Valuing a cryptocurrency is not nearly as simple as valuing a stock. A stock is a piece of a company, and you can look at what the company owns and its revenue, costs, profits, and trends to determine some sort of estimate of its worth.
For crypto, it’s far more nebulous since coin values aren’t usually connected to revenues, profits, or any of the usual fundamentals that factor into valuations. It’s more about popular opinion — otherwise known as the network effect.
In a research note this week from Goldman Sachs’s economics research team, authors Zach Pandl and Isabella Rosenberg, explored using some attributes that digital assets have to find analogs to stock fundamentals.
Previously, the authors wrote, equating it to precious metals like gold (“a store of value”) was a common framework to view assets like bitcoin. The big difference is gold doesn’t really have networks of users.
But social media does.
“Cryptocurrency prices may also be related to the value of their underlying distributed networks, in the same way that equity valuations of social media companies like Facebook are related to the value of their proprietary networks,” the authors wrote. “We therefore compare cryptocurrency valuations to various proxies for network size, similar to the way in which social media valuations are compared to network metrics such as monthly active users (MAUs).”
A way to think about crypto’s fundamentals
Using blockchain addresses to estimate the number of users on a network (say, bitcoin or dogecoin), the Goldman analysts compared this with the currencies’ market capitalization (how many coins are in circulation multiplied by the coin’s value). They did the comparison for Bitcoin, Bitcoin Cash, Dash, Ethereum, Ethereum Classic, Litecoin, XRP/Ripple, and Zcash.
“We observe a clear correlation between market capitalization and network size in cross-sectional data,” the analysts wrote.
How big the correlation is the question, however. The network effect is often seen 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 correlates to the number of connections.
But for cryptocurrency assets, there’s already a real value attached — the market cap — so the Goldman analysts looked at the relationship between the number of participants and the market cap to see how it aligned with the “clear correlation” they observed across those eight crypto assets.
“Cryptocurrency market caps have generally been positively correlated with network size, and have risen more than one-for-one with network growth,” the analysts wrote. The average growth curve, they calculated from historical data, is something like value = users to the 1.4 power. This gives a benchmark…