How to Find Bitcoin and Other Crypto Asset “Fundamentals”: Goldman Sachs


Bitcoin cryptocurrency coins and a PC motherboard are pictured in Kiev on July 19, 2021. (Photo by STR / NurPhoto via Getty Images)

Valuing a cryptocurrency is not as easy as valuing a stock. A stock is a part of a business, and you can look at what the business owns and its revenues, costs, profits, and trends to determine some sort of estimate of its value.

For crypto, it’s much more nebulous as coin values ​​are usually not tied to income, profits, or any of the usual fundamentals that go into valuations. It’s more a matter of popular opinion – otherwise known as the network effect.

In a research note released this week by Goldman Sachs’ economics research team, authors Zach Pandl and Isabella Rosenberg explored using certain attributes that digital assets must find analogous to stock market fundamentals.

Previously, the authors wrote, equating it with precious metals like gold (“a store of value”) was a common framework for displaying assets like bitcoin. The big difference is that gold doesn’t really have user networks.

But social networks do.

“The prices of cryptocurrencies can also be linked to the value of their underlying distributed networks, in the same way that the stock valuations of social media companies like Facebook are linked to the value of their proprietary networks,” said wrote the authors. “So we compare cryptocurrency ratings to various proxies for network size, in the same way that social media ratings are compared to network metrics such as Monthly Active Users (MAU).”

A way to think about the fundamentals of cryptography

Using blockchain addresses to estimate the number of users on a network (for example, bitcoin or dogecoin), Goldman analysts compared this to the market capitalization of currencies (how many coins are in circulation multiplied by the value of the coin). room). They did the comparison for Bitcoin, Bitcoin Cash, Dash, Ethereum, Ethereum Classic, Litecoin, XRP / Ripple, and Zcash.

“We are seeing a clear correlation between market capitalization and network size in cross-sectional data,” the analysts wrote.

How big of the correlation is the question, however. The network effect is often observed in a relationship in which the value increases by the square of the number of nodes or participants. (So ​​10 nodes would give a value of 100 and 9 would give 81.) In this theory, the value is correlated with the number of connections.

But for cryptocurrency assets, there is already a real value attached – market cap – so Goldman analysts looked at the relationship between number of participants and market cap to see how it aligned with ” clear correlation “that they observed between these eight crypto assets.

“Cryptocurrency market caps have generally been positively correlated with network size and increased more than one to one with network growth,” the analysts wrote. The average growth curve, they calculated from historical data, is something like value = users to the power of 1.4. This gives a benchmark ratio for what fundamentals “should” be, similar to using a historical P / E ratio as a benchmark for what a stock “should” be valued for.

Bitcoin’s market cap is well above its ‘fundamentals’

For bitcoin, there is a serious deviation from the value it should have (its “fundamentals”) based on the amount of user growth compared to the value it actually has in the form of its. market capitalization.

In recent years, analysts said, bitcoin’s value has increased 520% ​​from its 2018 average, while its network has only grown between 60% and 100% (according to the where you are counting from in 2018.)

Bitcoin cryptocurrency coins and a PC motherboard are pictured in Kiev on July 19, 2021. (Photo by STR / NurPhoto via Getty Images)

Bitcoin cryptocurrency coins and a PC motherboard are pictured in Kiev on July 19, 2021. (Photo by STR / NurPhoto via Getty Images)

Based on the growth in its user base, the increase in bitcoin’s value should have been less – 90% to 150% – and not 520%. Again, the idea here is that this number could represent the growth of bitcoin’s “fundamentals” which, like stocks, don’t always tell the whole story.

The difference between its fundamental value and its market cap means that it is either poorly valued now or poorly valued in 2018, a combination of the two. Or there are other factors at play, like bitcoin seen as cool, new, an easy get-rich-quick scheme, or some other engaging way.

Some of these factors, like feeling, further complicate matters. But how many people actually use a crypto asset is a form of sentiment – whether they join the network and create an address or buy and sell cryptocurrency.

This is why examining these network “fundamentals” is really just one tool in an assessment toolbox.

“Rising prices can generate more speculative business activity and therefore attack growth. For this reason, increased network activity may not represent an improvement in cryptocurrency ‘fundamentals’: platforms do not have more economic value through network effects simply due to ‘higher speculative trade,’ wrote Pandl and Rosenberg. “For cryptocurrency networks to have lasting value, business will need to be driven by non-speculative use cases.”

For now, they added, those use cases just aren’t there.

Ethan Wolff Mann is a writer at Yahoo Finance who focuses on consumer issues, personal finance, retail, airlines, and more. Follow him on twitter @ewolffmann.

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