Valuation of Crypto Assets – All you need to know
Understanding how crypto assets underlying technology works is critical to understanding how crypto assets derive their value.
The advent of the crypto ecosystem spawned a slew of new terms that are frequently misunderstood in the literature. Almost everyone has heard of phrases like blockchain or Bitcoin, but only a few people can describe them and their underlying technology in a straightforward and understandable manner. Understanding how crypto assets underlying technology, especially distributed ledger technology and blockchain, works is critical to understanding how crypto assets derive their value.
Crypto asset valuation
Regardless of its current market price, the underlying value of a crypto asset is determined during its valuation. This aids in determining if a token is overvalued or undervalued. The fundamental study of traditional financial assets such as equities is analogous. Financial reports aid in the calculation of a stock’s value in traditional fundamental research. This no longer applies to crypto assets, and new valuation procedures are required to determine the monetary value of crypto assets.
What are crypto assets?
Crypto assets are digital assets that produce a medium of exchange for financial transactions using cryptography techniques. To safeguard financial transactions, manufacture new units, and validate asset transfers, the money is encrypted (secured) using cryptography. Crypto is considered a DeFi, or decentralized finance, as crypto does not rely on intermediaries such as banks in order to make transactions.
Crypto Assets are assets that can only and only be transferred via blockchain technology, such as digital coins and tokens, as well as any other sort of digital medium of exchange, such as Bitcoin, Ethereum, and Ripple. In DeFi, crypto assets are recorded in a public ledger.
Why do crypto assets need a valuation?
There are three key reasons why it’s important to perform a valuation for crypto assets: taxation, financial reporting, and investment considerations. Most often, crypto assets are used as compensation for any goods or services rendered. When making crypto transactions, it’s advised to have a valuation to find the value of the assets relative to goods or services exchanged. It’s also important to consider the supply and demand dynamics within the crypto economy.
Types of crypto assets that need a valuation
The nature of a crypto asset determines its value, with the most important distinction being whether the asset offers its owner the right to a stream of future cash flows or not. This has been demonstrated on three different types of tokens: security tokens, utility tokens, and cryptocurrencies.
- Security tokens – Because security tokens are frequently linked to a securities offering, they should truly be called “security tokens”. The securities in question are typically shares in the company that issued the token as a kind of long-term investment in the technology company’s growth. They’re regulated in the same way that securities in more traditional markets are. The right to have some influence in what occurs with the organization that issued the security token is a key characteristic of most security tokens. When you purchase a security token, you are effectively becoming a major shareholder, and the amount you invest is directly influenced by the company’s valuation.
- Utility or MAG tokens – Utility tokens are the most popular type of token issued in an ICO. Rather than reflecting a share of the company’s ownership, they’re more akin to “golden tickets”. They provide holders with unique services or preferential treatment, such as a discount when a start-product up’s line is launched.
For example, these items could be software bundles or a platform for software as a service. Utility tokens aren’t regarded as investments because they’re more like promotional tools than ownership holdings in companies. Utility tokens can appreciate in value if the token they represent becomes extremely popular and in demand.
- Cryptocurrencies – Cryptocurrency, often known as crypto-currency or crypto, is any type of digital or virtual currency that uses encryption to safeguard transactions. Cryptocurrencies operate without a central issuing or regulating authority, instead of relying on a decentralized system to track transactions and create new units.
How to value crypto assets?
Free cash flows are observable in crypto assets. Staking incentives, mining awards, and other ways developers have developed to motivate users to offer services to the network may all be monitored. These free cash flows may be used to determine the network’s present return on investment (ROI), project growth into the future using an acceptable discount model, and so “guess” if buying a token now makes sense given our future estimates for token growth. The problem with this concept is that crypto-assets are extremely volatile.
Approaches to value crypto assets
Fundamental analysis, which uses financial statements to examine publicly listed companies, is used to make equity investments. We can’t use information like that in the case of cryptocurrency because there isn’t any. As a result, we must either modify our valuation perspective to a cost perspective or adopt comparable value methodologies.
- Financial reporting – Financial reporting is a typical accounting procedure in which financial statements are used to reveal a company’s financial information and performance over a specific time period, usually annually or quarterly. When your company buys bitcoin, you should record the asset on your balance sheet at its fair market value on the day it was bought. This is accomplished by debiting the asset’s account.
- Taxation – Tax experts have been debating whether cryptocurrencies should be classified as a ‘currency’ or an ‘asset’. The terms cryptocurrency and crypto-assets are often used interchangeably. However, describing it as a ‘currency’ requires government legal backing; without this, it is safe to consider it an asset/property. Because the tax implications would arise regardless of legality, designating them as “assets” would be a better method than waiting for a government explanation.
- Investment considerations – The legal ramifications of these new currencies and the technologies that power them are becoming increasingly clear. Regulatory agencies, tax officials, and central banks worldwide are attempting to determine what digital currencies are and what they represent. Individual investors can make a lot of money investing in cryptocurrencies, but they risk breaching the law when they buy and sell them. Much of the ambiguity surrounding cryptocurrency’s legal status stems from its relative youth when compared to other currencies and payment systems.
How to value each type of crypto assets?
The type of decision-making and distribution rights connected with security token ownership vary, but all share one fundamental aspect: the right to future distributions. Under the market and income approaches, this allows for the use of classic valuation methodologies. Each method helps determine the accurate valuation of crypto assets, yet they have various different processes.
- Market Approach – The market approach’s value mechanism for a given token is determined by its liquidity and level of development. The scenarios that are relevant range from a token with no liquidity and no directly observable price at the time of launch to a token with continually updated prices in a direct trading pair against a fiat currency.
- Income Approach – From the standpoint of determining intrinsic value, an income strategy based on cash flows to the security token’s holder is logically the ideal solution. It can be especially beneficial in guiding investment decisions in markets where inefficiency, sentiment, and speculation play a large role. It may, however, be incompatible with the value bases required by financial reporting and tax valuation rules, which favor more directly market-based measurements.
- Cost Approach – Opportunity costs can give an observable proxy for value when secondary transaction pricing is unavailable or liquidity is insufficient to rely on the price. The utility token’s role as a medium of trade is revealed. Participants in the utility token network will quote prices in terms of the utility token for items or services they offer for sale. As a result, these mentioned prices may be compared to the prices paid in fiat currency for different ways of acquiring the same number of products or services.
- Quality Theory of Money – Utility tokens serve as a medium of trade, or to put it another way, the only “legal tender” within their particular networks, drawing comparisons to fiat currencies. The tiny economy metaphor is useful because it allows you to look at the price of utility tokens through the lens of the QTM. Suppose the level of real output remains constant and the velocity of money remains constant. In that case, the overall price level of goods and services is proportional to the money supply in an economy. The same dynamics that affect the supply and demand of any product also affect the supply and demand of money: a rise in the money supply.
Common discounts used in crypto asset valuation
Every business wants to make a profit, yet it has to offer some discounts to its customers. Various common discounts are used in the crypto asset valuation and these crypto asset valuations are further used to make transactions more feasible.
- Liquidity discount – The term “liquidity discount” refers to a reduced valuation given to illiquid shares. Lack of liquidity may cause the share price to be more volatile. As a result, investors will discount an illiquid investment at a higher rate than a liquid one. The higher Discount rate will cause the liquidity discount.
- Blockage discount – The blockage discount, also known as the blockage factor, is the discounted price or value given to equities by the market when a block of shares is sold. The amount of shares that make up a block varies. The securities are issued in the company’s industry and are released onto the market all at once.
How to use discounts in crypto asset valuation?
Investors are increasingly attempting to diversify their portfolios by adding crypto assets such as Bitcoin, non-fungible tokens, and other digital offerings to capture some of the potential upsides of this new asset class. Crypto assets are a rising class of investments, and if you decide to invest in them, you’ll find it easier to keep track of them all with tools and apps. Platforms and tools for crypto asset management allow you to take advantage of your assets without having to bother about the technical aspects.
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