The Theory of Relativity

Key Insights

• Layer-1s are hard to value in absolute terms as they operate within an independent system, generating flows only in their native currencies.
• A relative valuation between crypto assets can help find potential value with limited exposure to market risk.
• By comparing their market caps with related protocols, potential value mismatches can be found between meme coins, interoperability chains, and platform chains.

Only a Sith deals in absolutes

My background is in equity research, where there are clear, agreed-upon models for valuing stocks. The Discounted Cash Flow (DCF) model is, perhaps, the most common one. The DCF model values a company on the present value of its future cash flows. These cash flows are based on growth and profitability assumptions by the researcher. Finally, they are discounted as per the investors' expected returns. Although assumptions and expectations can lead to differing opinions, the method of calculation is similar across analysts, fund managers, and investors. As the future unfolds, the investor with assumptions closer to reality is rewarded as the price moves closer to their target.

In crypto, however, there is no agreed-upon model, especially for Layer-1 coins, despite there being many attempts (see Tom Dunleavy’s Ethereum model here). The key problem is that Layer-1s do not interact with fiat as a part of their business operations. Their revenue (the transaction fees paid by users) and their costs (the security costs paid to miners and validators) are denominated in the native token. As the price of the token changes in fiat terms, the profitability of the blockchain also changes in the same direction. This recursive relationship is perhaps why we see the extreme highs and lows in crypto prices.