The Basic Guide to Valuing Cryptocurrencies

This basic guide to valuing cryptocurrencies will help you do a more comprehensive analysis on any crypto, helping you sieve out the wheat from the chaff.

Cryptocurrencies are the new kids on the block. After gaining so much media attention with Bitcoin going up from $800 to $19500 in 2017, and with Ethereum hitting US$1000 and higher, new investors are flocking into this asset class looking for their 10x riches.

However, a new asset class means that there’s no established way to value a crypto. The danger of that would be people thinking they are flocking into the next ‘Ethereum’ or ‘Bitcoin’ when in actual fact they are buying vaporware, or worse still, join a Ponzi scheme.

THE LESSONS FROM DOT-COM

This is reminiscent of the dot-com bubble days.

When the internet companies got hot, people started believing that because it was such a new revolution, any company with a .com behind its name was bound to profit massively and change the world.

Because it was such a new paradigm, people threw out the old methods of valuing companies. There was no need for ratios, book values, or profit margins. It was a revolution! Companies could lose money, add a .com website and then saw their fortunes reversed.

It was a time of mania and common sense was thrown out of the window.

At the height of the dot-com bubble, its market size was about $3 trillion. Comparatively, the crypto market is small at $300 billion+, about 10% its size, but there are still lessons we can glean from there.

In the end, did the internet change the world? Yeah, it did, and more so than ever. The few good companies like Amazon and Apple popped like the rest of the companies but saw a rise even far beyond its market capitalization during the bubble.

The key point here is this: Yes, cryptocurrencies will change the world. But also true: most coins without good fundamentals will fade into non-existence (or a very low market cap)

So while everyone is being irrational or emotional about the market, it’s good to get acquainted with the key factors that determine the valuation of coins.

A GUIDE TO VALUING CRYPTOCURRENCIES

1. Who Controls It? 

For a typical company, it is made up of those who run the company (i.e. the employees),  the owners (i.e the shareholders) and the regulators (the government bodies). These stakeholders contribute to the running of the company and ultimately to its success (or failure).

In the traditional fundamental analysis, the management team is judged by their experience, expertise and diversity in skillset. The shareholders may or may not be assessed but will give a clue to the direction the company may head. And of course, if you’re in the good books of the regulators, it’s likely your company will succeed.

For cryptocurrencies, the 3 layers are the coders, the miners and the companies who will get people use the coin. All these can be judged separately and can determine if the coin will ultimately succeed.

The coders will determine the quality of the code and therefore the coin. Are there security flaws? Is the code open-sourced for all to audit? When the code is open-sourced, there are many trained and experienced developers who will scrutinize it to ensure it’s robustness.

The miners will determine if the coin actually works. The miners are people who will earn the coin in exchange for verifying and supporting the eco-system. They have an incentive to see the coin rise as much as possible. In the case of a crypto, who are the miners who will support the eco-system?

Mining, however, if too centralized, means that there might be a single point of failure. If the one organization who is mining the crypto goes bust, then the whole system may also collapse. Also, a centralized mine may also mean a Proof-of-Work coin can be subjected to a 51% attack.

Last of all, the companies that will push for adoption of the coin. Who’s in the front, out there, making partnerships, encouraging adoption by the general public? A weak business arm of the coin may cause its downfall.

2. Adoption and Utility – Who will use it?

The key question for whether a crypto will succeed is: What is the purpose of the coin? Would anyone use it in the first place?

There are many ICOs that created coins for very specific purposes like game credits, merchant loyalty programs. Funnily enough, people actually buy into them because they are ‘cryptos’ or ‘blockchain related’.

The question is: Why not just use the US dollar? Why is there a need to create a separate currency entirely?

Having your own currency usually means that there is a need to count value in a different way, or even across borders. That’s firstly what makes Bitcoin special – I can pay for goods and services in Japan in the same currency I can pay in Singapore.

If the only place I can use a new coin is in a private server or a very specific company, then the coin is more like a game credit, loyalty points or even just keeping a tab with the company. Hardly an innovation.

In the game of stocks and shares, the analysis looks at the profit margins. In the game of cryptos, the analysis should look at the current adoption and also the rate of adoption.

3. Supply – How will the coins be created and distributed?

Importantly, how are the coins being created into existence and how are they being distributed.

One of the most important qualities of a crypto and what gives it value is supply scarcity.

Bitcoin, for example, it’s been programmed to ever have 21 million units in existence. It is even more scarce than gold or silver in this sense. Also, in order to bring Bitcoin into existence, the miners have to input in tremendous amounts of electrical power, like how gold or silver would be mined off the ground.

There are other coins like Ethereum, for example with programmed inflation. About 15 million Ether is created every year.  To many, some inflation is good because it keeps up with the growth in population and usage, and debatably might be more sustainable in the long run.

Other coins, like Ripple (XRP) for example, are pre-mined. This means that all 100 billion XRP already exist from the beginning and there is no way for new coins to come into existence. Rather the company Ripple is holding on to 55 billion XRP in escrow, with a set agreement of releasing new supply into the market.

This, however, does not sit well with many in the crypto-space. If a company holds most of the supply and there are no ways for an individual to create supply into the market, then the coin is centralized in control – which is rather against the whole spirit of a crypto in the first place. Hence, many people do not consider Ripple to be a true-blue cryptocurrency.

(However, it may not have been designed to be such. It has other plans for adoption that may see its value rise, still)

4. Market Sentiment – What do people think about it?

A coin’s value can also be determined by how much of the market’s attention is on it.

While it does not guarantee the success of a coin, the more attention a coin has, the more likely it will be used and adopted faster than if a coin did not have that attention. That is assuming that a coin would eventually come good and actually produce a working product.

However, this means that many unsophisticated investors may also jump on the boat, not knowing what they’ve purchased. In fact, leading up to the end of 2017, there were several coins without a working product, yet finding themselves top 10 in the crypto market capitalization.

Personally, I have seen friends on the street touting popular cryptocurrencies like Ripple (XRP) or Tron (TRX). That was when I knew that the best move would be either to sell, or stay far away from them. (I’m not questioning its value, but the hype around it).

When your average person on the street becomes a crypto expert buying a particular coin, it’s probably time to get out of it.

As a trader or investor, it may be more profitable to find valuable coins that have less attention on them. They may have higher upside when the real value of the coin catches up through actual adoption for business use cases.

OTHER WAYS TO VALUE CRYPTOS?

So there you have it. The four key analysis you need to make when deciding to buy a cryptocurrency.

The market will always swing between overvalued and undervalued – the key for you, is to have eyes to see a coin’s real value when everyone else is speculating.

Do you have other ways to value cryptocurrencies? Feel free to comment in the section below and share them!

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