Many attempt to value Layer 1 (L1) public blockchains using models designed for stocks. This approach is fundamentally flawed. Instead, we should view networks like Ethereum, Solana, and similar platforms through the lens of "nations" rather than "companies." Here’s how to rethink their valuation.
Why Earnings Multiples Fail for Public Blockchains
Earnings multiples—such as Price-to-Earnings (P/E) or Price-to-Sales (P/S) ratios—are common in stock valuation. Applying these to public blockchains leads to misleading and often alarming metrics. For instance, if Ethereum reduced its average gas fee by half, its P/E ratio would double. But rather than indicating overvaluation, this could spur exponential platform growth.
Token holders are also users of the blockchain. The value of a public chain stems from the level of economic activity within its ecosystem, not the percentage of "profit" captured from that activity.
Think of a public blockchain as a sovereign economic ecosystem, akin to a country. If the U.S. government doubled all tax rates, its "P/E" would halve. Would that benefit the U.S. economy? Unlikely. Similarly, comparing state-heavy economies like China to more privatized ones like the U.S. using P/E ratios reveals little about their true economic value.
The Shortcomings of Discounted Cash Flow (DCF)
Discounted Cash Flow (DCF) is another standard equity valuation model that falls short when applied to public blockchains. DCF estimates an asset’s current value based on the sum of its future cash flows, discounted to present value.
However, L1 tokens like ETH or SOL are both currencies and yield-generating assets. Using DCF for these tokens creates a circular reasoning problem: future revenues are denominated in the native token, whose future price depends on its current value. This makes a dollar-denominated DCF model impractical and logically inconsistent.
A more effective approach is to treat L1 tokens as national currencies rather than corporate stocks. This shift in perspective calls for valuation models based on exchange rate theories rather than equity dividends.
Valuing Blockchains as Sovereign Economies
To value L201 blockchain tokens effectively, we must adopt frameworks used for national currencies. One of the most elegant models for this is the Equation of Exchange, also known as the Fisher Equation:
M × V = P × YWhere:
- M = Money Supply
- V = Velocity of Money
- P = Price Level
- Y = Real GDP
Rearranged, the equation becomes:
P = (M × V) / YThis formula helps understand how the value of a currency relative to another is determined. For instance, comparing the U.S. dollar to Ethereum’s ETH:
ETH/USD = (M_us × V_us × Y_eth) / (M_eth × V_eth × Y_us)According to this model, the price of ETH in USD appreciates under these conditions:
- Ethereum’s GDP (Y_eth) grows faster than U.S. GDP (Y_us).
- The U.S. money supply (M_us) expands faster than Ethereum’s money supply (M_eth).
- The velocity of the USD (V_us) increases faster than that of ETH (V_eth).
Historical data supports this. The expansion of the U.S. Federal Reserve’s balance sheet correlated strongly with the rise in ETH’s price. Similarly, growth in Ethereum’s on-chain transactions, wallet addresses, and Total Value Locked (TVL) closely aligns with ETH’s valuation trends.
Measuring Blockchain GDP: Key Indicators
Unlike nations, blockchains lack official statistical agencies to report GDP. However, we can infer economic activity through proxies:
- Transaction Volume: Increased transactions often signal higher economic output.
- Wallet Growth: A rise in unique wallets suggests an expanding user base, akin to growth in a country’s workforce.
- TVL (Total Value Locked): Reflects the scale of financial activity within the ecosystem.
Data shows a nearly linear relationship between transaction growth and ETH price appreciation. A 10% increase in transactions historically correlated with a 13% rise in price. Similarly, a 10% growth in wallets corresponded to a 7% price increase.
Another compelling metric is the acceleration in new wallet creation, which has shown a 1:1 relationship with ETH’s price growth.
Developer activity is also a leading indicator. The number of GitHub repositories for "Ethereum" compared to "Solana" has shrunk from 65x to 17x within months, mirroring SOL’s rapid price appreciation.
The Role of Cash Flows in Blockchain Valuation
While cash flows—such as transaction fees used for token burning or staking rewards—don’t directly determine token prices, they contribute to long-term stability. These mechanisms mimic governmental fiscal policies, where taxes underpin currency value.
In blockchain ecosystems, embedded transaction fees provide a similar anchor, fostering confidence among token holders. However, the primary driver of value remains the growth of the blockchain’s economy—its GDP.
The Metaverse: The Next Frontier for Blockchains
The metaverse represents a digital world where individuals assume digital identities and engage in immersive experiences. Unlike centralized virtual worlds depicted in films, a true metaverse must be decentralized, featuring self-sovereign identity and value systems enabled by blockchain technology.
Public blockchains are the essential infrastructure for such decentralized metaverses. Just as multiple social networks and operating systems coexist, future metaverses will likely be pluralistic. This means ample opportunities for various L1 blockchains to serve as foundational layers.
Investors should evaluate public chains from this long-term perspective—viewing them as emerging digital nations or metaverse infrastructure—rather than through traditional corporate lenses.
Frequently Asked Questions
Q: Why can’t we use P/E ratios to value public blockchains?
A: P/E ratios measure corporate profitability. Blockchains derive value from ecosystem activity, not profit capture. Reducing fees might lower "earnings" but can stimulate growth, making P/E misleading.
Q: How is blockchain GDP measured?
A: While there’s no official GDP, key metrics include transaction volume, wallet growth, TVL, and developer activity. These indicators correlate strongly with economic output.
Q: What is the Equation of Exchange?
A: It’s a formula relating money supply, velocity, price levels, and real GDP. Adapted for blockchains, it helps estimate token value based on economic activity and monetary policy.
Q: Do transaction fees impact token value?
A: Fees contribute to token stability via mechanisms like burning or staking rewards. However, the primary value driver is economic growth within the blockchain.
Q: Why are blockchains essential for the metaverse?
A: Blockchains enable decentralized identity and value systems, critical for an open, user-owned metaverse rather than a centrally controlled virtual world.
Q: How can I track the health of a blockchain economy?
A: Monitor on-chain metrics like daily transactions, active addresses, TVL, and developer engagement. These provide insight into economic vitality.
Understanding public blockchains as digital nations offers a more nuanced framework for valuation. By focusing on economic growth indicators and monetary dynamics, investors can better navigate this emerging asset class. 👉 Explore advanced valuation strategies to deepen your analysis.