In many respects, the new world of cryptocurrencies is the same as the old world. The cryptocurrency market may look alien to the untrained eye, but it’s a market nonetheless. Fundamental research takes a back seat and the old rules don’t apply, but the new ones aren’t that different. The whole world is waking up to the fact that despite its trials and tribulations, this new asset class is here to stay. Now, the problem is, how do we determine its worth?
In a recent Coindesk article, Tyrone Ross, OnRamp Investing CEO remarks:
“As far as literacy is concerned, the biggest trip-up for advisors is still the valuation methodology for crypto assets. There is no way to discount cash flows for crypto assets. You need to embrace new valuation methodologies like daily active users or network access. If you’re still talking about price-to-earnings ratios, discounted cash flows or the capital asset pricing model, you need to realize that those terms do not apply here. The old models don’t fit.”
The article continues: “most cryptocurrencies can be valued based on the size of the network participating in their underlying blockchain.” That’s a variation of Metcalfe's Law, whose premise is that the value or impact of a network is proportional to the square of the number of users or nodes in the network. In the Cryptonized episode titled “How to Value Crypto Tokens,” I interviewed Coordisc’s founder Noah Healy and we tried to solve the valuation problem once and for all. The thing is, we didn’t see eye to eye on the matter.
I fought for more traditional KPIs, adapted for the cryptocurrency market. For example:
I would argue that all of those factors are key, and I caution investors not to lose sight of this list when evaluating a project. Also, look for all the financial reporting you can find. Check out financial statements if they are available. Consult the project’s investments and taxation status; there might be surprises there. And always be on the lookout for new regulations anywhere on the planet. We’re in that precise moment in which rules are being written. At any moment, world-shattering news can alter your whole business plan, for better or worse.
The main reason Noah Healy believes current cryptocurrency projects aren’t viable in the long term is because they don’t prioritize sustainability. And that includes Bitcoin and Ethereum. According to the Coordisc founder, “All of our cryptographic systems will eventually fall to a combination of technological and mathematical breakthroughs.” Healy thinks that only protocols with a multi-algorithmic approach will survive. And there are none at the moment.
Besides that fatalistic notion, Healy advises that the first thing to do is “decide on your own timeframe.” Is this a long-term investment or a short play? Are you committed to studying this asset for your whole life? Healy also recommends studying the incentives. Discover them, and many questions about the project will be answered.
Besides sustainability, which is Healy’s first test that no one passed, there’s the question of management. Who’s behind the project, and what do we know about the team? Is this a legitimate project with achievable ideas? What have they done so far, and what do they plan to do? In a way, this evaluation method is not that different from my KPI-focused one.
The third factor is cultural embedding. How is this project used? What is the token’s intent? Is it, in fact, being used for that intent? Does the project have a culture behind it?
In the end, we’re looking at the same beast from different angles. Healy thinks that “the existing system is so FUD-driven” and he’s focused on private tokens at the moment. I couldn’t be more optimistic about the future of cryptocurrency. We agree on most points, though.
In an old article about the topic at hand, analyst Lyn Alden reminds us that “price is what you pay, value is what you get.” She breaks down the two most popular approaches at evaluation and explains why they don’t quite work with the cryptocurrency market:
“Most buyers and sellers of cryptocurrencies are speculating, meaning they are just looking at price charts and guessing that it may go up or down with technical analysis. Fundamental investing, on the other hand, uses a bottom-up approach to find the inherent value of something. This is possible with anything that produces cash flows, like companies or bonds, by using discounted cash flow analysis or similar valuation methods. But when something doesn’t produce cash flows, like commodities, it gets trickier.”
To “come up with a reasonable forward-looking valuation estimate for a given cryptocurrency,” Lyn proposes a three-step approach:
1. “Understand the numbers and growth rates of how many units can exist in that cryptocurrency. That’s easy.”
Say what you will about cryptocurrencies, but they’re completely auditable and their books are open 24/7. Read the tokenomics of the project you’re evaluating and make sure that the money went to where the team said it was going to go.
2. “Estimate how much economic activity or value storage will occur in total blockchain cryptocurrencies in 5-10 years. That’s hard.”
Even with Bitcoin and Ethereum, this is almost impossible to do. With newer projects, trying to estimate their economic activity is almost useless. Everybody has their reasons, but we’re all guessing to some degree. And we have to keep guessing to the best of our ability.
3. “Estimate how a given cryptocurrency will change or retain market share of total cryptocurrency usage. That’s hard.”
Once again, easier said than done. So far, the only constant is that bitcoin has been number one since its inception. Besides that, the cryptocurrency market is a never-ending bloodbath, and the darlings of yesterday no longer exist. Still, we have to keep guessing to the best of our ability.
As a rule of thumb, always check Token Sniffer before investing. It only takes a few minutes and it could save you from disaster. Their token audits will do a Swap Analysis and tell you if the coin is sellable. They’ll do a Contract Analysis and verify that the “creator is not authorized for special permission.” Token Sniffer will also do a Holder Analysis and check on the creator wallet and the burned supply. Finally, they’ll do a Liquidity Analysis and determine if the current and initial liquidity were adequate, and evaluate what percentage is “burned/locked for 15 days.”
To be sure, use the three methods described in this article and finish the process with a Token Sniffer audit. Better safe than sorry.