Blockchain networks are churning out memecoins by the millions. How should traditional investors value them?

The crypto market is in a Meme Spring. In the month of April alone, 640,000 tokens, virtually all memecoins, were launched on Solana. Many of the most popular crypto projects, like pump.fun and rug.fun, center on memecoins. Proponents are praising memecoins for injecting playfulness and collective joy into a ‘Dying Internet.’ Detractors are dismissing them as zero sum dopamine hits that leave the less experienced ‘rekt.’ Most everyone is in agreement that memecoins are not going anywhere. Neither are their dizzying returns.

Traditional investors, including hedge funds and venture capital, are taking note. In this cycle, more of them are dipping their toe into memecoin markets traditionally dominated by degen investors. That marks a notable shift in the investment paradigm of professional investors. Memecoins, by their nature, defy the valuation models that guide traditional investments. Without clear fundamentals, or actual or anticipated cash flows, memecoins resemble a gamble more than a calculated risk.

Memecoin investing poses a challenge for fund managers, who must justify their strategies to investors accustomed to conventional assets. Skeptics will argue that the role of investment managers is not to bet on viral trends but to seek out assets with measurable, sustainable value. In this light, the memecoin craze tests the boundaries of what constitutes a legitimate investment in the new ‘internet of value.’

Meme Fundamentals

Identifying the next breakout memecoin is a combination of art, science, and getting hit by lightning. Despite the absence of traditional financial metrics, investors can still look to ‘fundamentals’ of a sort (emphasis on fun-). These include cultural resonance, community engagement, and the whims of online sentiment. While some may dismiss this approach as less rigorous, it is tailored to the nuances of a market driven by attention and virality rather than earnings reports and balance sheets.

Among other things, memecoin investors must estimate the potential 'moon' factor—how high and how quickly a memecoin might soar. Durability is also key; a memecoin must hold value long enough for a profitable exit. Finally, investors must calibrate their bets, balancing the lure of high returns against the risk of a total loss.

Memecoin fundamentals can be divided into extrinsic or intrinsic. Extrinsic fundamentals relate to forces from outside the memecoin itself. They shape its potential for success or failure. On the flip side, intrinsic fundamentals spring from the meme's core idea: e.g. that the dog wearing a pink beanie might ignite a community's passion and drive the token’s popularity.

While these categories seem clear-cut, they're not. Memes feed off and respond to their environment and are in a constant dynamic dance with it.

Extrinsic

A memecoin's success is correlated with some of the below extrinsic fundamentals.

Team. A launch team's reputation and history of launching successful memecoins can be a magnet for early speculators and meme investors, giving that token early traction in a sea of choice. Meme hunters look for teams with a track record of not just creating buzz, but also sustaining it.

Mascot. Beyond the team itself, investors might look to a mascot. In December 2020, dogecoins’ mascot, Elon Musk, tweeted, “One word: Doge,” which resulted in a 20% increase in the dogecoin’s price.

Market. The broader investment climate plays an important role. During risk-on periods, investors flock to high-risk, high-reward assets like memecoins, pumping energy into the market. Memecoin season is another phenomenon to watch. When memecoins become the talk of the town, their value can skyrocket as mainstream media attention and FOMO (a celebrated driver of crypto markets) kicks in.

Tokenomics. How the tokens are distributed and managed, can signal long-term viability, or suggest potential for a dump, affecting investor confidence. New modes of distribution, such as through tips on Web3 social platforms, can ensure that a memecoin is widely held and rendered more stable. In contrast, a large allocation reserved for the founding team, constraining the circulating token supply, or rampant token farming by bots can create distortions and an overhang risk of an abrupt dump. And there is always the risk that the smart contract is a honey pot scam.

Chain. The choice of blockchain matters. Chains with communities that embrace memes can offer a fertile ground for a memecoin to flourish. Solana and more recently Base (aided by Farcaster) have proved to be the best at incubating successful memecoins.

Exposure Vacuum. Occasionally memecoins are positioned to fill a vacuum in the investment landscape by providing indirect exposure to a product or ecosystem that has chosen to forego launching its own native token for the time being, most commonly for regulatory reasons. For example, $degen, which is closely integrated with Farcaster, a Web3 social platform, satisfied investor demand for exposure to Farcaster itself.

Intrinsic

Key intrinsic drivers of memes include those relating to their traction, convergence, effervescence, infectiousness, composability, spread, durability, aura, utility, and their cultural scene.

Traction. Traction is the spark that ignites interest in a particular coin amidst a crowded field. Without it, a memecoin is doomed to obscurity. Traction emerges from the meme's inherent appeal, its ability to become a focal point, and the collective excitement it generates. Memes that resonate often riff on current events (e.g. $tremp and $boden) or tap into viral internet culture ($doge and $wif). Humor and irony also play well, as do coins that embody a strong belief or institutional critique like bitcoin (which has a strong meme component) and $USA (a satirical fiat-coin). Here, it pays to poll your normie friends who can assess the meme from the mainstream.

Convergence. A memecoin's ability to become a beacon for collective attention—a so-called schelling point—is crucial, particularly as memecoin supply expands in accordance with its own version of Moore’s Law. This can happen when the memecoin is the first of its kind (e.g. $doge) or carries a unique story or 'lore' (e.g. $slerf). An existing community can also give a memecoin a running start. (The DogWifHat meme for example, which features a Shiba Inu wearing a pink beanie, first gained popularity in the gaming community in late 2019, well before the launch of $wif.)

Effervescence. The strongest form of convergence implies the presence of what sociologist Emile Durkheim called 'collective effervescence’: a shared buzz and camaraderie around a meme that is akin to the electric atmosphere of a concert encore, where everyone is united in a moment of joy.

Infectiousness. The most successful ‘viruses of the mind’ are the most infectious. Accordingly, memes that spread effortlessly have an edge. They're often pushed by influencers or propelled by a strong community ready to share them far and wide.

Composability. Composability, the meme's ability to merge with other memes or imagery is a key propagative advantage. The most powerful memes colonize pre-existing touchpoints in the culture, usually by transforming or remixing them (e.g. placing the dog’s pink beanie on the Vegas Sphere), harvesting their appeal and reach for the new meme’s benefit. More practically, by holding certain types of memecoins, you may be automatically recycled into adjacent coins through targeted airdrops.

Spread. The total addressable market (TAM) for the meme matters too; the more people who can relate to a meme, the better its chances of spreading. Dog memecoins are popular because of the large number of people who have dogs or have a positive opinion of them. (While cats are also popular and despite recent efforts, a feline flippening is unlikely to occur anytime soon.)

Durability. Durability is what keeps a meme in the limelight and gives it longevity. Our identity can play into this; the more a meme becomes part of who we are, the stickier it gets. Some memes, like bitcoin and $doge, become almost religious in their hold over people.

Aura. The best memecoins have an ‘aura’—a specialness or authority that can arise from being the first (or Lindy) or having a unique origin story. While not all memes will have this aura, those that do can become legendary. (The quality of ‘aura’ is also palpable in memetic NFT collections like Crypto Punks that have a strong claim to originality.)

Utility. Memecoins that are associated with actual productivity and utility are more likely to become durable. Until this cycle, this typically meant that a memecoin might be used as a medium for payments or tipping, as with $doge. However, the arrival of ‘community coins’ has extended this logic. Community coins “cross over” to become the private currency of an otherwise productive blockchain economy and ecosystem; examples include $degen (Farcaster), $bonsai (Lens), and $enjoy (Zora). They also include memecoins that are used as native tokens on L3s and other infrastructure built by and for the meme community itself (which may begin to display political ambitions as a cloud nation or “network state”).

Cultural Scene. The capacity of memecoins to create a cultural scene on another platform or dApp lends them a certain hardness that can insulate them from rapid extinction when the underlying meme fades. Conversely, imprisoning a memecoin within a product and its features can rob it of its memetic mojo, causing it to fizzle.

Lightning in a Bottle

Chance plays a fickle role when it comes to memes and landing on a viral coin can feel like capturing lightning in a bottle. At best, memecoin ‘fundamentals’ might suggest when the conditions might be ripe for a particular coin to succeed and are far from guaranteeing success. This is more akin to a long range weather forecast than a highly predictive financial model.

Each memecoin's journey is unique, influenced by a mix of factors and a good deal of luck. Investors should weigh the presence or absence of fundamentals carefully in each case but some memecoins will defy odds and soar, while others may never take flight, regardless of their attributes.

From an investor's perspective, a meme's strength may not align with financial gain. A memecoin that captures the zeitgeist can explode in popularity and value rapidly, offering a narrow window for substantial returns. Such fleeting success stories often eclipse the slow and steady growth of their more established counterparts. The most successful memecoin investors will seek out not just strong memes but also those with the potential for quick and profitable exits.

The Exit

Exiting memecoins is a high-wire act. Attention, the lifeblood of memecoins, is as fleeting as it is fickle. No cash flows anchor their value, making them prone to sharp declines when the crowd looks away. Investors must keep a vigilant eye on the 'health' of a memecoin, gauging its vitality through the lens of online buzz and market sentiment. This constant monitoring is crucial to determine the optimal moment to step back, lest they are caught in a sudden downturn.

The growth trajectory of a memecoin is rarely smooth, zigging and zagging with the whims of the internet. Recognizing where a memecoin stands in its life cycle is essential for survival and conversion of paper gains.

As for investment sizing, memecoin investing resembles high-stakes poker, where players must balance the risk of a win with being wiped out on any one hand. As in poker, the Kelly Criterion serves as a guide for calibrating bets in this unpredictable market. It suggests that the optimal investment is one that maximizes the expected logarithmic return, balancing the potential for growth against the risk of losing everything. By applying this principle, investors can theoretically achieve the highest long-term wealth growth.

Mindshare Matters

Investors who once turned up their noses at the idea of meme-driven markets now find themselves wrestling with a new reality. Mindshare, the collective attention an asset garners, has emerged as a potent market force—one that is not limited to memecoins. Even conventional bets in public equity markets are capable of morphing into partial or predominantly meme plays, at least for a time (e.g. Gamestop and AMC). The fading line between meme and traditional assets is a sign of the times. Savvy investors will do well to track attention flows much like they track cash-flows.

Like it or not, we are all meme investors now.