Do you value a token to see its potential before buying into it? Or do you simply buy because… everyone is talking about it? Or perhaps you saw how the price rallied from $40 to $90 and would like to hop on the rocket to the moon. Vrooom.
It may seem like crypto cannot be valued, given that the price volatility is far beyond that of traditional market [a token could be up 10% one day and down 20% the next], and there’s no cash flow available for financial analysis. However, there are actually a few methods we can employ to understand the value a crypto asset can potentially bring.
We will be diving into 2 methods to value crypto: (1) Project metrics and (2) Financial metrics.
A whitepaper is released when a crypto project is newly launched, and is going for an Initial Coin Offering (ICO). It is a technical document that usually contains the following information:
- Target Problem
- Project’s Solution
The whitepaper often begins with an introduction of the crypto project, which highlights the existing problems the project is targeting. So, what do we have to look out for in this section? Essentially, we have to consider whether the problem is ‘real’, is it an issue that is troubling any stakeholders, be it users or developers? In addition, we have to understand the significance of the problem. How many parties are affected by the problem and what is the extent to which they are affected? Both of these are critical aspects to look out for, as it tells us whether the project would be of value and the level of value it provides.
Let’s understand this through a concrete example: Uniswap.
Uniswap was created to solve the liquidity issue faced by decentralized exchanges (DEX). In simple terms, it refers to how easily an asset can be bought or sold. In an illiquid market, it takes a long time for a suitable buyer or seller to be found, lengthening the transaction duration. In addition, it could also lead to slippage, where the transaction is executed at a different price as compared to what was intended. For example, I placed an order to purchase 100 Ethereum tokens at $3,000. Should the market be illiquid and a suitable seller cannot be found, it could lead to me purchasing 100 Ethereum tokens at $3,100 instead, causing me to spend an extra $10,000.
This is indeed a significant problem for DEX users, for they are unable to purchase or sell the assets that they are holding onto. And the slippage could cause users to spend much more compared to what they had planned. This is highly inefficient for the DEX users.
After establishing that the target problem is real and significant, we then move on to understand whether the solution provided by the project is sensible and feasible. This would mean evaluating whether the solution proposed is capable of resolving the target problem, without creating any negative side effects, that means to say, a new problem.
In the case of Uniswap, instead of simply matching buyers to sellers, they make use of a ‘Constant Product Market Maker Model’, which uses a math equation to balance the demand and supply, ensuring that both buyers and sellers are able to receive the asset they desire, at the price they have set. This is a sensible solution as it helps to make the market more efficient with faster transactions and minimizes the issue of slippage faced by users since there is now a balance between the buyers and sellers.
To get a more in-depth understanding of how the constant product market maker model works, check out this video.
In addition, a way to evaluate the solution would be to actually try it out! As an user, experiencing the project could help you get insights on how friendly the user interface is, on top of just understanding the technical soundness of the solution.
A roadmap is akin to a schedule, where the project clearly outlines their future developments. This can give investors insights to the project’s strategy and how they plan to carry out their plans. More importantly, the roadmap serves as a vital piece for evaluation of a project’s progress, as investors can use it to determine whether the project is achieving the milestones they have set out. In addition, it also serves as a cursor as to the kind of value that the project aims to bring in their future developments.
Once the project has launched, it is key to monitor the project’s progress. Should the project successfully achieve their goals for each quarter, it helps to increase the reliability of the project, gaining users’ confidence and garnering more users. In the event where the project falls behind their stipulated timeline, it serves as a reminder to investors to be cautious as to whether the project team is indeed capable of delivering what they have promised.
Tokenomics refers to the mechanics of the token, as designed by the project team, and has a direct implication on the value a token can accrue. In this article, we will focus on 1 particular aspect: The token supply.
Deflationary: A token’s value increases if there is lesser supply
Inflationary: A token’s value decreases if there is more supply
Let’s take a look at a concrete example to get a better idea.
There is a set supply of 21 million Bitcoin, meaning to say that only 21 million Bitcoin will exist, ever. As of today, there is an approximate 19 million Bitcoin that already exists. Thus, there remains only 2 million Bitcoin that can be minted. Given this limited supply, Bitcoin does not face any significant inflationary pressure that could depreciate its value.
On the other hand, Dogecoin does not have an upper limit to its supply cap. With no limit to the creation of Dogecoin tokens, Dogecoin is subjected to inflationary pressure. An increase in Dogecoin’s supply would cause erosion of its value, causing it to depreciate.
Thus, it is important to understand the project’s tokenomics, and in this case, the total supply a token has, to have a gauge of how the token’s value will change with time. An inflationary token with lots of hype might be able to able to experience price appreciation in the short run. However, as time passes, the lack of actual usage of the token gets translated to low demand, and the inflationary pressure will cause the token to be depreciated.
Market Cap/Total Value Locked
One of the most frequently used metric to determine whether a crypto asset is under or overvalued. Let’s take a look at how it is calculated and what information it could provide us.
Market Capitalization (Market Cap)
Market cap: Total value of the crypto asset that has been mined
Market cap = Volume of crypto tokens in circulation x Market price of a single token
Market cap is an easy method to estimate the value of a crypto asset as determined by the market. The market cap is often used as a gauge of a crypto asset’s stability. This is because large cap crypto assets have already shown a track record of growth, and is capable of garnering more market confidence. Whereas small cap crypto assets are subjected to high volatility that relies on market sentiments, given that there has been no concrete evidence of growth nor reward to holders of the crypto asset.
The table below describes the various categories of market cap.
|Large-cap||More than $10 billion||Lower risk|
|Mid-cap||Between $1 billion and $10 billion||Medium risk|
|Small-cap||Less than $1 billion||High risk|
Total Value Locked (TVL)
TVL refers to the total volume of crypto assets that are deposited into a particular protocol. These crypto assets could be deposited through any of these mechanics: Staking, liquidity provision, lending. This is a metric that serves as a good gauge of the amount of interest people have in the protocol, thus assessing the health of a protocol. For a protocol with very TVL, it could likely be due to the fact that the protocol does not bring significant value. Thus, people would not be willing to participate in the protocol.
By taking market cap/TVL, we are able to estimate whether a protocol is under or over-valued.
This metric estimates the crypto assets’ market value vs the amount of interest the market has indicated for the protocol. With a market cap/TVL of less than 1.0, it can be inferred that the market valuation of the protocol is still lower as compared to the consensus of the market. This is an indicator that the protocol is still undervalued, and there is still growth potential for the protocol. Vice versa, a market cap/TVL ratio that is more than 1.0 would mean that the market is overvaluing the protocol, beyond that of the value locked in the protocol.
With one-third of the people who purchase crypto not knowing anything about them, it is evident that there is a large portion of people who purchase crypto without understanding anything about its value proposition. Nonetheless, through this article, we have uncovered that they are certain methods to go about valuing a protocol, and it isn’t necessarily rocket science. By taking some time out to evaluate the protocol qualitatively and quantitatively, we can get a gist of the value proposition of a protocol, and determine whether the protocol is currently over or under-valued. This can then shape our view on whether it is worth our investment.
Following the general public and buying based on recommendations is indeed very easy, and it does has the possibility of helping you reap profits. However, without understanding the protocol and keeping up with their updates, it is likely that one would panic when the price dips, due to the lack of conviction in the protocol. There is a high chance of panic selling and be greeted with a rise in price again a few weeks later. All in all, doing a fair share of due diligence and research would be beneficial for both you and your wallet.
Here are some resources and steps to find the whitepaper of projects and financial metrics for financial analysis.
- Google the protocol of your interest
- Enter the protocol’s website
- Scroll through to look for either ‘Docs’ or ‘Whitepaper’
Financial Metrics – Market cap
- Enter https://messari.io/
- Search for protocol of your interest
- Click onto ‘Metrics’
- Market cap can be viewed from ‘Reported Marketcap’
Financial Metrics – TVL
- Enter https://defillama.com/
- Search for protocol of your interest
- TVL can be viewed from ‘Total Value Locked (USD)’