Original Article Title: "Exploring Cryptocurrency Valuation Models"

Original Article Author: 0xCousin, IOBC Capital

Crypto has become one of the most dynamic and promising sectors in the fintech field. With the influx of institutional funds, properly valuing Crypto projects has become a key issue. Traditional financial assets have mature valuation systems, such as Discounted Cash Flow (DCF) Model, Price/Earnings (P/E) ratio, etc.

Crypto projects come in various forms, including public blockchains, CEX platform tokens, DeFi projects, meme coins, etc., each with their own characteristics, economic models, and token utility. It is necessary to explore valuation models that are suitable for each track.

1. Public Blockchains—Metcalfe's Law

Law Interpretation

The core idea of Metcalfe's Law is that the network value is proportional to the square of the number of nodes.

V = K*N² (where: V is the network value, N is the number of valid nodes, K is a constant)

Metcalfe's Law is widely recognized in value prediction for internet companies. For example, in the independent research paper "On the Value of Facebook and China's Largest Social Network Company Tencent (Zhang et al., 2015)," over a 10-year statistical period, the value of these companies exhibited the characteristics of Metcalfe's Law with respect to the number of users.

ETH Example

Metcalfe's Law also applies to the valuation of blockchain public chain projects. Western scholars have found that the Ethereum market capitalization has a logarithmic linear relationship with daily active users, which closely fits the formula of Metcalfe's Law. However, the market value of the Ethereum network is directly proportional to the users to the power of 1.43, with a constant K of 3000. The calculation formula is as follows:

V = 3000 * N^1.43

Statistically, the Metcalfe's Law valuation method shows some correlation with the ETH market trend:

Chart showing the logarithmic trend:

Limitation Analysis

Metcalfe's Law has limitations when applied to emerging public blockchains. In the early stages of public chain development, the user base is relatively small, making it less suitable for valuing based on Metcalfe's Law, such as early Solana, Tron, etc.

Furthermore, Metcalfe's Law also fails to reflect the impact of staking rates on token prices, the long-term effects of Gas fee burn under the EIP1559 mechanism, and the potential game theory of the public chain ecosystem based on Security Ratio to TVS (Total Value Secured), among others.

II. CEX Platform Tokens - Profit Buyback & Burn Model

Model Analysis

Centralized exchange platform tokens are similar to equity tokens, related to exchange platform revenue (transaction fee revenue, listing fees, other financial services, etc.), the development of the public chain ecosystem, and the exchange platform's market share. Platform tokens generally have a buyback and burn mechanism and may also incorporate the Gas Fee Burn mechanism found in public chains.

Valuing platform tokens requires considering the overall platform revenue, discounting future cash flows to estimate the intrinsic value of platform tokens, and also considering the platform token's burn mechanism, necessitating the assessment of its scarcity changes. Therefore, the price movement of platform tokens is usually related to the exchange platform's transaction volume growth rate and the platform token's supply reduction rate. The simplified Profit Buyback & Burn Model valuation method calculation is as follows:

Platform Token Value Growth Rate = K*Transaction Volume Growth Rate*Supply Burn Rate (where K is a constant)

BNB Example

BNB is the most classic exchange platform token. Since its inception in 2017, it has received widespread acclaim from investors. The empowerment of BNB has gone through two stages:

· Stage One: Profit Buyback - From 2017 to 2020, Binance used 20% of its profits each quarter to buy back and burn BNB tokens;

· Stage Two: Auto-Burn + BEP95 - Starting in 2021, the Auto-Burn mechanism was implemented, no longer referencing Binance's profits but instead calculating the burn amount based on BNB's price and the quarterly block count of the BNB Chain through a formula; additionally, there is a real-time burn mechanism through BEP95 (similar to Ethereum's EIP1559). 10% of each block's reward is burned, and as of now, a total of 2,599,141 BNB has been burned through the BEP95 mechanism.

The Auto-Burn mechanism calculates the burn amount based on the following formula:

Where N is the BNB Chain quarterly block production, P is the quarterly average price of BNB, and K is a constant (initial value is 1000, adjusted via BEP). Assuming a 40% Binance trading volume growth rate in 2024 and a 3.5% BNB supply burn rate in 2024, with a constant K of 10, we have:

BNB Price Growth Rate = 10 * 40% * 3.5% = 14%

This means that based on this data, in 2024 compared to 2023, BNB should increase by 14%.

From 2017 to date, a total of 5952.9 million BNB have been burned, with an average quarterly burn of 1.12% of the remaining BNB.

Limitation Analysis

When applying this valuation method in practice, it is important to closely monitor changes in the market share of the trading platform. For example, if a trading platform's market share continues to decline, even if its current profit performance is acceptable, future profit expectations may be affected, leading to a decrease in the valuation of the platform's token.

Regulatory policy changes also have a significant impact on the valuation of CEX platform tokens, as policy uncertainty may alter market expectations for platform tokens.

III. DeFi Project — Token Cash Flow Discounted Valuation Method

DeFi projects adopt the Token Cash Flow Discounted Valuation Method, where the core logic lies in forecasting the future cash flow that the token can generate and discounting it to its present value at a certain discount rate.

Where FCFt is the free cash flow of year t, r is the discount rate, n is the forecast period, and TV represents the Terminal Value. This valuation method is used to determine the current value of a token based on the expected future earnings of the DeFi protocol.

Using RAY as an Example

In 2024, Raydium's Revenue was $98.9m. Assuming a 10% annual growth rate, a 15% discount rate, a forecast period of 5 years, a perpetual growth rate of 3%, and a 90% FCF conversion rate.

Future Five-Year Cash Flows:

Future Five-Year Discounted FCF Sum: $390.3m

Terminal Value discounted to $611.6m

DCF Total Valuation = TV + FCF = $611.6m + $390.3m = $1.002B

RAY's current market cap is $1.16B, which is relatively close. Of course, this valuation is based on a 10% annual growth rate over the next 5 years. In reality, in a bear market, Raydium is likely to experience negative growth, and in a bull market, the growth rate may be higher than 10%.

Limitation Analysis

The valuation of DeFi protocols faces several challenges:

First, governance tokens generally do not capture the protocol's revenue value. To avoid being classified as securities by the SEC, they cannot directly share dividends. Although there are ways to mitigate this risk (such as staking rewards, buybacks, burns, etc.), the incentive for DeFi protocols to distribute profits to tokens is insufficient;

Second, predicting future cash flows is extremely difficult due to rapid market shifts between bull and bear markets, significant cash flow volatility for DeFi protocols, fierce competition, and changing user behavior;

Third, determining the discount rate is complex and requires considering various factors such as market risk and project risk. Different discount rate choices can have a significant impact on the valuation result;

Fourth, some DeFi projects employ profit buyback and burn mechanisms. The implementation of such mechanisms can affect token circulation and value. DeFi tokens with such mechanisms may not be suitable for valuation using cash flow discounting methods.

IV. Bitcoin - Comprehensive Consideration of Multivariate Valuation

Mining Cost Valuation Method

Statistics show that over the past five years, the percentage of time Bitcoin's price has been lower than the mainstream mining machine's mining cost is only about 10%. This clearly demonstrates the significant role of mining cost in supporting Bitcoin's price. Therefore, Bitcoin's mining cost can be seen as the price floor of Bitcoin. Bitcoin's price has only been lower than the mainstream mining machine's mining cost for a small percentage of time, and historically, these periods have been excellent investment opportunities.

Gold Substitute Model

Bitcoin is often seen as "digital gold," capable of substituting for some of gold's "store of value" function. Currently, Bitcoin's market cap represents 7.3% of the gold market cap. If this ratio were to increase to 10%, 15%, 33%, 100%, the corresponding Bitcoin prices would reach $92,523, $138,784, $305,325, $925,226, respectively. This model is based on the analogy of their store of value properties and provides a macroscopic perspective for Bitcoin valuation.

However, Bitcoin and gold still have many differences in terms of physical properties, market perception, use cases, etc. Gold has become a globally recognized safe-haven asset over thousands of years, with widespread industrial use and physical backing; whereas Bitcoin is a virtual asset based on blockchain technology, with its value stemming more from market consensus and technological innovation. Therefore, when using this model, it is necessary to fully consider how these differences may affect Bitcoin's actual value.

Conclusion

This article aims to advocate for finding valuation models for crypto projects to promote the sustainable development of valuable projects in the industry and attract more institutional investors to allocate to crypto assets.

Especially in bear markets, only the most rigorous standards and simplest logic will do, in order to find projects with long-term value. Through reasonable valuation models, just like capturing the "bubble burst" of Google and Apple in 2000, one can unearth the "Google and Apple" of the crypto space in bear markets.

Original Article Link

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