As the cryptocurrency market is growing and large numbers of ICOs are being conducted, we are facing the tricky aspect of valuating crypto tokens. Matters are complicated by the fact that there are several types of tokens in the market; some resembling currencies and others acting more like gateways to specific functions and applications.
Given this complex nature of crypto assets, it has become important for us to engage in research to calculate the viability and potential of the alt coins. Only then can we make better investment decisions and encourage increased mainstream adoption.
Factors That Influence Token Value
There are three main factors that affect the value of tokens in the market; utility, scarcity and perceived value.
When a coin boasts a strong function that can incentivize people to hold it, its value increases and without any use, it becomes speculative in nature; devoid of any fundamental value. A token’s utility can range from voting rights to dividend payouts or being a specific medium of exchange within a particular ecosystem. Take the example of ETH, the currency that drives the Ethereum ecosystem. If anyone wants to develop applications on the Ethereum platform, they must possess Ether or ETH, which will act as fuel for transactions.
The factor of scarcity is based on plain laws of demand and supply. Anything that is finite in number and has a great utility factor will be priced more than something that has an infinite supply. Our day-to-day currencies are priced on this aspect. Bitcoin has a finite supply of 21 million coins, and its role in acting as a currency of exchange has driven its prices to soar to unprecedented levels.
The third point of perceived value is related to factors specific to the development of the project. Projects that live up to their promise and consistently meet the demands of investors are perceived in a positive way. Collaborations with important companies, influencers and celebrities also drive up token value.
Different Approaches to Value Distribution
The price appreciation component is primary here, and we are not talking about speculative price appreciation. Price increases with an increased adoption rate. In this case, dividing the size of the market by the number of tokens existing will give us the token valuation. An example of this is the decentralized storage startup, Storj Labs, whose tokens do not pay out any dividends or buybacks, but the price depends upon how well the protocol gets adopted.
Other projects like Iconomi, a decentralised fund management platform, has adopted dividend characteristics. A portion of earned income (in ether) which is generated from asset management and associated fees is retained by the company for development purposes and the rest is distributed to token holders. Moreover, this distribution is done by smart contracts, without any particular group’s involvement.
Due to regulatory uncertainties, such kind of valuation structures will get complicated in the near future. This is especially true with the US SEC watching over projects with a hawk-eye, in case they find any token acting as securities for investors. In that case, buybacks would become a viable option.
The Network Value-to-Transactions Ratio
Thanks to blockchain pioneers and financial analysts, new tools are coming up, which can calculate the underlying value of blockchain networks. The concept of comparing values of networks associated with tokens has been researched in detail by Chris Burniske, who has also authored a book on this topic.
The network value is the number of coins in circulation multiplied by their price, which is further divided by the transaction value; the dollar value of the transactions in the underlying blockchain. The method is used to calculate a relative value rather than the intrinsic value of a token. Burniske maintains that the science of evaluating the intrinsic value is still not mature enough to be applied.
What Makes it Difficult to Value Crypto Tokens?
The industry is too nascent and demand is flaky. This has created some hurdles in valuating crypto assets so far. The absence of a set risk-free rate and the presence of systemic risk in the crypto markets make it harder to discount future cash-flows to the present and leads to investors taking on both project-specific risk and market risk when they invest in this sector.
Also, since major crypto tokens are developed on the Ethereum blockchain platform, any attack on it will result in a risk for associated projects too. This kind of dependency risk is unheard of in any other industry, and with time we will find better ways to tackle it.