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Crypto vs. Stocks: Valuation Heuristics

Much like traditional capital assets, digital assets generate revenue and exhibit characteristics of commodities and stores of value. However, the similarities end there. The multifunctionality of digital assets sets them apart from their traditional counterparts. For instance, Ether, the native asset of the Ethereum blockchain, can be used to pay for services within the Ethereum network, stake to provide network services, or even vote on the governance of the ecosystem. This is a stark contrast to traditional assets like Ford stocks, which are primarily used for investment purposes.

The data structure of public blockchains further differentiates these digital assets. As digital bearer instruments, these assets can be self-custodied and transferred peer-to-peer. They trade 24/7/365 globally in liquid markets, a feature that distinguishes them from traditional financial markets that operate Monday through Friday for approximately seven and a half hours. This constant trading allows for continuous information processing, contributing to the volatility of crypto networks.

Perhaps one of the most significant features of public blockchains is the transparency and accessibility of data. As permissionless, fully transparent open data networks, anyone can access the data on these networks. This transparency offers a wealth of information for analysis and research, with platforms like Token Terminal providing visualization tools to make this data more accessible.

In essence, digital assets are more than just a new form of capital; they represent programmable equity with limitless potential for use cases. However, their multifunctionality also makes them more complex to analyze compared to traditional assets. As such, investors need to consider a different set of key metrics when evaluating these assets. This is one of the many challenges that the crypto industry faces today, but it also presents an exciting opportunity for innovation and growth in the world of finance.

In traditional markets, there is a well-established consensus on how to value different assets, with key data points, metrics, and ratios such as price-to-earnings, earnings per share, debt-to-equity, and revenue multiples. These metrics are based on audited financial statements that are made public every quarter, allowing the market to process this information and reach a consensus on the proper value of an asset.

Token Incentives: A New Spin on an Old Model

Cryptocurrencies have introduced a novel approach to incentivizing user activity. Much like venture-backed businesses such as Uber, which used capital to subsidize services and attract users, crypto networks often distribute their governance or native tokens to encourage participation. However, the comparison is not entirely apples-to-apples.

Crypto networks, in essence, are multi-sided markets that require a delicate balance of participants to function effectively. For instance, Ethereum or Bitcoin needs to incentivize miners or validators to secure the network, much like Uber needed to attract drivers. The key difference lies in the method of incentivization. While Uber spent cash, crypto networks distribute tokens, akin to the network's equity, to bootstrap their ecosystems.

This approach, while seemingly costly in the short term, can lead to robust network growth. It's akin to Uber offering shares to its drivers, turning them into stakeholders and evangelists for the platform. This inclusive approach to equity distribution fosters a more decentralized model, creating a network effect that traditional businesses often struggle to achieve.

DeFi Lending Case Study

In DeFi, lending protocols that have their own token face a significant challenge: discouraging the selling of that token. While market forces inevitably influence a token's price, a project should strive to instill sufficient utility and stimulate demand. This is particularly pertinent when considering that most participants in these protocols are primarily profit-seeking. When a lending protocol incentivizes activity through token emissions, it essentially invites sellers. As prices increase, users are incentivized to supply assets and earn higher yields, leveraging the same asset when it is profitable to do so.

However, paying out token incentives is not a futile strategy. Many protocols have successfully implemented this approach. Yet, it can become extremely value-extractive if the proper measures are not put in place. Some protocols have implemented locks and penalties for eager sellers, demonstrating this point.

Tokens of lending protocols are frequently subject to highly inflationary schedules. Many projects attempt to salvage cratering prices by adding utility to their tokens. Greater utility contributes to less decline from higher demand. However, quantifying the effects of utility features is challenging, and it would be beneficial for projects to gain deeper insights into how their initiatives and ideas perform. Holder count can be a valuable metric for protocols, but it is arguably more important to understand the paths that users holding those tokens take.

When emitting tokens, the primary reason for doing so is to incentivize activity. A feature of the best outcome for protocols is that a significant portion of their tokens are held in wallets, various smart contracts, and liquidity pools.