When investing in a specific coin, do you ever take time to assess its overall value? Besides basic supply and demand theory, why is it that coins are priced at the value they’re at? Well, lucky for you, you’ve come to the right place to figure these questions out. Within the cryptocurrency market there are several valuation techniques and models that expert investors follow to properly assess how much an asset is really worth. Let’s go over what valuation techniques are and which ones are most popular amongst the best crypto investors.
This is not financial investment advice.
This article discusses key valuation techniques and models found within the cryptocurrency industry.
In this article
Valuation: Valuation is the process of determining the current worth of an asset or a company. There are many techniques used for doing a valuation. An analyst placing a value on a company (or coin) looks at the business’s management, the composition of its capital structure, the prospect of future earnings, and the market value of its assets.
Circulating Supply: The total number of coins in a cryptocurrency that are in the publicly tradable space is considered the circulating supply. Some coins can be locked, reserved or burned, therefore unavailable to public trading.
Market Capitalization: Market capitalization refers to the total dollar market value of a company’s outstanding shares (coins). Commonly referred to as “market cap,” it is calculated by multiplying a company’s shares outstanding (coins) by the current market price of one share. The investment community uses this figure to determine a company’s size.
Trading Volume: Volume of trade is the total amount of coins or tokens traded for a specified asset. It can be measured on any type of security traded during a trading period. Volume of trade or trade volume is measured on all types of commodities.
Familiarize yourself with these key terms in order to better understand how valuation models work.
What Are Valuation Techniques?
As always, before we dive straight into the different kinds of valuation techniques, let’s take a second to completely understand how they work and why they’re so effective in the first place. Valuation models serve as a way to assess the value of a certain company, project, or in this case a coin. This is much more common in the stock market, where the assets you invest in are able to produce financial reports and tangible data which directly correlates to how the business performs.
There are two types of valuation techniques that each model can fall under: absolute & relative. Absolute valuation models analyze a business, project, or coin and give it a general value based solely on the characteristics of that asset. Without taking other projects and market conditions into consideration, absolute valuation models seek to define a company’s worth by only taking the information and data relevant to that project. On the other hand, relative valuation techniques use models that compare a company’s value to that of its competitors along with industry peers across the rest of the market to assess its financial worth. Both can be used as alternatives for one another or together as they can play hand in hand.
However, it’s important to understand that traditional valuation models and techniques won’t cut it when it comes to cryptocurrency, since these assets are different from stocks in multiple ways. Stocks, bonds, and even real estate properties fall into the basket of what is known as “traditional asset classes” which provide an ample amount of data to use when assessing their value. Cryptocurrency, on the other hand, requires different models which do fall under relative and absolute valuation techniques, since they lack necessary data like recurring cash flows or dividend payments that can be estimated.
Valuation techniques are ways to assess the value of a company, project, or another asset. There are relative and absolute valuation techniques, with cryptocurrency requiring its own unique models which cannot be applied to stocks, bonds, or other traditional asset classes.
Absolute Valuation Techniques
Before we go over some of the relative valuation techniques, it’s important to remember that there is no broadly applicable valuation model for cryptocurrencies because most — if not all — coins fall into different categories and use cases. However, there is an approach that may be helpful in thinking about how to value a cryptocurrency generally. The first valuation technique that is applicable to crypto is known as the Equation of Exchange (Quantity Theory of Money) Monetary Model. This model attempts to measure the value gained by users of a particular cryptocurrency network, while relating that back to important pieces of information like velocity and coin supply to come out with an actual value for it.
So then, what’s the actual equation that’s in the name itself? This model can be represented by the following equation: MV = PQ, where “M” stands for money supply (coin supply), “V” stands for velocity of money, “P” stands for price level, and “Q” stands for quantity of god and services (utility). Essentially, you’ll have to project the supply schedule for a coin, estimate its market exposure and share, forecast the velocity of the coin being traded, and determine its overall utility for users on the network.
Of course, there are always going to be a few limitations which arise when translating this model to cryptocurrencies, including a high degree of uncertainty given the lack of raw data available and inconsistent information due to the high number of assumptions being made. Yet, if you are able to keep as many numbers consistent as possible, then you’ll have a good way of assessing the value of that coin based solely on its own network capabilities and utility.
The Equation of Exchange (Quantity Theory of Money) Monetary Model is one of the best absolute valuation models as it allows one to analyze the value of a coin based solely on its own network capabilities and overall utility. Limitations include high uncertainty and inconsistent values.
Relative Valuation Techniques
Relative valuation techniques involve less models and more comparisons, as this gives us a good idea of how a coin is valued based off of current valuations. Additionally, relative valuation models isolate various pieces of information that is readily available for most if not all coins. So let’s go over some of these techniques to accurately assess the value of cryptocurrencies.
The first metric to use when attempting any relative valuation model is mining profitability. Understanding the technical side of the project should be your first priority, since that is the real product that is being showcased. This is also a great indicator of how many users are directly involved with the project, which is correlated with trading volumes on the exchanges that it’s listed on. Of course, the higher the trading volume and the more efficient the underlying technology is, the higher its value when compared to other coins.
Another metric to use is looking at the maximum number of transactions it can handle. The TPS (transactions per second) of a network is another great indicator of how efficient their technology is, which can also be compared to the TPS for other top coins as well. Additionally, the Network Value to Transactions (NVT) ratio measures the dollar value of a cryptocurrency’s market capitalization relative to the daily on-chain transaction activity. Together, these metrics can be coupled with an assessment of the cryptocurrency’s ownership base characteristics to further analyze and compare the value of certain coins.
Relative valuation models analyze the value of a coin by comparing it to that of another cryptocurrency. Some of these indicators include mining profitability, transactions per second, and general ownership base characteristics.
Besides performing technical analysis and identifying patterns, valuation models also provide a means for analyzing the value of a coin. You can use these techniques to further analyze coins on the market and make more informed decisions when investing. The most experienced and successful traders in both cryptocurrency and other asset markets such as stocks and real estate use some kind of model to value the things that they are about to invest their money in. If you have time and want to increase the depth of your knowledge when it comes to investing, then you should definitely start learning more about how to implement and perfect these models within your own strategy. As always, happy investing!
What other valuation models or techniques do you use?
Let us know in the comments!