Advice from JoyWallet's regular equity research analyst contributor, Jonathan Casteleyn. All recommendations are his own.
The crypto markets are moving quickly and there are dizzying crosscurrents that make seeing the true investment merits of this burgeoning market difficult at times. What does Elon Musk hosting
Saturday Night Live have to do with the price of
Dogecoin? Are the U.S. and European Central Banks, in a coordinated effort, going to squash investor sentiment for digital assets with new regulations? Has the big institutional money already been invested in
Bitcoin (BTC)?
These are all valid questions. But in my experience as an institutional investor, if there aren’t any counterarguments in the marketplace that make investors reticent, then markets are priced to perfection and will only come down.
What I always advocate for investors is to know what you own and what your asset is worth. Otherwise, you have no idea when to buy and sell and those exercises become more outcomes of luck than anything else. For this reason, I am outlining my work on the valuation framework for my favorite digital asset,
Ethereum (ETH), and how it can easily have a fair value of $10,000 per token.
An understanding of this setup will take some of the guesswork out of seeing the bigger picture and give a more structured framework of trading and owning this important technology's profitability.
While I covered some ground in my last article on Bitcoin and its continuing potential to
compete and take share from the Gold market, I am personally more excited and have more invested in ETH, which I think is the best opportunity in the digital asset sector, right here, right now. Here's why.
Bitcoin vs. Ethereum
While BTC and ETH assets are heads and shoulders above other alt-coins in market value with BTC tallying a $1.1 trillion market cap and ETH sporting a $479 billion market value, the investment merits of each are quite different.
BTC is gaining share and investor dollars as a store of value and is benefiting from its fixed supply and growing global network. BTC, in essence, is the cryptographic version of PayPal with a broader global reach based on a decentralized network. That said, however, I don’t believe that BTC is a currency in any way, shape, or form because no one spends a currency that goes up +20% monthly (or is perceived to have that kind of appreciation).
Instead, BTC is an innovation in alternative assets that is riding the zeitgeist of the ongoing debasement of global fiat currencies and also global fixed income. Bitcoin is taking an almost dollar-for-dollar share from the more antiquated Gold market. With only an 11% share of the current exchange-traded and physical Gold market, BTC has modeled market values of $116,000 per token at an 18% market share to Gold and $291,000 per coin almost at parity to bullion.
While BTC is the “store of wealth” asset, I think ETH should be viewed as a good, old-fashioned disruptive technology.
Ethereum, or Ether or ETH, has substantial industrial logic, meaning the Ethereum network eventually will be a substitute for cloud computing infrastructure. Ethereum allows developers to create decentralized applications and
smart contracts, and is the platform on which other digital tokens are being issued. If Bitcoin is a cryptographic PayPal, then Ethereum is a digital Ant Financial with basic technology infrastructure in borrowing and lending, asset exchange, digital payments, and next-order asset management services.
This commercial utility is what separates ETH from BTC in that Ether has actual developer revenues behind its infrastructure. In 2020,
blockchain network fees on ETH were a solid $600 MM. However, fees are exploding in 2021 and run-rate revenue levels will be very close to $4 BB.
It is this industrial-use case that has drawn me in as an ETH investor. The Cloud has been such a successful disruptive technology having displaced Client-Server architecture about a decade ago and the growth trajectory and technology functionality of ETH and the setup against the Cloud looks very similar.
In 2004, the Worldwide Global Client Server industry was the dominant tech solution as private and public enterprises built their own tech hubs by purchasing server architecture to store, access, secure, and manage digital data. The Global Client Service industry was the de facto standard with $49 billion in revenues in 2004, which supported $1.3 trillion in the market cap of the related companies in the industry.
Later in 2004 however, the nascent and fast-growing disruption of Cloud-based services made physical infrastructure less necessary as companies could now simply subscribe and virtually host their tech hardware by tethering to some of the main providers such as
Amazon,
Microsoft, or Google.
This Software-As-A-Service (SAAS) model was developed to help small businesses avoid massive hardware capital expenditures coupled with the flexibility of a monthly payment schedule.
Early in the adoption of Cloud technology in 2004, $125 million in revenue supported just $3 billion in market cap. However, seven years later with a CAGR of nearly 30%+, the Cloud industry had grown to a $10 billion top-line revenue industry supporting $217 billion in market cap. Current day stats are even more impressive with Cloud-related market cap totals nearly $2.0 TT, supported by $90 BB in Cloud industry revenues.
This is where the next transition appears to be happening. Developer revenues on Ethereum, which are the main technology engine for decentralized networks, are already at a run rate of $4 billion in 2021, which is a pittance of Cloud annual sales levels of $90 billion. Thus, the next-level technology has more than ample room to take market share and grow. Ethereum’s revenue share is just 4.2% of the Cloud industry with a current-day market cap of just $479 billion, or just 25% of the Cloud industry’s market valuation.
Monolithic services like Amazon Web Services (AWS), Microsoft Azure, and Google Cloud are “centralized clouds” of sorts with dedicated data centers. While the Cloud was an innovation from the old Client-Server architecture by providing economies of scales in that one tech dollar spent could benefit many tech clients, even Cloud networks will become less useful and less powerful over time.
Blockchain protocol run atop a global network of computers forms a more unified distributed network for building, hosting, and deploying new decentralized applications that will eventually be faster, more secure, and more robust than the current solutions in the marketplace.
ETH's worth
So, what is ETH worth? When thinking about how to value Ethereum, let's start with the current ETH fee run rate of $3.9 BB for 2021 and assume that ETH network growth over the next 5 years could be 3x the growth of the Cloud industry.
I then apply a standard 20x Cloud Price-to-Sales multiple (which is the current revenue multiple in which public Cloud companies trade). This arrives at a $1.2 TT market cap for ETH compared to today’s market value for Ethereum of $479 billion. For conservatism, I have assumed that ETH tokens will likely grow annually as they have done in the past, and this model is built on 125 MM ETH units outstanding supporting this final forecasted value of $10,242 for ETH.
The Ethereum network looks to have a similar disruptive setup to the Cloud a decade ago, which has amassed almost $100 billion in industry revenues and almost $2 TT in market value, which outdated the former architecture of client-based servers. I think long-term investors in ETH will be rewarded and I welcome some digital asset price mean reversion lower as the sector has moved straight up over the past 12 months.
As investors, we always advocate for a dollar-cost averaging discipline that means that successful investors, whatever their periodicity, should consistently average into assets on a monthly, quarterly, or annual basis. This avoids the simple single-cost basis, which is normally not the best entry point over time.
