• Bear Market Valuations

Crypto Exchange Perspectives

Updated: Apr 1, 2019

We (BMV) have developed a perspective on the current (February 2019) Cryptocurrency exchange market, and may have identified a potential investment opportunity.

Welcome to our first research article. While we will do our best to distill key findings from our research below, we highly recommend (1) doing your own research and (2) reading the full research report HERE.

This material is advisory only, and any positions taken may be at your own risk. BMV may hold positions in the underlying assets. Naturally, we do tend to believe our own research.

Our Objective Today:

Despite the increasing maturation of the Cryptocurrency space (and the growing acceptance that distributed ledger technology will play a role in finance) there is a lack of fundamental financial analysis in this space. For our introductory research article, we focus on Cryptocurrency exchanges - we have found that understanding these players, and the longer term trends impacting them, provides a strong knowledge foundation that helps inform more esoteric areas we hope to delve into in later articles.

In this article we will:

  1. Briefly explain why markets tend to consolidate

  2. Assess the industry as it currently stands, and make a few predictions

  3. Attempt to provide baseline token valuations for select exchange utility tokens

Related to #3, Bear Market Valuation (BMV) ONLY attempts to create baseline valuations. It is our perspective that many assets in this market represent 'call options' on future development and adoption. We ignore all non-certifiable claims to create a valuation we believe a token should always trade above.

1. Markets Naturally Consolidate

There is a significant amount of theory, empiricism, and logic behind the claim that markets tend to consolidate, and we will give a highly reductionist version below:

  • Larger markets reduce search costs: Larger markets are objectively better than small markets to identify a trade counterparty to do business with, even in opaque or poorly traded assets

  • Higher volume provides better prices: Larger markets reduce the risk of trade slippage, and lower the bid / ask spread

  • Larger markets provide better security: Larger markets are economically incentivized to afford better security / comply with regulation, and have reputational incentives to discourage negative trading behavior

In short, large markets tend to grow larger as they provide the best user experience. This positive return to scale leads leads to high concentration of volume on just a few platforms (think Amazon, Ebay, Craigslist, NYSE, etc.).

2. The Cryptocurrency Exchange Market is Oversaturated

Using equity markets as a crude comparison, we find that approximately $300T worth of assets are traded on just 60 exchanges. By comparison, for a market capitalization of $120B, there are 240 Cryptocurrency exchanges. There is an extremely long-tailed distribution of exchanges (see slide 5 of report), and we believe the volume traded on those exchanges will naturally accrue to today's current top players (or new entrants from traditional finance - Fidelity Digital Assets, etc.).

Normalized Exchange Volume

Beyond volume, there are a few other key considerations which serve as potential differentiation and bases of competition. Of the exchanges BMV believes will succeed, Binance and Liquid both have issued exchange tokens worth exploring further (BNB and QASH respectively).

3. BNB has Intrinsic Value, QASH is a Potential Opportunity

BNB and QASH valuations are underpinned by commitments from two of the largest volume Cryptocurrency exchanges, which makes them relatively easy to deconstruct. The summary of our findings is below, and specific details on the valuation methodology are summarized below the chart (and in better detail in our full report HERE).

In each case, we viewed the token through the lens of a (1) traditionally discounted cash flow (using committed token purchases as incoming cash flows), and also performed an (2) order book analysis to understand the impact that committed token buys might have on relatively illiquid tokens.

Before delving deeper, please remember this is a BASELINE valuation - it ignores all future technology development, adoption, partnerships, etc. - anything that would be part of the 'call' payoff in the call option. Using this methodology, the price for each token should only trade at or above these prices. In both cases, we believe this 'option' value to be considerable.

Binance Coin (BNB):

  1. Fee Discounts: Year 1: 50% | Year 2: 25% | Year 3: 12.5% | Year 4: 6.75% | Year 5+: 0%

  2. Quarterly Token Burn (Using 20% of exchange net profits)

For BNB's valuation, we place 0% weight on fee discounts, and all value in this case comes from the Quarterly Token Burn. In short, our issue with the fee discounts is Binance is economically incentivized to immediately sell any BNB received for fees back on the open market, simply increasing token velocity (but not value). Only the quarterly buy-back and token burn is guaranteed to provide some value.

For the order book analysis, BNB is a highly liquid token, and the annualized committed buys amount to around 1/3 of a percent of its annual volume. This is negligible, and not worth exploring further.

Liquid (QASH):

  1. Fee Discounts: Perpetual: 50%

  2. Various (Airdrops, HODL Campaigns, etc.)

For QASH's valuation, we place 0% weight on the various one-time windfalls that Liquid sporadically announces for QASH. These simply are too unpredictable to add value, and tend to have geographic restrictions.

There is considerably uncertainty about the scope of commitments that Liquid has made for QASH, so we felt we had to publish a range of valuation (Pessimistic - Optimistic). Per Liquid's management team, more detail on these assumptions will be released in March 2019 - and this report will be updated with the incremental detail.

QASH's order book analysis was of particular interest to us. This is a highly illiquid token, and even in the pessimistic state we see considerable daily buy pressure forming. Projecting this out (even with extremely conservative assumptions) gives a lower range 2020 forecasted price of $0.32 / QASH. Given QASH trades at the time of this writing at $0.07, and Liquid daily volume is nearly 2x our $100M projection, we see this token as having considerable upside.

Notes: Per Liquid's marketing team, there are hints of additional 'utility' to be added to QASH in March. This has been ignored for this valuation. Further, fees may only be enacted on global accounts - which has been conservatively factored into this analysis (pessimistic case assumes just 20% of Liquid volume is outside of Japan).

Author's Notes: While Liquid has set incredibly ambitious goals for itself, it has also demonstrated a history of missing key development deadlines without communication. We believe the ambitious nature of Liquid's objectives outweigh the development risk, but DYOR. We do not recommend taking any position in QASH until they have clarified the fees / utility to be enabled in March 2019.

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