There are few resources and metrics out there to assess the value of NFTs. In this series, we are going to develop a methodology to value NFTs:
The Ethereum Blockchain
A pre-requisite to the NFTs themselves is their underlying blockchain, Ethereum. Though there’s competition out there, Most NFTs are built on the Ethereum ecosystem, and it’s considered the best operating system of the blockchain.
What does it mean to be the operating system of the blockchain? A good analogy to understand this is that it will be the AWS of Web 3.0 as it provides the tools (hosting and software) for developers to build apps on top. Unlike AWS, Ethereum doesn’t buy the servers that its customers use. Instead, that’s done by the miners or nodes of the network. Ethereum provides the glue that allows the miners to connect with users and other miners in the networks.
Ether is simply the currency that powers the Ethereum blockchain and is known to have rapid swings in price. Not only do these swings affect NFT prices but also, to invest in most NFTs, it is required to have some Ether. Based on its current price, is it a good idea to put some of your hard-earned money into this currency? Well, Let’s compare it to an asset that we have a lot of data on company stocks.
Valuing Traditional Companies
The most common way to value companies is to take a multiple of their yearly profit or earnings and compare it to the total value of their stocks, otherwise known as market cap. Even though Ethereum does not have profit, they do have a market cap which is the total dollar value of all Ether in the world. Anytime the Ethereum network is used, the user does have to pay a miner to use it and has some amount burned.
Let’s say John wants to send Sarah 1 Eth. John will actually end up paying something like 1.00231 for this transaction. 1 Eth will go to Sarah, .00021 Eth will be burned, and the rest will be given to the miner. For more details on calculating the specific cost check out Etherurem’s page.
The amount burned is a good comparison to what Ethereum’s profit would look like if it was a traditional company because Ethereum has no overhead (such as employees or server costs) the amount burned is the extra money that the user is paying to use the network. Let’s take a look at another analogy to understand this better.
Uber is something nearly everyone in the world has used. Typically, a passenger calls a car from their phone to take them to a destination and they pay a fare to make this happen. A small portion of this goes to the company and a more significant portion goes to the driver that is getting them to their destination. In the same way, when you use Ethereum, a small portion of the fee is burned, and a larger portion goes to the miner that enables your money to move across the Ethereum network.
Right now we can track how much Ethereum is burned on watchtheburn. In the past 12 months, at the time of this writing, there has been $4,996,259,124 worth of ETH burned. The current market cap or the total value of all Ethereum tokens in circulation is $417,015,823,261. This gives us an 83.46 earning times valuation ratio. Let’s compare this to traditional web companies.
Take Amazon, for example. They have an earnings multiple of around 50. Amazon has been around since the 90s and its earning multiple has steadily decreased as time has passed. Generally, the older a company is, the lower its earnings multiple is.
On the other hand, Uber is a much newer company and hasn’t even made a profit; therefore, they have a negative earnings multiple. However, they still have a market cap of 68.35 Billion dollars because there is a perception that Uber will grow and ultimately give investors a return on their money as time goes on.
Ethereum is a much newer technology than Uber yet still has a more favorable multiple. Additionally, there are many other “growth stocks” out there that have a higher multiple than Ethereum. The conclusion we can draw from these comparisons is that Ethereum is being valued like a regular tech company.
The Protocal Sink Thesis
There is one more aspect to consider, Ethereum is nothing like a current tech company. One of the best frameworks for understanding the value of Ethereum is the Protocol Sink Thesis by David Hoffman.
In this thesis, Hoffman argues that Ethereum is a global public good that will be the foundation of the new decentralized internet. Furthermore, Ethereum is the sink that every decentralized app needs to use in order to have any functionality. He uses an analogy of the Mississippi River Basin to explain this. Any droplet of water that falls anywhere within the Pink region will reach the basin where the Mississippi River meets the Atlantic Ocean.
Ethereum is this basin. Any app or use case that leverages Web 3.0 functionality will have to be built on Ethereum.
Bringing it all together
The conclusion we can draw from the fact that Ethereum’s earnings multiple is in line with growth stocks and that it has a much larger potential than any traditional web company, as outlined by the sink hypothesis, is that it is a great investment to make at the time of this writing. In the next part of this series, we will look at metrics specific to NFTs.
Disclaimer: This is not meant to be financial advice.
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