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| “You make most of your money in a bear market. You just don’t realize it at the time.” - Shelby Cullom Davis |
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In today's issue: This week, Token Terminal released one of the greatest innovations in crypto: quarterly financial statements.
We're big fans of Token Terminal's reporting. We use its data for our Top 10 Fundamentals newsletter which Premium subscribers receive every Thursday.
These reports take things a step further and show you financial performance over time.
Today, we unpack how to read these financial statements and explain why they're so powerful. They're the crypto investor's newest secret weapons. |
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New NFT Investor Scorecard: Mutant Ape Yacht Club!
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| | | Must Read Today's most important story for crypto investors. |
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Bitcoin, like all software, must be maintained by developers. In this excellent piece of reporting, the Wall Street Journal tracked down as many bitcoin developers as it could and interviewed them.
Two things are striking about the story. First, being a bitcoin dev is no walk in the park. It's a poorly-paid, high-stress role that comes with headaches and frequent burnout.
Second, the core bitcoin team is really small. As we'll show you in our column below, it's concerning how small the bitcoin core team really is. It's one of the core metrics uncovered by these new financial statements.
Investor takeaway: The size, overwork, and lack of leadership of their core dev team is a yellow flag for bitcoin investors. How can bitcoin get big if its team is so small? |
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| How to Read Crypto Financial Statements by John Hargrave |
This week, Token Terminal released one of the greatest crypto products I’ve seen in years: crypto financial statements (see them here).
The idea of creating crypto financial statements may have started with James Wang, who created one for Ethereum in Q1 2021. It was a clever concept. Public companies are required to disclose their quarterly financials. Why not do the same thing for crypto “companies?" Since blockchain technology is transparent, these financial statements would be much better than those of traditional companies. They wouldn’t be prepared by an in-house financial team shrouded in secrecy and released weeks later. They would be available to anyone instantly. Now, Token Terminal has taken this a step further: it'sautomated them. The SEC, which prides itself on requiring clear and transparent financial information for investors, should be praising this latest development. This is so much better than the way it’s done with public companies.
I’ve been geeking out over these reports all week. As a long-term crypto investor, these financial statements are like secret weapons. It cuts through the hype and the headlines and gives you cold, hard facts about any listed crypto project (currently about 150). The best part? The product is completely free. Today I’ll show you how to read crypto financial statements and some of the quick numbers you can pull to see whether a crypto investment might be worth your hard-earned money. |
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Bitcoin’s financial statement. Let’s break it down.
Understanding the Income Statement First, a caveat. Token Terminal needs to work on its token terminology. If you’re used to reading traditional income statements, you’ll have to wrap your head around these confusing names, so I’ll break them down. What it calls “fees” is like a traditional company’s “revenue.” As every crypto investor knows, you have to pay fees to use crypto products. These fees are the money the crypto company takes in (like revenues of a traditional company). “Supply-side fees” are the share of these fees that go to the miners or validators. They're the ones who maintain the network. In a traditional company, this might be like salaries paid to employees or what you pay to make the product (also known as cost of goods sold or COGS). What it calls “revenue” is transaction fees paid to token holders or (in some cases) tokens that are burned. Think of this more like “dividends” and “stock buybacks.” It’s revenue benefiting the “shareholders” or "owners" (i.e., those who hold the token). “Token incentives” are “extra rewards” paid to users to get them to use the product. Compound, for example, pays COMP tokens to lenders and borrowers. This encourages usage of the product, but it continually dilutes the value of COMP for everyone else. This is a useful metric, and I don’t think there’s a public-company equivalent. It would be like if Uber paid stock to get you to use their product in the early days (more info here). Finally, what's called “earnings” are the aforementioned “revenue” minus “token incentives” (or value that accrues to shareholders minus value that's taken away). Earnings is incredibly valuable (even if it’s confusingly named) because it tells you whether owners/shareholders are gaining value or losing it. Here’s a quick reference guide: |
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Let’s take a few real-life examples and the “story” you can tell from each. To tell the story, we read the statements from right to left or past to present.
Bitcoin Income Statement |
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The story: Fewer people are using the bitcoin network over the last few quarters (from $30 million down to $16.67 million in fees). This isn't surprising given the current market. Calling the bottom line “earnings” looks like the bitcoin company is losing money every quarter, which isn’t really accurate. However, it highlights an important point. All bitcoin fees are going to miners and none to the owners (or BTC investors).
In these reports, negative earnings are not necessarily bad. They just mean you (the owner/shareholder) are not getting additional value on top of the value of your underlying BTC. As an analogy, some traditional investors only want to buy companies that pay dividends. Others don’t care about regular payments so long as the company has good, long-term growth prospects. Bitcoin would appeal to the second type of investor. Ethereum Income Statement |
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| The story: A much better financial picture. Not only are fees (think "revenues") holding up, but earnings (think "the value of your investment") is going from negative to positive. This is a positive trend for ETH investors. Uniswap Income Statement |
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| We have a new metric here, which is the confusingly-named GMV or “gross merchandise volume.” While this sounds like something a clothing manufacturer would measure, GMV is how much money being moved. On a decentralized exchange like Uniswap, it’s the trading volume. With a lending company like Compound, it’s the value of active loans. The story: Total trading volume is down about half from two quarters ago. Again, not a surprise in the current market. All the fees earned by Uniswap go to the liquidity providers (you can read more about LPs in our Investor’s Guide to Uniswap). As with bitcoin, UNI investors are betting on the company (i.e., that the UNI price will rise), not on any payments to shareholders. Understanding the Treasury Forward-thinking crypto companies keep a “treasury,” (a bit like “retained earnings” for traditional companies) that can be used to grow the businesses. You might use a treasury to create new developer incentives, fund related startups, pay executives, or anything else that might cost real money (even though it’s held in tokens, it can be converted into cash). Communities usually vote on where to spend treasury funds. |
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| Here’s a look at Compound’s treasury: |
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The story: When you see the treasury slipping from $442 to $126 million (bottom row, right to left), you may think a boatload is being spent on what is clearly a declining business (top row, right to left). However, everything is affected by the macro market. When crypto is down, the demand for loans is down. The same goes for the value of the firm's treasury. Since it’s likely held in COMP tokens, the value of the token affects the value of the treasury. Not a great financial picture, but more investigation is needed. Which brings us to… Understanding Market Data You’re already familiar with “price.” Unfortunately, it’s the only metric most crypto investors use (that’s why these reports are your secret weapon). They give you two market cap metrics, and the difference is how many tokens have been minted vs. how many have been promised:
“Fully diluted market cap" is the total value of the crypto company when all tokens are minted, according to their promised rules;
"Circulating market cap" is the total value of all the tokens in circulation today. “Trading volume” shows you the value of tokens traded during the quarter, while “tokenholders” tells you how many individual wallets hold the token (imperfect number since people can hold more than one wallet, but probably close enough). Here’s the market data for Balancer (BAL): |
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The story: Bucking market trends, the price of BAL has increased over the last few quarters, as have the number of BAL tokenholders. There are roughly $250 million in tokens issued out of $615 million that can eventually be minted. Looking at the total picture, we can see that even though trading volume (top line) has declined with the overall market, and earnings (think "shareholder value") are in the red, the price of BAL keeps going up. This is a red flag. Why are investors so optimistic? This may be the answer. Understanding Valuation Multiples In the traditional world, valuation multiples are ratios of one financial metric to another. They’re useful for comparing different companies (apples to apples). These reports list four valuation multiples: P/F ratio (fully diluted): Fully diluted market cap / annualized fees. P/F ratio (circulating): Circulating market cap / annualized fees. P/S ratio (fully diluted): Fully diluted market cap / annualized revenue. P/S ratio (circulating): Circulating market cap / annualized revenue.
The most helpful here is probably P/F ratio (circulating), which gives you the total value of all tokens divided by the fees (or revenue) generated. Think of this like P/E ratio in traditional investing. (You’re probably wondering why they chose the letter “P.” It stands for “price” in traditional price-to-earnings ratios. Super-confusing names, but great idea.) |
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| The rule of thumb is that stocks with higher P/E ratios are more overvalued, while those with lower P/E ratios are more undervalued. As value investors, we hope to buy good companies with lower P/E ratios. They're the “hidden gems.” Here are the valuation multiples for Lido (LDO): |
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The story: We can see healthy financials, with a growing number of assets staked (top line), a growing treasury, and a steadily increasing price. The P/F ratio (circulating) has increased from 3.6x to 4.8x, showing you that LDO is not quite the deal it was back when we issued our BUY ALERT in July. However, it's still quite low compared to many other crypto projects (Ethereum, for example, is selling at a 150x P/F ratio). It still might be a great buy. Understanding Alternative KPIs
Finally, the alternative KPIs section gives you key information to gauge the health of the business: “Daily active users” is like the number of loyal customers. DAU is one of the most important metrics in blockchain due to network effects (please read our piece on Daily Active Users: Like X-Ray Vision for Crypto Investors). “Active developers” and “code commits” show you how many people are behind these projects. Think of this like the size of the tech team and how many big changes are being made each quarter. Let’s compare these metrics for bitcoin and Ethereum: |
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| The story: You’ll be surprised to learn that bitcoin had only 13 active developers last quarter, while Ethereum had 165. The team made just 250 changes (code commits) for bitcoin compared to 2,000 for Ethereum. This paints a picture of Ethereum as a growing, vibrant ecosystem, while bitcoin is a tiny squad of developers keeping the lights on (and as the Wall Street Journal reported today, this is indeed the case). Putting it All Together These financial reports are significant milestones for the crypto industry. They’re not perfect; they could be more intuitive, but they're the start of something really great. A picture of financial health over time. No more do we have to rely on hype and headlines to make investing decisions. We can now evaluate the businesses ourselves using reason and reporting over FUD and FOMO. These reports are still works in progress as there are no generally accepted accounting principles (GAAP) for crypto. In fact, most people won’t even admit that cryptos are companies. That's why these reports are godsends for serious crypto investors. We’ve been saying for years the obvious truth. Even if they’re not technically companies, we can think of cryptos as companies. With these new financial reports, we now have powerful new tools to evaluate their corporate performances. They're the crypto investor’s secret weapons. |
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| Health, wealth, and happiness, John Hargrave Publisher Bitcoin Market Journal |
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