Narrations on the Market: Part II The Embedded Crypto Put

July 5, 2024

Disclaimer: This is not financial advice. Anything stated in this article is for informational purposes only and should not be relied upon as a basis for investment decisions. Triton may maintain positions in any of the assets or projects discussed on this website.

TL;DR

  • Digital asset projects are publicly tradable far earlier in their life cycle than traditional startups
  • Most startups fail, but digital asset startups can leverage embedded ‘crypto puts’ by launching a token instead of shutting down
  • Continual token launches, often at highly inflated FDVs, put consistent downward pressure on alt markets
  • As the industry matures, fundamentals-driven projects will increasingly outperform, but long-term investment horizons and a stomach for volatility are required

Introduction

Last week we described the concept of points campaigns and airdrops while dissecting Starknet’s approach to its own recent public release, highlighting the positive and not-so-positive aspects of their program. The broad takeaway of that piece is that projects only have a discrete window during which they can leverage their ‘upcoming airdrop’ to attract users en masse to their ecosystem. If they capitalize on this opportunity and use it to build on strong product market fit and establish significant network effects, these programs can be immensely valuable. The opposite is also true: once that airdrop/token generation event happens if the protocol hasn’t found PMF, those users will disappear overnight while dumping the token, as Starknet discovered all too well. 

This is just one example of a long list of airdrops/TGEs that resulted in down-only prices for their tokens and ecosystems devoid of any meaningful activity. Head-scratchingly, many of these projects are still worth millions or even billions as measured by circulating token value. Cardano ($18B), Hedera ($3.8B), Algorand ($1.5B), EOS ($1.2B), and Tezos ($800M) are just a few examples of highly valued projects that lack the supporting fundamentals to justify those valuations. Among smaller projects (e.g. those valued between $50-$500M), there is a long list of projects with ‘live’ tokens but relatively dead ecosystems. 

Reminder: exit liquidity in digital assets comes far earlier

A few weeks back, we explained how digital asset projects differ from traditional startups in terms of liquidity horizons. Specifically, with traditional startups, the path to exit requires later-stage private financing rounds (series C/D/E+) before IPO or being acquired by a competitor. This necessitates continued growth in underlying fundamentals to achieve that next step. More often than not, this is not the case: only ~40% of startups that raise a seed round continue on to raise a Series A, and of those, only slightly more than half continue on to raise a Series B. Less than 10% of startups progress to a Series D round.  It is hard, even more so now with softer funding markets than has been the case over the past decade.

Source: TechCrunch 

So how does this differ in digital asset markets? Rather than running this multi-step gauntlet that traditional startups face and typically fail at navigating, digital asset startups can get their exit far, far earlier via a token generation event (TGE). Instead of having to prove sustainable 100-200% revenue growth, strong PMF, and a fundamentally sound business to a VC, projects can just launch a token into the public market where there is generally far less sophisticated capital (e.g. retail) evaluating projects. They are also able to take advantage of the uniquely powerful points/airdrop opportunity inherent in digital assets to drive attention, and demand, and thus potential launch FDV regardless of PMF and product quality. In short, with the opportunity to exit disconnected from actual success, the ability to hold a TGE at any point effectively provides an embedded ‘crypto put’ for founders: unbounded upside if successful, but protected downside no matter the outcome.

More insidiously, whether done so intentionally or as a side effect of now-normalized industry practices, private investors compound this by pushing teams to launch at as high of valuations as possible. Further, the tokenomics and public supply schedules are often convoluted and obfuscate the actual token dynamics at play. Not only does this give the project a splashy launch and longer glide path down to 0 (or more likely to its non-zero embedded crypto put value), but it also allows investors to substantially mark up their investments to show better performance on paper while elevating the secondary market value at which they can potentially sell their locked up tokens (many secondary sales are framed as a discount vs. FDV). Projects often also constrict circulating supply at launch (e.g. just 5-10% of token supply in public hands) while enlisting market makers to support asset prices post-launch.

Source: Worldcoin’s astronomical FDV via TokenTerminal

Worldcoin is one of the most egregious examples of this dynamic: out of a total supply of 10 billion WLD tokens, just 111 million (1.1%) were actually released at TGE in Jul 2023. Of that, 100 million WLD were loaned to market makers, with an explicit incentive structure to support the token price of around $2.00. That is, just 11 million WLD tokens – out of 10 billion total supply – were actually in the hands of the public. Despite this complete lack of price discovery, the team and investors were able to trumpet a $20 billion FDV, provided by the 10 billion tokens and artificial $2.00 price level. Due to only a tiny fraction of tokens circulating (still just 2.6% as of writing), Worldcoin’s FDV reached an eye-watering $117B in March 2024 but has since fallen back to $22.5B. Investor and team unlock are due to begin this month (e.g. 12 months post-TGE) – and will likely take advantage of the immensely inflated FDV to realize returns, despite the project being fundamentally overvalued by multiple orders of magnitude purely due to the engineered tokenomics. 

Source: A snapshot of new supply pressure via TokenUnlocks

This same dynamic repeated across hundreds of projects leads to a strong overhang on the broader ‘alt’ token market (e.g. generally anything beyond Bitcoin, Ethereum, and Solana). Given the immense difficulties that most institutional investors/allocators still face in being able to trade and custody digital assets (especially at scale), there is a structural dearth of capital available to support the public side of this market when compared to the supply pressure coming from the private venture side. Compounding this, digital asset performance is often highly narrative-driven in the short run stemming from the heavy retail makeup, leading to what many refer to as the ‘crypto hot ball of money’. All taken together, the relatively limited amount of available public capital is spread increasingly thin across the ever-expanding number of projects launching tokens. 

Dispersion will start to increase going forward, driven by project fundamentals

While these dynamics result in periods of extreme volatility in the alt markets, as the industry continues to mature, infrastructure gets further developed and valuation models become more standardized, there will be an equilibrium reached where the public side of the market can adequately support the quality projects coming from the private side, as is the case with traditional markets. Dispersion in returns accruing to quality projects with strong fundamentals will only continue to grow. There will assuredly still be periods where many token valuations are completely detached from fundamental reality and the strongest projects underperform (e.g. 1Q of this year) in the near term, but it is our belief that a long-term investment horizon and allocating only to projects with the strongest underlying fundamentals - while maintaining conviction to weather the volatility -  ultimately yields returns worth waiting for. 

ECON 101 and Digital Assets
Jul 10, 2024

This market pain is to be expected. We are thrilled to see it. 

Narrations on the Market: Part II The Embedded Crypto Put
Jul 5, 2024

TGEs and airdrops allow founders and investors to exit projects earlier, even if they failed

Narrations on Recent Market Dynamics: Part I
Jun 27, 2024

Airdrop campaigns are a uniquely powerful mechanism, but only if used correctly

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