All investors need to look at valuation and, more importantly, what problem a particular coin is solving, and whether that may affect a sector for years to come.
A common misconception in the cryptocurrency market is that there is no way to value a coin. In this article, we can see how traditional markets valuation metrics apply to crypto markets, some crypto valuation metrics you can apply, and how crypto markets valuation metrics are more efficient than traditional markets.
What is the valuation?
Valuation is the process of determining the true value of an asset. This can be the value of an asset relative to a particular financial metric, such as revenue, profit, or book value. Also, it can be the value of an asset relative to the industry or competitors. These metrics are compared to the price of a publicly traded stock to gauge whether the company in question is overvalued or undervalued.
In the traditional stock market, the three most used valuation metrics are:
- Price / sale ratio: Price of the shares to the income obtained per share of the company.
- Price/earnings ratio: share price over the company’s earnings per share
- Price to book value: share price at book value of shareholders’ equity
Is there a valuation in crypto markets?
To measure a stock’s valuation, you need a company’s revenues and profits. These are retrieved from the quarterly or annual profit and loss statements and the balance sheet. However, cryptocurrencies do not have such financial statements. So what metrics can we use and how can we run a valuation analysis?
To run a crypto valuation model, we replace:
- Fully Diluted Market Capitalization (FDV) Price
- Income with annualized total income
- Earnings with protocol income
- Book value with total value locked
What are the key valuation metrics?
Using these crypto metrics, we arrive at the following valuation metrics:
1. Price/sales ratio:
Fully diluted market capitalization divided by total annualized revenue (revenue for the last 30 days expressed for the full year). The revenue earned by a protocol is the total of fees paid by users when using the protocol.
2. Price/earnings ratio:
Fully diluted market capitalization divided by annualized protocol revenue (last 30 days protocol revenue expressed for the full year). Protocol revenue is the proportion of total revenue that is paid to token holders after paying incentives to participants (such as liquidity providers and lenders) and fees to the network.
3. Market Cap to TVL:
Market capitalization at the dollar value of all assets locked within a protocol. This shows how the market is valuing the project, represented by market capitalization, based on the actual use case of the project, represented by TVL.
How can you value cryptocurrencies?
During a spike or dump, feedback metrics are helpful. You can use the above metrics to see if a coin is undervalued or overvalued relative to its fundamentals. This allows you to buy low and sell high if used correctly.
You can use the following data sources to gauge the valuation of a cryptocurrency:
Why is crypto valuation more efficient than stock valuation?
In traditional stock markets, valuation depends on metrics retrieved from quarterly or annual financial statements. However, in the crypto market, the valuation depends on the metrics retrieved from the daily fees paid or the total value locked. This makes the cryptocurrency valuation model more efficient.
That said, cryptocurrencies are an evolving asset class. While there are robust valuation metrics and methodologies, more ways to value a coin are emerging. Investors must adopt a holistic framework before investing in a project. Fundamentals are a key part of this framework.