Our Process for Evaluating New Tokens
A lot of new money is piling into cryptocurrencies right now. For the most part, the new money is investing in memes. Memes are most commonly thought of in the context of snarky-captioned images that spread on social networks like Reddit, but a meme is just an idea that spreads from person to person within a culture. Memes are now manifesting in the form of cryptocurrencies and spreading like wildfire across the globe. BTC is a meme: digital gold. ETH is a meme: digital fuel for decentralized applications. XRP is a meme: bankcoin.
Cryptocurrency-based peer-to-peer networks are complex organizational structures that can offer real value based on fundamentals, but the market is currently showing no concern for the underlying fundamentals. If you have a decent meme, you have a cryptocurrency worth $1B+ in total market value (even if no one is using the network and there has been no code changes in the past year, see DOGE). If you have a great meme, you have a cryptocurrency worth $100B+ in total market value (even if no one is using the network and it’s highly centralized, see XRP).
I’ve been thinking deeply about long-term fundamentals of the networks that underly cryptocurrencies for quite a while and decided to publicly share our evaluation process for new token-based networks. This is a process that I’ve shared with the 1confirmation LP base, which includes arguably the best angel investor ever and the top debt investor, VCs, and fund of funds in the world. Historically, investing has been shrouded in secrecy, but I believe that more transparency around crypto investing is much better for everyone in the long-run.
Some argue that crypto is an asset class where investing should be left to the professionals who understand cryptography and how to read code, but that view goes against the inclusive and democratic values that initially attracted me to the space. What we’re doing is highly specialized and requires significant time and effort to do at an elite level, but I believe this framework can benefit anyone interested in the space on some level
At 1confirmation, we evaluate all new projects based on 4 simple fundamentals that we think drive the long-term value of any token-based project: team, product, community and token mechanics. A project must be exceptional in all 4 categories for us to pull the trigger on a new investment.
The most important question is who is the founding team behind the project? Surprisingly, this is a question that not enough new crypto investors are asking. Is the team exceptional technically, inclusive, transparent, objective and capable of fostering a vibrant global community? You can filter out the majority of the cryptocurrencies in the top ten right now by asking that simple question.
All token-based networks require buy-in from a broad-base of people globally and the founding teams must operate in a balanced, transparent manner and understand the ethos of the broader blockchain community to gain global buy-in. This is different than the case of traditional companies, where founders can build a great product without worrying much about transparency or fostering a healthy and vibrant community.
Founding team assessment:
- Each founding team receives an overall “aggregate founding team” score (between 1 and 10). Target score: >9.
Founding team is evaluated based on:
- History of success, demonstrated ability to overcome obstacles to success and strong desire beyond money
- Attract and surround themselves with top technical talent who are inspired by vision and leadership
- Obsessive about the problem they’re solving
- Mature thinkers — deeply thoughtful about problems and realistic about growth plan
- Team is uniquely suited to tackle the technical problem
It takes an elite founding team to score highly across the board.
I believe there are currently a lot of mistakes being made when assessing founding teams, especially around evaluating vision and technical skills. For example, there is a lot of investor excitement around forks of Ethereum and Bitcoin. The founding teams behind forked blockchains often lack the vision and technical skills of the founding teams behind the core blockchains, and as a result are typically less attractive opportunities on a risk adjusted basis.
Note: We rely on technical advisors (Balaji, David, and Brendan) to help vet the technical competence of founders. Access to top technical talent is scarce and assessing technical competence directly is one aspect of the process that may be difficult to replicate for someone who isn’t doing this professionally.
The main question to consider about product is whether or not the product solves or will solve an important problem for a segment of people (that segment can either be small with potential to grow or large)? It’s incredible how many tokens can be filtered out because the answer to this question is no (once again, the majority of top ten market value cryptocurrencies).
Each product receives an overall score (between 1 and 10). Target score: >9.
The product assessment is based on:
- The technical specification that describes the product. Is the technical specification thorough and does it demonstrate mastery of the subject matter?
- At least two customer or potential customer reference calls — are there people out there who want and need this product right now?
- Does the product benefit from network effects?
- Is there a core technical or product advantage that is likely to lead to competitive differentiation?
- Does the product surprise and delight users?
Right now, we are focused on products that solve problems for the existing crypto community rather than products that solve problems beyond the crypto community. Products that solve problems beyond the crypto community, like supply chain management or real estate applications, sound exciting, but we believe that the products that are most ripe for adoption in the next 2–4 years are infrastructure and middleware that serve the existing community rather than end-user applications that appeal to the masses.
There are some consumer applications that we think are ripe right now (like investment/speculation and work markets), but generally speaking we think it’s early for consumer dapps and spend most of our time on products that are solving problems for the existing crypto community.
Is there a community developing around the project or does there appear to be a group of people within an existing community that values what the new network will offer? Does the founding team demonstrate the potential to foster a vibrant and healthy community long-term?
Each community receives an overall score (between 1 and 10). Target score: >9.
The community assessment is based on:
- Reddit community (# of subscribers, daily engagement)
- Slack, Rocketchat, Gitter, Telegram (# of members, daily engagement)
- Has the founding team demonstrated the characteristics (inclusive, transparent, objective, etc.) necessary to build a healthy community? Have the public or private interactions by the founding team been balanced and unemotional, or have they been emotional and irritable?
Note: The founding team is important for community in the early days, but identity of the founding team is not necessarily important. For example, Satoshi was quite active and transparent on Bitcointalk and IRC in the early days of Bitcoin. Many communities in the future may emerge from pseudonymous founders on online forums, much like Bitcoin did.
Is the token a usage token, a work token, a security token, or a combination? More on the types of tokens can be found here.
Token mechanics are evaluated based on:
- If it’s a usage token, is the digital service being offered useful and does the network underlying the digital service aggregate resources (hashing power, file storage, etc.) that will differentiate the service in the long-term?
- If it’s a work token, is there a strong network emerging that wants to contribute and is the UX well thought through? And is the service offered useful to people?
- If it’s a security token, is there some technology underlying the security that gives the token a long-term competitive advantage?
- Is the team distributing the token in a fair and equitable manner, considering all market participants and optimizing for long-term usage of the product rather than short-term fundraising?
Investing in memes has done phenomenally well to date, but we think memes are fleeting and the underlying fundamentals need to be strong for the value of cryptocurrencies to persist over time. Team, product, community, and token mechanics are undoubtedly the 4 most important fundamental characteristics in our view. If you think deeply about most cryptocurrencies with this framework, you can filter them out quickly.
This is just one simple framework to evaluate the fundamentals of token-based projects. You may notice that our framework is relatively simple: we’re not trying to create complex formulas that define what the exact value of something should be. Value is relative; we think that cryptocurrencies will continue to grow in value over the long-term and we also think there are tremendous misallocations right now between projects with fleeting memetic value and projects with long-term fundamental value. By focusing on fundamentals, we think it’s possible to benefit from these misallocations in the long-run.
As a fund, we execute on this framework currently but we also recognize that the space is nascent and evolving quickly so this is subject to change. I always love to hear from people with different perspectives so don’t hesitate to reach out if you disagree with the framework in any way or would like to talk through anything.