As blockchain projects are relatively early in their business cycles, investors usually find it challenging to accurately value them. Here we would like to discuss several valuation methodologies that are commonly used in the crypto industry.
1) Stock-to-Flow (similar to Reproduction Cost)
This is mainly used to value Bitcoin or physical commodities like gold, silver, which have a scarcity of supply. This ratio reflects how many years it will take to rebuild current stock level at current annual production rate (flow).
At the moment, there are around 19,718,303 BTCs in circulation, and about 450 BTC are generated everyday (i.e.164,250 BTC per year), hence the stock to flow ratio is 19,718,303/164,250 = 120 years. This translates into a fair price of US$77,567, with one-standard-deviation range of US$43,691~137,707.
Historically, bitcoin's price has followed the stock to flow model (as shown in the chart below). And you may recall that in every 4 years, Bitcoin production is halved, causing the stock to flow ratio to increase significantly post-halving, which is expected to lead to a much higher bitcoin price under this model.
Source: s2f.hamal.nl
2) Valuation Multiples
The most commonly used valuation multiples for blockchain projects are
• Fully Diluted Market Cap/30-day Annualized Fees - Here the fee means transaction cost (gas fee) generated on a particular blockchain network from user transactions, i.e. the total tax that users paid to use this network. It is similar to the Price to Sales ratio used in equity valuation. As you can tell from the chart below, Solana (SOL), Arbitrum (ARB, the largest Ethereum Layer 2 Chain by TVL) and Ethereum (ETH) have some of the cheapest valuations among major blockchain peers based on this metric.
Source: Blockworks Research, as of 6/25/2024
• Fully Diluted Marketcap/Total Value Locked (TVL) - This is similar to Price to Book ratio used in equity valuation. Arbitrum (ARB) & Ethereum (ETH) are relatively cheap among their peers.
Source: Defillama, Mulana IM, as of 6/29/2024
• Fully Diluted Marketcap/30d Annualized DEX Volume - This valuation multiple only captures the crypto trading activities on decentralized exchanges (DEX) deployed on each blockchain network. While there are other economics activities on blockchains such as borrowing/lending, liquid staking and NFT transactions etc., DEXs as the most frequently used dApps and play a dominant role in most of the blockchain ecosystems. This metric is equivalent to Marketcap to Gross Merchandise Value (GMV) ratio commonly used in the valuation of internet platforms. Arbitrum (ARB) and Solana (SOL) are among the cheapest in this metrics thanks to strong DEX trading activities within their respective ecosystems.
Source: Blockworks Research, as of 6/25/2024
• Full Diluted Marketcap/30d Active Accounts - This is similar to Marketcap to Monthly Active Users (MAU) ratio that is commonly used in the valuation of internet companies. The shortcoming of this metric is that it only captures the active accounts that have directly interacted with dApps deployed on the mainnet. As more blockchains such as Ethereum (ETH), Optimism (OP), Avalanche (AVAX) are primarily expanding through Layer 2 or subnet solutions, this metric may not provide a complete picture of the user engagement and adoption within their ecosystems.
Source: Coinmarketcap, Artemis, Mulana IM, as of 6/29/2024
Besides the horizontal comparison among blockchain peers, it is also helpful to track the historical trend of these valuation multiples over time, to see whether a blockchain project is relatively undervalued or overvalued compared to its own historical average.