Article Summary
- Analysis of different Ethereum valuation models.
- Evaluation of the reliability of each model.
- Discussion of factors influencing Ethereum's price.
- Is Ethereum currently undervalued?
Introduction
What should be the fair price of ETH? The market has presented many valuation models for this question. Unlike Bitcoin, which already exists as a commodity asset, Ethereum, as a smart contract platform, should be able to summarize a fair and generally accepted valuation system, but it seems that the Web3 industry has not yet reached a consensus on this matter. A website recently launched by Hashed presents 10 valuation models that are likely to be widely accepted in the market. The calculation results in 8 out of the 10 models showed that Ethereum is undervalued, with a weighted average price exceeding $4,700. So, how is this fair price, close to the historical high, calculated?
From TVL to Staking to Revenue
Hashed listed 10 models divided into three categories based on reliability: low, medium, and high. We will start with the low-reliability valuation models.
TVL Multiplier Model
The TVL multiplier model believes that Ethereum's valuation should be a multiple of its DeFi TVL, simply linking market capitalization to TVL. Hashed adopted an average market capitalization to TVL ratio from 2020 to 2023 (personally understood as from the beginning of DeFi Summer until the layering wasn't too severe) of 7 times. By multiplying the current DeFi TVL on Ethereum by 7 and then dividing by the supply, i.e., TVL × 7 ÷ Supply, the resulting price is $412. This crude calculation method, which only considers DeFi TVL and cannot accurately derive the actual TVL due to complex layering, truly deserves low reliability.
Scarcity Premium Resulting from Staking
This model takes into account that Ethereum, which cannot be traded on the market due to staking, will increase Ethereum's "scarcity," using the current price of Ethereum multiplied by the square root of the ratio of total supply to circulating supply, i.e., Price × √(Supply ÷ Liquid), resulting in a price of $3,528.2, a 16.6% upside from the current price. This model was developed by Hashed itself, and the square root calculation is done to mitigate extreme cases. However, according to this algorithm, ETH is always undervalued, regardless of the reasonableness of only considering the "scarcity" brought about by staking and the additional liquidity of Ethereum released by LST, which is also very crude.
Mainnet + L2 TVL Multiplier
This valuation model is similar to the first, but this model adds the TVL of all L2s and gives a double weighting for L2's consumption of Ethereum. The calculation method is (TVL + L2_TVL × 2) × 6 ÷ Supply, resulting in a price of $4,732.5, a 56.6% upside from the current price. As for the number 6, although there is no explanation, it is very likely a multiplier derived from historical data. Although it includes L2, this valuation method still simply refers to TVL data and is not much better than the first method.
"Commitment" Premium
This method is also similar to the second model, but it adds Ethereum locked in DeFi protocols. The multiplier in this model uses the total amount of ETH staked and locked in DeFi protocols divided by the total supply of ETH to represent the percentage of premium brought about by "long-term holding belief and lower liquidity supply." After adding 1 to this percentage, multiply it by the value premium index of "committed" assets relative to liquid assets of 1.5, and finally get the fair price of ETH under this model. The formula is: Price × [1 + (Staked + DeFi) ÷ Supply] × Multiplier, resulting in a price of $5,097.8, a 69.1% upside from the current price. Hashed stated that the model was inspired by the idea that L1 tokens should be regarded as currency rather than stocks, but it still falls into the problem that the fair price is always higher than the current price. The biggest problem with the above four low-reliability valuation methods is that the single dimension considered lacks reasonableness. For example, TVL data is not always better the higher it is. If providing better liquidity with lower TVL is an improvement. As for considering Ethereum not participating in circulation as a scarcity or loyalty and thereby generating a premium, it seems impossible to explain how to value it after the price actually reaches the expected price. After talking about 4 low-reliability valuation solutions, let's look at 5 medium-reliability solutions.
Market Capitalization/TVL Fair Value
This model is essentially a mean reversion model. The calculation method is to assume that the historical average of the market capitalization to TVL ratio is 6 times. If it exceeds, it is overvalued, and if it is not enough, it is undervalued. The formula is Price × (6 ÷ Current Ratio), resulting in a price of $3,541.1, a 17.3% upside from the current price. This calculation method superficially refers to TVL data, but in reality, it refers to historical patterns and performs valuation in a relatively conservative manner, which seems more reasonable than simply referring to TVL.
Metcalfe's Law
Metcalfe's Law is a law about the value of a network and the development of network technology. It was proposed by George Gilder in 1993, but named after Robert Metcalfe, a pioneer of computer networks and founder of 3Com, to recognize his contributions to Ethernet. Its content is: the value of a network is equal to the square of the number of nodes within the network, and the value of this network is directly proportional to the square of the number of connected users. Hashed stated that this model has been empirically verified for Bitcoin and Ethereum by academic researchers (Alabi 2017, Peterson 2018). Here, TVL is used as a proxy indicator of network activity. The calculation formula is 2 × (TVL / 1B) ^ 1.5 × 1B ÷ Supply, resulting in a price of $9,957.6, a 231.6% upside from the current price. This is a more professional model and has also been marked by Hashed as an academically verified model with strong historical correlation, but it is still biased to consider TVL as the sole consideration.
Discounted Cash Flow Method
This valuation model is by far the most considering Ethereum as a company, treating Ethereum's staking rewards as income and calculating the present value through the discounted cash flow method. The calculation method given by Hashed is Price × (1 + APR) ÷ (0.10 - 0.03), where 10% is the discount rate and 3% is the perpetual growth rate. This formula obviously has problems. In reality, the calculation result should be Price × APR × (1 / 1.07 + 1 / 1.07 ^ 2 + ... + 1 / 1.07 ^ n) when n approaches infinity. Even using the formula given by Hashed cannot calculate this result. If calculated with an annualized interest rate of 2.6%, the actual fair price should be about 37% of the current price.
Valuation Based on Price-to-Sales Ratio
In Ethereum, the price-to-sales ratio refers to the ratio of market capitalization to annual transaction fee revenue. Because fees ultimately flow to validators, there is no such thing as a price-to-earnings ratio for the network. Token Terminal has adopted this method for valuation, with 25 times as the valuation level for growth technology stocks. Hashed calls it the "industry standard for L1 protocol valuation." The calculation formula of the model is Annual_Fees × 25 ÷ Supply, resulting in a price of $1,285.7, a 57.5% downside from the current price. It can be seen from the above two examples that the price of Ethereum is severely overvalued using traditional valuation methods, but it is clear that Ethereum is not an application. The author believes that adopting this valuation method is a mistake in the underlying logic.
Valuation of Total Assets on Chain
This valuation model is a model that seems unreasonable at first glance, but seems to make sense after thinking about it. Its core viewpoint is that in order to ensure network security, Ethereum's market capitalization should match the value of all assets settled on it. Therefore, the calculation method of the model is very simple, which is to divide the total value of all assets on Ethereum, including stablecoins, ERC-20 tokens, NFTs, etc., by the total supply of Ethereum. The result is $4,923.5, a 62.9% upside from the current price. This is the simplest valuation model so far. Its core hypothesis gives a feeling that something seems wrong, but one cannot say what is wrong.
Yield-Bearing Bond Model
The only high-reliability valuation model, which Hashed stated is favored by TradFi analysts who evaluate cryptocurrencies as an alternative asset class, is to value Ethereum as a yield-bearing bond. The calculation method is to divide Ethereum's annual income by the staking yield to calculate the total market capitalization. The formula is Annual_Revenue ÷ APR ÷ Supply, resulting in a result of $1,941.5, a 36.7% downside from the current price. The only model, possibly considered to be highly reliable due to its widespread adoption in the financial field, has become another example of "undervaluing" the price of Ethereum through traditional valuation methods. So this may be good evidence that Ethereum is not a security.
Public Chain Values May Need to Consider Multiple Factors
The public chain token valuation system may need to consider various aspects. Hashed weighted the above 10 methods based on reliability, and the result was about $4,766, but given that the calculation of the discounted cash flow method may be wrong, the actual result may be slightly lower than this number. If the author were to value Ethereum, the core of my algorithm may be in supply and demand. Because Ethereum is a "currency" with practical uses, whether it is to pay gas fees, buy NFTs, or assemble LPs, ETH is required. Therefore, it may be necessary to calculate a parameter that can measure the relationship between supply and demand of ETH for a period of time based on the degree of network activity, and then combine the cost of actually executing transactions on Ethereum, and compare historical fair prices under similar parameters. However, based on this method, if the growth of activity on Ethereum does not keep up with the degree of cost reduction, there is a reason why the price of ETH cannot rise. In the past two years, the degree of activity on Ethereum has sometimes exceeded the 2021 bull market, but due to the reduction in costs, the demand for Ethereum is not high, resulting in an actual oversupply. However, the only thing that cannot be included in this valuation method compared to history is the imagination of Ethereum. Perhaps at some point when the prosperity of DeFi returns to Ethereum, we also need to multiply it by the "market dream rate."
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