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Fundamental analysis aims to arrive at the intrinsic or fair value of an asset versus the price. Price and value are not the same and this has never been truer than in the world of crypto assets, which have dramatically different total supplies, liquid supplies, token lock-ups, inflation rates, emission structures, token burning, and so on. Traditionally, investors can measure value with cash flows like dividends with stocks and coupon payments with bonds using P/E ratios. 

However, with (most) crypto assets, there are no expected future cash flows, making crypto-asset fundamental analysis totally different. While we have entered into an entirely new paradigm with the emergence of cryptocurrencies, valuation and fundamental analysis are not impossible, it just requires new mental models around the new asset class.

In traditional investing, investors buy equity in a company, ensuring that if the company’s value grows, so too does their investment. This is not the case in crypto assets. Crypto assets are not shares in a company. A true crypto-asset should not even have a company. Value accrual and value capture are not one and the same and this difference is at the heart of many struggling token projects. This is, in part, what separates Bitcoin from the ICOs and VC-backed coins of the world, but that is a topic for another post.

While distinct, he core strategy underlying crypto fundamental analysis does share some similarities to that of traditional finance.

• Determine the key success drivers within the company's business sector.
• Determine which measurements capture the desired outcome most accurately.
• Monitor measurements on a sector-wide scale in order to assess performance over time.
• Invest in companies with both intangible (people, network, moat) and measurable (metric-based) upside.

This hypothesis is substantially more difficult to implement in practice than in conventional markets. Not only do businesses trade less efficiently, but the underlying technique by which tokens accrue value is highly uneven. As a result of stock ownership, a clearly defined set of rights guarantees privileges; tokens, on the other hand, are inconsistent in function and subject to regulatory flux.

This implies that two companies with functionally equivalent tangible and intangible features may trade independently. Adapting to this is achievable through tokenomic analysis, despite the fact that it is currently challenging.

Analysts review hundreds of different factors, metrics, and parameters across core categories for evaluating value, potential, and risk for crypto assets by a human-led team. While simply using data scraping to aggregate on-chain/Github/node count/social media data is quick and helpful, it is only a small fraction of the total picture. This approach (the popular approach by many of the leading crypto “research firms”) is inadequate, lacking the necessary depth, context, and nuance needed to evaluate a crypto project appropriately. Most things in life are rarely so black and white, and the wild, new world of crypto assets is no exception. Some examples of nuanced questions include:

• Project X has 25 developers, and Project Y has 50. Which one has the “better” overall team?
• Project X has 200 GitHub commits in the last month, while Project Y only has 20. Is Project Y stagnating? Is X gaming the system? Or are they having to do 10x the work because their original code was shoddy? https://medium.com/santiment/tracking-github-activity-of-crypto-projects-introducing-a-better-approach-9fb1af3f1c32
• Project X has a staking reward of 10% and Project Y 5%. But what about inflation? Or pay-out times/lockups? Our underlying currency risk? Is one losing value compared to the other?
• Project X has 100 nodes and Project Y has 1000. But are there master nodes? A permissioned system? Same consensus mechanism? What’s the node geographic distribution? The concentration of mining pools?

Our goal from day one has been to provide unbiased, high-quality, comprehensive research in order to deliver high signal-to-noise, practical, and impactful information you can immediately use to your advantage. CryptoEQ is a research platform and suite of products that bring a multi-factor, comprehensive framework to the complicated world of crypto but present it all in an intuitive, user-friendly platform, making crypto accessible to all.

Applying Traditional Models

Central to the valuation discourse are two predominant methodologies: intrinsic and relative. The intrinsic methodology anchors its valuation on an asset's inherent potential to generate cash flows over time. In stark contrast, the relative valuation, often referred to in financial parlance as "pricing", evaluates an asset's worth by juxtaposing it against the valuations of its peers or comparables. To illustrate, while an investor might harness the discounted cash flow (DCF) methodology to ascribe a value to a stock, the same technique would be inapplicable to, say, a piece of fine art. Drawing a parallel, the multifaceted nature of crypto assets necessitates the development of bespoke valuation techniques.

Robert Greer’s three-fold classification of assets is a good starting place. He defines Capital Assets as entities that consistently yield value, akin to traditional bonds and stocks. Consumable/Transformable Assets, on the other hand, are those that hold value but don't inherently generate a steady stream of it—commodities being a case in point. Lastly, Store of Value Assets are those entities that, while not being consumable or generating income, hold value—currencies and collectibles being primary examples.

Deep diving into the application layer of the crypto universe, one can discern three primary asset classes. Governance tokens, which confer upon their holders both ownership and voting rights, can be analogized to common equity in the traditional financial spectrum. Utility tokens, by contrast, predominantly influence the economic machinery of a given system. Non-fungible tokens (NFTs) have carved a niche for themselves as digital collectibles, akin to fine art.

Turning our attention specifically to the intrinsic valuation of Ethereum, a PoS asset, we discern its similarities to dividend-yielding stocks. A DCF analysis of Ethereum can be structured as follows: From the perspective of a validator, transaction fees that are amassed within the network are effectively channeled to these validators. Furthermore, token issuance, rather than diluting the validator's value, endows them with rights reminiscent of stock-based compensations. 

In closing, while our analytical foray provides a comprehensive valuation framework, it's imperative for discerning investors to treat this with the requisite caution, undertaking their own rigorous assumptions. The guiding principle behind our approach was a conscious bent towards conservatism, cognizant of Ethereum's inherent volatility. It's also worth noting that our analysis implicitly assumes the asset's monetary premium or the “Store of Value” component is seamlessly embedded within the DCF analysis.

Tokenomics

Blockchain protocols and cryptocurrencies can be valued in multiple ways, but a project’s “tokenomics” and value capture are front and center of the discussion. Crypto tokenomics refers to the economic principles and design of a cryptocurrency or token. It includes the total supply, distribution, and use of the tokens within a blockchain network or ecosystem. Tokenomics can also include the way in which tokens are created, distributed, and used to incentivize network participation, such as through mining or staking rewards. It plays an important role in the overall design and functioning of a blockchain or cryptocurrency project.

A well-designed token economy can help a project grow by creating a positive feedback loop where the value of the tokens increases as the project becomes more successful. However, the success of a project ultimately depends on the strength of the product or service being offered. Tokenomics can be affected by changes in the distribution of tokens, such as the shift from initial coin offerings (ICOs) to more professional investors having a larger share of tokens.

In addition, tokens can also be used for governance, allowing holders to vote on important decisions for the project. However, the lack of clear regulations and best practices for tokenomics can create challenges for established companies. They have to navigate the uncertain regulatory environment and exploit risk from new tokenomic models, and greater visibility of these firms keeps them trapped in the status quo.

Inflationary Rewards 

Blockchain token prices are dependent on their supply and demand, both of which are affected by many factors, such as the token issuance rate, owner/VC vesting schedules, and revenues earned by token holders or stakers. 

On the supply side, token issuance in protocols can cause inflationary pressure on the token price. Inflation for cryptocurrencies is an increase in the number of tokens in circulation, either through mining or issuance with a fixed schedule.For example, Bitcoin has a current supply of ~19.2 million and a supply cap of 21 million. The hard-coded and immutable supply schedule with its infamous “halvings” create supply inflation of 1.8% annually. These factors play a major role in making Bitcoin disinflationary as it approaches its 21 million ceiling. 

Another example of a higher inflationary network is Solana. Solana’s initial inflation rate is 8% and decreases by 15% each subsequent year until reaching a final, fixed 1.5% inflation rate. Solana’s long-term inflationary goal is aimed both at supporting sustainable growth for its ecosystem and at rewarding stakeholders in proportion to the SOL they staked.

While protocol inflation and staking rewards are commonplace and a key part of any crypto asset’s most fundamental design, crypto users often only see it through a particular lens: a yield for holding the token.