A must-read for investors! Valuing DeFi tokens with traditional finance's price-to-earnings ratio

Most cryptocurrencies do not have financial statements like traditional stocks that can effectively evaluate the value of tokens. The demand for tokens and the revenue generated by protocols are difficult to quantify, leading to many traditional financial market valuation models being difficult to apply to cryptocurrencies. However, if it is decentralized finance (DeFi) tokens, using traditional financial valuation models may be feasible.

Can DeFi Tokens Be Valued?

In a recent publication by Bankless, author Lucas Campbell pointed out that most DeFi projects allow token holders to share a portion of the protocol's generated revenue, whether through governance participation, providing liquidity, or simply holding the token, granting economic rights to share in the protocol's earnings. As a result, the author attempts to value the tokens of various DeFi protocols using the traditional financial market valuation model known as Price-to-Earning Ratio (PE).

The PE formula is "Price per share (P) divided by Earnings per share (EPS)," which is one of the most widely used indicators in the current securities market. It reflects a company's value by the ratio of stock price to earnings per share, demonstrating the company's future profit potential. Assets with high PEs typically indicate two possibilities: either the asset is overvalued or investors expect significant future price appreciation. Conversely, if an asset's PE is low, it suggests that the market believes the asset is undervalued or has lower expectations for future growth of the asset.

However, valuing DeFi tokens using PE requires an understanding of the protocol's revenue performance. Therefore, the author utilizes on-chain cash flow data from Token Terminal as a reference for EPS.

Profitability of Various DeFi Projects

The following chart shows the average 30-day annualized revenue data calculated by Token Terminal, highlighting that the stablecoin project Maker dominated the annual total revenue in the DeFi space in 2019.

This is mainly due to Maker's mechanism where generating the stablecoin Dai requires paying stability fees (around 10-20% in 2019), which are then used to repurchase and burn Maker tokens (MKR), providing significant returns to token holders. However, with protocol upgrades to a multi-collateral collateral mechanism, liquidity issues in March 2020, and the continuous addition of supported collateral assets, Maker's profitability has significantly decreased.

Additionally, Synthetix (SNX) and Kyber Network (KNC) have gradually expanded their revenue share since the end of 2019.

Kyber Network maintains a fairly stable growth trend, with transaction volumes reaching nearly $200 million in March alone. Synthetix appears to be the fastest-growing project, although this seems not to be solely due to rapid growth at the end of 2019. According to an article by Fiskantes, co-founder of crypkit.com, the project experienced high returns due to malicious arbitrage attacks, resulting in a discrepancy from actual performance. However, Synthetix has since addressed this vulnerability, bringing returns back on track.

Estimating the P/E Ratio of Issuing Projects

By utilizing DeFi revenue data from Token Terminal, the author fits issuing DeFi projects into the PE valuation model to estimate the value of the projects' tokens.

The results indicate two significant outliers among all DeFi projects with tokens: Augur (REP) and 0x (ZRX), with ratios of 16,761 and 6,935, respectively. This anomaly suggests that investors may have high growth expectations for these two liquidity and derivative tool protocols.

In traditional financial markets, a PE ratio between 50-100 is normal for many high-growth tech stocks; for instance, Netflix's current PE is approximately 86. Therefore, DeFi protocols with PEs below 100 imply that, based on current revenue conditions, token prices are relatively fair. However, if the PE is too high—such as Tesla's PE of 198—it may indicate an overvaluation of the stock price or investors anticipate significant growth in the coming quarters.

Nevertheless, the author emphasizes that while "protocol revenue" and "token price" are positively correlated.

However, the PE valuations of the aforementioned projects should be taken as references only, as cryptocurrency assets are a highly nascent and immature asset class with low market efficiency, making it impossible to be 100% certain if earnings can drive token price increases. The author states:

"The valuation of many cryptocurrency assets is driven by speculative activities. Protocols may increase in value entirely based on speculative investment, attracting more users to the ecosystem, leading to increased adoption and subsequently higher returns."

Further Reading

• 【LongHash Column】The Collapse of MakerDAO is Rocking DeFi
• Cao Yin: The Lendf Incident Resembles Apollo 13, Saluting DeFi Adventurers

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