Monetary Assets vs. Financial Assets

A Deep Dive into the Emerging Valuation Divide

There is a clear distinction emerging in the valuations across the major categories of crypto tokens. This difference is being drawn between what can be considered monetary assets and financial assets. 

We’ll show what the data shows today, and what we think that means for the future of crypto valuations in each of these categories. 

Let's start with an overview of the market cap of crypto for context:

The Majority of Value in Crypto is in L1s

The data above excludes stablecoins. Clearly BTC and ETH make up the majority of value. These are some of the oldest and most well known tokens in the crypto market. But what kind of valuation multiples might explain this? Looking at traditional assets, typically there is a fundamental driver of value. 

There is Clear Divide in How Tokens are Valued

Revenue multiples collected from Token Terminal as of 9/7/23

We see two categories of Market Cap to Revenue multiples - those in the double digit range, and those triple digits and above. 

For context, the current enterprise value to revenue multiple of the NASDAQ is 4.7x. The highest in the last 13 years was 7.2x. 

Comparing this to the chart above, the only categories that come close to this are DeFi, Infra, and Web3. Even today, NVIDIA, one of the hottest stocks in the world, enterprise value is trading at 33x the last twelve months revenue. This is above its long term average of 16.8x. 

Perhaps crypto app revenue is more comparable to NASDAQ earnings - the current multiple on trailing earnings is 22.0x, down from a high of 30.9x in November of 2021. That seems to be in the right range. 

However, Memes, L1s and L2s are all trading in a different stratosphere (pun intended). What is driving the difference? 

Valuation Multiples are defined by asset type and architecture

DeFi, Infra, and Web3 all are forms of non-sovereign crypto entities. They exist to generate fees, and eventually pass those fees back to token holders. They issue tokens, but users don't pay gas fees in those tokens. Their purpose is similar to a traditional centralized company that would trade on the Nasdaq, and are increasingly being valued as such. 

On the other hand, L1s and many meme coins are sovereign in that they issue their own token, which users pay gas fees in, and the network compensates validators for security with. These tokens are actually used like money, and the market values them accordingly as well. 

L2s seem to be valued like L1s, although they currently behave more like a DeFi dapp in that they generate fees and pay gas fees for security on Ethereum L1. It appears that the market is valuing them in between the two because there is a possibility that in the future the leading L2s will move towards sovereignty (more on this in another post). 

Lets formalize the distinction between these two broad categories: 

Monetary Assets in Crypto

Monetary assets in the realm of cryptocurrency are perceived as stores of value or mediums of exchange. Renowned examples include Bitcoin and Ethereum. These assets are driven by network effects, which essentially mean that the more people hold and perceive a token as a store of value, the more its intrinsic value is driven. It's crucial to understand that nobody views these assets in terms of traditional financial metrics like discounted cash flow.

Four criteria enable a crypto asset to be perceived as money:

  • Shared Execution & Network Effects - This means having multiple applications on one execution layer. As more applications integrate with a platform, the value of each additional application increases, leveraging network effects.
  • Sovereign Monetary Policy - A truly decentralized network possesses the power to decide when and how to inflate its token supply.
  • Gas Fees Charged in Native Token - Sovereign networks can set and control gas fees in their native token, further strengthening their economic ecosystem.
  • Plausible Scarcity - The potential for inflation is acceptable only up to a certain point.

Financial Assets in Crypto

On the flip side, financial assets in the crypto world, such as DeFi protocols and Web3 platforms, are valued based on the cash flows they generate, similar to traditional companies. Think of them as centralized companies in the decentralized world. These assets are evaluated on user growth, usage, unit economics, and their dependence on the underlying base layer.

For these assets:

  • There's No Monetary Sovereignty - Since they operate atop a base layer, these assets don't possess their own monetary policies.
  • Gas Fees Aren't Charged in Native Token -They rely on the gas fees of their base layer.
  • Driven by Financial Metrics - Unlike monetary assets, these assets are typically evaluated using traditional financial metrics.

What does this mean for the future of crypto valuation frameworks:

Crypto tokens of the financial asset type will continue to converge on reasonable valuations resembling those that can be had for other centralized businesses that trade on liquid exchanges. As the population of investors who participate across asset classes (crypto and traditional stocks) continues to grow, investors will choose between the two based on their projected forward cash flow yields, growth profile, and long term scale potential. 

An important note to make is that many of the aforementioned sophisticated investors will not tolerate unclear value return mechanisms forever - for example, investors will eventually expect applications like Uniswap to begin making distributions of revenue to token holders, buying back tokens, or some other form of value return to token holders. I believe that with regulatory clarity, the bluechip DeFi protocols will begin this process and the rest of the industry will follow suit. Valuation multiples will adjust in turn - if it becomes clear that only a small fraction of fees generated by a protocol will make their way to token holders, then they will cease to be valued as if fees are equivalent to earnings. It's up to the global DeFi community to lead the way in creating standards here. The clearer the exit multiples are for DeFi protocols, the more investment will flow in the space, and the better off the entire crypto ecosystem will be. 

L1s and meme coins, on the other hand, will bifurcate into two subgroups. The first will have cult followings that don’t concern themselves with sustainable security models and accept mild inflation rates. The other subcategory will need to have plausible scarcity, which means sustainable security models where fees and token issuance to validators has a realistic chance of achieving balance. In both cases, the long-term valuation will be uncapped relative to revenues, and will be far more dependent on the network effects surrounding the token, which will serve to distribute the token to an ever growing population, strengthening its use as money and further reducing the relevance of a revenue based valuation. 

The Layer 2 Conundrum

The future of L2 solutions seems to be at a crossroads. They can either choose to move towards a monetary asset, demanding a more significant share in crypto valuation, or regress to being perceived as financial assets. Today, leading L2 solutions like Optimism and Arbitrum still rely on Ethereum for data availability. However, there's an ongoing transition where L2s are leveraging different data availability services to gain more monetary sovereignty, potentially driving them towards being perceived as monetary assets.

The convergence of L2s into monetary-like assets depends on:

  • Adopting Sovereign Monetary Policies - Breaking free from the L1s and adopting independent monetary policies.
  • Implementing Staking Mechanisms - Proof of stake has been instrumental in driving value to crypto assets.
  • Charging Gas in Native Token - This step is crucial to provide autonomy to L2s and to allow them to establish their tokens as a store of value.

Final Thoughts

As the crypto market continues to evolve, the distinction between monetary and financial assets will shape its future. For investors and users, understanding this difference is vital to make informed decisions. The choices that Layer 2 solutions make today will undoubtedly have long-term implications on their value and role in the broader crypto ecosystem.

In a world where we could potentially have hundreds or even thousands of L2 rollups, how these layers navigate their path will play a pivotal role in defining the next phase of cryptocurrency adoption and growth.

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