How Do We Survive and Thrive in This Winter? One Veteran Web3 VC Answers: Fundamentals

The difference between a bull market and a bear market can be summed up in one word.

That word is momentum. In a bull market, there’s lots of upward momentum of asset prices, and it takes control of most investors’ decision making. If an asset’s price is going up and up fast, they want it. Little else matters. But when a bear market arrives and all that momentum stops, that approach to investing disappears very quickly.

This is where we are at with the digital-assets space right now, and the situation is causing a double whammy of stress for people who have only been holding digital assets for a couple of years.

It’s not just that they’re panicking at the falls in the value of what they’re holding. The death of momentum is also the death of the one thing they were using to make their next move in the market. They’re faced with the defining question of the moment – How do I survive and thrive in this market crash? – and are scrambling for answers.

Fundamental Labs: Reading the fundamentals right since 2016

The best place to turn for an answer to that question is people who are not only veterans of past crashes but have also been early backers of initial coin offerings (ICOs), decentralized finance (DeFi), non-fungible tokens (NFTs) and all the other innovations that have triggered new waves of market momentum over the past six or seven years. One of those people is Howard Yuan. He’s a veteran Web3 venture capitalist (VC) and the co-founder of Fundamental Labs, which has been backing digital-asset ventures since 2016. Now in the process of raising its sixth fund, Fundamental Labs has thrived through the bull and bear markets that have come and gone as the digital-assets ecosystem has quickly progressed through various iterations.

Fundamental Labs was founded in 2016 with its unique investment philosophy: A focus on data about assets’ fundamental viability is always the best way to make investment decisions. Fundamental Labs has invested a number of crypto projects, including flagship deals like Coinbase, Binance, Chainlink, etc. In a recent chat with CoinDesk Thought Leadership, Yuan used fundamentals to explain what made the momentum of the most recent bull market die out, as well as to offer some invaluable suggestions to people who are coming to grips with the current bear market.

The fundamentals behind the crash

According to Yuan and the team at Fundamental Labs, warning signs about the viability of the ventures whose collapse triggered the most recent market crash were plain to see if you looked closely enough at the fundamentals, but they were overlooked by most people because of that obsession with momentum that takes hold in bull markets.

The collapse of LUNA/UST is a case in point. According to Howard, the undercollateralization of this digital asset was detectable in the data, as was its unreasonably high deposit annual percentage yield (APY).

The collapses of crypto lender Celsius Network and crypto hedge fund Three Arrows Capital, the two other major milestones in the current crash, were also due to weak fundamentals. Above all, the data showed they were highly leveraged and giving little thought to risk management. Fundamental Labs and other Web3 funds that have been around for several years have generally stayed clear of ventures like these, and that’s exactly why they’ve entered the bear market without any major concerns.

Fundamentals to look for in the future

So the fundamentals can tell us about what’s gone wrong in the past. But what about the future? Right now, in spite of the gloom hanging over the market, Yuan and the Fundamental Labs team are actively making new investments, and they’re doing so by using a nuanced set of fundamental metrics and indicators to pick out the ventures that will offer sustainable, long-term value rather than momentum that ultimately goes nowhere.

Here’s a lowdown of what they’re paying attention to.

On-chain metrics

Yuan sees the health of a digital asset’s chain as a key indicator of the asset’s viability. For that reason, he pays close attention to its number of nodes and active addresses, its protocol revenue and, above all, its hashrate.

Financial metrics

The asset’s chain infrastructure also needs to be backed by sound financials. Among the key metrics to look for here are fully diluted value (FDV), market cap, total value locked (in the case of DeFi), inflation rate, staking return, burn rate and circulating supply.

Technical scope and credentials

Moving away from purely quantitative indicators, Fundamental Labs always does its due diligence on what investment is going into the off-chain technical side of a venture. Priorities here include its founding team, tech stack, documented use cases, tokenomics and utility, product UX/UI, the professional backgrounds and track records of team members, and the level of detail and substance to be found in documents detailing the project’s roadmap and milestones.

Health of the community

This crucial area of a venture is a mixture of qualitative and quantitative. It’s possible to combine some figures to obtain a picture of it – for example, putting figures on growth of the user base into the context of churn figures is one approach, high growth and low churn being the ideal combination. On the qualitative side, assessing the enthusiasm that both the users and the devs are expressing about the quality of the product and what they hope it to accomplish is essential. In doing so, Fundamental Labs is careful to separate genuine commitment to the product from marketing hype.

So what does a project with healthy fundamentals look like?

To give you a sense of which of the biggest players in the digital-asset space score well across the fundamentals we’ve looked at here, Bitcoin, Ethereum and BNB have on-chain metrics that indicate they’ve got a healthy future ahead of them. The growth of Bitcoin’s hashrate looks particularly strong, and Ethereum remains the king between competing layer 1 chains focused on smart contract functionality. Meanwhile, BNB Chain has released a new technical roadmap and claims to have more than 2 million daily active users. A great example of an asset with a healthy user community that has high probability of success through the bear market is Bored Ape Yacht Club (BAYC).

Of course, BTC, ETH, BNB and BAYC are not emerging investments. However, Fundamental Labs is turning to the indicators it has defined to scope out startup projects of all different sizes from across the world. In particular, as the firm enters its sixth investment round, it’s going to be looking for projects that are showing healthy growth in their fundamentals within frontiers of the digital-asset space that have the largest unmobilized populations of potential users, such as Web3 social and play-to-earn crypto games. Fundamental Labs focuses on empowering the fundamental innovations in the Web3 stack.

If you’re interested in getting more detailed, fundamentals-driven investment insights from one of the most seasoned VC firms in the space, sign up for the Fundamental Insights weekly newsletter. Visit Fundamental Lab’s website for more information about the fund.