Reverse ICOs: Part 2
By: Harry Mclaverty
Tags: Blockchain, Token Economy, Regtech, Insight, Cryptoeconomics

How Should We Think About Valuations?

Current models suggest that the more a cryptoasset is exchanged, the less valuable it becomes — incentivising hoarding

Lately, there has been a lot of talk about whether or not we’re in a crypto-bubble (cue Jamie Dimon). I’d argue the former. Very few people are actively discussing valuation methodologies so most token prices are only based on hype and the occasional celebrity endorsement (Jamie Foxx, Floyd Mayweather, DJ Khaled etc)— this is not a sustainable way to go forward as the market becomes more complex and fraudulent.

‘I mean, for instance, one of the hallmarks of mania is the rapid rise in complexity and the rates of fraud’: Michael Burry 🤷‍ (Played by Christian Bale in ‘The Big Short’ — Source: https://goo.gl/7Qmexp)

One person has thought very rationally about this — cburniske at Placeholder VC. He recently outlined a method to value Filecoin (a decentralised storage platform) that uses formal economic terms like TAM and CAGR and methods including the use of S-Curves.

The (very) basic process follows four main steps:

Calculate ‘Total Addressable Market (TAM)’ — the total market demand for the product or service Calculate ‘Market Value (MV = TAM x MP)’ — Market Penetration (MP): the percentage of the market that the company controls; Market Value (MV): the total market that the company can reach with their sales channels Calculate ‘Network Value (NV = MV / TV)’ — Token Velocity (TV): the average number of transactions a token will be used in during a given year; Network Value (NV): the total value of the network/community Calculate ‘Utility Value (UV = NV / TS)’ — Token Supply (TS): the number of tokens available for exchange, Utility Value (UV): the value of the use of each token

Note: Other models are also out there, here’s one — and there are some more ideas in the video below!

Here’s a more in depth explanation of Chris’ model — from the man himself! 👀 🔥

With a few assumptions not relevant for this article, we can make two substitutions to determine that:

Hence, we can claim that for a very early-stage post-ICO cryptoasset — the four price drivers are Total Addressable Market (TAM), Market Penetration (MP), Token Supply (TS) and Token Velocity (TV). From a traditional VC perspective, TAM and market penetration make sense; and we could use ‘CAGR’, ‘decline of CAGR’ and other metrics to update the basic model over time — but the market fundamentals are the same and have an expected proportionality to the token value.

From a cryptoeconomic perspective, token supply is relatively similar to the number of shares; for the same amount of investment, purchase for a smaller number of shares means that they are valued higher — much the same as making an angel investment based on capital required and relative risk.

From an economic perspective, token velocity is where things become more interesting. By this basic model, the more a cryptoasset is exchanged, the less valuable it becomes — incentivising hoarding. This is detrimental to the use of a platform like a decentralised SoundCloud because people won’t use it if the token price is not stable.

If the token velocity is low, then the token is being hoarded and acts as a cryptoasset; conversely, if the token velocity is high then it is being largely speculated on rather than being used for a specific function on the network i.e. utility function. The question is, how do we find the sweet spot? Does this change for each platform? If so, what are the key drivers behind this?

In Chris’ latest post, he explores removing ‘bonders and hodlers’ from the model i.e. speculators and holders — we could do the same. He says that ‘in reality, a small percentage of bitcoin in the float likely exchanged hands a lot more than that, while a larger percentage sat locked in hodlers’ hands’ so we may assume that the token velocity would decrease, and the token utility value would increase. This was a great update, but we need to do much more thinking about this aspect of the valuation model.