Three Concise and Applicable Token Valuation Models
The blockchain, born from the advent of Bitcoin, has carried a Utopian dream since its day one. Against the backdrop of people tired of the control and exploitation of centralized institutions in the real world but could not do anything, they turned their eyes to the blockchain, a brand new technology paradigm.
What is more exciting than the concept is people’s enthusiasm in investing in crypto assets and participating in cryptocurrency transactions. The enthusiasm is still wild after several alternations of bearish and bullish markets.
However, compared to the stock market that has been developed for hundreds of years, digital currency is still immature, full of gambling, irrationality, and money scams. Not a few individual investors, lack of the basic knowledge of the underlying logic of a certain token, could risk investing huge money blindly. On the other hand, some blockchain projects use the issue of tokens as merely a means of financing, so the tokens are separated from the chain business, or are pegged to it by brutal force.
In my opinion, in addition to having an understanding of a project’s prospects, we also need to be able to estimate the value of the token before investing. Warren Buffett’s value investment philosophy should be applied to the cryptocurrency market in addition to the stock market.
As a researcher on the Stafi project team, I participated in the design of the Stafi token (FIS) circulation model, so I need to objectively value FIS that early participants can see the potential of FIS. During my work, I have found a way to distinguish between token models and evaluate them. Different tokens varies in their token models, their valuation methods must thus be completely different. And the value difference is also very large in many cases. Before investing in them, I hope that investors may brighten their eyes and evaluate tokens wisely.
I divided token models into three types: ①Currency model ②Point model ③Stock model, which we will discuss in sequence:
1. Currency Model
The currency model refers to blockchain-based cryptocurrencies. The purpose of its creation was to be used as currency. The most typical one that falls into this model is Bitcoin and a string of its altcoins. Tokens in currency model is currency, which exists as a transaction medium and a value storage entity, and its value is supported by consensus and the scale of use. The value of bitcoin comes from its consensus which is built for over a decade, be it in the physical sense (there are tens of thousands of bitcoin full-nodes in the world), or in the sense of spiritual conviction.
Therefore, a currency model token without a consensus basis means nothing, and it is hardly possible to evaluate tokens in this model for the scale and toughness of consensus is not measurable. When we are evaluating a token that belongs to this model, we always compare it to a similar counterpart in the real financial world, for example, Bitcoin and gold.
As the concept of blockchain is becoming ever more popular, more developers are shifting their attention to applicable tokens, solving specific problems through tokens, stimulating network growth, and regulating the distribution of benefits. Existing projects taking this model is really limited these days.
2. Point Model
Tokens that suits this model can be used to purchase various services on the chain. I am not sure whether the word “point” is accurate, but let’s call them this way at least now, because it reminds us that in our daily life, points are given to us when we are shopping and can be used in the following purchases or the redeem of presents. Point system is a method taken by the sellers to stimulate consumers’ repeated purchase or actions that the sellers want. In blockchain world, tokens belong to this model carries more functions, such as the stimulation of the growth of the network, adjusting the balance of supply and demand, as well as many other specific applications.
The ETH of Ethereum is a token in this model in essence. In Ethereum, Gas are consumed when transaction or the running of smart contracts, and must be bought by ETH. Gas can be seen as a service provided by Ethereum.
When a new project issues a point token, it is pre-selling their services on the chain. To evaluate tokens in this model, we can use this common formula.
In a given period of time:
the value of tokens circulated=the value of products(services) circulated
On the left, the value of tokens circulated can be calculated by unit price*circulation*circulation times.It is very simple on the right, the GMV of on-chain service in this given period of time.
Then we have:
P(token’s unit price)*M(circulation)*V(circulation times)=G(GMV)
Moreover, we need an Maximum after discounting.
For example, in the number t year of a blockchain project, the GMV reached a certain number, presented by Gt. According to inflation rate, we can calculate the quantity of tokens that year:Mt(the staked tokens needed to be considered if the project is a PoS one. estimate a stake ratio and deduct the tokens staked). Considering the characteristics of the project, we estimate the average circulation times this year is Vt, then the unit price of the token at this time is:
If we assume the discounting rate is r, we can work out the unit token price(EPt) in the number n year by the discounting formula:
The discounting rate r is related to interest rate, representing the usage cost of the capital. It is also affected by the risks of the project, to be specific, proportional to it.
It is assumed that the project touches the ceiling in the 10th year, and then enters a stable operation period.
We need to calculate, in this way, EP1, EP2, EP3, EP4 … to EP10, whichever is the largest value is our final estimate of the token value. Why not continue to calculate EP11, because after entering the stable operation period, the growth rate of GMV will be lower than the discount rate, so EP11 is guaranteed to be smaller than EP10. The calculation of subsequent figures will be meaningless.
We can denote this maximum value as Max (EPt), which is the valuation of a single token. According to the above formula, we can get the final formula:
For your understanding, let me give an example:
Assuming a blockchain project whose token model is an integral one. Its on-chain transaction scale is US $ 200 million (G0 = US $ 200 million) this year. It is expected to grow at a rate of 30% in the next 10 years and enter a stable operation period in the 11th year, when the growth rate is estimated to reduce to 5%.
Then the future GMV fluctuation of the project, represented by the relationship between Gt and t, is as follows:
Let’s assume that the total number of tokens of the project this year is 1 billion and the staking ratio is 50%, and the ratio will remain stable in the future; the annual further offering rate after will be 10%, and the loss rate (referring to lost coins, Slash, burning, etc. that cause token reduction) is 1%. We can deduct that the net increase rate is 9%.
The number of circulating tokens in the future, that is, the relationship between Mt and t is as follows:
Assume that the average annual circulation of the token (or the average annual turnover) of the project is 3.5 times, and will remain stable in the future, that is, V = 3.5.
To calculate the present unit price of the token in the fifth year: EP5
Known that:G5=0.571bn USD, M5=0.7706bn, r=12%, V5=3.5
Calcuate by the formula above
Using Excel, we can also calculate the token unit price for each year in the next 15 years based on the initial data.
It can be seen that the estimated value of the token is
Max(EPt)=EP10≈2.20USD
In many case, we don’t have to go through such a lot of trouble. Through the initial data, we can basically deduce that Max(EPt) is when EP10, that is, the present value of the unit price of the token in the 10th year is the biggest.
There may be two questions. First, if there is a project where sustainable growth rate is always greater than the discount rate, so the curve in the figure above will go up indefinitely. In this case, Max(EPt) = ∞. There will not be a ceiling for this project. It is clearly impossible in reality. Second, if it is an infinite deflation model, then the amount of tokens in circulation will keep decreasing under the condition of stable business scale. Under this circumstance, Pt seems to grow infinitely at a rate beyond the discount rate. Will Max(EPt) be infinite? Judged by the formula, it will. However, in the model of infinite deflating token, the deflation process is more like in the form of dividends to all token holders. This model is more like Stoke Model, which will be introduced later.
Some of you may find the formula very familiar, especially those who have financial knowledge. Isn’t it Fisher Formula?
MV=PQ
On the left, M is the quantity of the currency and V is the circulating speed of it. On the other side of the formula, P is the unit price of goods or services in society, and Q is the quantity of them. However, the equation proposed by Fisher is only to express the correlation between various variables, but not to create a tool for quantitative calculation. That is because it is very difficult to measure M, P, and Q accurately in the real world. At best, we can judge whether it increases or decreases. The more difficult is V. In Fisher’s concept, V is an abstract concept that represents the circulating speed of currency, which relatively stable in a certain historical period. It can be viewed as a constant. Only when discussing different historical periods, V has meaning as a variable. For example in banknote economy, V must be greater than that of the precious metal currency economy.
For a blockchain project, however, the economic model is rather simple and the services it provides is limited or even specialized.
Therefore, evaluating Q is evaluating the development scale of a business;and evaluating V is virtually evaluating the frequency of transactions.
The most interesting part is M. The society is full of various forms of financial behavior, so there are different concepts of broad money and narrow money. And the amount of money in real circulation becomes unmeasurable. But in blockchain projects, token is easy traceable. If you intercept a certain historical period, you can have access to how many tokens in circulation or how many times each token is in circulation. Even the speculation of future data is easier than that of in real world economy. There is no borrowing, no securitization, or varied financial behavior on the blockchain. Therefore there is only M0, but no M1, M2, M3. (The financial behavior outside the chain does not affect the token ecology within the chain system). As long as we take the the inflation rate and loss rate and staking rate (if any) into consideration, it is totally possible to estimate the value of M in a certain period in the future accurately.
I have to say that blockchain is a great invention that allows us to pilot a myriad of economic models, which in turn may give us a better understanding of the complex real-world economy.
3. Stoke Model
The token that falls into the stock model represents the revenue right of the business on the blockchain of a project. Holding this type of token is similar to holding the stock of a company. This model is rather interesting.
Some exchanges issue tokens then promise to repurchase them at a specific price in the future. This is more like bond financing. Tokens are similar to bonds or preferred stocks — this is not a common model, but more like tokenization of securities in traditional finance. The token designed by stock model is more in line with the token economy concept.
A typical stock model token is to let the token holder and the chain share become a community of common destiny. For example, MKR is the equity-like token of MakerDAO. When a user stakes ETH on MakerDAO to lend the StableCoin DAI, the CDP contract will begin to charge. Finally, when the user returns DAI to redeem ETH, the user will be charged, which is related to the amount and time of DAI borrowed by users, and also related to the fee rate dynamically adjusted by MKR holders through governance voting. This fee is called stable fee.
The stable fee must be paid by MKR, which, once paid, will be BURNT directly. This is a detoured way of profit sharing for all MKR holders.
This is because the value of MKR burnt will take shape of the increase in the token price of MKR. So the value is virtually allocated. But if you do not own any MKR, this has nothing to do with you.
Of course, MKR goes far more than that. As a work token, possessors must engage themselves in the governance. All important parameters in the system is decided by voting. And your influence in the voting is proportional to the MKR you possess — another similarity between MKR and stocks. We will save ink on this for it takes tons of time to explicate work token. If you are interested, you can have access to numerous spelendid materials publihsed. We will focus on the valuation of token in this passage.
Since it is the stock model, we can estimate token’s value by what we do for stocks. The most classic and common way of evaluating stock is DCF (discounted cash flow). Virtually, it is to convert all expected future earnings per share into present value.
The calculation formula of DCF:
P一the estimated value of an enterprise;
n一the life span of an asset or enterprise;
CFt一the cash flow of an asset or enterprise at t time.;
r一the expected discount rate of the cash flow.
Since it is about revenue, why we use cash flow instead of profit? This is because the profits in the company’s finance are easy to be faked, so “cash flow discounting” is used in valuation practice instead. But for blockchain projects, it is completely fine to calculate by revenue discounting.
So we can replace CFt with Rt (revenue at time t), and R means revenue
We need some variables. The first is discounting rate, and the second is the initial size of the business on a blockchain and the development rate in each year ahead.
It should be noticed that many token are inflating, which must be considered in the calculation as an adjustment value.
We can understand this adjustment value in this way: although we hold a certain amount of tokens, but the ratio of tokens we hold in the whole system keeps changing. This is different to stocks, in which companies cannot further issue stocks at their ease to dilute ones you hold. In this scenario, the stocks you hold represents the fixated equity share.
If the total amount of a token is 100 million, one single token represents 1 of 100 million in the total revenue. But if the token inflates to 110 million in the next year, 1 represents 1 of 110 million in that.
Therefore, if we calculate P, we still need to take inflation rate into consideration. We cannot get the value of each token by dividing “total number”. For the total number of a token keeps changing, we denote the token number in the t year as Mt, a function of t.
Introducing Mt, we can calculate the value of each token using the formula:
we still need to know how to calculate Mt. Different projects takes different inflation strategies, so the means of calculating them are also diverse. To illustrate:
Fixed-proportion Inflation Model
Fixed-quantity Inflation Model
Shrinking Growth Model
Frequent Adjustment Model
Why there is no deflation model here is because in blockchain projects, inflation and deflation are totally different in nature. Inflation is often the issue of new tokens to dilute the rights of holders, while deflation is often the destruction of some tokens, giving value to all token holders in equal proportion. This does not change the token holder’s holding ratio, and of course, the holder’s rights stays immune. As mentioned earlier, destruction is more like a dividend to token holders.
It should be noticed that, in a project where inflation and deflation coexists, we need to assume that the tokens deflated still exists during calculating. Otherwise, the dividends distributed by deflation will be double counted.
Most application chains use the PoS consensus mechanism. In the token valuation of such projects, we can completely assume that the tokens we hold are staked. Due to the existence of stochastic parameters in the consensus mechanism, the return of stake fluctuates in the short term. However, in the long run, its return is equal to the inflation rate divided by the stake ratio.
Stake yield = inflation rate / stake ratio
Here the net yield of stake can be made clear if we further subtract the operating cost of staking. The operating cost of staking refers to electricity costs, system maintenance costs and the like.
Stake net yield = Stake yield — stake cost
We may have a simpler way: delegate our tokens to professional stake service providers (such as Chorus, Wetez, Certus, Hashquarks, etc.), which will charge you commissions from stake yields(10–15% at average).
Stake net yield=(1-Commission ratio)*stake yield
If we assume the net yield of staking as s, and put s into the formula, we can get the final formula of calculating a single token of stock model:
Of which:
t stands for time, s is the net yield of stake, r is the discounting rate, Rt is the total profit of the on-chain business at time t, Mt is the total number of tokens on the chain at the beginning of time t (tokens burnt at time t is included, those burnt before t are not).
If there is a large difference in the yield of the take in different periods, then we need to replace s in the formula with st (the yield of the take in t)
We can input initial data into excel, which are our estimations to Mt, Rt, St in the following years, and set a variable r, then the calculation can be made.
The result we need can be summed by by the Sum function integrated in excel. Due to the lifetime of an asset n could be infinite, the longer the form(the bigger the value t), the final result will be more precise.
If you still find it a little bit troublesome,
we can sacrifice some of accuracy and make a hypothesis like this: take no account of stake cost and assume that the stake ratio is 100%, then the net yield of stake equals inflation rate. Therefore, Mt=M0(1+s)^t(M0 is the token quantity at the initial stage). Then we put Mt in:
In this formula, the equity increase generated by staking counterbalances the equity reduction caused by inflation and stake cost. Under this assumption, the proportion of tokens we hold to the total number of tokens remains unchanged. After this simplification, the valuation of tokens will be almost the same as the valuation of stocks. Then we can put a lot of mature calculations of DCF into use to get better valuation result.
Conclusion and Supplement
In this article, I introduced three token models and their corresponding valuation methods. In addition, I would like to make the following three explanations: First, different projects in all respects of blockchain worlds are facing varied demands, so their token’s circulation pattern, application scenarios are all not the same. But the aforementioned 3 ways of valuations should be sufficient. Many projects do not take a single token model, but a fusion of two or more. The valuation of those projects should follow two principles: what is its dominating token model?which value is higher taking different valuation approaches shall be adopted. I’ve seen many tokens of application chains serving as points and stocks. For them, we should take the higher value.
Second, the categorization method taken in this article is to facilitate the valuation of tokens. So the categorization is neither careful nor comprehensive. If you are interested in token economy, you can search on the internet for more categorization methods of tokens. As far as I know, there is a 5-dimension classification methods, analyzing and categorizing tokens from 5 aspects. This is a very detailed way, but not necessary for the valuation of tokens.
Third, in many cases, tokens can be derailed from its value. Apart from the common optimistic or pessimistic atmosphere of a project, there may be other reasons. It may be that the price of a token in a currency model exceeds that of the other two models. To put it in another way, the currency attribute of these tokens are exploited completed, which causes the price of them higher than its application value. Such as the price of gold far exceeds its application value in life and industry. However, this is not always a good thing for application tokens. Although a high token price can give core team of the project more fund to develop their system, but some roles on the chain may be twisted by it, affecting the growth of the network.
We know that the speculative factor has always been an important part in the making of the token price, but the healthy development of the business on the chain actually requires token price to be stable(or stable and predictable growth or decrease). We can separate the speculative factor from the price in one way: to transfer the non-business transactions off-chain and create M1 and M2 outside the chain system, making the circulation of native tokens focusing on the on-chain business. What is circulating in the off-chain circulation is the bond that can be exchanged for the native tokens — killing two birds with one stone.
Stafi protocol can be very useful in this prospect.
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Due to the limits of my ability, if there is any inconsistency in the text, please feel free to help me correct it. If there are better methods for token valuation, your inputs are also welcomed.
By Liam & Msize, blockchain researcher of Stafi
About Stafi Protocol
STAFI Protocol solves the contradiction between the token liquidity and Mainnet security by issuing ABT tokens, which provides the liquidity of your Staking Assets. ABT token increases the staking rate to a higher level (100%, theoretically) ,and it could be tradable, its security is guided by Stafi Protocol which ensure ABT token is the only collateral that can apply to redeem staking assets from original staking blockchain ( Tezos, Cosmos, Polkadot, etc,.)
Website: www.stafi.io
Twitter:@Stafi_Protocol
Telegram: https://t.me/stafi_protocol
