I still remember the days when the bull market started in 2021. The most mentioned names, besides Cathie Wood, were Buffett. Of course, Buffett was more criticized in the cryptocurrency industry because of his pessimistic remarks. At the craziest time, people regarded ARK's Cathie Wood as a god and looked down on Buffett, thinking that he could not keep up with the times and could not understand new things. At that time, any child's earnings from Tesla in the US stock market could make him mutter in his heart that Buffett was just so-so, not to mention the exaggerated fluctuations of altcoins.

How exaggerated was the market sentiment at that time? A "Buffett's handwritten resignation letter" made by an internet celebrity could actually be directly published by major mainstream technology media without verification. People at that time were too willing to believe that the stock god was old and the new world had its own logic.

But when the bubble burst and liquidity tightened, we who have experienced the catastrophe saw that Wood Sister's return has retreated by more than 60%, while Buffett is still frighteningly stable. In the secondary market, retreat is the last thing that players want to happen. So what can the stability of the stock god give us to think about?

The emergence of value investing

If Benjamin Graham in the 1930s put on the latest popular Apple Watch at the end of 2022 and opened the CeFi or DeFi platform for cryptocurrency trading, he might frown and smile. Don't panic, I know the answer to this question.

In the United States in the 1920s, the stock market was far less mature than the bond market and was an emerging niche market. There were few investors in this market, and most of them were traders. Among the traders, there were professionals and ordinary people. "Economists" were very popular, and "leeks" also followed the opinions of star fund managers. At that time, there was no value investment, and everyone's trading method was basically "technical", watching the trend and chasing the rise. Graham, who entered the financial market very early, was like a fish in water in this market by analyzing company financial reports. He soon became a big V and a star manager. The fund he managed once made a profit of more than 100%, and the market value of the fund increased sixfold in 3 years.

In the Roaring Twenties, Gatsby is obsessed with Daisy, while many ordinary people rely on the myth of the stock market to make a fortune overnight.

In 1929, Graham was already a millionaire (equivalent to today's billionaire) and was ready to make a big move. After all, the most famous economist at the time, Irving Fisher (a master of monetarism), had vowed before the stock market bubble burst in October of the same year that stock values ​​had not yet been matched.

Starting from October 24, 1929, the US stock market began to plummet, ushering in the infamous Great Depression, and even the big V leeks were not immune. Irving Fisher and Graham's wealth shrank greatly. Although Graham's fund only lost 70% when the market lost 74%, it could not save his wealth that evaporated in a few days. Graham dismissed the servants in his mansion in New York, divorced, remarried, and divorced again, and spent a relatively chaotic period. After that, Graham learned from his pain and sorted out his value investment philosophy while teaching at Columbia University. He published "Security Analysis" and officially opened the era of value investment.

For more than half a century thereafter, Graham's disciples such as Buffett applied the theory of value investing to investing, creating a generation of investment masters.

The stock market at that time was similar to today's cryptocurrency market in some senses. So can the value investment used for stock analysis also be used to look at cryptocurrencies?

Value investing is simple, but people in the world are too complicated

Graham's value investing is very simple, and Buffett also follows the simplicity of the theory in his operations, often doing calculations on the back of a napkin (napkin valuation). Buffett himself has never done several pages of modeling and various sensitivity analyses for investment actions. In terms of asset pricing and stock price justification, the stock god's operations have always been as simple as water.

The price investment calculation given by "Securities Analysis" is: V = EPS [8.5 + (2g)].

At that time, Graham used a PE value of 8.5, which was applicable to companies with no growth rate at the time of the book. Later, PE generally used company value. For emerging companies that do not have many reference company indicators, Aswath Damodaran, a well-known professor at New York University, has a list of PE values ​​for emerging industries. The calculation of this price investment has also changed slightly.

Today, value investing has evolved slightly, but the essence remains the same, and it still insists on looking for undervalued securities in the stock market. Common indicators used in modeling/calculation include PE, PB, EPS, etc. The most important thing is to leave enough margin of safety, that is, the company price is greater than the intrinsic value. Buffett recommends at least 25%.

The concept and practice of value investing has been passed down through time by a generation of value investing masters, and based on a decade, it has become a stronghold that spans bull and bear markets. However, before the U.S. stock market crashed in 2020, value investors were rubbed by funds that advocated investing in emerging technology companies for a period of time, and their returns were much lower than those of growth funds. The underlying logic used by one of the most watched funds at the time, Cathie Wood's ARK, and the rise of Tesla, one of the stocks with the highest returns at the time, was very different from value investing. Many technology stocks in our era are not profitable before and after listing, with PEs of dozens or even hundreds of times, but this does not prevent these companies and stocks from growing explosively. The core logic of ARK is to hold a large number of technology stocks with explosive growth. In the era of technological explosion, such funds have indeed achieved extraordinary achievements in the short term. Companies with exponential growth are not within the safety margin for value investment funds, so value investors may not even look at such companies.

Even in China, Zhang Lei, who advocates value investment and studied under David Swensen at Yale, did not completely follow the classic price investment operation. Instead, he re-expressed his views on "value", believing that as long as it is "worth it", no matter how expensive it is, it can be bought. Therefore, Hillhouse also heavily invested in high-growth stocks that are not within the safety margin and have negative profits every year, such as Bilibili and Pinduoduo. At the same time, Zhang Lei emphasized that early research is very important, which is somewhat similar to the thinking of Li Lu, another person who insists on venture capital on the other side of the strait.

This feeling is similar to the logic of investing in Amazon twenty years ago. Amazon's stock price rose year by year before the dot.com crash, so it was not a bad investment, although it did not turn a profit for the first time until seven years after its establishment, and the profit was very weak.

In contrast, Buffett's positions have remained the same for decades. Several stocks that Buffett outperformed the market: Coca-Cola in the 1980s, Apple in 2016, and TSMC in 2022 all have the following characteristics: relatively low PE, industry leader, high profits, safety margin, and good dividends.

For the stock god, buying and selling stocks is not the most important thing. The most important thing is to have a high-quality business that can make long-term profits. The stock god usually has cash in hand and believes that crisis is an opportunity. If there is no cash to buy high-quality assets at the right time, it is tantamount to investment failure.

Buffett is not against technology, but whether the technology can match his indicators. Apple, which is managed by the stock god, is one of the classic investments. In 2021, Berkshire Hathaway invested in Brazil's FinTech disrupter bank Nu Bank, and Nu Bank plans to launch its own cryptocurrency in 2023.

Buffett and his partner Munger have openly scoffed at cryptocurrencies, believing that there is no real value behind the assets, although the stock god is not opposed to the technology and logic of blockchain.

Since the top value investing practitioners of our time do not recognize the crypto market, is it possible for the concepts and operations of value investing to be applied to the project analysis of cryptocurrencies?

Defining cryptocurrency is difficult, and investing in it is also difficult

First of all, it may be very important to define the investment object before investing, because only in this way can we know the nature and laws of the investment object.

Which asset class should cryptocurrency belong to is something that regulators, investors, and users have not figured out yet, or perhaps it should have its own asset class. In the eyes of regulators led by the Bank for International Settlements and major central banks, cryptocurrency is called "cryptoasset", so the central bank and the financial fathers do not recognize the existence of cryptocurrency as a circulating currency. The risk of cryptocurrency arrival does make it fail to meet some of the most basic requirements of currency. This is not only reflected in the documents released by the central bank, but also in the government's definition of cryptocurrency. For example, the documents filed by the US SEC against FTX show that the SEC believes that FTT should actually be treated as a security through earlier buy and burn activities. If FTT is defined as a security, then BNB may also have similar attributes. Securities will be regulated by the SEC, while commodity contracts will not. At present, the United States has defined virtual currencies such as Bitcoin and Ethereum as commodities through the Commodity Exchange Act.

Cryptocurrencies do have commodity attributes and also have foreign exchange market attributes. The transaction prices of commodities and foreign exchange markets are determined by the supply and demand of assets. Similar to commodities, the price of commodities is a unit of a certain raw material (gold, oil, etc.), which has a one-to-one relationship. Each cryptocurrency token is also a unique embodiment of a certain value. Commodities and tokens need to be traded in pairs, and they are also cyclical. Moreover, in the case of high inflation, commodities and cryptocurrencies are considered by investors to be inflation-resistant in a sense. Currently, cryptocurrencies, which exist as commodities, are relatively loosely regulated. If cryptocurrencies are defined as securities, they need to provide more transparent financial reports so that their price fluctuations can truly become the value that investors expect.

Even so, cryptocurrencies cannot be strictly called "electronic gold". Although the rise and fall of cryptocurrencies are similar to the occasional trends of commodities and are not completely consistent, some scholars (Lawuobahsumo et al., 2022) say that this correlation is likely to be a spillover effect of other market environmental factors.

So what about currency? Can cryptocurrencies use FOREX logic?

After all, the core logic of cryptocurrency from its inception is theoretically to solve the lag of centralized currency, making transactions faster, more convenient, and resistant to inflation. Later, various derivative encrypted "currencies" appeared, although many of them did not have the attributes of circulating currency, more like a "stock" of a company or project, just like legal currency itself is also a reflection of national sovereign value to some extent, although national debt would be a better analogy.

However, some scholars (Liang et al., 2019) found that the current crypto market is more similar to the stock market than the FOREX market, except that both are 24-hour transactions. This is also easy to understand, after all, the transactions in FOREX are all national fiat currencies and fiat currency derivatives, and each fiat currency is essentially a liquidity tool for a certain country and region and trade. On the contrary, the actual use behind each cryptocurrency is actually different.

Based on this, can we say that cryptocurrencies are more suitable for the logic used to analyze securities, because we can see with the naked eye that cryptocurrencies are highly correlated with US stocks. However, Isah and Raheem (2019) pointed out that the underlying logic of this correlation is the quantitative easing (QE) of the US central bank, so the rise and fall of the stock market and the crypto market all come from the tightness of the US dollar.

So far, the author believes that although cryptocurrencies have some characteristics of commodities, foreign exchange, and U.S. stocks (note that they are U.S. stocks, not other stocks), they cannot be simply classified into one group. If they must be classified, they are most closely related to the U.S. stock market and are deeply affected by macro policies. When there is no way to quantify the financial reports of crypto projects, it is not necessarily possible to use micro value investment, but is more suitable for following macro operations. Therefore, value investment is not very applicable to the crypto market.

Asset Pricing in Crypto: What can you do if you can’t do value investing?

It is very difficult to do value investment research in cryptocurrency. First, there is no mature quantitative system, and no expert has yet come up with a calculation tool to model it. Second, the cryptocurrency data is also worrying. Unlike the financial reports in the US stock market, which are generally not allowed to be falsified, people can trust the financial data provided by the company, and the rest of the things that are not in the report can also be traced. However, in cryptocurrency, 6 million users may just be boasting, and only the company itself knows the actual ARPU of each user.

If there is no reliable hard data for measuring specific projects, how can we make calculations and value investments?

At present, some scholars have provided some hard indicators for asset pricing modeling for your reference.

Hubrich (2017) applied the French-Fama model to cryptocurrencies, using only three attributions. The scholar used the market value, trading volume, and market value/trading volume of the coin as indicators to measure the market, and used the inflation "spillover" effect of each coin to measure the relationship between the attributions (i.e., the conversion rate of each coin mined, carry), etc. The final conclusion is that the biggest reason for the project's performance is the market, there is a little relationship between coins (carry), and the alpha is very small.

EY has also released a report stating that CAPM and other methods can be used to estimate cryptocurrency portfolios, but no detailed guidance was given on how to use them.

The author is very interested in this topic, and welcomes readers who are interested in modeling or are doing related work to contact the author. If we can develop some asset pricing systems for cryptocurrencies, whether it is the value investment style or the French-Fama style, it will be a great achievement.

Why value investing (in cryptocurrencies)?

Graham proposed value investing, but he himself is not the master of value investing. Although the returns are not bad, he just has too many other interests and hobbies. He even participated in the drafting of the Bretton Woods system and regarded his contribution to monetary theory as his most outstanding contribution. In the following decades, as the US stock market gradually matured, Buffett, who had a relatively single hobby of investing and making money, applied this theory to perfection.

In Graham's system, net is the core, that is, worthwhile stocks must be bought cheaply, and in groups. If they rise, they will rise greatly, and if they fall, they will not fall much. Then, we can grasp the two points of value investment: safety margin + high value and low valuation. Based on this, although there are many excellent assets, Buffett may not invest because they are expensive. In 2020, Buffett repeatedly stated that he did not intend to invest because the projects on the market at that time were too expensive. When everyone fell to the bottom of the pants, the stock god with a strong cash flow began to buy.

But you may think this is a bug. "Cheap" is a relative term. $600 is expensive compared to $100, but $60,000 is cheap compared to the rising valuation. Value investing believes in absolute cheapness, not relative cheapness. When Buffett bought Apple, his average cost was about $37, but today Apple is already over $100.

By transferring these principles to cryptocurrency "investment", I think we can learn something. That is, don't chase the ups and downs of the market. Don't chase the market when it's high. When the project is relatively small, buy some stocks that have positive cash flow in a dispersed manner, and don't add leverage. Technology may not work, because you are not buying the logic of explosive technology. You must see whether there is positive capital, and this is the difficulty. Specifically, you may want to see whether gas/arpu+users are a profitable business. It won't fall much. When the market rises, the value of the currency in hand can naturally be pulled up. Buy a few more coins in a bear market, but also keep enough cash. Don't touch Meme coins. Don't short.

We don’t know whether cryptocurrencies will mature like the stock market, or whether they will not exist one day. The above summary only supports those who want to adhere to the value investment belief in cryptocurrencies, not just verbally, but actually abide by the core logic of value investment.

At least Buffett has used his investment career to prove that value investing is still an evergreen tree. Although ARK achieved a return of 152% in 2020, Tesla also achieved a return of 695% at its peak. By 2022, ARK's retracement reached 65%. Berkshire Hathaway's retracement due to stock declines in 2020 was only 19%, and it continued to be brilliant in the next two years. In 2020, it held about 48 billion US dollars in cash and swept the world. By 2022, Berkshire Hathaway's stock price hit a new high. This is the closest operation of the stock god to us. In fact, Buffett's operation is the same every decade. The stock god has told everyone again and again that you should buy cheaply, buy good companies, and hold them after you buy them. Don't do messy operations. It's just that everyone thinks this method is too simple, so simple that it doesn't reflect the complexity of finance and the understanding of the market.

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