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Thinking about crypto valuation

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Thinking about crypto valuation

If you are asking yourself this question on how to value a crypto asset then these slides provide some framework for thinking about it. If you are not yet familiar with blockchain, bitcoin or ethereum then refer to masterclass in blockchain

If you are asking yourself this question on how to value a crypto asset then these slides provide some framework for thinking about it. If you are not yet familiar with blockchain, bitcoin or ethereum then refer to masterclass in blockchain


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Thinking about crypto valuation

  1. 1. Thinking about Cryptovaluation Thiyagarajan M (Rajan), October 2017
  2. 2. Why should you care about blockchain now ?
  3. 3. $100 in 2009 in bitcoin will be $500 million in 2017 5-6X 7% of 1 cent (1/100 $) in 2009 to $5000 on Oct 15 2017 Fastest growth of anything known to humans As 20 Oct 2017
  4. 4. Google Search Trends - Bitcoin Bitcoin Rises from $30 to $230Gawker Article About Silk Road $10 to $30 Passes $1000 first time All time at $5000 China bans ICO exchanges
  5. 5. Ethereum is the new Java $150b $30b All cryptocurrency Ethereum All India Internet Startups $60b All India B2B Software Startups Startups $8b In 10 yrs In 10 yrs In 4 yrs In 10 yrs
  6. 6. In 3rd Stage, hitting escape velocity Prototype Stage Sin Enterprise (Gambling, Black Markets) Legitimate Enterprise The Evolution of the Bitcoin Economy: Extracting and Analyzing the Network of Payment Relationships -
  7. 7. Bhajan, Gita & Veda level of thinking (Metaphor, Mental Model, First Principle)
  8. 8. Understanding - Bhajan, Gita & Veda Level ‘BHAJAN’ LEVEL ‘GITA’ LEVEL ‘VEDA’ LEVEL ‘Repeatable Metaphors’ ‘First Principle Thinking’ ‘Simple Formula/ Mental Models’ F= ma
  9. 9. Level of understanding per user type Tech Legal Business Home User Miner Trader/Investor Entrepreneur Engineer F= maF= ma
  10. 10. Crypto Assets There are about 800 crypto assets so far and new ones coming every month
  11. 11. Should bitcoin be valued like $ or gold or other other commodity ? If bitcoin does not serve the payment use case as anticipated, why is it trading at $6000 ?
  12. 12. Should an ICO token be valued like IPO stock or startup angel investment ?
  13. 13. Bitcoin like money, ICO like IPO is only a metaphor “Never confuse brains with a bull market” - Warren Buffett “All models are wrong, some are useful but some dangerous ” - NN Taleb “It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so.” - Mark Twain
  14. 14. Popular mental models break down F= ma “Never forget the six-foot tall man who drowned crossing the stream that was five feet deep on average.”- Charlie Munger Modern Portfolio Theory (Standard Deviation, Sharpe Ratio, Correlation) have several limitation already
  15. 15. Many mental models are creaky F= ma Source - Howard Marks, Oaktree Capital Volatility is not risk
  16. 16. What is value ? Use Value, Exchange Value, Symbol Value, Store Value Marx Talks about
  17. 17. Value arises from imagination of future Fear and Hunger
  18. 18. Money is story with highest belief coefficient that help in survival against both fear and hunger in the future
  19. 19. Belief/trust on Nation state as custodian of the money story is broken Alternates ? Gold, Distributed Consensus ?
  20. 20. “Bitcoin will be a store of value when everyone believes it is. The price is the current probability. Fundamental analysis is impossible. “ @naval
  21. 21. What is valuation ?
  22. 22. Estimating / forecasting the future
  23. 23. ”We have two classes of forecasters: Those who don’t know – and those who don’t know they don’t know. ” - Kenneth Galbraith
  24. 24. Startup valuations are 80% story, 20% data Startrek Journey
  25. 25. Public company valuations are 20% story, 80% data Everest
  26. 26. Innovation Accounting tracks journey of a startup to well functioning company Uncertain & Non repeatable Value Probability distribution Unknown Certain & Repeated Value Probability distribution Known Idea/Startup Large Company Takes 7-11 year journey Pivots P/M fit Power law, 1 in 10,000 succeed
  27. 27. Valuation Intrinsic Valuation Relative Valuation Early Startup Growth Startup Large Company Value using DCF (With adjusted rate of return) Value as ‘Options’ Value like DCF, (replaceCashflow with Growth rate) Use Comparables Uncertainty Risk DCF - Discounted Cash Flow Source - Aswath Damodaran
  28. 28. About Price (aka Relative Valuation) “Can’t estimate or predict the outcome of the collective based on individual action, markets are emergent” - NN Taleb “Markets can remain irrational longer than you can remain solvent” - John Maynard Keynes
  29. 29. Relative Valuation is arbitrage or pyramid scheme ? Idea/Startup Public Company 7-11 years P/M fit Angel Investors Venture Investors PE, Hedge Funds & Public market Traders Crypto Token ICO
  30. 30. ICOs possibly best treated like angel investments
  31. 31. Error in your mental model is my opportunity - Value investing Value is different from Price, Picking mispriced, Invest out of cycle
  32. 32. Arriving at an intrinsic value still need lot of assumptions For a given supply & velocity of token, what is the GDP (measured in $) of the use case need to be supported F= ma
  33. 33. MV = PQ F= ma M = size of the asset base, V = velocity of the asset , P = price of the digital resource being provisioned, Q = quantity of the digital resource being provisioned
  34. 34. INET Valuation, Example from Chris Burniske R30gmuKM2Y/edit#gid=1912132017 F= ma
  35. 35. New Markets in early stage, must watch out for Speculation of Crowds , Bubbles, Ponzi Scheme & Scams, Cornering , Pumping & Dumping.
  36. 36. Appendix

Editor's Notes

  • Frog story of hot and cold water
  • No putting the genie back.
    Most exciting technology after internet.
    Be an early adopter in your circle
    But do not ride the tide (Dotcom)
    MUST understand it in a way that you can explain it others.
  • 2008 Crisis exposed the risk of modelling using normal function & standard deviation

  • As risk increases,
    •the expected return rises,
    •the range of possible outcomes becomes wider, and
    •the worst outcome worsens and ultimately becomes negative.
  • Valuation is an exercise in estimation of future value today
    It is part story of future & part data/numbers from past.
    Future in general is unknowable, sometime the past data modelled as probability can give a model to use for estimation.
    Uncertainty is when probability distribution is unknown, Risk is when there exists a probability distribution model

  • Each person can do own estimation of future value today. Use value is subjective
    Exchange value (Price) is the arbitrage in different individuals estimation.
    Most of the times it is hard to understand & predict second order effects.
    It is always useful to look for a comparable.
  • 15.5%India
    8.5% US
    22-26% IRR US

  • Estimate Intrinsic value
    Look for Margin of Safety via in Mispriced assets
    Out of cycle investment
  • Healthcheck for Networks
    Miners * Hash rates
    HHI Index
    Geo distribution,

    Factors that influence valuation - Governance, Supply Schedule, Use case, Basis of Value
    Whitepaper - Should tell the narrative of the future of use case ( keep in mind pivots are possible)
    Is there Need/edge for decentralization (Blockchain need ?) - That a token would be needed Money replacement for bitcoin working for remittance not others)
    For the use case GDP to work what of # tokens are needed. Growth/Adoption assumptions change price.
    Supply Schedule determine impact amount of token available for circulation.
    Total Value = Utility (Use Value) + Speculation Value (Exchange Value)
    Velocity of token exchange itself has implication for price

  • GDP of a cryptonetwork is represented by the on-chain transaction volume of its cryptoasset.

    TAM & Market share
    Coins needed to support the GDP of the use case. Equation of Exchange is MV = PQ, and when applied to crypto is interpreted

    Cryptoasset valuation is largely comprised of solving for M, where M = PQ / V. M is the size of the monetary base necessary to support a cryptoeconomy of size PQ, at velocity V.

    Supply Schedule
  • ( more deflation than inflation), Lessons from Zcash, Bitcoin & Steemit (premine & instamine)
    (Affirmation, Contagion, Repetition, Prestigious)
    This time is different argument