Exploration of Cryptocurrency Valuation Models

Cryptocurrency has become one of the most promising sectors in the fintech field. With a large influx of institutional funds, how to accurately assess the value of encryption projects has become a key issue. The traditional financial sector has mature valuation systems, such as discounted cash flow models and price-to-earnings valuation methods.

The types of encryption projects are diverse, including public chains, exchange platform tokens, decentralized finance projects, and meme coins, each with its unique characteristics, economic models, and token functions. Therefore, it is necessary to explore valuation models suitable for each subdivision.

1. Valuation of Public Chains: Metcalfe's Law

Law Analysis

The core idea of Metcalfe's Law is that the value of a network is proportional to the square of the number of nodes.

The expression is: V = K*N² (V represents network value, N represents the number of active nodes, K is a constant)

The law is widely recognized in predicting the value of internet companies. An independent study on social networking companies shows that over a statistical period of 10 years, the value of these companies exhibits characteristics of Metcalfe's Law in relation to the number of users.

Ethereum Instance

Metcalfe's Law also applies to the valuation of blockchain public chain projects. Research has found that the market value of Ethereum has a logarithmic linear relationship with daily active users, which essentially conforms to the formula of Metcalfe's Law. Specifically, the market value of the Ethereum network is proportional to the 1.43 power of the number of users, with the constant K being 3000. The calculation formula is as follows:

V = 3000 * N^1.43

Statistics show that using Metcalfe's Law for valuation has a certain correlation with the actual market value trend of Ethereum.

Limitations Analysis

Metcalfe's Law has limitations when applied to emerging public chains. For public chain projects that are in the early stages of development and have a small user base, such as the early Solana and Tron, this law may not be very applicable.

In addition, Metcalfe's Law cannot reflect the impact of the staking rate on token prices, the effect of the burning mechanism on long-term supply, and factors such as the potential games related to the total locked value based on the security ratio in the public chain ecosystem.

2. Valuation of Exchange Platform Tokens: Profit Buyback and Destruction Model

Model Analysis

The platform tokens of centralized exchanges are similar to equity tokens, and their value is closely related to the exchange's revenue (including trading fees, listing fees, and other financial business income), the development of the public chain ecosystem, and the market share of the exchange. These tokens typically use a buyback and burn mechanism, and some also have a burning mechanism within the public chain.

When assessing the value of platform tokens, it is necessary to consider the overall income situation of the platform, discount future cash flows to estimate intrinsic value, and also take into account the impact of the token burn mechanism on its scarcity. Therefore, the price fluctuations of platform tokens are usually related to the growth rate of trading volume on the trading platform and the rate of decrease in token supply. The simplified valuation method for profit buyback and burn model is as follows:

Platform token value growth rate = K * trading volume growth rate * supply destruction rate (K is a constant)

Case Analysis

Since its launch in 2017, the platform token of a well-known exchange has received widespread recognition from investors. The empowerment of this token has gone through two stages:

Phase 1 (2017-2020): Adopt a profit buyback mechanism, using 20% of profits each quarter to buy back and destroy tokens.

Phase Two (2021 to present): Implement an automatic destruction mechanism that no longer references exchange profits, but calculates the destruction amount based on the token price and the number of quarterly blockchain blocks using a formula. At the same time, introduce a real-time destruction mechanism, where 10% of the rewards for each block will be destroyed.

The automatic destruction mechanism calculates the destruction amount based on the following formula:

Burn amount = N * P / K

Where N is the quarterly block production, P is the average quarterly price of the token, and K is an adjustable constant (initial value is 1000).

Assuming the trading volume growth rate of the exchange in 2024 is 40%, the token supply destruction rate is 3.5%, and taking the constant K as 10, then:

Token value growth rate = 10 * 40% * 3.5% = 14%

This means that according to this data, the expected increase of the token in 2024 is 14%.

Since 2017, the platform has accumulated the destruction of approximately 59.529 million tokens, with an average of 1.12% of the remaining tokens destroyed each quarter.

Limitation Analysis

When applying this valuation method in practice, it is important to closely monitor the changes in the exchange's market share. If the market share of a certain exchange continues to decline, even if its current profit performance is acceptable, future profit expectations may be affected, thereby reducing the valuation of the platform tokens.

Moreover, changes in regulatory policies also have a significant impact on the valuation of centralized exchange platform tokens, and the uncertainty of policies may lead to changes in market expectations for platform tokens.

3. Valuation of Decentralized Finance Projects: Token Cash Flow Discounting Method

The core logic of the discounted cash flow valuation method used in decentralized finance projects is to predict the future cash flows that the tokens may generate and to discount them to their present value at a certain discount rate.

The calculation formula is as follows:

Present value = Σ(FCFt / (1 + r)^t) + TV / (1 + r)^n

Among them, FCFt is the free cash flow in year t, r is the discount rate, n is the forecast period, and TV is the terminal value.

This method determines the current value of the token by the expected future收益 of decentralized finance protocols.

Case Analysis

Taking a certain decentralized trading protocol as an example, suppose the income of the protocol in 2024 is $98.9 million, with an annual growth rate of 10%, a discount rate of 15%, a forecast period of 5 years, a perpetual growth rate of 3%, and a free cash flow conversion rate of 90%.

Cash Flow Forecast for the Next Five Years:

• $89.01 million in 2024
• 2025: 97.91 million USD
• $107.7 million in 2026
• 2027: 11847 million USD
• $130.32 million in 2028

The total discounted free cash flow over the next five years is approximately $390.3 million.

The terminal value discount is approximately $611.6 million.

Total valuation = terminal value + free cash flow = 611.6 million + 390.3 million = 1.0019 billion USD

The current market value of the protocol token is $1.16 billion, which is close to the valuation result. However, it is important to note that this valuation is based on the assumption of a 10% growth rate per year over the next five years, and the actual situation may vary due to market cycles.

Limitation Analysis

The valuation of decentralized financial protocols faces several major challenges:

1. Governance tokens often fail to directly capture the value of protocol revenue, and to avoid being classified as securities by regulators, they cannot provide direct dividends. Although there are indirect methods such as staking rewards and buybacks for token burns, the incentive for the protocol to feed profits back to the tokens is insufficient.

2. Future cash flow forecasting is extremely challenging due to the rapid transitions between bull and bear cycles in the encryption market, significant cash flow fluctuations in decentralized financial protocols, and the changing behaviors of competitors and users.

3. The determination of the discount rate is complex and requires comprehensive consideration of various factors such as market risk and project risk. The choice of different discount rates can have a significant impact on the valuation results.

4. Some decentralized finance projects adopt a profit buyback and burn mechanism, and the implementation of such mechanisms can affect the circulation and value of tokens, which may not be suitable for cash flow discount valuation methods.

4. Bitcoin Valuation: A Comprehensive Consideration of Multiple Methods

Mining Cost Valuation Method

Data shows that in the past five years, the time when Bitcoin prices were below the mining costs of mainstream mining machines only accounted for about 10%, highlighting the importance of mining costs in supporting Bitcoin prices.

Therefore, the cost of Bitcoin mining can be seen as the bottom line for Bitcoin prices. Historically, periods when Bitcoin prices fall below the mining costs of mainstream mining machines are usually considered excellent investment opportunities.

Gold Substitute Model

Bitcoin is often referred to as "digital gold," with the potential to partially replace gold's "store of value" function. Currently, Bitcoin's market value accounts for 7.3% of gold's market value. If this ratio rises to 10%, 15%, 33%, and 100%, the corresponding price per Bitcoin would reach $92,523, $138,784, $305,325, and $925,226, respectively. This model is based on the analogy of the value storage properties of both, providing a macro reference for Bitcoin valuation.

However, Bitcoin and gold still have significant differences in terms of physical properties, market recognition, and application scenarios. Gold, with thousands of years of historical accumulation, has become a globally recognized safe-haven asset, with a wide range of industrial uses and physical backing. In contrast, Bitcoin is a virtual asset based on blockchain technology, and its value is more derived from market consensus and technological innovation. Therefore, when applying this model, it is necessary to fully consider how these differences affect the actual value of Bitcoin.

Summary

This article aims to explore the valuation models of encryption projects to promote the robust development of valuable projects in the industry, while attracting more institutional investors to allocate encryption assets.

Especially during market downturns, we must search for projects with long-term value using the strictest standards and the most basic logic. Through reasonable valuation models, we hope to uncover potential stocks in the encryption field during the bear market, just like the tech giants that rose after the internet bubble burst in 2000.