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How to value crypto-currencies

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How to value crypto-currencies

Cryptocurrency traders are using a new kind of valuation measure — the NVT ratio — but some financial traditionalists are questioning whether this helps people understand cryptocurrency valuations.
A primary concern with cryptocurrencies is that there appears to be no way of assessing their true value, says Andrew Evans, fund manager at Schroder Global Value Team.
He explains that one of the most basic ways of assessing how a company is valued by investors is to look at its price/earning (P/E) ratio — that is, its share price divided by its earnings-per-share — and comparing that, for example, with history, with its peers or with the wider market.
However, he says that aficionados of bitcoin and other crypto-assets have started to refer to their own kind of P/E ratio.
“The measure’s actual name is the Network Value to Transactions (NVT) ratio, which — to take bitcoin as an example — is essentially the market value of all the bitcoins in the world divided by the US dollar value of transaction activity,” he explains.
The NVT includes a reference to the value of the crypto-asset on both sides of the equation, which is redundant, Evans argues.
He adds that the ratio effectively boils down to considering the value of an asset relative to how much speculation there is in it — meaning, if you want the NVT valuation of a bitcoin to fall, you just need to trade it more and more.
In fact, Evans believes that this may be why bitcoin investors are so keen on the metric — the more they speculate, the “cheaper” the asset becomes and the more they can encourage fresh interest in the market.
“As an example, according to Woobull.com, the bitcoin’s NVT stood at around 60x in June, close to 100x in October and is currently back down to around 60x,” says Evans.
While its advocates may argue the NVT ratio is similar to the P/E ratio, Evans says it is actually akin to looking at the market capitalisation of a company — put simply, its size — divided by the value of the shares being traded daily.
Doing the maths on three arbitrary well-known companies tells us GlaxoSmithKline, Centrica and Proctor & Gamble are respectively on 550x, 193x and 321x — in other words, just random numbers.
“So we would argue that, while the NVT may be gaining greater currency among crypto-asset investors, it does not tell anyone a great deal about anything — or at least not about the asset under consideration.
“It might, however, tell us something about the human race’s inherent need for reassurance they are not doing something silly,” he adds.