Frustrating Lessons Learned from Investing in Ethereum
Investing in cryptocurrency and DeFi is a completely new paradigm
Inefficient Capital - Holding tokens that aren’t composable within DeFi is often a significant opportunity cost. Composability means tokens can be staked as collateral or provided as liquidity in smart contracts across various DeFi protocols to generate returns paid in swap fees, interest, and governance tokens. An example of inefficient capital in my portfolio is:
ARCx - I’ve made a decent investment in the project because they have an innovative stablecoin idea that calculates risk based on blockchain history. I also believe in the founder, Kerman Kholil, and the protocol has been thoroughly audited. My ARCX tokens have been sitting idle rather than farming yield, making them very inefficient! It isn’t surprising the token price has suffered in part due to this. The irony is the platform is built to support efficient capital! They allow vault creators to use yield bearing tokens for collateral (e.g. xSUSHI, cDAI, yUSD).
Worth reading my article on productive capital!
Having Patience - Speaking of inefficient capital, a project I often write about and believe will be a critical DApp within the Ethereum ecosystem is Rocket Pool. Rocket Pool has been very slow to market and has lost signficiant market share and first mover advantage to LIDO, Shared Stake, Ankr, and others. Rocket Pool is the most thorough, audited, decentralized, and has trustless withdrawals, but will be at least 6 months behind other staking pool options. Having patience is very difficult in cryptocurrency investing, and one could argue I’ve suffered a significant opportunity cost by holding my $RPL rather than using the funds to yield farm in DeFi. However, being early is often the only way to generate the 10-100x returns and take advantage of the token utility before it gets cost prohibitive.
Crypto Valuation - I do not have a tremendous amount of experience investing in TradFi, but in my experience analysts primarily focus on financial metrics, set targets for EPS, revenues, profit, and the market prices assets accordingly. Should a company underperform, the stock price falls, and when it overperforms it goes up. This is a simple summary of fundamental analysis. However, in crypto, traditional, fundamental metrics rarely reflect price. This happens for several reasons:
Intangibles - Crypto markets value things like community, memes, Twitter influence, communication. This is essentially a crypto project’s brand. Brand equity is very powerful in common products and allows sellers to charge a premium for the quality or experience. In blockchain, eventually we’ll have a way to quantify memetics, community governance and leadership, support, and communication, but currently it’s based on look and feel. Without becoming intimately familiar with the ecosystem it’s impossible to understand this phenomenon.
Information asymmetry/incomplete information - The best analysts know how to mine or develop metrics for DeFi protocol performance. Many firms are emerging that provide these data (Messari, Delphi Digital, Nansen, Glassnode, Dune Analytics), but the constant innovation, disruption, and emergent DeFi projects require constant updates to these models to a point of overthinking it.
An example of good project with poor intangibles has been Harvest Finance. Harvest has been a top tier yield aggregator, second only to yearn. At one point, Harvest had ~$1b TVL and was trading at a P/E ratio of 0.48, meaning it was extremely undervalued. Harvest stakers were getting 30% of the profits generated by the protocol, and it seemed like an obvious buy. The price didn’t budge for many weeks and months due to a reputation for being “too Degen,” and because they suffered a smart contract exploit (not uncommon in DeFi).
Crypto Narratives - Speaking of valuation, shared narratives often lead to capital inflows and price appreciation better than fundamentals too. Narratives seem to be created for the sole purpose of proving the doubters/haters wrong, but are very effective. The best known narratives are:
Bitcoin - First, it was censorship resistant money, then it was a store of value, now it’s digital gold. These narratives ignore the fact the Bitcoin chain is slow, expensive to transact on, and does not support an application layer.
Ethereum - First it was digital oil, then the world computer, now it’s Ultra Sound Money.
When it comes to DeFi projects, you would be surprised about the order of the below projects’ market caps (after $UNI). Narratives, memes, and a fast-moving, communicative team have propelled Aave into the top 30 even though their earnings are substantially lower than Compound (#48) and Maker (#44). Sushi at #64 seems like a bargain (not investment advice)!
ETHBTC ratio - The ETHBTC ratio just spent 1,000 days below 0.043. This has been a painful time to be an Ethereum holder. Bitcoin maximalists are convinced there is only one true cryptocurrency, Bitcoin, because its monetary policy, decentralization, first mover advantage, and a litany of other reasons. It’s insufferable!
Although Ethereum’s blockchain technology, security model, applications, and utility are vastly superior to Bitcoin, price has lagged. It finally feels like the wait has been worth it as Ethereum’s scaling, switch to Proof of Stake, DeFi ecosystem, “Ultra Sound” monetary policy, and institutional investors are being priced in.
Taking profits - This is extremely difficult for new investors because of the very high opportunity cost of selling too early. We also get emotionally invested the more we know about a project and think the price will go up forever. I held through the brutal crypto winter bear market of 2018-2020, continued to invest on the way down, and this has certainly paid off. However, if I were to move a majority of my ETH to cash and wait for a healthier market, I could have increased my ETH stack at a lower cost basis. Nobody is an oracle, but it definitely pays to have some dry powder (cash) available for inevitable crypto pullbacks.
Transactions - Is there anything more agonizing than waiting for transactions to confirm and paying an arm and a leg to do it? I remember when average transactions were routinely over 500 gwei and $50 during DeFi summer. This was oftentimes cost prohibitive for many Ethereum users and made yield farming unprofitable. Fortunately, layer 2 solutions have moved a ton of transactions off the base layer and fees have dropped significantly!
Limit orders - Another painful lesson has been trying to invest with limit orders when the price is moving up. I have often had to raise my bid price multiple times before throwing in the towel and market buying. Waiting for a limit order to fill is usually the best option as patience pays off. Another option is to wait for dips and dollar cost average to bring your cost basis down.
What other frustrations am I missing about investing on Ethereum? Please share!