What is the Crypto J-Curve?
The crypto J-curve models how the market values a cryptocurrency over time. Usually, upon an Initial Coin Offering (ICO), or its initial listing on a major exchange, enthusiasm for a digital asset is high. It typically continues to moon (or boom) for a while. Yet, during this time, the utility value of the coin is usually minimal, or even non-existent.
As the coin gets utilised by others, potholes in the road appear, which the developers tried to patch up as quickly as possible. But enthusiasm wanes, and with that the value of the coin. However, as improvements are made to the protocol, things tick up again, drawing out a pattern in the shape of a ‘J’.
We introduced the equation of exchange in the post on crypto asset valuation. This model was conceived by Chris Burniske. However, he didn’t stop there and has extended the model further to form the ‘Crypto-J-curve’ hypothesis.
Let’s go into this step by step so that you can understand how market sentiment influences the value of your crypto assets.
Step 1: Utility Management
Burniske uses the discounted present value to measure the token utility. He assumes a specific maturity date, T, then proxies the token utility value by that date (in USD), finally discounting it back to today.
This is the formula:
Where:
PVEU = Present value of expected utility
UT = Utility of token
vt = Discount factor
Hence the price can be given by the equation of exchange:
Where:
M = Token supply
V = Token velocity
Readers should note that the utility measurement itself is futuristic. Future? Come again, Marty: In other words, if the token’s utility is considered immature today, we should consider its future utility and discount it back to get a fair valuation for its current price.
Step 2: CUV and DEUV, and What They Are
Burniske further decomposed the token price into ‘Current Utility Value’ (CUV) and ‘Discounted Expected Utility Value’ (DEUV).
The idea is that a token’s value consists of both:
- the value as if it can be used today
- the value as if it will be widely adopted in the future
By definition:
Where:
U0 = Token’s current utility
M = Token supply
V = Token velocity
Hence, we have:
The Crypto J-Curve in Action
Burniske believes that the enthusiasm for a crypto asset will initially be high and typically continues to grow for a while. In this period, the CUV of the asset is minimal, or non-existent if there’s no protocol. The asset is then largely composed of DEUV.
As the crypto assets progress through time, the enthusiasm may wane, weighing on the DEUV. Since the system is not yet mature, the CUV is low, and a high % of CUV presents a low valuation price.
The system will gradually mature with increased use, and the CUV of a crypto asset grows quietly. A growing CUV can occur even as the DEUV of the token continues to compress. If the market is bearish enough, the price of the asset may compress DEUV all the way to zero, leaving only CUV, and a drastically diminished price. Potentially, the market may even discount the asset to the point of trading below CUV, somewhat akin to a stock trading beneath book value.
The system will eventually reach a mature point where both CUV and DEUV are expanding, completing the whole market cycle.
Limitations and Caveats
Although the valuation model and the Crypto-J-curve provides a practical framework for analysing crypto assets, we would like to point out some problems and concerns with the model:
1. Arbitrary maturity date chosen
In Burniske’s example, he has used 30 years as maturity date. What if the token is more short or mid term focused? With a high discount rate (e.g. 30%), picking 10 years vs 30 years can significantly affect the result due to discounting.
2. Only single use case are allowed
Burniske assumed only one use case in his example. What if the token has more than one utility or use case?
3. It is hard to measure utility value in USD
Many arbitrary assumptions were introduced, including target addressable market and adoption curve.
4. An arbitrary discount rate
The discount rate has significant impact on the discounted utility, yet no sound methodology for calculating the discount rate is provided. Burniske subjectively picks 30% as the discount rate in his example.
5. Technological soundness is not considered
No factors are considering the technological soundness/platform and team capabilities.
6. The probability of failure
Projects may fail due to technology, execution, accidents, etc.
Is the Crypto J Curve Useful?
To conclude, Burniske provided one of the first crypto asset valuation models, which may provide directional insights for token valuation. It won’t give you a good estimate for exact token prices, but it has use as as a general roadmap for a token’s development.
How to Fully Understand the Value of Your Crypto
This post on the Crypto J-Curve completes a four-part series we created on cryptoasset valuation. You can also learn the 101 of crypto valuation, TradFi asset valuation tools, and other crypto asset valuation models in the other pieces of our series for a deep dive and DYOR (do your own research) on what your crypto is really worth.
Further Reading and References for the Crypto Serious
1. Chen, James. “How the Valuation Process Works.” Investopedia, 18 Nov. 2019, https://www.investopedia.com/terms/v/valuation.asp.
2. Chen, J. (2019, October 3). Time Value of Money (TVM) Definition. Retrieved from https://www.investopedia.com/terms/t/timevalueofmoney.asp.
3. Chen, J. (2019, July 15). Understanding Discounted Cash Flow (DCF). Retrieved from https://www.investopedia.com/terms/d/dcf.asp.
4. Chappelow, J. (2019, October 16). Equation of Exchange Definition. Retrieved from https://www.investopedia.com/terms/e/equation_of_exchange.asp.
5. Burniske, C. (2017, September 24). Cryptoasset Valuations. Retrieved from https://medium.com/@cburniske/cryptoasset-valuations-ac83479ffca7.
6. Ciaian, P., Rajcaniova, M., & Kancs, D. A. (2015). The economics of BitCoin price formation. Applied Economics, 48(19), 1799–1815. doi: 10.1080/00036846.2015.1109038
7. Mitchnick, R., & Athey, S. (2018, June). A Fundamental Valuation Framework for Cryptoassets. Retrieved from https://s3-us-west-1.amazonaws.com/fundamental-valuation-framework-for-cryptoassets/A Fundamental Valuation Framework for Cryptoassets_June 2018.pdf.
8. Chen, J. (2019, March 12). Relative Value. Retrieved from https://www.investopedia.com/terms/r/relative-value.asp.
9. Woo, W. (2017, February 24). Bitcoin Value to Volume Ratio. Retrieved from https://twitter.com/woonomic/status/835015883051298816?ref_src=twsrc^tfw|twcamp^tweetembed|twterm^835015883051298816&ref_url=https://cryptoticker.io/en/bitcoin-nvt-ratio/.
10. Woo, W. (2017, October 2). Is Bitcoin In A Bubble? Check The NVT Ratio. Retrieved from https://www.forbes.com/sites/wwoo/2017/09/29/is-bitcoin-in-a-bubble-check-the-nvt-ratio/#7dfdb2436a23.
11. Burniske, C. (2017, September 5). The Crypto J-Curve. Retrieved from https://medium.com/@cburniske/the-crypto-j-curve-be5fdddafa26.
