Crypto assets are relatively very new entrant into the asset class and there is no organized method to value a crypto asset.

Crypto assets are digital assets and can be used for either of the below purposes.
- Store of value
- Medium of exchange
- As a commodity for the base protocol architecture which the token is a part

The value of a crypto asset depends up on 
a) Token type 
b) Use case of the tokens.

There are different types of tokens such as, tokens which represent a project cash flow and derive value from those cash flows, tokens which give ownership rights in a project and there are other utility tokens as well.

Valuation methods are completely different for each type of tokens.

Before moving on to the different models of valuations of Crypto assets /Crypto tokens / Crypto currencies, lets understand some important concepts.

**What is a crypto token?**

A crypto token is a virtual currency and it represent a tradable crypto asset, or it can represent a utility of a block chain protocol. These tokens can be used for its intended utility or for exchange of value or store of value by the holder of the token.

**What is a protocol?**

A protocol is a general set of rules and in block chain, a protocol establishes the basic structure of the distributed database which allows the secure transfer of digital value and data. The first token issued in the block chain technology is the Bitcoin and it is nothing but a collection of bitcoin protocols which allows safe exchange of digital money. Protocols allow crypto currencies to spread across the network of full & partial nodes with no central authority.

The major contribution of Bitcoin protocol was the creation of a digital money which can be traded and spent without the issue of double spend (Double spend is the possibility of purchasing a crypto currency which was already spend and it is worthless now, just like purchasing a ticket from a black market and when we approach for entry, it is already used). Subsequent to the Bitcoin white paper, there were many advancements in crypto protocols with multiple functions and there are many crypto currencies came up with their own protocols.

One such major protocol was Ethereum protocol which is designed around a smart contract which means, contracts / agreements which automatically executes if the preconditions / criteria is satisfied. Now, there are multiple protocols with in the Ethereum block chain architecture which decentralized many financial products like insurance, lending etc. and automated the underlying agreements using smart contract protocol. There are many smart contract protocols other than Ethereum protocol also developed over the time in the block chain universe.

**What is NFT?**

Non fungible tokens are a unique digital asset which are not replaceable with other digital assets. Fungible tokens are replaceable with another token which is identical to it. E.g., Bitcoin, Ether etc. One Bitcoin can be exchanged for another Bitcoin as they have same value, every fiat currency also works in this way. But NFTs are not crypto currencies like Bitcoin & Ether, but they are based on protocols which guarantee ownership of an asset. Most NFTs are Ethereum based tokens and gives digital title to assets such as real estate assets, art works, music etc. Each token is different from other ownership tokens and is non fungible in nature.

**Who are Block chain Validators?**

A blockchain validator is someone who is responsible for verifying transactions on a blockchain. Once transactions are verified, they are added to the distributed ledger. In proof of work (PoW) systems like Bitcoin, validators, also known as miners, solve complex computational math problems in order to win the right to verify transactions and receive rewards for the “work.” In proof of stake (PoS) systems like Avalanche, validators are given rewards as long as they stake the network’s token (AVAX) and correctly participate in the network. This mechanism helps secure the network by imposing the need to lock up value in the network in order to participate in the consensus decisions.

How will one value these multi variety of crypto assets? each one is different from other crypto assets, which may seem similar but will be completely different on protocols, utility, token type etc.

**Valuing a Crypto Asset**

Generally, the value of a crypto asset is the function of the below three elements / process.

Economic Value creation
b) Supply of Token
c) Risk factors.

The total universe of expected Fair market capitalization of the crypto asset is computed and it is adjusted to the number of tokens available to arrive at the expected fair price of a token. Finally, the risk associated with the tokens such as technology risk, security risks, regulatory risks are adjusted to arrive at a final risk adjusted value.**

Some of the valuation experiments are as follows**

A) Valuing block chain protocol tokens: – The base protocol tokens like Bitcoin, Ethereum are very difficult to value because each tokens has multiple usage and it fulfill different functions. The protocol tokens have a floor value or intrinsic value unlike a fiat currency. The intrinsic value is derived from the transaction cost economy that the protocol supports. For example, a user in a block chain pays transaction costs to a validator and the present value of the future transaction costs act as a base line for valuation.
The floor Value of a Token based on Proof of stake protocols is the function of minimum transaction cost and minimum yield the validators accept and the floor value of tokens based on proof of work protocols is based on the minimum demand for the asset.

B) Valuing crypto currencies as a store of value: – A token which is used as a store of value is valued similar to a safe heaven commodity like gold and this method is flawed by its over dependence on the belief that supply derives value which is often untrue.

C) Valuing Application layer tokens: – These tokens rely on the basic infrastructure of another block chain and usually possess less store of value characteristics and hence not valued as a store of value token and it not even valued as a currency since a currency’s value is depended on its velocity and if we apply that model, these application layer tokens may fetch zero value which is also not correct. So, the common practice is to value these tokens according to the economic value generated by the basic project if the economic model (tokenomics) of the token has strong economic link with the value generated by the project.

D) Valuation of Security Tokens: – These tokens are direct parallels of traditional assets and confer the same entitlement to the cash flow and assets. They are valued in the same way as the traditional securities are valued.

F) Valuation of Tokenized Assets: – The example of tokenized assets are tokenized version of real estate or financial assets etc. They have the same value as the underlying assets such real estate and financial assets. The major point is to adjust the values for the platform risk.

G) Valuation of NFTs: – These tokens are very difficult to value since they gives ownership rights on assets whose values are highly subjective and individual centric (for example an art work can be valued by an individual at millions of dollars but others may value it based on its basic paper and paint which will give a completely different value)

H) Valuation of Stable coins: – The stable coins are also crypto currencies which are not mined but peg its value to some group of underlying assets. These are valued equal to the value of underlying currency or commodity they replicate.

**Supply of tokens and Risk Adjustments**

The fair market capitalization arrived at using any of the above methods needs to be adjusted to the supply of tokens and the inherent risk associated with the tokens. The various risks associated with platform such as a) Regulatory risk b) Security risk c) Technology risk etc. are adjusted to arrive at a fair value of the tokens.

**Conclusion**

These are some experimental methods applied to value a token / crypto asset and the experimentation is still going on to arrive at a stable model which link the value created in the decentralized economy with the value of tokens (tokenomics).

In an era of financial transformation, learn how digital currencies are reshaping economies worldwide.

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Digital Currencies

Central Bank and Fiat currency

One of the main responsibilities of a central bank is to make available sufficient money in the economy as long as there is a demand for it. The central bank issues money in paper or polymer form which is the legal tender in the respective country which is normally called as fiat currency. The value of the currency is totally based on the economic activity and the economic strength of the sovereign state.

Normal form of the currency eco system is as follows

**Digital Transformation**

With the evolution of technology and advancement in the field of digital fintech solutions and the transformational cum radical utility requirements from the users has changed the landscape of the currency eco system which was completely controlled by the central banks of respective countries.

Larger participation from payment service providers and stored value issuers in the currency cum commerce ecosystem has changed the shape & reach of the system from currency centric to value centric eco system. The users have started utilising the fiat currency through digital platforms and started to store values in private wallets for subsequent/ immediate usage. But still an acquiring bank or a settlement bank is a must. Then comes the Digital currency.

**Digital Currency
**
Fiat currency centric transactions are inherently prone to state sponsored exchange rate control measures as the mighty sovereigns will continue to use the monetary policy to artificially control the exchange rate to protect the economic interest of the state which is the ultimate thread of universal trade. This has given rise to different classes of currencies such as mighty currencies and weak currencies which is based on the relative strength of a particular sovereign state. The relative strength of the currency is akin to the relative comprehensive strength of the state which issues the currency. The currency can be s used as a tool to push economic ambitions of any state which has the economic might to do so.

One users’ loss is other users gain and it was always unjust looking from a human angle of equality of effort such as effort of one human group in 8000-mile East should be considered equal in value terms with the same effort of human group in 8000 miles West. But in reality, Historical dominance of a mighty state will come into play when come to real time valuation of an effort by an individual who wish to engage in an international exchange. The technology has come out with a decent solution to this particular situation in the form of DIGITAL Currency.

**Reality of Private Currencies**

Many factors have played pivotal roles to give life to encrypted, decentralised block chain technology architectures driven and token-based currencies from private players into the currency domain which was for the known history of human kind was issued and controlled by sovereign countries. They are normally addressed as crypto currencies.

**Some of the factors are**

a) the utility of digital transactions
b) advancement in the field of technology,
c) large penetration of internet & exponential growth in portable device-based internet users.
The private value wallet and vault is a reality now to store crypto assets.

**But is it safe?**

Nobody knows until it is widely used as a substitute for fiat currency. Following was experienced in the crypto currency domain till date

Highly volatile in value. It is based on block chain technology and decentralised ledgers. A token is issued to the users and its value is determined by the demand and supply of the token in the platform. It is definitely independent of sovereign states decisions but all the major crypto currencies in the past have been super volatile.
Mining of crypto currency is time consuming and highly demanding to be fast and in time. It requires lots of electricity due to the high-end devices and technology used by the miners.
Adhoc fixing of total number of crypto currencies to 21 million or any other number. Majority of the Common users has no idea why it is so fixed? and who decided it? and what is the real reason for it? There could be a reason for everything but its is largely unknown to common users of crypto.
Many users in the platform are largely traders and they consider the crypto currency as a commodity for speculative trade.
Restricted conversion into fiat currencies and it is not even partially convertible freely.
There is no central issuer of crypto currencies
No sovereign has accepted crypto currency as a legal tender except El Salvador a central American state with a population of 6.5 million.
Chances of Risk of mimicking the token by internet hackers and loss of value. In case of legal tender fiat currency and loss of money in banking channels, the users have at least one entity to lodge the complaint but in this scenario, there is no central organisation to complain and try to retrieve the lost money.
It completely by pass the monetary channels & system of the sovereign states and users can freely transfer value and enter into transactions. Is it a demerit? No one knows unless until it is declared so by the sovereign.
Having painted all the points, we have to accept a fact that the private crypto currencies are here and it will stay there until it is asked to shut business.

Among all the shrouded comments about crypto currencies, the following is widely used by the naysayers “The users are participating largely out of curiosity and speculation and definitely not fully understanding what is crypto currencies are and its underlying technology. “

Why these comments are aired at loud at least from some corners of the world?

We believe that one reason for this can be, as no user has convincingly answered a question that, what is the real utility difference of digital crypto currency and fiat currencies in digital platform?

**What can be the real utility difference?  Please do not the put the below reasons in support of crypto
**
a) Free from exchange rate fluctuations and inflations
b) Free from sovereign control. Etc. etc….
If these cannot be the utility difference of crypto currency and fiat currency in digital platforms, what can be a difference? We have to look into what the user is actually seeking in a crypto currency.

**What is the feature a user is actually seeking from a crypto?
**
Are you looking for the digital utility of a currency to be stored and exchanged for any transactions? Then you already have fiat currencies in digital platforms. We fully understand the full feature of a crypto currency but for the time being, we are looking only for the contemporary utility of crypto currency vis a vis to fiat currency in digital platforms.

Of course, the users will find a reason to love and doubters will find a reason to hate crypto, whether you agree or not, crypto currencies are here and it is useful to public. Now, how will the Central banks respond to it is more interesting to know….

**Central Bank Digital Currency (CBDC)
**
Before jumping into CBDC, let’s talk about online utility payments, eCommerce, e-wallet, and stored value facilities.

Initially, with the emergence of fintech platforms, users have started doing e-commerce and online payments widely. They were largely dependent on the account bank and their online platforms. This was partly due to the requirement of account settlement with the counterparties in fiat currencies (which is still very much there) and the absence of many payment service providers. The value stored in their bank accounts was used to transfer and transact online.   Then with the advancement of technology more payment service providers came into the arena with web-based and portable device-based applications to transact and transfer value for various needs.

With this, the traditional banks lost payment bank tag and business, they remain as the account & settlement institutions and Lending institutions. Everyone was caught unaware when the digital wallets came into force and payment service providers and stored value issuers joined hands to offer to buy now pay later utility (BNPL) to the users without any interest payment for the usage of money. It is slowly taking away micro-credit from the banks. This utility is increasing the economic activity without additional cost burden and it is growing exponentially.

Banks started to lose another tag and business from being an omnipresent & omnipotent PAYMENT CUM SETTLEMENT CUM LENDING INSTITUTIONS, they lost payment services and then started losing lending business to the fintech based cost-effective platforms. The only area which was untouched was the settlement institution tag and business.

Private wallets and private digital currencies will take away this business also if allowed to be flourished and people started using crypto currencies akin to legal tender fiat currencies. Settlement institutions are not at all required in the new ball game.

The banks have to look up to the central bank to intervene which has intervened in many a times in the past such as coming with a) unified payment cum recognition solution and allowing fellow participating banks to be part of the settlement mechanism where payment service providers are categorized as App-based interface only b) Seamless integration with core banking solutions to speed up the Realtime settlement which is the inherent feature of any fintech private platforms etc.

How will the central bank respond in such a situation where private wallets and private currencies are offering real-time value settlement bypassing all the conventional banking routes.

Will the central bank ban this utility? of course not, since it is bringing in rich economic benefit to the state. The central banks have started to brainstorm about the possibility of issuing their own sovereign digital currency.

CBDC (Central Bank Digital currency) is nothing but the fiat currency issued in digital form and it’s completely different from the fiat currency traded through digital platforms. Few possible features of CBDC can be

Programmable in nature: – The digital legal lender can be programmed to restrict the usage to one particular purpose. It is highly likely in states where the state subsidizes a variety of requirements of many sections of the society. It will guarantee no leakage. It can be programmed to expire within a certain period of time and it will increase the spending hence economic activity.
The sovereign will have absolute control over the money flow and it can use technology as a means to create barriers for money flow and hence influence the exchange rate.
Settlement banks will be a reality for life to the users and the value will be stored in the account bank. All the other players will be intermediaries for trade and final settlement in one particular currency has to be ultimately done with the settlement and account bank.
It has all the risks which typical technology-driven and technology-run digital platforms possess. It is totally based on network-centric real-time processors and internet connections, which will be a humongous task for a population-rich emerging market state.
It is a disruptive technology and how it will impact those economies which are currently dependent on cash transactions for smaller denominations and bank instrument-based transactions for high-value transactions are yet to be analyzed.

Currently, all the central banks are working towards a phased implementation strategy and examining use cases that could be implemented with little or no disruption. As per the recent Reserve bank of India (RBI) presentation on the topic “Central Bank Digital Currency – Is This the Future of Money” dated 22.07.2021 below issues are pointed out.

the scope of CBDCs – whether they should be used in retail payments or also in wholesale payments;
the underlying technology – whether it should be a distributed ledger or a centralized ledger, for instance, and whether the choice of technology should vary according to use cases;
the validation mechanism – whether token-based or account-based,
distribution architecture – whether direct issuance by the RBI or through banks;
degree of anonymity etc.
 

However, conducting pilots in wholesale and retail segments may be a possibility in near future.

 

Few examples of such initiatives are:

Digital Yuan by the Chines central bank where the digital currency came with an expiry date which has to spend within a stipulated period of time. This has created compulsive buying.
E RUPI by GOI: – Even though it is not completely a digital rupee, rather it is an e-voucher that is based on SMS strings where the Govt. will pass on redeemable vouchers to the mobile number linked to the unified identification platform such as Aadhar. The users can redeem it for the intended purpose but only for the intended purpose.
Conclusion

Digital inclusiveness and Real-time processing are here to stay and like the new age, private players sovereign will allow other traditional players to be part of the game by changing the turf altogether. A digital currency issued by the sovereign state based on the strength of the state is a certain reality in the future and it will have all the major traditional features of present fiat currencies and it can be used in all the modes and utilities a private cryptocurrency can be used.

Final words, “Absorb technology, respect rule of law else get dwarfed and eventually get extinct.”



"Unveiling the Future: Digital Currencies and the Emergence of CBDCs"

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Funding Possibilities L.L.C FZ
samisha.ambre@fundingpossibilities.com

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Valuation of Crypto and its important concepts

July 13, 2023

Digital Currencies

July 13, 2023