By Byron Gilliam, Markets Strategist at Blockworks.
Tokens Are Not Stocks, Part Deux
Crypto and equities have a bear market feel to them so far this year, which means it’s time to reexamine why you own what you own.
In my TradFi brokerage account I’ve sold a bunch of underperforming things that I can no longer remember why I bought and switched into some value things with yield and valuation support.
Getting defensive in crypto however, is more difficult, because tokens have neither of those defensive traits.
Yesterday I made the case for why tokens are not stocks by the logic of securities law, which you may or may not agree with.
But whatever your legal take is, tokens are different from stocks in some fundamental ways…none of which matter in a bull market.
When things get dicey, you typically want investments with earnings that will provide valuation support on the way down.
But that playbook is unlikely to work in crypto — even for DeFi tokens with real earnings.
I’ll go through the mechanics below, but here’s the TLDR: in terms of yield and earnings multiple, most DeFi tokens do not get cheaper as the token price goes lower.
DeFi Earning’s Math
If you invest in cyclical stocks on a medium-term view, you generally want to buy when the P/E is high and sell when the P/E is low (counterintuitively) — because P/Es are highest at the bottom of the cycle when things are bad and about to get better and lowest at the top of the cycle when things are good and about to get worse.
Picking the tops and bottoms of cycles is difficult, though, so I always preferred to think about the “earnings power” of a stock: make an estimate of what it can earn on average through the cycle and put an earnings multiple on that.
That’s your valuation support: if a stock sells off on near-term earnings concerns, in terms of its underlying earnings power, it gets cheaper.
This does not work so great in crypto. Because, for most tokens that have earnings, the earnings are denominated in the token itself — which means that as the token goes down, its “earnings power” goes down with it.
SushiSwap, for example, pays out the fees it collects to holders who stake their tokens, much like a stock pays dividends to shareholders — but SushiSwap’s fees are paid out to SUSHI stakers (who hold xSUSHI) in SUSHI tokens, so all of their earnings are denominated in their own token.
Which means that if the SUSHI token falls 50%, the value of SushiSwap’s earnings also falls by 50%.
This is, of course, not how it works in equities — the price of an iPhone is not denominated in Apple stock.
If you buy Apple at 30x earnings, and it’s cut in half the next day, you are now long a stock trading on 15x earnings — yes, you’re still down 50%, but hopefully the lower multiple will limit your downside.
In crypto, however, if SushiSwap trades on 30x earnings today and tomorrow it falls by 50%, it then trades on…30x earnings.
The earnings power of your SUSHI tokens has been cut in half, because the price of the token has been cut in half.
Which means that, if you were long SUSHI at 30x earnings yesterday, on your original investment you are now effectively long at 60x earnings — ouch!
DeFi Yield Math
The same goes for yield.
When you buy a tobacco stock that yields 8%, you feel pretty confident you’re not going to lose, say, 50% — because if it fell that much it would yield 16%, and surely it would find support long before then.
If a crypto token yielding 8% falls by half, however, it will then yield…8%.
That’s again because the yield is paid in tokens, so as the price of the token falls, the value of the yield (in USD terms at least) falls right along with it.
Worse still: If you bought your tobacco stock at an 8% yield, however much the stock falls, you are still making 8% on your original investment.
But if you buy a crypto token at an 8% yield, and the token then falls 50%, you are no longer getting 8% on your original investment — the value of the yield has also fallen by half, so now you’re making only 4% on your original investment.
So neither yield nor earnings is the defensive support in crypto that it is in equities.
This is admittedly a bit of a thought experiment: SUSHI’s yield, for example, fluctuates along with the level of trading activity and the percentage of holders staking their tokens.
But I think it’s the way we should be looking at fee-earning DeFi tokens, because longer-term, yield will be a function of earnings.
In other words, in terms of both yield and earnings multiples, most DeFi tokens do not get cheaper as the price goes lower.
In crypto, price is what you pay, as per Warren Buffett, but it’s also a large part of the value you get.
Tokens Are Not Stocks, Part Très
Of course, all this stuff works in reverse, too.
If you buy a token with a 10% yield and the token then doubles, you are still making 10%...but on double your original investment!
And none of this matters if you’re forward-looking, and you think DeFi tokens will have much higher earnings in the future.
But at the moment it feels like we don’t have to worry so much about our cryptos doubling or DeFi earnings taking off.
If we are, in fact, in for a bear market, it’s of course the downside we have to think about.
And there’s more to think about than just yield and earnings multiples…but I’ve gone over my 1,000-word limit, again.
So, if I didn’t completely lose you today, tune back in tomorrow for Tokens Are Not Stocks Part 3/n.
And in the meantime, know what you own and make sure you’re getting value for the prices you pay.
Original Blockworks article: https://blwk.omeclk.com/portal/public/ViewCommInBrowser.jsp?Sv4%2BeOSSu…
About the Author:
Byron Gilliam traded international equities for investment banks and brokers in Frankfurt, London, Paris and New York before becoming the Markets Strategist at Blockworks.
Now in Chapel Hill, NC, he writes a daily newsletter on crypto and markets. Byron has an undergraduate degree in history from Binghamton University and a master's degree in hard knocks from 20 years of trading.