By Jeff John Roberts
May 4, 2018

Unlike companies in the stock market, Bitcoin and other cryptocurrencies don’t have cash flow, profits, or other conventional metrics analysts use to evaluate whether something is a good investment. But there are some traditional economic principles that can help determine whether it’s a good time to buy Bitcoin and its fellow digital assets.

Chris Burniske, the co-author of the book Cryptoassets, shares insights on applying such a valuation methodology on this week’s episode of “Balancing the Ledger.”

Burniske is applying his strategies at his new venture capital fund, Placeholder, which has raised more than $100 million from investors including Morgan Stanley and Union Square Ventures. Placeholder, which launched last year, is betting on “decentralized information networks incentivized with a crypto asset,” and has made five investments so far, Burniske said.

Because Placeholder owns digital tokens as opposed to shares in companies, its positions will be more liquid than those of ordinary VC funds, as Burniske and his team can sell their holdings whenever they choose—such as when they lose faith in a management team, or if the assets become overvalued, he said. This means Placeholder will not be boxed into the industry’s typical strategy of seeking an exit after seven years through an IPO or acquisition. Nonetheless, the firm is focused on the long term and sees the developers who build up crypto platforms as its lodestar.

Unlike other crypto-focused VC firms, Placeholder is avoiding initial coin offerings, or ICOs, and mostly funds the companies it invests in with traditional fiat currency, which the startups need the most, Burniske said.

Meanwhile, cryptocurrency continues to disrupt the overall venture capital industry. This week, Andra Capital raised $500 million for a token called Silicon Valley Coin, which will provide its investors with access to a portfolio of VC-backed companies. Burniske sees this as another step in the adoption of token technology among institutional investors.

“I don’t think of this as a crypto-asset. I think of this as tokenized ownership in a venture capital fund,” he said. “I think we’re going to see a lot more of this tokenization of existing asset classes just as in 2004 when we had out first gold exchange-traded fund. That’s just adding existing asset classes that have existing well-known value drivers, and adding new world wrappers.”

Bitcoin Price at a “Historical Norm”

In the interview, Burniske also explains his methodology for determining the value of cryptocurrency projects. In the absence of balance sheets or discounted cash flow metrics, he uses a formula, “MV=PQ” to find a valuation.

The formula takes account of the crypto asset’s monetary supply (M) and velocity of exchange (V), as well as the price of the underlying goods (P) and the quantity (Q) of the asset. In the case of decentralized crypto applications such as Filecoin or Golem, the price (P) is based on the cost of services like file storage or computing power, while for pure digital currencies like Bitcoin or Litecoin, the price is derived from more abstract measures.

These valuations can in turn be used to compare various cryptocurrencies relative to their historical averages as well as to their peers—by dividing the network valuation by the blockchain’s transaction activity—thereby creating something analogous to the price-to-equity, or P/E ratio used to evaluate if a company’s stock price is reasonable.

Based on all this, Burniske says the data shows Bitcoin went into “bubble territory” late last year as the market began to overvalue the cryptocurrency in relation to its actual transaction activity. Now, however, Bitcoin appears to be fairly priced.

“We corrected and we’re now in a historical norm situation,” Burniske said, adding that when he recently crunched the numbers several weeks ago, Bitcoin was actually somewhat undervalued compared to its average.

Burniske acknowledged that his valuation metrics still require more data over a longer time period to confirm their usefulness. But for now, his theories offer rare guidance in navigating the often irrational world of cryptocurrency investing.

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