Quantitative and Qualitative Analysis: Interpreting the Value of Tokens and Protocols
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Quantitative and Qualitative Analysis: Interpreting the Value of Tokens and Protocols
Which quantitative components can contribute to the perceived value of capital assets?
Navigating Web3 tides with focused insightsAuthor: Robert Mullins
Compiled by: TechFlow
In this article, we will explore which quantitative components can contribute to the perceived value of capital assets. Combining qualitative and quantitative aspects helps explain why a token or protocol is assigned a specific value. Both aspects are equally important, and founders should give them equal attention when building successful Web3 businesses.
Quantitative Components
Data-driven asset valuation has become the standard approach in traditional financial systems—whether through comparing price-to-earnings (P/E) ratios of similar companies, performing discounted cash flow (DCF) analysis, examining earnings per share (EPS), or using any other popular quantitative method.
In the Web3 space, such analysis is less common than in traditional finance. Before smart contract advancements enabled DeFi, NFTs, and thousands of other applications to be built on-chain, quantifiable data points were limited to network usage via token transfers and fees paid to miners or stakers. Now, as the market matures, the data required for quantitative analysis is increasingly available, making this aspect of token valuation an area of growing focus for investors.
Below are some quantitative factors that can serve as part of research into what gives a token its value:
Total Value Locked (TVL)
Total Value Locked (TVL) is currently one of the standard metrics used to assess a protocol’s value. Primarily applicable to DeFi, this metric considers the total value of all crypto assets locked within a platform. This includes assets borrowed on Aave or liquidity provided to pools on Uniswap.
TVL often serves as an indicator of product-market fit (PMF), with protocols having the highest TVL generally considered the most trustworthy in terms of security and usage. This is because liquidity tends to flow toward the most actively used platforms, which in turn generates fees for liquidity providers.
DeFi Llama is a useful resource for researching current protocol TVL.
Number of Users
The number of users for a specific product or protocol can be used to infer adoption rates and the protocol's PMF. This data can be combined with other metrics to determine whether the product is achieving growth relative to competitors. User numbers for a protocol can be found on Token Terminal.
Revenue
Token Terminal defines revenue as “fees generated for token holders.” This revenue comes from fees generated through platform usage and captured by the protocol. The revenue associated with a given protocol represents the residual income the protocol (or token) captures as profit. This should not be confused with fees (sales) examined in price-to-sales ratios. Revenue refers to the net profit attributable to the project after deducting potential payments to various stakeholders. For example, it is the portion of trading fees retained by an AMM after liquidity providers have received their share.
By monitoring a protocol’s revenue, you can determine whether it operates as a profitable, revenue-generating business and whether its token captures value from the operations. These profits may or may not be captured by the token, depending on the token value capture mechanism designed into the system. Given the complex and varied nature of value accrual mechanisms across protocols, understanding how a token is intended to capture value generated by the protocol is crucial.
Market Cap / Total Value Locked (MC/TVL)
Evaluating similar protocols by dividing fully diluted market cap by total value locked allows assessment of the ratio between these two metrics. Comparing this ratio with industry peers can help determine how these projects are valued relative to each other.
Price-to-Sales (P/S)
The Price-to-Sales (P/S) ratio is a metric derived by Token Terminal based on protocol data. It is calculated by dividing the fully diluted market cap by annual revenue. This ratio shows how a project is valued relative to its generated revenue and can be compared across other Web3 companies.
Price-to-Fees (P/F)
Similar to the P/S ratio, the Price-to-Fees (P/F) ratio is calculated by dividing the fully diluted market cap by the annualized fees generated by the protocol. These fees may be distributed to relevant stakeholders enabling the protocol’s operation—for instance, liquidity providers on an AMM. This ratio indicates how a project is valued relative to its fee generation and can be compared with other companies in the same sector.
Discounted Cash Flow (DCF)
DCF is a valuation method that evaluates investments based on projected future cash flows, attempting to estimate what an investment is worth today based on expected future returns. Due to the lack of historical data, high volatility, and significant risks associated with this emerging technology, there is little evidence that this conventional equity valuation method is widely applied in cryptocurrency.
The traditional DCF formula is:
DCF = CF₁/(1+r)¹ + CF₂/(1+r)² + CF₃/(1+r)³ + … + CFₙ/(1+r)ⁿ
Where: CF₁ = cash flow in year 1, CF₂ = cash flow in year 2, CF₃ = cash flow in year 3, CFₙ = cash flow in additional years, r = discount rate.
Discounted cash flow uses the discount rate (r) to determine whether the investment’s future cash flows justify the initial outlay or whether the project is worth pursuing. When conducting a DCF analysis on immature or early-stage companies, future cash flows should be discounted at rates commensurate with the risks of investing in early startups—typically achieved by applying discount rates ranging from 25% to 50%.
Web3 companies, particularly tokens, involve many nuances in their monetary policies, making the traditional DCF formula not entirely suitable for analyzing crypto tokens. However, with data sources like Token Terminal now making relevant information more accessible, we will begin to see more adaptations and modifications of traditional methods to better analyze the Web3 landscape.
Implications for Founders
When analyzed in isolation, quantitative data points have limited utility, but they become powerful when combined. However, the key lies in appropriately weighing each factor according to prevailing market conditions and integrating them with the qualitative components discussed earlier.
A significant portion of value attribution depends on individual perspectives and biases. Some investors may prioritize revenue-generating projects, while others place greater emphasis on governance capabilities of leading industry initiatives. There is no right or wrong answer here—the tools listed in this article are simply instruments investors use to evaluate and value companies or tokens.
For founders, understanding these metrics is essential, as they shape the narrative presented to investors and the community. By combining qualitative insights with quantitative data, founders can demonstrate why their company and product hold value, build marketing strategies around this data, and craft a compelling story.
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