Valuing Cryptos Using Utility Value
I’m currently reading a great book on cryptos titled “Cryptoassets: The Innovative Investor’s Guide to Bitcoin and Beyond” by Chris Burniske and Jack Tatar. You may have heard me mention Chris’ name on some of my previous posts. That’s because he’s probably the leading crypto-investor out there today.
He’s done a lot of work on crypto analysis and he understands this space extremely well. He also runs one of the only ETFs that offers exposure to cryptos.
He’s a true finance guy, and he’s been working a lot on trying to come up with a framework for valuing a crypto.
For those of you that come from an equities background, you’ll know that there are existing frameworks out there to value companies, either through their earnings, or multiples, or by discounting their expected future cash flow.
I’ve done some research on these methodologies, they make sense to me, and so until recently this has really been the primary form of valuation of assets that I’ve considered.
However, in Chris’ book, he makes a great point — prior to the advent of cryptos, there were plenty of other assets aside from just equities that had value as well. In fact, he references a statement by Robert Greer, the VP of Daiwa Securities, who claimed that there are actually three interesting types of assets (each of which have classes, which themselves have sub-classes):
- Capital assets (the world of stocks and bonds)
- Consumable/transformable (C/T) assets (commodities live here)
- Store of value assets (fine art, etc.)
When you think about it, each of these assets needs to be valued in order to be bought or sold. Cryptocurrencies most closely resemble C/T assets since they can be consumed (i.e. spending ether to validate a transaction).
What’s also interesting is that cryptoassets themselves can be further sub-divided into three classes:
- Cryptocurrencies (the bitcoins and litecoins of the world)
- Cryptocommodities (the ethers of the world)
- Cryptotokens
Now, what I find the most enlightening is that if you think about valuing a cryptocurrency or a cryptocommodity, you can’t use things like DCF or P/E, but you can come up with a valuation method that attempts to find the value of that cryptoasset to a particular economic industry and aggregate the value across industries to find a per-coin value.
So what the heck did I just say?
Basically, if you’re trying to value a bitcoin, what you can do is find how much value needs to be stored in bitcoin to accomplish its requirements for all industries in which it’s used (i.e. remittances, international merchant payments, etc.), sum up that value, divide it by the future supply of bitcoin that will be available in the year you want to project to, and then discount that value back to today’s terms to find the theoretical current value of a bitcoin.
To me, this is extremely innovative because it provides an actual economic method for valuing a cryptocurrency that’s not tied to hand-wavy derivative metrics like number of addresses divided by transactions.
This method of valuation actually ties the cryptoasset back to the real world economy, which is something that has been lacking to date.
Now, there are a couple of very big issues here that need to be pointed out.
In his book, Chris points out that the value of a cryptoasset can be broken down to the sum of its utility value (described above) and its speculative value. But how the heck do you calculate speculative value?
Obviously as a cryptoasset matures, its speculative value goes down, as it becomes better understood and is further used for its utility. But until then, speculation drives price, and it’s hard to understand if that speculation is actually grounded in economic fact (i.e. buying up more bitcoin now makes sense since it will be scarce in the future), or if it’s driven by an irrational bubble.
On top of that, it’s pretty much impossible to forecast every market that bitcoin will serve, and its further impossible to forecast what percentage of that market bitcoin will capture. This essentially leads to the classic issue with asset valuation — you need a feasible story to back up your valuation, which means that any believable story can lead to a reasonable valuation.
Ultimately, I don’t think this is a problem specifically for cryptos, as I do appreciate the fact that there’s now a framework for tying a cryptoasset’s value back to economic reality. Rather, I think this is an issue with all valuation methodologies.
Having a feasible valuation of an asset is one thing, but it’s all-too-easy for a valuation to change when the mind of its creator changes.
I’m obviously biased, but I think a better way that will evolve as AI evolves is to forecast the value of assets in the future based on a plethora of underlying data that can be fed in to a learning model that understands how historical metrics and scenarios have led to valuations in the past.
All this ultimately goes to say that the crypto investment community is quickly maturing, and we’re seeing an incredible number of intelligent folks jumping into and accepting this new industry. It feels as if things will continue growing exponentially from here, and though there will definitely be bumps and crashes along the way, there is an air of transformational change going around, and we’re lucky to be here, right now.
