Benchmarking Crypto Valuations
Cryptoassets pose an interesting challenge from a valuation point-of-view. They combine some properties of currencies, commodities and equities, but don’t quite meet the definition for any of them. The lack of immediate, underlying utility makes valuation attempts even more challenging.
So far, I have seen three broad approaches for valuing cryptoassets. The first uses the equation of exchange (MV=PQ) under the assumption that cryptoassets are a medium of exchange. The challenge with this approach is that, at least today, cryptoassets linked to blockchain protocols (like Bitcoin and Ether), aren’t really used as a medium of exchange to buy real-world products. They are a store of value, but mainly because they are viewed as speculative assets or used as a medium of exchange to purchase other speculative cryptoassets built on top of protocols. In other words, their value is tied to the value of speculative assets further down the value chain, i.e. decentralized apps (DApps) with linked crypto tokens.
There are two other methods of relative valuation, using ratios, that can be used to value downstream DApps and tokens. These have been used to value cryptoassets before, but these valuations have only been compared with other cryptoassets. However, these ratios are applicable to some of today’s tech companies as well and these benchmarks should serve as invaluable reality checks.
Network Value to Transactions (NVT) Ratio
The network value to transactions (NVT) ratio is easy to comprehend. It is a simple ratio of the value of a cryptoasset to total daily transactions recorded on it.
NVT is most relevant for DApps where the transactions reflect utility or real-world usage of the token. While NVT is also used to value protocols today, the money supply argument above still applies, i.e. it only makes sense if the protocol transactions themselves have real-world utility. Today, most protocol transactions are either speculative or speculation enablers, i.e. the number of transactions imply represents scale of speculation rather than utility.
NVT’s applications lie well beyond the crypto ecosystem. Technically, it can be used to value any asset or company where transactions are associated with real-world utility. A great example here is PayPal. And luckily, Paypal’s transaction and valuation history stretches back over 15 years.
PayPal’s NVT ratio has remained remarkably consistent over its history. However, the NVT ratio for cryptoassets is about 200x higher, i.e. token usage (or transactions) would need to increase by 200x to justify today’s prices if we use PayPal as ground truth. Given how early crypto is in the technology adoption cycle, I would normally expect a higher valuation multiple. But not by an order of magnitude. Any asset worth billions must be able to stand up to scrutiny.
Network Value to Metcalfe (NVM) Ratio
The second ratio is slightly more complex than NVT and is based on Metcalfe’s law. Metalfe’s law is largely a mathematical representation of network effects and states that the value of a network is proportional to the number of unique connections it enables, i.e. roughly equivalent to the square of number of nodes (users). Consequently, the network value to metcalfe (NVM) ratio is the ratio of the value of a cryptoasset to the square of average daily active users.
Since this ratio is based on network effects, it can be applied to any product that exhibits bidirectional network effects between a homogeneous set of network participants, e.g. social media companies like Facebook and Snap.
Facebook and Snap’s pre-IPO NVM was set between 3.5 x 10^-7 and 19.8 x 10^-7. Based on these benchmarks, token adoption would need to increase by a factor of 3000x to justify today’s prices. Again, the fact that social media is well ahead of crypto in the technology adoption curve can justify a higher valuation multiple, but not by an order of magnitude when discussing assets valued at billions.
Even after applying appropriate handicaps, token adoption and usage would need to increase between 100x to 1000x to justify today’s market cap. This provides a striking contrast with the following comment from Ethereum co-founder, Vitalik Buterin:
The blockchain space is getting to the point where there’s a ceiling in sight. If you talk to the average educated person at this point, they probably have heard of blockchain at least once. There isn’t an opportunity for yet another 1,000-times growth in anything in the space anymore.
Given the gap between current valuations and the level of utilitarian adoption, I politely disagree.
Originally Published at Tech Thoughts.