Crypto Needs a Sound Value Investing Model

Investors who started on traditional markets and got used to established value investing models often opine:

Investing in digital assets is a sham! Participants in this industry are simply trying to anticipate price movements, rather than use fundamental analysis to determine why a token or coin might go higher or lower. There is no intrinsic value. It’s pure speculation based on technical analysis. It’s outright gambling.

If you could see stock and bond markets as they were 300 years ago, you would say the same.

In 1602, the Dutch East India Company issued the first paper shares. With this exchangeable medium shareholders got an opportunity to easily buy, sell and trade their stock with other shareholders and investors. For hundreds of years since that, investors and traders worked hard trying to predict price moves, without any of the tools we have today for valuing these securities. Back in those years, a stock trading at $100 was regarded as more expensive than a stock trading at $10, without paying attention to number of shares outstanding, underlying revenues, or business prospects. No value investing models existed, and some say that today crypto has the same problem.

Only in 1920s, after stock market crash and the Great Depression, two Columbia Professors, Benjamin Graham and David Dodd, devised a methodology for defining and purchasing securities priced well below their real value. Their book, “Security Analysis,” was released in 1934, and in it Graham and Dodd described a rational basis for investment decisions which are still used today by the world’s top value investors.

Warren Buffett decided to attend Columbia specifically to learn from Professor Graham (and received an A+ in his class). About 50 years later, Professor Frank Fabozzi developed similar valuation techniques and principles for investing in fixed income securities. And shortly afterwards, even better valuation techniques, such as Metcalfe’s Law, appeared to assist with computing networks valuation, and these methods were used decades later to value pre-revenue internet behemoths such as Facebook, Tencent and Netflix.

Gisli Eyland, who has written about the value investing philosophy, said that Graham and Dodd “described a fundamentally different approach to stock picking and investing in corporate securities by proposing that the investor should refrain from trying to anticipate price movements entirely. Instead, the investor should try to estimate the true Intrinsic Value of the underlying asset. Given time, the Intrinsic Value and market value would converge.” Today, investors and financial news outlets tout financial ratios such as P/E, P/B, EV/EBITDA, P/S, Dividend Yield and others as if they have been around forever, while bashing crypto assets as those which have no intrinsic value. Such people have to consider the fact that crypto assets are less than 10 years old.

Fundamental models in crypto are being developed

When will the Graham and Dodd of crypto emerge? They may be already here, working endlessly behind the scenes in order to devise a value investing model which later will be used by the Warren Buffets of crypto. Digital assets are still in their infancy, but new fundamental valuation methods are being created, tested and unearthed every day, from the original MV = PQ analysis, to discounted sum of utility and every other method in between. Many of these models lack sufficient proofs, possessing only a couple of years worth of data to support their methodologies, while other models have likely yet to be conceived.

Each of these methods has its pros and cons. Crypto assets are unique, similar to corporate bonds, making various valuation techniques applicable for specific token types. Just like a bond has various coupons, maturities, covenants and features (callable, putable, convertible, warrants, etc.), most crypto assets have unique features as well, which makes each analysis unique.

We believe, that the DCF analysis is best applied to tokens issued by cash-producing companies like exchange tokens such as Binance Coin (BNB) or Unus Sed Leo (LEO). The NVT Ratio may be good when comparing different smart contract platforms like Ethereum (ETH), EOS (EOS) and NEO (NEO). A version of Metcalfe’s law or total addressable market analysis can be applied to tokens which are in the early pre-launch stage or are running in the sector which is hard to evaluate.

Crypto analysts continue to develop their own methodologies to value digital assets. When such metrics become established and widely accepted, price floors and ceilings in crypto will be established on the basis of strong valuation — just like the debt and equity markets. Investors might just need an open-minded, long-view approach to investing in crypto.