What is Defi? How to value a Defi token or project?
This article discusses a few metrics that can be used to determine how the market values certain projects.
In the crypto markets, the decentralized finance (DeFi) sector continues to be one of the greatest performers. This may appear strange at first look, given that many DeFi tokens are primarily concerned with protocol governance or have even been labeled “worthless” by their designers. However, some of the tokens currently generate cash flows, therefore discounted cash flow valuations might be used. Others may, in the future, generate cash flows for their token holders as a result of government actions. This article discusses a few metrics that can be used to determine how the market values certain projects.
Defi token or project valuation
A DeFi coin is much like a digital version of a fiat coin — it transfers value in the course of a financial transaction. DeFi tokens also transfer value, but not necessarily always in a financial sense. Every day, new defi initiatives emerge in the crypto market, making it difficult for a new crypto investor to decide which cryptocurrency to invest in.
What is a Defi token or project?
Software protocols that run on top of a blockchain network like Ethereum or Cosmos are known as DeFi projects. To automate financial services, these projects make use of the underlying protocol technology as well as novel innovations. Decentralized Finance (DeFi) is a movement that uses decentralized networks to transform traditional financial products into trustless, transparent protocols that operate without the use of middlemen.
Purpose of Defi token
The purpose of the defi token is quite relatable to the digital counterpart which transfers value by a fiat coin during the financial transaction. The currencies are usually in the name of their own proprietary blockchain networks. DeFi tokens carry a value that is intangible in nature. DeFi’s most popular applications include sending money anywhere in the world (quickly and affordably); storing money in crypto wallets (and earning higher yields than at a traditional bank); borrowing and lending on a peer-to-peer basis; and trading cryptocurrencies anonymously and at any time, 24 hours a day, 7 days a week.
How does Defi token work?
DeFi Tokens are commonly referred to as Ethereum tokens and have the largest market capitalization. Traders and users can utilize DeFi tokens to access financial services through a newly created DeFi app. Borrowing, lending, investing, staking, trading, and risk management are all DeFi functions that can benefit from DeFi coins.
Tokens can be used for a variety of purposes other than payment. Crypto tokens are superior to coins. They may not be as valuable as coins in some situations, but they do have certain rights, such as governance and voting, as well as long-term benefits like utility and security. Tokens are created on a pre-existing blockchain network.
How to value Defi token?
The tokens have monetary or economic worth. As an incentive for using native DeFi tokens, DeFi users can obtain trade discounts or lower interest rates. Due to their uniqueness to DeFi networks, tokens are non-fungible assets, whereas coins have fungible value.
Key fundamentals of defi token valuation
The capacity to effectively anticipate the future worth of a project that may have utility and expanding adoption but lacks the usual measures used for the asset, profits, and market-based valuation is a typical challenge when dealing with developing technologies. The quantitative and qualitative evaluation of an asset’s intrinsic worth is the fundamental analysis of token valuation.
- Whitepaper – The whitepaper includes decentralization use case and tokenomic model, which are explained below :
- Decentralization Utilize Case – Smart contracts are only as trustworthy as the data they use to trigger execution – if a smart contract employs a centralized oracle for its data feed, bad actors have a single point of failure to attack.
- Tokenomic Model – Chainlink’s native token (LINK) is utilized to recompense the network’s data providers and payment networks. Nodes with accurate responses receive LINK, while those with inaccurate/incomplete data lose it. This approach assigns oracles a reputation score and allows high-value smart contracts to require more LINK as collateral from node operators in order to ensure data veracity. As a result, LINK is a scarce asset with utility and passive income prospects whose value is directly proportional to network utilization.
- Team – The team includes Business Development, Marketing, Partnerships, Community Engagement, Founders, Leadership, Developers, Engineers.
- Market share – The market share includes TAM, Market Cap, Liquidity, Active Users, Transaction Volume, Fees, or Revenue Generated. The total addressable market, often known as the total available market, is a term that refers to the income potential for a product or service. TAM aids in the prioritization of business prospects by providing a quick indicator of an opportunity’s underlying potential.
Important metrics to value Defi tokens
The usage of DeFi technology extends beyond lending and transacting, making it a viable alternative to traditional financial services. Here are a few examples of applications, How to examine important performance factors while investing in DeFi. Here are a few DeFi Indicators to be aware of:
- TVL (Total Value Locked) – Total Value Locked refers to the total quantity of tokens in a DeFi system, as the name implies. Crypto or USD can be used to calculate the entire value locked in a protocol. TVL is the overall liquidity in a liquidity pool in a specific marketplace. TVL is frequently used in conjunction with market capitalization. A cryptocurrency’s market capitalization (or market cap) is a measurement of its market value. To put it another way, it is determined by multiplying the value of tokens by their USD price.
- Incentives/interest – The audience is enticed to contribute its crypto assets by attractive interest rates on their crypto assets or the opportunity to earn a percentage of the protocol’s fees, among other things. The crypto creates the protocol’s balance sheet, which is swapped for these value flows, and the Defi protocol must efficiently monetize this balance sheet, just like in the old economy banks. The balance sheet will be stronger if the incentive is stronger. Because of its decentralized nature, lack of middlemen, and speed imparted through smart contract execution, Defi can monetize its assets and balance sheet more efficiently than the previous economy.
- Ecosystem – A blockchain ecosystem is a group of people who are part of a blockchain network and have similar business goals, relationships, and processes. The network is capable of efficiently creating and transferring commercial value. A protocol’s value production is dependent on four fundamental components that form an ecosystem. In order to generate protocol value, it is necessary to examine their responsibilities, motivations, and interaction model.
- Liquidity Providers – People who contribute liquidity to the protocol’s balance sheet are known as liquidity providers. The economic incentives encoded into the specific Defi system concept, like trading fees, interest rates, token giveaways, and so on, provide value to liquidity providers. Offering liquidity providers differentiated and unique value can help the DeFi protocol gain a lot of traction.
- Users – The protocol must provide consumers with stability, user experience, functionality, and security in addition to sustaining and developing liquidity. Security is extremely important; capital will flee at the first sign of faulty smart contracts or security flaws. Users must have faith in the protocol; otherwise, they will switch to a competitor.
- Token owners – Token holders, who are in charge of the protocol and receive a portion of the revenue earned. The value proposition is simple: the token price must exceed other Defi competitors as well as the cryptocurrency market index.
- Tangible value – A few unique drivers establish economic value; it usually refers to essential assets or core operations that optimize the protocol’s accrued advantages. The establishment of differentiated advantages to protect and enhance market share or profitability is what value is all about. Due to liquidity and client churn vectors from one protocol to another, this is difficult in Defi. Traditional competitive advantages such as economies of scale, patents, and regulatory licensing are simply not possible in the Defi ecosystem due to the crypto world’s proclivity for open source development.
- Intangible value – Cryptocurrencies are not investment vehicles. They are also devoid of physical substance. As a result, they qualify as an intangible asset and would be recorded at acquisition cost (i.e. price paid or consideration given). The process which is used to value the intangible assets is quite exclusive. In the blockchain system, a non-physical asset is an intangible asset. Patents, trademarks, copyrights, goodwill, brand recognition, customer lists, and proprietary technologies are examples of intangible assets.
Defi token valuation methods and their application
Usage-based fees are often given directly to liquidity providers or used to burn the native token to generate revenue for Defi networks (reducing total supply).
- Price to Earnings Ratio (P/E) – The price-to-earnings (P/E) ratio is a widely used investment heuristic for swiftly comparing an asset’s relative value to its competitors or its own previous performance. Higher P/E ratios may imply that traders anticipate future growth, whereas lower P/E ratios are generally preferred by investors because they signify a cheaper share price per dollar of earnings.
- Discounted Cash Flow Analysis (DCF) – The discounted cash flow (DCF) model is a method of calculating an asset’s present value based on its expected future cash flows. The idea is based on the time value of money, which states that a dollar paid in the future is worth less than a dollar spent today. While the theory is sound, properly predicting the model’s correct inputs is often difficult. Discounted cash flow (DCF) analysis is the preferred valuation methodology for all cash flow-generating assets. This strategy works well in theory (and in college final exams). However, in practice, DCF might be difficult to use when appraising stocks in practice.
- Token Velocity (Monetary Equation of Exchange) – M = PQ/V is the formula. Where M denotes currency value (market capitalization), V denotes currency velocity, P denotes token price, and Q denotes token quantity (Total Supply) Since the early days of Bitcoin, the Monetary Equation of Exchange (MV=PQ) has been used to estimate future token valuations. We must calculate the Market Cap in each future year, divide it by the estimated outstanding float, and then discount it to the target year to use the Quantity Theory of Money for token valuation.
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