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5 minute read / Sep 6, 2021 /

How Will We Value a Crypto Token?

Imagine you have a dollar to invest and you can choose between two options: a public cloud service or a layer 1 blockchain. How do you decide which is more attractive? How does a token differ from equity?

The answer is that tokens can act remarkably like equity if they are structured in the right way. In addition, tokens offer one benefit beyond equity: utility.

Property/ Asset Voting Dividend Yield Minting Utility Value Driver
Equity yes yes yes yes no revenue /ebitda
Token yes yes yes yes yes ?

Here’s a table that summmarizes the similarities and differences of equity and tokens. They are in fact, very similar.

Voting & Dividends
Many of us have bought and sold equity; it’s familiar. If I buy one share of a public company stock, I can vote in the shareholder decisions and receive dividends if the board elects to issue one.

A token provides voting rights when it is a governance token that governs a DAO (Decentralized Autonomous Organization). A DAO is the governance organization of a crypto company. It functions like a board and shareholder base. A DAO manages the roadmap and the treasury of the business and evaluates ideas for the business that are submitted by the community. Should the DAO elect to distribute profits from the treasury, a token holder would receive a share of those earnings.

I can lend the stock to short sellers in a practice called securities lending for stocks. If a trader would like to short stock, they must borrow it from someone - me! For the service, the trader pays a me fee communicated as an interest rate.

The same is true of tokens. Traders can borrow them to sell them short and pay a fee. Different tokens command different rates, like stocks.

A company’s board can create more stock simply by passing a motion. Poof! 10 million more Google shares. These new shares are often granted to employees as compensation.

Tokens work similarly, though it’s called minting. If I work on behalf of a crypto company, I receive tokens as part of my compensation.

But being an employee isn’t necessary to mint. I can also mint tokens if I participate in the network to help it along. If I operate a Solana validator to verify transactions or buy a Helium router to distribute internet in my city or stake Ethereum to verify transactions, each network would reward me with tokens. The network pays members with tokens much the same way a corporations pays employees in stock.

Public companies can choose to increase or decrease the number of shares outstanding through pool expansion or share buybacks. Tokens have their own mechanisms for controlling the total quantity of tokens.

Some tokens are inflationary (over time each token is worth less) and others are deflationary (over times each token is worth more). The same could be said of company stock. For example, Apple is a deflationary stock. There are approximately 1/3 fewer shares of Apple in circulation today than in 2012 because the company has used their cash to buy them back and retire them.

Unlike equity, tokens have a utility. I can use a Ethereum token to transact: buy an NFT, sell an NFT, execute a Defi contract to exchange Compound tokens for Aave tokens for example. If I arrived at a Microsoft store seeking to buy an Xbox Series X with a two Microsoft shares, the clerk would be more than befuddled.

To use my Microsoft stock and walk out of the store with the XBox, I’m required to swap my stock for US dollars and pay in cash or a credit card.

Valuation Driver
Most companies in the public market are valued on revenue or EBITDA; if revenue increases, so does the value of the stock.

As for tokens, it’s an open question. The valuation methodologies haven’t coalesced yet. Cryptoassets written by Burniske and Tatar in 2017 contemplates a few different models including velocity of money (mv=pq), discounted future cash flows (DCF), and speculative value (if this asset is worth X, this other one must be worth y). There’s a great example for Axie here.

But with significant differences in corporate structure (not all tokens provide DAO voting) differences in capital structure (does the value reside in the token or the equity of the cap table?), and the novelty that a token can be used as a utility in a way a stock cannot, the question is a perplexing one.

Assuming a crypto company and its DAO decide to structure tokens as similar to equity as possible, then tokens confer one marginal benefit beyond equity: utility. That utility is worth something. It’s an option to act. It’s also a way to transact that may have less transaction costs than converting to cash or paying through a credit card network.

Consequently, a token with the same rights as a share of a company should trade at a premium. The premium should be some combination of option value of the utility plus the discounted value of the tax and transaction cost savings.

In addition, the different layers of the crypto stack will be valued differently. An automated market marker and an NFT market place have very different revenue, net income, and cash flow characteristics. The same is true for a crypto bank and an L1.

How much for that Bizarden Tulip?

As the market matures, valuation methodology will cohere into a well-understood framework, much as it has in SaaS over the last decade. But today, the ecosystem is most certainly using the speculative value method: if the floor price of a CryptoPunk is 20 ETH, then a Degenerative Ape must be at least 150 SOL. How much is a Bizarden Tulip NFT? [1]

[1] this was the rarest tulip in Holland, yellow streaks on purple petals.

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