Cryptocurrency is an extremely difficult asset class to value due to its lack of traditional valuation metrics typically used in a Discounted Cash Flow valuation method. Unlike companies, crypto assets do not have revenue, cash flow, or profit to help evaluate its fundamental worth.
This article will quickly cover how to value crypto assets using a method originally proposed by Chris Burniske using the formula “MV=PQ” or the equation of exchange.
Equation of Exchange Explained
Originally derived by John Stuart Mill, the equation of exchange is typically used to find the value of currencies in relationship to its key statistics. Modified for crypto assets, the equation and its variables can be understood as:
How to Use The Equation of Exchange for Crypto Assets
When trying to make a valuation for a crypto asset, Burniske mostly setups up the equation of exchange to solve for M, which is the size of the monetary base necessary to support a cryptocurrency of size PQ at velocity V.
Once altered to solve for the equation for M, the equation of exchange looks like M = PQ/V.
Price or P does not represent the price of the crypto asset but instead the price of the resource being provisioned by the cryptonetwork. In the case of decentralized applications such as Golem or Filecomin, P is based on the cost of services of the crypto such as cost of storage for Filecoin and cost of computing power for Golem. P does not represent the actual price of the crypto asset. Burniske has admitted solving for P for purely digital currencies such as Bitcoin or Litecoin is incredibly tedious and abstract so this article’s purposes it won’t be covered.
Velocity or V represents the number of times an asset changes in a given time period. By rearranged the equation of exchange, we can solve for velocity of an asset : V = PQ/M. For clarification purposes, one could take the amount of money the Bitcoin network processed throughout transactions for the entire year and divide it by the average size of bitcoin’s asset base through the entire year to solve for velocity of the asset.
Although the equation of exchange is often setup to solve for M or size of an asset base to valuate cryptocurrencies, any four the other variables can be solved for by estimating inputs for other three variables.
Burniske has acknowledged that his modified equation of exchange still needs more data over a much longer period to adequately evaluate its accuracy. Despite its lack of track record, Burniske’s modified equation of exchange is one of few published models that attempts to valuate crypto assets.