Investing in cryptocurrencies can be extremely lucrative, that is if you choose the right ones to invest in. Many cryptos have, and can again, show a 10x, a 100x, and maybe even a 1000x return on investment.
These types of returns in crypto are unparalleled in comparison to the traditional stock market. However, they are still few and far between. You can’t just blindly choose a crypto to invest in and hope for a 10x return on your investment.
You need to follow an investment strategy and have some way of evaluating the cryptocurrency’s price.
While there are various tried, tested, and successful crypto trading strategies out there, successfully evaluating a cryptocurrency’s price, or fair value, has proven to be rather difficult and has become a big problem for investors.
Which begs the question… How can we value cryptocurrencies?
In the traditional stock market, investors/traders use what’s called the price-to-earnings ratio (P/E ratio) to determine the relative value of a company's shares in an apples-to-apples comparison to the company’s earnings.
What’s the P/E Ratio? Can it be applied to crypto?
The P/E ratio is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS). It indicates how many dollars an investor is willing to pay today for $1.00 of annual earnings per share of a company in the future.
In other words, it sheds light on how bullish investors are about a stock.
A stock’s P/E ratio can be calculated by dividing the current stock price of a share by the company’s annual earnings per share:
P/E Ratio= Earnings per share/Market value per share
Simple right? So, how do we apply it to crypto?
This is where the problem comes in. Cryptocurrencies do not have earnings. While it is possible for cryptocurrencies with smart contracts and special functionalities/utility to have earnings, none do as of yet.
That said, calculating P/E for cryptos, in the same way, it's done for stocks just isn’t possible.
However, there are many brilliant minds in the cryptocurrency space and some have attempted to recreate a P/E ratio-like indicator for crypto. One such individual is Willy Woo, a brilliant crypto market data analyst specializing in on-chain analysis for Bitcoin.
Willy Woo has attempted to create a P/E indicator for Bitcoin and its called the NVT Ratio (Network Value to Transactions).
NVT the First P/E Ratio Indicator for Bitcoin
Willy Woo’s BTC NVT ratio chart from charts.woobull.com
The NVT ratio created by Willy Woo is the first P/E like-ratio that aims to become the new gold standard of digital currency valuation.
Unlike the traditional stock P/E ratio which examines a company's earnings and price per stock to evaluate the value of a company’s shares, the NVT ratio examines:
- Market cap
- Volume of transactions
This is because digital currencies like Bitcoin do not have earnings, which is why the NVT ratio measures price against the utility of a cryptocurrency; namely, store of value and medium of exchange.
In other words, the NVT ratio compares a crypto’s network value to how much the network is being used.
The NVT calculation is:
NVT Ratio = Market Cap/Volume of On-Chain Transactions over 24hrs
A high ratio may mean that a cryptocurrency is very useful and has a lot of interest, indicating that its price may be lagging behind. However, the contrary may be true, as well. In order for the NVT ratio to be of real use, we must analyze the NVT ratio over time and develop a longer history; only then can we be more confident in knowing a healthy range.
That said, it’s important to note that the NVT ratio is still in some sort of Beta stage. Crypto investors and analysts are still experimenting with its use and it's really just the beginning of investing and trading with analytical rigor.
For instance, recently Token Terminal has launched a list of cryptocurrencies AND projects where they attempt to grasp some sort of a P/E for crypto.
What’s Token Terminal you ask?
Token Terminal is a website that provides traditional financial metrics for crypto protocols. Their metrics can be divided into three categories:
- Trading data (price, volume)
- Financial data (earnings, P/E, yield)
- Business KPIs (e.g. transaction volumes, staking rates)
Again, what Token Terminal is doing here with a P/E ratio for different cryptos, are first attempts and they are not perfect, but it’s something to start with and develop further.
That said, let’s take a look at some different crypto projects and their earnings:
4 Crypto Projects and their Earnings
1. Kyber Network (KNC) - [trading_volume] x [burn_percentage (~0.2%)]
Kyber Network is an on-chain liquidity protocol that aggregates liquidity from token holders to power instant and secure token exchange in any decentralized application. Kyber’s protocol can be directly integrated into a wide range of decentralized products and services including wallets, websites, and applications to enable instant, secure, and seamless token exchange directly into the application logic.
Earnings for Kyber Network (KNC)
Kyber’s on-chain liquidity protocol collects transaction fees paid in KNC from Kyber token liquidity reserves like Kyber Swap, a fast, simple, and secure platform for exchanging Ethereum and ERC-20 tokens. For each Kyber Network transaction, a portion of the collected fees (in KNC) are burned (taken out of circulation forever).
Kyber Network’s earnings are calculated by multiplying Kyber’s trade volume by the total percentage of tokens burned. As of April 30, 2020, Kyber Network is the second top DeFi earner and it's P/E ratio is 82.51.
2. MakerDAO (MKR) - [outstanding_supply] x [effective_fee]
MakerDAO is a decentralized credit platform on Ethereum that maintains the cryptot-backed Dai and Sai decentralized stablecoins whose value is pegged to USD. Anyone can use Maker to generate the Dai and Sai stablecoins by locking up ETH, BAT, LINK, and USDC as collateral in a collateralized debt position CDP.
Earnings for MakerDAO (MKR)
Maker smart contracts collect stability fees that are calculated against the total amount of DAI drawn against collateral held in a CDP. The fee is variable and can change when MKR holders vote on proposals.
Maker’s earnings are calculated by multiplying the outstanding supply of MKR tokens by the effective stability fee. As of April 30, 2020, MKR is the third top DeFi earner and its P/E ratio is 249.66.
3. Loopring (LRC) - [trading_fees] - [0.10% of trading fees]
Loopring is a non-custodial order book-based exchange protocol in which scalable decentralized exchanges (DEXes) can be built on. Loopring-powered DEXes can handle throughput on par with centralized exchanges as the protocol can settle up to 2025 trades per second with transaction costs as low as $0.003 per trade.
Earnings for Loopring (LRC)
Loopring makes its earnings from protocol fees on each trade facilitated by Loopring’s DEX protocol. The protocol fee can be configured by individual DEXes to be any percentage from 0.001% up to 0.255%, in increments of 0.001% (0.1 bps).
Loopring’s earnings are calculated by taking the total number of trading fees and subtracting 0.10% of the trading fees because that amount is burned (taken out of circulation forever). As of April 30, 2020, LRC is the seventh-largest DeFi earner and it's P/E ratio is 104.01.
4. Synthetix Network Token (SNX) - [trading volume] x [0.3%]
Synthetix is a DeFi protocol built on Ethereum for the creation of “Synths”: on-chain synthetic assets that track the value of real-world assets such as fiat currencies, commodities, and crypto-assets. Synths are traded as ERC-20 tokens on the synthetix.exchange non-custodial DEX.
Earnings for Synthetix (SNX)
Synthetix.exchange charges a protocol fee on each trade that’s facilitated on the non-custodial synthetix.exchange DEX. This fee is between 10-100 bps (0.1% - 1%), though this fee is typically 0.3%.
Synthetix Network’s earnings are calculated by multiplying the network’s total trading volume by exchange fees, which currently stand at 0.3%. As of April 30, 2020, SNX is the fourth largest DeFi earner and it's P/E ratio is 120.52.
The P/E ratio is a well-respected and reliable metric for determining the value of a company’s shares in the traditional stock market; and just recently, this metric has been adapted to a variety of cryptocurrencies.
However, given the fact that each of the above-mentioned crypto projects has a different formula to calculate their earnings, I think that calculating their final P/E gives an unreliable result.
But then again, these are just the first attempts at applying this metric to different cryptos. These crypto P/E ratios may not be perfect, but it’s something to start with and develop further.
After all, cryptocurrencies are barely 10 years old and there’s not a whole lot of data and history to go off of. But as market efficiency increases with more participants, the NVT ratio and crypto P/E ratios may become just as respected and reliable as P/E ratios in traditional markets today.
What do you think about the crypto P/E ratios described in this article? Do you think they can become a reliable metric for valuing cryptocurrencies? Let me know what you think in the comment section below.