Category: Valuation Framework

Articles about the Eat Sleep Crypto valuation framework

Tokenomics 101: Value Capture

Posted By under Tokenomics 101, Valuation Framework ,

In a talk at Stanford, Peter Thiel called value capture the “most important, yet least understood” aspect of business.

Value is captured by a business by taking profit. Value captured is the percentage of a product’s total value taken as profit.

In his book Zero to One, Thiel describes the problem of inadequate value capture.

Examples of inadequate value capture include a business selling widgets valued at $10 for $5 (undercharging), or another business selling a widget for $10 which costs them $5.

A business may have inadequate value capture because either it doesn’t charge enough, or costs incurred are too great a percentage of revenue.

In both cases, less value is captured than is created, and at a certain point, inadequate value capture leaves a business economically unviable.

Similarly, inadequate tokenomic value capture allows price to stagnate with adoption and leaves a blockchain vulnerable to economic exploits.

Value capture in tokenomics

Tokens and cryptocurrencies miss opportunities to capture value when they are either not used in ways that raise their price floors, or used in insufficient quantities.

Cryptocurrencies primarily derive value proportional to their use as a medium of exchange (see How to Value Cryptocurrency).

So, a currency that is used to pay fees in a protocol is valuable proportional to the value of fees paid. If such a currency is only used for fees, it is only as valuable as the total amount paid in fees.

Inadequate tokenomic value capture becomes a security problem when a blockchain’s native asset (e.g. Ethereum’s ETH) is used exclusively for paying fees when that chain is securing other valuable assets.

For more on blockchains’ economic security:

Valuing cryptocurrencies is much different than valuing companies, but the concept is the same – inadequate value capture dampens the value proposition of a business; ditto for a token or cryptocurrency.

Why value capture matters

Without adequate value capture, cryptocurrencies and tokens are vulnerable to massive price crashes, and if the tokenomics of a blockchain’s native asset is not considered by developers of token protocols, those protocols may incentivize economic exploits through perverse incentives.

When a token’s value capture and other tokenomic components are properly considered, a token’s price increases steadily with its use in applications, and it strengthens the blockchain network on which it’s built.

If you or a project you know need help designing a protocol or would like input on your project’s tokenomics, reach out to us for a free consult.

Tokenomics 101: What Are Tokenomics?

Posted By under Tokenomics 101, Valuation Framework

Tokenomics describe how a token’s use affects its price.

Good tokenomics increase a cryptocurrency or token’s price and prevent bad actors from destroying or weakening a network.

Poor tokenomics leave tokens and blockchain networks vulnerable to economic exploits which arise from a lower-than-possible price of a token, disappointing users and investors.

When considering tokenomics, incentives are everything.

Charlie Munger is Warren Buffett’s business partner.

Munger also famously said in regards to management practices: “show me the incentives, and I will show you the outcome.”

What you incentivize is what will happen – even more so for blockchains.

In management, incentives are malleable. In decentralized protocols, changing analogous incentives requires a complete overhaul. Changing tokenomics requires consensus to avoid fracturing network effects.

Token economists design protocols to be maximally secure, and maximize token value by applying tokenomic leverage and value capture according to the principles of tokenomics.

Many projects leave tokenomics to chance, relying on speculation to create price support. This leaves them vulnerable and all but ensures 95% drawdowns, and subsequent abandonment by users.

Good tokenomics give cryptocurrencies and tokens a price floor – a price at which they can’t sustainably trade below.

For more on price floors, follow Eat Sleep Crypto on Twitter, and stay tuned for the release of Cryptocurrency Price Floors.

Token Economic Analysis, Token Flow Modeling, and Token Engineering

Posted By under Cryptocurrency Valuation, Valuation Framework , ,

Background

If you’ve spent any time on this site, you’re likely familiar with the Equation of Exchange, MV = PQ.

This simple equation, first derived by John Stuart Mill and later popularized by Milton Friedman is the foundation of all our work.

The equation of exchange can be applied at a high level to quickly calculate price floors of a currency based on a few inputs or assumptions.

It can also be applied at a micro-level to tweak the economics and incentives of a cryptocurrency or token for maximum value capture.

If any of these terms are unfamiliar, you can refer to the Glossary page for their definitions.

Goals of this project

  1. Token analysis script
  2. Token flow visualization
  3. Token engineering framework

Token economic analysis

The first goal of this project is to create a script that parses transaction data of a given cryptocurrency or token in order to find components of its price floor according to the equation of exchange, MV = PQ.

Simple pulls include contract events and token transactions that take place within the token protocol to find PQ. Calculated components include circulating supply and address balances over time to find V.

Token flow model

Using variants of the equation of exchange, token flow can be modeled within an ecosystem.

A novel way to do this is by using a Sankey diagram.

sankey-diagram-token-economic-flow-model

The Sankey diagram takes its name from Irish Captain Matthew Sankey, who used it to model the energy efficiency of a steam engine.

Sankey compared the real energy efficiency of an engine to its ideal efficiency.

While Sankey was interested in energy efficiency, we are interested in value capture.

Value is most commonly captured by tokens when they are used as a medium of exchange, denominated in another separate unit of account – e.g. an expenditure of $10,000 worth of Bitcoin.

Components in a token flow diagram

Objects in a token flow diagram represent participants in the ecosystem within which a token circulates.

Value transferred via transactions is represented by the connections in between.

The dimensions (height x width x length = volume) of the “pipes” representing these connections represent:

  • Tokens circulating in an ecosystem (circulating supply)
  • The value transferred between participants in an ecosystem (PQ)
  • The time a token takes to circulate, represented by length of all pipes (V)

Token flow diagrams denominated in native units (e.g. BTC) and those denominated in another unit of account (dollars) can be overlayed to solve for the price floor of each unit.

In this way, token flow diagrams become a visual aid in calculating price floors.

Token economic engineering

Sankey diagrams are fitting for token flow visualization for more than one reason.

Sankey’s hallmark example of a steam engine makes for an excellent analogy to token ecosystems for our purposes of designing and refining the token economics of a protocol, token economic engineering.

Like steam engines, cryptocurrency protocols have mechanisms which direct the flow and efficiency of energy.

In our models, energy is economic “potential” energy, represented by tokens with purchasing power.

Keeping with the steam engine analogy, the “goal” of token economic engineering is to first to increase the volume of the pipes, and second to decrease the number of tokens flowing through them.

We discuss various ways to do this on Telegram, and we collaborate with each other in reaching the goals described above.

If you’d like to collaborate, send a message to @EatSleepCrypto on Twitter for an invite.

Hijacking Bitcoin, narratives, and the nature of truth in cryptocurrency

Posted By under Blog, Valuation Framework

As the first industry to operate in a truly free market, cryptocurrency is by nature the most competitive industry in the world.

There are many competing implementations of the idea of cryptocurrencies, and even more ideas on how cryptocurrencies should and even do operate.

How does one discern truth among all the competing claims?

Everyone on Earth has frameworks, worldviews, lenses through which they see and interpret events.

In crypto, we call these narratives.

Narratives are helpful in contextualizing and integrating information, but when relied upon too heavily, they obscure truth and exclude data from consideration.

Predictive capability

No narrative is perfectly correct; all lack some nuance. Yet narratives are necessary for human comprehension. The key is finding the right one.

But how does one know the narrative they subscribe to is correct?

In statistics, models are judged as useful or “true” according to their predictive ability.

Narratives in line with reality facilitate the correct prediction of future events.

Weekly Newsletter topics

This week, a number of things happened which destroyed the dominant narratives.

These events were explicitly predicted by several of cryptocurrency’s best and brightest.

  • Sept. 30th – The BakktFlop
    • We’ve been saying this investment thesis is just a poorly disguised subscription to the Greater Fool Theory.
    • The narrative here was encapsulated in the meme “Institutional [money] is coming.” Bitcoin speculators have based much of their optimism in the perpetuation of the BTC pyramid scheme on the eventual buy-in of institutions.
    • The Bakkt network – a creation of the Intercontinental Exchange, owner of the NYSE – disappointed investors so hard that JP Morgan said it caused a 25% drop in the price of Bitcoin (BTC).
  • Sept. 28th – Lightning bug
    • Another of BTC speculators’ theories is that the Lightning Network – an perpetually unfinished work – will soon scale and solve all of Bitcoin’s usability issues which were brought on by developers’ refusal to increase the block size limit.
    • A critical bug was “discovered” in the Lightning Network which allowed users to spend bitcoins that didn’t exist. Calling this bug critical is an understatement.
    • There’s nothing wrong with expecting technological advances to solve problems (see Moore’s Law). The issue with the Lightning Network is that a) evidence has been to the contrary since its inception, and b) basically all of BTC’s hopes of scaling in a decentralized manner were gambled on Lightning, which has perpetually fallen short of expectations.
    • In anticipation of this, a few developers created Bitcoin Cash, which is the continuation of Bitcoin as it used to be – fast, reliable, and cheap to use. The Bitcoin Cash community – mostly made up of long-time Bitcoin supporters – has also been predicting very underwhelming institutional interest in BTC.
  • Oct. 1 – UK Crypto regulations
    • As the Bakkt flop showed, “institutional” is probably not coming. Neither is it desirable. With institutions come regulations. This week, CoinShares sent out a request for comments on the UK Financial Conduct Authority’s intent to ban retail access to cryptocurrency derivatives.
    • In short, a healthy derivatives market allows more participants by making it less risky for smaller players. The only reason to ban these is that derivatives would make cryptocurrencies more stable.
    • Retail access to cryptocurrency derivatives is already extremely limited; as the non-events of Bakkt show, the institutional interest barely even exists. Governments are seeking to prevent the creation of such an ecosystem. If cryptocurrencies become stable, government-mandated fiat currencies lose their appeal, and then governments lose their hold on people.
    • This move will confuse those whose narrative suggests that governments will support the growth of the cryptocurrency ecosystem. With few exceptions, the broad swath of politicians and agencies are vehemently opposed to cryptocurrency adoption.

The narrative that’s predicted this holds that governments and other major players in the “money industry” want to shut cryptocurrencies down.

This view is held by a minority in crypto.

Due to their preconceptions, the majority of the cryptocurrency community believes that BTC is the frontrunner for bringing financial freedom, or long-term success to the crypto space.

They’ve missed the obvious:

Conclusion

Bitcoin’s opponents attempt to stop it by twisting the narrative of its supporters.

First, they introduce a perversion of an accepted narrative (e.g. Bitcoin as digital gold rather than electronic cash). Then, they change the protocol once the narrative gains critical momentum.

Luckily, narratives which are out of touch with reality doom those who operate by them to failure.

The expected value of a flawed model is false conclusions.

A subset of people in cryptocurrrency have a staggering history of correct predictions, and it’s these people we subscribe to. Through earnest reflection and examination of ideas, we hope to create more of them.

Bitcoin dominance is a flawed metric

Posted By under Blog, Valuation Metrics

Bitcoin dominance denotes the percentage market share Bitcoin has among all cryptocurrencies.

The metric made sense at its inception, though there was little need for other cryptocurrencies in 2013. It was assumed that Bitcoin would scale to handle all possible transactions.

Now, Bitcoin dominance is used to compare Bitcoin (BTC) to every other cryptocurrency – without regard to the fact that BTC is no longer a currency, nor does it aim to be one.

After Bitcoin was co-opted by globalists and the Bitcoin community split into two, the BTC branch started promoting Bitcoin as ‘digital gold,’ while the other side of the community became Bitcoin Cash (BCH) and promotes Bitcoin as cash.

Apples-to-oranges comparisons

Because BTC is no longer a currency, it seems ill-fitting to compare it with actual cryptocurrencies like Bitcoin Cash, Dash, and Monero.

In the Investor Series articles, we’ve modeled cryptocurrencies’ potential value according to their Total Addressable Market (TAM).

Apples-to-apples comparisons would use TAMs to compare cryptoassets with the same niches.

Actual BTC dominance

By this standard, BTC’s dominance is nearly 100%; no other cryptocurrency is as slow and expensive to use as BTC.

Through a host of cognitive biases, BTC maximalists have actually convinced themselves these are desirable properties for Bitcoin, since they are also features of gold.

We’re speaking somewhat tongue-in-cheek, but BTC is actually the only cryptoasset pursuing “store of value” uses for a Total Addressable Market.

Other TAMs

As we mentioned above, cryptocurrencies have a separate niche from ‘digital gold’. Cryptocurrencies like Bitcoin Cash, Dash, and Monero address the ‘medium of exchange’ market.

There are also many niches for blockchain applications to disintermediate. Many ICOs issued tokens designated specifically for this second niche.

Platform tokens

Through the 2017 ICO wave, speculators learned that separate currencies are unnecessary for specific niches. Most use cases of a blockchain can use the blockchain’s native asset, or a stablecoin built on it.

The blockchains underlying applications are generally called platforms; we call their native assets platform tokens.

Ethereum and ETH are one such example.

Platforms fit a large niche with several sub-niches, each with a corresponding TAM. In making comparisons, it would make sense to compare the supply of these platform tokens to each other, rather than to BTC, or to cryptocurrencies like BCH.

Conclusion

BTC used to be fast, cheap, and reliable – it used to work like Bitcoin Cash.

Now when BTC fees increase, people use other cryptocurrencies. The only context in which it makes sense to compare BTC to Bitcoin Cash (BCH) or Ethereum (ETH) is in the amount of money flowing into the ecosystem through each asset.

A new metric or series of metrics is required to measure dominance between cryptoassets.

For now, we’re specifying the TAM of each currency in our Investor Series articles and models. If there’s demand for it, we’ll create charts to classify cryptocurrencies according to target markets.

Let us know in the comments what you’d like to see in future articles, or in follow up to this one.