Dialogue Head First Class Zheng Siwei: How to build the capability of investment research and value discovery?

Recently, the 19th session of the Catcher Academy, hosted by Chain Catcher, invited Zheng Siwei, the Director of Research at First Class Warehouse, to share insights on "How to Conduct Investment Research for Value Discovery."

First Class Warehouse is a blockchain research institution centered around value investing, dedicated to uncovering quality projects and investment opportunities for users.

During the sharing session, Zheng Siwei provided community users with reference indicators for project evaluation, channels for discovering potential projects, common characteristics, and investment research themes for 2021. The following is a comprehensive summary of the valuable insights shared, hoping to inspire readers.

Chain Catcher: DeFi is the biggest hotspot this year. It is said that you have made a considerable profit in the DeFi field. When did you start laying the groundwork? Which projects achieved significant returns? What indicators do you refer to when evaluating projects in the early stages?

Zheng Siwei: We started building positions in June 2019, with most project positions established between June and September, including DeFi projects.

Our logic for building positions at that time was that we believed the market was already in the mid to late stages of a bear market, with many projects having fallen to historical lows since 2018, trading volumes were very low, and the community and market were quite quiet. We thought it was a good price and timing, so we began to build positions and wait for a bull market.

During last year's DeFi frenzy, I think most early participants made money, so I can't say we made a lot; overall, it was okay. Some projects made considerable profits, while we also missed out on many. Let me give an example of each.

One project that made a lot of money was AAVE, which was still called ETHLend at that time. They adopted an order book-based lending matching model. Their team was actually quite good and was one of the earliest explorers in DeFi (though it wasn't called DeFi back then, the concept had already formed).

However, they initially did not realize a problem: under the overall low participation and liquidity in DeFi, the efficiency of order book-based lending (which can also extend to trading, insurance, etc.) was very low.

At the same time, Compound, which used a liquidity pool model, had a business volume that was several levels ahead of ETHLend. In this context, our recognition of ETHLend was relatively low because, during our project evaluation, the business data on product usage after launch was a very important indicator. For lending projects, the scale of lending is the most intuitive indicator of business performance.

Later, ETHLend (AAVE) made a comeback because they recognized the issues with the order book model and adjusted to a liquidity pool model. Additionally, their improvements in currency selection and mechanism design were bolder compared to Compound, leading to significant overall business volume growth.

We bought in at the time when ETHLend (AAVE) decided to change to the liquidity pool model, believing it was a wise choice that could potentially lead to a comeback, and the price at that time was extremely low. This decision was later validated and recognized by the market, marking it as one of our more successful investments.

At the same time, we must admit that we also missed many good DeFi projects, such as 0x.

In this era of DEX, while liquidity pools are the best paradigm, we believe that with the maturation of infrastructure, order books will definitely become the mainstream paradigm for DEX in the future.

When we evaluated this project in 2019, we believed that 0x's fundamentals were consistently good and that it was iterating quietly. However, we felt that its token ZRX lacked a design for capturing value. In other words, at that time, 0x's business growth had little to do with its token, so we did not invest.

ZRX indeed performed well last year, and later some governance designs were introduced. This is a lesson; we previously thought that the ability to capture token value was a necessary condition for investing in a project. However, in the current market, this is not the case, and value capture is no longer a necessary condition. When investing, one must respect the market and not stick to one's own beliefs.

In addition to looking at business and token value capture ability, we also have different indicators or focuses when facing different projects and tracks. The important thing is to continuously adjust our focus based on the market, just like the insights gained from ZRX.

Chain Catcher: DeFi is widely regarded as a major trend for next year. What specific sub-tracks are you currently focusing on? Which leading projects do you think exist in these corresponding tracks?

Zheng Siwei: In the long run, the DeFi track will become more numerous and broader, with increasing maturity and complexity of projects within the track. From an investment perspective, we tend to focus on some emerging tracks and some infrastructure-related tracks related to DeFi, as their expected investment returns may be higher.

To determine which will be emerging tracks, in addition to constantly monitoring new projects, one also needs to exercise a certain degree of foresight. The development history of traditional finance is a good reference. Generally, it starts with assets, followed by trading, lending, and then derivatives, asset management, and other higher-level products.

In the DeFi world, lending initially had floating interest rates, and recently there has been a shift to fixed interest rates. Trading has also evolved from spot trading to the recent explosion of futures and options trading.

Asset management can be divided into active and passive. We will follow the historical development of the DeFi industry to focus on currently emerging and potentially popular sub-tracks, such as index-based passive asset management (e.g., PieDAO, Set, and Index in collaboration with Defipulse), futures and options (e.g., Perpetual Protocol, DerivaDEX, etc.).

Another track that is not in the DeFi field but is closely related to DeFi is Ethereum's Layer 2. Many leading DeFi projects have already begun researching and making choices.

The choices of leading DeFi projects can largely determine the landscape of Layer 2 projects, and selecting the right Layer 2 DeFi projects can also gain a greater competitive advantage in return.

For these projects, we will research their fundamentals. Simply looking at the design plans is not enough; technology is not the only influencing factor in this industry, but it is one of the main factors. Many times, in areas with significant network effects, first-mover advantage and social choice are the other half of success. These need to be continuously observed to determine which are the truly leading projects.

For example, if the current leading oracle had entered the market two years later, it might not have been the leader.

Chain Catcher: Recently, Bitcoin's price surged. Is it still suitable for ordinary investors to enter the market and buy Bitcoin? What are the main issues and risks they face?

Zheng Siwei: If the ordinary investors here refer to those outside the circle, there is a saying that has always held true: the best time to buy Bitcoin was ten years ago, and the second best time is now.

Of course, there is a major premise: ordinary investors should have a sum of idle money that they do not need for the long term. I believe that if they buy and simply hodl (hold), measuring over three to five years, even if they enter at a high point now, they can outperform most other asset classes. However, in the short term, I am not so sure; the recent Bitcoin charts do not look very good. I am not good at short-term market judgments, so I won’t give any investment advice.

Regarding risks and issues, Bitcoin itself does not have significant problems or risks; more lies with the investors. After buying, if the price rises, can they hold on? If it drops, will they panic and sell? If this year is a bull market, entering now can still yield substantial profits, but can they be sure to exit at a high point? Or will it be a roller coaster ride, leading to losses?

Investing is inherently a challenging endeavor. In such a volatile market, investors without experience in financial markets may find their weaknesses exacerbated by market fluctuations. Poor emotions and an incomplete investment system can easily lead to irrational choices, which I believe is the biggest risk in trading Bitcoin.

To advise on this risk, I think one should either prepare a comprehensive strategy (a collection of multiple if..then.. decisions) before entering the market, or simply hold, or not enter at all.

Chain Catcher: Some say that dollar-cost averaging into mainstream coins is the most advantageous investment method for ordinary investors. What are the advantages and disadvantages of dollar-cost averaging? How should one choose and grasp the timing?

Zheng Siwei: I believe that for those with limited energy who do not deeply understand blockchain, investing in mainstream coins is the most cost-effective choice. Among the various investment methods for mainstream coins, dollar-cost averaging may be the most cost-effective method.

The advantage of dollar-cost averaging is that it does not require too much time and energy for trading decisions, and it limits investors' operations, significantly reducing the emotional impact and turmoil they experience, which does not affect their main job and life. In terms of results, the probability of large gains and losses is reduced, but the overall expected value will not be low.

Of course, there are also very outside investors who have made excellent operations. For example, I heard that on March 12, Huawei employees made large purchases at the bottom. If the strategy is to buy the dip, in the past two years, any price below $6,000 has been a good buying point, buying heavily during significant drops. Now, Bitcoin's price has generally risen to a new level, making it unlikely to use the past two years' prices as a reference for buying the dip.

So for most ordinary investors, I think dollar-cost averaging is a very good investment method.

Chain Catcher: Ethereum recently reached a new high, and many people say this is due to Ethereum 2.0 stimulating the growth of ETH. More people will focus on Ethereum 2.0 and the opportunities it brings. How do you view the future value and investment opportunities of Ethereum?

Zheng Siwei: ETH 2.0 has set a long-term roadmap for Ethereum, but explaining this recent surge in Ethereum's price solely by ETH 2.0 may not be appropriate. This is because Ethereum's fundamentals have always been strong, coupled with a general market uptrend, making new highs highly probable.

ETH 2.0 will bring significant changes to Ethereum at the foundational level, which is very important for this field. However, if the perspective is investment opportunities, I think the full implementation of 2.0 is still quite far off. It might be better to look at Layer 2 first, as Vitalik has also mentioned that Layer 2 (especially rollups) will be one of the main lines for Ethereum moving forward.

Returning to the topic of Ethereum's value, from a longer-term perspective, many people criticize its scalability. I am personally quite optimistic about this. After reading some histories of computer and internet development, I found that most performance-related issues eventually turn out not to be issues.

If I were to be more rigorous, I think Ethereum has about three possible outcomes regarding scalability:

1. Very optimistic: Layer 2 + ETH 2.0 + other solutions effectively solve the scalability issue, allowing Ethereum to maintain its position in the ecosystem.

2. Moderately optimistic: Layer 2 and other solutions can only improve some performance but still cannot solve scalability issues under large-scale usage. Ethereum's on-chain resources may become quite expensive, suitable for users who are not sensitive to transaction fees or have a strong need for consensus on the ledger, while other users may turn to other chains.

3. Pessimistic: The solutions fail, and Ethereum can never scale, leading developers, liquidity, and users to be attracted to other chains.

I personally believe that the probabilities of outcomes 1 and 2 are higher.

Chain Catcher: More and more Polkadot ecosystem projects are emerging in the market. Which sectors do you mainly favor? There is a consensus in the Polkadot community that if a project's valuation exceeds $40 million, one should be cautious about investing. Does First Class Warehouse have more specific evaluation criteria?

Zheng Siwei: Polkadot is very hot. At this year's Shanghai Blockchain Week, Polkadot and DeFi were the two main themes. We started looking at Polkadot relatively late because we hadn't finished evaluating everything on Ethereum. After the new year, we will spend some time focusing on researching Polkadot and its ecosystem.

The $40 million consensus is quite interesting. I personally haven't been deeply involved in the Polkadot community, so I don't quite understand the origin of this consensus. But I wonder if it is because the Polkadot slots have not yet begun to be auctioned, and ecosystem projects only have plans without implementation (some haven't even launched their chains), making it unsuitable to assign a high valuation to projects that are still in their early stages.

Additionally, we have a relatively conservative view on projects within the Polkadot ecosystem. A successful project not only needs a good plan but also requires effective operational implementation.

Currently, many projects and teams are starting to "position" themselves in Polkadot, aiming to create Polkadot versions of MakerDAO, Uniswap, Synthetix, etc. From the white papers, many projects' plans do not have major flaws, and the logic is self-consistent, but this is merely a necessary condition for success, not a sufficient one.

Projects that can gain significant liquidity and users in the early stages and continue to iterate rapidly in the later stages have a greater chance of dominating a certain track in Polkadot.

Given that Polkadot has not yet truly landed, the latter part of this judgment criterion is missing, so we remain cautious when evaluating Polkadot projects and need more time to observe.

Chain Catcher: How do you discover potential projects and reach out to their founding teams? What common characteristics do potential projects share?

Zheng Siwei: Our method of discovering projects is very simple, somewhat like a draft selection. We first gather several main project aggregation sources, such as CMC, and then scan through these projects. With over 2,000 projects, it is quite easy to eliminate those that are not worth paying attention to.

They all share some common traits: lack of detailed technical/business documentation, an exaggerated demeanor, a strong marketing nature permeating from inside out, and Twitter/GitHub accounts that remain inactive for long periods, etc.

For the remaining two to three hundred projects, we have our main team conduct in-depth research on each one. Quality potential projects also have some common characteristics: first, the track must have prospects and be implementable. If the track is not right, no matter how good the other aspects of the project are, it is not worth it.

A simple criterion for determining whether a track is good is: if this thing can be done well without blockchain, then it is not a good track. Using this standard alone can filter out many "blockchain+" projects that emerged in previous years.

Secondly, the team must have good character (at least no black history), have ideas, and having funds is a realistic point. Currently, the industry is still in its early stages, and quality projects need to continuously experiment, iterate, and compete; without funding, it is very difficult to survive.

Having funds does not mean needing to raise tens of millions of dollars, but the expenses for two years should be sustainable. If they perform well, they may even be able to raise funds again after two years. Then there are the usual fundamentals that everyone talks about, such as business design, technical solutions, etc.

As for how to reach out to teams, many of the projects we invest in do not have direct contact with the founding teams. Engaging with the teams is important, especially in the primary market. Currently, we mainly operate in the secondary market, and there is enough public information available to make many judgments.

Of course, we closely follow the communities of heavily invested projects. Discussions and unformed ideas from founders and some core community members are also crucial for investment. In the future, we will place more emphasis on direct contact with founding teams.

Chain Catcher: Please review how First Class Warehouse's investment research system was established. What detours did you take along the way?

Zheng Siwei: It has not been easy along the way. I believe an investment research system consists of thought + execution. Our investment research philosophy is primarily based on the investment philosophy of our founder (Coffee): stick to value investing, find good projects, and good prices. He entered the crypto space in 2013 and is adept at learning and self-iteration. I personally feel particularly fortunate to have encountered a mentor in a relatively small city.

On the execution level, our system and business determine that we need many excellent talents to execute. Finding one or two outstanding talents is not difficult, but scaling is another matter.

After our researchers join the company, they undergo a relatively systematic training process to form a preliminary knowledge base and cognitive framework, and then they refine, iterate, and fine-tune through daily project research and report writing. We also place great importance on internal and external communication and discussion.

For example, this sharing session is also intended to spark ideas, boldly express some of my viewpoints, and accept the collision of ideas to correct myself.

There have also been many detours. Learning about the fundamentals of blockchain is a steep uphill road, and trading is filled with various pitfalls. As a long-time employee of the company, guiding the growth of new employees without having matured my own understanding inevitably leads to many mistakes.

To date, we cannot claim that our system is perfect; there are still many areas that need refinement, and it must be adjusted with the changes of the times. Like the earlier mentioned case of 0x, there are many others, and we value the market's education of us.

Chain Catcher: This round of the bull market is defined as an institutional bull market, with mainstream coins and altcoins experiencing explosive growth, making one feel the madness of the bull market. What distinguishes a bull market from a bear market? What stages do bull and bear markets have? How can one make more money and lose less in a bull market?

Zheng Siwei: Many people believe this is an institutional bull market. Let me first explain my understanding of bear and bull markets. When looking at the K-line over a long period, the history is strikingly similar: bear markets are long, and bull markets are short; you can check Bitcoin's historical price trajectory on CMC.

The boundary between bull and bear markets, in my opinion, is vague and transitional. There is no specific point in time when a bear market turns into a bull market; it may be a period. In the mid to late stages of a bear market, prices, trading volumes, and community sentiment are all very low. Friends who have persisted since 2017 should have this feeling.

In the early stages of a bull market, this low sentiment begins to gradually dissipate, and people become active in the community again, with trading volumes starting to grow, occasionally leading to the emergence of one sector after another.

In the mid-stage of a bull market, the continuous rolling of these sectors does not stop, and project token prices usually rise three levels and drop one level before continuing to rise. Until Bitcoin's price constantly makes headlines in major media outlets, attracting outside investors to enter the market.

In the final, most frenzied stage, countless coins experience daily increases of over 50%, with trading volumes expanding to unprecedented heights, and K-lines steepening to nearly 90°. The simultaneous rise in volume and price creates a perfect environment for early large holders to exit, leaving only the bursting of the bubble.

These are some rules summarized based on historical bull and bear markets, but they may not fully apply to the future. The shape of this bull market (let's call it a bull market for now) may be somewhat different, and how long it will last and how it will end still needs to be observed.

Regarding how to make more money and lose less in a bull market, for most people, diversification (not putting all funds into one project) and concentrated positions (good projects should be boldly invested in) to allocate positions, holding steady, and choosing to exit in the mid to late stages of the bull market without looking back may be the most cost-effective approach.

Some people excel at jumping around in a fast-moving vehicle, trying to catch every wave of growth; some leverage loans to enter the market; others want to fully utilize derivatives for higher returns. Although we ourselves focus on long-term value investing, I recognize different investment methods. I believe that each method, when honed to perfection, can yield profits.

The most important point here is to realize that a person can usually only master one or two of these methods.

In this case, mindset is crucial. If you are a long-term value investor, do not feel disheartened and switch strategies just because the coins you hold have not risen while other sectors are booming. It is very likely that chasing after the rise will lead to abandoning your long-held low-cost positions and missing out on your own sector.

In a bull market, basically all coins will rise. Spend time researching and select a few worthy targets to invest heavily in, hold patiently, and exit at the right time; this should allow you to outperform 80% of players.

Chain Catcher: What was First Class Warehouse's investment research theme for 2021? As the end of the year approaches, everyone is making predictions. What opportunities do you see for 2021?

Zheng Siwei: It is difficult for me to give a direct answer because First Class Warehouse truly seeks to understand all themes. The positions established by First Class Warehouse in 2019 included not only DeFi but also some other tracks, such as the established privacy coin track and some infrastructure tracks. We will continue to hold these tracks until the mid to late stages of a bull market.

In recent months, we have been focusing on researching some emerging DeFi tracks (some of which have been mentioned), Layer 2, and Polkadot topics. If I had to say what I am most optimistic about, I would still say Layer 2 and some subfields within DeFi.

Each institution has different investment characteristics. Some excel at capturing hot trends, entering and exiting quickly, with high capital utilization and flexibility. We are relatively weaker in this regard; we generally see good projects, find good prices, and may not sell a single token for a year (like AAVE).

Some institutions may choose two or three particularly promising tracks to invest heavily in, such as DeFi + Web 3.0; we prefer to explore and research all tracks.

There is no superiority or inferiority here; it is like investment methods, whether it is fundamentals or technicals, spot or derivatives, as long as one hones one of these methods to perfection, one can make a lot of money.

If I must mention opportunities, if there are any in 2021, the biggest opportunity is the bull market.