The article is translated from "DeFi Tokens: Investment Evaluation Framework" written by Kerman Kohli

During the cryptocurrency bull market in 2017, we experienced too much hype and mania. Token prices and valuations are irrationally influenced by too many irrational factors. Many projects have never completed their roadmap at all, and the mere announcement of partnerships and listings can drive token prices up.

Valuation

Valuation

Since the total supply of cryptocurrencies varies widely, we choose market capitalization as the first standard metric:

Price per Token * Total Supply = Total Market Cap

Based on standardized valuations, the following psychological expectation-based indicators are proposed to benchmark the market:

1. $1M-$10M = seed round, uncertain features and mainnet product. Current examples in this range include: Opyn, Hegic, FutureSwap. If you want to capture the highest alpha value, you can choose projects in this market capitalization range. However, it is not easy to purchase directly due to liquidity constraints, and the team is not necessarily willing to release a large number of tokens.

2. $10M-$45M = find a clearly suitable product market, and have data to support the feasibility of the project. Buying these types of tokens is easy for most people. While the other major risks (team, execution) are already minimal, there is still a risk of weak or even declining product data growth at this stage.

3. $45M – $200M = Leadership in their respective markets with clear growth, community and technology to support the project in achieving its goals. Most of the normally constructed projects in this range are not very risky, but their valuations need to climb a level, a large amount of institutional funds, a large market expansion or many new holders.

4. $200M-$500M = in absolute dominance. The only coin I can think of that fits this range is $MKR due to its broad usage base and institutional investors (a16z, Paradigm, Polychain). Buying tokens in this valuation range is mainly based on the hope of earning income from the violent fluctuations in the next round of bull market.

code rating

For most decentralized protocols, code quality is extremely important, and too many risk vulnerabilities can lead to hacking of the protocol itself. Any successful large-scale hack would bring the protocol to the brink of bankruptcy and greatly damage future growth. The following are key metrics for evaluating protocol code quality:

1. The complexity of the architecture. Smart contracts are very delicate programs because they can handle millions of dollars of funds. The more complex the corresponding architecture, the more attack directions. Teams that choose to simplify technical design are likely to have more experience writing software, and reviewers and developers can more easily understand the codebase.

2. The quality of automated code testing. In software development, writing tests before writing code is a common practice to ensure high quality of written software. This practice is critical when writing smart contracts, as it prevents malicious or invalid calls from being made while writing a small portion of the program. Codebases with low code coverage should be treated with extreme caution. For example, the bZx team failed to do the test and lost $2 million of investor funds.

3. Common development practices. This is not necessarily a critical factor in determining performance/security, but can further illustrate the experience of the team writing the code. Code formatting, git processes, management of release addresses, continuous integration/deployment pipelines are all minor factors, but can give hints to the writers behind the code.

4. Evaluate the audit results. What critical issues were found by the auditor (assuming the audit has been completed), how the team responded, and what appropriate actions were taken to ensure that there are no repeated vulnerabilities during development. Having a bug bounty is a sign of the team's confidence in security.

5. Protocol controls, key risks and escalation process. The higher the risk of the protocol and the faster the upgrade process, the more users need to pray and rely on the protocol owner not to be kidnapped or blackmailed.

Token Metrics

Since there are lock-ups in the total supply of tokens, it is important to understand the current circulation and potential total supply. Network tokens that have been running smoothly for a period of time are more likely to be distributed fairly, and the possibility of a single investor dumping tokens in large numbers and causing damage to the project becomes very small.

Also, it is equally important to gain a solid understanding of how a token works and the value it provides to the network, as purely speculative operations are risky. So we need to focus on the following key indicators:

• current circulation

• total supply

• Tokens held by the Foundation/Team

• Lockup Token Release Schedule and Unreleased Stock

• How will the token be used within the project ecosystem and what kind of cash flow can users expect?

• Does the token have inflation and how is the mechanism designed?

future growth

Based on current coin valuations, what key metrics should investors track to assess whether a coin can continue to appreciate:

• market size opportunity

• Token Value Acquisition Mechanism

• team

team

This is an often overlooked section that usually tells you more about the team's ability to execute going forward and how the product will perform in the future.

When investing in cryptocurrencies, we need to pay attention to whether the team has the experience of building traditional technology products (websites, applications, etc.), and whether they really have integrated professional knowledge in the encryption field. Some teams will have a preference for these two aspects, but this imbalance will prevent the team from finding the right market and path for the product.

In my opinion, teams that have too much experience building internet tech businesses without understanding the dynamics of crypto will:

• Lack of confidence due to lack of sufficient understanding of the market, so can change minds quickly

• Lack of careful trade-offs between security, user experience and business model

On the other hand, teams with pure crypto experience without any experience building an Internet technology business end up with:

• Too much focus on ideals of what the crypto space should be like, and not enough time figuring out what users want

• Lack of marketing about the product, weaker go-to-market capabilities and brand failure to earn trust, making it difficult to build product-market fit

Having said that, it is difficult for every team to be strong in both areas at the beginning. However, as an investor, whether the team has the appropriate professional knowledge in two aspects should be included in its investment consideration indicators and pay attention to the corresponding risks.