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Four Types of Valuation Models

"Have you heard of Bitcoin?"
No doubt you have, and it's likely you've not only heard of it, but you've heard of it in the form of this question 100 times over the last year. In fact, second to any mention of Donald Trump, this question may be the most tired phrase of 2017.
But if you had asked this question even a year ago, you would have gotten near-unanimous no's. In fact, seven years ago today, Bitcoiin had just reached its first 'bubble.' At $31.00, Bitcoin was certainly overvalued, the market said. And over the following 6 months, its price dropped back down to $2.00. Looking back, we think "Wow, what an opportunity, imagine if I'd bought it back then." And hindsight is 20/20, but how could we have known?
Well, this is the question some are now asking within the cryptocurrency community, and on Wall Street, albeit less publicly. Now I'll assume you've heard of Bitcoin, and are aware of the existence of thousands of other cryptocurrencies. Believe it or not, you probably know as much if not more about the tech than most people who are already invested.
Investment in cryptocurrency is a global phenomenon with few barriers to entry. This has brought those wiith no background in investing into the market, and because of that, the ways people value each 'currency' varies, especially in complexity. They use different heuristics which roughly fit four categories. I call them tiers, paradigms, levels - they're the lenses through which investors look at cryptocurrencies.
Tier One is a surface glance at a cryptocurrency and looks exclusively at price. Crypto markets saw a rush of presumably novice investors jumping on the bandwagon to invest in Ripple (XRP) and Cardano (ADA), two of the lowest priced cryptocurrencies because of their relatively high circulating supply, which results in a high market cap (although what crypto enthusiasts call market cap is more accurately monetary base). Most websites that provide historical price info for cryptocurrencies rank by market cap. This leads us to the next tier of crypto valuation.
Tier Two is a little more complex, but still an 'at a glance' kind of valuation. Investors with a "Tier Two" lens are looking at market cap relative to other cryptocurrencies', particularly to market caps of a currency's competitors. For example, blockchains in the cloud computing space have 3 main players: Golem (GNT), with a monetary base of $287.6 million, (RLC) at $65.8 million, and SONM (SNM) with a total value of $51.7 million for the entire outstanding supply of all SONM tokens - the currencies required to use the SONM network. Analysts might note that RLC has an excellent team and little marketing to date, or that SONM is going after a different market of service providers by leveraging smart devices.
Tier Three models begin to look at the factors which make each protocol unique and might provably affect its price. This includes mechanisms to improve the function of the network, like staking, and overtly deflationary price mechanisms like Binance (BNB)'s quarterly burn rate. There are still other mechanis ms in existence and more yet to be created which are starting to be used by developers and project leads to increase the value of a currency by some means - most fundamentally by increasing demand or decreasing supply.
Tiers One, Two, and Three all look at basic indicators in isolation, with a view of the scope of the technology's impact in view. A Tier Four view looks at a way to value a cryptocurrency by its intrinsic worth - as an economist or analyst would. Surprisingly, but perhaps not so, few people are doing this, at least publicly. One of the reasons is because the overlap of disciplines required. There are a few burgeoning thought leaders in this area, namely Chris Burniske, who co-authored Cryptoassets which gives an excellent look at the different types of cryptocurrencies with an economic and technology-focused view.
The fundamental recognition that most investors in cryptocurrencies don't have is that these are currencies, and therefore shouldn't be valued like stocks. Most don't pay dividends, and many have mechanisms to increase their price by creating demand for large quantities and locking up supply through a deposit system called staking. Stakes are essentially deposits given as collateral by network hosts who are paid to maintain the blockchain (miners), escrowed by the network to disincentivize bad actors. Burniske wrote an article which factors these in with his own assumptions in the resulting model - a good read, but a little more math-heavy.
Burniske's model revolves around the Equation of Exchange, an economic model for valuing traditional currencies, based on M1 and other factors. Other compelling models involve the Network Value to Transactions ratio (NVT), and the number of transactions per second on a blockchain (Tx/s). Each of these approaches can be used to approximate the intrinsic value of a cryptocurrency, and are what I would call Tier Four models. Interestingly, results in each often vastly deviate from current prices. For reasons including still-rampant speculation on cryptocurrencies and insufficiently nuanced models informing most investors, we can expect this trend to continue until there are more well-thought out models, discussions, and thought leaders in the space. Until then, the faults in others' current paradigms present an excellent opportunity for the savvy analyst.
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