Hey everyone, it’s Whatever Wednesdays again. It’s time to talk about crypto again, but this is going to be kind of a short post to try to understand “How to Evaluate a Cryptocurrency”.
Well….? How can we evaluate cryptocurrencies?
Here’s the short answer. It’s hard — maybe even impossible.
The problem for this is because there is nothing really like it before. All of the metrics that exist to evaluate other things don’t really work for cryptocurrencies. This is made even worse because at this point in the game, we’re not even sure if cryptocurrencies have value.
I think that the majority of people who understand blockchain technology would agree that it has value, but that doesn’t necessarily mean that cryptocurrency does, too.
Let’s step back a little bit.
How do we evaluate stocks?
Well, if you’re Warren Buffet, he looks at a couple things, from Investopedia.
- Past Performance (Return on Equity)
- Debt (Debt to Equity)
- Profit Margins
- Current Discount
Unfortunately, none of these metrics really can be applied to cryptocurrency except for maybe #5, but let’s talk a little bit about them all to see if we can get any kind of information at all.
- Past Performance – cryptocurrency is so young, can you even calculate a return on equity?
- Debt – cryptocurrencies are mostly formed from ICOs, so there is no “debt” in the traditional sense.
- However,without a governance/treasury system this could be a problem later. Does the cryptocurrency have a way to fund itself?
- Profit Margins – currently I don’t believe any cryptocurrency makes a profit, so this doesn’t really apply, at least not yet.
- Uniqueness – this is kind of a fancy way of saying, is their competition against them? It’s very difficult to tell whether a crypto is unique, because we don’t know which use cases will do well.
- Current Discount – this may be the only metric that you could potentially apply. However, it requires an internalized understanding of what you believe the value to be.
Of course, this is just how Warren Buffet evaluates stocks. There are other methods like the P/E (Prices/Earnings) ratio, but we can’t use that either. Basically, the way we value stocks can not be applied to cryptocurrency, except in maybe the very general sense I described above.
So what is investing in cryptocurrency most like?
I think it’s most like investing in a startup.
There is a high chance for failure, but also a good sized (financial) reward if it does well. While we may call it “angel investing” for startups, it’s really just more like gambling when it comes to cryptocurrency. However, we can try to draw some parallels between the two.
As an angel investor you are giving money to some people with a pitch deck and a vision. At this stage of the game, you are primarily betting on the team and the vision in a startup. So you give them a little money and hope they can make their company successful.
Here’s the problem currently plaguing the cryptocurrency space.
The way it’s currently set up, you aren’t giving people with a pitch deck and a vision a “little money”. You are literally giving them millions, or in some case billions of dollars. You are still betting on the team and the vision, but you’ve given them the pay out before they’ve even begun work.
The old startup adage is that creating a start up is like “jumping off a cliff and building a plane on the way down”.
For cryptocurrency it’s different if you’ve done a conventional ICO. For the founders in that case, It’s like jumping off a cliff with a parachute with your pockets stuffed with cash and still building a plane on the way down. See the problem? The founders don’t have an incentive to stay.
So what metrics do startups use?
Well, the metrics a startup uses are many:
- Revenue Run Rate
- ARPU (Average Revenue Per User)
- CAC (Custom Acquisition Cost)
- Churn Rate
- Burn Rate
- Operation Efficiency
- Gross Margins
You can read all about them in this article from Forbes — The Seven Startup Metrics You Must Track. These metrics help you to understand the value and potential value of the company being created… all of which don’t really work for evaluating a cryptocurrency.
So, once again, you are stuck with just the team and the vision in order to evaluate a cryptocurrency. Also, the elephant in the room is that hype and speculation can fuel the price of a cryptocurrency quite easily. When you don’t know how to value something, then its value could be anything.
Is there anything we can use?
Places have tried to “rank” cryptocurrencies by market cap, or by github commits, or some other metrics, but we have no idea whether these will actually correlate with success, and the likelihood is that they probably won’t.
Even after all that, we still don’t even have one example yet of a “successful” cryptocurrency.
- Yes, Bitcoin has proven that blockchain technology is important, and that it is possible to have people put their faith into something that is intangible and not backed by anything.
- However, where will its true value lie? As a store of value?
- Yes, Ethereum has a working smart contracts platform, but currently its best products are its ability to launch ICOs and trade virtual cats.
- Will Ethereum be used as a world computer? Will people pay to run dApps on their platform?
Once one cryptocurrency steps up that demonstrates real world value and that it can generate revenue and sustain itself, then new metrics may arise.
Until then, we’re just stuck with looking at the teams and the vision. Choose wisely and good luck!
All metrics that exist for evaluation don’t really work for crypto.
Gambling in crypto is probably most like being a mini venture capitalist.
Until we have one real success, we have no metrics to guide us.
So we’re just stuck with looking at the teams and the vision. Choose wisely and good luck!
Agree? Disagree? Questions, Comments and Suggestions are welcome.
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