Our approach to markets and investment views are based on three key investment pillars: business cycle analysis, valuation analysis and technical analysis. Whether analyzing mega-cap growth stocks or a cryptocurrency (crypto), we believe it is imperative investors follow a disciplined, repeatable process. Here we explore valuation analysis for crypto markets.

Some investors may be skeptical of crypto because of perceived analysis limitations and view the ecosystem as a means for speculation. We believe traditional fundamental analysis, including valuation, can be used to find opportunities in crypto markets.

Because crypto transaction data is publicly available, investors can analyze transaction fees as a proxy for cash flows for the network. With cash flow data in hand, investors can apply fundamental analysis concepts to value crypto networks. Figure 1 summarizes a few of the common crypto valuation methods we will explore.

Figure 1: Common Crypto Valuation Methods

Valuation Method Description Pros Cons
Realized Value / Transaction Volume (RVT) Ratio Similar to a Price / Earnings (P/E) ratio for stocks Data is readily available Network effect indicator Limited forecasting ability

Backward-looking indicator
Precious Metals Analogy Theory As bitcoin is accepted as digital gold, it will take market share as a store of value Easy to explain Specific to bitcoin and other “digital gold”

No quantifiable method to measure or model
Stock-to-flow Theory The price of bitcoin follows a 4-year cycle, positively impacted by “halvings” High correlation to the price of bitcoin so far Specific to bitcoin

High correlation may be spurious
Total Value Locked (TVL) Ratio Measures the amount users have “locked” into a decentralized finance protocol for lending purposes Network effect indicator Not relevant for bitcoin and other “digital gold”

Depending on the source of the data, it may be double-counted

Source: PNC

Crypto... Fundamentals?!

Admittedly, crypto transaction fees are not the same as sales and profit figures from a corporation. However, transaction fees provide an incentive to miners to maintain a network’s security and development — much like a corporation generating cash flows to support operations and remain competitive in the market.

With traditional investments, investors may consider a corporation’s price-to-earnings ratio to assess the value of a stock. Crypto investors can look at a comparable metric, a network’s realized value-to-transaction volume (RVT) ratio. This ratio is the network’s market capitalization divided by its daily transaction fees. Figure 2 depicts bitcoin’s price versus its RVT ratio, which has fallen to 1.5 times (x), below its 1.9x historical average, suggesting it is undervalued using this analysis.

Figure 2. Bitcoin RVT vs. Price


As of 2/28/2022 | Source: glassnode.com, PNC

View accessible version of this chart.

Let’s compare two examples to see how this would look in practice. The price of bitcoin experienced significant pullbacks in both February and April 2021. In the former case, bitcoin’s RVT ratio reached multi-year highs and remained relatively steady during the selloff. For this ratio to remain intact, it means the transaction volume was dropping in conjunction with the price. As such, in our view this pullback was warranted. In the April example, it was the bitcoin price that peaked — in fact it reached an all-time high — yet the RVT ratio dropped along with the price. What this means is that the pullback was likely a buying opportunity as the network’s transaction volume (the “T” in the ratio) remained strong despite the price decline.

Precious Metals Analogy

While specific to bitcoin and other “store of value” cryptos such as Litecoin and Bitcoin Cash, some investors compare these coins to a traditional store of value asset, gold. Similar to gold, bitcoin is a finite resource. The source code is programmed to stop generating new coins after 21 million are mined. With approximately 18.5 million mined to date, it is expected miners will reach 21 million by the year 2140 at the current rate. Similarly, other competing cryptos also have limits in place.

The digital gold argument is popular among crypto investors because should bitcoin or another crypto dethrone gold as a “store of value” asset, that crypto could take market share and enjoy significant price appreciation.

As of January 31, 2022, bitcoin had a market capitalization of approximately $700 billion, while the entire gold market was valued at more than $9 trillion.

Stock-to-Flow

Stock-to-flow is another popular crypto valuation model popularized by the anonymous Twitter user @PlanB. The model is based on the assumption that crypto with a predetermined supply schedule, such as bitcoin, follows a predictable price model based on the ratio between the supply of coins in circulation and the number of coins generated by miners at a given time.

In essence, the model is specific to bitcoin as its creator scheduled mining rewards to be cut in half every four years, popularly known as “halving.” When bitcoin began trading in 2009, a block of 50 bitcoin was rewarded to a miner (nearly $2 million based on current pricing). In 2022, the reward is 6.25 bitcoin per new block. In 2024, when the next halving is expected, the reward will be cut to 3.125 bitcoin.

The expectation of a shrinking reward system is that as more miners join the network, the competition to mine bitcoin, coupled with smaller and smaller block rewards, prevents a consortium or a single large mining operation from taking over the network due to the impact on profitability. The most glaring argument against the stock-to-flow model is that it predicted a bitcoin price of $100,000 by the end of 2021, whereas bitcoin ended the year at $46,000, more than 50% below the forecast.

Total Value Locked (TVL) Ratio

The total value locked (TVL) ratio is a valuation metric unique to crypto markets. Under certain conditions, users can “lock” in their investment on a network for a specific amount of time, somewhat akin to a time deposit in a traditional deposit account. Locking is assumed to help preserve the strength and liquidity of the network. As an incentive, users share in miners’ rewards, similar to receiving interest on bank deposits.

This was an especially popular investment method in mid-2020 when many new decentralized finance projects were coming online and needed the stability of long-term investors in those early days.

The tactic became known as “yield farming.” In theory, the TVL ratio indicates the strength of a network. If investors are willing to lock up an investment for an amount of time — considering the volatility in crypto markets — then it suggests there is a strong user base, and subsequently a strong network effect to indicate value (Figure 3).

Figure 3. Ether TVL Ratio to Price 
TVL Ratio Remains Strong Despite Price Decline


As of 2/28/2022 | Source: glassnode.com, PNC

View accessible version of this chart.

Valuing Crypto

While crypto valuation techniques may appear unorthodox, we believe they follow the same premise of traditional fundamental analysis.

 

TEXT VERSION OF CHARTS

Figure 2. Bitcoin RVT vs. Price (view image)

Date Bitcoin RVT Average Bitcoin Price ($)
2/1/2016 1.238035 1.870479 371.3705
2/29/2016 1.425209 1.870479 436.4222
2/1/2017 2.126982 1.870479 987.7524
2/28/2017 2.42901 1.870479 1195.837
2/1/2018 1.78877 1.870479 9014.026
2/28/2018 1.99173 1.870479 10397.9
2/1/2019 0.782442 1.870479 3488.655
2/28/2019 0.883261 1.870479 3855.674
2/1/2020 1.64746 1.870479 9392.875
2/29/2020 1.493757 1.870479 8615.228
2/1/2021 2.819887 1.870479 33543.86
2/28/2021 2.986077 1.870479 45119.13
2/1/2022 1.615653 1.870479 38784.5
2/28/2022 1.791274 1.870479 43204.6


Figure 3. Ether TVL Ratio Price - TVL Ratio Remains Strong Despite Price Decline (view image)

Date Ether TVL Ratio Price of Ether ($)
6/30/2020 0.08 226.3332
8/31/2020 0.18 435.5675
10/31/2020 0.26 386.5185
12/31/2020 0.21 737.9222
2/28/2021 0.30 1413.903
4/30/2021 0.40 2772.801
6/30/2021 0.42 2271.506
8/31/2021 0.41 3440.254
10/31/2021 0.44 4291.095
12/31/2021 0.55 3683.858
2/28/2022 0.57 2917.625