The valuation of crypto assets has been a subject of debate for almost as long as they existed. While late Charlie Munger didn’t hide his disdain for anything crypto, dubbing Bitcoin (CRYPTO: BTC) as "more expensive rat poison," digital assets evolved like any other following the price discovery process.
Changing prices based on fundamental economic principles also meant these assets could be studied and evaluated like traditional ones. In the absence of a comparative regulatory framework, this approach has become invaluable to many retail and institutional investors who are increasingly looking to diversify their portfolio holdings.
CFA Institute’s researchers tackled these issues in their latest guide, developing a comprehensive classification and best evaluation practices based on the asset subtype.
The first group consists of basic cryptocurrencies, with Bitcoin being the most prominent example. In a comparison to traditional assets, this group would correspond to basic money. The purpose behind it is to transfer value, and its demand comes from the utility as a means of exchange, store of value, or a unit of account.
Money-comparable assets often use the total addressable market approach. A simple formula uses the value of the target market (size of market opportunity) multiplied by the level of penetration (reasonable market captured), all divided by fully diluted supply (21 million for Bitcoin).
This approach requires a rather accurate prediction of the target market and level of penetration, both of which are moving targets. Another limitation of this comparison is its relatability only to traditional assets, without accounting for competition from comparable crypto assets.
Another popular method is the stock-to-flow model, authored by pseudonymous contributor PlanB. This model attributes Bitcoin as a store of value owing to its scarcity, arising from its limited supply and decreasing inflation rate (decreasing amount of Bitcoin entering circulation, while total supply increases). Thus, stock (Bitcoin) increases while the flow (new minting) decreases. Yet, critics of this approach refer to gold as an example. Over the last century, gold’s total market cap fluctuated wildly while the stock-to-flow ratio remained steady at around 60, indicating a lack of correlation between the two.
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Cryptocurrencies rely on networks of users, making Metcalfe’s law applicable. This law states that the value of a network is proportional to the square of the number of nodes or members in the network. In Bitcoin’s case, active addresses would be a proxy for the number of users. Per Glassnode data, Metcalfe’s law shows a strong, positive correlation of 0.789.
Since new Bitcoins enter in circulation via mining, the cost of production model, introduced by Adam Hayes, is yet another valuation option. By considering the primary mining cost (electricity), this model states that the marginal cost should be equal to the marginal product (new Bitcoin).
Simply put, p(price) = E day / (BTC/day), where Eday equals the marginal cost of mining per day.
The second group to evaluate is smart contract platforms. These base blockchains have built-in general-purpose programmability, allowing developers to write smart contracts and launch decentralized applications. The most prominent examples are Ethereum (CRYPTO: ETH), Solana (CRYPTO: SOL), Cardano (CRYPTO: ADA) and BNB Chain (CRYPTO: BNB).
Since smart contract platforms have a fee-based model, the discounted cash flow method can be used. For example, Ethereum’s transactions have dynamic "gas" fees, calculated as the computation effort required to process the transaction. The base fee is burned, thus reducing the total supply of ETH, while the priority fee goes to the transaction validator.
If cash flow (CF) equals transaction fees + newly issued ETH,
PV = [CF1 / (1+r)1] + [CF2 / (1+r)2] + … + [CFn / (1+r)n] + TV
- PV = Present cash flow value
- CF1 = Cash flow at the end of year 1
- CF2 = Cash flow at the end of year 2
- CFn = Cash flow at n specified year
- r = Discount or required rate of return
- TV = Terminal Value
Valuing blockchain platforms as a network involves treating the native asset, such as ether on Ethereum, as the official currency of a digital “nation” or “economy.” Similar to a national currency, the appreciation of the native asset is tied to the growth of the platform. Network effects play a crucial role, with positive effects driving growth in a cyclical manner. Validators are incentivized with fees, attracting more validators, enhancing network security, and consequently attracting developers and users.
Like with Bitcoin, Metcalfe's Law is also applicable to these networks, where quantitative researchers typically use daily active addresses as active users in the network.
Transparency allows participants to assess the blockchain's performance through metrics like blockchain size, number of active addresses or number of blocks. Naturally, a growing number of developers and total value locked correlates with higher future value. Collectively, these metrics provide a comprehensive view of a blockchain platform’s health and potential for appreciation in the native token’s value.
Token economics or "Tokenomics" is the structure of cryptocurrency's economy. These variables include supply, inflation, token burns, allocation to the founding team and staking yield. These factors, which are usually outlined in a white paper before launch, offer a great relative valuation framework for investors evaluating multiple smart contract platforms.
The final group is decentralized applications. These applications with their native tokens provide a specific service or product to blockchain users — either on top of general-purpose smart contract platforms or on a dedicated application-specific blockchain.
Decentralized finance (DeFi) applications are arguably the most popular, as their ecosystem includes a broad range of financial products aiming to transform the traditional financial industry. Examples include Polymarket, TokenSets, MakerDAO, Synthetix and Uniswap.
Due to similarities with traditional finance, there are applicable metrics that transfer over.
For example, financial ratios like the market cap to net assets ratio indicate how the protocol's net assets affect its underlying value. This ratio, which is similar to the public market price-to-book ratio, equals market capitalization divided by treasury — an on-chain wallet that stores the protocol's revenue and funds future projects.
The price-to-sales ratio is yet another approach, traditionally calculated by dividing share price by sales per share. For DeFi, it equals market capitalization divided by annualized revenue. This ratio is useful for relative analysis within the sector. Other good relative comparison ratios include the price-to-fees ratio and market cap to total value locked. Finally, like other cryptoassets, DCF methodology is also applicable to decentralized applications.
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