Cryptocurrency valuations can be based on network size: Goldman Sachs – Markets Insider


The photo shows physical imitations of cryptocurrency

Correctly valuing cryptocurrencies is complex, given their lack of tangible fundamentals. While digital assets don’t have established practices to determine valuation or pricing, they do share attributes with traditional assets and can be tied to similar fundamentals, according to a Goldman Sachs research team.

Economist Zach Pandl and strategist Isabella Rosenberg explored comparing crypto valuations to the equity value of social media firms based on metrics like monthly active users.

Crypto prices may be “related to the value of their underlying distributed networks, in the same way that equity valuations of social media companies like Facebook are related to the value of their proprietary networks,” they wrote in a note published Monday.

The team used Metcalfe’s law, which states that the value of a network is proportional to the square of the number of users, to explain the relationship.

To valuate the number of users of a cryptocurrency, they used blockchain addresses that could be a gauge for network size. These addresses are public identifiers for people who make cryptocurrency transactions.

“Addresses are therefore related to the number of users on the network, but the two concepts are not identical,” the analysts wrote, suggesting that addresses are likely to overstate the number of active participants.

Cryptocurrency assets are already attached in value to their market capitalization, which is the total worth of all coins mined.

So the research team compared the number of users with the cryptocurrency’s free float market capitalization, or the total value of all coins excluding those held by project founders or otherwise unavailable to the market. This was done to find a correlation between major cryptocurrencies.

The eight assets included in their analysis were bitcoin, bitcoin cash, dash, ethereum, ethereum classic, litecoin, XRP, and Zcash based on data from Coin Metrics.

“We observe a clear correlation between market capitalization and network size in cross-sectional data,” the analysts said.

The analysts noted that rising prices may generate more speculative trading activity, and consequently a growth in network addresses. So rising network activity may not be a direct representation of cryptocurrency “fundamentals,” or their platforms do not have higher economic value due to higher speculative trading.

“For cryptocurrency networks to have sustainable value, activity will need to be driven by non-speculative use cases. While these could develop over time, at the moment the real-world use of cryptocurrencies remains limited,” they concluded.

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