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As blockchain investors, how do we know if we’re getting a good deal?
All year I’ve been writing about the value of Ethereum: it’s the “Infinite Machine” that these new blockchain apps are being built upon. It’s like Windows or Android: the operating system for the new world of money. That makes Ethereum very valuable indeed.
But how valuable is it?
Three months ago, I told you that the easiest way to invest in the new blockchain boom is to simply buy and hold ETH. That was Sept. 4, when the price was $395.00. As I write this, the price is $590.00. That’s roughly a 50% increase in three months.
We’re not here to turn a quick profit; we’re here to invest in valuable blockchain projects over the long-term. We’re finding technologies that make the global money system faster and better. In this respect, ether is the meta-investment, since it’s giving birth to thousands of these financial innovations.
But how should we value ether? At its current price, is it a good deal? Is it overpriced, or “on sale”?
CoinDesk just ran an interesting series of webinars on How to Value Ethereum. Because you don’t have time to sit through two hours of videos, I’ll summarize them for you below, along with the relevant takeaways at the bottom. (If you’re busy, just skim through the parts in bold.) Metric 1: Total Value Locked This metric has made all the headlines this year, driven in part by the much-hyped chart on DeFi Pulse. |
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TVL: The ultimate vanity metric.
Total Value Locked is the total dollar value of digital assets held in DeFi smart contracts for a specific decentralized project.
In the webinar, Ilya Abugov of DappRadar described TVL as a “marketing metric,” and I agree. What he meant was that it helps to show hype around the industry, but it’s not so useful as a measure of value. (Instead of “Total Value Locked,” think of it as “Total Vanity Locked.”)
The reason is that Total Vanity Locked is denominated in U.S. dollars. So as the price of ether goes up, the TVL goes up, even if there’s not a corresponding increase in usage.
Real human users are the real value in blockchain. TVL confuses real human users with price fluctuations.
(To solve for this problem, DappRadar also calculates an Adjusted TVL, which tries to smooth out prices using a 30-day rolling average. It’s an improved version of Total Vanity Locked, but still far from perfect.)
The webinar also covers Unique Active Wallets, which is a better metric of real human users. In a traditional tech company like Facebook, this would be similar to Monthly Active Users, a valuable metric to show whether people are more or less engaged with Facebook (i.e., whether they log in daily).
Unique Active Wallets sounds simple, but it’s complicated. Over what period of time do we measure “active”? Daily? Monthly? Yearly? What if someone has a wallet but is just holding ETH long-term – shouldn’t they be counted?
It’s also hard to find good data on UAW. DappRadar lists UAW on its DeFi page, but it’s hard to believe their numbers. (For example, DappRadar reports just 931 unique active wallets for Compound over the last 24 hours, when we know from Dune Analytics that there are over 250,000 total Compound users.)
So we will file UAW under “not ready for prime time, but worthy of further study.” That would make a really long folder name.
Metric 2: Number of Accounts
In this webinar, Joanes Espanol of Amberdata spoke about measuring the number of accounts as a way to value ether.
Let’s pretend that Ethereum is a global bank. If we measured the number of customer accounts that were being used in any given month, wouldn’t that give us some idea of the value of the bank?
The first problem is that bank accounts can hold a little bit of money, or a lot. So if the bank has 100 very rich customers, it’s potentially more valuable than 1,000 customers who are constantly bouncing checks. So the number of accounts is not very useful to show us absolute value.
The second problem is that in blockchain, some accounts are held by humans, and some are held by smart contracts. When people enter into a smart contract (which is the foundation of blockchain), those smart contracts sometimes create their own accounts.
To put it another way, if you and I each have an account, and we enter into a smart contract that creates a third account, we’re kind of double-counting our accounts. It would be like if you and I each had a traditional bank account, and we put some money in escrow: you wouldn’t count the escrow account as a new “customer.” |
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1 + 1 does not equal 3.
So in my view, number of accounts is not useful for valuing Ethereum (or any Ethereum-based app) because it does not just measure humans: it measures humans and machines. Humans, in the end, are what matters.
Metric 3: Transaction Volume
Liquidity is good. Nature rewards liquidity, whether it’s in a fresh mountain stream or a healthy circulatory system. This applies to money -- and digital money -- as well.
Transaction volume is a measure of liquidity: the more transactions are flowing through the Ethereum network, the more liquidity there is. Here our bank analogy holds up: if we look at the number of transactions flowing through a bank, it’s a better measure of the bank’s health than the number of accounts (since accounts may be dormant). To get a sense of how Ethereum transaction volume is growing, here’s a chart that predicts Bitcoin vs. Ethereum transaction volumes through the end of 2020: |
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The big takeaway is that Ethereum is crushing Bitcoin in transaction volume. At this pace, Ethereum will have moved over $1 trillion in annual transactions by the end of 2020, the first digital asset to do so.
Ethereum and Bitcoin, remember, are two different things. Bitcoin is just an asset, like gold. Ethereum is an entire asset class. It’s the default operating system for blockchain. It’s where all the action is. This is why that blue Ethereum bar has shot past bitcoin in 2020: it’s just so much more useful.
Why invest in Ethereum? Because that’s where the money is flowing.
Metric 4: Gas Costs
In this webinar, Fredrik Haga of Dune Analytics listed what I consider the most important metric so far. (FINALLY! 1,000 WORDS INTO THIS COLUMN, HARGRAVE TELLS US SOMETHING USEFUL!)
Like so many things in blockchain, “gas” is a confusing term. (Blockchain developers: brilliant at math, terrible at naming things.) The simplest way to think about gas is a transaction fee for using Ethereum.
The original idea was that “gas” was the fuel that ran the Ethereum “machine.” (Get it?) You have to pay gas (transaction fees) to power the machine. If everyone wants to use the machine at once, gas prices (transaction fees) go up. If you don’t pay enough in fees, your transaction will “run out of gas.” |
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Remember: gas = transaction fees. It is just like paying a couple of bucks to withdraw money from an ATM, except the ATM will charge you $2.00 some days, and other days (when a lot of people want to withdraw their money) it will charge you $10.00.
For savvy blockchain investors, this means gas is a built-in warning mechanism. When gas prices are high, it is a signal that you are investing on emotion. |
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Note this is not always true: if all the lemmings are jumping off the cliff, and you are running in the opposite direction, that could be a good sign. But usually you are trying to buy into some hot token at the same time as everyone else, which is why transaction fees are so high.
High transaction fees also eat into your profits, if you make any profit. If you lose money, high transaction fees make your losses worse. And because transaction fees are usually denominated in gwei (don’t ask), it’s hard to calculate in dollars. Avoid investing when transaction fees are high.
On the other hand, total gas used is an extremely useful metric, as shown by Christine Kim in her terrific Research Note: |
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Note this is not total gas fees, but total gas used. In other words, price is removed from the equation, so we smooth out all the FUD and FOMO from the chart.
As an analogy, imagine we’re trying to measure the demand for cars at the beginning of the auto industry. We’re not measuring the money spent on gasoline for automobiles (since that fluctuates), but the total number of miles driven. More miles driven = more uses for cars = more demand for cars.
More demand, generally speaking, means more value created. The chart above shows the increasing demand for Ethereum, which means it is being used to run increasingly valuable applications.
Total Gas Used can measure the demand for individual DeFi apps as well, though I am not aware of any source that has this data in a user-friendly chart (great project for an enterprising programmer).
The TL;DR Summary Though bitcoin still has the lead in market cap, ether is potentially the most valuable digital asset on the market. This is because Ethereum is being used as a new “operating system” for DeFi applications, while Bitcoin just sits there. This means ETH is likely undervalued relative to BTC, but no one knows how to measure its true value. There’s a lot of data, but most of it is noise. Total Value Locked is a vanity metric (“Total Vanity Locked”); it’s helpful to see the hype around Ethereum projects, but avoid using it for investment decisions. The number of humans using blockchains is the most important driver of value. (The blockchain is about people.) For this reason, Total Users is a good metric, because it shows actual users of a blockchain – but it doesn’t tell you how many people are actively using them. Unique Active Wallets shows the number of humans actively using a blockchain, but it’s tricky to calculate, because there are different interpretations of what makes a user “active.” Total Gas Used is an excellent metric, because it shows the amount of “fuel” that is being used to power Ethereum (or any given DApp), removing price from the equation. But it’s hard to find.
As of today, I personally use Total Users as my rule of thumb for investing in DeFi (see my articles on “How to Invest in Defi” here and here). I understand this metric is not perfect, but no single measure of money ever is.
Bottom line, the blockchain is about people. If the number of real people using a blockchain is shooting up, and they’re getting real value from that blockchain, it’s probably a pretty good investment.
More value = more value. That’s an equation we can all agree on. |
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| Health, wealth, and happiness, |
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| John Hargrave Publisher Bitcoin Market Journal |
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Hi Everyone,
Exactly 24 years ago tomorrow will mark the anniversary of a speech that has had a significant impact on market psychology to this day.
Back then, the people running the Federal Reserve strangely interpreted their duty to keep asset prices stable as a two-way street.
Sure, during her time in the top position, Fed Chair Janet Yellen did make a few halfhearted attempts to talk down markets, but they were clearly disingenuous and undermined by opposing statements.
Now we have Fed Chair Jerome Powell, aka J-Pow, who seems consistently content to whisper sweet nothings into investors' ears and line their pockets with cash.
In the mind of Fed Chair Alan Greenspan (no known relation to yours truly) the stock markets had grown too much too quickly following the reelection of President Bill Clinton, and therefore a bit of jawboning was in order.
The term "irrational exuberance" was intended to calm investors down, and it did for a few days. The intended effect, to let a bit of air out of the stock market, was quickly achieved. However, what Greenspan didn't intend, nor could he have anticipated, was the long-lasting impact on the markets.
After all, why can't we remain irrationally exuberant?
Fast forward to the present, and this term is now used at least five times a day in various financial newspapers and television stations, as if we've completely forgotten that initial intention.
But beneath the surface, this statement is making a comeback that is much closer to its initial intent, but not in the way you might think.
Over time, free money injected into the market is combining with artificially suppressed interest rates to make the markets more and more irrational by the day, which in turn seems to fueling further investor exuberance.
While it's true that the market can remain irrational longer than you can stay solvent, it cannot stay irrational indefinitely, as Greenspan found out the hard way four years later when the tech bubble crashed following Y2K.
The markets also crashed during the great financial crisis, when the old man made an unfortunate exit from the limelight.
Though I've never heard this term used in relation to bitcoin before, please allow me to be the first.
We've come a very long way without any natural pullbacks. All that new Wall Street money is not dumb.
Nor do they have any celebration when reaching the new all-time high as we do. If they can get in at $17,400 instead of $19,000, they certainly will.
But then again, even though they're very familiar with the term we've highlighted today, they're a bit less familiar with the four-word acronym we've all felt, Fear of Missing Out.
Let's see how this plays out.
Have a wonderful weekend! |
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Mati Greenspan Analysis, Advisory, Money Management |
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