Every investor needs to look at the valuation and, more importantly, the problem a particular coin is solving, and if that can disrupt a sector in the coming years.
A common misconception in the cryptocurrency market is that there is no way to value a coin. In this article, we can see how traditional markets’ valuation metrics apply to crypto markets, a few crypto valuation metrics you can apply, and how valuation metrics of the crypto markets are more efficient than those of traditional markets.
What is valuation?
Valuation is the process of determining the true worth of an asset. This can be the worth of an asset relative to a particular financial metric such as revenue, profit or book value. Further, it can be the worth of an asset relative to the industry or competitors. These metrics are measured against the price of a publicly listed share to measure if the company concerned is overvalued or undervalued.
In the traditional stock market, the three most used valuation metrics are:
- Price to sales ratio: Stock price to the revenue earned per share of the company
- Price to earnings ratio: Stock price to the profit earned per share of the company
- Price to book value: Stock price to the book value of shareholder’s equity
Does valuation exist in crypto markets?
In order to measure the valuation of a stock, one needs the revenue and profit of a company. These are retrieved from the quarterly or annual profit and loss statements and the balance sheet. However, cryptocurrencies do not have such financial statements. So, what metrics can we use and how can we run a valuation analysis?
To run a crypto valuation model, we replace:
- Price with fully diluted market capitalisation (FDV)
- Revenue with annualised total revenue
- Earnings with protocol revenue
- Book value with total value locked
What are the key valuation metrics?
Using these crypto metrics, we arrive at the following valuation metrics:
1. Price to sales ratio:
Fully diluted market cap divided by annualised total revenue (revenue of the past 30 days expressed for the full year). Revenue earned by a protocol is the total of the fees paid by users when using the protocol.
2. Price to earnings ratio:
Fully diluted market cap divided by annualised protocol revenue (protocol revenue of the past 30 days expressed for the full year). Protocol revenue is the proportion of total revenue that is paid to the tokenholders after paying for incentives to the participants (such as liquidity providers and lenders) and fees to the network.
3. Market cap to TVL:
Market capitalisation to the dollar value of all the assets locked within a protocol. This shows how the market is valuing the project, represented by the market cap, based on the actual use case of the project, represented by TVL.
How can you value crypto?
During a rally or dump, valuation metrics come in handy. You can use the above metrics to see whether a coin is undervalued or overvalued relative to its fundamentals. This allows you to buy on the cheap and sell on the high if used correctly.
You can use the below data resources to measure a cryptocurrency’s valuation:
Why is valuing cryptos more efficient than valuing stocks?
In traditional equity markets, valuation is dependent on metrics retrieved from quarterly or annual financial statements. However, in the crypto market, valuation is dependent on metrics retrieved from the daily fees paid or total value locked. This makes the valuation model of cryptocurrencies more efficient.
That said, crypto is an evolving asset class. While there are robust valuation metrics and methodologies, more ways of evaluating a coin are coming up. Investors should adopt a holistic framework before investing in a project. Fundamentals are a key part of this framework.
