I’ll Read It For You, Vol. IV
Summarizing Chris Burniske’s “Bitcoin & Ethereum: Prices are Down More than the Fundamentals”
I’ve been meaning to take a trip into the hazy world of crypto network economics for a while now, and writing an I’ll Read It For You for the latest Chris Burniske post to make the rounds seemed like a good place to start. My thought in writing these summaries is that distilling the information presented by the experts into a shorter, more accessible post will force clarity of thought on my part. In the case of crypto network economics, however, clarity is an illusion; data is opaque and definitions are fluid.
I left this essay with an additional 8 Medium tabs open and a notebook full of questions. In short, as I’ve mentioned before, when it comes to valuing and pricing crypto assets, no one has any idea what they’re doing. But that’s not reason enough not to try! As Burniske said (in a separate essay), “Note that hundreds of years passed between the creation of the first stock market and the application of DCFs to value equities. I expect crypto to converge on its models of choice an order of magnitude faster, as markets, data, and number-crunchers are now ubiquitous.”
The Network Activity / Network Value Ratio
I’ll start this summary by noting that I believe the main source of confusion in the practice of valuing and pricing crypto networks is the total lack of consensus about what both the numerator and denominator in this ratio should be. Adding a further layer of complexity is the fact that clean and reliable data sources are elusive.
Be that as it may, it’s intuitive to believe that activity on a blockchain will influence the value of that blockchain’s native coin. The more use they’re seeing, the greater their value, right? Metcalfe’s Law is a commonly quoted maxim that says exactly this; posited by a guy (who invented ethernet, not a big deal) in the early 80s as a way to value telecom networks, it says that a network’s value is proportional to the square of its connected users. It’s tracked well with social networks and has seemingly become accepted wisdom.
It could very well be that Metcalfe’s Law is a valuable tool to measure crypto network activity and relative value. In his essay, Burniske suggests a number of different proxies for activity: number of daily transactions; estimated daily transaction value (in USD and only for bitcoin)[1]; gas used (in ETH for ether); and Daily Unique Addresses Used; and total miner hash rate for each blockchain[2].
First, he plots Total Network Value (simply defined as coins outstanding*price) alongside each individual proxy for network activity from peak value to the present (December for BTC, January for ETH). This paints a simple picture but doesn’t give much insight into whether current asset prices are fair value.
He then goes on to measure the difference in each proxy as a percentage of the proxy at peak price (i.e. current daily ETH transactions are 48% of daily ETH transactions on January 13, 2018 when the Network Value peaked). Next, he then applies Metcalfe’s Law to that difference to imply the justified change in Network Value (i.e. 0.48² = 0.23, implying a 77% decrease in Network Value).
In all but one case (daily transaction value for BTC), the drop in Network Value between the all time highs and today was greater than Metcalfe’s Law would imply.
It’s worth noting that he couldn’t get numbers for daily active ETH wallets. Data below:
My high-level takeaway is that these limited sets of metrics imply that BTC and ETH might be oversold. It’s not going to change my weekly accumulation schedule, and it of course doesn’t take into account any of the more practical market dynamics, like I detailed in my last post. This reading will, however, prompt me to think more about the following things:
- Metrics to evaluate network activity. How do they differ between networks and use cases? Is the a price to earnings ratio for crypto? (My gut says ‘No’.)
- How to evaluate network value. Lots of attack vectors here — UTXO age, monetary policy wrt inflation and deflation schedules, velocity, etc. I’ll be starting with Nic Carter’s talk from Baltic Honeybadger and seeing where it goes.
- Data integrity and availability. There’s a real opportunity for someone to be Bloomberg here, as Burniske notes in his piece. Lots of people doing good work (Messari, Coinmetrics, Nomics, etc..), I’m looking forward to see them develop.
[1] I have a small issue with Daily Transaction Value as a predictive indicator of Network Value. Aren’t they circular? In other words, doesn’t Daily Transaction Value (measured in USD), drop linearly with price?
[2] My understanding of the relationship between miner hashrate and coin price has been highly influenced by the CoinShares post from last month. My reading is that hashrate is necessarily a lagging indicator of price and thus not useful for evaluating current relative value of a network. It’s also currently higher (by a lot) than at the respective market peaks. Burniske sort of shunts it off to the side in his piece to focus on the ‘demand-side’ metrics above.