15May 2018

The Sad State of Crypto Valuation

by Henrik Andersson

Crypto-assets are new. Some are fungible, others digitally unique, they are tradable assets that depending on their underlying code and network economics, act sometimes like money, gold, consumables, collectables, or something completely different. Our current ability to effectively value these assets is sadly very limited. Even the most respected global hedge funds make basic mistakes in crypto valuation. Too many crypto investors blindly rely on the greater fool theory and the madness of crowds.

The crypto-market is retail driven. Institutional investors have so far stayed on the sidelines. The total crypto network value is currently around US$450bn down from a recent high of over US$830bn in January. Compared to almost any other asset class this is tiny. Global equities have a market capitalisation of over US$80 trillion; bonds, over US$23 trillion; derivatives, over US$1 quadrillion. That said, many protocols are clearly massively overvalued. Today there a multi-billion dollar coins that lacks a blockchain, a network, or anything resembling a product.

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Is not really strange to have overvaluations coupled with massive potential upside. If we think of many projects like early start-ups — the big outsized returns will come from a few winners. Our job as fund managers are to managed a diversified portfolio where we are exposed to this convexity. A few winners will likely make up lion-share of returns.

With more investment pouring in, it’s increasingly important that we have frameworks to help us understand where best to put that money. Institutional investors have thus far kept their distance, but are now entering the space. Goldman Sachs recently confirmed their intention to trade in bitcoin, and ICE, the parent company to NYSE is allegedly launching a crypto platform. While there are still a number of practical hurdles to that process, such as a lack for qualified custodians for crypto assets and clarity on tax and regulation, another hurdle is a lack of trusted valuation techniques.

People like Chris Burniske, partner at Placeholder, and Thomas Lee Co-founder of Fundstrat, have done important, early, work on the value of utility tokens and network effects in blockchains. Chris Burniske rightly states that by definition each crypto-asset functions as a currency in the protocol economy it supports. Here, the equation of exchange (MV=PQ) can be used to determine the flow of money needed to support that economy, where M is the size of the monetary base necessary to support a crypto-economy of size PQ, at velocity V. Thomas Lee has worked on another equation called Metcalfe’s law. Metcalfe’s Law says that the value of a network is proportional to the square of the number of users in that network. Based on this model, Fundstrat found that 94% of bitcoin’s price moves in the last four years can be explained. Unfortunately, however, the equation is more descriptive that predictive. Another technique being use is a ratio based valuation called Network Value to Transactions, or NVT. This has been dubbed the PE ratio for crypto. The main idea behind this is to relate the price of the crypto-asset to its fundamental use, in this case the daily volume of on-chain transactions. Despite these techniques, some crypto-assets don’t fit neatly into any of these frameworks. As an example, investors are increasingly viewing Bitcoin as a form of digital commodity, or gold 2.0. In this case, valuation can be determined by looking at bitcoin as a substitute to the gold market and simply deriving how much one bitcoin would be worth if it took, say, 5% of the today’s gold market.

In general, we still need much more research around the value of these new networks. Companies like Messari are doing this by building a research database, but more needs to be done an even experts are making serious blunders in their valuations.

Multicoin Capital is a $50m hedge fund based in the US which has raised money from the likes of Marc Andreessen. They have publicly accessible research and valuation reports available on their website — a really fantastic resource. Last week I had a look at their model for 0x. Apollo Capital happens to like the 0x project (we are not currently holders of the 0x token), and this partly is due to the difficulty in valuing its native token. Multicoin produced a model attempting to do just this but due to a simple mistake their valuation overvalued 0x by a factor 2–4x. This was the conversation that followed on Twitter with the co-founder of Multicoin, Kyle Samani:

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Crypto is an area where even professional investors make simple errors which go undetected for a long time. This just doesn’t happen in more traditional markets. Going back to 0x’s web site, I found a blog post from March 26 discussing the valuation of their token:


They link back to another post by Multicoin explaining the effect of velocity, arguing that 0x will ultimately have zero value (more on that in a future post) as a utility token. All the value in 0x might instead come from it being a governance token. I think it is fair to say we just don’t know yet how to accurately value governance in blockchain networks, and that people don’t understand the effect velocity will have on the value of their utility tokens.

Binance Coin is another interesting example of the state of crypto valuation. Binance was a hugely successful ICO: after only 8 months they reported a higher profit in Q1 than 148 year old Deutsche Bank. The use of the Binance Coin is outlined in their white paper. In the first 4 years, Binance Coins gives users a discount on fees on their trading platform. After 4 years the only use of the Binance Coins will be on their yet to be built decentralised exchange.

So how do we value Binance Coin? It’s firstly important to remember that Binance is using a share of their Q1 profit to buy back up to 100M of the total 200M coins in circulation. We can now calculate the utility value for BNB the first 4 years and we can assume a circulating supply adjusted for the buyback. The problem is that, it is very hard to come up good assumptions after year 4 as there are just too many unknowns at this point. How do we not value Binance Coin? This blog post by @BambouClub is a good example. The writer applies a PE-ratio of 51 to the buyback. This of course makes no sense at all since we know there will ultimately be at least 100M coins in circulation, so we can just adjust the utility value with a lower coin count. Someone who didlike this ‘analysis’ is the young billionaire CEO of Binance, Zhao Changing, who invited BambouClub to dinner:

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The state of crypto analysis is young and in flux. Thanks to people like Chris Burniske, Thomas Lee and first like Messari and Multicoin Capital we are building the early frameworks for crypto valuation, but clearly there is still much work is still to be done in this exciting new field of finance.

Henrik Andersson

Henrik is the Chief Investment Officer at Apollo Crypto and is the fund manager for the Apollo Crypto Fund. He also acts as the fund advisor for the offshore Apollo Crypto investments funds, the Apollo Crypto Frontier Fund and the Apollo Crypto Market Neutral Fund. Henrik's expertise in traditional financial markets comes from spending a decade on Wall Street as a vice president in institutional equity sales. His exceptional understanding of DeFi comes from co-founding two successful DeFi protocols, mStable and dHEDGE.