How To Value Crypto: A Guide To The Basics

The valuation of crypto assets has long been a topic of discussion and debate. While some critics dismiss them as “expensive rat poison,” others see them as a valuable addition to an investment portfolio. To address this issue, the CFA Institute has developed a comprehensive classification and evaluation framework based on asset subtype.

The first group of crypto assets is basic cryptocurrencies, with Bitcoin being the most prominent example. These assets function as a means of transferring value and derive their demand from their utility as a means of exchange, a store of value, or a unit of account. When evaluating these assets, the total addressable market approach is often used. This approach considers the size of the market opportunity, the level of market penetration, and the fully diluted supply of the asset.

Another popular method for evaluating cryptocurrencies is the stock-to-flow model, which attributes value to scarcity. This model suggests that assets with limited supply and decreasing inflation rates, like Bitcoin, can be seen as a store of value. However, critics point out that this model does not hold true for other assets like gold.

Cryptocurrencies also rely on networks of users, making Metcalfe’s law applicable. This law states that the value of a network is proportional to the square of the number of nodes or members in the network. For example, the number of active addresses can be used as a proxy for the number of users in the Bitcoin network.

When it comes to evaluating smart contract platforms, the discounted cash flow method can be used. This method considers the transaction fees and newly issued tokens as cash flows and discounts them to their present value. Additionally, the value of these platforms can be assessed by treating the native asset as the official currency of a digital “nation” or “economy.”

Decentralized applications, or DApps, provide specific services or products to blockchain users. These applications can be evaluated using traditional financial metrics like market capitalization to net assets ratio and price-to-sales ratio. These ratios provide insights into the underlying value and revenue-generating capabilities of the DApps.

In conclusion, the valuation of crypto assets has evolved over time, and there are now various methods and frameworks available for evaluating them. These include approaches based on fundamental economic principles, network effects, and traditional financial metrics. As the crypto market continues to mature, it is likely that more sophisticated valuation models will emerge.