CFA Institute Launches Cryptoassets Valuation Guide for Investment Professionals

CFA Institute, the global association of investment professionals, has released a new cryptoassets valuation guide. Developed by the CFA Institute Research and Policy Center, the guide seeks to equip investment professionals with the most relevant valuation models and tools to support analysis of cryptoassets, in connection with smart contract platforms, decentralized applications, and bitcoin.

The guide contributes toward the development, over time, of a framework for valuing cryptoassets. The issue of valuation has become a critical topic given the growth in cryptoassets over the past decade, currently estimated to exceed $1 trillion in market capitalization1, globally. The numbers for India on cryptoassets are no less astonishing. The estimates suggest that there are around 120 to 150 million crypto users in India and the country is perhaps only behind the United States on cryptoassets trading as well as mining. The value of crypto assets held by Indians is most likely in the range of USD 250 billion, as per available estimates.

At the same time, the cryptoassets market has undergone significant upheaval and price volatility, making an analysis of valuation drivers imperative for any investor or investment professional investing, or considering an investment in cryptoassets. For this asset class, the valuation assessment is even more relevant in a country like India, which has a long way to go on financial literacy and investor awareness in general. To address some of the valuation issues associated with crypto, CFA Institute’s valuation guide will be helpful for the investors with the range of models and frameworks it discusses.

The guide addresses a critical market need in India because of the significance and interest levels cryptoassets have and given the strong growth over the past decade. In addition, considering the strong economic growth India is expected to deliver in the coming years and increasing investment flows to financial assets including cryptoassets, this valuation guide is an important step in building a rational and robust investment approach for valuing cryptoassets.

The models have been informed by interviews with industry professionals and a review of current literature. Given the plethora of valuation approaches available, many of which lack testing or rigor, only those models currently in use or considered relevant among practitioners are included in the guide. The primary objective of CFA Institute is to ensure that investment professionals and the wider industry are informed of current valuation methods and the discourse over their advantages and disadvantages. The publication serves as part of a proactive undertaking toward a larger debate on the value proposition of cryptoassets.

Rhodri Preece, CFA, Senior Head of Research, CFA Institute, comments:

“This guide provides a framework for investment professionals to undertake a thorough analysis of the valuation drivers of cryptoassets, including fundamental characteristics such as cash flows, growth rates, and tokenomics. Current valuation models have their limitations, and the lack of historical data makes statistically robust cryptoasset valuations challenging. No single valuation model or metric should be used in isolation.”

“After Graham and Dodd published the classic Security Analysis in 1934, it took decades for an established investment valuation framework to emerge for equities. Most cryptoassets are less than a decade old; as such, we should not be surprised that views over their valuation and legitimacy in investment portfolios vary widely. It is only through critique and debate that valuation models can develop and coalesce toward a consensus over time. This cryptoassets valuation guide can inform these important conversations and market developments.”

Key Takeaways:

Valuation of smart contract platforms, such as Ethereum, can be approached from two viewpoints: the platform is considered either as a network, or as a cash-flow asset.
As a network, a qualitative framework based on on-chain data can be used to assess these platforms on a relative valuation basis. Additionally, Metcalfe’s law, which values a network based on the square of its number of users, can be used to value the network relative to its market capitalization.
As cash-flow assets, the valuation involves using the discounted cash flow (DCF) model. The DCF model considers the transaction fees collected by these platforms as cash flows.

Valuation of decentralized applications – such as decentralized exchanges – can be performed using either a relative valuation approach or an intrinsic value approach using the DCF model.
Such metrics as the price-to-sales, price-to-fees, and market capitalization to net assets ratios can be used to value – on a relative basis — decentralized applications within the same sector or to compare them with their traditional finance counterparts.
The DCF model considers protocol revenue collected by a decentralized application as a cash flow, enabling the calculation of intrinsic value based on growth and discount rate assumptions.

There is no one valuation model that encompasses all the characteristics of bitcoin. The guide includes four models for valuing bitcoin: total addressable market, stock-to-flow, Metcalfe’s law, and the cost of production model. Each model is derived from underlying characteristics and take differing viewpoints regarding whether bitcoin represents a store-of-value or medium-of-exchange. Basing each model on just one of bitcoin’s fundamentals leads to limitations.
With the publication of this guide, CFA Institute Research and Policy Center does not endorse a particular view of cryptoassets but rather seeks to inform the valuation debate. The findings and approaches encompassed in the guide do not constitute an endorsement, validation, or denial of cryptoassets.