Warren Buffett and IDO platforms
Whether you have your doubts or its charm fully enchants you, we can all agree the Blockchain sphere is an exciting place to be and to observe. After only 12 years since its inception as an alternative mean of payment, this technology is still in its infancy, spurring innovative solutions in several economic sectors worldwide, making ever more often headlines and attracting substantial attention from investment institutions, governments and regulators.
It is essentially the ‘far west’ of our times, and together with its complexities and the excitement of discovery, independence, and the gold rush that comes with it, like then, the industry has been plagued, at least for its financial component, by improvised entrepreneurs, bandits, and greed, a lot of greed.
We have observed this with the syphoning of funds from Mt.Gox, the Silk Road, the ICO rush in 2017, countless pump&dump schemes, and most recently, the explosion of dubious, gold-plated, food-related liquidity pools.
In short, what once was born out of sane and fair principles, and which brought many benefits and potential forward, often gets a bad rap and is still highly speculative, full of uncertainties, and difficult to read for investors who would like to dedicate some funds to it.
It is no secret that Warren Buffett would purposedly stay away from new technologies and what he does not fully understand. From his perspective, this is simple: what is new is not proven and therefore yields very high risk. Thus, it can potentially be very profitable but goes against the tenet of capital preservation.
So, why would he even consider allocating part of Berkshire Hathaway’s funds to IDOs? Firstly, let’s briefly review his investment approach.
THE WARREN BUFFETT WAY
Warren Buffett’s strength in selecting value investments resides in his immense experience and adhering to a set of valuation criteria. Namely:
Pivoting around what the business does, Warren gives a lot of importance to 3 key aspects:
- Are the business simple and its economic model comprehensible?
- Does it have a coherent and successful operational history?
- Are long-term projections favourable and sustainable (USP, competition, niche)?
Often overlooked, especially by speculators and technical traders, Warren knows that a business is as good as its leaders. And so, he asks himself:
- Is the management acting rationally? [Does it invest its excess liquidity in value-generating operations, does it return it to investors, or does it diworsify?];
- Is the management transparent in reporting its successes and failures?
- Does the management resist the institutional imperative?
Past common sense, Warren then looks at the numbers. Without analysing the merits of the indicators he chooses, the commonality is to select only companies that produce constant, elevated economic value for their investors.
- Above-average ROE over the past 5–10 years, not EPS/P-E;
- Debt-to-Equity ratio;
- Are discounted profit margins growing? Is management able to lower operating costs?
- Market value (t) > [ Market value (t-10 years) + retained earnings ]?
All else pointing in the right direction, he then chooses when to acquire the company:
- Owner’s earning [intrinsic value of the company, ed.];
- Can it be bought at a significant discount?
In a nutshell, he selects simple, proven, profitable, healthy companies, run by competent and transparent management, which are currently undervalued.
On top of most of Buffett’s criteria, Peter Lynch, far more relaxed and sarcastic, touches of a couple of points, amongst many others, that are worth underlining:
- Identify investment opportunities possibly before other analysts start talking about them;
- Look for small companies that have already proven their concept works and can be replicated;
- Investigate, investigate, investigate. Invest at least as much time and effort in choosing a new stock as you would in choosing a new refrigerator.
IDO PLATFORMS aka. LAUNCHPADS
Whereas in traditional finance, companies that wish to raise capital through an IPO rely on investment banks and other agencies, the same can be found in the crypto world. Unlike for IPOs, however, IDO platforms allow the little guy to participate, in a democratic way, in the early rounds of financing a protocol.
In their very essence, they operate similarly to investment banks: they assess projects through due diligence, prepare a prospectus and raise funds before the project is listed on a public exchange.
Unlike previous iterations (ICOs, IEOs, etc..), however, IDO launchpads pursuing long-term success have begun implementing a series of features to reduce uncertainty around the investments they propose:
- Proposed projects are vetted against an array of strict selection criteria that skim away all those projects that are either dubious or still need a lot of work before they can be presented to the public;
- Through several mechanisms (staking 2.0, KYC, bot-detection, gradual vesting periods, sensible private-to-public allocation ratio, social mining, democratized allocation, etc..), the risk of pump&dump schemes and action is greatly reduced, and hodling and advocacy are encouraged;
- For those in need, a series of incubation services are available so that the core team can focus on the code while the IDO platform takes care of the rest.
Though we are not comparing apples to apples here, several strong commonalities can be noticed between selecting a business to invest in as a value investor and the path that some of the best launchpads have chosen to follow to protect their stakeholders and provide the most value.
During the vetting process, besides some fundamentals, first and foremost, great importance is given to understanding the business idea, i.e. the use case, of the project. What problem is it trying to solve? Does it have a good product/market fit? Is it innovative or a copycat of existing solutions?
Like Buffett’s framework, the business needs to be understood inside out. How does it generate value for itself and its token holders? What is its economic model? Has it been coherent in its development? Does it have a competitive advantage and opportunity against incumbents and newcomers?
Together with the above, what about the presence (or absence) and results of code audits by trusted certification agencies? And if they were conducted, have the suggestions be implemented? Also, is the project supported by renowned VCs and other credible partners?
Lastly, is there a clear, set, realistic roadmap?
While some of Buffett’s questions cannot be applied directly to startups like new blockchain projects, the same wisdom can still be there, all bound to understanding whether the people running the project are competent and have the project’s and stakeholders’ interest in mind or not.
Like Buffett observes whether the management is transparent in its reporting of success and failures, can we observe transparent and professional behaviour from the project’s core team? Is the leadership out there promoting and discussing their project? Do they have a face, a name and a verifiable, reputable history and experience? Is this current venture a recurring theme in their advocacy? Does the business have physical offices and a street address? While these are not strict requirements to some people, and for others, code is the law and nothing else matters, an active, declared leadership with their street cred on the table is much less likely to run away or abandon the project rug pull-style.
The longevity of the project may also play a part in the evaluation. But more importantly, is the core team behaving rationally? Is it focused on the core idea, or has it drifted and diversified towards unnecessary and unproductive areas?
With most blockchain projects being fresh operations, it is very hard, if not impossible, to look at them using financial indicators. However, IDO platforms consider a few gauges to give us an idea of the risk we can expect.
Specifically, they may look at whether the token’s existence is justified and how the tokenomics are set:
- Capped vs unlimited tokens supply and its monetary policy
- Is the token’s private-to-public allocation ratio fair and sensible, or does it promote token centralization?
- Are lockups and gradual vesting period present for both the founders, core team, early investors, and IDO participants?
- Can the token release schedule protect against pump&dump action?
Luckily for us, with an IDO, we purchase at a discounted price. However, it is still important to understand how the project valuation was calculated.
Moreover, if in TradFi we define stock price as the collective valuation of a business, understanding what the market thinks about a blockchain project in the making requires having one’s ear to the ground. So, is the community of early investors and analysts excited about the project? Is anybody raising any major red flag?
Whether an investor’s objective is to recover and gain from the investment in the shortest amount of time while protecting the invested capital, or whether he/she has a long-term perspective on a specific project, with their approach, launchpads contribute toward creating a safer investment option that aims at proposing only quality projects that have the intention and potential to succeed in the long term, while trying to induce dump friction and avoid pump&dump action.
We will never know whether Warren Buffett would invest in or through IDO platforms until he does. Still, we are sure he would appreciate the effort of reducing uncertainty through a structured approach and measures that selects only sound companies.
Here at ValueUnbanking, we have a lot of faith in the work that some of the best launchpads are doing. We place a lot of trust in their teams upholding the brand reputation, and so, proposing us only the most promising protocols. But we also believe that more can be done, and in the end, however, always do your own research, and before allocating any of your funds, ask yourself: “Would I buy the whole business?”
In the next article, “Assessing blockchain projects for investment: selection best practices and what is missing”, we will look in detail at the selection criteria that launchpads and CeX/DeX use for listing projects on their platforms, as well as consider what can be improved and what should be added to create a safer investment product.