As crypto investors grow more sophisticated, more digital asset valuation methods have emerged to provide investors with mathematical models to find winning investments.
Traditional company valuation models such as Discounted Cash Flow (DCF) or the Dividend Discount Model (DDM) cannot be applied to crypto assets, as they are an inherently different asset class than stocks. Hence, new valuation models are needed to provide investors with frameworks for the fundamental analysis of coins and tokens.
In this piece, our editors reviewed ten of the most commonly-used digital asset valuation methods, and how professional investors use them to make investment decisions.
|Valuation Methodology||Related to MV=PQ Equation||Observable Metric||Pro-forma Financial Model||Traditional Approach||New Crypto Asset Approach|
|Store of Value||X|
|The INET Model||X||X||X|
|Daily Active Addresses||X||X|
|Crypto Networks as Small Emerging Economies||X|
|Market-value-to-real-value ratio (MVRV)||X||X|
|Stock to Flow||X||X|
|Digital Assets as Alternatives to Traditional Businesses||X|
Digital Asset Valuation Methods
1. Store of Value (SoV) Thesis
Formula: Potential total store of value / # tokens outstanding = potential price per token.
The store of value thesis states that a digital asset’s value is a function of its ability to act as a store of monetary value for its investors and users. In other words, the more a digital currency or token can be used as a store of value, the more valuable it should become in the future.
Messari’s Qiao Wang believes that “value will ultimately accrue to [store of value] crypto assets.” For a digital asset to become a store of value, he states, they need to be immune to theft, have credibly low inflation, and a low cost of conversion.
As an example of calculating the fair value of the price of bitcoin with Store of Value (SoV) in mind, we could look at the price of gold and make the assumption that bitcoin could one day replace gold as the go-to store of value for investors.
At a current gold price of around $1,300 per troy ounce, the total value of the world’s gold bullion is around $8 trillion. Should bitcoin replace gold as a popular store of value globally and its total network value rise to $8 trillion, knowing that the total supply of coins is capped at 21 million, the price of one BTC would end up being $380,000.
Example: $8 trillion total store of value / 21 million BTC = $380,000 per bitcoin
2. Token Velocity
Multicoin Capital’s co-founder Kyle Samani computes token velocity as a function of transaction volume and average network value, generally measured annually. A high token velocity would suggest that while there is a high trading volume for a token, the value of the underlying network may not increase anywhere near the same rate.
Token velocity is calculated by dividing the total transaction volume of a digital coin or token by its average network value over the course of a year.
Formula: Token Velocity = Total Transaction Volume / Average Network Value.
Tokens that have a high velocity tend to have little utility in their networks. Hence, when comparing the token velocity of different digital assets – especially utility tokens – investors can recognize whether a platform’s adoption will actually lead to an increase in network value and, thus, the price of the network’s token in the long run.
This can be drawn from the Equation of Exchange (MV=PQ), where token velocity is a significant driver of token price.
M = size of the digital asset base
V = token velocity
P = price of the token
Q = quantity of the token
The lower the token velocity, the greater the token price is via an appreciation of M on the left side of the equation. This thesis states that tokens with low velocity will see higher prices than other digital assets.
3. Metcalfe’s Law
Another popular valuation method used in the digital asset markets is Metcalfe’s Law, which was originally used to measure communication networks. The law states that the value of a network is proportional to the square of the number of the network’s connected users.
Metcalfe’s Law can also be applied to digital asset networks, according to research by Dr. Ken Alabi. In a paper titled “Digital blockchain networks appear to be following Metcalfe’s Law,” Alabi concluded that “[blockchain] networks [are] fairly well modeled by Metcalfe’s Law, which identifies the value of a network as proportional to the square of the number of its nodes, or end users.”
To calculate the Metcalfe’s Ratio (MET) to value a digital currency network, we use Daily Active Address (DAA) as the number of connected users of the network per day and market capitalization as network value. By dividing the market cap by Daily Active Address squared, we arrive at the Metcalfe’s Ratio.
Formula: MET Ratio = Market Cap/(Daily Active Address)²
Metcalfe’s law is an excellent method to analyze the growth of a network as a function of its daily users.
4. Network Value to Transactions (NVT) Ratio
The network value to transactions (NVT) ratio measures the dollar value of digital asset transaction activity relative to network value, measured by market capitalization. The NVT Ratio is the digital currency industry’s valuation equivalent to the P/E Ratio and was developed by digital asset researcher Willy Woo in 2017.
To calculate the NVT Ratio for a coin or token, you take its market capitalization and divide it by its latest 24-hour transaction volume. The outcome is the NVT Ratio, which can then be used to compare one digital asset with another. Hence, the NVT Ratio is a relative valuation method.
Formula: NVT Ratio = Market Cap/Transaction Volumes.
In a Forbes article, Woo explained the theory behind the NVT Ratio. He stated that in the traditional stock markets, we have the P/E Ratio, which is used to value companies by looking at their share price in relation to company earnings. Since there are no earnings for digital currencies, though, a different metric is needed to value bitcoin and similar digital assets.
“[In bitcoin land] we have a price per token, but it’s not a company so there are no earnings to do a ratio. However since bitcoin at its essence is a payments and store of value network, we can look to the money flowing through its network as a proxy to “company earnings”. […] The value transmitted on the Bitcoin blockchain is closely tied to its network valuation. The idea that we can use the money flowing through the network as a proxy for network valuation is valid. We can express this as a ratio. I call it NVT Ratio, short for Network Value to Transactions Ratio,” Woo wrote.
Therefore, a high NVT ratio for bitcoin (or any other digital currency) would indicate a high speculative value as the price is high in relation to its network activity. While this may indicate a bubble, it may also show that investors believe that this digital asset network will grow in utility in the future.
5. The INET Model
The INET model was created by Chris Burniske, former Blockchain Products Lead at ARK Investment Management, and currently a partner at Placeholder, a New York venture firm that specializes in cryptoassets.
INET is a fictional token that was created as a placeholder for whatever digital asset is actually being evaluated or analyzed.
Formula: Download the sample spreadsheet here.
The INET model is a detailed financial model that estimates the value of a token using the Monetary Equation of Exchange (MV=PQ), also called The Quantity Theory of Money by economists. This can be seen above in the section on Token Velocity.
In the INET model, the pricing of tokens is broken down even further into two additional components. These are the Current Utility Value (CUV) and the Discounted Expected Utility Value (DEUV). CUV represents the value associated with current utility and usage of the token, and DEUV represents the value of the token associated with investment speculation.
The current value of any token can thus be modeled and projected into the future through the use of a variety of inputs, including:
- Supply-side drivers;
- Token adoption;
- Market saturation growth rate;
- Token demand;
- Token velocity.
It is also possible to model and estimate the influence of CUV and DEUV on token price.
Based on the Monetary Equation of Exchange (MV=PQ) any token (INET) price is equal to the future projected monetary base (M) divided by the number of circulating coins at that future date. M is calculated as equal to PQ/V, where PQ is the value of on-chain transaction value, also considered network GDP, and V is token velocity.
In this model, velocity is a crucial input value, and the assumptions made regarding velocity means the model suffers from drawbacks related to token velocity and its interaction with other factors, including the fact that velocity cannot be measured or defined precisely. This is also true for the other variables in the equation, and when velocity changes recording that change as it relates to P, Q, and M is often arbitrary.
6. Daily Active Addresses/Users (DAA)
Daily Active Addresses (or Daily Active Users) is an indication of how many users are conducting transactions on a blockchain network on a daily basis. It is also called daily active users. (Note: a single user could be conducting transactions using several different addresses, so it probably overcounts.)
Example: See this Dune Analytics dashboard for DAA for popular DeFi tokens.
The DAA metric is often used to measure the number of users of a software platform (called DAU in this case) and it can provide very useful data regarding the users of a network. This data can help detect emerging and continued trends and is complimentary to Metcalfe’s law and the Network Value to Transaction (NVT) ratio.
7. Crypto-networks as Small Emerging Economies
Another interesting idea put forward by Placeholder partner’s Chris Burniske and Joel Monegro in a VC thesis paper is that crypto-assets can potentially be evaluated in much the same way economists evaluate the currencies of small emerging market countries. (Listen to the podcast here.)
In the case of a cryptoasset, the consensus protocol used can be considered similar to the constitution of a country. The blockchain community is then similar to the constituency of the country, with the users being the demand side of the economy and the miners being the supply side. The core developers are similar to the executive branch of government who execute the code based on the approval of the community. The tokens are the same as the country’s currency, and investors buy and sell the tokens based on how attractive the project is, the same way investors buy and sell fiat currencies based on how attractive the small EM country is.
Whether we’re discussing cryptocurrencies or fiat currencies, investors look for the same features such as productivity, a good degree of equality, low corruption, good governance, and sound monetary policy. Interest rates also play a part in the case of an EM country, and they can also play a part in proof-of-stake currencies, which have a return on investment similar to an annual return.
8. Market Value to Real Value Ratio(MVRV)
MVRV ratio was created back in 2018 by David Puell and Murad Mahmudov. This came after Nic Carter presented the concept of a realized cap in the same year. As its name suggests, the MVRV is the ratio of an asset’s market capitalization to its realized capitalization, calculated by dividing the former by the latter.
The market cap of bitcoin, for example, is the total number of mined bitcoin multiplied by the latest trading price. The realized cap is calculated by individually valuing each bitcoin unit at the last price transacted on-chain.
When comparing these two metrics, the MVRV ratio is used to get a sense of when the price is below or above the “fair value,” therefore helping to locate market tops and bottoms.
David Puell states, “Realized value helps us eliminate some of the lost, unused, unclaimed coins from our total value calculations”. He goes on to explain, “It is an indicator of the sum of levels where groups of long-term, legit, buyer-hodlers entered into their Bitcoin positions, with local and immediate emotions and manias stripped out.”
MVRV has a similarity to Willy Woo’s NVT in that it also tracks interaction between market actors, that is, the hodlers vs speculators, high time preference vs low time preference, and Irrational exuberance vs. uncertainty acclimation.
A low MVRV ratio would therefore indicate an assets undervaluation. In contrast, higher ratios would indicate overvaluation due to hype-based excitement.
9. Stock to Flow
Stock to flow model is used to value scarce commodities like platinum and gold. Since bitcoin fits the “scarce” description, due to its limited supply, this model can also apply to digital assets.
Stock is the existing supply of a token: for example, the total number of bitcoin mined to date. Flow is the annual rate of production, that is, the number of tokens mined in a year. The ratio of the two is stock-to-flow (S2F). The higher the value, the more scarce the substance.
This model was popularized by a Dutch investor going by the pseudonym Plan B, in his attempt to price bitcoin in proportion to its scarcity. In an article, Plan B expands on the fixed nature in the supply of bitcoin whereby blocks are new blocks are created every 10 minutes. The newly created coins in a block, Subsidy, started at 50 bitcoin and halved every 210,000 blocks (approximately four years).
He adds, “That’s why ‘halvings’ are very important for bitcoin money supply and SF. Halvings also cause the supply growth rate (in bitcoin context usually called ‘monetary inflation’) to be stepped and not smooth.”
In Plan B’s argument, scarcity directly drives value. Additionally, stock to flow is directly proportional to the market value such that market value tends to be higher when the stock to flow is high.
Digital Assets as Alternatives to Traditional Businesses
This model explores the system of using digital assets to track the value and performance of real-world businesses. These digital assets are venture capital investments from a business operator’s perspective. For instance, Brave browser, a direct competitor to Google Chrome, awards internet users for watching advertisements. The rewards are given out as the Basic Attention Token, or BAT (currently a $2.5+ billion market cap).
Also, Binance Coin ($102 billion market cap) is a direct benefactor of the buzz created by the Binance company, the leading crypto exchange worldwide. This leads some investors to view holding BNB as a proxy for investing in Binance, the company. (BNB holders also receive additional benefits, like reduced transaction fees on the Binance platform.)
When valuing tokens from this perspective, it’s helpful to look at the underlying blockchain protocol or project as a “company,” even though it may not be structured as a traditional company. This is the approach we take at Bitcoin Market Journal (see our Investor Scorecard for more details.)
Principles of Crypto Asset Valuation
Here are a few principles we’ve learned from valuing and analyzing thousands of blockchain projects over the past several years.
Price on Intrinsic Value, Not Short-Term Volatility
Just like other investments, crypto assets should be valued as a long-term investment (5+ years). Like traditional value investors, we look for projects that are likely to become leaders in their category, then we patiently wait. (See our guide on Value Investing in Blockchain.)
Include a Liquidity Risk Discount
Due to the thinly traded (low volume/high volatility) nature of most digital assets, the wise path is to apply a discount between 0-90%, depending on the asset. For riskier altcoins, you may not be able to sell when you want to, so they get a higher discount. For the top 10 tokens on CoinMarketCap, you’re probably fine (though don’t forget fees — see our guide to Avoiding Fees).
Valuation Frameworks Should Be Consistent
It’s difficult to measure different types of crypto assets: an NFT is very different from an exchange token. So you want frameworks that can help you compare “apples to apples.” Our free Blockchain Investor Scorecard is a useful tool to look at very different crypto investments, and come up with a common 1-5 star rating for each.
Digital Assets are Different
Crypto assets come in all shapes and sizes. Digital currencies like bitcoin, Litecoin, and Monero are quite different from blockchain platforms like Ethereum, Solana, and Avalanche. It helps to use a few different valuation models, looking at potential investments through different “lenses.”
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