I have come to trust Vitalik Buterin to ask the most important questions in blockchain.
The ethereum founder did that again last month when he asked in a tweet: “Alright, the crypto market is now worth $525 billion, but how much of that valuation have we really earned?”
We can answer Vitalik’s question by using the tried-and-true method of discounted cash flows.
This time isn’t different
During the 1990s dot-com boom, valuation by counting eyeballs and various other body parts was rampant.
During the housing boom, valuation was whatever you wanted by tuning projects’ default rates, prepayment rates, volatility and correlation.
During the current crypto boom, science fiction such as network-based valuation, technical analysis, Metcalfe’s law and Moon-based valuation have all blossomed.
Unfortunately, whenver bubbles burst, discounted cash flows return with a vengeance.
So, while we all believe blockchain technology can solve all our problems including valuation problems, let’s pretend this time is not different, and one day either everyone in crypto will have to generate fiat cash flows in some form.
The less likely that you will get the cash you think you will get in the future, the higher the discount rate. That is a big mess when you are dealing with anything except government bonds, which academic orthodoxy treats as risk-free (never mind the humongous national debt).
Asset pricing gets even worse when commodities and currencies are involved and we have to start watching costs and benefits of HODLing all your digital GODL or any “implied interest rate” you might earn on your GODL. That forecast of net benefit to the HODLer is basically your cash flow forecast.
So, as Vitalik pointed out – the crypto market is worth $525 billion but what did we do that is worth that in the future?
The question is what did we solve, enhance, or deliver that will make individuals, companies or governments produce more, be more efficient, or enjoy their lives and relationships more?
At a high level, we can ask:
1. What features (e.g. Truffle), products (e.g. UPort) or platforms (e.g. Digital Trade Chain) did we build that a consumer is using or benefiting from? No, I don’t mean tether, Telegram chat channels, or proofs of concept.
2. Which enterprise solutions went live and how much new revenue or efficiencies did they create? This includes the work ConsenSys and IBM are doing in Dubai, trade finance platforms by IBM and R3, MUFGCoin and so on.
3. How much did we improve the infrastructure and stack by in terms of scalability, privacy, confidentiality and other such nice things? Quorum, zcash, Fabric, Corda, Coco – all count.
4. What original business models and technologies were created in 2017? ERC-20 tokens and CryptoKitties are included. Stablecoin crypto exchanges are excluded.
5. For each of these, what’re the odds that we will see the invention used by a real person or enterprise over time? In the absence of any information, let’s assume 50% for each.
Incremental value added in 2017
There is simply no way that we baked $500 billion worth of additional consumer value last year that we didn’t have in 2016 and all we had then was PoCs and a few promising ideas.
Any which way you make your list, there was just not enough useful kit in consumer or enterprise production last year.
Bitcoin scraped through to Segwit and all sorts of forks. A very large set of ethereum tools and solutions was released; Quroum, Corda, and Fabric became useful in the enterprise ecosystem, and a very small number of consortia got into technical production.
We bypassed VCs and made it possible for good, bad, and ugly blockchain startups alike to fund their runway.
When we calculate the value of ERC tokens and CryptoKitties, we will subtract the future disasters from future Amazons and probably get a much smaller number than the $3 billion that was raised last year in ICOs.
Then we will thank Vitalik that all this money that could have gone into a largely useless coin instead went into useful tech…