This article analyzes the qualitative and quantitative components that distinguish the value of tokens. Qualitative aspects include community participation, communication narrative, etc. Quantitative indicators include TVL, P/E ratio, etc. The author believes that both are indispensable, and founders need to consider them comprehensively and use data to tell a good project story. Blockchain asset valuation is still developing, and with the continuous enrichment of on-chain data, more traditional frameworks will be applied.
Why do tokens have value?
“Why would anyone buy a token? How can all this internet money have value? This is all just a giant Ponzi scheme and everyone is looking for a bigger fool to buy their wallet, right?” These are important questions that can help us sort things out.
During market downturns, skepticism tends to increase, so now might be a good time to answer fundamental questions and join the skeptics in asking “Why is the token valuable?”
First, live trading tokens have a well-defined value in the form of a market price. The market price at any given time is a function of supply and demand. On the supply side, the total supply of different tokens varies greatly, so comparing their prices is as difficult as comparing apples and oranges.
What’s more, the supply of some tokens will also increase over time. For this reason, the best metric to compare token values is the fully diluted market cap to account for differences in token supply. But where does the demand come from?
Tokens have value for different reasons. The “super asset class” framework provides answers to the question of demand and value for different types of crypto assets.
In this article, we first quickly introduce the framework of super asset classes. Then, we apply it to today's token market. Finally, we outline the different demand drivers for each super asset class.
Applying Super Asset Classes to Tokens
"Super asset classes" is a theoretical framework for classifying different asset classes published by Robert J. Greer in 1997 and popularized by Chris Burniske in 2016 when he attempted to classify Bitcoin using this framework. The conclusion reached was that Bitcoin cannot be classified as any existing super asset class because it has several attributes.
A 2016 Alcatel Investments white paper argued that Bitcoin should be viewed as its own unique new super asset class. Since then, a lot has changed in the crypto space, so it makes sense to apply the framework beyond Bitcoin to different types of tokens and crypto assets.
The three super asset classes are “capital assets,” “consumption/convertible assets,” and “store of value assets.”
The above table shows the application of super asset classes within traditional financial asset classes.
Crypto assets exhibit similar properties to traditional assets, so it makes sense to apply this framework to tokens. Since tokens are programmable money, they may fit into several super asset classes at once.
It’s important to note that proof-of-work tokens like Bitcoin and proof-of-stake native tokens like Ethereum sit squarely between the traditional super asset classes.
Bitcoin clearly has attributes of both a consumable/convertible asset (because it requires transaction fees) and a store of value asset (because it requires a monetary premium and has political and economic significance). Ethereum also has attributes of a capital asset because it provides regular returns to its holders through staking rewards.
For this reason, ETH is described by Bankless as a “triple-point asset.” Since both crypto assets fall into traditional super asset classes, one could argue that they create new super asset classes, as Alcatel Investments originally proposed.
Alternatively, we can continue with the original three super asset classes and allow the first layer of assets to fall between asset classes. This approach seems reasonable because the programmability of tokens makes the boundaries between super asset classes more blurred.
Most NFTs in existence today can be described as a store of value asset, similar to art in the traditional asset class. Generally speaking, profile picture collections and art NFTs in particular fit this bill. However, there is a growing focus on the utility of NFTs, so they are starting to fit more into the consumable/convertible category.
As new types of NFTs begin to gain traction, it may make more sense to categorize them individually. For example, real estate NFTs look more like capital assets than store-of-value assets like PFPs and art NFTs.
The pure utility token category is closest to the consumable/convertible category under the super asset category. In Web3, there are many decentralized resource networks that include tokens to coordinate supply and demand. For example, assets related to file storage networks (such as FIL (IPFS) and Arweave (AR)), computing networks (RNDR or GLM) and even data connections (such as Uplink).
Since some of these include mechanisms such as staking that provide returns in the form of tokens, they sometimes also exhibit attributes of capital assets.
A discount feature for a given product or service is another classic example of pure utility. “Pure” was added to “utility token” to distinguish it from legal uses of the term “utility token”, such as the definition by Swiss regulator FINMA.
Governance tokens, whether they are DeFi protocols like COMP (Compound) or MKR (MakerDAO), or different DAOs like Investing DAOs, clearly fall into the capital asset class. The protocols or DAOs they govern generate an “ongoing source of value,” whether through the fees they generate, investment returns, or other value streams.
Therefore, control of these valuable assets can be considered capital, regardless of whether there is a regular flow of value paid to token holders (as is the case with some governance tokens, such as GMX). Chris Burniske has also advocated for governance tokens as capital assets.
However, governance tokens often have other utility functions on top of the governance function, such as discount functions. In these cases, governance tokens can also be considered consumable/convertible.
Finally, stablecoins are an obvious store of value asset because their sole purpose is to be used as money. Often, they are even pegged to an existing fiat currency like the U.S. dollar.
Different value drivers for each crypto asset under the super asset class
Now that we have categorized the different categories of tokens into the framework of super asset classes, let’s look at what is driving the demand for each token.
People want to buy or hold capital assets, like governance tokens, to gain control over what they hold.
Whether they have a specific interest in valuable protocols or governed assets, or whether they are interested from an investment perspective, the interest is always specific to the protocol in question. It's not that they just want any governance token, but rather they want the governance token of the specific protocol they are interested in, such as Uniswap.
People who are interested in Uniswap governance have different reasons, whether as a user, builder, or liquidity provider, to name a few. If there were regular distributions to token holders, the motivation to invest would become more apparent. As the perceived value of the governance token increases, so would the demand for it, and therefore its market value.
The main reason to buy a consumable/convertible asset (such as a pure utility token) is the network of resources it grants usage rights to. For example, someone may want to store files on IPFS, either as an individual or as a developer of an application using the protocol.
We can distinguish between the need to use a resource network now or in the future. In the latter case, one may wish to purchase the corresponding tokens in advance to ensure access at a given market price. As a resource network is used more frequently, the demand for its corresponding tokens increases, leading to an increase in its value.
When it comes to store-of-value crypto assets, the main motivation for buying them is either to preserve their value in the future or to use them as a medium of exchange for another asset.
Depending on the risk profile, one can choose stablecoins or Bitcoin/Ethereum. PFPs and Art NFTs add aesthetic, expression, and identity dimensions to purely financial considerations, so the reasons for buying these things are more akin to buying art.
In all different cases, speculative demand is another reason to buy any token. It is important to note that classifying a token as a super asset class does not say anything about the legal status of the token, which needs to be determined on a case-by-case basis and will vary in different jurisdictions.
Qualitative and quantitative indicators of demand
We saw how tokens can have value for different reasons and how the framework of super asset classes provides a good starting point for distinguishing between different demand drivers.
Crypto assets are still new, so speculative demand can be said to be an important factor that differentiates different super asset classes. So a large part of the demand is actually a bet on various future needs.
Having laid the foundation for the value of tokens in this article, we will expand on this in the following articles. We will look at different qualitative and quantitative metrics to compare tokens in the same category. We will also pay special attention to the super asset class of “capital assets” where traditional finance valuation methods and ratios are most applicable.
Asking the question “why is this type of token valuable?” and attempting to answer it in a principled way is critical to distinguishing signal from noise in Web3.
Decomposing Token Value: Qualitative Analysis
What is a qualitative component?
Unlike investors in traditional companies, a large portion of the Web3 population consists of “millennial” or “gen z” investors who build narratives and communities around the projects they invest in, primarily through participation on Twitter and in Discord and Telegram channels.
For Web2 companies venturing into Web3 for the first time, it’s important to understand the advantages of this unusual alternative marketing approach. A vibrant community, marketing, and social media following are incredibly important in giving a company perceived value.
Narrative
Web3 is cyclical in nature, starting with the Bitcoin 4-year halving cycle narrative or short-lived market narratives that drive the entire market, it is very important to understand and know how to leverage these narratives to tell a story.
Using positive sentiment towards a specific industry or project to your advantage through partnerships, product announcements, and creating a connection between the narrative and your product can be extremely valuable in attracting users to your product.
Due to the importance of narrative in the Web3 space, it is important to continually monitor developments in your sector and leverage any narrative that may form to drive token value.
Community
Building a community is one of the most important aspects of driving the qualitative value of a token. Due to the decentralized nature of Web3, token holders may have governance votes on certain decisions of the protocol, so they are more likely to show interest in the day-to-day actions of the company.
A large, high-quality community is your number one choice for marketing, supporting your project on social media, writing marketing materials, and sharing what you’re building.
Key areas of focus include:
• Internal community tools (Discord, Telegram, WhatsApp):
￮Through competitions, activity in the channel, and ongoing engagement with the community you are building. Reveal some “alpha” information or insights into the future of the product through community calls, visits from the team or developers.
•Brand Representatives/Marketing Platforms (Twitter, LinkedIn, Reddit, Instagram, Facebook, YouTube, TikTok, Twitch):
￮These channels are good for growing your community and increasing your social footprint. By posting or shooting video content, you can attract more people to the content you are building.
•Brand publishing platforms (Medium, Substack, Quora):
For longer news content, you can choose to publish project updates or milestones on a publishing platform to publish news to the community.
By leveraging a tool like Lunar Crush, investors can look at the total number of social mentions and total social engagement over the past 3 months and run marketing campaigns that drive those engagements higher and higher.
Number of token holders
Web3 provides projects with a unique advantage and allows them to understand how their tokens are dispersed among the community. Decentralization is a core value of Web3, built on a diverse and distributed community, and monitoring on-chain data such as the number of token holders is a great way to track how diverse the community is. Ideally, the more unique the holders, the better. This should help increase governance participation as there are more token holders who want to have a say in the future of the product. It also means more people find your token valuable enough to hold and support your project.
Products and Tokens
As mentioned above, the value of a token is an imperfect reflection of the market’s perception of the future value of the token. Due to this market dynamic, investors consider future utility when evaluating the potential value of a token.
Building, iterating, and evolving is something every project does, especially startups that may veer significantly from their initial vision. Communicating the future utility of your token and a potential roadmap of product improvements is critical to keeping the community engaged and interested in what you’re building, even if it’s only a few paragraphs.
A token will typically derive its value by leveraging different value capture mechanisms. Ideally, it will have utility in the product, such as improving the user experience and governing the protocol.
In addition to utility, tokens should capture value through revenue sharing, buybacks, discounts, and perks, thereby creating demand to buy and hold the token.
The perceived value of the token will scale with the product, and as the product generates more PMF and higher usage, the token should capture that value and become more valuable itself.
The value capture mechanisms of some tokens are weaker than others, which may be due to a variety of reasons, including but not limited to regulatory restrictions in different jurisdictions and the way the tokens are used in the product.
For application-specific tokens, each iteration of the product is limited by the utility of its governance token. However, as Uniswap and the UNI token have shown, since the token manages the governance of the product, even a “weak” value capture mechanism has proven to be an important mechanism for demonstrating the value of the token.
In the specific case of Uniswap, governance of the Uniswap protocol is extremely valuable to token holders, driving the value of the UNI token.
summary
From the above discussion, we can find that they all revolve around one thing: the community and the narrative that can be launched for the development of the project. For a company that is switching from Web2 to Web3, community and brand are important, and this is also a big difficulty they face.
The community will be your biggest fans and critics, and understanding which metrics to use to track community maturity is one of the drivers of token value that is difficult to assess with traditional valuation metrics.
It’s also important to remember that tokens shouldn’t be the product, but should be used to complement the product, capture value, and enhance the user experience. If you’re not sure if you need a token, read this article from Outlier Ventures, “Does Your Product Need a Token?”
Additionally, it is important to ensure that the product and user experience solve the user’s pain points. If all of these aspects are aligned, your token has the best chance of capturing value through the qualitative nature of the token’s value.
Decomposing Token Value: Quantitative Analysis
Based on qualitative ingredients
As discussed in Part 1 and Part 2 of our token value series, the perceived value of a capital asset is made up of multiple components. The previous chapter focused primarily on the qualitative components, which cover the “intangible” aspects of a token’s value. This includes aspects such as community, narrative, and token utility.
This chapter will examine which quantitative components contribute to the perceived value of a capital asset. Combining the qualitative and quantitative components will help explain why a token or protocol might be valued the way it is. Both aspects are equally important and deserve equal attention from founders looking to build successful Web3 businesses.
Quantitative Components
Data-driven asset valuation has become the standard valuation method in the traditional financial system. Whether it is achieved by comparing the price-to-earnings (P/E) ratios of similar companies, performing discounted cash flow analysis (DCF), earnings per share (EPS), or any of the popular alternative quantitative analysis methods.
This type of analysis is not common in the Web3 space. Before advances in smart contract technology allowed DeFi, NFTs, and thousands of other applications to be built on-chain, quantitative data was limited to token transfers and fees paid to miners or stakeholders.
As the market develops further, the project will have real business income and sufficient data for quantitative analysis, and the value of tokens will become a focus of more attention from investors.
The token value mainly consists of the following quantitative components:
Total Value Locked (TVL)
Total locked value is one of the standard metrics for determining the value of a protocol today. This metric is mainly applicable to the DeFi space and takes into account the total value of all crypto assets locked on the platform. This could be assets borrowed in an Aave lending pool or assets deposited in a Uniswap liquidity pool.
TVL is often an indicator of product-market fit (PMF), where protocols with the largest total locked are the most trusted from a security perspective and the most used. This is because liquidity flows to where it is used most, as this generates liquidity provider fees.
The main website that studies the TVL of a protocol is DeFi Llama.
amount of users
The number of users of a particular product or protocol can be used to derive the adoption rate and PMF of that protocol. This data is used in the paper along with other metrics to determine if the product is gaining more adoption compared to its competitors. The number of users for a protocol can be found on Token Terminal.
income
Token Terminal defines revenue as “fees paid to token holders”. This revenue is derived from fees generated by the use of the platform and is the residual income captured by the project (or token) as profit. This revenue should not be confused with fees (sales) which we will see in the price-to-sales ratio below.
Revenue is the remaining profit accrued by the project after deducting fees that may be paid to different stakeholders. For example, the revenue earned by an AMM after liquidity providers receive their portion of trading fees.
By monitoring the revenue of a project, it is possible to determine whether the project is a profitable revenue-generating project and whether the token is capturing value from the operations of the project. These profits may or may not be captured by the token, depending on the token value capture mechanism used.
Since the value accumulation mechanism of each project is complex, it is necessary to understand how the token captures the value generated by the company, as there is no standard method for token value capture.
Market Cap/Total Value Locked (MC/TVL)
Projects are valued by dividing the fully diluted market cap by the total value locked on the platform. Comparison with other competing projects in the same space can be used to determine the value of the company relative to its competitors.
Price/Sales (P/S)
Price-to-sales ratio is a metric derived by Token Terminal based on project data. The ratio is calculated by dividing the fully diluted market capitalization by the annualized revenue. This ratio shows how a project is valued relative to the revenue it generates.
Price/Fee (P/F)
Similar to the P/S ratio, the P/F ratio is calculated by dividing the fully diluted market cap by the annualized fees generated by the company. These fees can be used to pay stakeholders that the company allows it to operate, such as liquidity providers on an AMM. This is a way to value a project based on how much it generates relative to the fees it generates.
Discounted Cash Flow (DCF)
A DCF is a method of evaluating investments based on their future cash flows and attempts to project how much an investment would be worth today based on future returns. Due to the lack of historical data, volatility, and extreme risks associated with new technologies, there is little evidence that this type of common stock valuation analysis is being used for cryptocurrencies.
The traditional DCF calculation formula is:
DCF = CF11+r1+CF21+r2+CF31+r3+ … +CFn1+rn
here:
CF 1 = Cash flow in the first year
CF 2 = Cash flow in the second year
CF 3 = Cash flow in the third year
CF n = cash flows in additional years
r = discount rate
The discounted cash flow method uses a discount rate, r, to determine whether the future cash flows of an investment are worth investing in. Historically, when completing a DCF for an immature, early-stage company, the future cash flows had to be discounted to bring them in line with the risk associated with investing in an early-stage startup by discounting the future cash flows by 25% to 50%.
Web3 projects, especially those with tokens, have many different monetary policies, and traditional formulas for calculating DCF of cryptocurrencies are not accurate. Now, data sources such as Token Terminal make data easy to use, and more and more traditional methods are being adopted and modified to better analyze web3 projects.
What does this mean for founders?
Quantitative data are of limited use when analyzed in isolation, but they become extremely useful when mixed together. The magic is in weighing each factor differently for different market conditions and integrating the qualitative components mentioned in the previous chapter.
Everyone has their own perspective and point of view when looking at problems. Some investors may value the project's revenue distribution, while others may value industry development and the project's governance. There is no right or wrong answer to this question, and the tools given in this article are just tools that investors can use to value projects or tokens.
As a founder, it’s imperative to know this information because it shapes the story you tell your investors and your community. By combining qualitative and quantitative data, you can show investors why your company and product are valuable, build marketing campaigns around that data, and create a compelling narrative.