Rapture #95: Fundamentals are just Narratives

One of my favorite OG crypto degens, Cobie (previously CryptoCobain), recently wrote an excellent article about the metagame of crypto. After reading his article, I thought it might be helpful to continue building on top of some of the concepts he mentioned.

More so than any other asset class, crypto is driven by narratives. Narratives are more important to crypto than other asset classes for two central reasons: there is no general consensus on the fundamental metrics that drive value for any particular cryptoasset and the most active market participants generally live on Twitter (I personally am down to an average of 4 hours a day from 8.5 hours a day according to screen time).

No General Consensus on Fundamental Drivers of Crypto

In stocks, you have cash flows you can discount to a net present value. For bonds, you have term to maturity and evaluating the credit quality of the issuer. In crypto, you have memes.

Unlike bonds or stocks, there is no standardized intrinsic valuation methodology that has emerged for crypto. Over the years, there have been many valuation frameworks that have risen and gone the way of the dodo (or are increasingly losing relevance as we speak): Chris Burniske’s MV = PQ in 2017, Plan B’s Stock to Flow Model, and Metcalfe’s Law. Furthermore, there have been data providers like TokenTerminal that in the past year have tried adding traditional valuation metrics, like revenue and earnings, to various protocols.

Yet crypto is still just a 12-year-old industry. Most people are still getting up to speed on what these assets are and are years away from any sort of consensus (if ever) on how to value them. It took centuries for there to be a widespread consensus on equity valuation. Despite the NYSE being founded in 1792, discounted cash flow analysis did not become an industry standard in finance until the 1960s.

It will be a long time before there is any sort of standard metric for what the value drivers of crypto prices are. Until then, metrics that support emerging narratives will come in and out of vogue, temporarily capturing the meta conversation of cyrpto and leading to a reflexive surge in prices.

For example, when DeFi was all the rage in the Summer of 2020, TVL was the en vogue measure that was used as a proxy for value. The more TVL a project had, the more value that project was seen to have. Furthermore, TVL was priced in dollars but was derived from the value of the tokens locked in a DeFi project. As the token prices increased, the value of the TVL in dollar terms increased, attracting more investor attention that yielded price increases, etc. TVL is a perfect example of a reflexive "fundamental" measure being embraced in crypto.

Like other measurements though, the market moved a way from TVL being the way to measure the success of DeFi projects when it lost interest in DeFi as a thematic play, which began in about February of this year. Many realized that TVL was not necessarily the most accurate way to value a project's success.

The fundamental metric that the crypto community decides drives value at any given time is based upon a narrative of why that fundamental metric is superior to the other metrics it competes against within the conversation of how to derive value in this space. While that statement in itself is quite meta, understanding it is essential to comprehending the reallocation of flows in the cyrpto industry.

Influence of Twitter

Yet the lack of the consistency in fundamental metrics is not the only reason why crypto is driven by narratives. The primary medium of communication for the industry is Twitter, and thus, the themes the industry pays attention to spread in the context of the social media platform. What I mean by this is that Twitter as a communication platform prioritizes constantly shifting, exciting narratives that rise and fall quickly in order to prevent boredom. Twitter as a platform would die if there was not a constant influx of new narratives to replace the old, as its users would become incredibly bored.

Thus, since crypto lives on Twitter, there needs to be a constant replacement of new narratives. Often, these narratives, like the rise of DeFi, are backed by a singular quantitative metric, like TVL, that itself is reflexive in nature. Both the conversation around the emergent theme and the quantitative metric used to justify the rise of that theme are reflexive.

The Key

Since these narrative loops emerge in crypto, the key, as Cobie identified, is to predict where the narrative shift will go next, knowing that there must be a narrative shift because of the lacking consensus of fundamental drivers and the fact that crypto as an industry lives on Twitter. Usually there will be some quantitative metric to support the rise of these narratives, like TVL was for DeFi or daily marketplace volumes were for NFTs or daily revenue was for Axie Infinity.