This episode reveals crypto's stark valuation problem, arguing that the market is shifting from speculative narratives to a brutal focus on real-world user adoption and sustainable revenue.
The Crypto Valuation Crisis
- The conversation opens with a critical assessment of the crypto market, where Bitcoin stands apart while most other assets are underperforming. Santiago argues that from a fundamental analysis standpoint, the valuations of most crypto projects are unjustifiable. He points out that despite a flood of positive headlines, including major financial institutions like JPMorgan launching tokens on public blockchains, prices for assets like Ethereum and Solana are stagnant or falling.
- This suggests the market had already "priced in" the optimistic narratives, leaving no room for further upside.
- Santiago frames the current crypto ecosystem as a classic Silicon Valley trope: "You just cannot justify the valuation of most projects in the space. And it's a classic Silicon Valley meme of like never show revenue, always sell the dream."
- The core issue is that while the dream of future adoption is compelling, the current economic activity does not support multi-hundred-billion-dollar valuations for most networks.
AI vs. Crypto: The Battle for Capital and Attention
- A central theme is the shift in investor focus from crypto to AI. Santiago asserts that AI has replaced crypto as the "main character" in the technology narrative, making it a more attractive destination for both momentum and fundamental investors.
- He draws a sharp contrast between the valuation metrics of leading assets in both sectors. While a company like Nvidia trades at a 30-40x price-to-earnings ratio, Ethereum trades at a staggering 200x price-to-sales ratio.
- Price-to-Earnings (P/E) Ratio: A valuation metric that compares a company's stock price to its earnings per share. A lower P/E can indicate a more reasonably priced investment.
- Price-to-Sales (P/S) Ratio: A valuation metric that compares a company's stock price to its revenue. It's often used for companies that are not yet profitable.
- Strategic Implication: For investors, this signals a critical need to re-evaluate crypto assets against opportunities in AI. The high-risk, speculative nature of crypto is now competing with an AI sector that, while hyped, often has more tangible revenue and earnings to justify its valuations.
A New Paradigm for Crypto Trading?
- The discussion explores whether the market is entering a new phase where shorting overvalued tokens becomes a viable strategy. Historically, shorting crypto has been notoriously difficult due to persistent speculative belief and the fact that "tokens don't file for bankruptcy."
- Jonah recounts advice from his former boss, Don Wilson of DRW, that token valuations can be sustained indefinitely because they don't face traditional bankruptcy pressures.
- However, the current sentiment, even among crypto natives on "Crypto Twitter" (CT), is shifting. As insiders and long-term holders begin to lose faith in "the dream," the social consensus that propped up these valuations is eroding.
- Actionable Insight: This potential paradigm shift suggests that investors and researchers should consider fundamental weakness as a basis for short positions, a strategy that was previously considered too risky in crypto's perennially optimistic market.
The L1 Dilemma: Ethereum's Fading Value Capture
- The conversation zeroes in on the structural weaknesses of Layer 1 (L1) blockchains like Ethereum and Solana. Santiago argues that Ethereum's valuation is particularly precarious because its revenue model is being systematically undermined.
- L1 (Layer 1): The base-level blockchain, like Ethereum or Bitcoin, which provides the fundamental security and consensus for the network.
- L2 (Layer 2): A secondary protocol built on top of an L1 to improve scalability and reduce transaction costs. Examples include Base and Arbitrum.
- The rise of L2s means that a growing portion of transaction fees (the primary revenue for a blockchain) is captured by these secondary layers, not by the main Ethereum network.
- Santiago uses an analogy: "It's like Ethereum acts like a federal government, wants a valuation as a federal government, but only collects state or city tax because most of the tax is being collected by L2s."
- This dynamic makes it nearly impossible for Ethereum's L1 revenue to grow enough to justify its $400 billion valuation, especially since blockspace is becoming a commodity rather than a scarce resource.
The Path to Real On-Chain Users
- The speakers agree that the single most important metric for the future of crypto is the growth of active on-chain users engaged in non-speculative activities. The current user base is small and churns frequently as traders get liquidated in the "casino."
- Referencing a report from a16z, Santiago highlights that the number of active users has failed to grow significantly, which is the "elephant in the room" for the industry.
- He compares crypto's 40 million users supporting a $1.5 trillion valuation (excluding Bitcoin) to OpenAI's 800,000 users, which is projected to IPO at a trillion-dollar valuation. The discrepancy in per-user value highlights crypto's reliance on speculation over utility.
- Strategic Implication: Investors must shift their focus from protocol throughput and technical features to projects that demonstrate a clear strategy for acquiring and retaining real, non-speculative users. This is the only sustainable path to long-term value.
Bitcoin as a Separate Asset Class
- A clear distinction is made between Bitcoin and the rest of the crypto market. While altcoins are framed as high-risk tech stocks competing with AI, Bitcoin is positioned as a unique macro asset, akin to digital gold.
- Santiago expresses confidence that Bitcoin can hold its value or experience less severe drawdowns even if the broader altcoin market collapses by 80%.
- Its thesis as a hedge against currency debasement and a store of value remains intact, supported by growing institutional adoption through ETFs.
- This cycle has already shown Bitcoin's relative strength and lower volatility compared to other crypto assets, suggesting it has "graduated" to a different asset class.
Inversion's Strategy: Acquiring Users Through Real-World Businesses
- Santiago outlines his fund's unique strategy: instead of building new crypto applications and hoping users will come, they acquire traditional, cash-flow-positive businesses and integrate blockchain technology to improve their efficiency.
- He uses the example of a remittance operator like Western Union, which trades at a low 4x P/E ratio. By integrating stablecoins, they could drastically cut costs related to sourcing local currency liquidity, making the business far more profitable.
- This approach solves crypto's biggest challenge: go-to-market and user acquisition. By buying businesses with existing user bases, they can bring millions of real, non-speculative users on-chain without having to change consumer behavior.
- The economic activity from these acquired businesses will settle on their proprietary chain, creating a durable and predictable stream of fees, unlike the cyclical revenue from speculative trading.
The Shift from Infrastructure to Applications
- The conversation concludes by drawing a parallel to the dot-com bubble of the early 2000s. The investment paradigm is shifting from the infrastructure layer to the application layer.
- In the 2000s, infrastructure companies like Cisco were market leaders but ultimately saw their valuations collapse. The real, long-term value was captured by application-layer companies like Google and Amazon, which used the new infrastructure to build indispensable services.
- Similarly, the last decade in crypto saw massive investment in L1s and other infrastructure. The next decade, Santiago argues, will be about the "killer apps" built on top.
- Actionable Insight: Investors should be wary of over-investing in new L1s or infrastructure plays (the "Ciscos" of crypto). The primary opportunity now lies in identifying and backing applications that can attract a mass user base and generate sustainable revenue.
Institutional Adoption and the Value Capture Fallacy
- The final segment debunks the simplistic narrative that institutional adoption will automatically drive up token prices. While banks like JPMorgan are experimenting with blockchain, their activities don't necessarily translate to direct buying pressure or value accrual for native tokens like ETH.
- JPMorgan launching a deposit token on Base, an L2, benefits Coinbase (Base's creator) but does little for Ethereum's direct revenue.
- The speakers warn against confusing a great service with a good investment. Just because institutions find blockchain useful for back-office settlement doesn't mean they will buy and hold the network's token at a 200x P/S multiple.
- The value will likely accrue to the institutions that deploy the technology to cut costs and the application builders who control the user relationship, not necessarily the underlying infrastructure token.
Conclusion
This episode argues that crypto is facing a valuation reckoning, forcing a pivot from speculative hype to fundamental utility. Investors and researchers must now prioritize projects with demonstrable user acquisition strategies and sustainable revenue models, as the era of valuing infrastructure on pure narrative is decisively ending.
