*Foreword:* *At present, the valuation model of cryptocurrency is still immature, and cryptocurrency is also a new type of asset. Its valuation method is not the same as that of traditional company assets.* *At the same time, due to the large differences in the capture of token values for different projects, there are currently few common valuation models.* *This paper proposes to draw on the DCF model, which is also an attempt for some projects with fee income.* *The author of this article is John Todaro, translated by the "Blue Fox Notes" public community "HQ."*

At present, people use various models to try to construct a valuation framework for cryptographic assets. For the valuation of traditional financial and cryptographic assets, these models can be divided into relative valuation models and absolute valuation models. The relative valuation model assumes some baselines that can be used for comparison. In stocks, the most commonly used relative valuation method is the P/E model. Investors judge whether an asset is at a premium or discount by comparing its P/E ratio with its peers.

A high P/E ratio (relative to companies in the same industry) means that the market is paying a premium for other companies with similar income. In many cases, this premium may be guaranteed, such as a company with a higher revenue growth rate or an innovative CEO that can drive long-term high returns.

- QKL123 market analysis | Federal Reserve cut interest rates as scheduled, safe-haven assets fluctuate (1031)
- QKL123 market analysis | Fed interest rate cuts expected to strengthen; Britain's hard Brexit is uncertain (1017)
- UK FCA publishes the final guide to cryptographic assets, clarifying its jurisdiction
- QKL123 market analysis | Risk aversion surge, Bitcoin strong Hengqiang (0802)
- QKL123 Quote Analysis | Bitcoin is a commodity or currency? Most countries are open-minded (1118)
- QKL123 market analysis | short-term change is imminent, uncertainty increases (0813)

Many times, high P/E ratios are seen as the market is paying a premium for the company. As a result, stocks of these companies seem less attractive than companies in the same industry with lower P/E ratios.

## Relative valuation model

In the area of cryptographic assets, experts say that the most similar ratio to the P/E ratio is the Network Value vs. Transaction Multiplier (NVT). It was first proposed by Willy Woo and Chris Burniske. When the NVT of an encrypted asset is high, it indicates that its network valuation exceeds the value passed on its payment network. Similar to stocks, when the network is growing at a high speed, the market is pricing it, or when the asset price is overheated and unreasonably overestimated, a higher NVT will occur.

Willy Woo pointed out that during the two main bubbles of Bitcoin, the NVT ratio increased significantly, as shown below:

As Willy described, this indicator does not predict the arrival of the bubble before the bubble occurs, but after the asset is sold, the NVT ratio will soar, indicating that the asset was previously in a bubble. This is what we are currently seeing (June 2018), as the bitcoin price continues to fall sharply, the NVT ratio has reached its highest level in several years (see table below).

The reason is that during the frenzy, when speculators transfer these tokens to different addresses and trade through other trading channels, the payment network of the encrypted assets is often used excessively frequently. At the same time, Bitcoin is the most common pair of transactions for all other cryptographic assets, so the volume of transactions on the Bitcoin chain has also increased significantly.

The increase in the volume of these chains is recorded as an increase in the usage of the payment network, but in reality, this is only caused by speculators moving assets frequently during trading frenzy. Therefore, during the frenzy, when the market price rises, the number of transactions may increase. Therefore, a lower NVT ratio does not necessarily mean that the asset price is low, which may be due to the overuse of the payment network by speculators (in December 2017, the NVT ratio actually reached a relatively low level over a certain period).

However, this is not the way the P/E valuation is calculated. If the NVT ratio analogy P/E is strictly used, we believe that Bitcoin is undervalued during the peak market price in December 2017 because the NVT ratio has reached a relatively low level within a certain period. Similarly, as the NVT ratio reached a high level during this market adjustment, we believe Bitcoin prices are overvalued.

Therefore, it is clear that the NVT ratio is not the most attractive valuation tool because it is different from the P/E ratio and is only useful after a market crash. For example, the NVT ratio tells us now that in December and January 2017, Bitcoin was overvalued.

In addition, it is more difficult to use relative valuation models (different categories of assets, or the same assets in relative time) in a completely new field of cryptocurrency. For example, if Litecoin is considered to have a higher growth rate than Bitcoin, then by definition, it is reasonable to accept the price of Bitcoin first, and then Litecoin should be traded at a multiple of 2 times the Bitcoin NVT ratio.

In this new field, some experts insist that Bitcoin should be traded at a price of one million dollars, while others believe that bitcoin is worthless, because the ratio of bitcoin is uncertain, It is difficult to use as a valuation benchmark for other assets.

In a new field where historical multiples and price data are limited, the relative valuation model is not very applicable. Therefore, using absolute valuation indicators may be more suitable for crypto asset valuation.

## Absolute valuation model

The most commonly used absolute valuation indicators for cryptocurrencies are introduced in any introductory economics course – the currency trading equation. Chris Burniske reimagined a formula that would be more widely applicable to cryptocurrency models. Although this method is the best method I can think of for currency token valuation, this method does not apply when the encrypted asset is not used as a currency or exchange medium. Many cryptographic assets are more like equity instruments or bonds. Many cryptographic assets are now available as transaction fees for the platform, which is then paid to the token holders who are "working" for the network.

The cost of this work is different, but in many cases, this work often only needs to be connected to a high-speed network and then run a simple program. For these fee-boosted networks, I think it is most appropriate to use the DCF method for valuation. Most cryptographic experts do not use DCF analysis to evaluate cryptographic assets because they believe that these assets do not generate traditionally known cash flows. Nonetheless, these cryptographic assets are typically used to pay fees to token holders in Taiyuan, or ERC-20 tokens, or bitcoin. So, although not a "cash" stream, we can call it an etheric stream.

## Encrypting assets using DCF analysis

DCF is an absolute valuation indicator that does not require a relative multiple, but is strictly based on the cash flow paid to the holder of an asset (stock, bond or token). Therefore, we can value these assets without considering the transactions of other crypto assets in the market. I expect that in the long run, more cryptographic assets will use a fee-based incentive model because it captures more value for token holders than many other encryption models (such as strict governance or exchange media).

In our report on the Republic Protocol, I and my collaborators built a DCF model to value the R token. The Republic Protocol is a decentralized dark pool platform in which nodes run a simple matching program and then get transaction fee income from the network. The main motivation for owning R tokens is to be able to hold and mortgage these tokens, thereby qualifying to run a node to earn transaction fee income. We can treat these fees as cash flows to the token holders. Below, we will show how to use the DCF model to make a fair token price estimate for R. This model can be used to value any network that pays a token holder.

First, we need to assume a fixed growth rate for the platform to calculate the expected future cash flow. The following assumptions apply only to the case where R is in a bull market.

The key in the above table is an estimate of the expected cash payment to the node over the next five years. Using the DCF formula, PV = [CF1 / (1+r)1] + [CF2 / (1+r)2] + … + [CFn / (1+r)n] + TV, we discount the cash flow back The current date gives the present value (PV) of the R network.

PV = present value of cash flow

CF1 = cash flow at the end of the first year

CF2 = cash flow at the end of the second year

CFn = cash flow at the end of the nth year

r = discount rate, or required rate of return

TV = final value

In any DCF model, we must discount the cash flow back to the current date, because the value of $1 next year is different from the value of today's $1. A key point to note is that all expected cash flows cannot use the same discount rate. We must establish a risk metric. The more uncertain the expected cash flow, the more discounts are needed. Currently, in the digital asset market, no suitable risk rate can be used as a unified benchmark. Therefore, our report draws on other financial markets. In the A-round equity financing of venture capital, the generally accepted interest rate is 30-50% per year. As a digital asset platform, the Republic Protocol has not been verified for some technical details, and the risk is relatively high, so we use 40% as the discount rate.

Finally, in our DCF model, we need to include the fees paid in five years. We consider the R platform to be sustainable, and this assumption is also appropriate in the stock market. We use the Gordon growth model to calculate the final value TV. We conservatively forecast a sustained growth rate of 2% (g = 0.02), which is in line with estimates of mature companies and GDP estimates for developed countries. Let's use the Gordon growth formula:

TV = [Cash flow in year 5* (1+g)/(rg)]

TV = 1,506,093,750*(1.02)/(0.4–0.02) = 4,042,672,697

Adding the annual cash flow and the final value, we get the following equation:

0 + 42,857,142 + 117,091,836 + 214,012,390 + 280,034,686 + 4,042,672,697 = 4,696,668,753

Finally, by dividing the total network cash value (4696668753) by the number of circulating tokens (519094022), each R is $9.05. That is to say, according to our assumptions and the best scenario prediction, the value of R should be $9.05 per token.

In summary, I believe that the absolute valuation indicator will be more applicable when evaluating crypto assets. I also hope that DCF analysis can be used more in the field of encryption. At present, few experts want to use DCF to value encrypted networks, in part because most cryptographic assets do not have a charge incentive network, so there is no cash flow. This cost-based model has a good appeal, and I think more new encryption projects will be used to pay cash flow to token holders to create more value for token assets.

——

Risk Warning: All articles in Blue Fox Notes do not **constitute investment recommendations** . **Investment is risky** . Investment should **consider individual risk tolerance** . It is recommended to conduct in-depth inspections of the project and carefully make your own investment decisions.