How to measure the value of a cryptocurrency?

The question arises as the asset class becomes more widespread. With Eliezer Ndigna with 21 shares.

Cryptocurrencies have a tumultuous life. In two years, the universe has grown by more than 194%, going from $390 billion to more than $1,100 billion in market value, at the cost of rolling volatility. Macroeconomic uncertainties and the unraveling of a number of protocols degraded performance in the first half. The question then arises: how to value a cryptocurrency? The 21 Shares platform offers in its quarterly publication “State of crypto” a valuation framework for the asset class. Insight with research manager Eliézer Ndigna.

What is the purpose of this report, which was first published in 2020?

It provides an in-depth look at the state of the crypto-asset industry over the past few months, our perspective on the industry, as well as a summary of the most important news. It also provides a valuation framework for the asset class. What all methods have in common is that they assume that markets are inefficient, at least in the short run. Otherwise, price would be the best estimate of value and there would be no point in valuing an asset.

So can we determine the intrinsic value of a virtual currency?

Yes, absolutely. Contrary to crowd wisdom, some, but not all, cryptoassets have intrinsic value.

The valuation of a cryptocurrency remains an evolving topic in search of consensus, especially as the asset class grows in use cases.

Let’s start by distinguishing the two different types of sub-assets (with respect to their consensus) of the universe, on which valuation methods depend?

Proof-of-work (PoW) crypto-assets belong to the class of consumable and transformable currencies, as they essentially create a native digital asset in the form of a secure and globally accessible ledger space, much like commodities. In contrast, proof-of-stake (PoS) crypto-assets require native asset ownership to access a recurring stream of value created by the network. Therefore, PoS assets are productive and belong to the category of fixed assets in the same way as stocks.

What is your method for measuring the value of a cryptocurrency?

The valuation of a cryptocurrency remains an evolving topic in search of consensus, especially as the asset class grows in use cases.

The value of an asset is related to its fundamentals, namely ongoing cash flow, expected growth and risk. An intrinsic value can be calculated using the discounted cash flow (DCF) method, where the value of an asset is the net present value (NPV) of expected future cash flows, adjusted for time and risk. Also, intrinsic value methods cannot be applied to all cryptocurrencies and vary and adapt to the type of consensus. For example, the production cost to mine a bitcoin is one of the best ways to measure value, since mining is a source of income for miners. Fundamental and relative valuations can be applied to all cryptocurrencies, but must vary and adapt the type of consensus, relative valuation methods, such as Multiples and Market Sizing.

When it comes to valuation approaches, internal valuations focus almost exclusively on asset fundamentals, without considering market dynamics. Relative valuations, on the other hand, are more sensitive to market sentiment and momentum. As such, they can help determine whether an asset is undervalued relative to its peers based on indicators such as the price-to-sales ratio (P/S ratio). For example, intrinsic value can be measured by the discounted cash flows of a currency relative to its cost of production.

So, do you value Ethereum, which is a PoS asset, just like stocks?

Yes, but share certificate assets are not classified as securities; their value, due to shares, can be derived from the net present value of the annual flows to the validators. In other words, investors can value PoS cryptoassets using the classic DCF (discounted cash flow) valuation used in financial analysis. This segment includes all proof-of-exchange assets, governance tokens and NFTs, including MakerDAO, using an intrinsic valuation calculated by the DCF method.

So you equate Bitcoin, which depends on PoW consensus, to a commodity?

The cost of mining production is the main underlying measure for these types of monetary assets. However, market size and multiples also apply from a relative valuation perspective.

What is your definition of stable fundamentals of a virtual currency?

They result in a clear path to product-market fit in terms of revenue growth, user adoption, and market share growth versus competition.

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