Category: Valuation Framework

Articles about the Eat Sleep Crypto valuation framework

Valuation Methods: Finding PQ

Posted By under Cryptocurrency Valuation, Valuation Methods

PQ in the equation of exchange represents the total value of all purchases made with a cryptocurrency.

There are two ways to find total purchases.

The first is through direct, on-chain observation. The second is to use orthogonal metrics as a proxy for on-chain data.

Estimating PQ

Estimating PQ through proxy metrics is useful where data is unclear.

For example, Monero, whose chain can’t be surveilled – is impossible to gather data from.

XMR transaction amounts are hidden, and transaction histories are unclear.

XMR is mainly used on the dark web – exactly like Bitcoin when it started.

If you know the volume of purchases on the dark web, and the percentage of dark web transactions using Monero, you have a large component of PQ for XMR.

Finding PQ On-chain

In transparent blockchains, data is easy to parse.

Most blockchains are transparent, so on-chain data can be used as inputs to the equation of exchange.

It’s easiest to do this for Ethereum-based tokens. Transaction data can be interpreted according to documentation for the smart contract, which makes it easy to identify which transactions are speculative and which are to be included as part of total purchases.

For example, you can look at a Chainlink (LINK) transaction and understand which tokens are being paid to data providers, and which are simply being sent between exchanges by arbitrage traders.

[LINK dashboard Dune Analytics]

Etherscan is a helpful site to find known addresses like exchange wallets. Dune Analytics is a visualization platform with crowdsourced insights.

Combining Methods

Transparent medium-of-exchange coins, especially those which are UTXO-based (Dash, Litecoin, Bitcoin Cash) require a combination of on and off-chain analysis to find PQ for the equation of exchange.

It’s not always clear which transactions are self-sends, speculative purchases, or those sent to mixers for obfuscation, etc.

In this case, it’s helpful to identify known wallets and work from there.

Exchange addresses are publicly available, flagged on sites like Etherscan and Dune Analytics.

Source: Detecting Roles of Money Laundering in Bitcoin Mixing Transactions: A Goal Modeling and Mining Framework

On UTXO-based chains visualizations of transactions coming from mixers look different than visualizations of regular transactions, it just takes a little digging to identify these.

Going Further

Fundamental valuations of cryptocurrency are built on the equation of exchange – required reading for this article and others.

The equation of exchange is foundational to cryptocurrency valuation and the Tokenomics 101 article series.

We use these frameworks to design valuable tokens.

If you’re interested in building a token with fundamental value or valuing cryptocurrencies with a simple framework, reach out to us for a free consult.

Equation of Exchange: Simple Examples

Posted By under Equation of Exchange, Valuation Framework ,

The Equation of Exchange

The equation of exchange, MV = PQ is foundational to the Eat Sleep Crypto valuation framework. The following articles explain each component in detail:

Equation of Exchange Examples

Imagine an auto mechanic needs to purchase $10,000 worth of parts from China. The seller demands payment in CNY, which is traded on exchanges.

To complete the payment, there must be at least $10,000 worth of Chinese Yuan in circulation.

If there isn’t at least $10,000 worth of CNY in circulation, there are two ways to make it so:

1) CNY is printed by some means, and acquired by the buyer to complete his purchase.

Or,

2) The entire circulating supply is bought up on order books until the buyer’s CNY is worth $10,000.

The first method acts on the supply side, increasing the circulating supply.

The second is based on demand, where the currency’s price appreciates to meet demand for its use.

Valuing Cryptocurrencies With the Equation of Exchange

Our microeconomic example of the equation of exchange using CNY works the same at scale, with a couple more moving parts.

Since cryptocurrencies can’t be inflated at will, the buying up of cryptocurrencies and tokens on exchanges for actual use cases is how price discover occurs.

Let’s say Bitcoin is used to buy $100 billion worth of goods and services annually. We’ll imagine that 10 million BTC are in the circulating supply – they not lost or otherwise unavailable. And we’ll say that each bitcoin moves between 5 people per year, on average (historical velocity of the dollar).

So our velocity is 5.

So we have M = $100 billion (PQ)/ 5 (V) = $20 billion

Applied to cryptocurrencies, this fundamental value is a *price floor* – the minimum sustainable price of a cryptocurrency, absent speculation. Dividing $20 billion by 10 million BTC to get the price per unit gives us a price floor of $10,000 per Bitcoin.

In the Investor Series articles, we find price floors of various cryptocurrencies using models with adjustable assumptions.

Why Market Cap Is A Bad Metric

Posted By under Cryptocurrency Valuation, Valuation Framework

Market cap, short for market capitalization is a misleading metric when valuing cryptocurrencies.

Market cap is borrowed from traditional finance’s equity valuation methods. Cryptocurrencies and tokens are valued using the equation of exchange.

Types of supply

The cryptocurrency space has started to recognize the inadequacy of “market cap” in valuing cryptocurrencies.

Popular metrics now distinguish between issued supply, and total supply at some later date – fully diluted market cap.

This is only a partial solution, since not even all coins which have been issued are still in circulation (e.g. Satoshi’s coins).

Circulating supply in the Eat Sleep Crypto valuation framework refers to only those coins which have moved in a time frame.

The time frame is arbitrary; it’s only important that the other components of the equation of exchange use the same one.

Why circulating supply is best

The most meaningful comparisons can only be made by looking at different sets of coins – i.e. coins with the same Cryptocurrency Valuation Methods; Determining Coin Age at different dates.

Looking at circulating supply allows more useful comparisons of velocity and supply for the same coin over time.

Valuation Methods: Identifying Circulating Supply

Posted By under Valuation Framework ,

Circulating supply is the number of coins (cryptocurrencies, tokens) in circulation.

It can be defined different ways – the key is that it’s defined the same across components of the equation of exchange.

For example, if circulating supply means “coins which moved within the past year,” the velocity, monetary base, and total purchases should also reference those specific coins.

Generally, it’s helpful to define circulating supply to include coins with a coin age less than one year, and exclude coins on-exchange, staked, and burned.

Read Why Market Cap Is A Bad Metric to learn why other measurements of supply are misleading for valuing cryptocurrency with the equation of exchange.

Valuation Methods: Calculating M, Monetary Base

Posted By under Cryptocurrency Valuation, Valuation Framework ,

The equation of exchange is used in the Eat Sleep Crypto valuation framework, and in tokenomic architecture, analysis, and design.

To do this, the Equation of Exchange is reordered to solve for monetary base, M.

This gives us, M = PQ/V

We define M, the monetary base as including all circulating coins – not those on exchanges, lost, or burned.

M divided by circulating supply to find the price floor of a coin.

Other inputs are required to value cryptocurrencies with the equation of exchange.

First, circulating supply – the actual number of coins still accessible and in “hot wallets,” ready to be spent or sold, must be estimated.

Second, irrelevant transactions (e.g. speculative transactions, self-transfers) must be excluded from calculations.

Third, distinct uses for tokens must be identified and evaluated separately before combining them to find a price floor.

You’ll learn how in Valuation Methods: Identifying Circulating Supply and Valuation Methods: Estimating Velocity and using off-chain data in Valuation Methods; Finding PQ.

Valuation Components: Total Addressable Market

Posted By under Cryptocurrency Valuation, Valuation Framework

Total Addressable Market, abbreviated TAM is the total amount of value which could be expected to flow through a cryptocurrency across all use cases.

It’s used in the ESC valuation framework to calculate cryptocurrency price floors, and in tokenomic architecture, analysis, and design.

All else equal, a cryptocurrency or token with a larger Total Addressable Market, following the principles of tokenomics, will have a higher price.

Components of Total Addressable Market

A currency’s TAM and its components come from each of its use cases.For example, Ethereum’s native token, ETH has multiple Total Addressable Markets.

ETH is used to pay fees for all of the applications running on the Ethereum network. Demand for payment of ETH fees is one component of its Total Addressable Market.

ETH also used to collateralize other tokens – Dai, for example. So another of ETH’s Total Addressable Market is use as collateral.

This in turn comes from demand for Dai (a stablecoin with many uses) and varies with Dai’s capture of its Total Addressable Market.

To maximize ETH’s fundamental value or price floor, these two use cases must be maximized.

When seeking to maximize a token’s price, TAM should be made large.

This is generally done by having a token transfer large amounts of value, or giving it many uses.

Valuation Components: Circulating Supply

Posted By under Cryptocurrency Valuation, Valuation Framework

Circulating supply is the number of coins (cryptocurrencies, tokens) *in circulation*.

Circulating can mean this week, this month, or this year.

The time frame isn’t important, so long as it’s consistent across components of the equation of exchange.

For example, if *circulating supply* means “coins which moved within the past year,” V, velocity should also measure those specific coins.

Read about types of supply in Market Cap is a Bad Metric to understand why circulating supply fits with the Eat Sleep Crypto valuation framework using the equation of exchange.

Valuation Framework: Cryptocurrencies

Posted By under Cryptocurrency Valuation, Valuation Framework ,

Fundamentally, cryptocurrencies get their value through use as a medium of exchange. This includes cryptocurrencies paid for goods and services, and tokens paid for fees, collateral, and other tokenomic levers within a protocol.

Most cryptocurrencies and tokens are best valued using the equation of exchange.

The equation of exchange was first derived by John Stuart Mill, referenced by Adam Smith, and popularized by Milton Friedman.

Using the equation of exchange and circulating supply, we can calculate the fundamental value (and minimum sustainable price, price floor) of each unit.

Equation of Exchange Components

The equation of exchange, MV = PQ, describes how a token’s use as a medium of exchange drives its price.

Solving for M, the equation reads intuitively.

M = PQ/V

For any given time period, M, the monetary base is worth the total value of purchases (PQ) divided by the number of times each coin is used (V, velocity or churn).”

For example, if CashCoin is used to buy $1,000,000 worth of products per year, and each CSH is used an average of 5 times, the variables are as follows:

  • M, unknown
  • PQ = $1,000,000
  • V = 5

Solving for M using M = PQ/V gives us M = $200,000.

So the monetary base of CSH is $200,000.

Solving for p, Price Floor

Now imagine there are 10,000 cashcoins.

We can easily solve for the price of each, dividing monetary base, M by circulating supply, c.

$200,000/10,000 = $200 per CSH

Note that this only concerns circulating supply of CSH.

Coins which are lost, locked up, or in cold storage are not part of an economy – they’re not subject to supply and demand.

Stored coins may be relevant to speculators, but speculation is not priced in directly; the price floor of a cryptocurrency and its speculative price premium are different.

Price floor vs speculative price premium

A cryptocurrency’s price reflects:

  • Fundamental value, price floor
  • Speculative price premium

Cryptocurrency price floors

Fundamental value reflects supply and demand for a cryptocurrency as a medium of exchange.

This fundamental value is a price floor – a price a currency will not sustainably trade below.

When a currency trades at its price floor, volatility will naturally cause it to dip below, but buying pressure from aggregate demand brings the price back up.

A currency might trade below its price floor, but not for long.

Speculative price premium

The rest of a cryptocurrency’s price is speculative.

It may be rational to price in future returns (see Burniske’s DEUV), but it makes sense to distinguish speculative premium from fundamental value.

Price/price floor ratio is a meaningful measure of risk/reward – the closest

Most cryptocurrencies’ price floor can be extrapolated from on-chain data.

Identifying price floors using on-chain data

Dune Analytics is a free, open-source chain analytics platform.

Price floors can be worked out using on-chain analytics.

The components of price floors – circulating supply, velocity, and total purchases are all found on-chain.

Some on-chain data, like ERC-20 token data is easy to interpret. ERC-20 transactions are easy to reconstruct from blockchain analysis.

Commercial transactions on medium-of-exchange currencies are harder to distinguish from speculative trading, self-transfers, mixing, but it can be done.

Determining which transactions are speculative, self-transfers, part of mixers using just metadata requires getting creative.

Conclusion

This cryptocurrency valuation framework is used to identify and take advantage of price floors, calculate risk/reward ratios, and engineer tokens with price floors using the principles of tokenomics.

Further reading:

Tokenomics 101: Tokenomic Levers

Posted By under Tokenomics 101, Valuation Framework ,

Tokenomic levers are features of a protocol which capture value.

The degree to which a tokenomic lever affects value capture is called tokenomic leverage.

The three types of tokenomic levers act on corresponding components of the equation of exchange.

  • Supply levers capture value by decreasing circulating supply.
  • Demand levers increase demand for tokens, raising PQ, Total Purchase Amount in the equation of exchange.
  • Velocity levers capture value by decreasing a token’s velocity.
    • Velocity levers are only hypothetical. Discerning coins based on velocity (e.g. coin age) would destroy a their fungibility, one of the key properties of money.

Tokenomic levers’ effects on value capture are proportional to their input.

Supply-side tokenomic levers

Supply-side tokenomic levers are one of two types. They decrease circulating supply of a token, which increases its value according to the cryptocurency valuation framework.

Examples

A cryptocurrency’s utility value or price floor is proportional to its use as a medium of exchange. The total value of all circulating coins, called monetary base, M is solved for in the equation of exchange.

All else equal, less coins circulating makes each one more valuable.

Tokenomic mechanisms which decrease circulating supply in this way include:

  • Burns
  • Collateralization
  • Staking
  • Lockups

Demand-side tokenomic levers

Demand levers, or mechanisms are another type.

Demand levers increase demand for a token, reflected as an increase in PQ, Total Purchase Amount in the equation of exchange.

Examples

Cryptocurrencies capture value through use as a medium of exchange.

Other kinds of tokens capture value differently.

Examples of demand levers include:

  • Fees
  • Collateral
  • Dividends

Velocity Levers

Velocity levers must be hard coded into the protocol, which affects user experience, but limited examples exist.

Velocity levers can be justifiably imposed when gas costs are a concern – e.g. implementing a bi-weekly “paycheck” in a protocol where payments are accrued, in order to distribute tokens, rather than forcing users to pay for their own withdrawals.

A slowing of velocity can be measured in other components of the equation of exchange.

For example, a coin age scheme which incentivizes holders of a token to hold funds for longer periods of time will tend to split their coins between “old” and “new,” increasing the velocity of “new” coins and taking the “old” coins out of circulating supply. [[Valuation Methods; Determining Coin Age]] schemes are one example of tokenomic mechanisms which affect velocity.

Tokenomics 101: Tokenomic Leverage

Posted By under Tokenomics 101, Valuation Framework ,
“Give me a lever long enough, and a place to stand, and I will move the Earth.” – Archimedes

In the physical world, mechanical leverage multiplies the force of a given input. Similarly, tokenomic leverage multiplies value capture by affecting supply and demand.

Currency-like tokens capture value when used as a medium of exchange.

Adding leverage through tokenomic mechanisms in a protocol increases supply and/or demand pressure for a token, specific to the type of mechanism in use, by increasing the value exchanged through that token.

For example, staking decreases circulating supply by the amount staked; fee increases for an application increase the demand for the token used to pay fees.

Illustrating Tokenomic Leverage

first-class lever

Tokenomic leverage mirrors mechanical leverage. Using the analogy of a first-class lever, we can say that:

  • Value being exchanged in a mechanism is the force applied to end of the lever.
  • Value captured is the output of force from on the other end.
  • Tokenomic leverage is the ratio of the distances of each force from the fulcrum.

Tokenomic leverage example

The ratio of value captured to value created or transferred is called tokenomic leverage.

Higher tokenomic leverage in a mechanism or protocol overall is analogous to higher profit margins in a traditional business.

Tokenomic mechanisms further up the hierarchy of value capture have higher leverage. And it’s possible to have a tokenomic leverage greater than 1 – indicating more value is being captured than created.

Synthetix’s tokenomics are an example of high tokenomic leverage.

Users of Synthetix can create sAssets – synthetic TradFi assets collateralized by several times their dollar value in SNX tokens.

Synthetix governance decides this collateralization requirement, but it generally stays between 300% and 500%.

This means that SNX will necessarily be worth 3-5 times the value of all necessary sAssets.

So the tokenomic leverage of this mechanism in the protocol is between 3 and 5, depending on the current collateral requirement.

This is only possible because the protocol has a monopoly; higher tokenomic leverage requires extreme defensibility.

Synthetix’s collateralization mechanism introduces economic security issues only mitigated by active management of the c-ratio, and heavy inflation. As a result, Synthetix has begun to pivot its design toward other tokenomic mechanisms with lower value capture, illustrating tradeoffs between the principles of tokenomics.

Conclusion

Archimedes’s assertion – that simple mechanical leverage at scale was sufficient to move the Earth – was a bold and groundbreaking claim.

Tokenomic leverage is just as powerful, yet it’s highly underappreciated. It’s a key component of value capture – one of the three principles of tokenomics.

Even those with a deep understanding of tokenomics miss opportunities to apply leverage to their token. Others go But adding leverage to a token is one of the simplest, yet most effective ways to increase its price floor.

If you or a project you support is in need of tweaks to its design to increase leverage and maximize its value, reach out to us for a free consult.