Crypto Asset Valuation: How to Value Crypto Protocols and Blockchains
![](data:image/svg+xml;utf-8,<svg xmlns="http://www.w3.org/2000/svg" width="1200" height="675" />)
What Does Crypto Asset Valuation Mean?
Fundamental analysis is the art of valuing an asset according to its "fundamental value." In business, fundamental analysis commonly looks at:
The industry a business operates in: trends, profitability and business models.
The value proposition of the business.
Its different segments and what drives sales and profitability.
Its competitive advantage.
The impact of external forces like regulation.
Tokens and cryptocurrencies as investment vehicles are still novel compared to equities. But they are mature enough that their fundamental analysis is becoming increasingly important. However, valuing crypto assets is different from traditional assets like stocks. Here are factors you have to take into account when performing a fundamental analysis of cryptocurrencies:
The business model.
A token's competitive advantage.
The narrative and marketability of a protocol.
The community behind it.
Profit generation and revenue.
The treasury.
Tokenomics and token dynamics like emission schedules.
Security and software.
Cryptocurrencies and their valuation are thus a bit different from "traditional assets." Let's take a look at what really matters when you value crypto protocols.
What Is Important When Valuing Crypto Protocols and Blockchains?
Blockchains and blockchain protocols are permissionless, immutable, and open-source. This is a fundamental difference compared to "normal companies." Every stakeholder in the ecosystem of a blockchain protocol matters. It is important to understand their role and what makes them stay or leave because that affects a token's valuation.
Furthermore, crypto protocols are marketplaces and rely heavily on network effects. Our guide to network effects in crypto explains how network effects can decisively influence a blockchain's chances of success. Strong network effects can also be a moat.
A moat refers to a sustainable competitive advantage that a company possesses, which makes it difficult for other firms to replicate its success or to compete against it effectively. Typically, crypto protocols rely less on moats than traditional businesses because moats are barriers to entry like proprietary technology, patents, the location a business operates in, and others. Since crypto is open-source, the barriers to entry are lower. Still, a strong developer community could, for example, be considered a moat.
How To Build a Framework for Valuing Crypto Protocols
First, you need to define a protocol's market. It's important to compare apples to apples — an oracle service does not pursue the same customers as a GameFi application. Similarly, layer-one chains should be compared to other blockchains, money markets to other money markets, and so on.
Next, you need to assess the market concentration. For instance, who dominates the market for layer-one blockchains? There are several metrics you can look at, such as total value locked, transactions, monthly active users, and others. Get a rough understanding of the sector and who dominates the market.
The framework you want to build will answer two questions:
1) What are the demand-side advantages? In other words, what drives network effects?
2) What are the supply-side advantages?
Many products in crypto are multi-sided marketplaces. The more participants there are, the better the marketplace and the bigger the network effect. For example, a decentralized exchange with more liquidity attracts more traders, which attracts more liquidity, and so on.
A virtuous circle of network effects on an exchange
That is why DeFi protocols launch complementary products that facilitate their core business of token swaps and lending and borrowing services. For example, Aave's new GHO stablecoin aims to do exactly that — reduce the friction of interacting with Aave's core product.
In theory, more skin in the game (read: more liquidity on an exchange) should also lead to more security. There is a bigger incentive to audit smart contracts and patch leaks, and protocols should have bigger bounties. However, hacks are still all too common.
On the supply side, you are looking for economies of scale to provide a protocol with a competitive advantage. Ethereum scaling is a good example. It increases the chain's throughput, meaning the cost per transaction falls. The bigger the blockchain scales, the lower the transaction cost should be, which is the ideal outcome. In turn, this should attract more users, leading to bigger network effects.
There are also other supply-side comparative advantages: a big treasury that fuels marketing and business development, a strong and productive team, a tight-knit community and more.
What Are Market Metrics in Crypto and How Do They Matter?
There are several key metrics you need to know:
Circulating supply
Total supply
Market capitalization
Fully diluted value (FDV)
Total value locked (TVL)
To value crypto protocols, you have to look at the relationships between them.
The Ratio of Circulating Supply to Max Supply
The higher the ratio, the lower the outstanding token emissions are. A token that has 90% of its supply unlocked faces less selling pressure from future emissions and is thus closer to its "fair value."
The Ratio of Market Cap to FDV
This is just another way of measuring the same thing, so the same principle applies. Fully diluted value is a tricky metric that needs to be analyzed in terms of its short-term risk. If tokens are scheduled to be unlocked soon then FDV matters more than if future emissions are delayed far into the future. Furthermore, tokens may also be burned, which can increase the ratio. The emission schedule can also be fixed or dependent on reaching milestones or usage of the protocol itself, as is the case for Ethereum.
Here is a full explainer of how FDV impacts tokens in a bear market.
The Ratio of FDV to TVL
The ratio of a token's fully diluted value to the total value locked is the market value of one dollar locked in a protocol. However, TVL is another tricky metric. Issuing tokens to the market distorts the actual demand for them. For example, if you issue tokens to the users of a protocol, did they use the protocol to get the tokens, or would they have used it anyway? And how does this impact their buying behavior?
3 comments