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“You’ve got to be careful if you don’t know where you’re going, ’cause you might not get there.”

— Benjamin Graham, quoting Yogi Berra

Permissionless preview: Christopher Jensen on crypto fundamentals

Back when US equities were as unregulated as crypto tokens are today, few, if any, investing decisions were made on the basis of “fundamentals.”

Before regular financial disclosures were mandated by the Securities Exchange Act of 1934, basic information about a company’s revenue or earnings was so hard to come by, you probably had to be on the board of directors to know anything about its stock. 

In that early era of investing, the stock market was primarily split between insiders trading on privileged information and outsiders trying to guess what those insiders might know.

This dearth of publicly available information is why Benjamin Graham, the first great value investor, employed his famous “cigar butt” strategy.

When Graham started investing in the 1920s, it was impossible to know very much about companies. So, Graham’s strategy was simply to buy the very cheapest ones, irrespective of business fundamentals, and hope for the best.

By the 1949 publication of The Intelligent Investor, things had improved enough that Graham could advise readers to seek out companies with “stable earnings, strong balance sheets, conservative financial policies, good management and a low price relative to their value.” 

But as late as the 1960s, good information remained so hard to come by that Graham’s most famous disciple, Warren Buffett, considered company balance sheets an informational advantage because you had to physically go to an SEC office to get them, and very few people did.

If crypto is speed-running traditional finance, I think crypto investing may be approaching the 1960s.

Most crypto types still consider valuation to be a meme and I can understand why — there’s no obvious correlation between good fundamentals and good token performance.

But a small and growing cohort of intrepid investors are stubbornly attempting to apply the principles of value investing to this new asset class.

One of those intrepid few is Christopher Jensen, director of digital asset research for Franklin Templeton's Digital Asset Investment Strategies Group. Jensen is also a scheduled speaker at Permissionless, where crypto’s founders, developers and investors will gather in October to hash out this industry’s future movements.

That’s important because — to paraphrase the great value investor Yogi Berra — if we don’t know where our investments are going, we might not get there.

After speaking to Jensen this week, I’m more optimistic that crypto investing is going in the direction of value — and that we’ll get there faster than equities did.

Here’s an edited transcript of our conversation:

Is there a shortage of crypto investors dedicated to investing in liquid tokens?

I’ve heard estimates that the amount of capital raised on the venture capital side is 10 times what’s been raised on the liquid side, creating an interesting opportunity for those investing in digital asset tokens. One of the things that's unique about crypto is you can get those venture-like asymmetric returns, but when doing it in token form, you have some liquidity too. Being able to offer a product that has liquidity yet still exposure to these early-stage projects in token form…you get a little bit of the best of both worlds. 

If there's a shortage of funds dedicated to liquid tokens, why do tokens seem so expensive? 

There are some really interesting, undervalued tokens and projects, but those are probably few and far between. But I think in this choppy, sideways market, one of the things that we’re finding is that some of these altcoins that have traded off 80% or so actually have decent fundamentals. So we’re finding some interesting value in this market, which we expect goes away once we're back in full bull market mode. So, generally, sure, this space can seem rich at times, but we're still finding pretty well-valued projects and tokens that have good, attractive fundamentals. There's not a ton of it, but it's there. 

Of the things you consider value in crypto, would they be considered value on the stock market too? Or only relative to other tokens? 

We do intrinsic-valuation metrics as well as relative-value metrics, and whether we’re comparing to other crypto projects or growth-y tech stocks, some of these projects still seem attractive.

How cheap does a crypto token have to be to be interesting to you? 

It depends. Using an intrinsic-valuation model, you can back out what growth trajectory is assumed based on the current token price. Then it comes down to your view on the future, a protocol’s competitive moat and its ability to achieve network effects and drive adoption. We look at price-to-sales and price-to-earnings multiples, but we're also running full intrinsic-valuation models. We triangulate all that and sometimes you get a sense of comfort and sometimes it looks rich no matter how you look at it.

What’s an intrinsic-valuation model? Is that like a DCF model? 

Yes, we use DCF models as well. Then when you apply it in a similar fashion across projects in a sector, that intrinsic-valuation tool becomes a relative valuation tool as well, which is another way we use DCFs.

If you run a DCF on a crypto where the protocol’s revenues are denominated in the token itself, do you get a circular error?

Great question — it emphasizes the reflexive nature of the asset class. In TradFi commodities businesses — for example an oil and gas E&P firm, you would look at through-the-cycle multiples and use a through-the-cycle price deck. So, we've applied some of that in crypto, where we run everything in US dollars. If it's a project building in an ecosystem like Ethereum, we could then also do the valuation in native ETH terms and look at it that way. So we try to do both. Valuation is as much art as it is science and the circular and reflexive nature of the asset class certainly doesn’t make it easy.  

Do you value layer-1 tokens just based on fees?

I think the concept of total economic value, which is looking at the MEV plus the fees, is interesting. But we also like to ask, what's the probability that a killer app would land on this ecosystem versus another? You want to maximize those odds. So, from a technology standpoint, a community standpoint, all these different things, what's the chance that the next big thing gets created on Ethereum versus, let’s say, Solana? And then what that would do in terms of the value that would flow through to token holders. So that's another way to think about it.

Do you have an opinion on the fat app vs fat protocol debate? 

The fat protocol thesis still has a lot of credibility. As some of the crypto gets abstracted away, however, the ability to own the customer relationship — that last mile — will be valuable. I don't think we're there yet, but we're heading in that direction. Even if you look at our own technology that we're building at Franklin Templeton, the Benji Investments app, which is now on a few different chains, the hope is that it's eventually all abstracted away. Right now, people still care about what chain it's on, but eventually it's just going to be seamless and they won't care as much. And then the ability to add on additional services by managing and owning that customer relationship will be valuable. 

What if crypto turns out to be just infrastructure and the apps on top of it are Web2 businesses? Would that be a fail for the industry? 

I don't think that will be the case. By having an in-house VC team, we get a look at a lot of startup teams and the innovations that they're working on. One of the sectors that we see a lot of potential in is DePIN — in a way, it's crypto infrastructure, but in another way, it’s real world infrastructure bootstrapped by token incentives. That's why we like it. We think those things have legs and will take off. If none of that works out and crypto is just the next evolution of, I don't know, cloud services or the internet tech stack, the plumbing, I think it would be a failure. We wouldn't be realizing the full potential of everything that distributed ledger technology and digital assets can bring us.

Are you optimistic that a DePIN project will go mainstream within our lifetimes? 

Definitely. First of all, there is a lot of experimentation happening across a variety of interesting end markets. Also, a lot of these founders, they're from the real world and they've come to crypto because they tried to build this not on a blockchain and it didn't work. Just from a first-principles standpoint, the idea of using token incentives to bootstrap a network and crowdsource your capex, that makes a lot of sense. The unit economics of some of these businesses could just be better as DePINs. And it's a way to create a wedge with some of these Web2 incumbents. So, from seeing the quality of the teams, from seeing the number of different projects that are launching and experimenting and iterating, and then just thinking about it in terms of first principles, I think there's a lot to be excited about there. It's just a matter of time. 

From your view of the VC world, do you see a pipeline of potential consumer apps outside of DePIN, or are we entirely dependent on DePIN being a hit? 

There’s other things. For a couple of cycles now, people have been talking about gaming and I think there's still something to be said there — I think we'll see something happen there eventually and it will be transformative. We're obviously seeing a lot of stuff on the payments side — even big names are getting involved in that space. The creator economy is another area, I think. And then, although hyped, there’s the intersection of AI and crypto, where AI is all about abundance and crypto brings in scarcity and provenance.

Do you consider tokens to be equity? 

Not in the strict sense, no, but I think there are equity-like properties in a protocol’s tokenomic design that can help facilitate value accrual to the token. In other words, when we’re evaluating digital asset tokens at potential investment opportunities, we’re looking for something in the tokenomic design of the protocol that would suggest that…as the network grows and as the value of the network grows, that will increase the value of the token. 

So what do token holders own?

It depends on the tokenomic design of the protocol. Broadly speaking, there are spending tokens and investment tokens. We focus on the latter, where a necessary, but not sufficient, condition is that there is some value accrual mechanism embedded in the code of the protocol. 

So it's a de facto claim on earnings? 

I think so, yeah. Essentially a programmatic claim, rather than a legal claim, on the residual value of the project.

Do you think crypto is an asset, or is it only “asset-like?”

I do consider digital assets a new asset class. From a portfolio construction and theory standpoint, their risk, return and correlation characteristics, and just the global and permissionless nature of these types of business are all supportive of it being its own asset class, rather than just an extension of, say, tech stocks.

Do you consider protocols to be businesses? 

I think looking at protocols as businesses is helpful when thinking [about] how to analyze them. There are other camps that look at them as digital nation states or just through a commodities framework and I think those mental models are interesting too — but I find them a little less useful. At the end of the day, these tokens have commodity-like properties, equity-like properties, currency-like properties. So, getting back to the theme of triangulation, I think looking through all these lenses is helpful. My favorite, though, is looking at it in terms of a business, but that's also just my DNA and how I look at things in general. It's not perfect, but it's a lens through which we can start to make sense of it. 

Is value accrual the primary thing you look for in a token?

When we started, we put tokenomics and value accrual as number one on the list of what we were looking for. Over time, that's come down to second. The first thing now is making sure there is product-market fit. Plus, given these are early-stage startups going after large end markets, the highest and best use of their capital is often to reinvest in growth. The way we look at things now is really trying to underwrite product-market fit and being able to onboard the next 100 million users, and having some network effects and a moat that can be relied upon. And then, second, it's thinking through how that value would be shared with token holders.

Does crypto have moats?

In an industry all based on open-source code, the only moat that seems to really have legs is network effects. A good example is liquid staking, which we think is a winner-take-most market. It's hard to develop a real moat beyond that — at least from what we’ve seen. 

Are crypto fundamentals the same as equities fundamentals?

There’s a lot of nuance in crypto fundamentals that's very crypto-specific. A great example is token unlocks. There are projects that literally double their circulating supply overnight. That doesn't happen in equities. “Incentive alignment” is another really nuanced part of crypto, because in addition to the protocol, you may have a labs entity and a foundation entity and each of these can have their own incentives. It’s important to try and figure out who all the various stakeholders are (investors, founders, influencers, etc.), how they’re being incentivized, when their tokens vest, etc. And then the reporting and transparency can be a lot more challenging in crypto. I think eventually there will be some form of standardized reporting in crypto and that will help a lot.  

Is understanding valuation the way to invest in crypto? 

I think it's incredibly important. From a traditional, factor-based approach, the momentum factor probably has more signal than the value factor. But as this asset class becomes more institutionalized, and there are more firms like us looking for fundamental reasons to own these assets, valuation will matter more.

— Byron Gilliam

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