Calculating the Utility Value of a Crypto Asset

Crypto modeling is not conducted in the same way stock analysts calculate rational market pricing. The goal in a crypto economic model is to determine how much adoption is needed to justify a cryptocurrency’s price point.

Because we are dealing with an entirely new asset class, new methods of calculating utility value must be innovated. Evaluating utility value for equities typically begins with discounted cashflow models. This method does not apply to crypto assets because protocols do not have business plans or cash flows, rather they have incentive structures. They catalyze a community to contribute to a decentralized good or service. More specifically, ‘what does the demand of the service require, and what does the economy it supports look like?’ One approach is the equation of exchange within the crypto asset sector. (MV=PQ)

In classical monetarism, the equation MV=PQ is used to analyze the money flow of a fiat currency within an economy. Within this equation, M is the money supply or size of the monetary base. V is velocity or how many times a dollar turns over within a year. P is average prices of goods and services, and Q is quantity of goods and services. P & Q multiplied together yields the GDP of a nation. In the book Cryptoassets, Chris Burniske preposes,

“A cryptoasset valuation is largely comprised of solving for M, where M = PQ / V. M is the size of the monetary base necessary to support a cryptoeconomy of size PQ, at velocity V.”

Crypto assets should be viewed as mini economies which offer a good or service. This way a similar M = PQ / V model can be applied to crypto assets. Price is not the price of the currency but rather the price of the resource being provided. For bitcoin, one price resource provided could be the remittence market. In 2017, let’s assume the global remittance market was around $500B. If bitcoin were to take 20% of the remittence market share, then that portion would be worth $100B. Assuming bitcoin has a velocity similar to that of the US dollar, the turnover value would be around 5. If you divide 20% of the remittance market ($100B) by the velocity of bitcoin (5), you are left with $20B. $20B divided by the quantity (total supply of coins 21 million) yields the utility value of the asset: $952. Therefore, $952 is the minimum price of a bitcoin required to service 20% of the global remittences market. ($952 = $20B / $21M)

It is important to remember this model is very simplistic and is based off of a lot of assumptions such as velocity and market impact percentage. Fortunately, this crypto economic model provides a ballpark estimate which is useful for determining the price distinction between utility value & speculative value.

Additionally, the remittance market is only one assumed use case for bitcoin. Bitcoin as digital gold is another speculated use case. Hypothetically, one could ask ‘how much would bitcoin have to cost in order to service 10% of the global gold market?.’ Currently (5/23/18) the global gold market is worth about $6.6 trillion. 10% of $6.6 trillion is $660B. Bitcoin as digital gold has an assumed velocity of 1 because the asset is being held as a store of value, and therefore has minimal turnover. Since bitcoin has a fixed supply of 21,000,000 coins we can divide the gold market value by bitcoin’s total supply to find the minimum price needed to service 10% of the global gold market. Therefore, bitcoin would have to be worth at least $31,428 per coin in order to service 10% of the global gold market. ($31,428 = $660B / $21M)

Burniske’s model is useful when it comes to estimating the minimum cost of a crypto asset in a particular use case. There are still many uncertainties and it is impossible to predict how much market share bitcoin could take from gold or the remittences market.

This crypto economic model was created by Chris Burniske and is included in chapter 12 of his book CryptoAssets. For more use cases of this model go to https://medium.com/@cburniske/cryptoasset-valuations-ac83479ffca7

Disclaimer: I am not a financial advisor. This is not financial advice. Please do your research independently and make objective decisions. This article is intended to educate readers about crypto economic models. The author does hold positions in bitcoin and other cryptocurrencies.