Back in May, I wrote a commentary about why old school valuation metrics such as free cash flow don’t work when estimating the fair or intrinsic value of cryptocurrencies such as Ethereum (CCC:ETH-USD).
I was intrigued. Has someone come up with a financial calculation to value Ethereum?
Alas, no, Payal Shah, CME Group’s Director, Equity and Cryptocurrency Products, did not put forth such a thing. However, she did make some excellent points about Ethereum’s attractiveness, albeit in an abstract kind of way.
I’ll credit Shah. She led with the strongest argument why Ethereum has intrinsic value. That is, it has the ability to perform “programmatic smart contracts and applications via its own currency — ether.”
Indeed it does.
Smart contracts for decentralized finance (DeFi), non-fungible tokens (NFTs) and who knows what else brilliant people will do with them.
Utility Makes Ethereum Attractive
Utility remains the biggest reason to invest in Ethereum or any crypto for that matter.
“DeFi allows users to trade assets and borrow and lend directly to one another without involving banks, and also acts as a means to creatively unlock value – for payments, loans, insurance and more,” Shah wrote on Aug. 23.
The use of smart contracts still doesn’t give you the ability to mathematically calculate Ethereum’s intrinsic value from a dollars and cents standpoint. Still, it does provide comfort that it’s adding value through its platform.
I’ll throw out the final two of the five remaining reasons Shah likes Ethereum: Disinflationary Supply and Correlation to Bitcoin (CCC:BTC-USD). While they’re very relevant to Ethereum’s current and future value, I don’t see these as part of one’s calculation of Ethereum’s intrinsic value–the financial one, that is.
The third point by Shah is Ethereum’s move to a Proof-of-Stake (PoS) model from a Proof-of-Work model. You can find plenty of information on this move all over the internet and right here at InvestorPlace. So, I won’t get too much into the weeds on this one.
My colleague, Josh Enomoto, recently discussed why shifting to PoS is not without risks. I recommend you give it a read. He brings up an excellent contrarian view of the move.
Shah argues that Ethereum 2.0 has the potential to influence the future of the global financial system.
“If Ethereum 2.0 succeeds, the blockchain will have significantly more transaction-processing capability,” Shah wrote. “That scalability is needed if Ethereum is to play a meaningful role in the global financial system and to be more environmentally friendly than proof-of-work alternatives such as bitcoin.”
At the end of the day, if Ethereum can make a meaningful contribution to the global financial system while also reducing its carbon footprint to the cloud-computing it uses for its servers, it’s a win for investors and a win for the world.
I can’t put a dollar value on this, but I’d say it’s substantial.
The fourth point of Speed and Scalability dovetails with the third. Shah suggests that should Ethereum 2.0 reach 15,000 transactions per second; it would equal the speed of any centralized payment processing system that exists today.
That, too, adds substantial value.
The Bottom Line
I suppose you could say that valuing cryptocurrencies such as Etheruem is no different than valuing an ounce of gold. And while gold bugs will tell you that the precious metal has intrinsic value, they won’t be able to give you a “true” value in dollars and cents.
For years, investors such as Warren Buffett have discussed the idea of a company’s intrinsic value — MoneyChimp.com has even put together a formula — but in the end, it’s more about understanding a company’s business model and the ability of that company to keep growing by following that business model.
While articles such as Shah’s are useful to remind investors why cryptocurrencies such as Ethereum have intrinsic value, I continue to struggle with the idea that something is worth owning without a good understanding of an investment’s financial underpinnings.
Currently trading above $3,200, I couldn’t tell you whether Ethereum’s intrinsic value is higher or lower than this number. I also couldn’t tell you how much higher or lower.
If you can, Charlie Munger’s got some advice for you.
“When you’re trying to determine intrinsic value and margin of safety, there’s no one easy method that can simply be mechanically applied by a computer that will make someone who pushes the buttons rich,” Munger stated in the 2007 Berkshire Hathaway annual meeting.
The same advice applies doubly so when it comes to Ethereum.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia.