The cryptocurrency market is rife with speculation. Over the past couple of years, the total market cap of crypto grew 23x to surpass $3 trillion. The rise of decentralized finance (DeFi) and non-fungible tokens (NFT) sectors have also sent the valuations of crypto assets skywards. So, just how do you value a crypto company?
The entire crypto industry has been growing at a fast pace, with digital assets being used around the world for investment, operational, and transactional purposes. According to a World Economic Forum survey, it is suggested that 10% of global GDP will be stored on blockchain by 2027.
Amidst all this traction and growth, venture capital funding for blockchain and crypto start-ups also grew to $32.8 billion in 2021, according to Galaxy Digital. Last year, the deal count also stood at an all-time high of over 2,000, almost twice as many as the year before.
Getting into crypto
Venturing into the crypto sector gives exposure to technological advancement, which is seen as the new iteration of the internet, the Web 3.0. Crypto provides access to new demographic groups, new users that value transparency in their transactions and possess much higher purchasing power than an average non-crypto user.
Crypto enables access to new capital and liquidity pools through traditional investments that have been tokenized and new asset classes. It also furnished options that are not available with fiat currency.
Moreover, crypto provides a new avenue for enhancing a host of more traditional activities, such as enabling simple, real-time, and secure money transfers and helping strengthen control over the capital of the enterprise. Crypto may also serve as an effective alternative to cash which depreciates over time due to inflation.
All of these use cases of crypto make them valuable, enhancing their future potential. As an investable asset, crypto has also performed exceedingly well, but volatility risks are to be considered. Crypto companies can also be taken as a proxy for tokens and replace traditional stocks in an investment portfolio.
Some of the most popular crypto companies are Coinbase, FTX, Binance, MoonPay, Circle, Gemini, Chainalysis, Paxful, Anchorage, Algorand, Fireblocks, Aave, NYDIG, Nansen, Blockdaemon, Consensys, and many more.
But how to value crypto?
A user is likely to find their way into this exciting and volatile world of crypto by either investing in crypto directly or through crypto companies, which is popular among more traditional and a bit risk-averse. But with thousands of crypto and crypto companies working on revolutionizing the financial sector, just how to determine their value? Especially in the face of mainstream adoption of crypto happening rapidly and money pouring into the market to capture this trend.
In the traditional stock market, for example, investors do valuing to calculate the fair market value of a stock to predict future or potential market prices. The purpose of valuing is to provide investors with the information to make investment decisions that meet their goals.
Investors use several methods for valuing assets and companies in traditional markets. The Price/Earnings ratio, where a company’s stock price per share is divided by a stock’s earnings per share, and asset valuation, where the market value of the company’s assets is used to determine its worth. Discounted Cash Flow is another one where a company’s future cash flow projects and discounts, with an annual rate, to determine a present value estimate.
But applying these valuation approaches to crypto has a few challenges, such as cryptocurrency and blockchain networks are not companies and do not have cash flows. There is no way to discount cash flows for crypto assets in crypto, so old models do not fit here. As such, the industry embraces new valuation methodologies such as daily active users, tokenomics, and protocol revenue.
In crypto, open-source technologies are being built, and they can be valued based on the size of the network participating in their underlying blockchain. Network size and Metcalfe’s law, a mathematical principle that the value of any network is the square of its number of participants, can be used to figure out the value of tokens.
Factor analysis is another method where crypto assets are grouped based on factors like size, quality, and service. But cryptocurrencies are new, and there is limited data present to group them into factors.
On-chain metrics also give us information about the activity across a blockchain, including transaction count, the total value of transactions, active addresses, hash rate, and fees paid. These metrics are used to then find meaningful ways to determine the value of a digital asset.
NVT ratio, calculated by dividing the market capitalization of a digital asset by the transaction value over a given period, and MVRV, the ratio between the market capitalization of a cryptocurrency to the value of tokens stuck or abandoned in inactive wallets, are two such methods.
Currently, there is no industry standard to value crypto assets or crypto companies. We are still in the early stages of development, but as a potential investor, one should be looking at the vision of the crypto project that they want to invest in, the problems they are aiming to solve, and their adoption and marketing strategy. Besides having a technically equipped team, a strong community is an essential component of a successful crypto project.
In qualitative terms, the market cap of a coin, it’s trading volume, circulating supply, and total supply help to know where the market is going. The demand and supply of a token, its utility, media coverage, and the narrative surrounding it are some other great ways to gauge the interest in a cryptocurrency project and if it has the potential to survive.
Overall, valuing crypto assets and projects is still a difficult task. Still, some of the approaches mentioned above can help individual investors and investment funds get started and determine if they’re the right investment for their financial goals.