Exploring the governance token valuation model can help identify tokens that may be undervalued compared to core basic indicators and on-chain utilization.
Original title: “The Way of DeFi丨Explore the relevant valuation models of governance tokens, and understand how to achieve value capture”
Written by: Luke Posey, Glassnode Analyst Compiler: Kyle
With the continued enthusiasm surrounding NFTs and the successful implementation of EIP-1559 in the London hard fork that was activated last week, on-chain activity has also risen, mainly due to the continuous launch of new NFT collectibles and the market excitement. .
In this article, we will explore:
- Preliminary network effects after the release of EIP-1559.
- Explore the relevant valuation models of governance tokens.
- Use on-chain data to evaluate the token valuation of the entire field.
EIP-1559 is online
EIP-1559 came into effect on August 5, and made a key change in the design of the Ethereum network transaction fee. A portion of the ETH network fee, called BASEFEE, is now burned instead of being rewarded to miners.
This mechanism effectively offsets the impact of issuing new ETH to the network through block subsidies. The current ETH issuance rate for miners is 2 ETH/block, and 0.0625 ETH is provided for uncle blocks.
As the activity on the chain increases, users pay more transaction fees, thereby destroying more ETH. Therefore, this mechanism converts economic activity on the Ethereum blockchain into the scarcity of ETH tokens. Since the launch of EIP-1559, the average burn/block is about 0.71 ETH/block. This means that the effective issuance rate of ETH supply has slowed by 36%.
In the extreme case of high demand for block space, net ETH issuance does cause net deflation, that is, more ETH is burned than issued. It is worth noting that according to the current PoW issuance schedule, reaching this level of deflation will require much higher network usage than today.
With the new issuance of 80,000 ETH from August 5th to 10th, the 28,400 ETH previously supplied has been burned through the EIP-1559 fee burning mechanism.
Many examples show that there have been net deflationary blocks that have been unearthed. In the high network usage environment, especially after the transition to the low issuance status of Proof of Stake (PoS), it is entirely possible that the deflation through the destruction mechanism will structurally destroy more than issuance.
There is also an argument that EIP-1559 net reduced selling pressure, because the supply is expanding at a lower rate, the dilution of existing tokens is smaller, and the demand for holding ETH tokens increases accordingly. As the transition to Proof of Stake (PoS) is getting closer and ETH holdings are converted into the number of validators, miners are also more motivated to hold a certain percentage of ETH.
An interesting note is the exchange’s net position change indicator. It shows that there has been a considerable outflow of funds throughout July, and the price of ETH was around $2,000 at the time. The outflow has slowed down in relative scale, but it is still high compared to historical standards. After EIP1559, it has not yet had a significant impact on the transaction flow, but this is an indicator worth paying attention to.
Explore governance token valuation metrics
The token price of the entire Ethereum ecosystem has also seized market opportunities in the past few weeks. Under these market conditions, it is useful to take a step back and think about how to identify the asymmetric value of governance tokens. The goal is to identify tokens that may be underestimated compared to their core basic indicators and on-chain utilization.
Value Lock-in (TVL) and Valuation
Starting from the simplest analysis, we might compare the ratio of the total value (TVL) locked in the agreement to the token market value. Although TVL alone is not enough to measure the adoption, efficiency, and future value of the agreement, it can be a useful indicator for understanding short- and medium-term price behavior. Many people track TVL, so it has a reflexive effect on price and attention. It also provides us with advanced indicators of liquidity and product market fit added to the agreement (taking into account liquidity mining that may distort interpretation).
In the process of searching for value, we can see that, for example, Compound or Year, relative to the price performance of tokens, recently surpassed the agreement TVL. On the other hand, sushi is an example of the opposite observation. TVL growth has remained relatively stable, and the weak price performance reflects this.
Agreement revenue and valuation
Agreement revenue can create a powerful narrative for token holders interested in existing or potential cash flows. These are the accumulated income of many core DeFi protocols, which are directly used for finance or rewards to token holders. The higher the fee/market value ratio, the greater the value of each dollar invested by token holders (in theory).
In theory, COMP once again shows itself as a value game competing with AAVE, equivalent to 30 days of revenue, but MC is only 50%.
Please note how we display 2 lending agreements (Compound, Aave) next to two decentralized exchanges (Sushiswap, Bancor). In conducting these analyses, it is useful to compare projects by track to reflect similar cost generation mechanisms and competition for the same group of users. Comparing directly across the track is usually inappropriate and can be misleading.
Measure agreement cash/liquidity
We compared TVL with market capitalization in the previous section, trying to find the underestimation/overestimation relative to the allocated user capital. We can also use more important indicators, such as the fees incurred for TVL, to measure the efficiency of the agreement relative to the agreement’s liquidity.
TVL can’t tell the whole story, because the efficiency of the agreement may be much lower for the value that users allocate to their pool. For every dollar deposited, it may incur fewer fees. Therefore, the cost of deployment can be compared with TVL to directly measure this.
- A higher TVL/revenue value indicates a lower cost per locked dollar
- A lower TVL/revenue value indicates a higher cost per dollar locked
Note how much money is allocated to the two loan agreements ($10B+) to create each dollar of marginal income. Compound continues to show compelling arguments that are undervalued compared to Aave, and its TVL/revenue expenses have increased by 18%.
Regarding the two DEX agreements of Sushi and Bancor, the difference in fees is not so significant. The difference in this indicator is 11.7%, even though Bancor’s market value is only 44% of Sushi. Next we will compare the user groups of these protocols.
Users and market value
The total addresses that interact with the protocol are generally considered to be similar to the number of users. Considering a similar analysis framework based on this indicator also tells an interesting story. First, we evaluate the cumulative all-time user count for each protocol, where:
- High market value/user ratio indicates that the number of historical users relative to market value and potential overestimation is low
- Low market value/user ratio indicates a large number of historical users relative to market value and potential underestimation
Once again, we see Compound and Sushi are among the best on their respective tracks.
However, we must be careful when studying cumulative user metrics. Depending on the observed time frame, there may be deviations in the number of users. Although Compound users look dwarfed by Aave, looking back at 30 days of user growth tells a slightly different story. Compound’s user growth rate is still faster than Aave, but it has not reached the extremes shown in the table above. Also note the relative healthy growth of Sushi and the stagnant growth of Bancor.
Suggestions for further exploration
Consider exploring each indicator by replacing the market value with a fully diluted value (FDV). FDV represents the total value of the project after considering the total supply of the fully issued, which itself can be used to compare with the market value and serve as a guide for the selling pressure of future issuances.
Although Compound has shown a compelling value argument in the above analysis, it is worth considering that its token inflation exceeds Aave. Even so, the price of Aave FDV is $6.5 billion, and the price of Compound FDV is $4.9 billion.
Exploring FDV presents an interesting reality. Many tokens are priced at their market value because this is the value that investors are accustomed to viewing on price browsers. Exploring FDV, we found some interesting anomalies among the tokens with a large total supply. Many items other than the top 100 in market capitalization that you might overlook are actually the top 100 in FDV. Curve is an example of this. Its FDV is about $7 billion, which is completely within the top 100, but it is always outside the top 100 by market value.
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