Utility and Security tokens Explained

Cryptocurrency markets have evolved rapidly, leading to the emergence of various types of tokens. Two key classifications are security tokens and utility tokens. But what is a token? A token is a digital asset that represents ownership of something, such as a real-world object or a financial instrument. In the context of blockchain technology, tokens are created on top of existing blockchains (like Ethereum) to represent new assets.

UTILITY OR USE-CASE?
Token utility refers to the specific function or purpose of a token and answers the question, “Why should I hold this token?“. Ex: paying transaction fees, providing access to specific services or features, etc.

Token use-case refers to the specific application in which a token is used within the ecosystem and answers the question, “What is this token used for?“. Ex: medium of exchange, governance, etc.

Tokens have diverse applications ways, such as providing access to specific services within a designated platform; acting like rewards points allowing users special privileges when using them while interacting with different applications built on top of the same network; facilitating transactions between parties directly without intermediaries involved by paying transaction fees through these coins. The value and function of tokens vary widely depending on their use case which could range from improving security protocols to streamlining payment processes.

Now, let’s explore the differences between the two tokens.

A utility token is a digital asset that provides access to specific products or services on a blockchain network, usually by providing users with the right to use certain features of an application. Utility tokens are different from security tokens in that they do not represent ownership in any real-world asset nor do they confer rights to dividends, or profit sharing, and their value is derived solely from their functionality within the associated platform. Utility tokens are generally subject to fewer regulatory requirements than security tokens, although regulators may still classify some utility tokens as securities, depending on their specific characteristics.

Examples: Ethereum (ETH), Binance Coin (BNB), and Chainlink (LINK).

A security token represents ownership in an asset, such as equity or debt and token holders have rights to dividends, interest, or other forms of profit sharing. Unlike utility tokens, which provide access to specific products or services, security tokens represent regulatory-compliant financial instruments, making them subject to federal laws and they offer investors the opportunity to profit from price appreciation, dividends, revenue-sharing rights, interest payments, etc., much like traditional securities do.
Regulatory Compliance: Security tokens are subject to securities regulations and must comply with relevant laws and regulatory frameworks, such as the Securities Act of 1933 and the Securities Exchange Act of 1934 in the United States.
Issuers of security tokens must adhere to Know Your Customer (KYC) and Anti-Money Laundering (AML) requirements, which involve collecting and verifying the identity of token holders.

Examples: tZERO (TZRO), Polymath (POLY), and Harbor (R-Token).

WHAT ABOUT GOVERNANCE TOKENS?
Governance tokens should not be considered utility tokens, as they are used or held exclusively when a proposal requires voting. However, can utility tokens possess governance rights? Yes, they can.
The Curve model introduces Vote Escrow Tokens (veTokens), which can be used to give voting power to stakeholders and/or liquidity providers.

Disagree? shoot me a DM.

Summary and More

Security tokens and utility tokens serve different purposes within the realm of cryptocurrencies and blockchain technology. While security tokens represent ownership in an underlying asset and are subject to strict regulatory compliance, utility tokens provide access to specific products, services, or platforms, with less regulatory oversight. Both types of tokens have distinct use cases and offer various opportunities for investors, developers, and users in the expanding digital asset ecosystem.

THE HOWEY TEST
To determine if a token is a security or utility token, we can apply the Howey Test, which is also used by the Securities and Exchange Commission (SEC) to distinguish between securities and non-securities. This test has been employed in the crypto industry on numerous occasions to ascertain whether a token is a utility or security token.

Ask yourself these questions:

• Is there an investment of money involved?

• Does the investment involve a common enterprise?

• Is there an expectation of profit for the investors?

• Is this expectation reliant on the efforts of others?

The majority of token sales (ICOs) meet these criteria, so it’s important to recognize that most tokens in the market should be considered securities.

Equity tokens

An equity token is a type of digital asset that represents ownership in a company or organization. They are essentially similar to traditional securities, such as stocks and shares, but operate through blockchain technology.

Equity tokens allow companies to raise funds by offering investors access to an ecosystem where their assets can appreciate over time based on the success of their venture. These tokens can be traded much like other cryptocurrencies, providing liquidity for investors who want an exit from the investment. Unlike utility tokens, which are used primarily within a specific platform or application, equity tokens represent an actual value within real-world businesses.

TOKENIZATION OF REAL-WORLD ASSETS
Tokenization of real-world assets, like real estate, art, or intellectual property, is an expanding trend in the crypto space. As more assets are tokenized, the distinction between these two types of tokens might become less apparent, leading to the emergence of new classifications. This token belongs to the security token category.

What the future holds

As the cryptocurrency and blockchain industry continues to evolve, we may witness the emergence of new types of tokens, as well as the convergence of characteristics between security and utility tokens. For instance, some projects may explore hybrid token models that combine features of both security and utility tokens.

Regulatory authorities worldwide are intensifying their efforts to provide clarity and guidance for token offerings. The evolving regulatory landscape will likely lead to the development of more sophisticated token models that better adhere to legal requirements and protect the interests of investors.

MEMECOINS/SH*TCOINS
Memecoins are tokens without utility, serving as speculative assets.
Fueled by a narrative that entices speculators to buy low and sell high.
Indeed, there is an expectation of profit.
Therefore, it raises the question of whether they should be considered security tokens. We welcome your thoughts on this matter. Let us know your thoughts.

Conclusion ~ Understand your investment

Understanding the differences between security tokens and utility tokens is essential for investors, developers, and regulators navigating the cryptocurrency landscape.

Each type of token presents distinct opportunities and challenges, and their ongoing evolution will significantly influence the future of digital assets and blockchain technology. By staying updated on the latest trends and developments, stakeholders can better position themselves to capitalize on the growth of this dynamic and rapidly evolving industry.

Mark ~ May 6, 2023

THIS IS NOT FINANCIAL ADVICE
Nothing in this report/analysis constitutes professional and/or financial advice. The shared content is for educational and informational purposes only. Do your own research before investing.

Portfolio Diversification Explained

Diversifying your portfolio means putting your money into a wide range of different assets to lower your risk. The idea behind it is simple: Don’t put all your eggs in one basket.

“Diversification is for idiots, because you can’t diversify enough to know what you are doing.” – Mark Cuban
“Diversification generally makes very little sense for anyone that knows what they are doing. Diversification is a protection against ignorance.” – Warren Buffett
“Much of what is taught at modern corporate finance courses is twaddle.” – Charlie Munger

Many respected investors in the traditional market suggest that diversification is not the best solution to building financial wealth, some investors, such as Bob, suggest that investing in multiple asset classes, such as stocks, bonds, real estate, and crypto, can reduce exposure to any single investment that may decline in value. This helps ensure that if one part of your portfolio underperforms or experiences losses due to market fluctuations or other factors beyond your control, the rest will continue generating profits for investors, which helps balance out overall portfolio performance over long-term horizons.

“To diversify, or not to diversify, that is the question”.

Diversification plays a crucial role in long-term financial planning as it helps balance short-term risks with long-term gains, resulting in better overall returns.

So which investment strategy is the best?

Concentration. By focusing your investment on three assets or areas you’re familiar with, you can conduct deeper due diligence and devote more time to preparing your entry and exit strategies. However, this approach also increases risk: if an investment goes sideways in one of those areas—such as during stock market crashes—it may significantly impact your portfolio.
Diversification. Spreading your investment among 10 to 100 assets reduces liquidation risks, but at the same time, diversifying also means that you are not heavily invested in any one particular opportunity, and thus profits generated from each investment may be lower than if you had bet on just one or two opportunities.

While no strategy guarantees success every year, nor does it guarantee against loss, prudent investors understand how diversified portfolios provide smoother experiences through market cycles than more concentrated ones do.

That being said, there are many self-made millionaires who made it by investing in 1–3 assets at the right time, which is a very important variable when it comes down to entry and exit strategies, as previously mentioned.

Ultimately, both concentration and diversification have pros and cons. Finding the right balance between the two depends on your experience, goals, preferences, risk tolerance, and other factors.

E&E (enter and exit) STRATEGIES
Smart investors know when to invest and when to get out of an investment; usually, the exit strategy is well-defined before investing (during this period of time, the investor’s mind is more rational, not being involved with the investment yet).
With regard to the entry strategy, it is important to take into consideration variables such as market sentiment and the project development stage.

Conservative diversification

Diversification is one of the most important principles in investing, but it’s easier said than done. It requires extensive market knowledge and experience to build a well-rounded investment strategy.
Many investors work with brokers or financial advisors to help them make a personalized long-term plan that takes into account their risk tolerance, time horizon, liquidity needs, tax concerns, and other factors that affect their investments.

If you can’t afford a broker or a financial advisor, we suggest going for conservative diversification, which has lower risks involved but also lower expectations of profits. Developing a conservative diversification plan requires conducting proper due diligence on desired assets and gaining a deeper understanding of the market and its regulations. Here are two examples:

Traditional market

15% in liquid cash.
40% on long-term investments (ex: ETFs, bonds, commodities, etc.).
25% on blue-chip assets (ex: Amazon, Bank of America, Google, Netflix, etc.) +$100 billion market cap. These assets must:
- must have long-term expectations (+10 years)
- must have a high reputation.
- might pay dividends.
15% mid-term investment on growth stocks (ex: Mercedes-Benz, Airbnb, Shopify, etc.); assets with high expectations.
5% in high-risk investments (crypto and penny stocks).

Allocating a bigger piece of the pie to ETFs, bonds, and commodities is not a bad idea considering that the traditional market is less volatile; that being said, a 15% allocation to cash is a must. Being liquid is also very important because performing transactions (i.e., selling assets) is slower in the crypto market.
In the traditional market, you can allocate more money to mid-term and high-risk investments because the return on the investment is slower and lower compared to the crypto market.

CORPORATE LAWYERS
Not only can brokers or financial advisors help you build an investment portfolio, but corporate lawyers also play a crucial role when crafting complex portfolios for high-net-worth individuals or private equity firms looking into merger and acquisition opportunities.
We suggest watching this TV show for fun and educational purposes: Suit.

What is an ETF?
ETFs (exchange-traded funds) are a type of index fund; by buying these funds, you invest in everything that is in the fund. Investors do not own the underlying assets, but they may still be eligible for dividend payments. There are many ETFs in real estate, energy, and more.

Crypto market

30% in liquid cash or stablecoins (at least 2 of them). Read more about stablecoins in Episode #5.
35% on blue-chip assets (ex: Bitcoin and/or Ethereum).
20% on long-term investment (ex: providing liquidity to stablecoins).
12% mid-term investment (ex: staking Ethereum for passive income).
3% short-term investment and highly volatile assets (ex: NFTs, DeFi, etc.).

We have allocated a huge piece of the pie to cash and stablecoins because of the high volatility of the crypto market and because of the many opportunities (it is good to have liquid assets ready to be invested). As per the other allocations, it is very important to know what you are investing in, and experimenting with asset classes can broaden your knowledge and experience, even if it’s only 3%.

Modern Portfolio Theory
MPT is a set of rules in finance that are meant to help investors get the most out of their investments while minimizing the risks.
This method involves spreading out investments by putting together groups of assets that have a good balance of risk and reward.
The goal is not only to get the highest expected returns but also to take into account how much risk a person is willing to take.

Disclaimers: DO NOT take these allocations for granted; this is just an example. The fund allocations should depend on your investment plan, which is based on many variables such as individual goals, preferences, risk tolerance levels, and more, as previously mentioned.

How many assets should you hold in your portfolio?

Know that you can’t beat the companies that have more than 10 market analysts, whose job it is to lower the risks and increase profits for the companies they work for. Over-diversifying into assets that might give you a 100x return might not be the best idea, especially in the crypto space.

How to diversify in 2023

Needless to say, 2023 will be a tough year for investors. Will the bull market continue? Are we going into a market recession? Or is the bull market next door? Whatever your gut tells you, trust only the numbers, and if you don’t have a plan, fly safely with a super-conservative investment plan.
This is a historical moment for the market. Everyone is more or less suffering as a result of COVID, the Russo-Ukrainian War, and the bank collapse (even though many people were able to hedge the market and profit from the situation, such as pharmaceutical companies and their investors).

You can’t beat the market; you have to adapt your plan to it. Where there is fear and depression, there are more risks involved with investing, and to mitigate these risks, the best solution is to get ready for the worst outcome that may come and invest when bullish signals start appearing (ex: when the FED makes it clear that it will stop these interest rate hikes or start doing interest rate cuts; it is all a matter of timing!). Here are two examples:

Traditional market

35% in liquid cash.
35% on long-term investment.
18% on blue-chip assets.
10% mid-term investment in growth stocks.
2% in high-risk investments (high-risk investments include investing in start-ups, venture capital projects, and options contracts.).

Money is sovereign. Cash is the most liquid asset we have in our economy, making it less volatile. Nevertheless, investing is important because, as we all know, money loses value over time due to inflation. To safeguard against inflation, we must put our capital to work while always attempting to limit losses. Considering the scarcity of information and uncertainties with regard to the market, it’s essential to conduct proper due diligence before investing (this advice cannot be emphasized enough).

Crypto market

50% in liquid cash or stablecoins.
25% on blue-chip assets.
15% on long-term investment.
9% for mid-term investment.
1% short-term investment and highly volatile assets.

The crypto market is the most volatile of all. For this reason, more time and attention have to be deployed before investing, and even if you are not invested but hold a big chunk of your bag in stablecoins, there is no guarantee that the asset won’t depeg. Diversification is a good way to mitigate your risk, but it is not a final solution.

FIRST TIME INVESTING?

If you are a new investor and you don’t know how to diversify your portfolio, you can fly safer by buying the S&P 500 and ETFs for passive income (7–12% yearly).
But what if you are new to the crypto industry? Here are some options:

Go solo, learn by yourself, and invest in what you know and understand. More risks are involved.
Join DAO-driven ventures or investment groups that will help manage your investment (similar to ETFs, but less regulated).
Hire MHL Solutions to build you a custom investment plan based on your needs and goals. Click here to request this service.

Risks involved with diversification

Over-diversifying (or deworsifying) your investments may lead to lower overall returns as the gains from high-performing assets will likely be offset by losses in underperforming ones.
Holding too many different assets could make it difficult to keep track of all your holdings and monitor their performance effectively.
Even if you buy a lot of different securities, that doesn’t mean you’re truly diversified if they all move in the same direction with market trends instead of being affected by different things that affect each security on its own. This phenomenon is called correlation risk.

Conclusion ~ it’s up to you!

So, what’s the answer? To diversify, or not to diversify Better to all in on one asset or spread your investment among 100 investments? Both strategies are right in their own way; it mostly depends on the investor’s mindset and needs. New investors tend not to diversify, while more experienced investors have a well-diversified portfolio. Diversification can be a beneficial solution, provided that investors stay informed and conduct thorough due diligence, while also being aware of the associated risks. Don’t get fooled by influencers who put $10 into hundreds of projects, hoping for a 100x return, when you can invest in a few projects and perhaps earn more. But what really matters is having a plan, whatever it may be.

Mark ~ Apr 12, 2023

Stablecoins Explained

Stablecoins are digital tokens designed to maintain a stable value relative to a specific asset or basket of assets, such as FIAT or a commodity like gold, with the purpose of having a non-volatile and highly liquid asset. There are many stablecoins (SCs) out there, but which one is safer?

First of all, what problem are stablecoins solving? In order to have an efficient market, trades must run smoothly, and to do so, you need liquidity. While introducing FIAT currencies is an effective way to enhance liquidity in the crypto market, the process of exchanging cryptocurrencies for FIAT can be time-consuming and costly. Stablecoins were introduced to the crypto market with the sole purpose of being able to exchange your unstable asset for a stable asset in a matter of seconds and preserve the total value of your portfolio.

Let’s identify what types of stablecoins are available on the market.

FIAT-pegged Stablecoins are backed 1:1 by FIAT and held in a safe bank account, which gives more security to the holders even though it makes the SCs centralized and puts them at risk of having their funds frozen by governments. For each FIAT held by the company behind the stablecoin, there is one token in circulation, not one less. Every time the liquidity in the bank increases, the company mints new tokens; if the liquidity in the bank decreases, the tokens are supposed to be burned.

Examples: Tether (USDT), USD Coin (USDC), Gemini USD (GUSD), we do not hold this stablecoin.

Algorithmic Stablecoins are tokens whose price is dictated by an algorithm that manipulates the supply of the SCs (which many consider not to be a good solution in the long term) based on the “rules” of the smart contract (when the price goes up, new coins are issued to reduce the price and vice versa) and not by the reserve stored in a bank, so that they do not need assets such as FIAT, gold, or crypto as collateral.

We suggest caution with algorithmic stablecoins, and it is important for investors to conduct their own research (DYOR) before engaging with them.

Overcollateralized stablecoins use crypto and tokens (making the reserve easily auditable) as collateral rather than FIAT or a different store of value, making the price highly volatile. These SCs are 150% collateralized in order to preserve price stability.

Example: Dai (DAI)

Commodity-pegged Stablecoins are backed by commodities such as gold.

Examples: Paxos Gold (PAXG) and Tether Gold (XAUt); we do not hold these stablecoins.

What about the “wrapped” versions of cryptocurrencies such as WBTC, WETH, etc.? These are crypto-pegged tokens, not stablecoins; they are not stable in price; their price depends only on the token or crypto they are pegged to.

USDT is not 100% backed by FIAT (~80% is in cash); it is also collateralized with assets and receivables from loans made by Tether to third parties.

Are Stablecoins Securities?

Now that we have explored the different types of stablecoins, let’s touch upon the regulatory considerations surrounding their classification.
FIAT is a government-issued currency that is supposed to be backed by commodities such as gold, but truth be told, it is not.
Most of the cryptos and tokens are considered utilities, even though some of them are securities. So, stablecoins are to be considered utility tokens. But what happens if a stablecoin is backed by securities such as US bonds or Treasury bills? In this case, it has to be considered a security instead of a utility token. What about crypto-pegged tokens? These are also to be considered utilities if they are pegged to a utility token.

What else can you do with stablecoins?

Let’s go back to the business model and how companies profit from releasing stablecoins into the market. Mostly, companies such as Circle and Coinbase created their own stablecoins in order to increase their audience and make transactions easier within their exchanges and with other exchanges. Other companies charge a fee for trading their SCs.

How can users benefit from stablecoins? Is there any way to earn money from holding stablecoins? Yes, there is. One of the safest investments in the crypto space is providing liquidity to stablecoin pairs such as USDT/USDC and earning trading fees.
Read more about how liquidity works in our previous: #EP 3 ~ Liquidity Explained
Another way to earn from SCs is to speculate during depeg periods, but how? EX: Let’s say for some reason USDC goes down to $0.9; here you have an opportunity to buy USDC with a premium and earn 10% once the USDC price goes back to $1. It is a risky trade because the price might go down, causing the stablecoin to fail (this has already happened in recent events), but if it works, it is a short-term trade to make quick bucks.
Landing, borrowing, and leverage trading are other ways to profit from your stablecoins.

Are stablecoins safe?

Not as you may think. Holding your money in the bank is safer because it is insured if it is lost or stolen. But when it comes to stablecoins, there is no refund; if a stablecoin deviates from its price, you are most likely to lose your portfolio value. What should you do then? The best solution is diversification; holding stablecoins is not a bad idea, but holding one single stablecoin is. DYOR and diversify your stablecoin portfolio based on your needs.

FIAT-PEGGED STABLECOINS LIQUIDITY
In addition to their role in providing stability, stablecoins also play a crucial role in maintaining liquidity within the cryptocurrency market.
As we mentioned above, when a company injects new stablecoins into the market, they are supposed to collateralize them (in banks in forms of cash, tresuary bills, etc.), so what can they do with these funds? Not much, they can invest these assets but losing them will make the stablecoins depeg.

Conclusion ~ Long-term stability

A lot of crypto adopters do not consider stablecoins cryptocurrencies because, whether collateralized or algorithmic, they are both controlled by a company and so they do not respect the crypto narrative. But stablecoins must be considered tokens because FIAT-pegged stablecoins, for instance, are tokenized versions of FIAT currencies.

We talked about what problem stablecoins are solving previously, but what we haven’t said yet is that this is not a long-term problem; cryptos such as Bitcoin are highly volatile due to their low market cap. The higher the market cap (simply put, “money in”), the lower the volatility. Long-term investors speculate that stablecoins will no longer be needed once Bitcoin reaches a more stable price. Therefore, the question is not what problems they solve but for how long they will be needed.

Another question comes to mind: why are we using stablecoins if we cannot trust them? Well, there are two answers here:

The short-term trader in me would say, “I got out of a profitable trade; I want to rest and get in on the next one”.
The long-term investor in me would say, “I am out of the market, and I want to preserve my portfolio value”.

Stablecoins have less than 15% of the market’s dominance, compared to BTC (44%), and ETH (20%), which is very low. I would say that we do not trust stablecoins enough to own major allocations of them, but we are looking forward to a less volatile market.

Mark ~ Mar 13, 2023

Liquid Stacking Derivates Explained

Liquid Staking Derivatives (LSD) is a new staking option that enables stakeholders to profit from staking and maximize their returns by trading or using stTokens in the De-Fi protocol.

What is staking?

Staking is a token distribution mechanism used to issue tokens in the market through smart contracts; it also functions as a rewarding mechanism because it rewards stakeholders with the assets staked.

In traditional staking in Proof-of-Stake (PoS) protocol-based projects, which is also the most secure version of staking because it is done directly with the chain, your tokens are in a lockup period during which the tokens staked cannot be withdrawn for a certain period of time; in some chains, there is also a minimum number of tokens to stake. Although it offers a secure return on staked assets similar to a bond, it also limits the potential to earn higher returns on those assets from the DeFi ecosystem. Additionally, in some chains, there is a minimum number of tokens required for staking.

Lido, Coinbase, and RocketPool are offering a unique solution called Liquid Staking Derivatives (LSD):

that simplifies the staking process with a user-friendly interface, requires no additional resources, and operates serverless.
that provides an opportunity to earn on small deposits.
stTokens can be traded or used to maximize your profits in DeFi protocols.
it also provides a different solution from other staking options.

These are the reasons why DeFi advocates are crazy about it! Because they can have fun and generate more profits by trading them or providing liquidity (ex. stETH/ETH). Isn’t it lucrative?😌

STAKING OPTIONS
Solo staking: which requires setting up a validator node and a minimum deposit (i.e., Ethereum requires a minimum of 32 ETH staked).
SaaS staking: with this option, you have your own validator but still have to trust a third party (usually centralized) and still have to make the minimum deposit required.
Centralized exchanges: even though APRs are higher, I do not suggest locking tokens on CEXs.

How do LSDs work?

As mentioned above, several protocols offer LSD; for the sake of example, we will use Lido (which is the protocol with the highest deposits).
Lido is a protocol that acts as an intermediary for staking your ETH (and other tokens) on the Ethereum chain without a lockup, keeping your staked “ETH” in your wallet.
There are two ways to earn rewards, and both require a stTOKEN:

Connect your decentralized wallet to stake.lido.fi and swap your token (ex. ETH) for stETH (which is not an Ethereum native token; it is a pegged ERC-20 token with counter-party risks). Once the swap is successfully completed, you will start earning rewards.
Buy stTOKEN on CEX (not all CEXes support stTOKENS) and withdraw to your wallet (e.g., Metamask).

Add the stTOKEN to your wallet so that it is visible when you withdraw. The contract address can be found on CoinMarketCap.

More about lido

Lido promotes itself as a leading liquid staking solution and assures users that by staking with Lido (which manages deposits, staking rewards, and withdrawals), your assets remain liquid and can be used across a range of DeFi applications, earning extra yield (for this service, Lido takes a 10% fee).

Lido has $8.5 billion in staking assets (at the time of this report).
The Lido DAO acts as a management entity, responsible for picking node operators, configuring the protocol parameters, and much more.

How are APRs calculated?
Lido uses the following formula to calculate users’ APR:

User’s APR (Lido staking APR) = Protocol APR * (1 — Protocol Fee)

Risks involved with staking with LIDO:

The ecosystem is built around the fact that these staked tokens are 1/1 liquid. In this scenario, there will be a liquidity issue, and the price of the staked coins will drop.
LIDO uses other validators but also runs its own, so it might go offline, reducing the rewards.
The DAO can take votes on proposals that might negatively affect the ecosystem (for example, raising the Protocol fees).

SUPPORTED CHAINS:
Ethereum = $8.4 billion staked
Solana = $57.8 million staked
Polygon = $72.2 million staked
Polkadot = $18.4 million staked
Kusama = $3.8 million staked

SUPPORTED WALLETS:
Metamask, WalletConnect, Ledger, Trust Wallet, Coinbase, Phantom, Exodus, Brave, and more.

WHAT IS LEVERAGE STAKING?
A new type of staking is available with LSD now, called leverage staking, which basically works this way:

Swap ETH for stETH (on Lido)
Earn rewards
Stake stETH to earn ETH
Swap ETH for stETH (on Lido)
Earn rewards
Stake stETH to earn ETH
and repeat that again…

It looks to me like an endless Ponzi scheme… I do not like it at all.

Conclusion

Staking data
Despite being the second largest cryptocurrency by market cap, $ETH has a very low supply staked; according to Messari, 15% of the $ETH in circulation is staked, compared to 90% of $BNB, 68% of $SOL, and 46% of $DOT. Furthermore, Kraken, Coinbase, Binance, and Lido own over 60% of the ETH staked, making Ethereum staking centralized.

Liquidity
LSD runs on a liquidity basis, as the name suggests. If the LDS tokens in circulation are not backed 1/1, the system dies; the same goes if these tokens run out of liquidity because when you swap your ETH with Lido and get back stETH, Lido must stake ETH in the Ethereum native staking contract to earn $ETH and reward stETH holders.

But what would happen if all the stETH holders wanted to swap back for ETH? Is this possible if the ETH held by Lido is locked? This scenario is very unlikely to happen, but taking it into consideration is not a bad idea. Be prepared for the worst.

Mass adoption
Some on CT believe that LSD has the potential to become the dominant staking mechanism, becoming the quickest and most profitable way to stake your assets and invest in or trade them at any time.

LSD has quickly gained popularity among DeFi investors because, as previously stated, it allows you to use the same asset to earn in two protocols. Isn’t that cool?

That being said, I believe the technology and application of LSD are impressive, and I may agree with the DeFi advocate who claims that this will dominate the staking mechanisms for one simple reason: Degens freaking love maximizing their profits!🤟

Mark ~ Feb 18, 2023

Liquidity Explained

In finance, “liquidity” refers to the degree to which assets or securities can be bought or sold in the market without affecting the asset’s price. A liquid asset can be bought or sold quickly and easily, as there are many buyers and sellers available in the market. An illiquid asset is more difficult to buy or sell, as there are fewer buyers and sellers or the asset is not in high demand.

The greater the liquidity of the asset, the more stable its price is likely to be. This is because there are more participants in the market willing to buy and sell the asset, which helps to smooth out price fluctuations.

Bob is going to go to the lakes (pools) to fish with his grandfather. Once they arrive at the pools, they have to decide on which one to throw the bait, and Bob insists on fishing in the ‘scenic’ pool even though there are fewer fish (10 fish and 5 fishermen). Instead, Bob’s grandfather is going to the pool that has more fish (100 fish and 20 fishermen).

Who will catch the most fish today?

Obviously, Bob’s grandfather wins. But why? Let’s pretend all the fish were to be caught. What would be the total catch for Bob and his grandfather?

Bob’s pool: 10/5 = 2 fish per person out of 10 fish.
Bob’s grandfather pool: 100/20 = 5 fish per person out of 100 fish.

(Bear with me; these numbers are not realistic; they might get more or less fish, but for the sake of the example, we will keep it very simple.)
Even if there are more people around, Bob’s grandfather will be able to catch a greater number of fish due to the abundance of fish in his pool, allowing him to easily catch them.

Bob has learned a new lesson today. The following day, Bob and his grandfather are going to fish in a new and bigger pool (1000 fish, 50 fishermen).

1000/50 = 20 fish per person out of 1000 fish. Despite the fact that each fisherman is supposed to catch 20 fish, Bob only caught fifteen and his grandfather twenty-five. This could be because Bob fell asleep for a few minutes, went behind the bush to piss, or, more likely, because he lacks experience and skills.

Again, Bob has learned a new lesson today. Knowing where to fish does not guarantee that you will perform as well as the others.

Crypto Liquidity Pools

The liquidity pool is a smart contract that allows traders to trade tokens even if there are no buyers or sellers instead of using the traditional order book from the stock market and CEXs.
Every liquidity pool is initialized with a pair of assets in a 50:50 ratio (ex: ETH/MHL Token), and most liquidity pools utilize an algorithm called the Constant Product Automated Market Maker that decides the price of the token based on the amount of the token bought and the ratio in the pool; basically, the more MHL Token you buy, the higher will be the price of each token bought because the pool is trying to keep the ratio at 50:50.

This pool was initialized with 1 ETH and 100 MHL tokens.
1 ETH = $1,300
100 MHL tokens = $1,300 = $13 per token.
Pool total value: $2,600 — — Ratio 50:50

What happens when you buy 20 MHL tokens? Once the trade has been concluded, there will be fewer MHL tokens and more ETH (20 MHL tokens x $13 = $260).
First of all, you will never buy the tokens at the same price; the price will increase with every token you purchase because the ratio between the tokens also changes, therefore their value. But let’s keep it simple.

Now the pool has ~1.2 ETH = $1,560
80 MHL Tokens = $1,560 = $19.5 per token
The price of MHL tokens has increased because it has to balance the pool back to 50:50 — — Pool total value: $3,120

TRADE TOKENS WITHOUT A PAIR (ROUTING)
What if I want to sell MHL for AVAX?
Well, if the DEX does not have the pair AVAX/MHL, you will still be able to exchange your MHL tokens for AVAX; in this case, the contract will execute 2 transactions:
Sell MHL for ETH then Sell ETH for AVAX.
It will take a little longer, and you will have to pay more in gas fees.
Most of the time, you do this kind of procedure because the token may have just been launched and the DEXs are not offering that specific pair.
If you really want to buy such a token, I would suggest you do it on a big DEX, such as Uniswap, so that the trade will be faster (if the token is liquid enough).

Every time you trade tokens using a liquidity pool, you will pay gas fees to conclude the trade.
But who pays these fees? Liquidity providers. That can be a single person, an entity, or the team or founder of the token.
The earnings generated by a liquidity provider depend on how much you contribute to the pool (in this case, ETH and MHL).

ETH/MHL pool total value: $3,120 — — The ratio is 50:50.
Let’s pretend you want to add $3,120 as an investment into the pool (this means: 1.2 ETH = $1,560 & 80 MHL Tokens = $1,560). The pool value will increase to $6,240, and you will own 50% of it; therefore, you will earn 50% of the fees collected by the pool every day.

The more people invest in the pool, the lower will be your ownership of the pool, and the bigger the value of the pool, the more stable will be the price of the assets because more money is required to impact the price.

PRICE VOLATILITY
The bigger the value of the pool, the more stable will be the price of the assets; this means that if the pool is small, the price impact will be bigger.
Always ensure that your trade will not have a significant impact on the price of the token, because if you buy an illiquid token and its price rises by 30%, traders will sell to make a quick profit out of it.

Risks of investing in liquidity pools:

Rug Pull: without going into technicality, this is a scam performed by a team, founder, or token owner who sells a large amount of the token in a pool that they initialize, which is not enough liquid to absorb the selling pressure. Pulling out the liquidity.
Impermanent loss: due to the lack of space in this report, I will share below a YouTube link from Binance Academy. Please listen carefully before becoming a liquidity provider:

Conclusions — Don’t be exit liquidity

WHAT ABOUT NFTs?
Why do people say that NFTs are not liquid? Because they are not. In order to sell your NFT, you have to list it on a marketplace and wait until someone meets your price needs and buys it. This is a peer-to-peer trade.
Even though there are some protocols trying to fix this issue by introducing liquidity for NFTs, the problem persists. It is indeed harder to sell NFTs than token.

Let me tell you very quickly why knowing how liquidity works matters:

Let’s pretend you bought a token a while back, and during the bear market, the token dropped by 80%, and you are still in, frustrated. What to do now? You can either sell it and hope there will be enough liquidity in the pool to sell the asset, or you’ve got to hold it.
A friend of yours told you to buy a token that is launching soon, and even though you don’t know how liquidity pools work, you still want to buy that new token. If it is illiquid, it may be difficult to buy (let alone sell), and the price impact will be significant, and you will not know why.
Let’s say you are purchasing a token on a less-established DEX with low trading volumes because that token isn’t listed on major DEXs; this token is most likely a scam, or there might be some bugs in the contracts; It is advisable to invest in tokens that have undergone contract audits.
You invested in a private round of a token sale, and you have a vesting period of 6 months; but in the 4th month, the founder of the token/project decided to remove their initial liquidity from the pool, so now it will be harder to sell because the token is more volatile, and when this happens, most of the liquidity providers remove their liquidity too. In this case, 99% of the time, the price drops significantly due to panic sales.

These are some of the most common scenarios in which a lack of liquidity causes your investment to fail. The best way to prevent this is by not buying illiquid assets. Liquidity doesn’t really matter until it does.

Mark ~ Jan 14, 2023

Crypto Fundraising Explained

Fundraising is the process of collecting money from individuals, organizations, or businesses in order to support a cause, project, or organization; it is also used by blockchain-based projects to raise funds and is typically used to support the mission or goals of the project, such as to fund research and development or for marketing purposes. Before discussing the methods that teams use to fundraise, let us take a brief look at how many types of fundraising exist.

IPO

An initial public offering is the process by which a private company becomes a publicly traded company by offering its shares for sale to the public. The IPO process involves the company issuing shares of stock to the public for the first time, typically through an investment bank. The process for this fundraising mechanism is long and expensive; for this reason, blockchain-based projects were looking for different solutions.

In 2014, Alibaba Group Holding Limited went public through an IPO on the New York Stock Exchange (NYSE), and it raised $25 billion.

ICO

An initial coin offering is the process by which a private company issues a new cryptocurrency or token to the public. ICOs are typically used by startups to raise capital for their projects. One of the most profitable fundraising bubbles in history was the ICO. In 2017 and 2018, $14 billion was raised during ICO rounds, and in 2019, ICOs raised less than $400 million. The drop-off is due to the failure of 99% of these start-ups. The main reason behind the rise and fall of ICOs was regulation.

In 2014, Ethereum conducted an ICO to raise funds for the development of its platform, which raised over $18 million in the process. In the Ethereum ICO, “ETHER” was the crypto issued in exchange for Bitcoin.

IEO

An initial exchange offering (IEO) is a fundraising event that is conducted by a cryptocurrency exchange (CEX) on behalf of a blockchain project. In an IEO, a cryptocurrency exchange acts as an intermediary between the project and investors, providing a platform for the sale of the project’s tokens or coins. IEO was introduced after the failure of the ICO mechanism in order to prevent investors from being scammed. In 2019, IEOs raised over $1.6 billion, which is not much if you think about it. This is because you can’t trust an unregulated exchange; the issue persists.

In 2019, BitTorrent conducted an IEO on Binance Launchpad held in two rounds: in the first round, investors used $BNB to purchase $BTT; in the second round, Bitcoin was added as a second option, raising over $7 million in funding.

STO

A security token offering is an alternative to an IPO in which a company issues tokens that represent ownership of the company or its assets. The token acts as a share of the company (fractional ownership). Blockchain technology is used to issue and track the tokens.

In 2018, Telegram Open Network (TON) raised $1.7 billion in an STO that was aimed at funding the development of a decentralized messaging app and a blockchain platform.

IDO

An initial DEX offering is a fundraising event in which a company issues tokens that are sold through a decentralized exchange (DEX). IDOs are similar to initial coin offerings and initial exchange offerings, but they use decentralized exchanges rather than centralized ones to sell the tokens. IDOs have become a popular way for startups to raise capital, but it is important for investors to carefully research the company and its business plan before participating in an IDO.

In 2020, Polkastarter (POLS) raised $875K during their successful IDO in just six hours from more than 500 investors worldwide.

Benefits and risks of fundraising

Fundraising is used by teams that need money to research and develop their product because, most of the time, they do not have the financial resources to develop and deliver it to the market. Teams will use the funds raised by the investor for:

Research and development: build the back- and front-end, develop smart contracts, audit the code, and more.
Marketing and branding: paid advertising; paying designers or artists; building a go-to-market strategy with a professional marketer; and more.
To pay themselves and private contractors.
Build partnerships and find investors for the next round.
And more.

But fundraising is also beneficial to investors, even though buying in early has its risks. When investors purchase a company’s shares or tokens, they receive a discount from public sales based on the risk; the greater the risk, the greater the discount.

How much should the team raise? This depends on how much time and effort the team will put into the development phase, the marketing strategy for the short and long term, and how much they are going to need for product and community management. These numbers must be backed by a solid plan; without one, it will be hard to convince private investors, venture capitalists, DAOs, and Web3 consumers to invest in your project.

How much should an investor invest? Well, this depends on your risk tolerance. In the crypto space, we used to say, “Invest only what you can afford to lose.” The secret to a good investment is to research and diversify based on your knowledge and the market you like the most (NFT, L1, L2, gaming, metaverse, DeFi, etc.).

Are there any risks during the fundraising phase? Yes, there are.

Investors may lose money if they invest in a team without experience in product and community management or because of market conditions that influence the project’s performance.

The teams might not reach the hard cap, so they won’t be able to execute their plan, or they might waste or lose the funds raised (because of a bad marketing strategy or because of mistakes made during the contract’s development, for example).

FOLLOW THE MONEY
Here are two websites where you will be able to follow the investors’ money during the fundraising of blockchain-based applications:
https://www.coincarp.com/fundraising/
https://crypto-fundraising.info

Having difficulties with company valuation for fundraising purposes?
Check out Educational Program #1.
Be prepared to explain the amount of funding you are requesting from the investor. Know your numbers.

TIPS
Here are some tips that can help you succeed during a fundraiser.

Clearly define the purpose of the fundraiser and the benefits of the product or service being offered.

Develop a strong business plan and financial projections.

Build a solid team.

Engage with the community.

Be transparent.

Follow all relevant regulations and guidelines.

Overall, the key to success during fundraising is to have a clear vision and plan and a strong understanding of the needs and interests of potential investors.

Conclusion

Founders have been using fundraising mechanisms for many years now, and overall, they are working very well because they give new entrepreneurs the opportunity to launch their projects. Despite this, you must be careful of projects that use blockchain to carry out unregulated fundraising.
Approach each investment with logic; if you miss an opportunity today, you will have another tomorrow. Patience is a virtue of winners.

Mark ~ Jan 4, 2023

Startup Valuation Explained

What is a startup? A startup is a company or venture with a unique and scalable product or service, led by a new entrepreneur.
A business valuation, also known as a company valuation, is a process and a set of procedures used to estimate the total economic value and the assets of a business.

Founders, how many times have you been in the position of coming up with a valuation for your project or company but had no clue how to do it?
Investors, how many times have you invested in a blockchain-based project (token sale or equity deal) for a valuation that was too high and asked yourself how the team came up with that huge number?

Well, today I will explain how to properly value your project so that you’ll be ready next time.
The valuation of your company depends on many factors, such as the following: the goods owned by the company, the intrinsic value of the business, revenue generated, and forecasted profits for the following years.

How to evaluate your business

Bob wants to start a homemade lemonade business using his grandmother’s recipe. But Bob has no money to incorporate the company, pay expenses, or purchase inventory. Now Bob is looking to raise his first round of investors.

Before incorporating a company, it is advisable to consult with a lawyer and an experienced entrepreneur in the sector to develop a solid business plan and an effective go-to-market strategy.
What is Bob’s business worth right now? $0, because this is just a business idea, but Bob has “proof of concept” because other people have run the same business successfully, and this can bring his valuation to $1.

Bob is trying to raise the first round of investors, the so-called “Friends and Family (and Fools, because 50% of the startup does not make it)”.
After raising $50k from the 3Fs-round (for 20% of the company at a $250,000 valuation, or rather, the possible future evaluation), Bob incorporates the company (by paying taxes and the lawyer), designs his company brand, buys the first materials to start the business (lemons, water, sugar, and Grandma’s secret ingredient), and spends a couple of funds on advertising.

FRIENDS, FAMILY, AND FOOLS ROUND
Usually, during the 3Fs-round, the valuation of the company is very low because of the high risks, and it can range from $50,000 to $500,000.
Are the investors in the 3Fs-round a good deal? No, most of the time they bring only money and no experience, and they take a big chunk of your equity.

What is Bob’s business value right now? Between $1 and $50,000. If Bob decides to sell the business after a month because he wants to switch carriers or because it is losing money, he will get between $1 and $50,000, depending on how much risk the investor is willing to take, because he hasn’t made any profits and owns a company that isn’t making money yet.

And let’s assume Bob managed to get a patent for his homemade lemonade; this will increase the value of the company since nobody except his company can manufacture that specific lemonade.
After the second month, Bob started making money, and his marketing campaign turned out to be good. He managed to make $50,000 in sales with $30,000 in operation expenses, bringing the real valuation of the company to $20,000 + multipliers, but it is too early to talk about this because Bob is not done. He is confident in his business, so Bob decided to put the $20,000 he made back into the company.
After the sixth month, Bob’s business is doing well, with $200,000 in sales (in the first 6 months) and $125,000 in operation expenses, bringing the real valuation of the company to $75,000 + multipliers.
After one year, Bob has $500,000 in sales and $300,000 in operation expenses (salary, utility, inventory, marketing, etc.); bringing the company valuation to $200,000 + multipliers.

Risk management in the early stages

Before spending funds on advertising, it is very important to build a marketing plan based on the financials of the company. No rush; just because you are spending money today does not mean that you will make it back tomorrow.
Door-to-door and word-of-mouth advertising are the best and cheapest forms of advertising because you are selling your product directly to the consumer.

The valuation of the company at the moment is $200,000 (EBIT = Earnings Before Interest and Taxes) because this is the amount of money earned from the business (if there are liabilities or debt, the amount must be subtracted from the valuation of the company), but now we have to take into consideration the multipliers (the number of years with the expected revenue that must be backed by the numbers, the business size, the brand, and the market trends; usually between 2x and 6x) based on the risk of the business. The smaller the business, the higher the risks involved; usually, for businesses with revenue smaller than $1 million, the multiplier is between 2 and 3 (in years).

Let’s say, for the sake of the example, that Bob’s revenue was linear over the first 3 years in the business.
Year 1: $200,000;
Year 2: $200,000;
Year 3: $200,000;
Total: $600,000

And Bob expects to earn the same amount in the next three years (the multiplier is 3).
Year 4: $200,000;
Year 5: $200,000;
Year 6: $200,000;
Total: $600,000

For a total of $1.2 million, this is the valuation of the business.

Let’s pretend Mark Cuban (this is just a hypothetical example) is interested in buying Bob’s Company.

How much should he pay? $1.2 million, but usually investors are looking for discounts (from 10–30%) because $1 today is worth more than $1 tomorrow. With a discount, the investor recovers the investment before the end of the sixth year. Here, it is up to Bob to sell the company for the best price possible; however, Bob is confident in his abilities and the company, so he declined Mr. Cuban’s offer.

What would I advise Bob to do?

First of all, I would value the company at least $1.5 million, depending on the value of the goods owned by the company.
Second, I would advise him not to sell the company.
It is better to sell 10% of the company for a $120,000 investment (at a $1.2 million valuation) to an investor (in an angel or seed round; typically in these rounds the valuation of the company is between $500,000 and $2,000,000) to help Bob improve the business model and the advertising strategy to reduce his operational expenses and increase his margins.

Assume Bob’s new business partner is Chef Wonderful (this is just a hypothetical example), and he manages to increase his revenue by 50% every year (revenue typically grows by 5% to 30% per year).
Year 4: $300,000;
Year 5: $450,000;
Year 6: $675,000;
Total: $1,425,000

After 6 years, Bob’s revenue is equal to $600,000 (first 3 years) + $1,425,000 = $2,205,000 (this may appear exaggerated for a lemonade business, but for a startup, it is not).
He now expects to earn 50% more each year, as he has in the previous three.
Year 7: $1,012,500;
Year 8: $1,187,500;
Year 9: $2,278,125;
Total: $4,478,125

REVENUE VS PROFIT
The revenue is the income generated, including the expenses. Profits refer to the net income earned after accounting for taxes, employee salaries, investor returns, and personal compensation.

What is Bob’s business value after six years in business?

$2,205,000 + $4,478,125 = $6,683,125

Bob is tired now and wants to exit the business. He is selling the company to Lori Greiner for $7 million (this is just a hypothetical example) because he still owns the patent and inventory for the next year and because the size and brand of the company have increased. Now Lori is going to make a billion dollars out of it! Classic.

Bob’s exit profits = 7,000,000 * 70% = $4,900,000
3F-round exit profits = 7,000,000 * 20% = $1,400,000 (28x on their investment after 6 years)
Mr. Wonderful exit profits = 7,000,000 * 10% = $700,000 (5.8x on his investment after 3 years)

I guess Bob’s granny is proud of him.

Other variables

The Friends and Family round could be structured as a convertible note (which converts to equity at a later stage to delay the company’s valuation) or a SAFE (Simple Agreement for Future Equity) which is a convertible security that has no payment requirement, no maturity date, and no interest rate.
Pre-money valuation. EX: $100,000 investment for 10% at a $1 million valuation keeping the valuation at $1,000,000 after the investor has made the investment.
Post-money valuation. EX: $100,000 investment for 9.09% at a $1 million valuation brings the valuation to $1,100,000 after the investor has made the investment.
Vesting. Both for the founders, in order to ensure that they will continue to work after the funds are raised (between 2 and 4 years), and for the investors.
A business idea is not a business. Before making up valuations, think of the expenses and your margins. Do you have a prototype or beta test? How are you and your investors going to be profitable?

Once you have the answers to these questions, the product, and the business model, you can get closer to a realistic valuation of your business.

WEb3 project valuation

Can we apply the same valuation model to Web3 startups? Yes, we can.
Even though valuations in the Web3 space are frequently exaggerated, we can apply the same valuation model to blockchain-based startups.
Whether they are selling equity shares or tokens during the sale rounds, the team evaluates their project at a “future evaluation”, which is why investors sign SAFE and/or SAFT agreements.

SAFE & SAFT
Simple Agreement for Future Equity is a founder-friendly alternative to convertible notes, which are used by founders to raise capital in early rounds).

Is there a formula to calculate your future valuation without revenue? No, there is no such thing. This type of valuation is based on two factors:

Proof of concept: You can get a similar valuation from others who have run a similar business. But that doesn’t make for a fair assessment.
Non-rational valuation: If the business model is unique, the founders value their company based on the price they are willing to sell it for. But no one would buy a business that does not make money.

So, what should you do? Compromises have to be made with investors or VCs who will buy tokens or equity based on their valuation of the business.
However, before assigning an arbitrary valuation to potential investors, it is advisable to consult with industry experts such as Web3 lawyers, financial advisors, product managers, or DevOps professionals. Don’t be greedy; be smart.

Mark ~ Dec 1, 2022