One of the things I enjoy most about penning this column is the ability to engage with readers and join them on a journey of learning more about this nascent asset class of crypto. Sure I know some stuff, but there is still plenty to explore. Of particular interest to me is tying crypto to my background in traditional finance (TradFi).
I used to be an equity research analyst. My focus was on valuation. I always viewed getting valuation “right” as being of paramount importance and tried to answer two related questions:
- What’s an entity worth?
- Is it trading above or below that amount?
If a company was trading below the projected market value, I’d rate it a “buy.” If it was trading above – well, in all candor, I’d usually find another company to cover, rather than rating it a “sell.” A number of dynamics exist in sell-side equity research that lead to those types of decisions, and perhaps I’ll discuss them in a future column.
I employed a combination of fundamental and technical analysis, exploring both absolute and relative valuation techniques. Absolute valuations were based on the level of cash flows that the company was generating, and relative valuations were based on its value relative to a similar entity, or itself at a prior time.
Unlike companies, bitcoin (BTC) and many other crypto assets don’t generate cash flows upon which to base a fundamental analysis. But bitcoin isn’t a company. Bitcoin is a peer-to-peer cash system that allows the transfer of value from one entity to the next, without the need for third party validation. People see value in that, so valuations should be explored.
Given that it has a fixed supply, some also view bitcoin as a hedge against the devaluation of fiat currency or against the actions of inept central banks. I view it as both, as well as a viable asset class where I choose to store some capital.
Over in equities, price-to-earnings (P/E) ratios are a common relative valuation metric. There are better valuation techniques, but it provides a quick comparison that tells you how much is being paid for a company versus how much it is earning. The crypto version of P/E is the Network Value to Transaction (NVT) ratio. The metric, created by cryptocurrency analyst Willy Woo, measures the relationship between market capitalization and network transfer volume. Transfer volume is analogous to earnings, and is simply a count of how much bitcoin is moved from one address to another.
In my view, for P/E and NVT to be comparable you must decide that observers value something about both. For companies (and therefore P/E), shareholders value earnings. For BTC (and therefore NVT), it’s the ability to store value in a digital asset, which I view as space on the blockchain itself. And as demand for that space grows, the value of bitcoin increases. If you can get your arms around that, then the NVT ratio is worth including in your analytic framework.
High NVT ratios indicate that investors are valuing bitcoin at a premium. Low NVT ratios indicate the opposite, potentially making a crypto asset alluring to value investors who like to buy things at discounted prices.
But what numbers mean high or low? And when did those readings occur? Given the age of cryptocurrencies, it’s quite possible that what was overvalued in one period, may not be in another. It also makes sense to look at where they are relative to past history. And, once again, it also makes sense to condense it over particular time periods. What is overvalued in one time period may not be in another.
The highest NVT ratio for bitcoin that I found on record was 448.15 on Aug. 29, 2010. Was it overvalued? Well, BTC traded for about 6 cents at the time, and is around $22,000 now, so the relevance of this reading is a bit dubious in my opinion. What if we toss out all data before 2014? That gives a maximum NVT ratio of 98.52, which I think is more sensible. Bitcoin’s lowest NVT on record was 0.22 on Jan. 24, 2016, when BTC was trading at $403. The average NVT over the time span studied was 24, which I also think has relevance.
BTC’s current NVT is 44.89, an 82% premium versus its average since 2014. But it’s at a 20% discount to its 30-, 60- and 90-day moving averages. It makes sense to me that the average premium ascribed to a newer technology like the Bitcoin blockchain, and newer assets like bitcoin itself, would increase over time. It also makes sense to me that its extremes on both the high and low end would narrow, which is what we’ve seen with the data.
Ultimately the position that one takes on the current NVT level will depend on what you anchor to. Those looking over the entirety of BTC’s trading history may see it as overpriced. But a more narrow look shows that BTC may indeed be trading at a compelling valuation.
From CoinDesk’s Nick Baker, here’s some recent news worth reading:
- BIG WEEK: No exaggeration, this felt like a giant week in the Crypto Regulation by Enforcement Era. Kraken agreed to shut down its U.S. staking service (news that CoinDesk broke first) to settle Securities and Exchange Commission (SEC) charges that the operation was offering unregistered securities to customers. Coinbase CEO Brian Armstrong discussed his unease with any staking crackdown, and SEC Chair Gary Gensler sent a pretty clear warning that Coinbase (and others) should pay attention to the Kraken case. Then, Paxos, facing regulatory scrutiny, said it would stop issuing Binance’s stablecoin, BUSD. It’s hard to fathom that this is the last we’ll hear about efforts to curtail crypto in the wake of the FTX disaster.
- GOOD NEWS? At the core of crypto is the ethos that decentralization is better than the alternative. Bitcoin, after all, was born right after the 2008 financial crisis, when the Federal Reserve and other central banks poured money into the financial system to save it – something that rankled some people who became crypto’s earliest backers. The SEC’s apparent effort to get centralized exchanges out of the staking game might actually be good news for crypto folks who like decentralization because individual efforts to stake are seemingly unaffected by the regulatory efforts.
- BANKING CONUNDRUM: A longstanding issue for crypto is getting linked into the conventional banking system. That’s never been particularly easy. And it seems to be getting harder, posing another obstacle besides the staking issue blocking the industry from mainstream adoption.
- RUSSIAN SANCTIONS: An excellent deep-dive investigation by CoinDesk shows how Russians are raising money via crypto to supply troops fighting in Ukraine – sidestepping sanctions. Just add it to this week’s long list of ways crypto is playing with fire (the conventional global regulatory regime).