encryption investment, bet on fundamentals or capital flow?

Written by: Jon Charbonneau

Compiled by: Chopper, Foresight News

The latest popular narratives in the crypto space are "yield" and "DAT (crypto treasury)", which highlight two completely opposite investment approaches:

Fundamental investment: Buying an asset is based on the expectation of obtaining quantifiable economic returns (such as cash returns) under a series of clear assumptions. These returns create intrinsic value for the asset.

Foolish investment: Buying an asset solely because you believe someone will buy it from you in the future at a higher price (even if the market price is already above its intrinsic value).

In other words, are you primarily betting on fundamentals or capital flow? This short article will provide a simple framework to help you understand the value of both.

Fundamentals and Capital Flow

The core lies in the future

Compared to pure betting capital flows, fundamental investing is generally considered to have lower risk and less volatility:

Lower downside risk: Fundamental investors often manage to avoid large losses. Due to the intrinsic value of the assets, you can gain some downside protection. This may be reflected in the market price of the assets or in their ability to generate cash flow for you.

Smaller upside potential: Fundamental investors often miss out on the biggest winners. You will completely miss out on purely speculative investments (like a Meme coin that rises 1000 times) and often sell positions too early (like exiting before reaching the peak valuation).

Although the above situations are often marginal returns, both investment methods ultimately rely on predictions about the future - and your predictions could be right or wrong. You are betting on the future fundamentals (for example, you believe that protocol X will generate Y dollars in revenue next year) or on future cash flows (for example, you believe that token X will have Y dollars in net buying cash flow next year).

Therefore, the core of both methods lies in how confident you are in these predictions. In fact, fundamental investing often makes it easier to make confident predictions. For example:

Fundamentals: You can see companies like Tether or protocols like Hyperliquid continuously generating high income. With an understanding of the core business, you can reasonably predict future cash flows. A quality project will not lose all its customers or revenue overnight, and ideally, it will grow.

Capital flow: How long can the bet on DAT frenzy last? I don't see too many advantages (except for insider trading). It could cool down tomorrow, or it might last for a year; I really don’t know.

Growth and value

Fundamentals are not equivalent to dullness or low returns. Purely betting on fundamentals can also lead to explosive winners. In this case, you typically focus more on betting on the improvement of future fundamentals (i.e., growth investing) rather than the maintenance of current fundamentals (i.e., value investing). Betting on high growth typically means higher risk, so you expect to receive higher returns as compensation.

This is also a gradual process; growth and value investing are not mutually exclusive. Given that the crypto space primarily involves early-stage investments, most fundamental investments here lean more towards growth rather than value.

Assets that are currently losing money but have high growth potential may be more suitable for fundamental investment than those that are currently profitable but have low growth potential (or even shrinking profitability). Would you prefer to hold OpenAI or Ethereum? This leaves many crypto participants feeling confused, as investments with high price-to-earnings ratios can actually also be fundamental investments. The key difference is:

Fundamental investment: You believe that the protocol has the potential for significant future growth, which can translate into high returns in the future.

Foolish investment: You don't expect growth or returns, you just hope someone will buy from you at a higher valuation.

Fundamental-driven and DAT-driven

Based on all of the above, I still prefer to hold fundamentally strong underlying assets. This includes mature projects with strong current fundamentals that I expect to continue, as well as early projects with high future growth potential in their fundamentals.

On the contrary, we have not participated in any DAT to date (although I am open to its value proposition under certain circumstances). I am also cautious about those investments that rely almost entirely on the flow of DAT funds rather than the strong fundamentals of the underlying assets. Once the DAT frenzy fades, the price support for these assets may collapse rapidly. I believe this is mainly driven by a speculative trend fueled by fund flow, and personally, I do not see much room for excess returns. It is better to invest in areas with advantages, and DAT can also be used to purchase assets with strong fundamentals.

Reduce reliance on human psychology

Buffett and Bitcoin

The confidence in predictions is often inversely proportional to the degree of reliance on the "unpredictable human psychology and behavior assumption".

The core of fundamental investing is: you do not need others to agree with you. A simple test is: "Even if you can never sell it, would you still hold this asset?" Warren Buffett does not need the market to agree with his views. The stocks he buys generate enough cash flow to not only recover the investment but also to provide a certain rate of return.

Bitcoin: Buffett once stated that he wouldn't spend $25 to buy all the Bitcoin in the world. Because it does not generate any income for the holder, it only has value when it can be sold to someone else.

Apple stock: Conversely, anyone would be willing to pay $25 to buy all Apple shares, even if they could never sell them. Because Apple can generate $25 in revenue in an instant.

Clearly, fundamental investors can usually sell their assets, but at least they are aware when buying that the market value of an asset may deviate from its intrinsic value for a long time, and they are willing to endure that period. In extreme cases, they would say: "If you are not willing to hold a stock for 10 years, don't even consider holding it for 10 minutes."

Fundamental investors will still consider human behavior, as it affects the prediction of an asset's future returns (for example, whether people will continue to pay for the protocol's products). However, they no longer have to take the additional, more difficult step of believing that others will agree with their logic and buy the asset. Even when an asset can clearly create value through product sales, predicting market reactions is often very difficult (i.e., the market may be irrational in the long term, underestimating assets with strong fundamentals); and when an asset clearly cannot create value through product sales (such as Meme coins), predicting market reactions becomes even more challenging.

Even when investing based on cash flow, you can enhance your confidence in predictions by reducing reliance on human psychology. For instance, instead of solely depending on predictions driven by narrative-induced emotions, you can forecast selling cash flow by quantifying token issuance, investor unlocking timelines, and unrealized profits held by investors.

In addition, recognizing certain long-term behavioral patterns can also reduce uncertainty. For example, humans have used gold as a means of storing value for thousands of years. Theoretically, it is possible that everyone suddenly thinks gold is only worth its actual utility value tomorrow, but this is almost impossible. If you hold gold, this is usually not the biggest risk.

Bitcoin, Ethereum, and Meme coins

Similarly, the rise of Bitcoin over the past 16 years has made us increasingly clear about when and why people buy Bitcoin. This helps us reduce the reliance of investment on human psychology (for example, do people buy Bitcoin when global liquidity increases?), and instead rely more on other underlying investment logic that we actually want to bet on (for example, will global liquidity continue to increase?). Therefore, even though Bitcoin is largely driven by capital flow as an investment, it may still be the most confident investment target for most cryptocurrency investors.

This also helps us understand why the investment logic of Ethereum is essentially more complex. It requires making more uncertain assumptions about human behavior and market psychology. Most investors generally believe that the cash flow generated by Ethereum alone is insufficient to support its valuation based solely on fundamentals. Its continued success is more likely to stem from becoming a lasting store of value (more like Bitcoin), which requires making some or all of the following predictions:

Various means of cryptocurrency value storage: You might predict that people will start assigning relatively higher value storage premiums to assets outside of Bitcoin (such as Ethereum), making Bitcoin no longer special. However, we have not seen this situation today, and historically, people tend to favor a particular asset for such functions (for example, gold is primarily priced based on its monetary value, while silver is mainly priced based on its utility value).

Replacing Bitcoin as a store of value: You might predict that Bitcoin will ultimately fail (for example, due to security budget issues or quantum computing), and Ethereum will naturally become the successor to "digital gold." But it is likely that once confidence collapses, all crypto assets will fall.

Value storage tied to specific utilities: The logic of Ethereum is often linked to its additional utility compared to Bitcoin, which can be measured through various indicators such as "collateralized value", EVM activity, "Layer 2" activity, or DeFi usage rates. However, unlike the cash flow (i.e., revenue) generated by Ethereum, these indicators do not provide intrinsic value — they are merely the narrative of value storage. Therefore, Ethereum is far from a pure expression of the underlying logic that "network-level indicators will grow"; while betting on these trends, you are also betting on how the market will price Ethereum as a result.

It should be clear that there is nothing wrong with making these bets. When buying Bitcoin in 2009, similar uncertain assumptions had to be made about human behavior, and the results were quite good. Investors just need to understand what they are actually betting on and how their views differ from market consensus. To achieve sustainable excess returns, one must understand where the market is wrong.

Looking at the extremes, there are also pure Meme coins. They are destined to not have lasting monetary premiums; you are betting entirely on human psychology and the market's short-term reaction to new narratives. Is this Meme stimulating enough? Interesting enough? Or is it too boring? It's like a "game for cowards."

Conclusion

The two investment methods we discussed are not inherently right or wrong. For investors, the key is whether you can make confident predictions using them systematically. More confident predictions can reduce volatility and downside risk; predictions that are more confident than market consensus can help you achieve excess returns.

In most cases, especially for long-term investments, I find that I can better utilize strategies that rely more on fundamentals to replicate Alpha values. But as mentioned earlier, this is not absolute. Investments like Bitcoin may fall somewhere between "fundamental investing" and "FOMO investing," depending on how you quantify the utility of the currency. You may have high confidence in betting on Bitcoin (mainly based on capital flow), while lacking confidence in betting on a particular DeFi project (mainly based on fundamentals).

Ultimately, these two approaches are not mutually exclusive. You can invest based on both fundamentals and capital flows simultaneously. In fact, the investments with the best risk-adjusted returns are often the product of a combination of both.

Historically, as a crypto investor, it has been worthwhile to primarily focus on capital flows. This makes sense: in the past, tokens would inexplicably surge every four years, interest rates were zero, investors raised too much capital, and very few projects generated enough cash flow to support high valuations. However, looking ahead, as the industry matures, I believe that focusing on fundamentals may ultimately yield more excess returns.

I also hope that fundamentals will become more important, as this is crucial for the long-term health of the industry. I have no objections to meme coins (most of them are just fun gambling), but trading narratives around assets that do not create value is essentially a zero-sum game. In contrast, allocating capital to projects that can generate cash flow could be a positive-sum game. Building projects that can generate cash flow requires creating products that customers are willing to pay for; whereas issuing tokens purely for narrative purposes does not have such a requirement, as the token itself is the product.

The cryptocurrency sector requires this feedback loop created by fundamental investment:

Fortunately, the overall trend in the cryptocurrency space is:

Cryptocurrency investments are becoming increasingly driven by fundamentals. We finally have more tokens that can generate significant cash flow, the framework for token transparency is becoming widespread, and the frameworks for token valuation are also becoming easier to understand. As a result, the differences in token returns are also becoming larger.

Traditional financial investments are becoming increasingly driven by capital flows. The world is becoming stranger and more degenerate, with Meme stocks and crazy IPO first-day surges becoming more common. Understanding the next hot narrative is crucial.

One day, the two will converge, and we will only talk about "investment." But one thing will not change: fundamentals and capital flows will still be important.