Propose a basic valuation framework and possible valuation ranges.
Written by: Andrew Kang, Benjamin Simon, and Daryl Lau, partners, researchers, and partners of Mechanism Capital, respectively. Compiler: Perry Wang
The author authorized Chain News to publish the Chinese version of the research report
Since YFI was launched in July, it is no exaggeration to say that it has swept the entire cryptocurrency world . Although its creators issued some strongly worded warnings: “The value of YFI is 0” and “I test it in production”, the price of YFI has exploded, reaching a peak of nearly $44,000 per token. , The total market value is about 1.3 billion US dollars .
The rapid rise of YFI is largely due to its mystery . YFI’s ” fair start ” and lightning-fast token distribution schedule-all 30,000 tokens were distributed within the first week, giving this fledgling token a great Internet celebrity explosion temperament. In addition, YFI’s early success has inspired a strong and active community with distinctive characteristics.
But the Internet celebrity explosions and community governance are just superficial qualities. Its underlying essence is the governance token of the DeFi protocol yearn.finance. yearn.finance is a veritable behemoth that Andre Cronje has been promoting for several months, and the agreement continues to upgrade at an alarming rate.
Not only did Andre implement the original vision of building an automated stablecoin revenue optimizer , but he also formulated a grand plan to build an fascinating financial building on these solid foundations.
Obviously, YFI tokens will play an important role in the future of the Year ecosystem. The purpose of this article is to propose and discuss some key frameworks for the valuation of this token .
Total Value Locked
A common method of basic valuation in DeFi is to look at the relationship between the TVL of the agreement and its market value. But we don’t think TVL is a reliable indicator, because the agreement can vary greatly in terms of the benefits that can be generated from its ” lock-up value “.
An alternative approach is that our main focus on YFI is not on TVL, but on YFI as an income-generating asset for currency holders.
For now, Year’s machine gun pool yVault charges users a 5% performance fee (based on yVault revenue, not TVL) [1] and charges a 0.5% fee for withdrawals from yVault. These fees are allocated to YFI holders who pledge in the governance contract. [2]
Although TVL is usually used for valuation, it has no reference value for us because TVL only accounts for part of the agreement’s income equation. Valuation of YFI through TVL is similar to valuing a company through labor size rather than revenue. Companies such as Macy’s company may employ many workers and may even generate a lot of revenue, but compared with such higher-margin company Netflix, Macy’s profit margin dwarfs, “even though the value of the production process of Netflix “Lock” is much less.
P/E ratio
The current price-earnings ratio model commonly used in the securities market as a valuation method is much better than TVL, because this model regards YFI as a production asset , and YFI does.
The existing price-earnings ratio valuation method allows us to briefly understand the relationship between YFI’s current income and its market value. The following is our current P/E ratio calculation, assuming the YFI pledge rate is 100%. [3]
In order to compare the P/E ratio of YFI and other DeFi agreements, we must first distinguish between price/earnings (P/E) and price/revenue P/R (also called price/sales). The two are often confused.
YFI’s P/R is approximately 2.5 times: the market value of $1 billion divided by the annualized revenue of $400 million for Year users. YFI’s P/E is approximately 11.5 times , which is obtained by dividing its market value by the annualized income of YFI holders.
In order to maintain consistency, we hope to compare DeFi’s P/E ratio . To this end, we first need to determine which protocols can bring benefits to token holders. Then, we considered the unique token economics model of each protocol, and calculated the current P/E ratios of these protocols one by one. In order to standardize our comparisons, we used the fully diluted market capitalization and annualized returns over the past 30 days , and also, as we did above in the current P/E ratio of YFI, assume that the pledge rate of each plan is 100%.
It is clear from this chart that even after the recent price spike and subsequent decline, YFI still has the lowest price-to-earnings ratio among these agreements.
But a surprising finding worth noting is that a considerable part of the income comes from the high withdrawals from the yVaults machine gun pool in recent weeks. By calculating the weighted average of each yVault’s daily withdrawal rate, we found that about 57% of the weekly income in the past 14 days came from this item. [4] Even if the withdrawal fee only applies to the yVault machine gun pool, the rate is only 0.5% , and the withdrawal fee alone generates more than $66 million in annualized revenue. We believe that the high withdrawal amount is the result of constant changes in the revenue farming pattern, which has led to frequent movement of users’ assets. In contrast, the 5% performance fee charged by yVault’s earnings only contributes less than a quarter of the total annualized earnings of YFI pledgers.
yVaults machine gun pool withdrawals have begun to slow down, and we expect this trend to continue. We expect that the final withdrawal fee income will reduce the share of income generated by YFI holders in the Year agreement, similar to the ratio of withdrawal fees to transaction fees charged by exchanges.
Performance: a more sustainable source of revenue
If withdrawal fees are unlikely to become the main source of income for YFI holders, what kind of income will replace it? We think Yearn Finance can learn a few things from the tricks of institutional investors , especially institutions that are non-directional and automated trading like Year.
Comparing encrypted and non-encrypted asset management platforms, source: Maple Leaf Capital
Hedge funds usually use the ” 2/20 ” fee model: an annual management fee of 2% and a 20% profit distribution (or “performance fee”). The former is calculated based on the total amount of asset management; the latter is calculated only based on the profit of the fund. Yearn can adopt a similar structure, perhaps waived the annual management fee, and can allocate a fixed share of performance fee to the development fund . In fact, Year has implemented a method of paying policymakers, paying directly to developers whose yVault strategy is approved by YFI holders.
Up to now, a 5% performance fee is charged based on the revenue of the yVault machine gun pool, but this model can be extended to charge a performance fee based on the revenue of yToken [5]. We believe that a performance fee of 5% to 10% will bring considerable value to the tokens and help fund continued protocol development. We also believe that this performance fee range is low enough that if a fork agreement charges a lower fee, it will not bring a clear competitive advantage.
A stable performance fee has the advantage of appropriately adjusting incentive measures . With the development of Year and the growth of user base, the withdrawal amount relative to TVL will naturally show a downward trend. This downward trend is also positive for Year Finance, because it means that the retention rate of the agreement continues to increase . However, the decline in the withdrawal amount will of course also lead to a decrease in the withdrawal fee income of YFI holders. In contrast, the performance fee allows Yearn and YFI to accumulate value and take a portion of the growing revenue of the agreement to compensate YFI pledgers participating in the governance of the agreement.
Forward price-earnings ratio and discounted cash flow method
Regardless of whether the performance fee is expanded or not based on both yVault and yToken revenue, it is clear that Yearn Finance is still in the early stage of development. Not only will the withdrawal rate change, but the agreement’s TVL and annualized income APY will also continue to change. Therefore, evaluation models like the current price-to-earnings ratio are naturally limited because they do not take into account future growth and changes in the agreement.
In order to fill this gap, we explored two future-oriented models: forward price-earnings ratio (end of 2020) and discounted cash flow method D CF.
For each model, we propose three “situations”: a basic situation assumption, a conservative situation assumption, and an aggressive situation value. These assumptions are not only different in TVL, APY and withdrawal amount, but also in performance fees and withdrawal fees.
We should emphasize that these situations do not mean that all future possibilities can be covered. Of course, permutations and combinations of different situations, such as high TVL growth and low agreement fees, are completely reasonable. It is assumed that only three cases is how to provide a direction for YFI valuation based on future potential of YFI. [6]
Forward P/E ratio (end of 2020)
The following are the three scenario assumptions we made for the P/E ratio model at the end of this year.
A note first: Since performance fees are currently only applicable to yVault, we include two different P/E ratio calculations for each situation: one only calculates performance fees for yVault, and the other for yVault and yToken income Both calculate performance fees. The performance fee cell containing yToken revenue is shaded in light purple.
Base case assumption
The basic situation we envisage for the end of the year is: assuming that the TVL of yToken and yVault has increased, but assuming that the withdrawal rate of yVault has decreased slightly. We expect that in the next few months, the enthusiasm in the revenue farming market will continue, but the APY of yVaults and yTokens will decline slightly . This basic assumption keeps yVault’s performance fee unchanged at 5%, and includes a 5% performance fee on yToken revenue.
Conservative situation
Under this assumption, the TVLs of yToken and yVault remain unchanged, and their respective APYs stagnate. In addition, this bearish assumption also includes performance fees and withdrawal fees that are lower than current rates, as well as a weekly withdrawal rate of 30% , which is less than half of the 14-day historical average of yVaults withdrawal rates. In fact, the lower withdrawal rate in the forecast includes historical withdrawals since Year’s establishment, which means that the withdrawal rate has to be drastically reduced to make the average drop from the current level.
Although this assumption is bearish, it is worth pointing out that the P/E ratio it generates still puts YFI in the echelon with the lowest P/E ratio among various DeFi agreements.
Radical situation hypothesis
In this case, we assume that the TVL and APY of yToken and yVault will both show significant growth by the end of this year. This assumption also assumes that the transaction volume is high, and it incorporates the assumption of a higher performance fee rate (10%, compared to 5% now).
Some factors of this bullish forecast are more reasonable than other assumptions. For example, the recently introduced wETH yVault machine gun pool demonstrates that the Year protocol can still attract capital inflows: within 48 hours, more than 125,000 ETH (market value of about 45 million US dollars) poured into the wETH machine gun pool, and the locked asset value of the machine gun pool since It reached its peak, over 250,000 ETH . In contrast, the forecast of 80% weekly withdrawal rate is extremely aggressive, especially considering the fact that withdrawals have been slowing down in recent weeks.
Discounted cash flow method DCF
The above forward price-to-earnings ratio model gives YFI’s end-of-2020 revenue estimates. However, valuation from a longer-term perspective is necessary, so that we can convert its profitability into a potential token price range.
The discounted cash flow method (DCF) valuation is instructive in this regard. These forecasts are intended to estimate the general size of discounted cash flows, not to provide accurate estimates.
For the three DCF scenarios we assume, the starting value is the same as the starting value in the forward price-earnings ratio assumption. But our DCF forecast combines the growth/decay of TVL and APY over time. What’s more noteworthy is that all three DCF cases assume a significant decline in withdrawals in the next few years. In this way, the DCF model has a distinctive feature: it can quickly understand the future valuation of YFI once the withdrawal boom cools down and the performance fee fills the main income share of YFI holders.
The last two factors before delving into the forecast. First, we assume that the discount rate is 30% and the terminal growth rate is 5% . Secondly, like the forward price-earnings ratio model, we provide two different value accumulation models for each situation: one includes yToken performance fee , the other does not (cells containing yToken performance fee are also shaded in light purple Display).
Base case assumption
The YFI price derived from our envisaged DCF basic situation is slightly higher than its historical high price, and the performance fee charged on yToken revenue means that the current valuation has real room for increase .
This hypothetical situation is expected that TVL will reach US$5.2 billion by the end of next year, US$ 15.6 billion in 2023, and more than US$48 billion by the end of 2024. Considering the speed of DeFi’s current absorption of encrypted and non-encrypted assets, we believe that this TVL growth assumption is reasonable, especially for agreements like Year that have already identified a market fit .
Conservative case hypothesis
Our conservative DCF model assumes that the overall growth rate is much lower, and its price predictions ($13,500 and $15,800) reflect the conjecture of currency prices under this pessimistic situation .
In this hypothesis, as in the other two cases, with the passage of time the withdrawal amount decreases, and the estimated income of the performance fee will eventually far exceed the estimated income of the withdrawal fee.
What factors can cause stagnation like this? We believe that, in addition to the Black Swan incident, the most serious obstacle to Year’s future expansion is whether the DeFi rate of return will drop sharply. Once this happens, if Yearn’s other product segments fail to achieve significant development, the agreement may still achieve TVL and revenue growth, but it may not achieve the explosive growth we have witnessed so far.
Radical situation hypothesis
In our bullish DCF hypothetical scenario, the valuation range of YFI tokens is between US$241,000 and US$315,000, depending on whether performance fees are charged for yToken revenue.
Assuming that by the end of 2024, TVL will exceed 150 billion U.S. dollars-this must be a very radical assumption, this value is almost three times the current market value of ETH! However, given the growth in the stablecoin and machine gun pools we have already witnessed, and Yearn has only implemented part of the planned potential strategy, we don’t think this situation is impossible.
We also don’t want to forget that tokenized real-world assets are beginning to enter DeFi. Yearn’s total potential market size is several orders of magnitude larger than its TVL, and its unreleased financial infrastructure products may further promote growth and network effects.
to sum up
Valuation of YFI is not easy. The Yearn ecosystem is very complex, and the role of YFI in it has not yet been determined. The various models we have outlined in this article produce a large range of estimates to reflect the very different results that may arise. These assumptions do not fully capture every potential source of revenue or cost, such as the growing portfolio of products built for the ecosystem, such as ytrade, yliquidate, yinsure, etc.
The main purpose of this article is to enrich the objective evaluation framework and determine the magnitude of the potential valuation of YFI in various situations.
We believe that Yearn Finance already has a unique value proposition: it enables retail investors to passively profit from the market’s revenue momentum , as if they were actively and professionally “cultivating.” If Andre continues to innovate and the community remains strong and active, Yearn has the potential to build a powerful DeFi ecosystem through a powerful and composable product suite .
Special thanks to Marc Weinstein, Weeb McGee, Andre Cronje, Milky Klim, Simon Tan, Armand Cao, Alex Wearn and others who provided valuable help and feedback.
Disclaimer: Any content in this article does not constitute any investment advice.
Remarks
The platform currently charges a 5% performance fee to subsidize Gas fees, and only charges for transactions
Once the accumulated amount of 5% performance fee in the treasury reaches USD 500,000, it will be distributed to YFI pledgers immediately
Currently, only 21% of YFI is pledged in the governance contract: https://stats.finance/ygov
You can see the withdrawal amount in this table: https://docs.google.com/spreadsheets/d/1JlsLOcicxu2DFSiDC5rs977OF9sOnAu9DBvrvR02Q/edit?usp=sharing
yToken is an independently packaged stable currency that generates income and is the underlying asset of yCRV (yDAI, yUSDT, yUSDC, etc.)
Since we are unable to include all possible situations in this research report, we have published a table containing forward price-earnings ratios and DCF assumptions for readers to read: https://docs.google.com/spreadsheets/ d/1MBQHl3Mug4WVYKgLERzBN90Tto4zB0xxhFTBE4V6rzA/edit#gid=1745957732
