Value Capture and Quantification Cryptocapital vs Cryptocommodities Final fggr.pdf

Value Capture & Quantification: Cryptocapital vs Cryptocommodities

Since publishing the new asset class white paper in 2016, defining and valuing the diverse set of cryptoassets before us has been a long-running obsession of mine. Iterations have come as experiments and empirical observations flow in – this paper is a continuation of that exploration.

What follows is a description of the two main buckets of cryptoassets we are seeing today (capital and commodities), which then feeds into a discussion of the differences we can expect in the value capture and valuation models between the two. It is both a revision and expansion of Cryptoasset Valuations, driven in part by the explosion of stake-based assets since 2017, which as productive assets don’t fit the MV = PQ model.

The piece is not meant to be exhaustive or descriptive at a technical level, but rather to offer two primary directions for future valuation work. While I’ve put the words to paper, I consider these ideas to be my interpretation of the collective output of the last year of conversations with Joel, Brad, Alex, Mario and the broader crypto community.

The majority of cryptoassets are shaping up to be capital assets in nature, whereas many early examples like bitcoin are better characterized as commodities, with a subset poised to become commodity monies. Within the burgeoning capital asset field of crypto, some closely resemble equity, others more closely resemble debt, and others have a bizarre enough mix of capabilities and value streams to be unrecognizable from prior renditions of capital assets. As part of explaining why governance assets have value, Joel has done an excellent job of laying out foundational principles behind capital, which is a piece that should be read before continuing here.

Following the economic interest can lead us to key defining characteristics that bifurcate the world into cryptocapital and cryptocommodities. This bifurcation creates a fork in the road for how to value these two groups of assets.

The TLDR is that cryptocapital will take inspiration from its capital asset peers, and as a productive asset its value will be calculated as the net present value (NPV) of annual value flows to supply-siders. Meanwhile, the equation of exchange (MV = PQ) remains our best bet at pricing non-productive cryptocommodities, where PQ = annual transaction volumes using the native asset. Note that “annual value flows to supply-siders” and “transaction volumes” are separate metrics, and serve as the respective linchpin metrics for cryptocapital and cryptocommodities.

A mistake I made in 2017 with Cryptoasset Valuations was to suggest MV = PQ could be used for all cryptoassets, whereas it’s now clear to me the equation only applies to the non-productive subset of cryptoassets. As this world of programmable value unfolds before us, making mistakes, acknowledging those mistakes, and learning from them, is part and parcel of iterating towards the truth.

In the search for valuation models to explain the prices we see, valuing cryptocapital will be less foreign to equity and bond analysts than pricing cryptocommodities, which should accelerate the number of analysts contributing to the “theory follows price, price follows theory” effort. Converging on consensus models to value cryptoassets is essential to improving the efficiency and thereby stabilizing the volatility of the crypto markets.

Asset Superclasses

A bit of context to set the stage for delineating between cryptocapital and cryptocommodities. Broadly, there are three superclasses of assets, under which most of what we consider to be “asset classes” fall. Below is a table from the 2016 ARK and Coinbase new asset class white paper, with descriptors pulled from Robert Greer’s 1997 paper, What is an Asset Class Anyway?

Per Greer:

• Capital Assets (CA): “Ongoing source of something of value… valued on the basis of net present value of its expected returns.” Obvious examples are equities, bonds, income producing real estate, and so on.

• Consumable/Transformable Assets (C/T): “You can consume it. You can transform it into another asset. It has economic value. But it does not yield an ongoing stream of value.” Oil, wheat, natural gas would singularly fall into this bucket, while some precious metals and scarce commodities are C/T assets but also socially accepted stores of value (overlapping with the 3 superclass).

• Store of Value Assets (SoV): “Cannot be consumed; nor can it generate income. Nevertheless, it has value; it is a store of value asset." Assets like art, collectibles, and fiat currencies are purely stores of value of varying quality, while the SoV superclass also has overlap with the rarer consumables/transformables.

An asset can fall across multiple superclasses, but historically blended assets have been a mix of a C/T and SoV asset, as is most clearly the case with gold. With many cryptoassets we are seeing an explosion of blended capital assets and consumables/transformables (CA + C/T), which is a more foreign combination.

This doesn’t de-facto mean these “CA + C/T” cryptoassets fall under existing securities laws, because most of them require active participation in order to receive value flows, and as the SEC has recently pointed out, “Usually, the main issue in analyzing a digital asset under the Howey test is whether a purchaser has a reasonable expectation of profits (or other financial returns) derived from the efforts of others.” The “efforts of others” is much more nebulous in cryptoland when compared to the clear cut lines of traditional corporate entities.

$$ \mathrm{^{c}A A+C/T^{}} $$

Even if such “CA + C/T” cryptoassets are ultimately labeled securities and regulated by the SEC, they still include supply-siders in the value stream and capital appreciation of the service, as opposed to equities where investors passively claim the profits of the entire system. While subtle, this inclusive shift is an important component of leveling the playing field against pure capital allocators. I say this as a capital allocator that sees how uneven the current playing field is.

$$ \mathrm{^{C l}C A+C/T^{}} $$

Each protocol has the potential to operate as globally as TCP/IP from inception, these networks can potentially scale geographically much more quickly than company-provisioned-services can.

Capital Assets (CA)

Capital assets, under Greer’s framework, are an “ongoing source of something of value… valued on the basis of net present value of its expected returns.” These are productive assets, in that holding them gives claim to a stream of “something of value.” It should be immediately obvious how different this is from bitcoin, where the holder of BTC gets no ongoing claim. While we traditionally think of “something of value” as being cash flows, Greer’s word choice leaves the field of value open to interpretation.

Any cryptonetwork that requires ownership of the native cryptoasset to gain access to a recurring value stream generated by the network, thereby creates a capital asset as opposed to a commodity.

Translating this to cryptoland, any asset that is staked, bonded, or otherwise committed in order to get a claim on value flows can be considered cryptocapital. A sustainable value stream comes from transaction fees and asset inflation, though the latter is not strictly needed. The steady flow of transaction fees assumes the network is providing a valuable service, which is an assumption we’ll have to make if we believe these assets can effectively and sustainably coordinate resources as well as existing social contracts (e.g., equities).

Generally the network demands some kind of cost to be incurred to get access to the value stream of the network (no free lunch). Currently, the three most common costs demanded are 1) staking/bonding the native asset, an internal capital cost 2) running machines that perform the services of the network, an external capital cost 3) participating in the governance of the system, a human cost in the form of pure labor. Note that cryptocommodities tend to only demand #2 (external capital cost), whereas cryptocapital networks can demand all 3 as inputs of work to get access to the value stream of the network.

Some have referred to cryptocapital as the taxi-medallion model, or work tokens. Work tokens are part of the picture of cryptocapital, but refer more to the equity side of the equation.

If, on the other hand, the asset has utility beyond merely being a supply-side coordinator then the non-staked, non-productive asset base can be used in a consumable/transformable capacity. This raises the question of whether velocity enters the equation for CA + C/T hybrids, where the CA component is DVF’d and the C/T component could be MV = PQ’d. In such a scenario, I’d expect the vast majority of the asset’s value to come from the DVF instead of M = PQ/V, making velocity in the C/T component a minor point.

In my mind, any purely proof-of-work asset can be considered a cryptocommodity, and MV = PQ remains our best bet at pricing such assets.

$$ \mathrm{CUV_{t}=P_{i}Q_{t}/V} $$

$$ \ ext{In a digital world, there is no natural consumption/destruction of the commodity (beyond lost keys) the way there is in the physical world. While this allows the cryptocommodity’s stock to accumulate nicely over time, it also requires the supply of the asset be mindfully constrained through mechanisms such as forced burning or extreme scarcity.}$$

Conclusion

The most common pushback I get to the above models is that they sound too complicated. That’s fair, but having built models to value companies such as RedHat or Salesforce, I don’t think the final form of valuing cryptoassets—be it cryptocapital or a cryptocommodity—will be more complex. In time, I expect similar convergence on standard valuation models to happen around popular cryptoassets until we get to the point where we have consensus mathematical models and merely bicker over the inputs to the models, as currently happens with the rest of the capital markets.

My hope is that in elucidating these differences in value capture and quantification, cryptofolk stop thinking everything is zero-sum, which should lead to less bickering, more building, and better analysis.