Crypto asset valuation methods for crypto startups
A number of new terminologies are frequently misunderstood in the literature and were created with the emergence of the crypto ecosystem. Most people have heard of terms like “blockchain” or “Bitcoin”, but very few can clearly and understandably explain what they mean and the technology behind them. To appreciate how crypto assets derive their value, it is essential to comprehend how their underlying technologies — particularly distributed ledger technology and blockchain — work.
Value of Crypto Assets
The fundamental value of a crypto asset is established during its valuation, regardless of its current market price. This helps determine whether a token is valued too highly or too lowly. Analogously, the fundamental analysis of conventional financial instruments like shares.
Traditional fundamental research uses financial reports to help determine a stock’s value. To estimate the monetary value of crypto assets, new valuation techniques are needed because this no longer holds true. A wide variety of crypto valuation methodologies have been developed by a number of writers and influential figures in the cryptocurrency sector, and these will be discussed in the following sections. However, research is still in its early stages (just like with crypto assets) and it will take some time until highly complex and reliable valuation models for this emerging asset class are available.
What do Crypto Assets Mean?
Crypto assets are digital possessions that function as a medium of exchange for money-related transactions through the use of cryptography.
The money is encrypted (protected) using cryptography to protect financial transactions, produce new units, and verify asset transfers. Since it doesn’t rely on middlemen like banks to complete transactions, cryptocurrency is referred to as a DeFi or decentralized finance.
Crypto assets include digital coins and tokens as well as any other type of digital medium of exchange, including Bitcoin, Ethereum, and Ripple, that can only be exchanged through blockchain technology. Cryptographic assets are tracked in a public ledger in DeFi.
Why are Crypto Assets required to be valued?
Consensus-based transactions involving many nodes in the cryptocurrency are approved by a decentralized network. There is no fiat authority to act as a counterparty to risk and compensate lenders in the event of a transaction gone wrong, such as a government or other monetary authority.
The cryptocurrency is designed in such a way that it cannot be copied or altered in any way. It may come in a variety of varieties, each with its own variances. When someone “spends” or “transfers” the same bitcoin in two or more different locations, a duplicate record is created.
Various Crypto Assets that need to be valued
The most crucial differential in a crypto asset’s nature that will affect its value is whether or not the asset grants its owner the right to a stream of future cash flows. On three different kinds of tokens — security tokens, utility tokens, and cryptocurrencies — this has been proven.
1. Security tokens
Security tokens should really be called “security tokens” because they are typically connected to a security offering. As a sort of long-term investment in the expansion of the technology firm, the securities in question are often shares of the company that issued the token. They are subject to the same regulations as securities traded on more established markets. A significant feature of the majority of security tokens is the ability to have some control over what happens with the company that issued the security token. You effectively become a large shareholder when you buy a security token, and the amount you invest depends on how much the firm is worth.
2. Utility or MAG tokens
The most common sort of tokens issued in an ICO is utility or MAG tokens. They resemble “golden tickets” more than a portion of the company’s ownership. They offer holders exclusive benefits or special treatment, like a discount when a new product line is introduced.
For example, these products might include software bundles or a platform for software as a service, for instance. Because utility tokens are more akin to marketing tools than ownership stakes in businesses, they are not considered investments. If the token they stand in for gains enormous popularity and demand, utility tokens may increase in value.
3. Cryptocurrencies
A cryptocurrency, or simply crypto, is any form of digital or virtual currency that uses encryption to secure transactions. Cryptocurrencies use a decentralized system to log transactions and issue new units in order to function without a central issuing or regulatory authority.
How are Crypto Assets valued?
Cryptographic assets exhibit free cash flows. Monitoring is possible for staking rewards, mining rewards, and other methods that developers have created to encourage users to provide services to the network. These free cash flows can be used to anticipate growth into the future using a reasonable discount model, calculate the network’s current return on investment (ROI), and “guess” whether purchasing a token today makes sense given our projected token growth. The difficulty with this idea is how volatile crypto assets are.
Methods for Valuing Crypto Assets
Equity investments are made using fundamental analysis, which examines publicly traded corporations using financial information. Since there is no such information for cryptocurrencies, we are unable to use them. As a result, we must either adopt comparable value approaches or change our valuation perspective to a cost perspective. With the technology in crypto valuation, various methods are developed.
1. Financial reporting
Financial reporting is a common accounting practice in which financial statements are used to present a company’s financial data and performance over a predetermined time period, typically annually or quarterly. When your business purchases bitcoin, you should reflect the asset’s fair market value as of the purchase date on your balance sheet. Debiting the asset’s account does this.
2. Taxation
Tax professionals disagree about whether cryptocurrencies should be categorized as “assets” or “currencies”. Crypto assets and cryptocurrencies are frequently used interchangeably. It would be safe to classify it as an asset or piece of property without the legal underpinning needed to call it a “currency.” Waiting for a government answer would be preferable to labeling them as “assets,” since the tax ramifications would exist regardless of their legality.
3. Considerations for investing
These new currencies and their underlying technologies’ legal implications are coming into sharper focus. All throughout the world, regulatory bodies, tax authorities, and central banks are attempting to define what digital currencies are and what they stand for. Individual investors run the danger of breaking the law when they acquire and trade cryptocurrencies, but they can make a lot of money doing so. Since cryptocurrencies are relatively new compared to conventional currencies and payment systems, there is a lot of confusion over their legal status.
How should each kind of Crypto Asset be valued?
Security token ownership comes with a variety of decision-making and distribution rights, but they all have one thing in common: the right to future distributions. This permits the application of conventional valuation techniques under the market and income methods. Each technique aids in the precise value of digital assets, yet they all have unique workings.
Market Approach
The liquidity and stage of development of a given token influence the value mechanism under the market approach. Relevant scenarios range from a token that is launched with little liquidity and no directly observable price to a token with continuously updated prices in a direct trading pair against a fiat currency.
Income Approach
Logically, the best option for calculating intrinsic value is an income approach based on cash flows to the owner of the security token. In markets where sentiment, speculation, and inefficiency are major factors, it can be extremely helpful in directing investment decisions. The value bases required by financial reporting and tax valuation laws, which emphasize more directly market-based evaluations, might, nevertheless, be incompatible with it.
Cost-based approach
When secondary transaction pricing is not accessible, or there is insufficient liquidity to rely on the price, opportunity costs might provide an observable proxy for value. The utility token’s function as a means of exchange is made clear. The utility token network participants will set prices in terms of the utility token for goods or services they are selling. As a result, these prices can be contrasted with the costs incurred while purchasing the same quantity of goods or services using alternative methods and fiat currency.
Money Quality Theory
Comparable to fiat currencies, utility tokens act as a medium of exchange or, to put it another way, the only “legal tender” within their own networks. The advantage of the little economy metaphor is that it enables you to view the cost of utility tokens from the perspective of the QTM. Let’s assume that both the real output level and the money flow stay constant. In that situation, the relationship between the general level of prices for goods and services and the money supply in an economy is linear. The dynamics affecting supply and demand for any good or service, such as an increase in the money supply, also apply to supply and demand for money.
Seek Competent Advice and Assess your Business
You should see a specialist for help if you want to learn how much your firm is worth. A business valuation, a process for determining a company’s economic value, is used to achieve this. The value of your firm, assets, accrued income and other elements can all be determined with the help of a business valuation.
On any queries and for assistance, reach out to Eqvista.
