Background

The blockchain is not just a new way to exchange value, but also a new approach to building software, creating organizations, acquiring customers, representing shareholder value and more – blockchain-based projects are fundamentally different from traditional companies.

This is why FNDX takes a first-principles approach to token selection and evaluation. This document outlines

• FNDX’s view of how a blockchain-enabled economy works and why

• its principles for how value is captured and distributed in this world, and

• the method by which it identifies tokens with substantial value-capture opportunities

A. The Macro View

The Bitcoin Whitepaper, written in the wake of the 2008 financial crisis, opens with the weaknesses of the prevailing “trust-based model”.

It then elegantly brings together cryptography, compute power, networks, incentives and a new rationale for intermediary-less value exchange into the idea of an entirely new, revolutionary concept of the Blockchain.

Blockchains have made it possible for the first time in human history for people to

• represent value of any kind digitally, as a token,

• program the behaviour of the token,

• exchange it globally,

• without the need for a trusted intermediary

This is significant because the story of the world economy since the dawn of global trade is the story of such trusted intermediaries

• Banks as the intermediaries for monetary deposits and credit

• Card networks as the intermediaries for local and global payments

• Ratings agencies to manage financial reputation

• Educational institutions to verify credentials

• Cloud providers to hold your life’s private data

• Social media companies as the intermediaries for our online existence 

• Marketplaces for real estate, cars, other assets

and so many more. These are our brands. These are our icons. These are our multi-trillion-dollar market caps.

Such intermediaries enabled today’s global economy and the dramatic rise in standards of living across the world. In doing so, they captured – justifiably – massive value facilitating transactions by ensuring trust, taking on risk, providing credit, executing contracts, and so on. This value accrued to the equity shareholders of these companies.

Now for the first time, it’s become possible to disintermediate many of them. To have individuals and systems interact with each other, to provide services across industry sectors and uses, and compensate service providers without the need for intermediaries to be trusted.

This change has immense consequences for wealth creation and is directly relevant to FNDX’s foundational principles.

So far, only select individuals and institutions with access were able to share in the value created by and captured by these giant intermediary companies. Even when such intermediaries went public, usually only people in the country where the company was listed were able to buy shares in that company, concentrating wealth creation by geography.

In contrast, any individual, any institution anywhere can hold tokens of any project from the very beginning of the token offering. They do not need permission, they cannot be locked out of their holdings, and they cannot be blocked from transferring these tokens to/from other people.

Unlike with any such wealth creation wave previously, participation does not require preferred deal flow. There is no access or information asymmetry.

Why FNDX holds tokens instead of equity

FNDX’s investment strategy holds tokens of projects likely to be successful in the new on-chain economy. It does not hold equity in underlying entities, if any. This is because the very primitives of the blockchain economy are different from the traditional economy.

In the traditional economy, a business – say a grocery chain – procures, stocks and sells a variety of goods. These goods are paid for by cash – some form of fiat currency. Net of expenses, they form the company’s earnings and profits. The discounted value of these fiat cash flows over time determines the intrinsic value of the stock, reflected in the price of its shares.

Blockchain-native, token-incentives-driven web3 companies operate fundamentally differently from the goods,

For such projects, the token is the 'security' which is supposed to have some intrinsic value, but it is also what is used to pay for the service. For instance, the ANKR token for access to Ankr RPC nodes.

More broadly, in blockchain-native projects, entities stake the project token for the right to provide the core service. Consumers pay for the service with the same tokens. Service providers are directly or indirectly compensated by these fees with a stream of the same tokens. The project organisation itself may earn a share of these fees. Other token holders may contribute their tokens, or delegate them, to a specific service provider for a share of their earnings. Token holders also vote in project governance with their tokens.

This is both a simplification and a generalisation, but serves to illustrate the essential way in which blockchain native companies are different: capital, payments, earnings, expenditure, treasury and voting are all mediated through the project’s native token.

With token mechanics, traditional valuation and investment methodologies break down.

If one were to apply the discounted cash flow model to calculate the ‘intrinsic value’ of a token, there are basic issues:

For instance, what the project’s operating margin is to calculate free cash flow. What is free cash flow itself: the entirety of user fees? Is it the share earned by by the service providers? The share earned by the organisation, which may be zero?

What is the 'value' at which the business will be sold after a certain number of years? Is it the equity value of the underlying entity? The entity itself, even if it exists, only develops the product – the service itself is provided by stakers, which participate in the governance of the product’s roadmap.

While one attempts to fit valuation models to the project, how reliable are any of its projections, say ANKR token pay-outs to node operators over five or ten years, given that most projects like Ankr are early-stage companies, and it may be premature to evaluate them as listed entities/going concerns? 

This does not even include other dissimilarities such as, notably, multiple 24x7 markets for a token with multiple prices and multiple counterparty tokens, in some cases across multiple blockchains.

Clearly the blockchain economy requires new, ground-up, first-principles-based models for token evaluation and portfolio creation. This document describes FNDX’s own pioneering fundamentals-driven investment framework.

The scale of the token opportunity

The blockchain economy is an exercise in world-building from its very primitives. Unlike the economy is replaces, it is digital, borderless, transparent, permissionless, pseudonymous and composable.

In the early days of the consumer internet, it was compared to the telephone system, which it was expected to disrupt as a new ‘communications medium’. It turned out to be much, much more.

Likewise, the blockchain is commonly viewed narrowly as a new medium for transactions, especially for payments and speculative trading. This results in the perception that these are merely coloured casino chips with nothing ‘underneath’ them.

Just like communication, trust is central to every interaction and as we have seen, arbiters of trust are now open to disruption.

As value shifts from existing institutions to on-chain projects, fiat currency and traditional security will be on-ramped to their on-chain counterparts. We are in the earliest stages of this shift in value: the largest asset managers in the world today each manage a few times the combined value of all cryptocurrency projects.

Currently, capital from traditional markets has flown primarily to stablecoins – USDT, USDC, BUSD – and to native tokens of the major blockchains – Bitcoin, Ethereum, BNB Chain, XRP, Polygon, Solana and others. Just these named examples have a combined ‘market cap’ of USD 1 trillion out of the total market cap of about USD 1.15 trillion as of this writing.

We can expect future capital to instead flow to other projects that disintermediate and unlock value. The FNDX Fundamentals strategy is, at its core, to drive significant capital to these successful projects. FNDX’s participation in even a small fraction of this gigantic shift in capital is a very large sized opportunity, attractively remunerative to its participants.

B. The FNDX ValCap Strategy

We’ve explained why FNDX Fundamentals is a liquid token strategy: it holds the native tokens of high quality blockchain-native projects instead of equity stakes in the underlying entities.

The strategy itself is based on one simple principle: that strong growth in token price of a blockchain-native project can be better predicted when value captured or created anew by the project accrues primarily to the project's token, as opposed to the equity of the project entity. It follows that

Blockchain-native projects are unique in that this usage can be verified on-chain instead of having to take the project's word for it. For the very first time, we can verify the growth of a project trustlessly, permissionlessly, immutably – core characteristics of a blockchain.

This has no equivalent in either early stage or listed equity investing and provides a strategy like FNDX Fundamentals evidence of participation, usage, competitive position and value captured.

FNDX Fundamentals then evaluates projects with strong product offering, strong growth and a strong competitive position for inclusion in its portfolio. We describe these in more detail in the next section, our evaluation framework.

Note: If the usage of a project cannot be demonstrated on-chain, it’s also a clear counter-signal that the token isn't in a strong position to capture value – perhaps one is better off holding an equity position.

FNDX has observed that for many such projects the blockchain isn't core to their functioning.

Even if it is, they may be vulnerable to becoming unviable because of regulation, or uncompetitive because of nimbler, centralised alternatives.

Likewise if a project is verifiable on-chain but most of its competitors are centralised non-token-driven entities, the project's true competitive position is not verifiable. In addition, it may also indicate that the service provided does not necessarily depend on the blockchain, if centralised alternatives work just as well.

When is token price correlated with usage?

There exist specific token mechanics for blockchain native projects where the token is an integral part of the product's functioning:

For the decentralised oracle Chainlink, data providers must deposit LINK tokens for the right to be part of any given decentralised oracle network. These providers are rewarded with LINK tokens as the oracle is used. They also stand to forfeit some of their LINK if they fail to live up to expected service levels. This keeps incentives aligned against counterparty risk. And users of the oracle (e.g., other DeFi projects) pay for access to the data feed contract in LINK tokens. LINK has a fixed supply.

Chainlink’s token mechanics as on their website

Now given this, there are three broad groups of token owners.

• Stakers, delegators, consumers: actual users of the product

• Traders, lenders, liquidity providers: speculators in the project token

• Holders: passive accumulators of the project token, or team/project owner-owned tokens to be unlocked for specific purposes

The price of a token is set by the activities of speculators and users. As of today, most projects are in their infancy, and speculators far outstrip users in terms of token quantity and, by extension, price setting. See diagram below.

But as product usage increases, demand for the tokens by users increases. Token supply begins to shift from speculators to users.

(Over time we can expect supply to move from holders to speculators and therefore to users, as token vesting of early investors and team unlocks, and as tokens from ecosystem development and grant pools are issued.)

As this transition happens, price begins to now be increasingly set by users. They have either staked or delegated their tokens (among other roles) or hold tokens in order to pay for the services offered by the product.

The propensity of an average user to acquire or sell tokens is driven more by their usage than market movements. For example, during a market panic, a speculator may decide to sell before the price falls any further.

On the other hand, a participant in a Chainlink decentralised oracle network who has staked LINK and contributes information to a Chainlink oracle is less likely to unstake and sell. The participant's break-even calculation is based on the LINK they will earn in relation to the LINK they have staked. How much & how quickly they earn is based on the usage of that Chainlink oracle, not market movements. If anything, they may use the price fall to acquire LINK tokens for usage, stabilising the price. Likewise, their response during market rallies.

Both the consumers of Chainlink oracle feeds and providers of data for oracles are less likely to buy and drive up the price of LINK irrationally because they have rational reasons that inform their buying.

FNDX Fundamentals can then evaluate and hold tokens of the most dominant, highest-growth projects in a given sector. The strategy itself is sector-agnostic.

C. The ValCap Token Evaluation Methodology

All tokens go through a three-step evaluation process before they become part of the FNDX portfolio. Each step is directly related to FNDX ValCap – the axiomatic principle of value capture, described in the section above.

Input

The FNDX Fundamentals strategy evaluates tokens systematically from the highest market cap downwards. Currently its consideration set is the top 100 tokens by market cap, excluding stablecoins, wrapped tokens/LP tokens/basket tokens, and derivative/synthetics tokens.

However, the strategy is also open to evaluating tokens of projects outside of the top 100 building novel products that are blockchain-native – i.e. they are only possible on a decentralised trustless platform like a blockchain.

Stage 1 – Does the token capture value created?

This stage examines the token demand and supply mechanics between the different entities in the product. FNDX has identified specific token utility mechanisms where the demand for the token is directly correlated with the usage of the product. Other entities have also identified such mechanisms - Read “New Models for Utility Tokens”, Kyle Samani, February 2018.

Equally, FNDX has identified mechanisms where the token demand – and therefore price – is not directly tied to the adoption of the project’s product.

An example is pure governance tokens such as the UNI token of the decentralised exchange Uniswap. As of this writing, the exchange charges a fee on every trade made. However, UNI token holders do not directly benefit from these fees. The entirety of the fee goes to the providers of liquidity on the exchange. The only utility of the token is in participating in the governance of Uniswap. The incentive to participate in governance is driven by different incentives than adoption – it may not necessarily be correlated, and even then, only indirectly.

Another such category is where the token is incidental to what is a centralised product. An example is CHZ, the native token of the Chiliz fan engagement platform. As of this writing, actual fan tokens run on the centralised Chiliz blockchain and can only be used for interacting with the sports organisation via the centre used Socios community app.

Any token FNDX Fundamentals evaluates is classified into one of the ValCap categories – either one of the positive ones where the token does capture value or a negative one where it does not.  

Stage 2 - Is there substantial value to be created?

FNDX evaluates token incentive driven projects like early-stage ventures, including

• Proposition

  • Whether the product is inherently blockchain-centric

  • Size and maturity of the market opportunity

• Adoption

  • By users and by service providers

  • By market share vs other token incentive driven project competitors

  • Moat vs competitors

• Revenue model – how each party to the project earns revenue via its token mechanics. Not all projects will have all the roles below

  • Service providers or validators. Projects may have specific roles beyond these

  • Delegators

  • Platform developers if applicable

  • Foundation or treasury

  • Team

• Management

  • Founding team, churn in leadership

  • Advisors

  • Major governance decisions made either by team or via community; issues with these

• Capital raised

  • Via token offering

  • Equity capital

  • Token vesting schedule of private allocations, current stage in vesting

• Regulatory risk

The difference between traditional startups and token incentive driven projects is transparency. Several of the metrics in the list above can be verified by on-chain data and via contract code. For instance, services like Dropstab publish the token vesting schedule of certain projects, like for example for the blockchain data indexing project The Graph, whose native token is GRT:

However, the most significant predictor of value creation is current adoption. As reasoned in the previous section, for projects where value accrues to the token, it is inevitable that token price will begin to correlate directly with usage more than with trading volumes.

It follows that the probability of a strong appreciation in token price is linked to strong growth in usage of the project - specifically, the smart contracts that make up the mechanism of the product.

Contract usage can be verified on-chain. For example, The Graph is a decentralised, token-incentivised blockchain indexing project. The product has multiple roles: indexers that actually process and serve data from blockchains, curators that signal to indexers what data should be indexed in the first place, delegators who delegate their tokens to indexers, and consumers, or end users of the indexed data, which are most commonly other decentralised apps or dapps.

Data about the usage of contracts for each of these roles is available on-chain and can be visualised using on-chain query applications. Dune Analytics is one such product to visualise blockchain data. (Dune itself, as of this writing, is not a token incentives-driven project)

Via Dune, here is a chart of actual queries made to The Graph over time, including fees earned by the protocol from such queries:

Also, via Dune, indexers and delegators over time (one net new per quarter, one cumulative by quarter):

Finally, the total cumulative number of The Graph users over time, across all roles:

Token-driven projects inherently have strong network effects. Therefore, in addition to evidence of increased usage, the FNDX Fundamentals strategy also evaluates the dominance of the project among its competitors. This can also be verified on-chain, even if competitors' supply and contracts are on other chains.

For some projects, competitors are centralised entities. Such centralised entities may even be market leaders.

A example is ANKR. Major players in the RPC Node or Blockchain API Access market are Infura, Alchemy and Quicknode, all entities which are not token incentivised. Usage data for these entities cannot be verified on-chain since there is no token, no token mechanics and no contracts - they are "web2" companies that provide a "web3" service.

The only usage figures are those that are self-reported. In such a market, comparing relative adoption reliably is impossible.

Such tokens will not pass ValCap Stage 2.

Stage 3 – Does the token have sustainably healthy liquidity?

The third and final stage of evaluation for ValCap is whether the token has healthy liquidity on decentralised exchanges.   

This includes, among others

• Liquidity pairs for the token against stablecoins or other reference tokens like WETH or WBNB or WMATIC

• The absolute depth and trading volumes on these liquidity pools

• The trading volume on centralised or decentralised exchanges

(Ideally FNDX would also like to compare the actual depth of liquidity on centralised vs decentralised exchanges for a given token. However as referenced in the section, this is limited by the inability to independently verify this information on centralised exchanges.)

ValCap values decentralised liquidity. As the section on ValCap described, for projects whose token mechanics are such that value created accrues to the token, increasing usage results in token supply moving from trading to usage ie from exchanges to the smart contracts that run the project’s products.

Centralised exchanges have several inherent disadvantages.

• Transparency about reserves and internal controls. This has been borne out repeatedly over 2022. While the exchange FTX was the most glaring debacle, other centralised projects like Celsius, Voyager and Vauld also lost customer tokens despite being well regarded and funded. Ultimately with centralised exchanges and services, customers do not have self-custody over their tokens; they have the equivalent of a claim on them, a claim that needs to be legally enforced in case of issues

• Geographically limited – exchanges are typically limited to customers from specific countries, especially if they also have on- and off-ramps from fiat currency to crypto. Some are even limited to certain states or provinces, such as in the US – exchanges that are not licensed by the state of New York will not accept signups from customers in that state.

• Disclosure requirements: Most centralised exchanges now require a KYC process that is limited to customers from the jurisdiction serviced, and not all exchanges will allow transfers of tokens to arbitrary wallet addresses, for instance most Indian exchanges at the time of this writing. Other exchanges will least will require disclosure about the identity of the recipient and the purpose of the transaction. This makes it challenging for many decentralised apps and entities to automate movement of tokens

• Regulatory vulnerability: the threat of regulatory action against exchanges affects their reliability. A case recent as of the time of writing is the USA SEC’s case against Binance US (link), Coinbase (link) and Kraken (link) among others.

Ultimately independently auditable, boundaryless, permissionless sources of liquidity for tokens are essential for movement of supply between holders, users, developers, speculators and others – ergo, decentralised exchanges/automated market makers.

D. Portfolio Construction and Risk Management

Portfolio Construction

FNDX’s portfolio construction methodology is well documented internally with clear processes for implementation. Given the early stage of the blockchain universe itself, the methodology continues to evolve. For now, the following general principles apply:

• Capital received is generally deployed in full. There is no target cash position except in exceptionally volatile times.

• Tokens in the portfolio are generally weighted equally. There is no target weightage for tokens nor any sectoral allocation.

• There is no scheduled rebalancing, token weights are only adjusted when new tokens are introduced into or discarded from the portfolio.

Risk Management

• Token caps apply to avoid overexposure to any given project

• Token liquidity across decentralised liquidity pools is considered. This is part of the token selection process itself since deep, decentralised token liquidity is an indication of the ease of movement of supply from speculation to usage.

• The risk of distortionary effects of liquidity shocks are considered, e.g., from vested tokens flooding markets with supply. This is also part of the token selection process.

• Past instances of ad-hoc buyback/burn events to influence token price are also considered: e.g. BitDAO’s December 2022 plan to buyback tokens worth $100mn and Klaytn’s burn of appx half of all token supply in March 2023. Like the above, this is part of the token selection process.

• In the case that the strategy holds wrapped tokens in lieu of the underlying token, the strategy monitors the peg constantly and intervenes in case the peg slips. Follow-up action will depend on the factors that led to the depeg. See FNDX’s post about how it handled the late-2022 depeg of the WBTC wrapped token for its erstwhile FNDX 100 strategy.

Conclusion

Blockchains have made it possible to exchange value in a trustless, permissionless, borderless way.

Blockchains have the potential to unlock trillions of dollars in value from institutions across industry sectors are arbiters of trust.

We already starting to see this play out in certain sectors, and the total value of traded tokens is already over USD 1 trillion.

This unlocked value, for the first time, flows to token-holders of new, blockchain-native projects instead of to equity shareholders of legacy centralised entities.

This makes blockchain/crypto/web3 not just the largest and fastest wealth creation opportunity in recent history, but also the most democratic.

This document has identified the thesis underlying the Fundamentals strategy.

FNDX hopes this document is helpful to developers of blockchain-native projects, those new to and familiar with the decentralised ledger space, legacy institutions that have served as custodians of trust, regulators seeking to protect citizen's interests, and more.

Disclaimer

This document does not constitute an offer to sell, a solicitation of an offer to buy, or a recommendation of any security or any product or any service by FNDX or its agents to any entity, regardless of any information contained herein, including but not limited to references made to named crypto tokens and/or projects. Please read the Terms of Use carefully.

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