How to estimate the cost of cryptocurrency?

Narek Sirakanyan — President of Freedom International Group Ltd., former top manager of the Rosatom state company.

I had encountered this task for the first time when we were preparing for the first private ICO crowdfunding round for Sessia, one of our key projects. Sessia is a new-generation social network with a convenient marketplace, where you can buy goods and services lucratively, receiving bonuses and cashbacks. You can publish posts about your purchases in the Sessia Feed, and friends (or even friends of friends) who see your post and also make purchases at the same store, can bring you the commission offered by the store’s loyalty program. It was when we were analyzing the potential price of Kicks, Sessia’s cryptocurrency. Today we’ve established that the cost should be affordable and we need to release the maximum amount for marketing purposes, however, we still haven’t eliminated the key question: what should the real capitalization of all the tokens be?

CryptographyPriceDate of issueTotal trade volume for the last 24 hoursPast hour price change
BTC Bitcoin $13,006.78 Jan 3, 2009 $370,318.17 $319.8412
ETH Etherium $337.95 Jul 30, 2015 $2,326,457.73 $4.2881
XRP Ripple $0.46 Feb 2, 2013 $624,412,355.96 $0.0031
BCH Bitcoin Cash $482.65 Aug 1, 2017 $345,716.13 $6.4278
EOS EOS $6.61 Jun 26, 2017 $27,177,628.79 $0.0822
LTC Litecoin $130.51 Oct 13, 2011 $2,409,443.77 $1.4863
XLM Stellar $0.12 Jul 19, 2013 $330,088,379.32 $0.0013
TRX Tron $0.04 Sep 26, 2017 $2,217,660,821.66 $0.0007
BSV Bitcoin SV $215.41 Nov 15, 2018 $57,726.48 $0.0884
XMR Monero $103.16 Apr 18, 2014 $220,027.62 $0.4674

I have a degree in finance from Harvard and McGill. An investment banker in the past, I’ve also worked as a financial analyst in the FIG (Financial Institutions Group) department at Credit Suisse London, learning how to create complex company evaluation models. Our department included banks, funds and insurance companies that cause maximum difficulties in the evaluation process. Everyone used the standard DDM (Discounted Dividend Model), DCF (Discounted Cash Flow Model), CMF (comparable multiple analysis) and TMV (transaction multiple analysis) for company evaluation.

To estimate token value, at first I relied precisely on these models, which I am perfectly well-versed in, but it only worked in assessing the project itself and of the company share value. In this case, the evaluation yielded two capitalizations, one – that of the company itself, the second, specifically that of tokens: they also create major added value for the project. However, none of these formulas provide an estimate of the value of the tokens themselves. It is important to note that with tokens you are not the owner of a company's shares. Thus, my main task was to find a rational valuation logic, which would not overestimate or, conversely, underestimate their value. I did not want to reinvent the wheel, so I decided to work with other formulas.

I used the DCF (Discounted Cash Flow Model) model, which is employed to estimate the value of the company's shares, and adapted it to the cryptoworld. Analysis was required prior to its implementation to find out what the limitations of the current model are for the cryptoworld. When we assess the value of a company, as a result, we do obtain its value, or capitalization, and cryptocurrency itself adds yet another capitalization to the company, that is, supplementary added value. There is a certain paradox here: it lies in the fact that the cryptocurrency capitalization of a company is higher than its direct value, that is, with cryptocurrency, you get two capitalizations.

The DCF (Discounted Cash Flow Model) model estimates the value of the company and, accordingly, the value of one share. However, we know that it is impossible to directly buy the company's products with stocks. There is a certain process involved.

Cryptocurrency dictates alternate rules of the game, different from those in the conservative financial world: here you can directly buy your company's cryptocurrency products. It’s very easy! But, unfortunately, this model does not take the community’s capabilities into account. If I am a shareholder of Samsung, it does not mean that I will definitely buy myself a Samsung instead of an iPhone. And in the world of cryptocurrency, the communities themselves are more loyal to the brand: if I owned Samsung cryptocurrency, most likely, when the new model came out, I would use my cryptocurrency and choose a new Samsung instead of an iPhone. Accordingly, the DCF does not take into account the community’s strength and influence, which is established through cryptocurrency. The model also does not take into account the fact that the company's cryptocurrency can be mined, thus, its volume can constantly grow. A company has the option of issuing new stocks by conducting an SPO, Secondary Public Offering, while a company’s cryptocurrency mining may be ongoing.

I took all these nuances into account in my advanced formula, the Community Flow Model, or CFM. This is not Cash, but Community, since this world is currently behind this community and the crypto enthusiasts.

Contribution to the community:

In the first part, which incorporates the CC (Community Flow) value, the formula displays and predicts the contribution of all community members to this cryptocurrency for an unlimited number of years. Community members may include:

  • the company itself, its management and programmers: all of them very often receive their company’s cryptocurrency as bonuses;
  • company’s clients: they buy tokens so that in the future it is more profitable to buy company’s goods/services or receive them for certain actions;
  • company’s business partners: they buy tokens to remove certain limitations on doing business, that is, cryptocurrency removes all restrictions on doing business, it saves money and boosts speed, which is crucial for small and medium businesses;
  • investors: they buy in order to sell higher in the future.

Each project has its own evaluation criteria, in this case - investments in cryptocurrency. We were guided by the example of the Sessia project and, specifically, Kicks cryptocurrency. Our forecast was based on the following criteria: the number of businesses integrated in Sessia and the average number of their customers using the application. Next, we estimated the average customer check and the average cashback percentage that a business will pay to a customer through the application. Due to the fact that you can only pay cashbacks with Kicks (the app’s cryptocurrency), we were able to predict what amount of Kicks will be purchased by businesses to distribute them to their customers. This is called contribution to the community, which is very similar to cash flow that the company should receive, but in this case it is an estimate of how much cryptocurrency was purchased.

The next important element in the formula is Fout, or FLOW OUT, which stands for what the people who received cryptocurrency of a particular company will do with it. In our situation, there are customers who receive cashbacks in Kicks, and we can evaluate the following actions:

  • keep Kicks in their account for future purchases, that is, become a short-term or long-term investor;
  • sell them;
  • spend them;
  • exchange Kicks for another cryptocurrency.

Any of these actions affects the supply and demand for the cryptocurrency itself. Hence, it affects its price, which was extremely important to account for in the formula. If cryptocurrency is retained by the community members who receive it, it’s a good sign. It means that they have a good understanding of the project, which it can positively affect cryptocurrency valuation and adjust the discount rate (reducing it) in the future, since this is a signal that the cash flow to the cryptocurrency is more than reliable.

The formula itself is very simple. We predict the average amount of the purchased Kicks to be sold annually. We need to obtain the discount rate to understand the current price of the future flow into the cryptocurrency.

The DCF model has a CAPM (Capital Asset Pricing Model). I reformulated it as CAPM (Crypto Asset Pricing Model) for cryptocurrency valuation. The formula as a whole remains the same, but instead of using S&P500 as the marker of the market return, as is customary, we use the indicator of cryptocurrency’s market return. Accordingly, we use the Bitcoin and Ethereum market, since they generally account for more than 70% of the total cryptocurrency market.

Using this formula, we were better able to formulate our forecasts for clients and cryptoinvestors. Moreover, we gave them the opportunity to try and build their own estimates and realistically evaluate the potential price of our cryptocurrency.

Our formula provided a theoretical price of 1 Kick = $86 a year after the launch on the exchange. When the first private round of sales started, we sold Kicks at the price of 70 cents each. That means that growth can potentially be very impressive if the team lives up to its White Paper claims.