Exploration of crypto asset valuation model

Crypto has become one of the most dynamic and potential sectors in the fintech field. With the entry of many institutional funds, how to reasonably value the Crypto project has become a key issue. Traditional financial assets have mature valuation systems, such as cash flow discount model (DCF Model), price-to-earnings ratio valuation method (P/E), etc.

There are many types of Crypto projects, including public chains, CEX platform coins, DeFi projects, meme coins, etc. They each have different characteristics, economic models and token functions. It is necessary to explore valuation models that are suitable for each track.

1. Public chain-Metcalf 's law

Law analysis

The core content of Metcalfe's Law: The value of the network is proportional to the square of the number of nodes.

V = K*N² (where: V is the network value, N is the number of valid nodes, and K is a constant)

Metcalf's Law is widely recognized in the value prediction of Internet companies. For example, in the paper "Independent Research on the Value of Facebook and Tencent, China's largest social network company (Zhang et al., 2015), the value and number of users of these companies showed the characteristics of Metcalf's Law over a decade of statistical time.

ETH instance

Metcalf's law also applies to valuation of blockchain public chain projects. Western scholars have found that Ethereum market value is in a log-linear relationship with daily active users, which is basically fitted with the formula of Metcalfe's law. However, the market value of the Ethereum network is proportional to the user's N^(1.43), and the constant K is valued at 3000. The calculation formula is as follows:

V = 3000 * N^1.43

According to statistics, Metcalf's law valuation method does have some correlation with ETH market value trend:

Logarithmic trend chart:

Limitation analysis

Metcalf's law has limitations when applied to emerging public chains. In the early stages of the development of public chains, the user base was relatively small and it was not suitable for valuation based on Metcalfe's law, such as early Solana, Tron, etc.

In addition, Metcalf's law cannot reflect the impact of the staking rate on token price, the long-term impact of Gas fee burn under the EIP1559 mechanism, and the possible game of the public chain ecosystem on TVS (Total Value Secured) based on Security Ratio.

2. CEX platform coins—profit repurchase and destruction model

Model analysis

The centralized exchange platform currency is similar to the equity token, and is related to exchange income (transaction fee income, currency listing fees, other financial businesses, etc.), the development of the public chain ecosystem, and the exchange market share. Platform coins generally have a repurchase and destruction mechanism, and may also have the Gas Fee Burn mechanism in the public chain.

The valuation of platform coins requires consideration of the overall revenue of the platform, discounting future cash flow to estimate the intrinsic value of platform coins, and also considering the destruction mechanism of platform coins, which requires measuring its scarcity changes. Therefore, the rise and fall of platform coins are generally related to the trading volume growth rate of the trading platform and the reduction rate of the supply of platform coins. The simplified valuation calculation method of the profit repurchase and destruction model:

Platform coin value growth rate = K* transaction volume growth rate * supply volume destruction rate (where K is a constant)

BNB Example

BNB is the most classic exchange platform currency. Since its birth in 2017, it has received widespread praise from investors. The empowerment method of BNB has gone through two stages:

Stage 1: Profitable repurchase-- From 2017 to 2020, Binance repurchased and destroyed BNB with 20% of its profits every quarter;

Phase 2: Automatic Destruction +BEP95 - The Auto-Burn mechanism will be implemented in 2021. It will no longer refer to Binance profits, but will calculate the destruction based on the formula based on the price of BNB and the number of BNB Chain quarterly blocks; in addition, there is a BEP95 real-time destruction mechanism (similar to Ethereum's EIP1559). 10% of Reward of each block will be destroyed. As of now, 2599,141 BNBs have been destroyed by the BEP95 mechanism.

The Auto-Burn mechanism calculates the amount of destruction based on the following formula:

Among them, N is the quarterly block output of BNB Chain, P is the quarterly average price of BNB, and K is a constant (the initial value is 1000, adjusted by BEP).

Assuming that the Binance transaction volume growth rate is 40% in 2024 and the BNB supply destruction rate in 2024 is 3.5%, and the constant K is 10, then:

BNB Value Growth Rate = 10*40%*3.5% = 14%

That is to say, according to this data, BNB should rise by 14% in 2024 compared with 2023.

Since 2017, more than 5952.9w BNBs have been destroyed, with an average of 1.12% of the remaining BNBs being destroyed each quarter.

Limitation analysis

When using this valuation method in actual operations, it is necessary to pay close attention to changes in the exchange's market share. For example, if the market share of an exchange continues to decline, even if its current profit performance is acceptable, future profit expectations may be affected, thereby reducing the valuation of the platform currency.

Changes in regulatory policies also have a great impact on the valuation of CEX platform coins, and policy uncertainty may lead to changes in market expectations for platform coins.

3. DeFi project-Token cash flow discount valuation method

The core logic of the DeFi project adopts the Discounted Cash Flow (DCF) method of token cash flow discount valuation method (Discounted Cash Flow, DCF) is to predict the cash flow that the token can generate in the future and discount it to its current value at a certain discount rate.

Among them, FCFt is the free cash flow (Free Cash Flow) in the t-th year, r is the discount rate, n is the predicted period, and TV is the final value of Terminal Value.

This valuation method determines the current value of the token by expecting future returns of the DeFi protocol.

Take RAY as an example

The Revenue of Raydium in 2024 is 98.9m. If the annual growth rate is 10%, the discount rate is 15%, the predicted period is 5 years, the perpetual growth rate is 3%, and the FCF conversion rate is 90%.

Cash flow in the next five years:

Discounted FCF in the next five years Total: 390.3m

Terminal Value Discount is 611.6m

DCF Total Valuation = TV + FCF = 611.6m + 390.3m = 1.002B

RAY's current market value is 1.16B, which is similar overall. Of course, this valuation is based on the annual growth rate of 10% in the next five years. In fact, Raydium may have negative growth in a bear market, and the growth rate may be more than 10% in a bull market.

Limitation analysis

There are several main challenges in the valuation of the DeFi protocol: First, the governance token generally does not capture the value of the agreement's revenue. In order to avoid the risk that the SEC determines as a securities, dividends cannot be distributed directly. Although there are ways to avoid (pled rewards, repurchase and destruction, etc.), the DeFi protocol has insufficient motivation to feedback profits to the token; Second, the future cash flow forecast is extremely difficult, because the market bull and bear market conversion is rapid, the cash flow of the DeFi protocol fluctuates greatly, and competitors and users' behaviors are changing; Third, the determination of the discount rate is complex, and multiple factors such as market risks and project risks need to be comprehensively considered. The choice of different discount rates will have a huge impact on the valuation results; Fourth, some DeFi projects adopt a profit repurchase and destruction mechanism, and the implementation of such mechanisms will affect the circulation and value of the tokens. DeFi tokens with such mechanisms may not be suitable for using the cash flow discount valuation method.

4. Bitcoin—Comprehensive Considerations of Multivariate Valuation Method

Mining cost valuation method

According to statistics, in the past five years, the amount of time the Bitcoin price is lower than the mining cost of mainstream mining machines is only about 10%, which fully demonstrates the important role of mining costs in supporting Bitcoin prices.

Therefore, the cost of Bitcoin mining can be regarded as the bottom limit of Bitcoin price. The price of Bitcoin is only a few times lower than the mining costs of mainstream mining machines. Judging from the past, these are excellent investment opportunities.

Gold alternative model

Bitcoin is often regarded as "digital gold" and can replace the "store of value" function of some gold. At present, Bitcoin’s market value accounts for 7.3% of gold market value. If this ratio increases to 10%, 15%, 33%, and 100%, according to the corresponding conversion, the unit price of Bitcoin will reach US$92,523, US$138,784, US$305,325 and US$925,226 respectively. This model is based on the analogy between the two in the store of value attributes, providing a macro-reference perspective for Bitcoin valuation.

However, there are still many differences between Bitcoin and gold in terms of physical attributes, market cognition, application scenarios, etc. Gold has become a globally recognized safe-haven asset for thousands of years, with a wide range of industrial uses and physical support; Bitcoin is a virtual asset based on blockchain technology, and its value comes more from market consensus and technological innovation. Therefore, when applying this model, the impact of these differences on the actual value of Bitcoin needs to be fully considered.

Summarize

This article aims to promote the search for valuation models for Crypto projects to promote the steady development of valuable projects in the industry while attracting more institutional investors to allocate crypto assets.

Especially when the market is in a bear market, we must use the strictest standards and simplest logic to find projects with long-term value. Through reasonable valuation models, just like Google and Apple that seized the "bubble burst" in 2000, they explored the "Google and Apple" in the Crypto field in the bear market.