· When narrative matters more?

As I said above, the easiest return comes from quadrant 3 to 2&4. But personally, I love good narrative more than data in this stage, maybe the weight ratio is 90/10.

I gave a detailed example in narrative analysis in previous piece on Cover. Other than this, I will give a more brief but apparent explanation here.

Taking DeFi interest rate protocol sector as an example, many projects emerged in this sector, some of which are backed by renowned investors. Note that I only compare the protocols that have already launched tokens here, namely Saffron, 88mph and barnbridge . Now all three are in the quadrant 2&4 but in the beginning they were all in the quadrant 3.

Firstly, I suggest you know a little about definition of fixed income or structured product in traditional finance. But if you don’t, it doesn’t matter, you just need to know it’s a new sector where has few competitors now.

These three projects do a similar work, that is risk tranching. It’s all about how to give people a fixed interested rate based on different risk tranche, and how to leverage rate return in case high risk-tolerant investors need.

Saffron designs a 3-tranche system. A tranche offers a normal interest rate under a low risk, AA tranche offers a 100x interest rate under a high risk, while S tranche rebalances these two tranches. The S tranche is currently merged with AA tranche. The project didnt’t specify but it’s really an interesting try. The product launched based on DAI/COMPOUND and DAI/RARI tranche with a total TVL of $37M in deposit pool, staking pool and liquidity mining pool. The narrative and data are both fairish.

88mph is easy to draw people’s attention with a cute UI design and a name that salutes to ‘Back to the Future’. Looking back at other products created by the team (bacon labs), the style is kind of fantastic, you know, I can’t express in a very accurate word. Back to the business, 88mph launched products very quickly and early in this space. It initially did two things: one is a fixed deposit rate integrated with several protocols like AAVE, Compound and Harvest. Another is a floating-rate bond which represents the bond buyers are longing the interest rate. The team moves fast with bright new ideas, rapid product iteration and continuous partnership progress. But the TVL isn’t very ideal in the first two months, it was stuck in $2M I remember. Fortunately, the TVL started to ramp up recently, and sits total $22M TVL right now, of which is $9M deposit TVL, $4M liquidity mining TVL and $9M staking TVL. The narrative is stronger while the data is chasing behind.

Barnbridge, which had a very large TVL at the beginning of liquidity mining, hasn’t launched a product yet. But it peaked at $577M TVL and now the amount is still $340M. The largest pool is USDC/DAI/sUSD pool, it’s a lossless pool and the token price guarantees its considerable APY. The data performance is very strong even compared with other protocols.

If I got the chance, I would buy all the three projects when they were in quadrant 3. But if I must choose only one project, I will buy the iteration ability of product. Because high APY is not sustainable, you could buy the certain chance that they go from quadrant 3 to 2&4, but I buy the opportunity that 88mph finally goes to quadrant 1 or the ‘buffer zone’.

Nevertheless, these protocols are all in its infancy, you should keep an eye on their respective progress.

· When data matters more?

Data can be falsified. The true or false of data doesn’t matter much when we estimated a quadrant 3 project. But when it comes to evaluating projects from 2&4 to 1, data really matters.

If I am a data scientist, I will get a very abundant and useful data from blockchain for modeling and analyzing. But I’ m not and I will give my own simple ways here.

1. Use third-party data to get an overall information.

Many data website will help, e.g., Debank, Defipulse, Dune Analytics, etc. Apparent buying chance occurs when a project has a trend of explosion in its business.

The opportunity I regret most recently is Sushiswap. Sushiswap is a DEX and used to be in the quadrant 3 with a totally forked mechanism of Uniswap. But its extremely high APY in the beginning attracts a very large liquidity mining TVL and it went to quadrant 4. With big capitals and developers backed up, it partnered with Yearn in Dec,2020. The product line distinguishes with Uniswap from then on. The narrative developed stronger and it got the chance to the ‘buffer zone’. I was supposed to recognize its potential marching to quadrant 1 from then on but I didn’t.

The main ordinary data of DEX are trading volume, user and transaction, which can all be found in Debank. Now all three indexes rank second just behind Uniswap(I don’t want to bother to snapshot the page, you can check it by yourself). Sushiswap’s growing data of business from Dec last year is very decent as the picture shows.

Sushiswap Liquidity and Trading Volume

There are also other data like social media followers (promotion effect), github updates (developer ability) to tell you the basic info. Here is an exmple of social volume and development activity made by Santiment.

Sushiswap Social Volume and Developemnt Activity

And you could also take a reference at some indexes or models made by data analytics websites like Nansen, Intotheblock, TokenTerminal ,Santiment, etc. Here’s an example of price to sales ratio designed by TokenTerminal. As the ratio shows, Uniswap and Sushiswap are both undervalued.

DEX Price to Sales Ratio

2. Use data selected by yourself to find your dream project.

When comparing quadrant 1 projects, what I consider more is whether this project has a profound culture or not. Some data selected by yourself will tell.

For example, now Sushiswap’s market cap ranking is 51, which I think is a little bit high. Sushiswap’s trading volume is meeting half of Uniswap’s, but the number of users and launched tokens are at a hundredfold gap compared with Uniswap. The large gap will let me feel that Uniswap has a wider range of market influence and user dependence as a pioneer in DEX space. This analysis of Sushiswap written by Santiment is very objective.

Another example, many projects now use Snapshot to vote and Discord/Telegram to chat. But I really prefer a project which has a forum. LOL. It may be outdated but I think only true project lovers will open the computer to make a long proposal or discuss in the forum.

For my favorite project, AAVE, it has a forum, so does Yearn and Uniswap. The data I list below can kind of tell whether the forum is active or not. You can choose more indirect data and read the proposal by yourself to decide the quality of the forum.

Maybe I can find some other interesting data when I research projects in the future, But I don’t have the ability to modeling them. Data thinking is divergent, I can just feel more than understand.

Never Forget about Tokenomics

It helps you judge the most cost-effective price that you want to ape in.

If the project doesn’t have a poor tokenomics like Curve, you can kind of cancel the worry. LOL. This is my exaggerated joke. Curve is an excellent stablecoin swap protocol with a very large token supply, and the 62% of the supply will allocate to liquidity providers in 2 years, which leads to a very low initial supply but a very high everyday sell pressure. The $Curve price pumped to $30 in the beginning and now it is $1.5. A normal tokenomics won’t affect the price very much, especially in the bull market, but things will be better if tokennomics can incentive the performance of a project to reflect in the token price. And if you are a qualified crypto investor, you can definitely calculate the initial market cap, fully diluted valuation, and some other indexes. If you can’t, you can also check Coingecko.

Ending Word

I am still very uninitiated as a crypto investor, and I wrote down almost my most important methodology and hope it will inspire you in some ways. English is not my first language, and if there is any mistake, please feel free to tell me. Any other comments are welcome. Cheers!