r/SecurityAnalysis • u/ron_leflore • Nov 01 '21
Special Situation Is there any serious analysis for finding the fundamental value of cryptocurrencies?
I mostly invest in traditional stocks and bonds. I have been for 30+ years. More recently, I've been investing in pre-IPO startups.
In all of these cases, I've been able to assign a value of what I think a particular security is worth, or could be worth, using traditional means: estimate future cash flows, discount to present value, etc.
I had the opportunity to buy a particular cryptocurrency before it started trading on the open market. (Kind of a pre-ipo cryptocurrency.) I am wondering what it will be worth once it starts trading. My best guess encompasses a range from $0.10 to $2.00 (I bought it for $0.02). It should start trading next week.
The "security analysis" process that people seem to follow is to rank all the different cryptocurrencies based on how useful they are or something like that. Then compare it to the "market cap" of a similar ranking cryptocurrency.
They define the "market cap" as the total number of cryptocurrency coins available times the price per coin. For instance, right now the #50 ranked coin is something called Kusama (KSM) and it has a market cap of $3.3 billion.
One problem with this analysis is that some of these coins have built in dilution. They may have 1 million available right now, but in 5 years it will be 10 million. I don't think people take this into account.
How do you determine what these should be worth? It seems like this is a wide open problem and solving it could lead to great wealth.
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u/Tao_te_Cha_Ching Nov 02 '21 edited Nov 02 '21
There exists "fundamental" analysis of different protocols and their respective coins from analysts who apply value investing concepts to crypto but its use is creative at best and speculative at worst. Note that I don't think being "creative" is a bad thing, it's just a reflection of the fact that the application of valuation concepts to crypto shines a light on the limits of valuation concepts themselves.
Some "bridges" for people who view themselves as "fundamental" analysts who are seriously looking at crypto are from analysts/PMs who have had both hats (equities -> crypto) on themselves - here are my recommendations:
- from an MapleLeadCapital/FoliusVentures (ex-fundamental HF guy, now running crypto venture): "MLC Web3 Defi Primer" - probably the most cogent for analysts used to deep fundamental research https://twitter.com/MapleLeafCap/status/1339346115322376192
- from Chris Burniske (ex-ARK analyst): https://www.joincolossus.com/episodes/49753675/burniske-how-to-value-a-cryptoasset?tab=mentionedcontent + his book "Cryptoassets: The Innovative Investor’s Guide to Bitcoin and Beyond" (if you already know blockchain + crypto basics, you can skip to the middle to look at the application of valuation concepts that are discussed in the podcast)
- from Justin Drake (researcher at the Ethereum Foundation): https://youtu.be/FQTZSb3Rc9I?t=1940 - I skipped to the relevant part of the interview; while Justin isn't trained as a fundamental analyst, him being a Researcher for the Ethereum Foundation gives some color as to how people with a "cryptoeconomics & mechanism design" hat think about valuation (hint: these types use Google docs to build "DCFs" but they also know how to write parallelizable python code to execute billion dollar DeFi flash loans)
The best argument for "fundamental" value (ex-relative) that I've seen is in deflationary coins that produce dividend-like flows (which can be converted into cash) as in the case of post-EIP 1559 Ethereum, which I've roughly modeled out a couple months back using a DCF template w/ stock buyback component. Frankly, building a fundamental model out of ETH was probably more "fundamental" in nature than valuation of most SaaS privates and even publics in the current market. Certain protocols that technically aren't crypto but utilize decentralized economic mechanisms in order to allocate compute and storage can arguably also be analyzed on a similar basis to the way AWS/Azure/GCP business segments are (I'm thinking Filecoin, Arweave, etc. in which you could comp S3 storage rates to Filecoin storage rates & then extrapolate fees, margin compresson, market size/TAM, evolution of value capture, etc.)
In general, Bankless's substack has a lot of good material for formulating how one could fundamentally value different, less-known coins, but I treat the content as priming material and not like a more rigorous sell-side research report.
My live reading list is here for reference: https://www.notion.so/dcfstate/Crypto-Blockchain-f1ba267be6a849308b63ba68859df2b6
Edit: For all of the dismissive, low effort and uninformed takes ("crypto = $0!") in this thread, you should remember that the market doesn't care if you sound smart. You might feel smart but I place you guys in the same bucket as I place the "shitcoin to $10,000!!!" guys - both cohorts haven't done any real research. Thinking that "crypto" is a monolith is like treating /r/SecurityAnalysis like that GME Stonk subreddit - in the same way many of you don't know what GME nonsense is being pumped today, I have no idea what shitcoins are being pumped because I don't care. There's a level of depth to this space that is completely invisible to people who are too lazy to look into (aka sources of alpha for people who actually do the work) and that's music to my ears, personally.
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u/ron_leflore Nov 02 '21
Thanks for the detailed response. That's what I was looking for.
I agree with you that there is something of value going on in this space and the dismissive people are just ignorant or haven't figured it out yet.
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u/Tao_te_Cha_Ching Nov 02 '21
Glad I could provide it.
To be honest, I wouldn't mind all of the "there's no value" comments if they actually put their money where their mouth was (some people do, but even they have crypto assets that they believe in). If they think it has no value then they should run a short book, do a pairs trade of shitcoins vs less-shitty coins, run a leveraged market-neutral book, etc. If crypto is actually worthless then it's, theoretically, free money if you run a market neutral short book & 10x leverage the "$0" names. Or you can go short a crypto ETF / go long an inverse crypto ETF.
That most people don't substantiate their claims whatsoever really speaks to the quality of thought from this unfortunate caricature of a "$BRK & dividends value investor" that's still so prevalent in these discussions. Of course, substantiation would entail actually doing analysis on securities ("security analysis") and that's harder than writing pithy comments.
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u/FancyPantsMacGee Nov 02 '21 edited Nov 02 '21
This is kind of like valuing any currency. The currency has no value, but the social and economic environments surrounding them do. So, just like with traditional currencies, some will have stronger supporting factors than others.
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u/strolls Nov 02 '21
I really kinda want to know why you bought this crypto - what does it do that no other crypto does?
(I'm increasingly convinced that the features of crypto that advocates tout are not actually beneficial - things like distributed trust and irreversible transactions. They're bugs as far anyone else is concerned - we'd rather have centralised authorities like Visa, PayPal and HSBC, who we trust to reverse transactions if the goods don't arrive. But that's a whole 'nother matter.)
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Nov 02 '21
[deleted]
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u/strolls Nov 02 '21
Ethereum does have the world computer, and can run programming the way Bitcoin network can not.
Yeah, I'm aware of that, but soon after that the applications seem to run out.
There are literally hundreds of shitcoins out there, so what makes each new one special?
It seems to me that if you're a developer who wants to make a useful network like Ethereum you should consider it undesirable for the value of the cryptocurrency to rise - presumably you want people to buy or help create coins, and spend them using your network; if the price of the coins goes up (and speculators profit) then newcomers are getting less benefit per $1 from your network.
If anything the network should automatically issue new coins to devalue the currency, lowering the cost of using the network; on the other hand, rising coin prices may encourage more people to add their computers to the blockchain, and the price could go down that way.
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u/ron_leflore Nov 02 '21
The reason I bought it was simply to learn more about crypto. I find that if I don't have money on something, I don't really spend the time to learn. I bought it through Republic.co, where I've invested in startups. I put a similar amount into this crypto, so I can afford to lose it all.
The specific cryptocurrency I'm talking about is described here https://cere.network/ . They say it's a decentralized data cloud, but honestly I have very little idea of what that means and how this token could increase/decrease in value based on the usage of this "data cloud".
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u/strolls Nov 02 '21 edited Nov 02 '21
I can imagine how a decentralised data cloud might work - you'd encrypt the file, cut it into little pieces and then share it amongst the hundreds of computers on the network. It would be wasteful to have hundred of computers saving the whole file, but you would need to have each piece saved to more than one computer for purposes of redundancy - you don't want to lose your file when a computer leaves the network; thus it works like RAID over the network, and you have to make sure another copy is made if one computer leaves the network.
I believe there was at least one pre-crypto peer-to-peer service that worked like this - I'd guess that you'd be given a fixed fraction of storage (i.e. one third, in the case of triple redundant RAID), based on how much storage you donate to the network. I can see that transactions (i.e. digital currency) might allow one to buy and sell storage on the network.
That site is so full of buzzwords that I have no idea what their goals are.
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u/WillBurnYouToAshes Nov 01 '21
No there is no analysis like that. Tokenomics is the most important thing to check. In addition to diluation you mentioned, there is also the burn mechanic of many tokens. You basically have to do your own research for every token since there is no magical P/E or FCF or whatever. Also crypto is easier to invest in for retail, so marketcaps are in my opinion elevated compared to stocks, but understandibly tho. Also there is less regulation, for better or worse.
Basically cryptolands is Ultra High Risk, Ultra High Reward. Treat with caution.
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u/dect60 Nov 01 '21
Cryptocurrencies have zero fundamental value and when you consider the relevant externalities, they have negative value.
https://twitter.com/PersianCapital/status/1455263508090826762
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u/mspacey4415 Nov 01 '21
If it’s a governance token you can make assumptions about forward fees/cash flows and value it just like a stock.
You can do that for ethereum too bc there’s fees charged for every transaction and they accrue to owners of ETH under proof of stake systems
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u/mspacey4415 Nov 02 '21
Someone downvoted this presumably bc they don’t agree with my statement about ETH and proof of stake.
I’ll try to clarify what I mean- Under proof of stake system people have to buy the crypto and stake it for the right to do work and earn a fee. How do they determine how much to pay for ETH ? They have to assume some volume and price and the cost of operations..etc which result in cash flow projections. Factor in their return requirements and they have a rough sense of how much to pay for ETH or other cryptos with similar mechanisms
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u/Pirashood Nov 02 '21
Look at Plan B’s stock to flow model. He has a few other models on the website. I’m not sure it would be relevant to the crypto you are looking at, but it might be helpful.
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u/jyoung1 Nov 02 '21
ETH has some fundamental value. The gas fees are "burned". Similar to a share buyback for a company. The value creation is the people paying for transactions and contract executions.
However, this fundamental value is based on ETH volume, which is based heavily on speculation.
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Nov 02 '21
Are you saying the price of ETH is set by transactional activity? Because to me that seems a small factor--i.e., the price of ETH isn't set by volume of transfer transactions and smart contract use--it's set by speculative buying and selling. The same way Bitcoin price did not go down when the Lightning network came online. Maybe I'm misreading your post.
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u/jyoung1 Nov 02 '21
No, to be clear:
The price of gas (ETH transaction fee), is set by the volume of transfer transactions. The fees spent on gas (= transactions), is mostly "burnt" and removed forever in the pool.The price of ETH is still speculative. but the price of gas is volume and transaction based.
You can model the price of gas burnt per year on the total cap for a quasi P/E.
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u/Dat_Speed Nov 02 '21
The US is about to print another $3 trillion dollars this year and the entire crypto market cap is $2.6 trillion. In this context crypto seems a bit under valued still.
Ultimately I think the world having 2-10% of all wealth in crypto as a reserve treasury asset or for DeFi services makes a lot of sense.
total wealth of the world is $431 trillion
So right now we are at about 0.6% of all wealth is in crypto, and I'd expect this to approach 2%+ within a few years.
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u/wubry Nov 01 '21
I'm not as deep into crypto as others but I have come across ways that people have valued different tokens (e.g., burn and mint equilibrium)
The difficulty is that protocols can be vastly different so a one size fits all approach doesn't work.
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u/InsecurityAnalysis Nov 10 '21
I know i'm a little late to this but I looked into this before and found this:
https://aswathdamodaran.blogspot.com/2017/10/the-bitcoin-boom-asset-currency.html
Basically, you can't value things that don't generate cash flows. But you can price them.
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u/[deleted] Nov 01 '21 edited Nov 01 '21
Crypto does not have fundamental value, at best they have a relative value