Valuing crypto is difficult.
It seems pretty straightforward that Zimbabwean dollars are worth less than American dollars, but comparing Solana to Avalanche is more complex. That is because cryptocurrencies are new, have different use cases, and tend to be controversial. Traditional assets like commodities or currencies have valuation models that cryptocurrencies don’t have.
However, there are ways to approximate the intrinsic value of cryptocurrencies. This article looks at:
- How the intrinsic value of money is defined.
- Which factors you can use to assess a coin’s intrinsic value.
- The conclusions to draw for your investment strategy.
The intrinsic value of money
On the surface, money has no intrinsic value.
It is either numbers on a screen or numbers on a fancy piece of paper. You cannot eat or drink it, and you cannot use it on a deserted island after your plane crashed. Still, we dedicate a good chunk of our life to attaining as much as possible, so it must have some kind of value.
In fact, you can easily explain the intrinsic value of money according to six attributes.
Scarcity
You will later learn that money can be too scarce but generally, scarce is better. The less money there is, the more valuable it is. This concept is commonly known as inflation.
Utility
If you have a house and your neighbour has three sports cars, would you trade? What if your house was dilapidated and old? The value of money is that we can attribute a numeric value to both and easily compare.
Divisibility
If we used gold instead of money, it would be tough to value microtransactions like leaving on a lightbulb for one hour. Money allows us to value even fractions of a whole.
Transportability
Say you are extremely wealthy, but money doesn’t exist, and goods are traded in gold. Do you think this would be comfortable or safe?
Durability
Unlike apples, money cannot perish and is thus well-suited as a means of exchange.
Hard to counterfeit
The more difficult a good is to counterfeit, the more appropriate it is as money.
How to assess intrinsic value of cryptocurrencies
Not all cryptocurrencies want to be money, but at least the two most important ones have claimed to be superior to fiat money. Therefore, keeping in mind the definition of money’s intrinsic value is useful. However, cryptocurrencies can be valued according to several other vectors.
Utility
Similar to fiat money, crypto has to be useful.
That can mean being useful in its own ecosystem — its application or its blockchain — or even beyond that. Most coins are utility tokens, governance tokens, or both. You can use them as money and/or as voting power. The better a coin performs these functions, the more useful and thus valuable it is.
Utility can also arise from innovation: maybe a coin enables something impossible before. Bitcoin did this with decentralised peer-to-peer transactions. Alternatively, utility can arise from future utility, so whether a coin is developing something new and/or improves existing processes. Ethereum promises to challenge existing financial networks with a decentralised and scaled version of its current network.
Scarcity
Scarcity is the most important factor in how to value a cryptocurrency for many crypto investors.
A coin’s scarcity is defined by its tokenomics. For instance, Bitcoin’s tokenomics define that only 21 million coins will ever exist. That is one important factor influencing its valuation, but it is not the only one.
Scarcity is also influenced by concepts like circulating supply and fully diluted valuation. Technically, a bit more than 18 million Bitcoin are circulating, but in reality, it is much less because some coins are irretrievably lost, and others are in the hands of HODL-ers (hold on for dear life).
Fully diluted valuation is the current market capitalisation of a coin multiplied by all the coins that will ever be in existence. For instance, Bitcoin’s fully diluted valuation is close to its current valuation because only two million more coins will be mined. But for other coins, only a fraction of its supply is circulating, and many more coins will come, meaning the inflation rate will be very high.
In regards to this, you should also pay attention to a coin’s insider allocation. How many coins belong to the team, and when are they allowed to sell them? The higher the insider allocation, the more careful investors should be.
Demand
The US-dollar is the most valuable currency in the world because it has the highest demand. Americans need it, but so do many international companies and financial markets.
The same is true when valuing cryptocurrencies.
Look at how many people need a coin to interact with an app or pay for a service or use it as a store of value. You also need to consider a coin’s velocity when assessing its demand. Many people want Bitcoin, but a lot of people will never sell their Bitcoin, meaning it has low velocity. On the other hand, Dogecoin has high velocity because almost all people use it for speculative purposes only.
A second factor to consider is Metacalfe’s law. This law defines that the utility of a network grows exponentially to the number of users. Say two people use phones; then phones have a utility of four. But if ten people use phones; phones have a utility of 100.
In other words, the more users a cryptocurrency has, the more useful and sought-after it is. Bitcoin has many more users than Worldcoin, so demand for Bitcoin is exponentially higher than for Worldcoin, which is reflected in its valuation.
Perceived value
A big factor in a coin’s valuation is the perceived value or, in other words, the narrative around a coin.
Bitcoin has, over time, built up a narrative of being a store of value. The more people believe it, the more they use it this way, becoming a self-fulfilling prophecy. The same is true for other cryptocurrencies that brand themselves as the new Bitcoin or Ethereum killer and others, trying to build up a narrative to push up their perceived value.
Another important factor here is the team working on a cryptocurrency. The more reputable and well-known a team is, the more trust the market will have in the token, which will reflect on its valuation. This is especially true for more recent tokens used as utility tokens and more similar to stocks than money.
Production cost
Although money does not have very high production costs, some cryptocurrencies do.
All proof-of-work coins technically are worth the electricity needed to mine the coins. This is an important factor influencing a coin’s valuation. However, it does not mean that proof-of-work coins are automatically more valuable than proof-of-stake coins because mining also incurs costs like attacks on a coin’s reputation for its environmental impact.
The team can, in a way, also be seen as a production cost since a coin’s value is a function of the people influencing it. For instance, Dogecoin is heavily influenced by Elon Musk’s tweets, so even though Musk is not a team member of Dogecoin, the value of his reputation influences the coin’s value.
Availability
Finally, how often and easily a cryptocurrency changes hands also heavily influences its valuation.
This is different from scarcity because the quantity of a cryptocurrency does not equal its availability. For example, take BTC and YFI. Bitcoin’s total supply is 21 million, but YFI only has 36,000 tokens, making it much scarcer. However, the proportion of Bitcoin holders that will never sell is higher than the proportion of YFI holders that will never sell, making YFI more available.
This is the aforementioned concept of monetary velocity, meaning a coin’s valuation is lower the more often it changes hands.
Another way of comparing availability is to look at the value of other asset classes.
For instance, if you think that cryptocurrencies will become as available as stocks, you should compare their total market capitalisation to that of the stock market. If you think they will mostly serve as a store of value, you might want to compare it to gold. This also works for individual coins like comparing Ethereum to the valuation of Visa or Mastercard.
Comparing valuation across asset classes is highly complex and involves a lot of guesswork, but it is a good way of estimating a coin’s fair value.
Conclusion
As you can see, many factors influence a cryptocurrency’s valuation. It is in many ways harder to do so than using a model since so many factors are subjective.
Investors should see this as an opportunity. The less obvious a coin’s valuation, the lower the chance that smart money knows its approximate true value. However, the opposite is true since a few insiders may be aware of a coin’s true value and have a big advantage over the market.
Either way, the crypto market carries more risk but also more opportunity, which is one of the reasons for its massive volatility. Enjoy it while it lasts
