Thread by @danzuller

1/ Just attended a very interesting @duffandphelps luncheon on valuing #cryptoassets. Here’s a thread on my key takeaways, as I understood them.

2/ Note: this is NOT a thread on experimental valuation methodologies for #cryptoassets like Metcalfe’s law, MV=PQ, discounted expected utility, etc. Rather, this is on how trad. valuation experts and accounting rule makers are currently thinking about valuation best practices.

3/ "Currency Tokens"

Valuation approach(es) to consider:

Market Approach – considering the robustness of the market
-Timeliness and volume
-Quality of information

4/ It is encouraged to use P*Q on an exchange to price an asset, unless a market participant has reasonable knowledge that the exchange volume is manipulated, in which case best practice appears to be to resort to the next most principled exchange and apply P*Q.

5/ I asked if there is a perceived difference b/w pricing & valuing, particularly in the context of currencies (as many argue currencies can’t be valued, only priced relative to each other), and if so, what that difference is.

6/ The answer I received was that yes, there can be a difference, but that these types of nuanced questions must be answered in the context of a defined framework. In the accounting system, judgmental application is needed as the definition of fair value is somewhat recursive.

7/ Fair value is defined in ASC 820 as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date”. It is somewhat recursive because it is sort of defined in terms of itself.

8/ A noteworthy takeaway is that the accounting rules state that fair value excludes transaction costs. For #cryptoassets, there are transaction costs at both entry & exit w/ fiat. There are also transaction costs to transfer/exchange #cryptoassets. Validators have to get paid!

9/ This makes the case for valuing #cryptoassets exceptionally difficult, because certain assets can be exchanged for others & thus can be priced in terms of other assets, but that pricing, based on the existing fair value rules, is not necessarily representative of fair value.

10/ In the context of fiat <-> #crypto transactions, Level 1 valuation guidelines apply (P*Q) and transaction costs can be ignored.

11/ In the context of assets that are priced in terms of other assets & can be exchanged for others (e.g., like exchanging $BTC or $ETH for alts), such assets can potentially be disqualified from being Level 1 assets (becoming Level 2 or Level 3), esp. if there is thin volume.

12/ Examples of Level 2 or Level 3 assets in trad. markets are bankruptcy claims & other exotic, thinly traded financial instruments & derivatives in secondary markets that don’t trade on liquid exchanges at the same breadth & depth of volume that public stocks and bonds do.

13/ B/c the execution risks & counterparty risks are higher for Level 2 or 3 assets, discounts can be applied to the price to arrive at fair value consistent with accounting guidelines.

14/ Thus, intrinsic value may very well be different from fair value, and the price a market participant pays may be different from *both* intrinsic value *and* fair value. Therefore, pricing can sometimes =/= valuing.

15/ "Security Tokens"

Valuation approach(es) to consider:

-Approaches that would be utilized to value the company as a whole (transactions, milestones, traditional income or market approaches)

16/ "Security Tokens" (continued)

-Allocation methodologies appropriate for the determination of specific rights and claims on the value of the company (waterfall/liquidation, scenario analysis, option theory or common percentage ownership)

17/ Thus, security tokens are somewhat akin to “equity interests” and can potentially be fair valued like any other equity investment (may be complex, similar to early stage VC investments).

18/ "Utility Tokens"

Valuation approach(es) to consider:

-Market approach – comparison of price of other like or similar services
-Functionality analysis – including an excess earning approach or related transfer pricing analysis

19/ This seems complex, but it is really not much different from trad. approaches for intangible assets. Judgment is needed, but the idea is to assign value to the functionality of the goods or services provisioned within a network. This may already be priced by the market!

20/ "Other Tokens (e.g., Asset-Backed)"

Valuation approach(es) to consider:

-Fair value can be determined using market participant assumptions depending on the facts and circumstances of a given transaction at that point in time

21/ Other Evolving Valuation Considerations:

-Cost of Production Approach (e.g, cost to mine subject coin/token) – can potentially be used to indicate a floor value
-Network Approach – supply & demand analytics

22/ Unfortunately, very little time was spent on the network approach, something I was particularly interested in learning more about.

23/ That’s the wrap of my takeaways, as I understood them. In conclusion, the bottom line is to remember valuation is not just a science, but also an art, and judgment is often needed in many cases.

24/ The landscape continues to evolve, and so too is our understanding of #cryptonetworks and their underlying economics. Valuation best practices continue to develop & will be made more robust as time goes on.

{Fin}