How to put the right value on digital assets?
Successful crypto investing requires a solid framework for value-based decisions. The efficient market hypothesis suggests that prices already include all information about an asset and that prices reflect absolute value.
However, there are thousands of examples that contradict this theory in the crypto and stock markets. The reality is that markets are inefficient. Why did Apple's stock price drop by 30% in February 2020 due to the Covid-19 crisis? Apple sold 30% fewer products? Apple made 30% less revenue? Why did GAP stock crash 70% in 49 days? Did the largest clothing retailer in the United States suddenly sell 70% less clothing?
The answer to all of these questions is a resounding “no.” Markets are often irrational, and prices do not reflect their value. As Warren Buffett said, “Mr. The market is a drunken psyche.”
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This is where the concept of value investing comes from. Value investing attempts to identify securities that are undervalued due to market irrationality. These securities are selling below market value (ie, with a margin of safety), and investors who buy them hope that, one day, the price will reflect the value of the stock. To quote the great investor Warren Buffett again: “What you pay for is what you get.”
The same thing happens with crypto assets. In March 2020, during the Covid-19 crisis, the price of Bitcoin (BTC) fell by 50% – only to recover to previous levels 55 days later and to double its value in the following five months. Do these price movements accurately represent the network's true value, activity, active wallets, transaction volume, and network importance? Do the prices reflect the value?
The answer is no. The trick is to find the right tools to identify these opportunities – tools like fundamental analysis.
Fundamental analysis allows traditional institutional investors to understand the industry, attract more capital and create more unicorns, as has happened in the Internet and consumer industries. These core techniques have become increasingly popular with retail investors seeking high-potential investments over long-term investment horizons.
Hype and growth, value for money
There are a few axioms that are very important for any asset, including crypto assets. And although crypto assets are a relatively new asset class, they inherit the same core principles:
Most crypto assets represent an underlying network, utility or community built on some form of decentralization. The market swings between bullish sentiment and bearish sentiment, between greed and fear, between unsustainable optimism and unwarranted pessimism. Valuation methods are useful in maintaining a rational investment strategy. The future performance of an investment is a function of its present value compared to its fundamental valuation. Risks can be reduced by looking at valuation parameters to avoid overpaying for overpriced projects. rather than their value.
So what is the difference between price and value?
Prices are usually the result of many other variables that differ from the price: sentiment, market hype or depression, speculation, fear, greed, exaggerated news, etc. All assets are irrationally indifferent, but crypto sometimes suffers from this. Disruption to high levels – especially recently in the memecoins sector. In particular, there are many factors that affect cryptocurrency prices, including market demand, market sentiment, government policies, regulatory changes, technological innovations, industry partnerships, project progress, and more.
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Valuation refers to determining the financial value of an asset. Valuation involves analyzing data to determine an asset's intrinsic value using fundamental analysis. As the industry gradually matures, we are finding that traditional financial evaluation methods can help overcome the pressure to identify projects with sustainable growth potential – due to undervalued market or untapped volumes – sealed market opportunities.
Crypto evaluation framework
Given the diversity of crypto assets in the market, there is no “one-size-fits-all” valuation method. Investors should look at different options and see which one suits each case best. The first step is to divide the property. Is it a non-trivial token (NFT)? Payment token? A utility token? Or something else? (After all, unlike securities, cryptocurrencies and tokens have a wide range of purposes and services and offer different rights to investors.)
For native cryptocurrencies – such as Bitcoin – you can use Metcalfe's Law, for example. You can use the same method on layer-1 like Ethereum (ETH) or you can choose something else like stock-to-flow model.
Once you've assigned the token, use the analysis of your choice – one of the above or a different one from the image below.
Long-term successful investing in crypto does not require extraordinary IQ, special business insights or insider information. You just need a solid framework to make investment decisions based on value rather than guesswork. Good investment!
This column is excerpted from “Digital Asset Pricing Framework” published by HashKey Capital in April 2024.
Jupiter Zheng is a liquid fund and research partner at HashKey Capital, a financial services firm with offices in Tokyo and Singapore. He previously served as Deputy Head of Zhongtai Financial's FinTech Department and Senior Associate at BOCOM International's Research Division. He holds a bachelor's degree in applied physics from Beihang University, operations research and business statistics from Hong Kong Baptist University.
This article is not intended for general information purposes and should not be construed as legal or investment advice. The views, ideas and opinions expressed herein are solely those of the author and do not necessarily represent the views and opinions of Cointelegraph.
