How to evaluate the fair value of a crypto-currency ?

The market of crypto-currencies has experienced a popularity unprecedented in 2017, and early in the year 2018, the trend does not fail. Even if I think that we are still relatively far from the bursting of a bubble, any investor with long-term prospects in this market must consider such a possibility. How ? By positioning itself on the crypto-currencies for which the chances of sustainability are higher, and whose value is close to their actual value.

How to value a crypto-currency ?

Objective criteria such as the size of the target market, the strength of the technical solution offered and the number of partners (companies, public organisations and associations) who are interested in allow you to gauge the viability of a crypto-currency. These objective criteria are of course appreciated differently depending on the affinities of each one, but there is a concrete basis for evaluation. However, the issue of development of a crypto-currency is much more complex. Because behind this generic term hides a whole series of fundamental differences.

The different types of crypto-currencies

Schematically, we can identify 3 broad categories of crypto-currencies :

  • The chips (tokens) that are used to run networks, such as Ethereum
  • Distributed applications
  • The crypto-currencies stricto sensu, which serve as a store of value or means of payment
  • What is the intrinsic value of protocols utilities ?

    If the last category is much more simple to value, how to determine the intrinsic value of the “protocols utilities” (1 and 2), as the name is John Pfeffer, who has tackled this thorny question in his paper entitled “Opinion of an investor’s crypto-assets” ? His analysis is not very positive for the crypto-currency in this category, such as ETH.

    EthereumMedium

    Here is his explanation :

    “The tokens that are used on the networks, protocols, utilities are used to manage and allocate resources of the network, available in limited quantity. It is the computing power, memory and bandwidth necessary to operate the chain block in question. These resources have a real cost in terms of energy and equipment. These costs are borne by the miners which permit the chain of blocks of live by providing the required resources. The miners are paid for their services either through transaction fees, or through a payment in tokens. If the developers of the protocols, could argue that their token can also serve as a medium of exchange between users, I think that when the technology will be at maturity of the chips there will be no other role than the allocation of computing resources, with the exception of the special case of crypto-assets that fill the role of a reserve currency. “

    Ouch ! In short, the value of the chips of the protocols utilities would be derived from the costs of the resources needed to run the chain of blocks. Either the energy, the bandwidth and the computing hardware required to provide the computing power. In addition, these elements show the costs of deflation. If this were not enough, the author provides additional arguments to suggest that the value of these assets, the crypto may not be as high as one might think :

    • The chains of blocks can be forkées to the environment, which created a competitive environment particularly fierce. Imagine what would happen to Facebook if everyone had the ability to copy the full database of users and content on the site to create a clone ?
    • The popularity of a solution does not mean that it has a financial value. The author takes for example the TCP/IP protocol, which is not valued, because nobody has. Wikipedia is another example
    • The competition between juveniles is another factor of deflation. Most of the operational costs of a network are lower, the higher the value of the tokens drop
    • Competition general : not just any crypto-currency is likely to face competition sudden a fork, but the competition between the different protocols is also fierce. For example, KiK is going to consider the abandonment of the platform Ethereum, which becomes slowly too expensive to use

    And, finally, the value network of a version of “jetonisée” sector-become decentralized (this is Uber, a platform of paris online, etc) will be of benefit primarily to the users, not the founders or investors.

    If you follow the reasoning so far, this means that the solutions of the scaling is also a factor in deflation for the value of these tokens.

    The real crypto-currencies, a pet that is easier to tame

    The crypto-currencies in the strict sense of the term are less complex to evaluate. Like the assets that make up the monetary system classic, it can introduce 3 features (one or several at once) :

    • Means of payment
    • A store of value
    • Unit of account

    M2 dollar To attempt to value a crypto-currency on the basis of these criteria, it is “sufficient” to refer to this, which endorse this role in the present monetary system, and estimate the market share that it could be appropriated. For example, the market value of gold is $ 7.1 trillion. With 21 million BTC in circulation, it would be therefore more than 230 000 per unit. If you believe that Bitcoin will become a store of value digital reference, we may consider such market value, or more in the case of a new financial crisis. You think that Litecoin may become a currency as popular as the u.s. dollar ? On the basis of the monetary aggregate M2, which currently stands at 13,455 trillions of dollars, we would be about 160 000 $ per LTC.

    In conclusion

    Calculate the fair value of a crypto-currency is currently impossible, unless you have a crystal ball. By contrast, elements developed above seem to indicate that those that do will choose not to role money may see their value drop precipitously when the bubble bursts or the market is disciplinera. There is also the risk of ban. But this is yet another story, which I will speak another day. In conclusion : nothing alarming, for the short-term traders. But things you should be thinking about in the context of your investment strategy long-term.