Cryptoasset Valuation Frameworks: What is a Coin Really Worth?
Cryptocurrency has experienced a surge in interest since December 2017, when Bitcoin’s price peaked at just shy of $20,000 per coin.
However, even for the most experienced investors, it is hard to place an accurate value on any given coin. When compared to traditional markets, equities or bonds, valuation models for cryptoassets — a more general term for cryptocurrencies, since not all coins are viewed as currencies — are few and far between. However, thought leaders in the space have put forth their own theories about how cryptoassets ought to be valued, and in some cases, even a formula to calculate a price per coin.
In this post, we will briefly discuss existing cryptoasset evaluation frameworks, with the aim of providing a bird’s eye view of different methods:
Store of Value
The basic premise behind the Store of Value (SoV) thesis is that cryptoassets represent an investment vehicle that will hold its value over time. Outside of the cryptocurrency space, perhaps the most classic example of a SoV asset is gold.
Cryptoassets that stand to become a good store of value have a higher market cap. As such, the most obvious example is Bitcoin, which is often referred to as “digital gold.”
However, there are other characteristics unique to Bitcoin that lend credence to this idea, namely its fixed supply (21 million), zero inflation, inability to be duplicated, storability in a secure location (cold storage), and relatively low cost of conversion to other assets like fiat currency.
On the other hand, Ethererum serves as a utility protocol, with the primary goal of serving as a base for other applications to be built upon. In general, the more a cryptoasset is optimized for utility, the less it is optimized as a stable store of value.
The rationale behind this is theory is that tokens with low velocity (meaning they change hands the least number of times) have the have the highest price per coin. This is based on what is called the Quantity Theory of Money, represented as the equation MV=PQ, where:
M – Money supply in circulation (or in this case, market cap)
V – Velocity, or number of times a coin changes hands
P – Price level
Q – Output of the economy
If V decreases, it would stand that M would increase, and along with it, the price per coin. So what could cause the V of a particular coin to decrease? Generally, low velocity could be an indication that investors are holding in hopes of a future price increase, or because there are some sort of staking rewards associated with keeping the coins in a wallet. However, it could also be a result of a coin whose utility is unappealing, which of course, would lead to a lower price per coin over time.
The NVT Ratio stands for network value to transaction ratio. This ratio compares the network value of a crypto asset to the daily transaction volume.
According to the creator of the NVT Ration, Willy Woo, “Bitcoin’s NVT is calculated by dividing the Network Value (market cap) by the daily USD volume transmitted through the blockchain.”
This models builds upon the basic premise behind P/E ratios, which are used extensively in to value publicly traded companies.
The P/E ratio is a company’s share price divided by earnings per share. With cryptocurrencies like Bitcoin, there are no earnings to take into consideration. Instead, it references the money flowing through the network. This is based on the assumption that Bitcoin is a payment and store of value network, and would seem to contradict the premise that a low coin velocity would increase price, as mentioned in the previous section.
The INET Model, proposed by Chris Burniske of Placeholder, relies also heavily on the Quantity Theory of Money. In this model, Burniske values a fictional token he has called “INET.” He breaks down valuations into two parts:
Current Utility Value (CUV) – Current value based on utility and demand
Discounted Expected Utility Value (DEUV) – Valuations driven by speculation
In short, it is weighted by current value and some possibility of future value. When a coin is first launched (ICO and shortly after), the vast majority of its value can be represented as DEUV. But over time, as it (hopefully) fulfills its stated purpose, its value lies in its CUV. The vast majority of cryptocurrency projects still skew more heavily to DEUV at this point.
False Precision – A new perspective
More recently, Arianna Simpson of Autonomous Partners stated that she doesn’t have a clean answer with respect to crypto asset evaluations. Asserting that the current crypto asset market is poorly understood and inefficient, along with questions such as, “How would you factor in the strength of the Ethereum developer community into your equation?” Simpson states that she is comfortable with a degree of uncertainty and isn’t bothered by not having a formula right now. Moreover, Simpson believes that the market will tighten in a couple years, which is when investing based on empirical calculations and formulas makes sense.
Cryptoassets are an emerging asset class, and there is a lot of ambiguity surrounding them. Given sufficient time for the market to settle upon fundamentals, coupled with a potential influx of institutional money, we should see many more evaluation frameworks emerge that will most likely use elements of all the methods discussed above.