Crypto investor diving into an undervalued coin

The current state of crypto asset valuation is what I imagine driving was like in the early 1900s — everyone’s still just trying to figure it out, and we’re probably going to go down a couple of wrong roads while we’re at it. In this article, I’ll attempt to go down the correct path of valuing the Binance exchange coin (BNB).

Unpacking Previous Valuations

There have been a couple notable analysis around this topic already. However, the erroneous categorization of BNB into it’s proper asset class, have led to elegant, but misguided approaches. The two most popular articles have either:

Considered BNB as an equity — deriving it’s value directly from Binance’s profits Considered BNB a consumable product — determining the total potential discounted fees provided by BNB as being a direct component of the token’s value

The first approach calculates the value of the total BNB supply as being equal to 20% of Binance’s, the company, implied market cap, given a PE ratio equal to a Hong Kong securities exchange. The premise of the first argument is formed from the fact that “20% of profit is used to buyback and burn BNB”. One can imagine that the concept of stock buybacks may have lead to a false cause fallacy. Indeed 20% of Binance profits each quarter are used to burn an equivalent amount of BNB coin, however, the value of profits are only directly tied to the value of the tokens at the time of the coin burn. The BNB coin itself has no claim on the actual assets or cash flow of Binance. Also take into consideration that Binance will stop burning BNB once 50% of the total supply (100M BNB have been burned).

The second approach is based on cash flow calculations and is slightly more convincing. The sum of transaction fees saved over the entirety of Binance’s discount lifecycle is calculated from estimated future transaction volume and BNB discount rates by year (see Coinfi’s article for calculation details). This cumulative transaction fee value of $258M over the next 4 years is extrapolated to account for 14% of the utility value of BNB. The remaining 86%, or $1.6 Billion, is conjectured to come from a combination of expected growth, future functionality, and referral program benefits for BNB holders.

The transgression in this approach is that BNB is modeled as a consumable — an asset that is used up, when the transaction fees are paid. In reality, each BNB can theoretically be used infinitely for paying transaction fees. The BNB you use to pay a transaction fee is not burned, but merely taken by Binance as payment, and if not part of the burned supply, will ultimately make it’s way back onto the open market for further use.

Characterizing Binance Coin

To help us understand how to properly value BNB, it would help to list out the use cases of BNB:

Discounts on transaction fees when paid with BNB Asset with multiple exchange pairs Double referral bonuses for those that hold at least 500 BNB Voting power during Binance Community Coin Voting

The key here is to observe the similarities between points 1 and 2. In both these cases, BNB is a Medium of Exchange — A currency used for exchanging value for either the cost of a transaction or to purchase another crypto asset. In the analysis below, I will show that there is immense value in the latter, and this is has not been considered by previous valuation attempts.

A Framework to Remember

I’ve uploaded the model into Google Sheets.

Given the characterization of BNB as a medium of exchange, the equation of exchange would be an apt framework to use. The equation of exchange is defined as MV = PQ, in which:

M = “total money supply” i.e. size of the cryptoasset base

V = “velocity of the asset” i.e. frequency that tokens change ownership in a given time period

P = “price of the resource” i.e. price of the goods and services being transacted/provided by the network

Q = “quantity of the resource” i.e. quantity of the goods and services being transacted/provided by the network

This equation is used in traditional monetary theory to understand the flow of money and can be extrapolated to cryptoassets with currency-like properties.

M, the monetary base, also commonly referred to as “market cap” is what we’ll be solving for in this scenario. M is a product of Token Price and Token Supply. Thus, the equation can be rearranged to M = PQ/V.

P and Q are often thought of together. The product of P & Q is the aggregate value of the transactions facilitated by the currency. This can be split into the two component parts mentioned previously:

Total exchange fees paid with BNB Total BNB exchange trading volume

Let’s zoom in on the numbers for 2018 to determine the current utility value. We assume an average of $1.5 Billion traded on Binance daily based on historical exchange volume. The BNB discount rate will be 25% for the next year. Assuming all transaction fees are paid in BNB (this rate is likely slightly lower than 100%) there will be $750k in fees paid in BNB on a daily basis, and $274M paid in fees in BNB on an annual basis. Examining the exchange volume for BNB year to date, we arrive at an average daily volume of $95M. This is extrapolated to $34.7B worth of BNB traded on the exchange every year.

The total annual value derived from the sum of both of these activities is $34.8B. The lion’s share — 99.2% - comes from BNB exchange volume. This monetary demand is more than 26 times the circulating market cap of BNB — this is only possible because of the concept of velocity, that a unit of BNB can be circulated multiple times within a period.

Determining velocity in traditional cryptoasset networks is not usually easy to measure given the complexity of on-chain data analytics. However, the turnover of BNB in the definitions we refer to, are neatly & perfectly captured for us on Coin Market Cap. An average of 7.3M BNB traded per day, gets us to 2.66B BNB traded annually. We can divide this by 139M, the total number of BNB tokens in float to arrive at a velocity of 19.1. Note that this does not capture the velocity occurring from payments of transaction fees. However, the amount of BNB used for transaction fees, is less than 1% of the BNB trading volume, so we can consider the additional velocity negligible.

The 139M BNB in float is not the same as the circulating supply. The circulating supply as stated on the Binance website is actually 144M. Where does the extra 5M BMB go? This is the BNB assumed to be held by an assumed 10,000 users (0.1% of Binance Userbase) who are incentivized to obtain the extra referral bonus reward activated by holding 500 BNB.

Utilizing the PQ and V we derived from these calculations, we are now able to come to a monetary base of $1.8B. Divide by the number of tokens in the float, and we are left with an average utility value of $13.13 per token. Compare this to the BNB price of $13.60 at the time of writing, and we see that BNB is only trading at a 4% premium to its intrinsic current utility value — an admittedly surprising result given the seemingly lack of rationale in cryptoasset market prices.

But what about speculation?

Speculation — easy to label, difficult to quantify. Luckily for us, we have good data to take a stab at this.

Remember the coins in float we calculated a minute ago? That was actually a slight overestimation. We removed the coins HODL’d for the sake of referral bonuses, but that metric didn’t take into account the coins that are HODL’d for other purposes (e.g. speculation). Using BNB’s current price, velocity, and economic value we can backcalculate a theoretical number of coins in float of 134M. This implies that of all circulating coins, 7% are being HODL’d for any particular reason, much less than traditional crypto asset benchmarks of 40–70%.

It’s unlikely that the amount of coins being HODL’d is actually this low, especially given the possibility that Binance itself likely HODL’s a good amount of BNB (the BNB it receives from transaction fees and doesn’t automatically sell back to the open market). This opens up the question as to whether the reported BNB volume metrics are accurate.

Sylvain Ribes conducted an eye-opening analysis on the amount of fake volume rampant in the crypto exchange industry. The idea is that exchanges with fake volume will see a much higher amount of slippage than their liquidity metrics would suggest. While the verdict on Binance markets as a whole was inconclusive, it’s BNB/USDT market saw a -85% difference in liquidity compared to what mathematical projections would expect.

One might argue that the potential future utility should also be baked in, and be responsible for much more than a 4% premium. This depends heavily on the projections of future transaction volume. What actually happens to Binance transaction volume is highly uncertain as it is ultimately a balance between fierce competition and the strategic & operational prowess of the Binance team. Assuming the transaction volume in future years stays the same, the present utility value of the token in those years would also be relatively stable.

Under the scenario that Binance daily transaction volume increases to $6B by 2020 (4x currently values), then we can model a current expected value of $31.72 / BNB (~140% premium). However, this calculation uses a relatively favorable 20% discount rate and what maybe considered an aggressive growth rate. The assumptions around Tx volume growth and discount rate can be easily modified in the model linked.

An Aside on Velocity

The velocity problem — the theory that tokens with weak holding incentive will not be able to maintain price appreciation — is commonly cited by crypto fund managers. BNB itself has minimal holding incentives. The average trader is not incentivized by gamification, staking incentives, or profit sharing to hold BNB when they are not trading. They hold it for two particular reasons:

Users trade often enough where the friction in buying and selling the exact amount of BNB needed for each trade outweighs the convenience of having a maintaining a stockpile of BNB for future use BNB price has historically not decreased significantly relative to other crypto assets, and has actually produced outsized returns

It seems to be the case that Binance has architected a solution to this problem that almost no-other non-protocol level coin has been able to acheive — becoming a store of value.

Conclusion

Binance has created a unique phenomena with their token. Initially bootstrapped by its utility as a discount vehicle, accelerated by the speculation of the perceived exponential growth of the Binance platform, it has morphed into an asset where it’s value has remained relatively stable compared to other cryptoassets. While BNB has lost roughly 40% of its value since its peak in January, it is up more than 100x from TGE. Compare that to alt coins as a whole which have lost 80–90% of their value, and even Bitcoin which is down 55% from its highs. BNB has shown itself to be a prime store of value within the cryptoasset space, reinforcing its utility as a transactional unit. This has a second order circular effect further driving its value.

Recent news from Libra Credit and Nexo regarding the offering of BNB backed loans is an indicator of its growing acceptance as a store of value. It is a testament to the belief that BNB will continue to maintain or appreciate in price, and the increased utility for BNB provided by these loans serves to augment this belief even further.

It is clear that there is a feedback loop here. The longer BNB retains or appreciates in price, the greater the perception that it is a good store of value. This could result in more financial products or indices built off BNB (e.g. BNB Stablecoin). Adoption of these products or indices would in turn drive further value creation and thus price maintenance, bringing us back to the beginning of the cycle.

The insight here to remember is that the vast majority of the intrinsic value of BNB is derived from it’s utility of being able to buy other crypto assets. This leads us to a host of questions around the security of its value. What if BNB exchange volume takes a nose dive? Will BNB price follow? Will BNB be able to maintain its utility as a medium of exchange even after its discounts eventually expire or will it continue be bootstrapped by a new feature?

The path BNB is taking to becoming a store of value is not unlike that of that of the US Dollar or Gold. Each of these examples have some intrinsic utility function — paying US federal taxes in the case of the US Dollar, and a base component of jewelry for gold. While Binance may eventually due away with the transaction fee discount, it could just as easily cement new intrinsic utility to BNB. Let’s also not forget another strong differentiating factor for BNB, and similar cryptoassets — provably scarcity. While we’ve covered many uncertainties in this post, one thing is clear — the ability for Binance to create a monumental moat around its token should not be underestimated.

_______________

Note that there are a few key assumptions that have been made in the analysis:

Overall Binance Volume is 100% real BNB volume is 100% real Every user account experiences the same fees (Market makers & Binance accounts likely trade with reduced/zero fees) All users actually use BNB to reduce fees

Thanks to Tim Enneking, Jeremy Kerbel, Spencer Applebaum, and Daniel Armitage for providing feedback on this post & model