The Biggest Question in Crypto: What’s it worth?

A brief and broad approach to crypto investing.

As the crypto markets appear to find support after last week’s purge, there are a lot of open questions:

1. Will inflation cause the US to raise interest rates, thereby lowering liquidity (and thus prices)?

2. What will US regulation look like?

3. What’s the right valuation for all this?

On the first point, inflation risks are very reasonable, and I can’t say for sure whether last week’s sell-off priced that in since it seems like that may have been largely retail sellers.

US regulation seems a little more positive. Tax controls are inevitable, but I would bet on securitization being inevitable as well. I’ve compared tokens to stocks before, and I think tokens are a better version of an equity asset. It can provide value in multiple ways, and also real ownership in the form of voting in a decentralized community. Blockchain assets are also much easier to issue and track than dollars in the current US banking system.

Now, in terms of valuation, this is all pure speculation, except for one part — the base value of a token.

Determining the Base Value of a Token

Here I will call the “Base Value” the minimum price or market cap based on the demand of the service.

For a decentralized app, there are no liabilities on the balance sheet. This is still an abstract principal in practice, but we’ll start here because that’s easier.

If there are no liabilities then the asset is simply worth its revenue, which is roughly equal to its demand in the market. So right now we’re saying Market Cap = Revenue = Demand.

Yes, Joe, an asset is worth what people will pay for it, great. But wait, there’s more…

Actually, there’s not. Decentralized apps are basically just pieces of code on the internet that anyone can use simply by paying the cost of the transaction (ie: the cost of the electricity for the network to process your request (ie: pennies in a Layer-2 network)).

This creates a very low base token value, or minimum market cap, aka the total required value to execute requests on the network.

Other Factors

0. [Recap] The Service: Most tokens are required to use the namesake service, giving it a clear, tangible, but small Base Value.

1. Token Burns: Like stock buy-backs (which also occur in Crypto), token burns are when some of the existing supply is destroyed, which of course increases the value of remaining tokens. This is not currently a major factor in the crypto markets.

2. Governance: This is the big one. If there’s a public service that a lot of people use, having a say in how it functions holds real value. There are takeover specialists like Bill Ackman that could make their way into crypto if networks aren’t secured. And in the case of most new chains (not Bitcoin), network security is tied to ownership.

So what is the Value of Governance?

This is where the math gets out of my depth, but in theory I’d tie it to the value of the assets being moved on the network; more generally, the value of governance is whatever the traded assets are worth to the network’s participants.

To me, this lends itself towards a network like Stellar, which is positioning itself as perhaps the world’s leading money-mover. Chainlink, which dominates a crucial space in connecting crypto to the traditional in a data sense, and others that clear a fill niche (including developer chains like Ethereum and Cardano). This sounds in theory like how companies are valued today but it’s different.

Companies on the stock market are only beholden to shareholders, so while in theory they have to improve as businesses, what it means to “improve as a business” is muddy at best.

For these crypto assets, it’s really about being efficient and valuable to your users, and that’s going to drive high demand for governance rights, which in turn will determine the real winners in Crypto assets.

Disclaimer

The highly speculative nature of Crypto is a feature, not a bug. Crypto allows retailers to get into very early stage projects, but that comes with risk. This is simply a framework for thinking about which tokens to invest in. That is, tokens that not only fill a clear need, but those that are actually fully decentralized (maximizing the value of governance), and who’s service involves assets that are highly valued to the network’s participants (money, data, etc.).

As always, the competence of the project team, their competitors, and a good mix of luck all play a factor.