Charlie Munger was not a fan of crypto assets, once dubbing Bitcoin (CRYPTO: BTC) as “expensive rat poison.” Despite this, these digital assets have evolved and become increasingly attractive to investors looking to diversify their portfolios. CFA Institute’s researchers have created a guide to help investors understand how to evaluate these assets.
The first group of crypto assets is Basic Cryptocurrencies, with Bitcoin being the most prominent example. This group is analogous to money, and its demand is based on its utility as a means of exchange, store of value, or unit of account. To evaluate this group, the Total Addressable Market approach is used, which is calculated by multiplying the market opportunity by the market captured and dividing by the fully diluted supply.
Another method, the Stock-to-Flow Model, is used to attribute Bitcoin’s value to its scarcity. This model, however, has been criticized due to its lack of correlation when applied to gold. Metcalfe’s Law is also applicable to crypto assets, as it states that the value of a network is proportional to the square of the number of nodes or members in the network.
For the second group, Smart Contract Platforms, the Discounted Cash Flow Method is used. These platforms are fee-based, and the base fee is burned, thus reducing the total supply, while the priority fee goes to the transaction validator. This method considers cash flow, which is equal to the transaction fees and newly issued tokens.
The third group evaluated is Decentralized Applications, with DeFi apps being the most popular. Financial ratios like the Market Cap to Net Assets Ratio, Price-to-Sales Ratio, Price-to-Fees Ratio, and Market Cap to Total Value Locked are applicable to this group. The DCF Methodology is also applicable.
Overall, when evaluating crypto assets, investors must consider various metrics, including network effects, token economics, and financial ratios. With the right approach, investors can accurately assess the potential of these digital assets.