What’s the fundamental trade?
My 2 cents on how to think critically about ideas in crypto
Something I always like to think about when investigating a project, team or even an idea is asking, “what is the fundamental trade being made here?”
Essentially what this means is that you need to zoom out through each layer of the idea and ask “why” until you reach a point where you’re reasoning about a set of entities and why their motivations will allow this idea to work. Most times out of 10, people forget to see the fundamental trade and get caught up in the elusive trade — the trade you want to see, not the actual trade.
A classic example of using this kind of thinking is when looking at an APY or yield being offered. There’s a ton of startups being funded right now for making “DeFi easy to use” by offering “high crypto yields” to normal people. Great idea right?
No, it’s actually a pretty terrible idea most times haha. Why? Well let’s use our fundamental trade framework here.
First question, where is the yield coming from? It’ll typically be one of two places:
The project is burning away giga amounts of free money
Where are they getting this free money? Their investors?
Why do their investors think giving away this much free money is a good idea?
Because they think that it’ll attract people
What if the people are only attracted for the yield and don’t have any reasons to stick around? Oops, the trade will eventually be invalidated. RIP.
There’s a counterparty who is willing to pay a large interest rate
Why would they pay this? Because they’re probably earning more money elsewhere.
Okay so what happens when they stop earning their lucrative trade? Traverse back up the logic tree, there is no counterparty willing to pay a large interest rate anymore. RIP.
Alternatively, when there’s a high interest rate being offered and the perceived risk goes down, everyone piles in compressing yields. Too much supply-side ruined the trade. RIP.
As you can see through the above statements, if you dig into an idea enough and keep asking questions you can see if the fundamental trade makes sense or not.
The majority of ideas in crypto do not hold up against this framework and have a limited life before they come crashing down. To make money in crypto you can ignore the fundamental trade and enter/exit quickly but if you want to make serious wealth, you need to be able to understand fundamental trades and bet appropriately.
Most can’t though, they’re just monkeys throwing darts.
Think critically, bet big.