Revisiting Bitcoin and Ethereum’s valuation
During 2020–2022 crypto cycle, the BTC and ETH prices are driven more by valuation multiple expansion than adoption growth. And from equity market’s experience, valuation multiples tend to swing from extreme high to extreme low in the event of liquidity crunch amid an extreme monetary tightening cycle. Even worse, Etherum’s network usage is more cyclical in nature than Bitcoin. If this is going to repeat in crypto, ETH price looks more dangerous than BTC.
Key conclusions:
- BTC and ETH market cap and prices are driven by 1) network usage as measured by daily active addresses; 2) valuation multiple as measured by Market cap to daily active addresses.
- ETH’s price pump driven more by multiple expansion than network adoption.
- ETH’s 20x price run during 2020–2022 driven more by multiple expansion (10x) less by network useage (2x).
- Ethereum’s network usage (DeFi, NFT) are much more cyclical than Bitcoin given use cases are financial in nature although Ethereum has evolved to a much more matured stage. This means network activity could collapse much more.
- In the event of liquidity event (such as Celsius) where liquidty crunch is contagious, multiples are going to contract sharply.
- When is the bottom: the money printing returns to the pumping norm.
The macro picture — money growth takes a nose-dive
My favorite chart of the year: US M2 money growth (light blue area) vs BTC price (blue line). Data taken on Friday. Current price is 10% lower than Friday. Ouch!
Clearly a lot of the price pump comes from the massive stimulus checks and credit expansion supported by quantitative easing. All of these lead to as high as 27% US M2 money growth (cash, retail savings, retail money market fund etc). Household have more $$$ in the bank account than they ever had (also thanks to booming housing price and stock market pump).
That money growth has significantly slowed down since the beginning of 2021 which coincidents with the collapes of bitcoin price. BTC price took a sharp recovery afterwards as concerns over FED rate hikes easied, given the FED repeatly said inflation is “temporary”. And that inflation’s last print at 8.6% for May 2022 is eating the household savings rate alive. Not good!
This is a chart we should frequently come back and check. Quantitative tightening’s impact on household deposits is not that straightforward!
And this one. Federal Reserve total assets at gigantic 9 trillion just started to shrink. And the shrinking pace will accelerate in September by 95 billion per month — 1.1 trillion per year.
There is no doubt we are in the hopeless Bearish state. Hang in there! Prioritize survival over profit while money growth is still trending down!
The valuation multiple
I choose Market capitalization to daily active addresses as the valuation multiple for a network such as Bitcoin and Ethereum. Think of it as valuation per active user — an valuation indicator we usually use for social media companies. When an investor investing into a network, she would assume the active users are going to bring revenue and profit for a long period of time. If we discount these user cash flows back to present day, that revenue generation capability is translated into a DCF-based valuation per user.
For example, Facebook (META) daily active user (DAU) 1.96 billion, current market cap at $ 532 billion. 532 / 1.96 = $271 per DAU. Equity investors in Facebook then is paying $271 per DAU. It is useful to compare valuations for companies with similar network effect business model.
Here daily active addresses are addresses that either initiated the send or receive actions on that day.
Let’s look at Bitcoin and Ethereum’s equivalent of Price/ DAU. Note that I don’t think Bitcoin and Ethereum are very comparable to Facebook in that they don’t represent shareholder’s claim to the network. Therefore, don’t compare Price/DAU of Bitcoin/Ethereum to that of Meta.
Bitcoin Marketcap to active addresses at $600,000
Ethereum marketcap to active addresses at $400,000.
Don’t jump into the conclusions so early! Just not yet!
The cyclical nature of valuation multiple: Ethereum’s multiple tends to swing wider than Bitcoin
Let’s break down the chart into two perioed: 2017–2018 and 2019–2022 the recent two crypto cycles (Figure 5, Figure 6).
It’s clear in both cycles, the multiple experienced a period of expansion at the beginning of the cycle and later contraction towards the second half of the cycle. I am not surprised! Long-period of valuation multiple expansion and contraction are common in equity market. Drivers include 1) loose/tight money supply and 2) fundamental operational improvement/deterioration of a company.
2017–2018 cycle
Also note that Ethereum’s multiple tends to swing wider than bitcoin. During 2017–2018 cycle (Figure 5), Ethereum’s marketcap to active addresses shot up to as high as 350,000 while Bitcoin’s multiple at 50,000 only. That’s common for the new shining thing when they received the warmest welcome from first batch of maniac supporters. The network was less used but the supporters would factor in a lot unrealistic positives that are not able to deliver in the short-term, thus followed by the down-to-earth multiple contraction phase.
2020–2022 cycle
This pattern repeats again during 2020–2022 cycle (Figure 6). Ethereum’s marketcap to active addresses multiple started off at $70,000 per active address, vs Bitcoin at $ 200,000 per active address at beginning of 2020. Later Ethereum’s multiple expanded to a peak level of $1,000,000. That’s a 10x bolloning of multiple. Not so common in equity market! Imagine a stock with 10x P/E ratio expanding to 100x P/E. Not sustainable! Even at the moment $40,000 per active address is 5.5x expansion from the bottome. For Bitcoin, from a bottom of $200,000 per active address to a peak of $1,200,000 (6x) then down to $600,000 (3x)per active address now.
Here a simple conclusion: Ethereum’s valuation multiple expanded wider that Bitcoin, ETH 5.5x multiple expansion from bottom vs BTC 3x. Wait, we need to look at the network activities (active addresses) to arrive at our final conslusion.
The network adoption: Ethereum’s network usage are more cyclical in nature compared to Bitcoin
So far haven’t touched upon the network useage. Ethereum definitely evolved to a much more matured stage from 2018 to now in terms of developer community, infrastructure ecosystem, dapp usage. And its use cases have expanded from ICO to defi, NFT, Gamefi, metaverse etc. This explained a much higher daily active addresses now vs 2018. However, we are talking about an avg Daily active address in 2021 at 535k vs 278k Jun-2017 to Jun-2018. Only 2X! Or a bottom to peak growth from 200k to 700k. 3.5X only! But recall during the same time ETH price ran from $180 to $ 4000. More than 20x.
Let’s overlay the multiple vs the active addresses (Figure 8, Figure 9). It is pretty clear multiple expansion is a much bigger driver of Ethereum’s price. And that’s not the whole story. Ethereum’s network usage are also more cyclical in nature compared to Bitcoin.
Because Defi and NFTs are still very much financial use case. When market is trading down, no one is going to use Defi to leverage up. When NFTs are locked up without liquidity and margin panic sell would send prices to zero, no more buyers for NFT! Don’t get me wrong, I am not trashing all NFTs. I still like BAYCs.
Vitalik is actually quite concerned on the only successful use cases so far on Ethereum have been financial ones. His latest toughts here.
Conclusion: ETH looks more dangerous than BTC in terms of 1) fall in network activity; 2) contraction of valuation multiple.
It’s funny that the chartists would use percentage of price corrections to predict the makret bottom. Like 85% price correction in last cycle. It may work out and it may not. Market bottoming is a dynamic process rather than back of envelope calculation.
Maybe we can draw similar conclusion on network activity such as daily active addresses collapsed by 70% from peak in 2017–2018 cycle. Maybe we could see similar pattern. So far Ethereum’s Active addresses have dropped by 45%. We may see another 30% drop from here.
Bottom sign?
Final words. In liquidity events such as the Celsius suspending withdraw, it is contagious and going to affect leverage and liquidity of other instititions. In these events, prices and multiples tend to move to irrational depressed levels. The free falling stage will eventually run out of steam when most leveraged positions are killed.
We need to actively monitor the defi and exchange liquidation data, network activities and the macro scenes.
Blame the cycles! Or Consensus 2022!
I wrote about Howard Marks’ theory on market cycles (link). Financial market cycles are driven by essentially two things:
- Money cycles: central banks manipulate the growth of money and interest rates
- Investors mood cycles: Investors’ moods rarely stayed in the neutral zone. They tend to quickly alternate between extreme Bullist to hopeless Bearish.
For crypto maybe we should add the third driver: the annual crypto meetup the Consensus conference! Consensus 2022 started over the weekend and we get a 20% discount on ETH (I know I know all Celsius’s fault). Consensus 2021 also coincidences with the flash crash in May 2021.
It actually makes sense as people tend to lose their independent thinking in a crowd and optimism or pessimism is contagious in these conferences. Insitututions are made up of humans. They are not free from human errors!
Disclaimer: Not investment advice. The author holds both BTC and ETH.
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