Investor Series #5 – Binance Coin


History

Binance was founded in 2017 by Changpeng Zhao. A newcomer to the Bitcoin space, the Binance exchange quickly became popular for its customer focus, and later for its native token, BNB.

Binance has also been working on a second exchange – one that is decentralized. The Binance “DEX” which will go live on or around April 23rd, 2019.

As of April 20, 2019, not much is known about the Binance DEX. In this article, we include as much information as possible in our analysis.

Updates to this article and accompanying model will follow.

BNB Token

BNB is an ERC20 token hosted on the Ethereum blockchain. Holding BNB in a Binance account gives users a 25%+ discount on trading fees when paid with BNB.

The Binance exchange also has BNB base pairs, as will the Binance DEX.

BNB is not used as a medium of exchange (MoE) for goods per se; it’s used as an MoE for other currencies.

Therefore, we can use the equation of exchange to value Binance Coin.

Valuation Principles

The popular narrative about BNB is that it resembles an equity and should be valued according to traditional formulas – a DCF model or similar. Adherents to the theory point to BNB’s correlation with Binance’s revenues, which are based on trading volume. The venture capital firm Multicoin Capital based their investment thesis on this heuristic.

Using Binance’s revenues as a proxy for BNB’s price assumes perfect value capture by the BNB token. The Binance team understands value capture, but based on observations, they are far from perfect at it.

More to-the-point, since Binance Coin is a currency whose variables can be identified and modeled, it makes more sense to value BNB as a currency, not as an equity, or a “store of value.”

For this reason, our analysis focuses on these factors: the circulating supply of BNB, and the variables in the equation of exchange, MV = PQ, which expresses the equivalence between the supply and demand of a currency.

Equation of Exchange Variables

In this article, we’ll abbreviate circulating supply to S.

In the equation of exchange, M represents the value of the circulating monetary base – all BNB in circulation.

V represents the velocity of those BNB. Velocity is the average number of times each unit is exchanged.

On the other side of the equation, P stands for purchases – the average value of a purchase made with BNB. Purchases with other currencies are of goods and services. Purchases using BNB are of other cryptocurrencies.

And Q is the quantity of purchases.

We model the future of each variable with adjustable assumptions in the Investor Series BNB model.

Supply and Demand

Fundamentally, currencies are subject to the same factors as any goods – supply and demand.

There are two sides to the equation of exchange; each side corresponds to supply and demand.

MV represents the supply side of the equation, while PQ represents demand.

Supply

Binance issued 200 million BNB as ERC20 tokens. Of these, 48 million are frozen, pending release according to Binance’s vesting schedule for employees’ tokens (found on page 9 of the BNB whitepaper). Over 11.6 million BNB have been burned by Binance in quarterly “coin burns”.

Due in part to Binance’s engineering the BNB supply, many of Binance’s supporters believe that Binance Coin is a “store of value.” It’s an somewhat irrational conclusion which becomes a self-fulfilling prophecy.

Most of BNB’s perpetual increases can be attributed to trading volume, with which it’s highly correlated.

The perception of BNB as a “store of value” disorients investors unfamiliar with currency valuation, especially since BNB is more frequently affected by changes in supply than other currencies.

Factors which primarily increase supply

Vesting of employees’ tokens

Tokens given as part of employees’ compensation are governed by a vesting schedule, found in the Binance Coin whitepaper.

Each year, 16 million BNB becomes available for employees.

Based on chain analysis and price history, we believe employees’ BNB vests in July each year. Employees appear to have sold their BNB within months of receiving it.

The BNB model includes an adjustable assumption for the percentage of employees’ BNB which enters the circulating supply the same quarter.

Factors which primarily decrease supply

Binance’s quarterly BNB burns

In a direct effort to reduce the total supply, Binance burns 20% of their profits in BNB every quarter.

Binance’s 7th quarterly burn included 829,888 BNB – around $15,600,000 USD at the time. Burns will continue until the total number of BNB tokens reaches 100 million.

Staking requirements for Binance Chain

The Binance Chain which supports the DEX uses a Delegated Proof of Stake (DPoS) consensus algorithm to keep the network safe from malicious actors.

As a result, the Binance DEX looks almost identical to BitShares (BTS). Difference are mostly superficial; the Binance DEX uses BNB instead of BTS, and its blocks are every second instead of every 1.5.

BNB holders elect block producers – one vote per BNB. Block producers can either campaign to receive votes from existing BNB holders, or buy BNB and vote for themselves.

Since it’s cheaper to buy votes than BNB, block producers will do this instead of hoarding BNB. This leaves circulating supply unaffected.

Under a pure Proof-of-Stake system, Binance DEX would require a significant percentage of total BNB, which could decrease the circulating supply. Some DPoS-based blockchains require stake as well; we’ll find out this week what the staking requirements for Binance Chain are.

If the Binance Chain requires a fixed BNB stake per validator, the circulating supply may be reduced by stake amount * number of validators.

Binance Launchpad

Binance Launchpad is an ICO platform that accepts BNB for ICO tokens.

BitTorrent accepted BNB for the first round of their ICO. BNB raised through ICOs stays out of circulation as long as BitTorrent’s treasury chooses to hold it.

BNB locked up for the DEX

BNB locked up via transactions on the Binance DEX is the most interesting way BNB supply is reduced; it’s also unexplored.

The Binance DEX doesn’t exchange other blockchain assets. Buying one BTC/BNB pair on the Binance DEX is actually a purchase of a BTC’s worth of BNB tokens.

When the BTC/BNB pair is purchased on Binance’s centralized exchange, BNB goes to one party, BTC to the other.

Both coins remain in circulation.

On the Binance DEX, it is just BNB being exchanged, except one party holds some number BNB in place of another asset.

This takes a disproportionate amount of BNB out of circulation, while increasing the demand for BNB on the other side of a trade.

The net effect of this is yet to be seen, but if the Binance DEX were to fully displace Binance’s centralized exchange, it would move the speculative value from other cryptocurrencies to the BNB token.

Unfortunately for BNB holders, the Binance DEX is quite limited in scope – requiring a Ledger to sign on.

We will reevaluate this possibility once the Binance DEX gains traction.

Factors which increase demand

Trading volume

BNB can be used to pay Binance trading fees at a discount. Increased trading volume on Binance brings more demand for BNB.

BNB is somewhat correlated with overall crypto trading volume, but not entirely. There are no major uses for BNB outside of holding a balance to pay for fees.

The Binance DEX, Launchpad, and future Binance endeavors may change this.

Factors which decrease demand

Regulatory crackdown

Regulatory action against Binance make BNB less valuable to the extent it restricted Binance’s users or operations.

Because Binance a) moves quickly and b) operates in several supportive jurisdictions, it is unlikely regulators will catch up to the company.

KYC is one of Binance’s concerns, however, and this may take a toll on their user base. It may also have inspired their DEX.

BNB Investor Series model

Now that we’ve reviewed factors which affect BNB’s value, we’ll construct the model.

First, the supply inputs.

The Binance exchange’s current wallet contains just over 91 million BNB.

Since there are no real off-chain uses for BNB, this is the circulating supply. 48 million BNB are frozen; 11.6 million are burned.

The rest are trading on other exchanges, or held by large investors and Binance employees.

Each quarter, we factor in employees’ tokens which enter circulating supply after vesting, and the number of tokens burned.

Based on chain analysis, employees’ tokens appear to vest in Q3 each year, and there are roughly 1.5 million tokens burned each quarter.

Trading volume inputs

Click here to open the model

Exchange fees

Aside from speculation, demand for BNB comes from trading fees on the Binance exchange.

We assume all trading fees are paid in BNB at 0.075% of trade value.

There are two sides to each trade, and each is paying fees, so we multiply the fee rate by 2 and apply it to volume.

Growth rate

Binance is already one of the largest exchanges, so its growth would come from cryptocurrency price increases rather than competitors’ volume.

Assuming increased trading volume is driven by cryptocurrency price increases, all else being equal, the default assumption of 50% quarterly growth reflect a $75,000 BTC price at the end of 2020.

Velocity

Velocity is the number of times each unit is transacted in a given time frame, on average.

We imagine Binance users refill BNB balances every two weeks, on average, which would give us a quarterly velocity of 6.5.

This assumption is adjustable also.

Monetary Base

Link to the model

To solve for the value of circulating coins, we rearrange the equation of exchange to isolate M:

M = PQ/V

In our example, where each BNB circulates 6.5 times per quarter, the required value of circulating BNB is 20.7 million.

Divided by the circulating supply of 89,500,000 gives us a per BNB fair value of around $0.35 in Q2 2019.

Conclusion

Unless we drastically overestimated circulating supply and/or velocity, this analysis suggests BNB is 70x overvalued for its use case – paying Binance fees.

This does not necessarily mean BNB’s price will fall.

Although cryptocurrencies trend toward their fair value, BNB is very popular with speculators. With no way to short, price discovery is difficult.

BNB has consistently traded above its fair value for most of its existence. Due to its noncorrelation with other cryptocurrencies, speculators treat BNB as a hedge. This drives demand up on exchanges while locking up supply.

It makes perfect sense that BNB would be uncorrelated while trading at 70x its value – it’s barely tied to fundamental drivers of value.

Tulips are also uncorrelated.

Future of BNB

An informed bet on BNB is a bet on the Binance team or community to create more uses for the token.

The Binance DEX could give BNB fundamental value if it locks up enough either as stake on Binance Chain or as collateral for pegged-assets.

A second round of ICO mania centered around Binance Launchpad could also bring fundamental value to BNB.

At Eat Sleep Crypto, we prefer cryptocurrencies with fundamental support from real use-cases.

These currencies have less downside and often more upside from less speculation. Maximizing upside potential while minimizing downside risk is key.

We’ll be talking about this concept in the coming week at Eat Sleep Crypto – look out for more email updates on BNB as we hear more information about Binance Chain and the Binance DEX.