In the 1930s, investment portfolios were allocated based on the perceived “goodness” of a company and the price in relation to that.
Robert F. Wiese is credited with inventing intrinsic value in “Investing for True Values” (1930).
The proper price of any security, whether a stock or bond, is the sum of all future income payments discounted at the current rate of interest in order to arrive at the present value.
Only one significant refinement was made by John Burr Williams in his 1938 book “The Theory of Investment Value”.
Earnings are only a means to an end, and the means should not be mistaken for the end. Therefore we must say that a stock derives its value from its dividends, not its earnings. In short, a stock is worth only what you can get out of it.
For a while, this was the leading theory of stock valuation, and still is an extremely practical approach for public market value investing.
In 1952, a 24 year old PhD student by the name of Harry Markowitz noticed a significant omission from prior work. In “Portfolio Selection”, he proposed for risk or volatility to be considered in addition to returns.
We first consider the rule that the investor does (or should) maximize discounted expected, or anticipated, returns. This rule is rejected both as a hypothesis to explain, and as a maximum to guide investment behavior. We next consider the rule that the investor does (or should) consider expected return a desirable thing and variance of return an undesirable thing.
It took years for Harry Markowitz's theories to be embraced by the stock market, but a more radical innovation was happening in parallel.
In 1957, Arthur Rock made the first Venture investment in Fairchild Semi-conductor, a company founded by the “traitorous eight”. These were a group of ex Shockley semi-conductor employees with 6 PhDs among them.
Beyond pioneering the venture deal structure, Arthur Rock had applied a radical way of estimating intrinsic value. With no cash, customers or even product, and thousands of decisions yet to be made, Arthur valued this new company based on the people.
To this day, more than 60 years later, very little research has been able to conclusively capture a predictive link between measurable qualities of management and the future value of companies. Venture capital remains a professional art form that few can master.
The protocol world has introduced an even more difficult valuation challenge. Successful investors have to balance venture capital-like considerations of team together with protocol value capturing power.
In this world, where value is captured through effective protocols, written in quality code, I want to emphasize internal tools as a valuable proxy for identifying promising protocol teams.
The Wall Street Journal recently argued that the secret to the success of major technology companies is how much they invest in their own technology.
Not the “product”, but the “technology that builds the product”.
In fact, under this interpretation, a modern software company is no different than a factory, with semi-automated pipelines that produce outcomes. The only difference is that these pipelines are written in code.
The best protocol teams have embraced this model:
- 0x have dedicated an entire package to showcasing their developer tools
- FOAM have openly talked about their developer stack
Teams that are able to consistently produce valuable tools for internal efficiency above and beyond what already exists in the ecosystem, just in the course of shipping their core products implicitly show the following qualities:
- Thought leadership
- Community influence
- Higher quality and security (through open source vetting)
Moreover, I would argue the tools and the process surrounding the tools add significant defensibility, allowing the teams to be more effective at developing new protocols or amendments.
There is a reason I regularly return to 0x and FOAM and it is that they are operating in a radically different way.
You can't see this by just looking at the economics.
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