As an investor, why is crypto so hard to value?
Crypto enthusiasts please don't hate....
When investing in companies, my preference is to buy in at an intrinsic discount to what I believe the asset is worth. To quote Buffer: 'Price is what you pay; value is what you get.'. i.e. buying shares of a company at $60 with a belief they are worth $100.
Price is the easiest part. Determined by the market, price is based on a number of factors including supply and demand as well as investor sentiment. With exchange-based assets (i.e. stocks and crypto), I can go to any exchange and find the price which fluctuates over time. Whereas with illiquid assets (i.e. a house), real estate agents can use past sales estimate the list price and buyer/sellers need to go through auction processes to find a market clearing prices.
With regards to the valuation of assets, they can be grouped into ones that produce cash flow (whether current or future) and those that produce zero cash flow (i.e. gold, currency, art, crypto and oil).
Cash flowing assets include real estate (rent), bonds (interest), and stocks/companies (dividends). Some companies like Tesla do not issue dividends to investors. The fundamental idea behind investing in a company is that one day they will grow and be so profitable that they will start to send cash back to investors. To value cash flowing assets, one can use a number of methodologies such as discounted cash flow, capitalization rate/rental yield and valuation multiples (i.e. EV/EBITDA, EV/EBIT and P/E). These methods are not perfect and are rough approximations in a hard-to-model world. To give an example, when looking to buy a rental property, I might look at the rental yield after costs of say $10k. Using the capitalization rate method and assuming a cost of capital of 7%, the property would be valued at ~$143k by dividing ~$10k by 7%. Now this is a simple example which does not include debt/leverage but hopefully you get the point.
When it comes to non-cash flowing assets, there are no current or future cash flows off which to estimate fair value. One could argue with the Efficient Market Hypothesis that price equals value because the market is efficient. The theory is based on investors being able to determine fair value therein correcting the price of any under, or over, valued asset. Efficient Market Hypothesis may work for indexes but there are examples of market bubbles or mispriced assets.
As an investor, supply and demand enables price discovery but I need cash flow to estimate fair value otherwise I feel like I am just trading. The majority of crypto tokens produce zero free cash flow and therefore I cannot value them which is why I choose to stay out of the market.
I'm in a similar spot. Did deep dives on tokens that didn't seem as speculative, and had specific purposes (AAVE, Ripple, etc.). Even in those cases, where there was quantifiable economic value - it didn't make sense. For example, speculation on the AAVE token that was strictly for governance and staking with returns paid in AAVE, which has no economic value other than staking, and price isn't strictly tied to the economic value derived from the network, but rather decoupled from the AAVE token itself. Read the Reddit/Twitter posts and everyone assumed the token and usage were tied - which as far as I could tell was not the case.
Gary Gensler has a similar outlook, taught a class at MIT about crypto and that was one of the main takeaways. He's generally bullish on the far future, but repeats these two questions often, and most tokens/concepts fail one or both:
1. Does this **need** to be on a blockchain? Why does it need to be secure, distributed, consensus-building, AND publicly visible? Most projects only need 1-2 aspects, and there are significant trade-offs when you build it on blockchain regardless - speed, cost, complexity, etc.
2. If it does need to be built, how do the economics work?
https://ocw.mit.edu/courses/sloan-school-of-management/15-s12-blockchain-and-money-fall-2018/index.htm