July 28, 2023
Introduction to Crypto Valuation Metrics
Digital asset valuation is a crucial part of any crypto investment strategy. You must have a methodology, or a thesis, about how to value crypto assets to capitalize on what you think are discrepancies in the markets, to catch a move or trend in its early stages, or in order to determine when you think a crypto asset is overvalued, and thus, it’s a good time to sell.
Valuation methodologies are generally based on one of two types of data: market data or fundamental data.
Market Data is essentially price data—Level I, Level II, order books, etc.—it’s all related to price movement. Very generally speaking, it’s fair to say that most traders who focus solely on market data aren’t exactly trying to value the asset, but more are trying to predict its movement. Market data engenders technical analysis, chart reading, and momentum trading.
Traders who use fundamental data, on the other hand, believe that an asset has a specific underlying value, and that value can be determined by on-chain data and metrics, which track the state of a blockchain by looking at the activities on the blockchain itself. These data and metrics include number of active users, block size, chain capitalization, and so forth.
Let’s take a look at four of those metrics.
Key Metrics for Digital Asset Valuation
Market Capitalization
Market Cap refers to the current measurable total dollar value of a blockchain’s tokens. It is calculated by multiplying the total supply of tokens by the current price of one token. If blockchain has 1,000,000 tokens in circulation and the price of one token is $10, then the market cap of that cryptocurrency would be $10 million.
Market capitalization is helpful in valuing crypto for a number of reasons:
Size and Rank - Market cap provides a quick understanding of how large a particular crypto is in comparison to others. Cryptocurrencies are often ranked by their market cap, providing a quick view of which coins are the largest in the ecosystem.
Size = Strength - Cryptocurrencies with large market caps are usually considered safer investments than smaller ones because they have more liquidity and are less susceptible to price manipulation and wild price swings on small volumes.
Size = Trust - A large market cap usually indicates a high level of trust and adoption among users. A crypto with a high market cap has gained significant acceptance, which generally makes it a more stable investment.
Trading volume
Trade Volume refers to the total amount of a specific crypto that has been traded on all exchanges in a given period, usually 24 hours. It can help you value crypto by giving you a sense of the following:
Liquidity - High trading volume often indicates high liquidity, which means that there is a healthy market of buyers and sellers for this crypto.
Price Validation - A high trading volume can provide validation of the crypto’s current price. Price movements on thin volume can be treacherously deceptive. In the same vein, high volume can indicate that the crypto has institutional +/or whale backing.
Market Sentiment - Trading volume can also indicate market sentiment. For example, a sudden increase in volume might suggest a change in sentiment, which speaks to valuation.
Network Value to Transactions Ratio
The network Value to Transactions Ratio (NVT) is somewhat analogous to the Price/Earnings (P/E) ratio used in equity markets. It can help you identify overvalued or undervalued coins. It is calculated by dividing the Network Value (often approximated by Market Cap) by the Transaction Value flowing through a blockchain. The transaction value is typically calculated daily, so the NVT ratio gives you a comparison of the network value to the daily transaction value.
The on-chain data you need to calculate NVT are:
- Network Value (NV) - This is essentially the market cap, which is calculated by multiplying the current supply of coins by the current price of one coin, and
- Transaction Value (TV) - This is the total value of the transactions taking place on a blockchain in a given time period, often daily.
So, NVT = NV/TV. The NVT Ratio has a few important uses in valuing a blockchain and its associated cryptocurrency:
Valuation Benchmark - The NVT Ratio can be used to compare the relative valuation of different cryptocurrencies; again, similar to P/E ratios for equities. A lower NVT Ratio could indicate that crypto is undervalued compared to other similar cryptocurrencies.
Market Cycle Indicator - Some analysts use changes in the NVT Ratio over time to identify potential price bubbles or troughs. For example, a sudden increase in the NVT Ratio could indicate overvaluation and the potential for a price correction.
Economic Activity - It can help assess the economic activity on a blockchain. A high NVT could suggest that the network's valuation is outpacing the value it transfers, indicating potential overvaluation. Conversely, a low NVT suggests that a significant amount of value is being transferred on the network relative to its valuation, which could indicate that the network is undervalued.
Market Cap to Total Value Locked (TVL) Ratio
Market Cap to Total Value Locked (TVL) Ratio gained prominence with the rise of DeFi, and users staking crypto to support a protocol. TVL is the total value of cryptocurrencies users have deposited into a specific protocol. It can be thought of as a measure both of the total liquidity in that protocol and user confidence in the protocol. The actual Market Cap to TVL ratio is calculated by dividing the crypto’s market cap by its TVL.
Here's why it's useful in valuing a blockchain and its associated crypto:
Valuation Benchmark - You can use Market Cap to TVL ratio as a relative valuation tool. If a number of protocols have similar utility and prospects, but one has a higher Market Cap to TVL ratio, it could be overvalued.
Assessing Utility and Demand - A high ratio indicates that users are actively depositing their assets into the protocol, which can be a sign of trust and perceived utility.
Risk Assessment - A high ratio can also indicate that the price of the token is inflated relative to the actual use of the protocol, which could be an investing red flag.
On-chain Data is Key
On-chain metrics offer insightful data about the activity on a blockchain, whether it's for Bitcoin, Ethereum, or other protocols. Understanding and analyzing these metrics offers enormous trading advantages.
But on-chain datasets are vast, and accessing them for live and historical data is incredibly difficult, and requires a massive data infrastructure, and a huge investment of time and effort. This is a distraction from a financial firm’s core business of providing financial services and products. A better approach is to work with a data provider that already has the necessary talent and infrastructure in place to collect and process digital asset data, providing a single integration point that eliminates the challenge of aggregating data from numerous disparate sources into actionable information that informs decision-making.
Amberdata’s unified API and data services provide a single integration point for obtaining a complete view of the entire crypto economy. We deliver comprehensive digital asset data and insights into blockchain networks, crypto markets, and decentralized finance, empowering financial institutions with critical market or DeFi data for research, trading and analytics, risk management, derivatives analytics, and compliance.
To learn more about Amberdata, please contact us to book a demo, hear about our products that can help your business, or receive pricing information.
