Cryptocurrency Evaluation
Although, we can use different methods to analyze cryptocurrency projects. But some people are still trying to use approaches from traditional finance like Discounted Cash Flow (DCF).
I don’t think that it is the best method because we don’t own shares of cryptocurrency projects, rather we are owning tokens. The success of a good project is heavily related to its’ native token price. With bad tokenomics, holders may not be able to capture revenue earned by a protocol.
We can also use supply and demand analysis. This will allow us to focus more on token holders. What forces behind the supply and demand side, do we have? Why the token is needed? How a cash flow generated by the protocol is distributed to the token holders? Do we have other benefits for the supply side?
I am going to share with you my framework to calculate profits for token holders.
This is a general framework, so it can be even applied to meme coins. However, it is most suitable for cash flow generating projects (both on-chain and off-chain).
Supply and Demand
Price is the result of supply and demand:
Demand⬇️ OR Supply⬆️ => Price⬇️Demand⬆️ OR Supply⬇️ => Price⬆️Price is set by these forces and will reflect everything that investors collectively believe, hope for, and fear:
Demand & Supply => Price (investor's expectations based on value & mood & momentum)Value is not equal to the price. It is driven by fundamentals (cash flows, growth and risk).
Momentum is price action in other words.
Supply and demand can be divided to:
Supply = Inflation/vesting - buybacks - staking (locking)
Demand = Real Utility (Value) + Financial Utility (Earning on token/coin in Defi) + Valuation Changes (Speculation)In this article, we will focus on the demand side, which can be further divided into 3 components. The first part of the demand, Real Utility comes from the value provided to the token holders (not application users). This varies across different projects so we take one project as an example.
Cash Flow Analysis
Let’s now move to a detailed analysis of Beethovenx and its token BEETS. This is an approved fork of Balancer on the Fantom network.
Think about this project as a DEX with ETF like products, which can simplify your portfolio management.
1. Cash flow generated by protocol via token $BEETS
2. Rights (potentially) to the Treasure (from protocol's fees)Here is a detailed analysis of cash flow distributed to token holders and a share of the protocol treasury: Cryptocurrency Fundamental Analysis - Template.
I’ve put all assumptions and calculations into a Google Spreadsheet, so you can copy it and play around with different parameters. If it’s too detailed for you, just check the summary below.
Whenever I am writing about BEETS holders, I mean FTM-BEETS liquidity providers (you can find here an explanation of how to become one). To simplify – only the people who put their tokens in this pool can capture generated cash flows.
We have 3 main revenue streams:
1. Platform revenue – Each token exchange has a platform cost fee. Part of this is redirected to token holders.
2. Emissions – Every day new tokens are minted and distributed to the users of this platform (liquidity providers). You can think about this as a marketing budget used by the early-stage company to acquire customers and build its market position. A significant amount of these tokens is distributed to the BEETS holders. Since they have value and are liquid, we can add these rewards to cash flow streams.
3. LP fees – As we are not just holding our BEETS tokens, but also providing liquidity paired with FTM. We are also getting complete fees from all swaps between them.
Part of the platform revenue is also sent to the treasury. As a token holder, you don’t have any rights to this now. However, this can change in the future, so I’ve added this as a separate, potential source of revenue.
This model is showing what will be the annual profit if all parameters won’t change. This is a strong assumption in cryptocurrency, so you can also check how indifferent changing factors will impact your cash flow.
Revenue depends mostly on the token price (tokens distributed to you have more value) and protocol fees (part of this is shared with you).
Take some time to digest this and let’s move to the Financial Utility part.
Financial Utility
This part can be harder to understand for crypto newcomers.
When you have stocks, you can’t do much with them. You can just wait for price appreciation and dividends. In crypto, we have tokens, which can be used as commodities or money in DeFi. Instead of just holding it, you can lend it to someone, or provide liquidity in AMM DEX.
Sometimes, you can even earn more from this than just from price changing. This is a long topic, so we will cover this in the next posts. Here we just introduce the basics to give you a sense of it:
Financial Utility is the ability to earn on our tokens in DeFi. 3 key parameters to consider:
1. Cash flow (APY) – How much we will earn in one year if nothing changes?
2. Growth of APY – How likely these changes are going to happen?
3. Risk (growth and cash flow sustainability) – How risky it is?
Before we finish, we also have to discuss the last part of our equation.
Relative Valuation
The last part of the demand is Valuation, which is caused by:
1. Momentum (price action) – Most people (and some bots) are buying if the price is rising.
2. Investor mood – What is trendy now? Where money is flowing?
3. Other pricing factors – Accessibility for US citizens, CEX and DEX availability, etc.
This is the most important factor in the short and very often midterm in crypto. As this market will be more mature, its impact will decay.
This is also a broad topic, so we will cover it later in a dedicated article.
How to Use This Framework?
1. Check what demand forces we have for this framework:
1.1. Real Utility – What is the value provided by this token (you can use my template as an example)?
1.1.1. Cash flow generated by the project to token holders
1.1.2. Other Utility
1.2. Financial Utility – How can you earn on this token in DeFi? Is this significant versus Real Utility?
1.2.1. Cash flow from DeFi
1.2.2. Growth of cash flow
1.2.3. Risks
1.3. Valuation – Other factors impacting the price
1.3.1. Momentum (price action)
1.3.2. Investor mood
1.3.3. Other pricing factors
2. How this demand can change over time? Will this offset the change in supply?
3. Compare the project with competitors to have a baseline.
Disclaimer
This article was written for educational purposes only and it is not a financial recommendation. I don’t have any BEETS tokens and I have no association with the Beethovenx project.
The analysis was created in January 2022. Many of the used numbers are not valid now, but you easily update them from provided sources. I intentionally not updated this to show the volatility of the crypto market and the limitation of this analysis in longer time horizons.
What next?
In the next articles, we will cover Investment and Selection process. After it, you will be able to start researching your crypto projects. I will share with you my framework, some examples and tips on how to start.
You can also follow me on Twitter to get more investment frameworks and cryptocurrency analyses.