Thread by @RealNatashaChe

In a new episode @zhusu & @hasufl talked abt my recent thread on valuing L1 blockchains like countries.

It's a great podcast, but misunderstood some of my points. Not their fault as issue is complex & my thread was brief.

Here're some clarifications:

https://twitter.com/zhusu/status/1458568418299318273?s=20

First off, this is my original thread on how to value layer 1 chains, for your reference.

https://twitter.com/RealNatashaChe/status/1457060324939423745?s=20

1. It scared some people when I said the value of a chain comes from size of its economy, not protocol profits.

Cuz on surface it rings similar to what you heard in dot-com boom: "companies don't need profits", which turned out a market topping signal.

https://twitter.com/RealNatashaChe/status/1457060335303553027?s=20

But here's the crucial difference btw companies & countries.

The only way for a company to sustain itself is to earn more of the tokens (read: currencies) of the economic system it operates within.

Apple & Amazon need to earn USD tokens. That's the only way to "profit".

Countries have more ways to profit.

They can make money through taxation, so called fiscal policy. It's equivalent to companies charging customers, and L1 chains charging transaction fees.

But they can also make money by 'making their own money', so called monetary policy.

This is the basic intuition of quantitative model of money:

GDP growth means amount of economic transactions grows--> demand for native currency grows too since it's needed in every transaction--> other things equal, it leads to currency appreciation.

https://twitter.com/RealNatashaChe/status/1457060363740975105?s=20

As appreciation pressure builds, the country can print more of its currency without lowering the currency price (i.e. exchange rate).

This is how countries "profit" from their economic growth, even without explicitly raising the charges (read: tax) on its citizens.

And this is where L1 blockchains are more similar to countries than companies-- they have their own native token, which allows them to benefit from system growth aside from transaction fees.

As their economy grows (read: token demand grows), they can issue more native tokens to reward validators & stakers (i.e. citizens).

Of course they can't increase token issuance to infinity. But as long as issuance is done at a pace aligned w/ economic growth, it has minimum effect on token price b/c of underlining demand pressure.

That's why for L1 valuation, what fundamentally matters is the growth of their economy, not how much fees they directly charge on users.

And a P/E or DCF model at best only captures fiscal revenue, not monetary revenue, thus missing the bigger picture.

2. The relationship btw L1 value & its on-chain "GDP" is a long-term relationship.

“In the short run the market is a voting machine but in the long run it is a weighing machine.”

Short-term price trend is dominated by sentiment & reflexivity. This is esp pronounced in crypto.

We're in a bull market. If you take coefficients from my price vs wallets regression & apply it to all chains, you'd conclude every L1 is "overvalued" right now.

Does it mean prices will all crash tomorrow? No.

Does it mean model is wrong? No, either.

https://twitter.com/RealNatashaChe/status/1457060385257922561?s=20

Any model is a map. Map is not the territory. You should judge a map by whether it gives you insights & points you in right direction.

That's why valuing L1s like countries is a model more helpful than frameworks like P/E or DCF, as it's a lot more aligned w/ longer-run empirical facts, even though it doesn't capture reality 100%.

3. Not every crypto token is supposed to be a nation state.

This model is not a "theory of everything".

There're a million ways for an asset to acquire value. Having a growing on-chain economy that drives demand for underlining L1 token is only one of the ways.

e.g. You don't want to use the same framework to value SHIB. Doesn't mean the latter can't have value.

4. Yes every model is a meme, but there's insight in memes.

Every framework is a story, a narrative created by people. It's true that when enough people believe in a story, it reinforces itself.

Why does a company's value need to equal to all future cashflows discounted?

It really doesn't have to. But way back when someone thought it was reasonable & others agreed. And the model lives on to become a guiding force in market arbitrages.

However, some narratives are more aligned w/ existing empirical facts & can explain a greater set of real life observations, than others.

That makes them useful frameworks, i.e. good map, even though they're not the 'truth'.

Gravity is a meme. It doesn't really 'exist'. (If you don't know this, google it. You'll learn some cool physics.)

But is gravity a useful model? Absolutely.

It helps you accurately predict many phenomena on earth, e.g. if you drop a rock from 3rd floor, which way does it go?

So don't dismiss models just b/c they're "only a narrative". The more important (and practical) question is does the model help you correctly predict which way a rock will fall?

Hope this helps you think deeper about layer 1 valuation. Go check out @zhusu & @hasufl's new episode. It's a good one.

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