Some leading investors and thinkers in cryptocurrencies have introduced many structures, heuristics, and metrics over the past year that investors should use to value crypto-assets or btc prediction.
I summarize the crypto-asset valuation structures of today in this article. I plan to clarify the main structures briefly and examine their drawbacks and discuss potential new areas for exploration. I conclude by focusing on the best approach to valuation for today’s market and the future.
Why is the value of cryptocurrency important?
Before we get into the details of how to value cryptocurrencies, let’s first discuss the asset valuation function and context. Valuing is what investors in the stock market do to determine a stock’s fair market value. The values are abstract in fact. These are used to forecast market prices of the future or potential.
And, of course, the purpose of a valuation is to provide information to investors to make investment decisions that fulfil their objectives.
Forms of valuing in traditional markets
For traditional markets, there are several standard methods for valuing assets: the P / E formula or price/earnings ratio is usually the best-known equity valuation. This follows a simple approach where the stock price per share of a company is divided by the earnings per share of a stock to find a present value of cryptocurrencies to determine its future value.
Discounted Cash Flow uses the potential cash flow plans of a corporation and discounts them to calculate a current value calculation at an annual rate. The present estimation of cost is then used to determine the investment potential.
The Gordon Growth Model uses a dividend-per-share strategy that is payable in one year, assuming the dividend is that at a permanent constant rate.
Challenges of valuing cryptocurrencies
The above examples are approaches to valuing currencies for the traditional stock market—for stocks that represent companies with cash flow, inventory and other elements of the conventional economy.
However, applying these valuation approaches to cryptocurrencies has a few challenges.
First, and most importantly, cryptocurrencies and the blockchain networks that generate them are not companies. They don’t have cash flows.
This presents a few fundamental problems. Notably, because of this, it’s impossible to apply the Discounted Cash Flow approach. The same goes for P/E evaluation because cryptocurrencies are not stocks that can be evaluated by price per share.
Many people argue that, because they do more than exchange value, cryptocurrencies should not be called currencies at all. They are not commodities as well, because they are not consumable.
An additional difference is that the crypto market is very new, so there is little information on the past performance of currencies to be used when determining how these resources could be doing in the future.
Key aspects of valuing cryptocurrencies
To develop a comprehensive understanding of how to value cryptocurrencies, it is vital to consider three specific topics: usefulness, scarcity and perceived value.
The utility is how a coin can or will be used and how it will be used in the particular blockchain network to which it relates.
Ether, for example, is the Ethereum blockchain currency, which has gained popularity due to the increasing importance of smart contract technology from Ethereum. ETH is required to execute commands and build applications for anyone on the Blockchain, so ETH is a currency in this process.
Since Ethereum technologies are used more commonly and people are carrying out more transactions with ETH, their value is growing.
Scarcity is the cryptocurrency’s other unique aspect. The price of an object is determined by scarcity and rareness in traditional economies — talk of diamonds. And vehicles of luxury. One of the items they esteem is their absence in the marketplace. The same applies to cryptocurrencies since they are in limited supply.
The bitcoin price prediction also determines a cryptocurrency’s relative value. This value of cryptocurrency can be reached by different means in the crypto marketplace.
Trust can increase within the community if a project fails to achieve its stated objectives. Or the value of cryptocurrency will increase if people outside the crypto market see the interest in a blockchain network. Ethereum is another excellent example.
Then, of course, there is Bitcoin, the leading cryptocurrency in many respects, which often creates massive interest among the general population.
Background of valuing cryptocurrencies
ARK Investment Management was one of the first organizations to rate cryptocurrencies. ARK was the first director of public funds to invest in Bitcoin’s exposure to security.
Chris Burniske, co-author of “Cryptoassets: The Innovative Investor’s Guide to Bitcoin and Beyond,” was one of the people leading that decision. When ARK invested in Bitcoin in 2015, basically no other investment firm thought cryptocurrencies was a good investment. But after valuation, Burniske and others at ARK recognized the potential for significant growth in cryptocurrency.
Approaches to cryptocurrency valuations
ARK Investments, subsequent companies other, individuals concluded that cryptocurrencies embody and contain an entirely unique economic model that demands its own form of study.
They developed a method called the Exchange Equation to calculate the value of the cryptocurrency. The equation appears as follows:
MV = PQ
M = Size of the asset base
V = Velocity of the asset
P = Price of the digital resource being provisioned
Q = Quantity of the digital resource being provisioned
Another way to value cryptocurrencies is to use the Factor Analysis approach. This calculation separates assets into several variables in the traditional stock market, typically three to six, and combines those stocks into a portfolio.
Bloomberg conducted a factor analysis study in which crypto assets were grouped into three factors: scale, quality and service.
The Size portfolio included Bitcoin and Ethereum, the two most valued currencies, as well as XRP, Litecoin, NEM, and Ethereum Classic.
The Quality portfolio included Bitcoin and Ethereum.
And the Service portfolio contained currencies providing services such as STEEM (the blockchain social media platform currency Steemit with a social media feature) and Iconomi (which helps people to manage digital assets).
Ultimately, Bloomberg’s analysis showed that the Size portfolio had doubled, the Service portfolio was the only one to crash, and the Value portfolio had the most volatility. Once again, the problem with applying this method is that, because cryptocurrencies are new currencies, the amount of data that can be used to classify coins into variables is limited.
Bloomberg’s method, however, provided data showing a relatively accurate snapshot of crypto-asset results.
Again, valuing crypto resources is still a challenging task. Yet, some of the above strategies will start to function as ways in which investment funds and individual investors can value these assets to assess whether they are the right investment for their financial objectives.
“Store of Value” Thesis
Key idea: The opportunity to provide consumers or stakeholders with a monetary store of value is a notable element driving interest in digital currencies. The capacity of a token to act as a store of value will give such parties a significant value.
Key argument: currencies have three features: value shop, exchange medium, and account system. Assets like Bitcoin (BTC) or secure coins may have useful “price shop” features that make them highly attractive to investors. Digital currencies with steady layout values (i.e. stable coins) or those that the community expects to be either stable or price-growing make attractive “value shop” coins.
Like any fiat currency or currency without meaningful intrinsic utility, the acceptance, collective belief and trust of the ecosystem concerning the asset is fundamental to its position as a crypto-asset “store of value.”
For valuation, equivalent store-of-value properties such as gold could be compared to have a good idea. The estimation of the total value of gold bullion in the world, for example. The spot price of $1300, according to some estimates, is about $8 trillion. If this is some indication, and if a coin like bitcoin replaces gold as a price store (a very, very big* if*), then such a crypto asset has excellent prospects for return. If we use the example of bitcoin in a simple quantification, with a limited supply of 21 M BTC, each BTC could see a price of $380,000 if it were to take the same place in the world as a store of value as gold ($8T/21 M coins= $380,000 per coin).
Token Velocity Thesis
Key idea: Token transaction rate is one of the key levers that defines the long-term value of the cryptocurrency.
Key Argument: Taking from The Monetary Equation of Exchange (MV= PQ), which economists call The Quantity Theory of Money, speed is a significant driver of the token price, and the lower the speed, the higher the token price is through an appreciation of M on the left side of the identity. The consequence of this study is that low-speed tokens, i.e. those that for whatever cause sit longer in wallets (speculation, store of value, etc.), will see higher prices than other coins, all the rest being equal.
The main aspect of this concept is that protocols and programs will give users a good reason to keep any coins over what they’re going to spend on the program. Holding the coin as a speculative investment or store of value could include motives. The protocol/project could also model features that require speed reductions, such as staking functions (seen in FunFair) or balanced burn-and-mint dynamics (seen in Factom). Staking features like those in PoS protocols would usually help promote low Velocity.
The thesis has widely recognized critiques such as speed cannot be reliably described or measured. In contrast, the model assumes that it can be specified/estimated and used for model meaning.
The other variables in the equation, M, P, and Q, can also be easily measured or estimated. Economists are actually going to say that you need models to estimate one of these variables along with their comparisons.
The choice of recording the effect in M, P, or Q is arbitrary as velocity changes and yields different consequences for the token price. Therefore, V’s relationship and association with these variables are complex, and it is again subjective and problematic to presume a steady relationship with P, Q, or M.
In crypto space, M itself is very difficult to measure, as a currency that may or may not be expressed in the M value of the prototype can be locked up or unmined.
INET & Crypto J-Curve Thesis
Key idea: Chris Burniske’s INET model is a detailed financial model where the price of the token is calculated using the Monetary Exchange Equation (MV= PQ) above. Remember that INET is just the name of a fictitious token evaluated by the analyst. Token prices are further broken down into two components whose contributions evolve over time:’ real utility value’ (CUV), which represents today’s utility-driven value, and’ discounted expected utility value’ (DEUV), which represents investment-driven value.
Key argument: Using inputs including supply-side drivers, acceptance and market penetration growth rates, token demand, and speed, the current market price of a token can be modelled and forecast. Besides, it is possible to model and estimate CUV and DEUV and their respective complex effects on the token price.
Following the monetary equation of exchange (MV= PQ), the token price in the future is equal to the estimated monetary base (M) divided by the number of coins in circulation in the future. M is measured as equal to PQ / V, or the value of the on-chain volume of transactions (or “network GDP”) divided by the token Velocity.
Velocity is a crucial presumption and input value of the cryptocurrency, and the model tends to suffer the same disadvantages linked to token Velocity and interactions with other factors as described in the above argument for velocity thesis.
Crypto J-curve thesis: CUV and DEUV take turns controlling token values as they stabilize and mature the ventures and consumer expectations. Because owners are excited about the tech and expect future price appreciation, DEUV dominates when a token is first released. As interest declines with unavoidable technological roadblocks, the demand falls and CUV is powered more by professional users and early adopters. As the group overcomes obstacles, as the token is more widely adopted, CUV slowly rises. So DEUV catches up as speculation, and the curiosity of developers is accompanied by anticipation. Ultimately, the CUV will push the token value in the steady-state.
Network Value-to-Transaction Ratio (NVT)
NVT= network value / daily amount of trx. NVT is an estimation ratio that compares the network cost (equal to the market cap) to the on-chain transaction volume of the network on a daily basis.
Key argument: Similar to the common equity P / E valuation ratio (either stock price/earnings per share, or market cap / total earnings). NVT may indicate whether a network token is below or overvalued by showing the market cap relative to the transaction volume of the network, which is the utility that users derive from the network. It shows a possible token overvaluation when the ratio becomes very high.
The best ratio refers to a capital, whose size of on-chain transactions is closely useful to users. The on-chain transaction volume of Bitcoin, for instance, reflects the ability it offers users to send money abroad for very low fees and a degree of anonymity. The ratio is unknown for networks with high transaction information privacy rates such as Monero and Zcash. Transaction behavior resulting from staking will inflate the denominator of networks with staking incentives such as Dash, allowing the ratio to be underestimated unintentionally. Subtracting staking operation from the volume of transactions may correct this effect.
Volumes of transactions tend to follow price changes, so both variables have an endogenous and “reflexive” relationship, undermining the ratio’s indicative power.
Daily active addresses/users (DAA)
Key idea: Daily active addresses are a metric and measure of the number of users in daily transactions using the crypto network.
Main argument: Similar to computer and app Daily active users (DAU), DAA can provide information about the number of users on a network that can monitor patterns and supplement other metrics such as NVT and on-chain transaction size.
Valuing cryptocurrency is very important, and if done right it can do wonders for you.