DEFI

Valuing DeFi tokens? Take a look at the PE ratios of top DeFi tokens and future value analysis

2020/2/29

share

Synthetix, Maker, Kyber, 0x, Nexus... Which one is more worthwhile?

By: Lucas Campbell, working at the blockchain consulting and DeFi rating company Fitzner

This article was first published in the English electronic magazine "Bankless" focusing on open finance. The Chinese version of this article is jointly released by Bankless and ChainNews. Bankless subscription address: bankless.substack.com

Advertisement - Please scroll down for more content

In traditional finance, the price-to-earnings ratio (PE) is a simple formula that investors use to evaluate the relationship between a company's future growth expectations and its earnings.

By definition, the price-to-earnings ratio is the amount the market is willing to pay for a company's earnings of $1. For example, Netflix, a tech company, has a price-to-earnings ratio of 84.2 times, meaning the market is willing to pay $84 for every $1 Netflix earns.

Generally, the price-to-earnings ratio is a useful tool for evaluating capital assets. Capital assets, such as stocks, bonds, and real estate generating rental income, provide investors with cash flows based on future earnings.

In 2019, with the prosperity of DeFi, many new currency protocols emerged on Ethereum. Many of these currency protocols generate cash flows by charging small usage fees. These cash flows are used to distribute directly to participants in their ecosystem or to burn their native tokens to increase scarcity.

Burning native tokens may not be the most effective mechanism for directly benefiting token holders, but burning tokens means that token holders increase their percentage in the blockchain network or protocol, which is essentially a dividend.

Since most of these permissionless currency protocols are accumulating cash flows, the price-to-earnings ratio can also be used as an effective tool to estimate the valuation of native tokens as they have similar attributes to traditional capital assets.

Considering that crypto assets are still relatively new, the price-to-earnings ratio is not a perfect tool or valuation method to measure their value. However, it does provide a simple framework for examining the value differences between these tokens.

From the perspective of crypto assets, the price-to-earnings ratio formula can be written as:

Market capitalization / Annual earnings

Fortunately, our friends at Token Terminal have done most of the legwork, collecting cash flow data for many well-known cryptocurrency protocols.

Here is some background information on several selected currency protocols and how they accrue fees in usage.

• Synthetix: A protocol for issuing synthetic assets, where SNX holders can stake their tokens SNX and earn fees generated by Synth transactions.
• MakerDAO: In Multi-Collateral Dai, the spread between the Dai deposit rate and the stability fee is used to burn MKR tokens.
• Kyber Network: KNC tokens are used to pay token transaction fees, with a portion of KNC being burned and permanently removed from circulation, while the remainder is allocated to reserve managers staking KNC.
• 0x: Fees are denominated in ETH, generated from token transactions, and proportionally distributed to liquidity providers staking ZRX.
• Nexus Mutual: After an insurance policy expires, the insured amount (ETH and DAI) is placed in a fund pool, thereby increasing the value of NXM tokens.
• Augur: REP holders earn fees denominated in ETH when they honestly report the outcome of any prediction market (soon to settle in Dai).
• Aave: Fees earned by initiating loans are distributed between the lender and the protocol. Protocol fees are used to burn LEND tokens.
• Uniswap: All trades on Uniswap generate a fee, which is distributed to respective liquidity providers in their respective liquidity pools.

Annual returns for each currency protocol, data source: Token Terminal

Looking at the annual cash flow of major currency protocols, Synthetix is clearly leading the pack, with annual fees generated by Synthetix.Exchange close to $32 million. Simply put, Synthetix charges a fixed fee of 0.30% on all Synth transactions, which is proportionally distributed to SNX token holders who provide collateral for the corresponding Synths.

Despite being the largest in market value and the foundation for other currency protocols, MakerDAO's annual revenue generated through stability fees is only $6.7 million. With the recent transition from Single-Collateral Dai to Multi-Collateral Dai, the introduction of the Dai Savings Rate (DSR) has changed the mechanism for MKR token burning.

The DSR allocates the accrued stability fee from the system's outstanding debt to Dai holders, whose Dai is locked in smart contracts. With a current spread of 0.25% between DSR (7.5%) and stability fee (8%), which is expected to increase to 0.5% (DSR at 7.5%, stability fee at 8%).

The cash flow from the spread is used to purchase and burn MKR tokens, effectively providing a general dividend to the governance of this essential system, the MKR token holders.

Kyber and Uniswap are the two largest decentralized liquidity protocols in DeFi, both capable of generating seven-figure annual revenue.

For Kyber, a portion of fees is used to burn Kyber's native token KNC, while the remainder is distributed to reserve managers. It's worth noting that the upcoming Kyber Katalyst upgrade will change the mechanism for fee accrual, distribution, and burning within the system.

Another prominent permissionless liquidity protocol, Uniswap, operates without its own token. The fees collected by Uniswap are distributed to liquidity providers staking ETH and other token pairs in their respective liquidity pools, a topic we will delve into further.

Another currency protocol with a decent cash flow performance is Nexus Mutual, a decentralized insurance protocol. Nexus Mutual operates based on a bonding curve, allowing users to purchase insurance for famous value storage smart contracts. The insurance covers a specific smart contract, protecting against losses due to hacks or system vulnerabilities during the user-defined insurance period. If the insurance expires without a claim, the ETH and DAI used to purchase the insurance are placed in a capital pool, thus increasing the value of NXM tokens.

Finally, there are several major currency protocols - 0x, Augur, and Aave - with meager fee collections compared to their circulating market value. Aave is relatively new, so we can overlook its accrued fees. However, both 0x and Augur have been live on the Ethereum mainnet for quite some time. 0x recently updated its token economic model, allowing liquidity providers to stake ZRX and earn fees denominated in ETH. Augur, on the other hand, is awaiting its upcoming v2 upgrade, where its prediction market liquidity will be denominated in DAI rather than the volatile asset ETH, a shift that, along with other improvements, should increase the platform's usage.

After discussing how these protocols generate cash flow, let's examine the price-earnings ratios of these well-known DeFi tokens.

Price-earnings ratios of various well-known currency protocols

As seen, whether viewed through traditional financial assets or crypto assets standards, the Synthetix and Nexus Mutual price-earnings ratios are quite low, at 5.7 and 13.2 respectively. These two tokens are driving the emerging open, permissionless financial products (synthetic assets and insurance), indicating that these currency protocols may be undervalued by the broader market.

Next is Kyber Network, with a reasonable price-earnings ratio of 31.2, commendable and almost on par with Microsoft's 30.27 price-earnings ratio level. Kyber Network established its leading position in permissionless liquidity protocols in DeFi in 2019; however, this growth has not been fully reflected in its token price. The upcoming Katalyst upgrade for the network in the following months, a reshaping of the token economy, is anticipated to impact its token price, as it is one of the highest trading decentralized exchanges.

MakerDAO's price-earnings ratio is 80 times, comparable to many high-growth stock price-earnings ratios currently. With over 12,000 MKR tokens burned and over 100 million DAI in circulation, MakerDAO has seen robust growth in the past few years and continues to play a pivotal role in DeFi development.

Chart provided by MakerBurn

MKR's price in USD has remained stagnant, mainly due to the poor performance of ETH in recent years. However, when priced in ETH, MKR's performance has actually been decent, rising 124% since January 2018.

The price-earnings ratios of other tokenized currency protocols 0x, Aave, and Augur are unreasonably high, unimaginable in traditional capital markets. One could argue that these protocols either need to attract more users to generate higher cash flows or redesign their token economic mechanisms to capture more value from their usage and protocol fees.

While various open, permissionless currency protocols are exciting, we also see major "cryptocurrency banks" like Binance initiating strategies with tokens like Binance Coin (BNB).

Each quarter, Binance allocates a portion of its operational profits to burn BNB, providing BNB holders with a dividend based on the quarterly profit. There are some controversies within the community regarding the execution of BNB burns (not buying BNB from the open market for burning but from unreleased ICO reserves). Nevertheless, this practice provides insights into comparing a centralized, permissioned cryptocurrency bank like Binance with decentralized, permissionless currency protocols, such as annual returns. In this regard, Binance leaves those DeFi protocols far behind.

Over the past four quarters, Binance has allocated approximately $115 million from its profits for BNB burns.

With $115 million allocated from annual profits, distributed to BNB tokens, and BNB's market capitalization at $2.83 billion, the price-earnings ratio for BNB is 17 times. As one of the highest-valued tokens in the industry, this multiple seems reasonable.

While the revenue amount is impressive, it is worth noting that BNB holders do not have the same legal protections as security holders, and the right to maintain the value of BNB through token burns is not legally protected. With changes in the Binance whitepaper regarding token burns, issues have arisen in this area. Therefore, investors should remain vigilant about the centralized risks of these token systems.

Hardly anyone noticed, but Binance changed its whitepaper last summer, no longer burning BNB based on profits. Research reports from Arca and Messari are inaccurate, and Zhao Changpeng happily retweeted and interacted with them. They are now burning BNB based on trading volume.

Larry Cermak @lawmaster

In my beginner's article on Bankless "The Possibility of Ethereum's Market Cap Reaching Trillions," I explored the potential scenarios for Dai. If Dai can capture a small fraction of the global currency supply, the circulating Dai needs to reach the billions (if not trillions) in scale.

So, in these scenarios, how would MKR be affected? By keeping Maker's current price-earnings ratio, spread rate, and Dai's circulating supply constant, a simple arithmetic calculation can determine the price of MKR in these scenarios.

The formula for calculating MKR price is:

Market Cap = Revenue × Price-earnings ratio

If Dai captures...

1. 51% of Argentina's M1 money supply = $13 billion

2. 1% of the US M1 money supply = $40.3 billion

3. 10% of the US M1 money supply = $403.4 billion

If we assume...

• Spread: 0.25%
• Price-earnings ratio: 80
• MKR Supply: 1,000,000 tokens

Then, the result is...

If capturing 10% of the US M1 money supply, it means the price of MKR will exceed $80,000. (Current MKR price is $609)

In my previous article, these numbers were just to give you an impression - potential valuations for MKR in the future and to approach this with cautious skepticism. This predicted price for MKR does not consider the MKR tokens burned in the past and only calculates the fully diluted MKR supply. Additionally, the Dai deposit rate, stability fee, and corresponding spread may change.

Furthermore, if these numbers mature, the price-earnings ratio will change. If Dai continues to capture a growing share from the existing money supply (thus reducing the potential future share to be captured), with decreasing expectations for future growth, investors may assign a lower price-earnings ratio to MKR.

Conversely, if Dai successfully establishes itself as a global permissionless stable value storage tool, with the market perceiving substantial growth opportunities, investors may assign a higher price-earnings ratio to MKR.

Uniswap quickly rose to become one of the leading permissionless liquidity protocols on Ethereum. In just 2019, Uniswap accumulated fees of $1.69 million. While Uniswap has distributed millions to its liquidity providers, it currently does not have its native token.

Uniswap's Path to $1 Billion? Source: DeFi Rate

Let's assume that Uniswap decides to integrate a native token into its protocol in the future. What would be its "fair value," measured by market capitalization, and where could it stand?

First, let's design a quick token economic model for Uniswap, accumulating value from its transaction fees, such as:

To become an Uniswap liquidity provider and benefit from the cash flow of the protocol, users must hold a certain amount (let's assume x) of UNI tokens.

This design is not elegant but simple enough. UNI represents the right to receive the accumulated transaction fees of Uniswap.

Based on the current annual revenue of $1.69 million, what level could UNI's market capitalization reach?

Its most direct competitor Kyber Network has a price-earnings ratio of 31 times. Calculating with this price-earnings ratio, the market capitalization of Uniswap's tokenization would reach $52.39 million. Due to Uniswap's explosive growth in the past year and optimism about its future prospects, its price-earnings ratio could be higher. Let's jump to 50 times.

Calculating with a price-earnings ratio of 50 times, Uniswap's market capitalization would reach $84.5 million, surpassing Kyber's current $76 million market value.

Just for fun, let's raise the price-earnings ratio to 100 times (less than half of Tesla's price-earnings ratio). Uniswap's market capitalization would reach $169 million, approaching the levels of other DeFi protocols like Augur (about $158 million) and Synthetix (about $185 million).

Most currency protocols generate cash flow, possessing characteristics similar to traditional capital assets. Therefore, for DeFi tokens, the price-earnings ratio is a meaningful indicator.

The key is that DeFi tokens cannot accumulate currency premiums (perhaps SNX can) because they are primarily used to facilitate related protocols, not used as reserve assets or value stores.

So, evaluating these DeFi tokens through the lens of traditional capital assets should be fair. Tokens like Synthetix and Nexus Mutual with low price-earnings ratios mean their utility is relatively higher compared to their market value. This indicates that either they are widely undervalued by the market, or their future growth expectations are low (which is unlikely as DeFi is still in its infancy with enormous potential).

On the other hand, tokens like Augur and 0x with high price-earnings ratios are off the charts, meaning these currency protocols need to go through a challenging period to accumulate significant cash flow to